Speaker 1: Bloomberg Audio Studios, podcasts, radio news.
Speaker 2: There's a group of lenders who used to be kind
Speaker 2: of off the radar in the world of finance, but
Speaker 2: who now seem to be having a real moment. We
Speaker 2: heard about them from Silas Brown, a Bloomberg reporter based
Speaker 2: in London.
Speaker 3: You have seen this kind of cascading effect where these
Speaker 3: kind of figures have suddenly become these industry financial heavyweights.
Speaker 2: The kind of people who might.
Speaker 3: Have dinner with Barack Obama, mansions on both US coasts
Speaker 3: and dazzling wild not art collections from Fankstella to Jean
Speaker 3: Michelle Basquiet.
Speaker 2: So who are they. They are leaders of what are
Speaker 2: called private credit firms. Private credit firms lend money to
Speaker 2: all kinds of businesses, but they don't have the same
Speaker 2: level of oversight as banks do, and it used to
Speaker 2: be that they didn't get that much attention.
Speaker 3: It was seen as the less glamorous of the two options.
Speaker 3: Investment banking dealing with these kind of like big M
Speaker 3: and A transactions and powerful deals, and private credit would
Speaker 3: sort of pick up the scraps on the bottom.
Speaker 2: But as interest rates have risen the past two years,
Speaker 2: these firms have suddenly found themselves to be the new
Speaker 2: darlings of the lending world.
Speaker 3: Everyone seems to like have a view on private credit now.
Speaker 3: Everyone seems to be like considering setting up their own
Speaker 3: private credit firm, or you know, like being kind of
Speaker 3: rude about private credit or whatever.
Speaker 1: Everyone seems to have to have a view on it.
Speaker 2: But all this new found attention is also coming with
Speaker 2: heightened scrutiny.
Speaker 3: I think as the market is kind of booming, regulators
Speaker 3: are cognizant of the fact that they don't know that
Speaker 3: much about what's going on in this market today.
Speaker 2: On the show, we go inside the world of private
Speaker 2: credit to find out what we know and what we
Speaker 2: don't about how it operates and what the future might
Speaker 2: look like for the one point seven trillion dollars of
Speaker 2: assets these funds are managing. This is the big take
Speaker 2: from Bloomberg News. I'm Sarah Holder, so stilas, how did
Speaker 2: private credit companies get so big? How are they making
Speaker 2: bask Yard money?
Speaker 3: Private credit is, at its route a tool for private
Speaker 3: equity firms to buy companies. So private equity firms buy
Speaker 3: companies by using some money of their own and their investors,
Speaker 3: and then also some debts provided traditionally by investment banks.
Speaker 3: People a while back that now tens of years ago,
Speaker 3: thought that there might be a new way of doing it,
Speaker 3: which was that they would provide private credits, which is
Speaker 3: an alternative to the bank led markets. What happened two
Speaker 3: years ago is that as rates rows, banks became much
Speaker 3: more cautious around underrating these big deals and private equity
Speaker 3: needed to still do some of these deals. They did
Speaker 3: do much less of the deals, but the deals that
Speaker 3: they could do. They then thought, oh, well, how about
Speaker 3: we knock on the door of these lovely mid sized
Speaker 3: lenders who have scaled and who are getting more and
Speaker 3: more money, and perhaps they can satisfy the needs that
Speaker 3: were once met by the investment.
Speaker 2: Banks and Silas says. Because these lenders were willing to
Speaker 2: lend when others weren't, they were able to charge higher
Speaker 2: rates to borrowers, which meant they could offer relatively higher
Speaker 2: returns to their investors. All of this made them popular
Speaker 2: with pension funds and sovereign wealth funds. But the thing
Speaker 2: about private credit that now has people nervous is that
Speaker 2: it's private, Unlike a lot of traditional bank lending, where
Speaker 2: banks make loans to businesses and then bundle them up
Speaker 2: and sell them off to other people. Private credit continues
Speaker 2: to be held by the private credit firm, and because
Speaker 2: it's hardly ever traded, the only people who know what
Speaker 2: it's worth are the people holding it, the private credit firms,
Speaker 2: and they have an incentive to say that the loans
Speaker 2: are worth a lot.
