Nick Nemeth: Private Credit Will Blow-up Insurance System | Immense Leverage, Shaky Loans, and Retirement System That Actually Does Have Run Risk (via Surrenders)

Nick Nemeth argues that private credit, not banks, will trigger the next major financial crisis, and that the primary victims will be insurance companies holding roughly one trillion dollars of private credit on ten trillion dollars in total balance sheet assets. He frames this as more dangerous than 2008 subprime, which totaled approximately 1.2 trillion dollars, because the insurance system is 150 percent the size of the Federal Reserve's balance sheet and losses will fall on retirement savers rather than bank counterparties.

The core underwriting problem is that private equity direct lending runs at roughly seven times EBITDA, but that EBITDA is adjusted for synergies that rarely materialize. S&P data shows that 50 percent of the time per vintage, EBITDA misses projections by 25 percent, and sometimes by 40 to 50 percent. After adjusting for rent addbacks, payment-in-kind interest accrual, and inflated EBITDA, Nemeth estimates effective leverage reaches nine to ten and a half times rather than the reported seven times. Direct lending company defaults are already running at approximately 6.3 percent based on S&P data, above 2008 levels even without a recession. He predicts that if this default rate persists for approximately six more quarters, CLOs on insurance balance sheets will face forced rating downgrades, and if defaults reach 10 percent the damage will be severe.

Nemeth is particularly bearish on recoveries for software loans, which represent roughly 60 percent of ARCC and FSK portfolios. He argues that most private credit software portfolio companies are wrappers around niche enterprise processes that frontier AI models can replicate today, with one-to-two-year contracts rolling off soon. These loans were underwritten assuming 10 to 15 percent compound annual revenue growth so borrowers could grow into their debt loads, and PIK structures allow companies to defer cash interest and mask deterioration until the very end. Buyers such as OpenAI or Anthropic will pay once for truly good data and ignore the rest, meaning underlying assets have minimal liquidation value.

He also challenges the claim that private credit is not heavily levered at the fund level, identifying approximately five to six stacked layers including portfolio company debt, BDC-level leverage, fund-level debt, GP financing at roughly 7 percent cost of capital with up to five times leverage, LP subscription lines, and sovereign wealth fund repo agreements achieving 10 to 20 times leverage against treasury collateral. He estimates total private equity debt including private credit at approximately ten trillion dollars, with only roughly one trillion dollars of legitimate cash directly invested and the rest borrowed. The rollup strategy common in BDC portfolios allows sponsors to immediately mark an add-on acquisition from seven times to twelve times EBITDA upon closing and extract additional debt against the inflated valuation, manufacturing paper gains while loading more risk onto lenders.

Apollo's Athene, with a balance sheet of approximately 350 billion dollars, pioneered the model of alternative asset managers acquiring insurance companies to access permanent capital. Nemeth disputes the permanent capital characterization because life insurance policies can be surrendered, creating genuine run risk the industry downplays. Athene holds approximately 8 percent of assets in level one instruments and approximately 50 percent in level three assets that Athene itself prices, meaning the majority of the balance sheet requires trusting Athene's own valuations. Some insurance company balance sheets are levered more than Lehman Brothers was in 2008, with some at 90 to 100 times leverage and some carrying negative equity. Fortitude, associated with Carlisle, has negative book value and received a fair value exemption from its regulator. A low single-digit percentage uptick in surrenders would be enough to push over 100 of the 680 insurers below their required risk-based capital ratios.

The ratings infrastructure underpinning this system is structurally compromised. CLO tranches rated triple-B are the primary asset insurance companies are rushing toward because they represent the maximum yield achievable within minimum capital reserve requirements. Underlying loans inside CLOs are rated by cheaper agencies such as Egan Jones and Kroll rather than Moody's, S&P, or Fitch, yet the market treats these ratings as comparable inputs into structured products. Nemeth describes Egan Jones as a ratings factory producing large volumes of ratings without rigorous fundamental credit analysis, drawing a direct parallel to pre-2008 mortgage ratings inflation.

State guaranty funds provide a minimum of 250,000 dollars per policyholder but are not pre-funded and are tied to tax credits on insurer balance sheets, meaning there is effectively no money available in advance. With 22 trillion dollars of in-force life insurance policies outstanding, a failure of even one large insurer would stress state balance sheets severely. Nemeth compares the current situation to 1929 more than 2008 because the scale and duration of the cycle are greater and the primary victims will be white collar workers and private equity professionals rather than retail mortgage borrowers. He estimates Fed intervention could start at one trillion dollars, escalate to two and a half trillion, and ultimately reach ten trillion, at which point dollar credibility itself becomes a concern. He predicts the igniting event will be outflows preceded by inflows simply slowing, with the cycle becoming reflexively self-reinforcing on the downside as defaults pick up, redemptions accelerate, and scrutiny increases.