{"id":28233,"date":"2023-06-27T14:11:59","date_gmt":"2023-06-27T18:11:59","guid":{"rendered":"https:\/\/ifintechworld.com\/investing\/are-private-credits-double-digit-yields-too-good-to-be-true\/"},"modified":"2023-06-27T14:12:01","modified_gmt":"2023-06-27T18:12:01","slug":"are-private-credits-double-digit-yields-too-good-to-be-true","status":"publish","type":"post","link":"https:\/\/ifintechworld.com\/?p=28233","title":{"rendered":"Are Private Credit\u2019s Double-Digit Yields Too Good To Be True?"},"content":{"rendered":"
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Private credit has gone from a backwater to the hottest asset class of 2023 with firms like Blackstone and Apollo jockeying for business, and assets approaching $1.5 trillion. Is Wall Street\u2019s latest lending boom heading for trouble?<\/h2>\n

By <\/sup>Hank Tucker<\/sup>, Forbes Staff<\/sup><\/h4>\n

A<\/abbr>lternative investment managers have spent the first half of 2023 trumpeting a similar refrain to investors wary of this year\u2019s stock market bounce: look at private credit.<\/p>\n

The industry has ballooned to $1.5 trillion in assets, more than tripling in the last decade, with every major alternative asset manager competing to lend to private businesses as an alternative to typical banks. Private credit loans generally come with a floating rate pegged to a base rate like the London Interbank Offered Rate (Libor). With one year LIBOR rates nearly 6% and private lenders tacking on spreads of 5-7 percentage points on top of that, many funds are offering double-digit yields to investors.<\/p>\n

\u201cI would say whenever you can get equity-like returns taking debt-like risk, that\u2019s something you should do,\u201d said Blackstone\u2019s billionaire president Jonathan Gray at the Forbes Iconoclast Summit earlier this month. The private equity giant manages $291 billion in credit and insurance assets among its $991 billion in total assets.<\/p>\n

Private credit assets surpassed the $1.4 trillion value of all outstanding U.S. high-yield bonds last year, according to the International Monetary Fund\u2019s latest Global Financial Stability Report released in April. Fundraising has slowed this year, but asset managers still had around $300 billion in dry powder in private credit funds last year, according to the IMF, and are continuing to put it to use. In this week\u2019s latest major deal, chipmaker Wolfspeed announced Monday that it\u2019s borrowing $1.25 billion from an investment group led by Apollo Global Management, the industry leader with $450 billion private credit assets, to finance expansion in the U.S. at 9.875% interest.<\/p>\n

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This spring\u2019s regional banking crisis that led to the failures of Silicon Valley Bank, Signature Bank and First Republic Bank is helping private credit firms to take more market share on the margins, and some are planning to take loans off banks\u2019 hands. Gray told the Financial Times in May that Blackstone is in talks with regional banks to funnel loans they originate to insurance companies. This way, Blackstone can use regional banks\u2019 existing lending relationships to rapidly expand its private credit business.<\/p>\n

The value of commercial and industrial loans from all commercial banks in the U.S. has declined 1.7% from $2.81 trillion in January to $2.76 trillion in May, but private asset managers have been cutting into banks\u2019 share of the market for far longer than that. This year\u2019s upheaval is merely accelerating a 15-year trend since the 2008 financial crisis, particularly since the Dodd-Frank Act tightened regulation and oversight of banks in 2010.<\/p>\n

\u201cThe banks were chastened by the great financial crisis, and Dodd-Frank made it virtually impossible for banks to hold risky loans and assets,\u201d says Chris Kotowski, managing director and senior analyst at Oppenheimer. \u201cAt the same time, you had this big expansion in the number of private companies looking for other sources of capital.\u201d<\/p>\n

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Borrowers typically pay a slight premium in interest to tap the private market instead of going to a bank for a syndicated loan, but they get to bypass some of the red tape of dealing with banks, which syndicate loans out to other lenders. They also get more confidentiality, while a bank loan gets rated by agencies like Moody\u2019s and Fitch Ratings. If a borrower wants to refinance or structure a more complex loan, collaborating with a private credit firm can be more efficient than going back to rating agencies and dealing with numerous lenders in a syndicated deal.<\/p>\n

