What “cockroaches” lurk in the market? Countdown to the “Second Lehman Crisis,” which also endangers Japan’s pensions

Footsteps of “Second Lehman” creeping up

As the global rise in crude oil prices undermines the real economy, there is an eerie “mounting frenzy” behind the scenes in the financial industry. The “private credit market,” which provides loans to corporations without going through banks. The market is said to be worth over $3 trillion (approximately 500 trillion yen), and since the fall of 2013, there has been a string of corporate failures among the lenders. Some of these companies have even begun to manipulate their accounts to extract loans, in what appears to be a fraudulent manner.

The enormous size of the market and the opaqueness of the actual situation are reminiscent of the “Lehman Shock” of 2008. Will the chain of scorched-earth loans of huge sums of money lead to a reoccurrence of the nightmare? An economic journalist explains the seeds of the “next financial crisis.

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Information on private credit is mixed. Since it is not a general financial product and is not listed on an exchange, it is difficult to grasp the actual situation, and the “size” of the market seems to have taken on a life of its own. If “private credit” is taken in a broad sense, the $3 trillion figure is not a ridiculous figure. It is understandable that people are worried about the possibility of a repeat of the Lehman Shock if losses spread.

However, although private credit is a relatively new financial asset, it is not the same as the complex securitization products that incorporated subprime mortgages, which were at the epicenter of the Lehman Shock. If we understand what private credit is as a financial asset and follow the facts that are currently happening, we can foresee to some extent its impact on the financial market. The following is a step-by-step explanation.

What is the mysterious “500 trillion yen market?

First, let’s look at private credit. Put simply, private credit refers to direct loans made by non-bank lenders to corporations. Non-bank lenders are usually asset management companies that lend to companies using funds collected from investors.

In other words, they are “funds” as financial instruments. Investors on the fund side are so-called institutional investors, such as life insurance companies, pension funds, and regional financial institutions.

The word “private” in the name comes from the word “private,” meaning not traded on exchanges or other public markets. Thus, private credit is “corporate loan receivables” that are not traded on the open market. Incidentally, loan claims traded in the market are typically bonds and commercial paper issued against corporate assets and cash flows, for which secondary markets are well-developed.

Misconception of mere “non-bank”

News articles on private credit often use the term “non-bank financing. While this is not incorrect, it is important to note that private credit is quite different from domestic non-bank financing.

Both private credit and domestic non-bank loans are targeted at small and medium-sized enterprises (SMEs), but the scale of these enterprises differs greatly between Europe and the United States. Small and midsize companies in Europe and the U.S. have sales and profits that are one to two orders of magnitude higher than those in Japan, and it is not uncommon to find companies that are the size of large companies in Japan. If the lender, the investment management company, is also a major player, its profit level is higher than that of a Japanese megabank.

Perhaps the term “non-bank” is used because it is cumbersome to explain, but the distinction should be made properly so as not to create misunderstandings.

Pension Funds and High Net Worth Individuals Are Joining the Market One after Another

In Japan, banks play a central role in corporate finance, but in Europe and the United States, private credit is a well-established alternative to bank loans as a means of raising funds.

In Europe and the U.S., where banking regulations are strict by nature, banks cannot extend loans without restraint. Since the Lehman Brothers collapse, regulations have been tightened considerably, and private credit has been used to supplement the financing needs of companies that have difficulty in obtaining bank loans.

In most cases, loans from funds have floating interest rates, and investors who provide funds have the advantage of earning higher yields than those from government bonds or corporate bonds. This is because companies that receive loans through private credit are less creditworthy than companies that can issue corporate bonds, and thus the borrowing interest rate is more expensive.

Especially after the “Corona Shock” in February ’20, more investors are actively investing in private credit under the global low interest rate environment. As a result, the balance under management has continued to grow, and is currently estimated to be around US$2 trillion (about 320 trillion yen) worldwide.

In recent years, in Japan, in addition to life and non-life insurance companies, pension funds, and regional financial institutions, banks, investment management companies, and university funds have been investing in private credit. In recent years, private credit has also been marketed to high-net-worth individual investors, who are increasing their balances in their own right.

The Identity of the “Cockroaches” Lurking in the Market

Next, let us look at the “incidents” occurring in the private credit market. In fact, there are two phases, and it is important to distinguish between them.

The first is the bankruptcy and sloppy management of the companies they finance. First, in September 2013, Tricolor Holdings, a U.S. auto loan company, and First Brands, a replacement auto parts manufacturer, went bankrupt one after the other.

