Shoring Up Solvency: Credit as a Defensive Tool

In today’s volatile markets, credit serves as more than just a funding source—it becomes a guardian of stability and a source of opportunity. Investors and institutions can unlock resilience by understanding and applying strategic credit tools.

The Evolution of Credit Hedging in High-Yield Markets

High-yield bonds once carried a reputation for attractive yields but also significant risk during market stress. Modern strategies now blend income generation with risk mitigation.

One pioneering example is the Simplify High Yield PLUS Credit Hedge ETF (CDX). This fund captures income from high-yield bonds while mitigating spread widening risk, offering a balanced approach to return and protection.

During mid-2024 recession fears—when spreads jumped into the mid-300 basis points range—the CDX structure outperformed traditional benchmarks, illustrating how credit overlays can defend portfolios without sacrificing income over a full market cycle.

Key hedging instruments include:

By combining these instruments, investors achieve diversifying exposures and hedging effects that preserve income and reduce portfolio volatility.

Consumer Credit Trends: Stability Amid Volatility

U.S. consumers have demonstrated disciplined borrowing in 2025, reinforcing credit’s defensive role at the individual level. Delinquencies are stabilizing, and originations are growing selectively.

• Super-prime growth drives originations: Credit card originations rose 4.5% year-over-year in Q1 2025, led by a 5.0% increase among super-prime borrowers.
• Record unsecured loan balances: Personal loan originations jumped 18% to 5.4 million, with total balances reaching $257 billion at Q2 end.
• Declining delinquency trends: Serious bankcard delinquencies fell by nine basis points, highlighting improved risk management.

These metrics suggest a return to pre-pandemic borrowing patterns, supported by refined underwriting and targeted risk assessments.

Harnessing Credit Insurance for Risk Transfer

Credit insurance allows banks and corporates to transfer non-payment risk and unlock additional capital capacity. By outsourcing credit assessment to specialized insurers, institutions can focus on core operations.

Globally, more than $100 billion in credit insurance coverage facilitates trade and project finance, with $135 billion in facilitated lending reported in a recent survey of banks and insurers.

Under U.S. regulations, credit insurance qualifies as an eligible guarantee, permitting institutions to substitute insurer risk weights for lower capital requirements. This approach stands as an economically akin to guarantees and derivatives, but with greater speed and flexibility.

Key benefits include:

• Enhanced capital efficiency through risk-weight substitution
• Outsourced credit assessment and monitoring
• Expanded capacity for trade and project finance

Private Credit: A Resilient Growth Engine

As banks retreat from certain lending segments, private credit has emerged as a flexible alternative, offering flexible, higher-yield financing with defensive traits.

By 2029, industry forecasts project private credit assets will grow to between $2.6 and $2.8 trillion, fueled by middle-market demand, acquisitions, and infrastructure financing.

• Middle-market tailwinds: Strong deal flow in healthcare, technology, and renewable infrastructure.
• Institutional adoption: Pensions and insurers seeking uncorrelated yield sources.
• Innovation and partnership: Collaborations between private credit managers and banks for origination efficiency.

Despite concerns over transparency and mark-to-myth valuation, private credit strategies have delivered consistent performance, preserving resilient credit quality through diversification across industries and geographies.

Implementing Effective Risk Management Frameworks

Robust governance is essential to harness credit’s defensive power. The Three Lines of Defense model provides a clear structure:

• First line: Business units own and manage credit risks daily.
• Second line: Risk and compliance functions establish policies and oversight.
• Third line: Internal audit provides independent assurance.

Coupled with advanced analytics platforms—such as Moody’s risk tools—this framework enables early identification of emerging threats and ensures disciplined portfolio steering.

Charting a Defensive Credit Portfolio for 2025 and Beyond

Integrating these credit strategies requires a holistic approach. Investors can follow these practical steps:

1. Assess risk tolerance and liquidity needs. Align credit exposures with portfolio objectives.

2. Diversify across segments: high-yield hedged ETFs, regulated credit insurance, and private credit funds.

3. Select experienced managers with transparent valuation processes and strong due diligence practices.

4. Monitor macro drivers—interest rate trends, corporate earnings, and geopolitical events—to adjust hedges and allocations.

5. Review performance through a defensive lens, focusing on downside protection as much as yield generation.

By embracing credit as a strategic ally, investors and institutions can build resilience, capture attractive yields, and navigate uncertainty with confidence. Deploying these tools transforms credit from a mere financing line into a powerful mechanism for enhancing long-term portfolio stability and growth.