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There's a group of lenders who used to be kind of off the radar in the world of finance, but who now seem to be having a real moment. We heard about them from Silas Brown, a Bloomberg reporter based in London.
You have seen this kind of cascading effect where these kind of figures have suddenly become these industry financial heavyweights.
The kind of people who might.
Have dinner with Barack Obama, mansions on both US coasts and dazzling wild not art collections from Fankstella to Jean Michelle Basquiet.
So who are they. They are leaders of what are called private credit firms. Private credit firms lend money to all kinds of businesses, but they don't have the same level of oversight as banks do, and it used to be that they didn't get that much attention.
It was seen as the less glamorous of the two options. Investment banking dealing with these kind of like big M and A transactions and powerful deals, and private credit would sort of pick up the scraps on the bottom.
But as interest rates have risen the past two years, these firms have suddenly found themselves to be the new darlings of the lending world.
Everyone seems to like have a view on private credit now. Everyone seems to be like considering setting up their own private credit firm, or you know, like being kind of rude about private credit or whatever.
Everyone seems to have to have a view on it.
But all this new found attention is also coming with heightened scrutiny.
I think as the market is kind of booming, regulators are cognizant of the fact that they don't know that much about what's going on in this market today.
On the show, we go inside the world of private credit to find out what we know and what we don't about how it operates and what the future might look like for the one point seven trillion dollars of assets these funds are managing. This is the big take from Bloomberg News. I'm Sarah Holder, so stilas, how did private credit companies get so big? How are they making bask Yard money?
Private credit is, at its route a tool for private equity firms to buy companies. So private equity firms buy companies by using some money of their own and their investors, and then also some debts provided traditionally by investment banks. People a while back that now tens of years ago, thought that there might be a new way of doing it, which was that they would provide private credits, which is
an alternative to the bank led markets. What happened two years ago is that as rates rows, banks became much more cautious around underrating these big deals and private equity needed to still do some of these deals. They did do much less of the deals, but the deals that
they could do. They then thought, oh, well, how about we knock on the door of these lovely mid sized lenders who have scaled and who are getting more and more money, and perhaps they can satisfy the needs that were once met by the investment.
Banks and Silas says. Because these lenders were willing to lend when others weren't, they were able to charge higher rates to borrowers, which meant they could offer relatively higher returns to their investors. All of this made them popular with pension funds and sovereign wealth funds. But the thing about private credit that now has people nervous is that it's private, Unlike a lot of traditional bank lending, where banks make loans to businesses and then bundle them up
and sell them off to other people. Private credit continues to be held by the private credit firm, and because it's hardly ever traded, the only people who know what it's worth are the people holding it, the private credit firms, and they have an incentive to say that the loans are worth a lot.
One thing that I think is fundamental to private credit is to do with the value of the loans. So in the traditional, lovely easy to kind of understand worlds of publicly traded debt, you can look at where the debt is trading versus you know, the sense on the dollar, and that gives you a good impression of how likely the debt is to be repaid. So like how risky
it is private credit, it isn't traded. People hold onto the debt for the life of the loan, but they still need to ascribe a value to what those loans are, so they are kind of basically trying to work out what their assets hold.
That seems a little like someone checking their own homework, right.
Yes, which is a pretty suboptimal state of affairs for investors, but also for regulators who are trying to understand the health of the market.
So the whole world of private credit seems, for lack of a better word, a little shady, or at least in the shadows.
Is that how you see it, well, I.
Think that's not how they see it. I think that much like kind of all private markets, there's much less access to information for outsiders, and the outsiders also include journalists that cover the market as well, and so we have much less data. We have to try to paint as accurate as picture as possible with fewer utensils than
are kind of like public market piers. Not to suggest that there is anything nefarious underneath, necessarily, but private credit has kind of rapidly become much more significant than it once was, and so where an insignificant thing, not knowing much about it doesn't have much consequence in the eyes of many. Now people are a bit nervous about how little they know about it, and I think what we're trying to establish is to what extent can we believe the valuations?
And the problem with trying to cross check the private firm's homework to look closely at how these valuations are being made is that the details behind the deals are not easy to get.
In Europe, where I sit. There are no publicly available data points for what the valuation of these assets are, so me, as a journalist, will have to find some clever, disfuntled fund manager to sort of sit on a park bench with me and go through the marks of their fund.
Did you sit on a park bench with a person like that?
No, I didn't, perhaps due to my incompetence as a journalist. No one has yeah done that for me.
But in the.
US there is some visibility over valuations. Publish their valuations on a quarterly basis, so you can see through these things called BDCs, which are effectively kin lending vehicles for some of the major private credit firms, you can see that the valuations that they're ascribing to their deals.
Silas and his colleagues wanted to compare the way private credit firms were valuing their loans and how the rest of the market might value them. So they ran a big data analysis using data compiled by Bloomberg and fixed income specialists Solve, and interviews with dozens of market participants. They found some eyebrow raising discrepancies. One scenario they looked at.
Was situations where two private credit firms are both lending in the same deal, so they're both holding the same debt, but there can be really substantial differences in opinion about where they should.
Value for debt.
He gave us an example.
If something is priced at eighty four cents on the dollar and something is trading at fifty nine cents on the dollar, that is a different picture that it's painting for an investor. One signal's like really deep distressed, like the companies in loads of trouble, and one signals kind of stressed, like the company's in trouble.
But like, you know, there should be a path forward.