Speaker 3: One thing that I think is fundamental to private credit
Speaker 3: is to do with the value of the loans. So
Speaker 3: in the traditional, lovely easy to kind of understand worlds
Speaker 3: of publicly traded debt, you can look at where the
Speaker 3: debt is trading versus you know, the sense on the dollar,
Speaker 3: and that gives you a good impression of how likely
Speaker 3: the debt is to be repaid. So like how risky
Speaker 3: it is private credit, it isn't traded. People hold onto
Speaker 3: the debt for the life of the loan, but they
Speaker 3: still need to ascribe a value to what those loans are,
Speaker 3: so they are kind of basically trying to work out
Speaker 3: what their assets hold.
Speaker 2: That seems a little like someone checking their own homework, right.
Speaker 3: Yes, which is a pretty suboptimal state of affairs for investors,
Speaker 3: but also for regulators who are trying to understand the
Speaker 3: health of the market.
Speaker 2: So the whole world of private credit seems, for lack
Speaker 2: of a better word, a little shady, or at least
Speaker 2: in the shadows.
Speaker 1: Is that how you see it, well, I.
Speaker 3: Think that's not how they see it. I think that
Speaker 3: much like kind of all private markets, there's much less
Speaker 3: access to information for outsiders, and the outsiders also include
Speaker 3: journalists that cover the market as well, and so we
Speaker 3: have much less data. We have to try to paint
Speaker 3: as accurate as picture as possible with fewer utensils than
Speaker 3: are kind of like public market piers. Not to suggest
Speaker 3: that there is anything nefarious underneath, necessarily, but private credit
Speaker 3: has kind of rapidly become much more significant than it
Speaker 3: once was, and so where an insignificant thing, not knowing
Speaker 3: much about it doesn't have much consequence in the eyes
Speaker 3: of many. Now people are a bit nervous about how
Speaker 3: little they know about it, and I think what we're
Speaker 3: trying to establish is to what extent can we believe
Speaker 3: the valuations?
Speaker 2: And the problem with trying to cross check the private
Speaker 2: firm's homework to look closely at how these valuations are
Speaker 2: being made is that the details behind the deals are
Speaker 2: not easy to get.
Speaker 3: In Europe, where I sit. There are no publicly available
Speaker 3: data points for what the valuation of these assets are,
Speaker 3: so me, as a journalist, will have to find some clever,
Speaker 3: disfuntled fund manager to sort of sit on a park
Speaker 3: bench with me and go through the marks of their fund.
Speaker 2: Did you sit on a park bench with a person
Speaker 2: like that?
Speaker 3: No, I didn't, perhaps due to my incompetence as a journalist.
Speaker 3: No one has yeah done that for me.
Speaker 1: But in the.
Speaker 3: US there is some visibility over valuations. Publish their valuations
Speaker 3: on a quarterly basis, so you can see through these
Speaker 3: things called BDCs, which are effectively kin lending vehicles for
Speaker 3: some of the major private credit firms, you can see
Speaker 3: that the valuations that they're ascribing to their deals.
Speaker 2: Silas and his colleagues wanted to compare the way private
Speaker 2: credit firms were valuing their loans and how the rest
Speaker 2: of the market might value them. So they ran a
Speaker 2: big data analysis using data compiled by Bloomberg and fixed
Speaker 2: income specialists Solve, and interviews with dozens of market participants.
Speaker 2: They found some eyebrow raising discrepancies. One scenario they looked at.
Speaker 3: Was situations where two private credit firms are both lending
Speaker 3: in the same deal, so they're both holding the same debt,
Speaker 3: but there can be really substantial differences in opinion about
Speaker 3: where they should.
Speaker 1: Value for debt.
Speaker 2: He gave us an example.
