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Speaker 1: Bloomberg Audio Studios, podcasts, radio news.

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Speaker 2: There's a group of lenders who used to be kind

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Speaker 2: of off the radar in the world of finance, but

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Speaker 2: who now seem to be having a real moment. We

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Speaker 2: heard about them from Silas Brown, a Bloomberg reporter based

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Speaker 2: in London.

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Speaker 3: You have seen this kind of cascading effect where these

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Speaker 3: kind of figures have suddenly become these industry financial heavyweights.

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Speaker 2: The kind of people who might.

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Speaker 3: Have dinner with Barack Obama, mansions on both US coasts

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Speaker 3: and dazzling wild not art collections from Fankstella to Jean

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Speaker 3: Michelle Basquiet.

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Speaker 2: So who are they. They are leaders of what are

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Speaker 2: called private credit firms. Private credit firms lend money to

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Speaker 2: all kinds of businesses, but they don't have the same

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Speaker 2: level of oversight as banks do, and it used to

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Speaker 2: be that they didn't get that much attention.

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Speaker 3: It was seen as the less glamorous of the two options.

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Speaker 3: Investment banking dealing with these kind of like big M

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Speaker 3: and A transactions and powerful deals, and private credit would

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Speaker 3: sort of pick up the scraps on the bottom.

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Speaker 2: But as interest rates have risen the past two years,

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Speaker 2: these firms have suddenly found themselves to be the new

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Speaker 2: darlings of the lending world.

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Speaker 3: Everyone seems to like have a view on private credit now.

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Speaker 3: Everyone seems to be like considering setting up their own

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Speaker 3: private credit firm, or you know, like being kind of

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Speaker 3: rude about private credit or whatever.

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Speaker 1: Everyone seems to have to have a view on it.

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Speaker 2: But all this new found attention is also coming with

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Speaker 2: heightened scrutiny.

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Speaker 3: I think as the market is kind of booming, regulators

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Speaker 3: are cognizant of the fact that they don't know that

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Speaker 3: much about what's going on in this market today.

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Speaker 2: On the show, we go inside the world of private

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Speaker 2: credit to find out what we know and what we

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Speaker 2: don't about how it operates and what the future might

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Speaker 2: look like for the one point seven trillion dollars of

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Speaker 2: assets these funds are managing. This is the big take

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Speaker 2: from Bloomberg News. I'm Sarah Holder, so stilas, how did

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Speaker 2: private credit companies get so big? How are they making

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Speaker 2: bask Yard money?

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Speaker 3: Private credit is, at its route a tool for private

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Speaker 3: equity firms to buy companies. So private equity firms buy

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Speaker 3: companies by using some money of their own and their investors,

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Speaker 3: and then also some debts provided traditionally by investment banks.

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Speaker 3: People a while back that now tens of years ago,

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Speaker 3: thought that there might be a new way of doing it,

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Speaker 3: which was that they would provide private credits, which is

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Speaker 3: an alternative to the bank led markets. What happened two

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Speaker 3: years ago is that as rates rows, banks became much

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Speaker 3: more cautious around underrating these big deals and private equity

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Speaker 3: needed to still do some of these deals. They did

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Speaker 3: do much less of the deals, but the deals that

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Speaker 3: they could do. They then thought, oh, well, how about

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Speaker 3: we knock on the door of these lovely mid sized

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Speaker 3: lenders who have scaled and who are getting more and

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Speaker 3: more money, and perhaps they can satisfy the needs that

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Speaker 3: were once met by the investment.

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Speaker 2: Banks and Silas says. Because these lenders were willing to

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Speaker 2: lend when others weren't, they were able to charge higher

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Speaker 2: rates to borrowers, which meant they could offer relatively higher

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Speaker 2: returns to their investors. All of this made them popular

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Speaker 2: with pension funds and sovereign wealth funds. But the thing

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Speaker 2: about private credit that now has people nervous is that

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Speaker 2: it's private, Unlike a lot of traditional bank lending, where

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Speaker 2: banks make loans to businesses and then bundle them up

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Speaker 2: and sell them off to other people. Private credit continues

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Speaker 2: to be held by the private credit firm, and because

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Speaker 2: it's hardly ever traded, the only people who know what

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Speaker 2: it's worth are the people holding it, the private credit firms,

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Speaker 2: and they have an incentive to say that the loans

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Speaker 2: are worth a lot.

