JPMorgan Leverages Unique Ability to React Proactively to Private Credit Woes

With redemption requests in retail-focused private credit funds at an all-time high, the country’s largest bank is getting ahead of what Wall Street worries might be its next financial crisis. 

JPMorgan has begun marking down the value of some loans used as collateral by private credit firms. Morningstar’s Sean Dunlop tells The Daily Upside that while the move creates a vicious cycle for liquidity, JPMorgan stands alone in its ability to mark down loans name by name without waiting for a borrower to actually default.

Wrong-Way Risk

The bank’s markdowns have been largely confined to loans to software-related companies and haven’t resulted in margin calls. Instead, JPMorgan is proactively reducing the lines of credit (specifically net asset value, or NAV, loans) that it provides to these funds. “By reducing the available credit line now, the bank avoids the ‘wrong-way risk’ witnessed during 2020, where funds aggressively drew down on their credit lines exactly when their underlying creditworthiness looked the most questionable,” Dunlop says. 

Most of JPMorgan’s peers don’t have NAV loan agreements that let them proactively revalue assets; they would need a trigger event first, such as a missed interest payment. 

“Even with these proactive haircuts for JPMorgan’s borrowers, most private credit operators should still have breathing room before facing margin calls,” Dunlop says. 

The recent meltdown is specifically tied to artificial intelligence concerns: For months, investors have been dumping stocks of software companies they fear won’t be able to keep up with the robots. Smaller, specialized technology private equity firms with private credit may be more at risk, says Ken Leon, director of equity research at CFRA. 

“If major banks have been doing their homework, they will know there’s a world of difference with some of the different types of software companies out there,” he adds: 

• In a research note Thursday, Leon said that leading firms with private credit concentration are Apollo Global Management, Ares Management and Blue Owl Capital, though more diversified firms like Brookfield Asset Management, Blackstone and KKR & Co. also have significant exposure. 
• “Some of the concerns have been extreme in terms of what impact AI disruption may have on some of the credits in these funds, which means that we’re likely to see probably less volatility and maybe even more disclosures on the quality of those credits,” Leon adds. 

Wall Street Worries: Some experts are more concerned. Former Goldman Sachs CEO Lloyd Blankfein, who led the firm during the financial crisis, told Bloomberg this month that “we’re getting close to the end of late stages of cycles” on private credit. “We’re due for a kind of reckoning.”