These two companies have a large number of creditors, and since there are some investment management companies scattered among them, it is assumed that a considerable amount of private credit claims are included. The total liabilities of both companies are estimated to be in excess of $10 billion (approximately 1.6 trillion yen), and major financial institutions such as JP Morgan Chase, Barclays, and UBS are also listed among the creditors.

After the collapse of these two companies, their sloppy management practices were revealed one after another, with unclear financing channels and use of funds. As a result, concerns emerged about lending to companies with low creditworthiness, especially for private credit, where the actual status of the loans is difficult to ascertain.

In October 2013, the CEO of JP Morgan Chase, the world’s largest financial group, said, “If there is one cockroach, there are others. He means that there must be many more cockroaches, or “bankruptcy reserves,” among the companies that have received loans.

Perhaps he was emotional because his own group was also suffering losses, and he used the term “cockroaches,” but his prediction proved to be correct. In February 26, a fund management company revealed that the companies it lent to were likely manipulating their accounts and window dressing their financial data. In addition, the British mortgage company Market Financial Solutions went bankrupt (Sumitomo Mitsui Banking Corporation has a claim of about 100 million pounds = about 21 billion yen here).

As these bankruptcies increase and sloppy management becomes apparent, concerns about private credit are growing – this is the first phase.

Panic!　Fear of not being able to cancel

The second phase is the churning of Private Credit funds. Against the backdrop of the concerns I have mentioned, requests for cancellation by corporations that have contributed funds have begun to appear, and there is now a wave of requests from wealthy individuals. The parties involved include Morgan Stanley, BlackRock, and private credit giants Ares Management and Apollo Global Management, among others.

Because private credit is invested in loans to corporations, fund cancellations are usually restricted. Cancellation timing is quarterly, and the maximum amount of cancellation allowed at any one time is 5% of the assets outstanding.

However, the situation remains confusing, with many investors complaining that they were not informed of the cancellation limits in the first place, and the different responses of each company.

Triggered by the spread of AI?　IT Stock Plunge

In fact, a new factor has added to this second phase. This is the suspicion that a significant number of software companies may be among the recipients of private credit.

The decline in software stocks has been noticeable in domestic and international stock markets since the beginning of ’26. In the U.S. market, the share prices of well-known Japanese companies such as Oracle, Salesforce, Adobe, and Microsoft plunged by 20-30% or more in less than two months. The reason for this is speculation that the widespread use of AI will lead to more in-house production of software, which will reduce sales of products and services offered by software companies.

The actual extent of the impact is currently unknown, but it is likely that even the world’s leading companies such as Microsoft and Oracle will be affected, and it is not unreasonable to assume that the impact will be greater for those companies that finance their products through private credit. The more loans they make to software companies, the greater the concern will be.

Some companies unscathed?　The Chain Failure Trap

The first phase is not to be taken lightly, but it is not as serious. Corporate bankruptcy, which depends on the economy, can occur at any time. If a company is no longer eligible for bank loans or cannot issue bonds, it is inevitable that the probability of default will increase.

The second phase is the tricky one. We don’t really know how much damage AI will actually do to software companies. If doubts and fears grow and private credit cancellations continue, even software companies that are not actually affected could find themselves forced to pull their loans and possibly go bankrupt. The turmoil here is expected to continue for the foreseeable future.

Nightmare Revisited?　The Second Lehman Crisis

So, will the private credit problem I have described at length become a “second Lehman Shock”?　The conclusion is that it will not be a “systemic risk (dominoes falling in the financial world),” but its impact on financial markets cannot be ignored.

Systemic risk refers to the risk that the insolvency of an individual financial institution will spread to other financial institutions and endanger the entire financial system. In the Lehman Shock, major European and U.S. banks had directly invested in securitized products containing subprime loans. The banks defaulted on these investments, incurring large losses, causing the banks’ financial intermediary functions to malfunction, and the financial system to come to the brink of crisis.

The reason why we do not believe that this time it will not become a systemic risk is that the banks’ losses are likely to be limited. Since private credit lenders are other than banks, they do not incur direct losses even if their portfolio companies default. Although there are cases of “indirect loans” to private credit fund managers, the damage will be limited because the managers will take the losses from default.

Losses Different in Scale from Subprime

To support this point of view, let us again compare the scale of losses incurred by subprime loans with the scale of losses expected to be incurred by private credit this time.

