Keep pulling the thread on Odd Lots.
Unlike private equity funds which call capital after finding an investment, most private credit funds take investor money first and then seek investments, creating pressure to deploy capital.
Intense competition among private credit funds for deals has resulted in lenders offering lower interest rates and weaker covenants to borrowers.
Post-financial crisis banking regulations explicitly prevent banks from lending to companies with greater than six times leverage, creating a vacuum filled by private credit.
The private credit market is now estimated to be larger than the public junk-rated bond market.
The rapid growth of private credit was fueled by investor demand for yield during the zero-interest-rate environment and by highly levered borrowers being shut out of the bank lending market.
The need for private credit funds to quickly invest incoming cash from retail investors has led to a degradation of credit underwriting standards.
In 2022, private credit funds appeared to perform well because they were not marking their assets to market, which attracted significant investor inflows.
If investor inflows slow, private credit managers facing redemption requests will have to either sell their highest quality, most liquid assets or finance the redemptions with debt.
A protracted redemption cycle in private credit could lead to funds becoming more leveraged while holding poorer quality assets, increasing the risk of a blow-up.
There are significant fears that recovery values on defaulted private credit loans will be low, particularly for highly levered companies with few hard assets.
A significant dispersion in returns is expected among private credit managers, ending a period where most funds showed uniform performance.
Some Wall Street analysts have suggested that default rates in the private credit market could reach 15%.