AI shock scenario could hit banks and insurers via private credit, warns UBS

Core Viewpoint - UBS warns that a rapid shock from artificial intelligence could lead to a significant increase in defaults in the US credit market, particularly affecting private credit [1][2]. Group 1: Default Projections - In a severe AI disruption scenario, UBS projects defaults could rise to 3-6% in US high-yield bonds, 8-10% in leveraged loans, and 14-15% in private credit [3]. Group 2: Market Evolution - Private credit has become a structurally significant part of the US corporate debt landscape, now representing 6% of GDP, while leveraged loans account for 5% of GDP, up from 1% and 5% in 2008 respectively [4]. Group 3: Systemic Risk and Stress Indicators - The shift from banks to private lenders has raised concerns about systemic risk, with current private credit defaults reported between 3% and 5%, and stress indicators nearing post-pandemic highs [5]. - Leverage in some sectors has increased, with debt levels at 7.5-8 times earnings, and interest coverage in middle-market deals around 1.7-1.8 times, exposing borrowers to risks if growth slows or interest rates remain high [5]. Group 4: Concentration of Risk - Risk is concentrated in specific sectors, with private credit heavily weighted towards services, technology, and healthcare, raising concerns about potential spillover effects into public markets [6]. Group 5: Exposure of Financial Institutions - US and European banks hold approximately $1.3 trillion in loans and around $1.1 trillion in undrawn commitments to non-bank financial institutions, with major global banks accounting for 60% of this total [7].