As of October ’08, after the Lehman Shock, the International Monetary Fund (IMF) estimated that the overall losses of financial institutions including related financial products were around $1.405 trillion. In fact, the loss on subprime loans alone was only about $50 billion, so it would not have been a big deal, but the appearance of securitized products incorporating subprime loans and “credit default swaps (CDS),” insurance products that guarantee the principal of such financial products, and their widespread sale, have caused the amount of losses to balloon to a huge sum. The amount of private credit, on the other hand, has now grown to an enormous amount.

Private credit, on the other hand, is currently estimated to be around $2 trillion. The default rate of the companies they finance is currently estimated to be around 6-10%, according to rating agencies and foreign analysts. This is a fairly high level, but if it stays in this area, it is nothing compared to the Lehman Shock.

Behind-the-scenes of Japan’s “GPIF” also making huge investments

Some reports put the total amount of private credit at $3 trillion, but this is probably a figure taken in a broad sense.

Private credit belongs to the category of “private assets,” which includes “private equity,” which invests in private equities, “private real estate,” which invests in real estate, and “private infrastructure,” which invests in infrastructure such as roads and airports. infrastructure such as roads and airports. Of these, loans secured by specific assets such as real estate and infrastructure are estimated to exceed $3 trillion when included in private credit (the private equity market is even larger ).

Incidentally, Japan’s GPIF (Pension Fund Investment Management Inc.) has also invested in private assets, which invest in private equities, real estate, infrastructure, and other assets. As of the end of March 2013, the balance was 4.1877 trillion yen. According to the Nihon Keizai Shimbun, the balance of assets in private assets amounted to 1.32 trillion yen at the end of 2013.

Strictly Optimistic!　Fear of 20% IT loans

However, just because this is not a Lehman-level shock does not mean that we can let our guard down at all. If a large number of defaults occur, such as the realization of the aforementioned concerns about software companies, the impact on the financial markets will be severe.

There are no hard data on how much of the private credit is going to software companies, but we can give a rough estimate. However, a rough estimate can be made. For example, the marketing materials for Blackstone’s Blackstone Private Credit Fund (BCRED), one of the largest private credit funds in the world, show that software companies account for 25% of its loans. Similarly, Goldman Sachs Private Credit Strategic Investment Trust has about 25%. (Both of these funds are marketed to high-net-worth individuals in Japan, so those interested should refer to the information provided.)

The contents of other funds are similar, with the lowest being around 20%. In other words, it can be estimated that roughly 20% or more of the loan recipients are software companies. This is a fairly high percentage. Private equity, which invests in private equity, also invests heavily in software companies. If AI is to cause a shakeout in the future, private equity firms will also incur substantial losses.

Soaring Oil Prices to Follow

In addition, there are two other factors of concern: First is the soaring price of oil. If prolonged, the global economy will become more fragile, and the shock from the loss of private credit will be amplified.

When Lehman Brothers collapsed, the real economy had already become more fragile due to the continued rise in crude oil prices. This led to a simultaneous global recession, and the Japanese economy, which is particularly vulnerable to rising oil prices, suffered a longer recession than those in the U.S. and Europe. This was despite the fact that domestic financial institutions held far fewer subprime loans and related products than in the West.

Already, inflation risks have resurfaced around the world, and in the United States, the scenario of a Fed rate cut that had been envisioned by the end of the year is being revised. The significance of this change in scenario is not small.

Creepy Derivatives Profiting from the Crash

The second concern is “disturbing. According to a report by Bloomberg, some financial institutions have begun to create derivatives (financial derivatives) that can profit from a decline in loan assets.

The emergence of such financial instruments will increase profit-earning opportunities for “third-party” investors who have not invested in private credit or private equity. This is similar to the aforementioned CDS that increased losses in the wake of the Lehman Shock.

The U.S. Treasury Department is nervous about the current trend of private credit, and it is unclear whether or not such derivatives will appear, but their future is quite worrisome.

The first sign of a crash is “investment company shares.”

Finally. The private credit discussed in this article is not traded on exchanges, so even though “we need to pay attention to the trend,” it is a hurdle for individual investors to keep a close watch on it.

So what should we do?　For example, Apollo Global Management, Ares Management, and Blue Aur Capital are among the investment management companies that have a high percentage of private asset-related business, and their shares are listed on the stock exchange. By keeping an eye on such stocks, one may be able to learn about the modulation of the financial market one tempo earlier. Although it is difficult to follow them in real time, you may be able to check their daily movements if you use online securities.