Trade war impact on private credit

As promised, this strategy note will focus on the trade war impact on private credit.

No meaningful pullback in bank lending

So far, we have seen no pullback in bank lending reminiscent of the recent past. Bank lending actually accelerated in April as credit lines were being drawn in order to bolster balance sheet liquidity to prepare for continued uncertainty.

Remember, as the Fed was raising rates in 2022 (and then when the bank failures started in 2023), bank lending growth stagnated as bank loan and lease growth was well below nominal gross domestic product (GDP) growth, which in turn opened up a massive opportunity for private credit to fill the breach.

As you can see from the chart below, bank loan and lease growth over a two-year period grew by over $600 billion less than expected (2023 and 2024). Even though private credit really only targets approximately half of that opportunity, it was still a welcome development—around $300 billion in new potentially long-term lending opportunities was an unexpected upside surprise. Post-election, it took a few months, but banks were once again starting to lend at nominal-GDP-like growth rates.

However, we have yet to see any meaningful pullback in bank lending from the trade war or increased fears of recession risk.

Bank lending for commercial and industrial loans

Source: Federal Reserve, as of March 31, 2025.

Spreads have widened, but we’re not seeing pricing of recession risk

In terms of pricing, spreads have widened by approximately 25bps from the recent tights of 475. In the big picture, private credit is still producing much higher income than before the Fed started hiking, with less risk due to lower loan-to-value (LTVs) and debt to EBITDA ratios than in 2021.

However, the pricing of substantially elevated recession risk is still absent in public and private credit markets.

Higher yields and lower leverage may offer compelling investment opportunities

Note: There is no guarantee that any fund or account will exhibit any of the described anticipated investment characteristics, use of proceeds or investor benefits. Trends [Spread, OID and Fees, 3-year asset yield] based on market trends of direct lending deals evaluated intra-quarter. There is no guarantee that these market trends will continue or sustain for the life of the Fund.

Private credit originations—ABL remains persistent

In terms of private credit originations, we have certainly seen a decline in activity for corporate loans where the use cases were private-to-private transactions and leveraged buyouts (LBOs), but have seen an unsurprising persistence of asset-based lending (ABL) to corporate borrowers with a motivation to boost cash on the balance sheet through receivable financing.

This is a welcome development. I was a little worried coming into the year that, in a cyclical boom where animal spirits were high, there would be a reduction of corporate management teams’ and private equity sponsors’ willingness to borrow at S+475 to S+600 in order to boost balance sheet cash. I guess nothing focuses the mind on balance-sheet-cash-needy firms than trade war uncertainty and recession risk going from 0% to a recent high of 1 out of 3.

Additionally, and unsurprisingly, we have had our first look at loan opportunities where the driving motivation is “tariff uncertainty.” In commercial real estate lending, the economic uncertainty has certainly once again mildly depressed acquisition and development lending opportunities—but has accelerated activity for rolling existing loans where perhaps the borrower was waiting for the Fed to cut more aggressively before the now highly probable near-term inflation shock put them on the sidelines (or that continued economic strength would help grow net operating income (NOI) before locking in new loan terms). Again, nothing like uncertainty to accelerate the need for financing certainty.

The effect on bank balance sheets

What we have yet to see, however, is enough angst and stress to drive banks to sell high quality assets at discounts. Given the election outcome and more relaxed regulatory framework expected by the banking industry, it will probably take a meaningful downturn to drive attractive opportunities there again. Furthermore, we have yet to identify any new countercyclical lending opportunities like we have historically in auto lending or homebuilding. However, if the U.S. economy rolls over, it would be surprising if no countercyclical lending opportunities surface.

Thoughtful underwriting is likely to insulate investors

We are often asked how concerned we are about the impact of the trade war and a potential recession on private credit. As always, the devil is in the details, and we expect a wide dispersion of outcomes. However, at the basic level, whatever driver stresses margins and cash flows, if you have performed thoughtful underwriting up front, the damage should be relatively contained.

The best corporate loans are originated to growing noncyclical businesses with healthy operating and free cash flow margins that not only provide ample free cash flow generation to more than cover the senior loan, but also more importantly maintain sufficient free cash flow to support the senior loan in a high stress environment.

The stress tests and stress outcomes can vary depending on the business, but they all center around lower revenue growth or a contraction, margin compression³ and lower free cash flow builds or outright declines over time. One factor that can cause margin compression is higher costs of goods sold (here’s looking at you, tariffs) and another is revenue declines (here’s looking at you, recession). However, if you have built in considerable cushion in your stress tests and senior loan in terms of margin and free cash flow, debt/EBITDA, LTV and debt service coverage ratios, things should be alright.

However, if you have been desperate to put money to work, have lent to cyclical business with thin margins and/or don’t robustly stress test loans at origination, well, “Houston, we have a problem.”