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Speaker 3: One thing that I think is fundamental to private credit

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Speaker 3: is to do with the value of the loans. So

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Speaker 3: in the traditional, lovely easy to kind of understand worlds

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Speaker 3: of publicly traded debt, you can look at where the

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Speaker 3: debt is trading versus you know, the sense on the dollar,

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Speaker 3: and that gives you a good impression of how likely

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Speaker 3: the debt is to be repaid. So like how risky

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Speaker 3: it is private credit, it isn't traded. People hold onto

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Speaker 3: the debt for the life of the loan, but they

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Speaker 3: still need to ascribe a value to what those loans are,

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Speaker 3: so they are kind of basically trying to work out

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Speaker 3: what their assets hold.

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Speaker 2: That seems a little like someone checking their own homework, right.

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Speaker 3: Yes, which is a pretty suboptimal state of affairs for investors,

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Speaker 3: but also for regulators who are trying to understand the

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Speaker 3: health of the market.

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Speaker 2: So the whole world of private credit seems, for lack

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Speaker 2: of a better word, a little shady, or at least

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Speaker 2: in the shadows.

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Speaker 1: Is that how you see it, well, I.

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Speaker 3: Think that's not how they see it. I think that

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Speaker 3: much like kind of all private markets, there's much less

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Speaker 3: access to information for outsiders, and the outsiders also include

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Speaker 3: journalists that cover the market as well, and so we

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Speaker 3: have much less data. We have to try to paint

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Speaker 3: as accurate as picture as possible with fewer utensils than

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Speaker 3: are kind of like public market piers. Not to suggest

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Speaker 3: that there is anything nefarious underneath, necessarily, but private credit

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Speaker 3: has kind of rapidly become much more significant than it

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Speaker 3: once was, and so where an insignificant thing, not knowing

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Speaker 3: much about it doesn't have much consequence in the eyes

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Speaker 3: of many. Now people are a bit nervous about how

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Speaker 3: little they know about it, and I think what we're

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Speaker 3: trying to establish is to what extent can we believe

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Speaker 3: the valuations?

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Speaker 2: And the problem with trying to cross check the private

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Speaker 2: firm's homework to look closely at how these valuations are

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Speaker 2: being made is that the details behind the deals are

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Speaker 2: not easy to get.

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Speaker 3: In Europe, where I sit. There are no publicly available

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Speaker 3: data points for what the valuation of these assets are,

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Speaker 3: so me, as a journalist, will have to find some clever,

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Speaker 3: disfuntled fund manager to sort of sit on a park

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Speaker 3: bench with me and go through the marks of their fund.

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Speaker 2: Did you sit on a park bench with a person

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Speaker 2: like that?

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Speaker 3: No, I didn't, perhaps due to my incompetence as a journalist.

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Speaker 3: No one has yeah done that for me.

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Speaker 1: But in the.

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Speaker 3: US there is some visibility over valuations. Publish their valuations

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Speaker 3: on a quarterly basis, so you can see through these

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Speaker 3: things called BDCs, which are effectively kin lending vehicles for

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Speaker 3: some of the major private credit firms, you can see

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Speaker 3: that the valuations that they're ascribing to their deals.

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Speaker 2: Silas and his colleagues wanted to compare the way private

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Speaker 2: credit firms were valuing their loans and how the rest

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Speaker 2: of the market might value them. So they ran a

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Speaker 2: big data analysis using data compiled by Bloomberg and fixed

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Speaker 2: income specialists Solve, and interviews with dozens of market participants.

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Speaker 2: They found some eyebrow raising discrepancies. One scenario they looked at.

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Speaker 3: Was situations where two private credit firms are both lending

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Speaker 3: in the same deal, so they're both holding the same debt,

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Speaker 3: but there can be really substantial differences in opinion about

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Speaker 3: where they should.

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Speaker 1: Value for debt.

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Speaker 2: He gave us an example.

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Speaker 3: If something is priced at eighty four cents on the

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Speaker 3: dollar and something is trading at fifty nine cents on

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Speaker 3: the dollar, that is a different picture that it's painting

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Speaker 3: for an investor. One signal's like really deep distressed, like

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Speaker 3: the companies in loads of trouble, and one signals kind

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Speaker 3: of stressed, like the company's in trouble.

