Standing at the Intersection of U.S. Private Credit and the AI Bubble

In the second half of 2025, risks in the U.S. private credit market began to emerge. Although concerns about private credit have eased somewhat after a significant decline in the U.S. regional bank index, we still find three significant discrepancies between the risk conditions in the U.S. private credit market and market expectations. First, the private credit risk exposure of large U.S. banks is far higher than that of small and medium-sized banks. After the global financial crisis, stricter regulations led U.S. commercial banks to structurally exit direct lending, opting instead to participate in the private credit market indirectly by providing funds to non-bank financial institutions. By the end of 2024, large banks held 67.7% of private credit risk exposure, while small banks held only 10.6%. Second, the main risk exposure in the U.S. private credit market is not concentrated in the banking system, but rather in insurance funds. As of 2024, the scale of private credit held by U.S. insurance funds (especially life insurance) accounted for 56.6%, making them the largest holders of risk exposure. Third, the "rating bubble" in the U.S. private credit market may have formed a connection with the "AI bubble." Currently, some U.S. tech companies are transferring capital expenditure risks to the private credit market through structured financing, while the private credit market itself faces issues of "rating inflation." If the private credit market undergoes a credit reassessment in the future, the private credit ratings of small and medium-sized tech companies may be significantly downgraded, potentially triggering extreme narrative trading regarding the "bursting of the AI bubble." Therefore, if the U.S. private credit market experiences a resurgence of tail default risks in the future, it may impact the private credit asset portfolios held by U.S. insurance institutions. Given the lack of sufficiently liquid direct credit default swap tools in the private credit market, CDX NA HY and its volatility-related assets may serve as alternative options to hedge against risks in the private credit market. Risks Begin to Emerge Amid the Expansion Wave of the U.S. Private Credit Market. In the third quarter of 2025, two companies associated with the private credit market filed for bankruptcy, raising concerns about the entire private credit market and the financial sector, particularly regarding the transmission of risks to U.S. small and medium-sized banks. Based on a growth rate of 18.5% in the private credit market from 2019 to 2023, it is estimated that by the end of 2026, the U.S. private credit market will reach a scale of $2.2 trillion. Therefore, although the current private credit-related events are only isolated cases, they may conceal risks with a scale reaching trillions, sufficient to trigger a reversal in the credit cycle. Despite the release of market concerns about private credit following a significant decline in the U.S. regional bank index, and on the surface, it appears that worries about private credit risks have subsided, we believe there are still three significant expectation biases regarding private credit risks in the current market. The Private Credit Risk Exposure of Large U.S. Banks Far Exceeds That of Small and Medium-Sized Banks. After the global financial crisis, stricter regulations led to the structural exit of U.S. commercial banks from the direct lending market; however, commercial banks have indirectly participated in the private credit market by providing funds to non-bank financial institutions (NBFIs) According to statistics from the Federal Reserve, by the end of 2024, the credit limit granted by U.S. commercial banks to private credit institutions has significantly increased to $95 billion. However, the current private credit market is fundamentally different from the regional bank crisis of 2023; the two differ not only in the paths of risk transmission and triggering factors but also in the entities that bear the risk exposure. The risk exposure of the U.S. private credit market is primarily concentrated in large commercial banks, rather than small and medium-sized commercial banks. Although U.S. commercial banks' risk exposure to private credit continues to expand, it has not formed corresponding concentration risk, and the risk exposure exhibits characteristics of diversification and differentiation. If private credit risks were to erupt in the future and transmit to the banking sector, given that large banks hold a significant amount of risk exposure that is generally dispersed, we expect the impact on the banking system to be relatively limited. The risk exposure in the U.S. private credit market is essentially concentrated in the insurance capital system. According to the IMF, the main direct funding sources for the U.S. private credit market are institutional funds such as insurance funds, pension funds, and family offices, while commercial banks mainly act as indirect holders of risk exposure. Based on 534 private credit products that Bloomberg has tracked since 2016, we find that small and medium-sized enterprises are the main entities seeking financing in the private credit market, with 42.2% of these