\u201cWe can design one loan that has a revolver component, a term loan component and a delay draw component,\u201d says Matt Stewart, managing director for global private debt at Oaktree Capital Management, describing an example where a business might want to delay part of a loan if they plan on acquiring multiple companies within a certain time frame. \u201cIt’s really about the flexibility, customization and certainty to close that we can bring that banks can\u2019t offer as much.\u201d<\/p>\n

Most private credit firms draw in money from pension funds, endowments and insurance companies, though individuals can also invest in the industry through dozens of business development companies. The Blackstone Private Credit Fund (BCRED) has $51 billion in assets and a 10.2% annualized yield. Credit specialists Ares Management and Owl Rock Capital and other major private equity firms like KKR and Oaktree have BDCs with similar yields. These BDCs are required to pay out at least 90% of their profits as dividends, and their debt-to-equity ratios are capped at 2-to-1. Stewart says Oaktree\u2019s non-traded Oaktree Strategic Credit Fund runs at less than 1-to-1, while banks routinely have leverage upwards of 10 times equity.<\/p>\n

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But double-digit returns rarely last forever, and in a recent report Moody\u2019s cast doubt on private credit\u2019s future performance. Associate managing director Christina Padgett and four coauthors cautioned that loans originated in 2021, when the market was most frothy and fundraising hit its peak, are likely more susceptible to defaults. The default rate for private company loans Moody\u2019s rates was 3.07% in the trailing 12 months from May 2023, which it forecasts will rise to 5.64% by this time next year.<\/p>\n

\u201cSyndicated loans are actively traded, and therefore have a market value on top of maintaining a monitored public rating. As a result, credit quality is quite transparent within the syndicated loan market,\u201d wrote the Moody\u2019s authors. \u201cWe believe companies in the syndicated loan market, though highly leveraged, are likely to have better credit quality than companies that sought financing within the private credit sector.\u201d<\/p>\n

With limited transparency and liquidity, the IMF report warned that a potential decline may spill over into other markets if interest rates rise more and institutional investors face margin calls. Any prolonged downturn, or recession, would be the first major test since the industry went mainstream, and Moody\u2019s expects managers with longer track records and greater scale to fare better at navigating the storm. Defaults need not be total losses for lenders as well, particularly if their loans are senior secured, taking precedence over junior debt and equity.<\/p>\n

\u201cThe biggest skill set that is needed for this environment is groups that have restructuring experience, the ability that if something goes wrong with a company and they’re unable to pay, the lender is able to take almost an equity-like approach and partner with that company,\u201d says Eric Deyle, a managing director at Stifel Financial subsidiary Eaton Partners, which helps private fund managers raise money.<\/p>\n

For now, lenders are passing the excess risk onto borrowers, charging spreads of around 6.5% on top of the base rate on average compared with a typical 5% spread for loans originated in 2021. That offers a larger cushion if some businesses can\u2019t repay their loans. \u201cEven if you do have a situation where you have some defaults in the portfolio, you have excess earnings to outweigh that,\u201d says Stewart.<\/p>\n

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<\/h4>\n

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Private credit has gone from a backwater to the hottest asset class of 2023 with firms like Blackstone and Apollo jockeying for business, and assets approaching $1.5 trillion. Is Wall Street\u2019s latest lending boom heading for trouble? By Hank Tucker, Forbes Staff Alternative investment managers have spent the first half of 2023 trumpeting a similar […]<\/p>\n","protected":false},"author":1,"featured_media":28234,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[239],"tags":[83],"class_list":["post-28233","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-investing","tag-featured"],"yoast_head":"\nAre Private Credit\u2019s Double-Digit Yields Too Good To Be True? | iFintechWorld<\/title>\n<meta name=\"description\" content=\"Private credit has gone from a backwater to the hottest asset class of 2023 with firms like Blackstone and Apollo jockeying for business, and assets\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/ifintechworld.com\/?p=28233\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Are Private Credit\u2019s Double-Digit Yields Too Good To Be True? 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