Speaker 3: If something is priced at eighty four cents on the
Speaker 3: dollar and something is trading at fifty nine cents on
Speaker 3: the dollar, that is a different picture that it's painting
Speaker 3: for an investor. One signal's like really deep distressed, like
Speaker 3: the companies in loads of trouble, and one signals kind
Speaker 3: of stressed, like the company's in trouble.
Speaker 1: But like, you know, there should be a path forward.
Speaker 3: And you know, people invest in these funds, and I
Speaker 3: think it's reasonable for them to be asking why there's
Speaker 3: such a discrepancy.
Speaker 2: After the break, will the private credit balloon pop? Hey,
Speaker 2: we're back. Before the break, we were talking about the
Speaker 2: striking rise of private credit funds, and Silas Brown was
Speaker 2: telling us about how these funds essentially check their own homework.
Speaker 2: They tell the market what the loans they hold are worth.
Speaker 2: But sometimes what the private credit funds say their loans
Speaker 2: are worth doesn't exactly match up to the way other
Speaker 2: people value them. He gave us a drastic example.
Speaker 3: This is like a really funny one. I still think
Speaker 3: quite a lot about it. So when debt is marked
Speaker 3: at one hundred, people say it's marked at par par,
Speaker 3: which basically, you know, is the most performing metric. Effectively
Speaker 3: that you can have a few examples that we've found
Speaker 3: of companies that go into file for bankruptcy and then
Speaker 3: the filing after that event marks the debt at par.
Speaker 3: If you were in the public market, there would be
Speaker 3: no way that after a Chapter eleven bankruptcy filing, which
Speaker 3: is obviously a very serious thing to happen, that there
Speaker 3: would be no kind of movement in the price of
Speaker 3: the debt.
Speaker 2: Those are the more obvious cases, but concern about the
Speaker 2: lack of transparency in the private credit market overall is
Speaker 2: increasingly getting attention. Here's former FDIC chair Shila Bhar speaking
Speaker 2: about it on Bloomberg TV.
Speaker 4: There needs to be a more holistic view among the
Speaker 4: regulatory community about the risks that are going into the
Speaker 4: non bank sector. You're having a lot of credit flowing
Speaker 4: into these private credit funds. Now they're not such at
Speaker 4: the same level of capital regulation and artist Transpori Syla said.
Speaker 2: One specific thing that has caught the eye of people
Speaker 2: watching this industry is the rise of what are called
Speaker 2: payment in kind deals.
Speaker 3: If you read our writing, you probably see this kind
Speaker 3: of annoying acronym PIK quite a lot, and it's called
Speaker 3: payment in kind loans. And what that means is that
Speaker 3: instead of paying the company paying in cash, they'll stop
Speaker 3: paying the interest on the debts for now and let
Speaker 3: it accrue. There's very clever arguments for why it isn't
Speaker 3: necessarily a signal of distress at all, but in some
Speaker 3: cases it clearly is. By and large, Like if there's
Speaker 3: an unexpected use of PICK and a company was paying
Speaker 3: interest and is now saying they don't want to pay
Speaker 3: interest and they're using pick to not pay interest, that's
Speaker 3: kind of like not ideal for a lender.
Speaker 2: And so, I mean, this growing concern from financial regulators
Speaker 2: about private credit companies sort of signals a shift in
Speaker 2: the initial enthusiasm about them. Right, you were saying they
Speaker 2: were seen as an alternative to move the lending away
Speaker 2: from bigger Wall Street banks and into these specialist firms.
Speaker 2: What about the economy right now has people changing that stance.
Speaker 1: Yeah?
