Private credit’s game of footsie is getting riskier
Stronger guardrails are needed before these funds seep into the $9tn US retirement market
Brooke Masters
Saba Capital recently offered to buy out investors in a Blue Owl fund at a 35 per cent discount to its stated value © Michael Nagle/BloombergIf anyone claims to know for sure what is going on with private credit right now, you should assume that they are either talking their own book or talking through their hat.
Loan default rates are low and returns have been good, but worried investors are trying to pull more than $10bn out of credit funds run by Blackstone, BlackRock and other big Wall Street names.
High-profile bankruptcies such as car parts maker First Brands have highlighted poor lending standards while AI advances threaten software companies disproportionately reliant on private credit.
The alternative asset managers behind these debt funds contend all is well, but opportunistic hedge funds, regulators and bankers have been sounding alarms about opacity and “cockroaches” to come.
Throw in higher oil prices and a possible data centre bubble, and the future looks cloudy.
The private credit furore is particularly loud around funds aimed at individuals rather than large pension funds, and with good reason.
The combination of flighty retail investors and hard to value long-term assets is a heady mix.
Stronger guard rails are needed lest they become a systemic risk.
In the past two decades, direct lending by private funds has become a crucial strand of the financial system, providing credit to start-ups and other companies that would struggle to get bank loans or sell bonds.
A classic private credit fund takes money from pension funds and endowments and locks it up for five years or more.
That allows funds to hold long-term loans without fear that clients will want their money back.
But Blackstone, Cliffwater, Blue Owl and others scented an opportunity: funds for wealthy individuals who wanted higher returns than they could get from public debt markets.
Marketed as “semi-liquid”, these evergreen funds had no formal end date.
Instead they promised clients quarterly access to their money, with the caveat that withdrawals could be capped at 5 per cent of fund assets to avoid fire sales.
The products were a hit, attracting nearly $200bn and growing 60 per cent annually between 2021 and last year.
The industry dreamt of further retail growth when the Trump administration announced plans to allow private assets in retirement accounts.
The skies darkened when some investors, worried that loans were overvalued, exited a Blue Owl fund.
Attempts to shore up confidence backfired and anxiety spread.
Now Morgan Stanley, BlackRock and Cliffwater have limited withdrawals.
The flow of new money has dropped by half.
Goldman Sachs estimates that up to $70bn could flow out of private credit funds in the next two years and force the worst-hit managers to sell loans to meet redemption requests.
Meanwhile JPMorgan has started marking down the value of some private credit loan portfolios and hedge funds are circling.
Saba Capital recently offered to buy out investors in a Blue Owl fund at a 35 per cent discount to its stated value.
Private credit firms downplay the potential for trouble.
Evergreen funds account for just 20 per cent of direct lending and a recent Bank of America survey found financial advisers are still seeing client demand.
Several executives told me that the imposition of withdrawal caps is proof that the system works and customers should have known they were trading limited liquidity for better returns.
“It’s on the cover, it’s in bold, it’s all over the documents,” one said.
Even so, the industry should consider itself warned.
When the headlines are scary, some clients will get spooked and try to run, no matter what the legalese says.
The more private capital plays footsie with retail customers and the bigger these funds get, the greater the chance of a blow-up.
Rules are needed to prevent contagion, either directly through fire sales or by spreading fear across the market.
Other financial services companies already know this.
When US banks sell “certificates of deposit” that reward savers with higher interest rates for surrendering their cash for a fixed period, there is no mealy-mouthed “semi-liquid” language.
Regulators insist on penalties for early withdrawal to limit runs.
Mutual funds have strict rules that prevent them from selling off their crown jewels if more investors want out than in.
That reassures investors that they will not be punished for staying put.
And institutional investors who want to get out of a fixed-term private credit fund have to turn to the secondary market, which usually means selling at a discount.
Before private credit gets anywhere near the $9tn retirement market, the industry must get serious about protecting retail customers from making terrible mistakes.
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