Minnesota and other pension funds invest in private credit. What are the high risk, high reward loans?

Wall Street analysts are warning that private credit, a high-risk, high-reward debt market operating outside traditional bank constraints, could be the source of the next economic downturn. Critics argue that defaults on these loans could push the U.S. economy into a severe contraction, with independent analyst Rod Dubitsky saying he sees "a degree of risk comparable to the global financial crisis." Private credit lending is a direct transaction between lenders and borrowers, typically extended to businesses that cannot obtain financing elsewhere and that pay high interest rates for fast capital. Lenders are usually private credit funds or business development companies (BDCs) such as Apollo Global Management, Blue Owl Capital and KKR & Co., which raise capital from pension funds, endowments and insurers.

The Minnesota State Board of Investment has invested in private credit for decades, and Executive Director Jill Schurtz said the allocation has weathered a full range of credit and economic cycles. Private credit represents about 1.7% of the board's $96 billion portfolio, which she described as spread across a broad range of managers, strategies, borrower types and geographies. According to a January Moody's report cited by the Star Tribune, the private credit market is approaching $2 trillion in assets under management and could near $4 trillion by 2030.

Weak spots are emerging despite the growth. Blue Owl, which financed a $30 billion Meta data center deal in Louisiana last year, announced on Feb. 18 that it will limit withdrawals from its retail debt fund, designed for individual investors that the industry is increasingly courting. The move tanked shares of Blue Owl and its competitors. The episode followed two auto industry bankruptcies last fall and a 19% drop in value of a BDC managed by BlackRock, disclosed in January. Anthony Saglimbene, vice president and chief market strategist at Ameriprise Financial, questioned whether underwriting standards have loosened in a cash-rich environment, and said Ameriprise limits private credit to clients after extensive due diligence. John Canavan, lead analyst at Oxford Economics, cited the opacity of private debt, which does not trade on public markets and therefore is illiquid with obscured valuations.

Regulators and policymakers have flagged similar concerns. A 2024 Federal Reserve paper warned that growing private credit flows could encourage riskier lending and that many borrowers would be unable to obtain adequate financing without it. JPMorgan Chase CEO Jamie Dimon told a U.S. Senate committee that as lending shifts away from regulated markets, the likelihood increases that risks go unseen. Canavan said the market is likely to keep expanding despite warning signs, and that investors typically return quickly to growing markets.