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Speaker 1: But like, you know, there should be a path forward.

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Speaker 3: And you know, people invest in these funds, and I

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Speaker 3: think it's reasonable for them to be asking why there's

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Speaker 3: such a discrepancy.

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Speaker 2: After the break, will the private credit balloon pop? Hey,

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Speaker 2: we're back. Before the break, we were talking about the

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Speaker 2: striking rise of private credit funds, and Silas Brown was

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Speaker 2: telling us about how these funds essentially check their own homework.

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Speaker 2: They tell the market what the loans they hold are worth.

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Speaker 2: But sometimes what the private credit funds say their loans

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Speaker 2: are worth doesn't exactly match up to the way other

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Speaker 2: people value them. He gave us a drastic example.

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Speaker 3: This is like a really funny one. I still think

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Speaker 3: quite a lot about it. So when debt is marked

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Speaker 3: at one hundred, people say it's marked at par par,

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Speaker 3: which basically, you know, is the most performing metric. Effectively

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Speaker 3: that you can have a few examples that we've found

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Speaker 3: of companies that go into file for bankruptcy and then

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Speaker 3: the filing after that event marks the debt at par.

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Speaker 3: If you were in the public market, there would be

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Speaker 3: no way that after a Chapter eleven bankruptcy filing, which

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Speaker 3: is obviously a very serious thing to happen, that there

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Speaker 3: would be no kind of movement in the price of

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Speaker 3: the debt.

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Speaker 2: Those are the more obvious cases, but concern about the

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Speaker 2: lack of transparency in the private credit market overall is

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Speaker 2: increasingly getting attention. Here's former FDIC chair Shila Bhar speaking

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Speaker 2: about it on Bloomberg TV.

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Speaker 4: There needs to be a more holistic view among the

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Speaker 4: regulatory community about the risks that are going into the

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Speaker 4: non bank sector. You're having a lot of credit flowing

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Speaker 4: into these private credit funds. Now they're not such at

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Speaker 4: the same level of capital regulation and artist Transpori Syla said.

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Speaker 2: One specific thing that has caught the eye of people

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Speaker 2: watching this industry is the rise of what are called

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Speaker 2: payment in kind deals.

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Speaker 3: If you read our writing, you probably see this kind

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Speaker 3: of annoying acronym PIK quite a lot, and it's called

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Speaker 3: payment in kind loans. And what that means is that

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Speaker 3: instead of paying the company paying in cash, they'll stop

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Speaker 3: paying the interest on the debts for now and let

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Speaker 3: it accrue. There's very clever arguments for why it isn't

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Speaker 3: necessarily a signal of distress at all, but in some

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Speaker 3: cases it clearly is. By and large, Like if there's

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Speaker 3: an unexpected use of PICK and a company was paying

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Speaker 3: interest and is now saying they don't want to pay

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Speaker 3: interest and they're using pick to not pay interest, that's

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Speaker 3: kind of like not ideal for a lender.

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Speaker 2: And so, I mean, this growing concern from financial regulators

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Speaker 2: about private credit companies sort of signals a shift in

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Speaker 2: the initial enthusiasm about them. Right, you were saying they

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Speaker 2: were seen as an alternative to move the lending away

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Speaker 2: from bigger Wall Street banks and into these specialist firms.

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Speaker 2: What about the economy right now has people changing that stance.

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Speaker 1: Yeah?

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Speaker 3: So, I mean I think to play the defender of

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Speaker 3: the private credit market against those dastardly banks. What I

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Speaker 3: will say is the leverage models that they have in

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Speaker 3: private credit versus like investment banks. It does cause a

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Speaker 3: sigh of relief among regulators. The leverage levels are still

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Speaker 3: by and large substantially lower than what you would get

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Speaker 3: in in investment banks, So that's a kind of good

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Speaker 3: thing for private credit. However, I think as the market

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Speaker 3: is kind of booming, regulators are cognizant of the fact

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Speaker 3: that they don't know that much about what's going on

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Speaker 3: in this market. It's become this kind of pretty titanic

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Speaker 3: force in leveraged finance, and leverage finance is among the

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Speaker 3: riskier forms of kind of global finance, and so they

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Speaker 3: are sort of scratching their heads and not quite sure

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Speaker 3: what is happening. It doesn't necessarily mean that something's bad happening.