And you know, people invest in these funds, and I think it's reasonable for them to be asking why there's such a discrepancy.
After the break, will the private credit balloon pop? Hey, we're back. Before the break, we were talking about the striking rise of private credit funds, and Silas Brown was telling us about how these funds essentially check their own homework. They tell the market what the loans they hold are worth. But sometimes what the private credit funds say their loans are worth doesn't exactly match up to the way other people value them. He gave us a drastic example.
This is like a really funny one. I still think quite a lot about it. So when debt is marked at one hundred, people say it's marked at par par, which basically, you know, is the most performing metric. Effectively that you can have a few examples that we've found of companies that go into file for bankruptcy and then the filing after that event marks the debt at par.
If you were in the public market, there would be no way that after a Chapter eleven bankruptcy filing, which is obviously a very serious thing to happen, that there would be no kind of movement in the price of the debt.
Those are the more obvious cases, but concern about the lack of transparency in the private credit market overall is increasingly getting attention. Here's former FDIC chair Shila Bhar speaking about it on Bloomberg TV.
There needs to be a more holistic view among the regulatory community about the risks that are going into the non bank sector. You're having a lot of credit flowing into these private credit funds. Now they're not such at the same level of capital regulation and artist Transpori Syla said.
One specific thing that has caught the eye of people watching this industry is the rise of what are called payment in kind deals.
If you read our writing, you probably see this kind of annoying acronym PIK quite a lot, and it's called payment in kind loans. And what that means is that instead of paying the company paying in cash, they'll stop paying the interest on the debts for now and let it accrue. There's very clever arguments for why it isn't necessarily a signal of distress at all, but in some
cases it clearly is. By and large, Like if there's an unexpected use of PICK and a company was paying interest and is now saying they don't want to pay interest and they're using pick to not pay interest, that's kind of like not ideal for a lender.
And so, I mean, this growing concern from financial regulators about private credit companies sort of signals a shift in the initial enthusiasm about them. Right, you were saying they were seen as an alternative to move the lending away from bigger Wall Street banks and into these specialist firms. What about the economy right now has people changing that stance.
Yeah?
So, I mean I think to play the defender of the private credit market against those dastardly banks. What I will say is the leverage models that they have in private credit versus like investment banks. It does cause a sigh of relief among regulators. The leverage levels are still by and large substantially lower than what you would get in in investment banks, So that's a kind of good
thing for private credit. However, I think as the market is kind of booming, regulators are cognizant of the fact that they don't know that much about what's going on in this market. It's become this kind of pretty titanic force in leveraged finance, and leverage finance is among the riskier forms of kind of global finance, and so they are sort of scratching their heads and not quite sure what is happening. It doesn't necessarily mean that something's bad happening.
It just means that there is an information gap that they're trying to kind of get to. But I think, by and large, if I was a regulator, I would think it's probably good that a lot of this risky debt is out of the hands of banks. However, a lot of the risky debt is in the hands of specialist lenders and the investors of the risky debt are also like pension funds that are relevant to the everyday lives of people like you and I.
Yeah, I mean, so, what's the worst case scenario of all this? If these loans are super overvalued, the whole house of cards collapses. How big of a deal.
Is that someone who's covering the market. I'm often very worried about an imminent collapse. I'm thinking about it quite often.
I think more likely what will happen is if the kind of downside scenario, there will be a lot of instances of defaults and debt f equity swaps, and it will be companies crippled by higher interest rates and high debt burdens, and lenders having to kind of cope with potential losses as a result of those companies going into default and going into kind of insolvency in some situations.
And so what was once a kind of market that could have been defined by owning a basqueyat becomes a market being defined by like owning some random company.
We've been talking about a lot of the risks, but what are some of them that have been proposed, whether by financial regulators or the private credit fund managers to prevent these downstream impacts to investors if these valuations are in fact too high.
I think they will be increasingly using and listening to third party providers, people like Lincoln International and Hulahan low Key and Deloitte places like that, who are by the way, paid by the lenders, so they're not kind of like totally independent assessors, but they do add this kind of layer of scrutiny over the values of the loans, So
I think that's kind of helpful. I think the market will probably benefit from industry bodies trying to kind of create coherent set of standards for everyone.
So the private credit industry kind of came of age in two thousand and eight. Does this feel like a full circle moment for it as people start raising concerns about its stability?
I mean, I think it's obviously boomed in a kind of more benign environment, and now it's having to deal with higher interest rates. But you know, I think most people believe that it will carry on growing, just as private equity will carry on growing. I mean, it serves a pretty clear function for private equity firms, but it hasn't really been through a full cycle yet, and you could argue that the next like eighteen to twenty four months, so like pretty defining for the market as it is now.
You know, in the two thousand and eight the situation the market was kind of like infinitesimly.
Small versus what it is now.
And there's a lot more players, a lot more deals, a lot more companies that are involved, and whether or not the market has like underwritten debt in a kind of efficient and like sensible way is definitely going to be evident over the next two years.
This is the Big Take from Bloomberg News. I'm Sarah Holder. This episode was produced by Adrianna Tapia. It was edited by Caitlin Kenny. It was mixed by Ben O'Brien. It was fact checked by Tiffany Choi. Our senior producers are Naomi Shavin and Jill Duddy Carley. We get editorial direction from Elizabeth Ponso. Nicole Beemsterborr is our executive producer. Sage Bauman is our head of podcasts. Thanks for listening. Please follow and review The Big Take wherever you listen to podcasts.
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