Private-credit strain spreads

CONCERNS over the health of the private‑credit industry are now showing up in a surprising corner of the US municipal debt world, potentially foreshadowing wider strain across credit markets, according to a Bloomberg report.

Scepticism about private credit – an opaque form of lending outside traditional banks – has been mounting in recent months amid several high‑profile setbacks and investors withdrawing funds.

Those jitters are rippling into a booming segment of municipal bonds known as prepaid energy securities.

Bloomberg notes that these bonds allow utilities to secure electricity or natural gas at discounted prices decades ahead of delivery, passing the savings on to customers.

But certain deals – especially those involving Athene Annuity and Life Co, an insurer owned by Apollo Global Management Inc – are now under pressure.

Investors, worried about Athene’s exposure to private‑credit losses, have been demanding extra yield to hold these so‑called munis, even as broader fixed‑income markets struggle amid inflation fears and rising oil prices, Bloomberg cites.

The widening of these spreads – essentially the extra return investors want for buying riskier debt – suggests buyers are uneasy about whether Athene will fulfil its part of the prepaid energy contracts should problems in private credit worsen, it notes.

Bloomberg data shows some Athene‑linked bonds have weakened more than benchmark municipal securities.

Bond stress

In one example, a prepaid energy bond sold through a Californian agency in 2024 has seen investors insisting on nearly two percentage points more in yield than top‑rated municipal bonds over the past month, according to Bloomberg.

At times, this has been among the widest spreads since the bonds were first issued.

In February, the average extra yield was about 1.7 percentage points; now it has grown further.

Other deals tied to Athene – including securities issued by agencies in Alabama and New York – have seen similar spread increases.

Bloomberg reporting highlights that these moves stand out because the municipal market as a whole has been generally ­resilient, even with rising ­interest rates and inflation pressures.

Prepaid energy bonds alone have become a substantial segment, exceeding US$100bil in outstanding debt since record issuance began in 2022.

Yet the deals’ complicated structures can make them particularly sensitive to changes in confidence.

In many prepaid energy transactions, the funds raised from bond sales go to an intermediary – often a bank or insurance company – which then invests those proceeds and makes payments to a utility so it can buy energy ahead of time.

Ratings agencies typically assess the creditworthiness of that intermediary, known as the funding recipient, when assigning ratings to the bonds.

Bloomberg notes that Athene has been a frequent funding recipient.

Investors are now questioning part of that calculus.

Some worry that if losses in private‑credit portfolios grow, it could weaken insurers like Athene and disrupt the cash flows underpinning these prepaid deals.

Voices and reactions

Industry participants see this as a reminder that complex credit structures can react sharply to stress elsewhere in the financial system.

Jude Scaglione, head of municipal credit research at Alvarez & Marsal Private Wealth Partners, emphasised the need for careful analysis.

“You really need to understand it if you’re going to invest in it,” he told Bloomberg, referring to the intricacies of prepaid energy bonds.

Athene itself pushed back in an emailed statement, suggesting that the rising yields reflected wider macroeconomic volatility rather than deterioration in its financial position.

“Spread performance on certain municipal prepay transactions in which Athene has issued its funding agreements do not accurately reflect the underlying strength of our balance sheet or credit quality of our portfolio,” the company said.

Athene added that 97% of its portfolio is investment grade and that levered lending levels “round to zero”.

Despite that assurance, the ties between Athene and Apollo have also weighed on sentiment.

Apollo’s shares have weakened along with those of other asset managers as private‑credit concerns have surfaced, including recent measures by firms such as Blue Owl Capital to limit investor redemptions from certain private‑credit funds.

Apollo president Jim Zelter has described recent turbulence in private credit as “growing pains”, yet investor caution persists.

Bloomberg reported that these dynamics have contributed to widening spreads in prepaid energy bonds linked to the insurer.

Broader market implications

Prepaid energy bonds are not alone in exhibiting volatility.

Many have moved in line with broader fixed‑income stress, particularly since geopolitical events such as the conflict in the Middle East have rattled markets.

But analysts told Bloomberg that the complexity of these bonds’ cash flows makes some more vulnerable to contagion from unrelated sectors like private credit.

Analysts at JPMorgan Chase & Co noted that prepaid gas securities backed by insurance companies lagged those supported by banks early this year.

Both banks and insurers have been attracted to prepaid energy because the low tax‑exempt borrowing costs in municipal markets allow them to borrow cheaply and profit by investing in higher‑yielding taxable assets, according to institutional research cited by Bloomberg.

Athene alone has been connected to about US$6bil of prepaid energy bonds sold since the beginning of 2024, underscoring how widespread its involvement has become.

Some portfolio managers see potential opportunity amid the dislocation.

Shannon Rinehart, co‑head of municipal investments at Columbia Threadneedle Investments, said that while ­concerns about Athene’s exposure to private credit have driven recent selling, the current yields on some of these bonds are attractive – though she believes they should offer elevated spreads.

“There’s just less transparency with the private equity‑owned insurers, so there should be a spread premium involved,” she told Bloomberg.

Mikhail Foux, head of municipal strategy at Barclays Plc, echoed that view.

“If you have wider spreads that could potentially be an opportunity,” he said, noting that prepaid energy issues with greater private‑credit exposure clearly face more pressure.

As Bloomberg highlights, the evolving picture in prepaid energy bonds may offer an early hint of where credit markets could be tested next.