Following the recent high-profile failures involving auto parts manufacturer First Brands Tricolor and Primalend, used car dealers and sub-prime auto lenders, the spotlight has also turned to the Bank for International Settlements (BIS), whose alarm adds to that of S&P, which we reported on in our Insight on October 17, 2025.
The rapid collapse of the three companies has shaken credit markets, with some investors highlighting concerns about their complex financing structures and leading to recommendations for more scrupulous rating checks. Smaller rating agencies have gained market share in the rapidly growing world of private credit by providing so-called private ratings, which are generally only visible to the issuer and selected investors. It should be noted that US life insurance companies have been among the largest purchasers of this type of debt.
The number of insurance securities rated by Moody’s, S&P, and Fitch has remained largely unchanged in recent years, while the amount rated by smaller companies has grown rapidly. This means that insurance companies have private debt allocations that are difficult to estimate in terms of both quantity and quality. According to the BIS, smaller groups may face commercial pressure to assign more favorable scores, leading to inflated credit ratings and obscuring the true risk of these complex assets.
Insurance companies with ties to private equity groups have made extensive use of private ratings. About a quarter of these insurance companies’ investments in 2024 were based on such ratings.
The lack of transparency and liquidity of private loans makes them difficult to accurately assess, increasing the risk of forced sell-offs that can amplify price swings during periods of economic and financial stress.
Adding to the BIS warning is the stance taken by Bank of England Governor Andrew Bailey, who warned last week that the role of rating agencies deserved closer scrutiny. Some Tricolor debt securities had received triple-A ratings months before the company collapsed.
The National Association of Insurance Commissioners, a standards-setting body for US insurance regulators, published a report earlier this year in which it attempted to quantify the overestimation of private creditworthiness: on average 2.7 times the companies’ internal assessments. Private ratings are inherently less robust as they are not subject to scrutiny by market participants. The NAIC report, which raised concerns that insurance companies might opt for more permissive ratings, was subsequently removed from the NAIC website. An analysis by Absolute Strategy Research found that US life insurance companies would need between $30 billion and $35 billion in additional capital to maintain their legal guarantees if private ratings were adjusted to NAIC estimates.
But that’s not all. The real bad news, according to the BIS, is that reliance on private ratings is just one example of the broader risks to financial stability that are building up in the life insurance industry.
In a recent paper, the BIS also describes the broader push by insurance companies toward riskier and more complex investments, the increase in liquidity risks for companies with high exposures to the US dollar, and the potential for conflicts of interest in insurance companies that have ties to private equity firms. The growing involvement of private equity in the insurance industry, through direct acquisitions of insurance companies or the management of their assets, may have raised “systemic vulnerabilities” in the sector.
Insurance companies affiliated with alternative investment managers invest approximately 24% of their portfolios in private credit, as well as in riskier and more complex assets, compared to 6% for non-affiliated insurance companies.
Growing investor demand for private fixed-income products has fueled competition among lenders to offer attractive loans and package them into various forms of securities. This, in turn, allows businesses and consumers of all kinds to obtain loans on generous terms and is helping to revive the acquisition fervor.
This month, the IMF warned that US and European banks could be destabilized by their $4.5 trillion exposure to non-bank financial groups, also known by the ominous term “shadow banks.” It called for greater regulation of private credit, private equity, and hedge funds, which are driving much of the lending boom.
But the US administration is moving in exactly the opposite direction, promoting deregulation of banks rather than imposing further restrictions on non-bank competitors. Last week, the Federal Reserve announced plans to revise its annual bank stress tests to make them less burdensome. According to consultants Alvarez & Marsal, US banking regulators are expected to make further changes to capital and leverage rules, which could unlock $2.6 trillion in additional lending capacity.
Banks now lend money to private equity, which uses the funds to leverage investor money, making loans and purchasing securitized debt. You can bet that retail flows will also be added to bank flows, which can be channeled into private debt thanks to the easing of restrictions granted by the US administration in favor (but we believe it is more correct to say “against”) retail investors, who can now channel their money into alternatives, long reserved for institutions and UHNWIs. And this is where the headaches begin. As is often the case, the “herd” of retail investors enters the final phase of a bubble to provide the liquidity needed to liquidate those who have profitably ridden this market: if not, is this not in fact a Ponzi scheme?
On the other hand, a model borrowed from the world of private equity, where a closed-end fund grants loans to multiple companies over a multi-year cycle, was and continues to be attractive to both borrowers and investors.
Deprived of their steady 6% return on investment-grade corporate loans by a couple of decades of negligible interest rates, bond investors, and in particular those who think in very long time horizons (decades rather than quarters), such as family offices, sovereign wealth funds, pension funds, and insurance companies, the promise of double-digit returns in exchange for what they calculated to be only marginally more risky (aided by perhaps fraudulently inflated ratings) was too tempting to refuse.
At the same time, companies—often medium-sized ones that struggled to convince banks in the post-subprime crisis era—suddenly found themselves with another way to raise capital through vastly simpler procedures, obtaining credit from a single entity rather than venturing into public offerings.
This situation is remarkably similar to that prior to 2008, raising fears of an unfortunate repeat of the most damaging financial crisis of the new millennium. Obviously, we are not alone in thinking this: we are in excellent company. The president of UBS recently stated on the sidelines of a conference that the insurance sector, especially in the United States, is engaging in “rating arbitrage” similar to what banks and other institutions did with subprime loans before the 2008 financial crisis.
And just as before the 2008 crisis, when anyone who dared to raise concerns about and criticize subprime investments was attacked or ridiculed, there is already a flurry of activity from those defending the private credit sector and its players. From those who accuse the top management of the global investment bank of having a commercial interest in seeing their new competitor fail, to the executives of the largest “shadow institutions” Apollo, Blackstone, and Ares, who were audited by the House of Lords Financial Services Regulatory Commission on the systemic risk their activities posed to the economy in general and pressed on the advisability of aligning regulation with that of traditional banks, have rushed to defend their vocation, namely protection against the ‘run on the bank’ typical of the banking system, which makes it more vulnerable to so-called contagion. Shadow banks, on the other hand, with their eight-year cycles and bilateral relationships, are resistant to such shocks and even serve as an important bulwark for the often unstable relationship between customers and banks.
Totò sang: Miss, my sweet miss, I want an encore, and you already know what I mean.
But we prefer to laugh at the performance of the well-known artist and hope that it is not Miss GFC (Ms. Global Financial Crisis).
Disclaimer
This post expresses the personal opinion of the Custodia Wealth Management staff who wrote it. It does not constitute investment advice or recommendations, personalized advice, and should not be considered an invitation to carry out transactions on financial instruments.