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Speaker 3: It just means that there is an information gap that

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Speaker 3: they're trying to kind of get to. But I think,

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Speaker 3: by and large, if I was a regulator, I would

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Speaker 3: think it's probably good that a lot of this risky

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Speaker 3: debt is out of the hands of banks. However, a

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Speaker 3: lot of the risky debt is in the hands of

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Speaker 3: specialist lenders and the investors of the risky debt are

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Speaker 3: also like pension funds that are relevant to the everyday

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Speaker 3: lives of people like you and I.

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Speaker 2: Yeah, I mean, so, what's the worst case scenario of

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Speaker 2: all this? If these loans are super overvalued, the whole

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Speaker 2: house of cards collapses. How big of a deal.

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Speaker 3: Is that someone who's covering the market. I'm often very

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Speaker 3: worried about an imminent collapse. I'm thinking about it quite often.

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Speaker 3: I think more likely what will happen is if the

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Speaker 3: kind of downside scenario, there will be a lot of

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Speaker 3: instances of defaults and debt f equity swaps, and it

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Speaker 3: will be companies crippled by higher interest rates and high

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Speaker 3: debt burdens, and lenders having to kind of cope with

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Speaker 3: potential losses as a result of those companies going into

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Speaker 3: default and going into kind of insolvency in some situations.

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Speaker 3: And so what was once a kind of market that

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Speaker 3: could have been defined by owning a basqueyat becomes a

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Speaker 3: market being defined by like owning some random company.

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Speaker 2: We've been talking about a lot of the risks, but

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Speaker 2: what are some of them that have been proposed, whether

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Speaker 2: by financial regulators or the private credit fund managers to

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Speaker 2: prevent these downstream impacts to investors if these valuations are

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Speaker 2: in fact too high.

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Speaker 3: I think they will be increasingly using and listening to

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Speaker 3: third party providers, people like Lincoln International and Hulahan low

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Speaker 3: Key and Deloitte places like that, who are by the way,

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Speaker 3: paid by the lenders, so they're not kind of like

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Speaker 3: totally independent assessors, but they do add this kind of

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Speaker 3: layer of scrutiny over the values of the loans, So

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Speaker 3: I think that's kind of helpful. I think the market

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Speaker 3: will probably benefit from industry bodies trying to kind of

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Speaker 3: create coherent set of standards for everyone.

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Speaker 2: So the private credit industry kind of came of age

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Speaker 2: in two thousand and eight. Does this feel like a

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Speaker 2: full circle moment for it as people start raising concerns

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Speaker 2: about its stability?

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Speaker 3: I mean, I think it's obviously boomed in a kind

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Speaker 3: of more benign environment, and now it's having to deal

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Speaker 3: with higher interest rates. But you know, I think most

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Speaker 3: people believe that it will carry on growing, just as

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Speaker 3: private equity will carry on growing. I mean, it serves

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Speaker 3: a pretty clear function for private equity firms, but it

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Speaker 3: hasn't really been through a full cycle yet, and you

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Speaker 3: could argue that the next like eighteen to twenty four months,

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Speaker 3: so like pretty defining for the market as it is now.

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Speaker 3: You know, in the two thousand and eight the situation

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Speaker 3: the market was kind of like infinitesimly.

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Speaker 1: Small versus what it is now.

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Speaker 3: And there's a lot more players, a lot more deals,

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Speaker 3: a lot more companies that are involved, and whether or

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Speaker 3: not the market has like underwritten debt in a kind

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Speaker 3: of efficient and like sensible way is definitely going to

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Speaker 3: be evident over the next two years.

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Speaker 2: This is the Big Take from Bloomberg News. I'm Sarah Holder.

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Speaker 2: This episode was produced by Adrianna Tapia. It was edited

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Speaker 2: by Caitlin Kenny. It was mixed by Ben O'Brien. It

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Speaker 2: was fact checked by Tiffany Choi. Our senior producers are

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Speaker 2: Naomi Shavin and Jill Duddy Carley. We get editorial direction

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Speaker 2: from Elizabeth Ponso. Nicole Beemsterborr is our executive producer. Sage

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