enterprises seeking private credit financing for leveraged buyouts. Therefore, the funding demand side of the private credit market can provide relatively high excess returns. Against the backdrop of a structural mismatch between the rigid costs on the liability side of insurance funds and the declining returns on the asset side, life insurance funds are actively shifting from the public bond market to the private credit market to obtain yields. Although the current market narrative around credit assets is overly focused on the uncertainties of commercial banks, according to statistics from the Chicago Federal Reserve based on the S&P Global trading database, as of 2024, the scale of private credit held by U.S. insurance capital (especially life insurance companies) has reached $849 billion, accounting for 56.6%. Thus, in reality, insurance capital (life insurance) is the largest holder of risk exposure in the U.S. private credit market. Additionally, the market share of private credit held by U.S. life insurance companies exhibits a significant negatively skewed distribution, indicating a high concentration of risk exposure to private credit. A connection may have formed between the "rating bubble" in the U.S. private credit market and the "AI bubble." Currently, some U.S. technology companies are transferring capital expenditure risks to the private credit market through structured financing. However, the "rating inflation" issue inherent in the U.S. private credit market has led to an underestimation of its systemic risk. This "rating inflation" not only causes credit spread pricing to deviate significantly from reasonable ranges but also results in regulatory capital being unable to effectively cover the true potential default exposure. At present, regulators are mainly focused on issues of maturity mismatch and leverage ratios, and have not given substantial regulatory attention to the "rating inflation" and "model arbitrage" phenomena present among small rating agencies. If in the future, regulatory bodies such as the U.S. Securities and Exchange Commission (SEC) or the National Association of Insurance Commissioners (NAIC) were to mandate small rating agencies to disclose underlying parameters and refer to traditional standards, the private credit market would inevitably face a wave of credit re-evaluation If the "rating bubble" in the U.S. private credit market bursts, a large number of pseudo-investment-grade assets will face cliff-like downgrades, which will trigger compliance sell-offs by cornerstone investors such as insurance funds. Given the high concentration of exposure in the U.S. software and IT services sector within private credit, if the rating adjustments lead to a credit reassessment across the industry, the private credit ratings of small and medium-sized tech companies may inevitably be significantly downgraded, further exacerbating the risks of soaring financing costs and cash flow disruptions , and may even trigger extreme narrative trading in the market regarding the "AI bubble burst" once again. The risks in the U.S. private credit market may be controllable in the short term, but long-term concerns remain. The default situation in the U.S. private credit market shows structural differentiation characteristics, with risks for medium-sized enterprises being controllable, while small and micro enterprises are already showing signs of crisis. As of the end of October this year, the default rate in the private credit sector remained at 5.2%. The default rate for medium-sized enterprise private credit has continued to rise, reaching a peak of 3.2% by the end of October, while the default rate for small borrowers with EBITDA below $25 million has soared to 11.7%. Therefore, we judge that there is a possibility of a resurgence of tail default risks in the U.S. private credit market in the future. In addition, within the next three years, the existing assets in the U.S. private credit market will face a concentrated repayment period, which may accelerate the market into a structural window phase of significantly increased refinancing demand. If future refinancing for small enterprise private credit is hindered, leading to a wave of defaults and forming a risk transmission chain, it could directly impact the private credit asset portfolios held by U.S. insurance institutions. Given the lack of sufficiently liquid direct credit default swap tools in the private credit market, CDX NA HY and its volatility-related assets may serve as alternative options to hedge against risks in the private credit market. Therefore, while maintaining a cautious attitude towards insurance institutions and business development companies (BDCs) with risk exposures, it may be possible to hedge against the valuation shock caused by a potential systemic collapse in private credit by allocating credit spreads of the North American high-yield bond index. Risk Warning and Disclaimer The market has risks, and investment requires caution. This article does not constitute personal investment advice and does not take into account the specific investment objectives, financial conditions, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article align with their specific circumstances. Investing based on this is at one's own risk