Pimco, the $1.95tn asset manager, has expressed scepticism about the direct lending segment of private credit, warning that the asset class remains overvalued and could face significant risks as capital continues to flood the market, according to a report by CityWire.
The report cites Kris Kraus, Pimco’s Head of Private Strategies for EMEA and Asia Pacific, as cautioning that the influx of new entrants into private credit, coupled with stretched valuations, could lead to potential blow-ups in the sector.
Kraus highlighted that the appeal of direct lending has diminished as spreads have narrowed significantly. “At the start of 2024, spreads were 200 basis points higher, but in many cases, they are now below 100bps,” he told Citywire. “You’re not being paid enough for the liquidity risk you’re taking.” He added that while higher interest rates could boost cash yields, they may also strain weaker companies that have relied on private markets for financing.
Pimco has maintained a bearish stance on direct lending since July 2023, citing concerns about refinancing activity pushing spreads lower and the potential for credit stress as rates remain elevated. These worries were echoed by JP Morgan Asset Management, which recently warned that lower-quality loans could struggle under prolonged high interest rates, though it remains broadly positive on private credit as an asset class.
Kraus also raised concerns about the surge of new players entering the private credit market, many of whom may lack the experience or underwriting rigour needed to navigate challenging conditions. “You’re going to have pretenders and people who can actually do it quite well,” he said. “There’s so much pressure to deploy capital that underwriting standards may be compromised.”
This sentiment was shared by industry leaders at the IPEM private markets conference in Cannes, France, in January, where the potential for a blow-up in semi-liquid or evergreen funds was a key topic of discussion. Peter Beske Nielsen, Global Head of Private Wealth at EQT, warned, “There will be a blow-up in evergreens – I just hope it doesn’t affect all of us.”
Alisa Wood, a Partner at KKR, argued that larger, established firms are better positioned to handle such crises. “When they do go off the rails, and not if, those larger firms will have the resources to respond,” she said.
Despite its caution on direct lending, Pimco sees value in asset-based finance, including residential mortgages, consumer loans, and aviation finance. Kraus highlighted the appeal of contractual cash flows in these areas, which provide regular principal repayments and attractive interest yields.
Pimco is also focusing on data centres and energy production, driven by the growing power demands of artificial intelligence. Kraus expects private credit to deliver returns in the “upper single-digit to low double-digit” range, with mid-teens returns achievable through financing strategies.
