Market Snapshot is a weekly view from our portfolio managers, offering sharp, thematic insights into the trends shaping markets right now.
This week in numbers
Last week’s one-day decline of the SPDR S&P Regional Banking ETF.
Sterling money market assets in September.
Market expectations of a 25bps cut by the Fed on October 29.
Past performance is not an indicator of future performance.
Quote of the week
We expect more banks – both in the US and Europe – to begin revealing the skeletons in their cupboards, as these developments are likely to encourage deeper loan book reviews.
Filippo Alloatti, Head of Financials, anticipates a broader reckoning within the banking sector.
This week’s Market Snapshot
Are (private credit) cracks widening?
Recent hairline cracks in the private credit sector have revived fears of wider systemic risk.
- Fraud disclosures have raised fears of weak lending standards in private credit.
- Unsettling comparisons to the banking turmoil of 2023 have given some investors a sense of déjà vu.
- The question remains: are these idiosyncratic cases or canaries in the coalmine?
A red flag, or a one-off?
The twin collapse of two leveraged US auto firms, Tricolor and First Brands, which led to renewed stresses in the US regional banking sector last week, has raised fresh fears about the health of global credit markets.
The failure of the two private credit-backed US companies was driven by alleged financial misreporting and excessive leverage, and exposed leading lenders – such as Barclays and JPMorgan Chase – to sizeable losses.
Investors are questioning whether these lending failures are isolated incidents within the private credit sector or early signs of broader risks across the industry.
During JP Morgan’s third quarter earnings call, CEO Jamie Dimon put it bluntly: “When you see one cockroach, there are probably more.”
As stress risks increase in credit markets, comparisons have been drawn to the implosion of Silicon Valley Bank (SVB) in 2023.
Zion Bancorp and Western Alliance, two US regional banks, disclosed exposure to possible credit fraud on October 16, sending the SPDR S&P Regional Banking ETF – a proxy for the US regional banking sector – tumbling by 6.2% in its largest one-day drop since the SVB fallout (Figure 1) amid a broader sell off in banking stocks.1
“The credit underwriting process itself lies at the heart of investors’ concerns,” says Karen Manna, Vice President, Client Portfolio Manager for Fixed Income at Federated Hermes.
“With billions of dollars in pursuit of yield, loans are increasingly being originated through opaque structures often by entities known as Non-Depository Financial Institutions (NDFIs), which include private credit funds,” Manna says.
The shift [towards NDGIs] raises questions about transparency, risk oversight, and the resilience of the system under stress,” she adds.
Figure 1: Bad loans spark worries… what comes next?
The reckoning
Filippo Alloatti, Head of Financials at Federated Hermes, argues that the recent lending failures are likely to prompt a broader reckoning within the banking sector.
“These events have reignited scrutiny of NDFIs, particularly in private credit and its ties to private equity, even though the sector has dominated financial press coverage for over two years,” he says.
“We expect more banks – both in the US and Europe – to begin revealing the skeletons in their cupboards, as these developments are likely to encourage deeper loan book reviews.”
However, Alloatti adds that the impact of any fresh revelations will probably depend on timing and market conditions, “It’s too early to tell if any new revelations will spook the market – although last week’s provision news and borrowing increases from the Fed’s standing repo facility (SRF) did just that.”
Outside of the US, several key factors could provide crucial support to European financial groups as they navigate the uncertainties caused by this situation, Alloatti adds.
These factors include: a positive interest rate environment (versus pre-Covid levels) and cleaner asset quality; as well as the drivers of adverse selection into private credit – led by not underwriting certain borrowers and significant risk transfers (SRTs).
In addition, Alloatti says, the EU benefits from a strong regulatory regime in comparison with the US (where regulatory focus is on larger banks).
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