Risk Concealed: Private Credit, PIK and the Banks
- Mar 15
- 9 min read
March 16, 2026 | In this edition of The Institutional Risk Analyst, we take our readers on a deep dive into the world of banking and private credit. As we’ve noted on X, there are two key attributes to bank lending to private equity/credit firms. First, the loans are generally made to or via a special purpose entity (SPE). Second, the loans are non-recourse, meaning that the bank cannot pursue repayment from the private credit or private equity sponsor.
A third component seems to be that investment bankers think that they can create and sell these dodgy "opportunities" to clients without any legal or financial consequences. Can a banker really deflect any risk from allegations of securities fraud by standing behind private contractual terms and non-disclosure agreements? As we discuss below, the episode in 2007 involving several large banks and the collapse of Auction Rate Securities suggests that this assumption is fallacious.
An upbeat note published by Vanguard describes the intersection of private credit and insured depository institutions:
“Private credit is now embedded in portfolio construction decisions. Banks have become increasingly involved, not as originators of middle‑market loans but as providers of financing to private credit managers. Ample dry powder provides flexibility but also affects pricing, structures, and documentation, particularly later in the credit cycle.”
The availability of bank credit has allowed the world of private credit to swell to more than $2 trillion in assets. Another aspect of bank involvement in private credit, however, is a tolerance for default, mirroring the forbearance practices used by banks in other markets such a commercial real estate and consumer finance.
Since 2022, as loan to non-depository financial institutions (NDFIs) have grown by double digit annual rates, banks loans where interest has been accrued but not collected have soared. Is this a coincidence? No, because the rest of the bank balance sheet excluding loans to NDFIs is barely growing. If loans to NDFIs are growing 5-10% a year on average, then the backlog in collections below is likely from NDFI loans. And $100 billion is 2x quarterly earnings for the whole industry.
Source: FDIC
According to KBW, nearly 9% of private investment income is now being paid via payment-in-kind or “PIK,” a stunning level of default that equates to a “B” bond rating for the entire $2 trillion portfolio. Can banks count a PIK payment as payment on a loan? Yes they can. Lenders treat Payment-in-Kind (PIK) interest as a valid, non-cash payment that increases the loan principal, allowing borrowers to defer cash payments. This is what veteran risk manager Victor Hong calls "Principal on original Principal" or "POOP." But the loan is in default, PIK or no.
Dubious practices such as accepting PIK as a valid payment on a loan make bank balance sheets illiquid and ultimately conceal credit losses from investors and regulators. The hidden credit risk on the books of US banks created by PIK is cause for concern since it increases the uncollected principal due to the bank.
Banks that accept PIK payments without declaring the loan in default are essentially zombies. As soon as a bank receives a PIK payment, the full amount of the loan should be charged off. But more than the mounting arrearages represented by PIK loans., it is the reputational risk that faces banks and investment firms that may be the biggest hazard when it comes to private lending.
Western Alliance, Jeffries Financial & Reputation Risk
The litigation involving Jeffries Financial Group (JEF) and Western Alliance Bank (WAL) provides a good illustration of the structural issues involved in many private credit defaults. WAL is suing JEF for over $126 million, alleging breach of contract and fraud after Jefferies-affiliated SPE Point Bonita Capital stopped payments on a loan secured by worthless First Brands Group receivables.
WAL claims Jefferies' fraud induced them into financing these "sham" receivables; Jefferies contends the loan was non-recourse and resulted from an extensive, independent fraud by First Brands leadership, Reuters reports. Of note, WAL did receive more than half of its exposure in loan repayments on the Point Bonita Capital loan, even though other lenders received nothing.
"In my entire banking career, I have never witnessed a breach of contract that so deliberately places the reputation and operating integrity of a counterparty at risk, forcing future banks, clients and counterparties to seriously reevaluate the dependability of that organization's commitment," Western Alliance CEO Kenneth Vecchione told analysts.
But the truth of the matter is that banks have been pursuing “opportunities” such as First Brands aggressively, often without understanding the full risk. The reason for the headlong rush into private credit is that the rest of bank balance sheets have barely been growing, while loans to non-depository financial institutions (NDFIs) have been growing at close to double digit rates.
In a remarkable March 9, 2026 press release and letter, JEF fired back at WAL and in doing so illustrated why private credit is going to be a mess for the banking industry. Memo to Miki: Reputation Risk. JEF stated:
For over four years, Western Alliance made non-recourse loans in steadily increasing amounts to borrowers named LAM Trade Finance Group LLC and LAM TFG I SPV LLC, with no guarantee or credit support from Jefferies or other affiliates.
The borrowers to which Western Alliance made loans are special purpose entities owned by the Point Bonita master fund, and their assets consisted solely of First Brands receivables and related proceeds.
The Loan Agreement was clear that Western Alliance had no recourse beyond the assets of LAM TFG I SPV LLC. Western Alliance had no guarantee or other right of payment from Jefferies or the Point Bonita master fund.
Shortly before First Brands’ bankruptcy filing in September 2025, when Western Alliance was considering a forbearance arrangement, Western Alliance asked the Point Bonita master fund and Jefferies to guarantee the Western Alliance loan to LAM TFG I SPV LLC. Those requests were denied.
When Western Alliance agreed to forbear in any event, Western Alliance was well aware that its counterparties were limited to LAM Trade Finance Group LLC and LAM TFG I SPV LLC, and that it had no rights to assets other than First Brands receivables.
The letter also addresses Jefferies’ exposure to UK mortgage lender Market Financial Solutions (“MFS”), which we discussed in an earlier comment to Daniela Cambone. One of Jefferies’ European subsidiaries loaned MFS £103 million under a warehouse facility secured by certain of MFS’s bridge loans to residential borrowers, property investors and landlords. Jefferies states in the letter the net impact to net earnings over time from the facility with MFS is likely to be less than $20 million. We’ll see.
Want to read more?
Subscribe to theinstitutionalriskanalyst.com to keep reading this exclusive post.