In the event the trade war sticks, and the U.S. enters a recession (fortunately, looking less likely by the day), performance dispersion should reveal the quality of loan underwriting and how selective private credit managers have been putting money to work.

Potential issues with traded, syndicated bank debt

The other key factor to consider is the clear and present danger of private credit managers loading up on traded, syndicated bank debt, which tends to gap down in price in bear markets and recessions.

For instance, if you have been raising a ton of dough but don’t have the origination platform to put the money to work, you were probably more bummed about conceding 100bps–200bps of income from your 10%–45% syndicated bank debt exposure in calendar year 2025 up until the end of February. As the trade war heated up and bank debt had a mini gap down in price in early April, you were probably sweating bullets about whether or not the U.S. would enter a recession.

The realities of holding traded, syndicated bank debt during a recession can be stark. For instance, consider this hypothetical situation: If you have 20% of assets in bank debt and you are conservatively levered 0.5 to 1, that means you have 30% of bank debt relative net asset value (NAV). If bank debt trades down to 80 in the next recession, that would be 6% downside risk (0.3 * 0.2), which is probably about 60% of your calendar year net distribution to clients. That’s 6% downside risk on top of any from your core portfolio of private loans.

We saw this play out mildly already in 2022, which was a mark-to-market event with most of the mark-to-market loss recouped in 2023 and 2024. However, given the trailing 12-month default rate of traded, syndicated bank debt was already around 4% before the trade war broke out, if we suffer a mild recession, a substantial portion of the potential future mark-to-market loss will probably be crystallized as realized loss this time around. This is obviously exacerbated by the lower recovery rates in bank debt recently due to the absence of covenants.

Preparing a portfolio for volatility

Entering any turbulent period with a clean vintage, low to 0% nonaccruals, as high a percentage of senior secured and ABL in the portfolio as possible, and high debt service coverage ratios (DSCRs) offers the greatest opportunity to minimize loss and maximize income and total return for investors.

While there has been no discernible movement in private credit default rates yet, and the acute DSCR stresses of 2022 and 2023 are behind us (thank you for cutting by 100bps, Jerome; and EBITDA growth in a strong economy can cure all ills), when entering a period of stress, the lower your nonaccruals, the higher your DSCRs and the higher the percentage of your portfolio in senior loans or ABLs, the better.

Sacrificing some return over time to lower risk

Additionally, remember the principal benefit of asset-based lending vs. cash flow–based lending: Potentially lower risk of loss! The more collateralized a loan is, the better.

Whether it is the ultimate economically resilient income stream of senior commercial real estate lending (can’t get further to the northwest quadrant of the efficient frontier⁴ than that) or more creative off-the-run asset-based finance/lending, the reason you sacrifice some return over time is to dramatically lower your risk in a downturn.

As an investor pondering a downside risk scenario, perhaps it makes sense to maximize ABF/ABL over CFBL…or to focus on lower risk instead of higher return. If you can have your cake and eat it too, all the better!

Being cash, cash flow and balance sheet rich

The importance of having cash, cash flow and balance sheet to deploy in times of uncertainty cannot be overstated.

As a lender, if you are cash and cash flow rich, and have ample balance sheet to deploy, it’s not that you overtly root for dark economic and market times. Inevitably, there will be some mark to market from spread widening in your current portfolio, which will modestly lower your calendar year 2025 returns and you could have a few nonaccruals pop up here and there even with the best underwriting in the history of mankind.

However, inevitably, economic and market stress leads to wider spreads and more creative lending opportunities, which in turn allow you to lock in more income for investors over the long term. The rub is that you can only take advantage of these opportunities if you are cash, cash flow or balance sheet rich—or some combination of the three. If your balance sheet is at its target leverage level and you do not have excess cash or predictable cash flow coming in, all you can do is study the opportunities with a sense of helplessness.

Ramping up public securities opportunistically

Finally, if your investment mandate allows you to opportunistically ramp up public securities, in the event high yield spreads widen and syndicated, tradable bank debt prices plunge into a bear market and/or recession, you can pounce and increase income while providing upside capture to market and economic recovery. But only if you are cash, cash flow, and/or balance sheet rich!

Investor considerations

Investing in alternatives is different than investing in traditional investments such as stocks and bonds. Alternatives tend to be illiquid and highly specialized. In the context of alternative investments, higher returns may be accompanied by increased risk and, like any investment, the possibility of an investment loss. Investments made in alternatives may be less liquid and harder to value than investments made in large, publicly traded corporations. When building a portfolio that includes alternative investments, financial professionals and their investors should first consider an individual’s financial objectives. Investment constraints such as risk tolerance, liquidity needs and investment time horizon should be determined.