Speaker 3: So, I mean I think to play the defender of
Speaker 3: the private credit market against those dastardly banks. What I
Speaker 3: will say is the leverage models that they have in
Speaker 3: private credit versus like investment banks. It does cause a
Speaker 3: sigh of relief among regulators. The leverage levels are still
Speaker 3: by and large substantially lower than what you would get
Speaker 3: in in investment banks, So that's a kind of good
Speaker 3: thing for private credit. However, I think as the market
Speaker 3: is kind of booming, regulators are cognizant of the fact
Speaker 3: that they don't know that much about what's going on
Speaker 3: in this market. It's become this kind of pretty titanic
Speaker 3: force in leveraged finance, and leverage finance is among the
Speaker 3: riskier forms of kind of global finance, and so they
Speaker 3: are sort of scratching their heads and not quite sure
Speaker 3: what is happening. It doesn't necessarily mean that something's bad happening.
Speaker 3: It just means that there is an information gap that
Speaker 3: they're trying to kind of get to. But I think,
Speaker 3: by and large, if I was a regulator, I would
Speaker 3: think it's probably good that a lot of this risky
Speaker 3: debt is out of the hands of banks. However, a
Speaker 3: lot of the risky debt is in the hands of
Speaker 3: specialist lenders and the investors of the risky debt are
Speaker 3: also like pension funds that are relevant to the everyday
Speaker 3: lives of people like you and I.
Speaker 2: Yeah, I mean, so, what's the worst case scenario of
Speaker 2: all this? If these loans are super overvalued, the whole
Speaker 2: house of cards collapses. How big of a deal.
Speaker 3: Is that someone who's covering the market. I'm often very
Speaker 3: worried about an imminent collapse. I'm thinking about it quite often.
Speaker 3: I think more likely what will happen is if the
Speaker 3: kind of downside scenario, there will be a lot of
Speaker 3: instances of defaults and debt f equity swaps, and it
Speaker 3: will be companies crippled by higher interest rates and high
Speaker 3: debt burdens, and lenders having to kind of cope with
Speaker 3: potential losses as a result of those companies going into
Speaker 3: default and going into kind of insolvency in some situations.
Speaker 3: And so what was once a kind of market that
Speaker 3: could have been defined by owning a basqueyat becomes a
Speaker 3: market being defined by like owning some random company.
Speaker 2: We've been talking about a lot of the risks, but
Speaker 2: what are some of them that have been proposed, whether
Speaker 2: by financial regulators or the private credit fund managers to
Speaker 2: prevent these downstream impacts to investors if these valuations are
Speaker 2: in fact too high.
Speaker 3: I think they will be increasingly using and listening to
Speaker 3: third party providers, people like Lincoln International and Hulahan low
Speaker 3: Key and Deloitte places like that, who are by the way,
Speaker 3: paid by the lenders, so they're not kind of like
Speaker 3: totally independent assessors, but they do add this kind of
Speaker 3: layer of scrutiny over the values of the loans, So
Speaker 3: I think that's kind of helpful. I think the market
Speaker 3: will probably benefit from industry bodies trying to kind of
Speaker 3: create coherent set of standards for everyone.
Speaker 2: So the private credit industry kind of came of age
Speaker 2: in two thousand and eight. Does this feel like a
Speaker 2: full circle moment for it as people start raising concerns
Speaker 2: about its stability?
Speaker 3: I mean, I think it's obviously boomed in a kind
Speaker 3: of more benign environment, and now it's having to deal
Speaker 3: with higher interest rates. But you know, I think most
Speaker 3: people believe that it will carry on growing, just as
Speaker 3: private equity will carry on growing. I mean, it serves
Speaker 3: a pretty clear function for private equity firms, but it
Speaker 3: hasn't really been through a full cycle yet, and you
Speaker 3: could argue that the next like eighteen to twenty four months,
Speaker 3: so like pretty defining for the market as it is now.
Speaker 3: You know, in the two thousand and eight the situation
Speaker 3: the market was kind of like infinitesimly.
Speaker 1: Small versus what it is now.
Speaker 3: And there's a lot more players, a lot more deals,
Speaker 3: a lot more companies that are involved, and whether or
Speaker 3: not the market has like underwritten debt in a kind
Speaker 3: of efficient and like sensible way is definitely going to
Speaker 3: be evident over the next two years.
Speaker 2: This is the Big Take from Bloomberg News. I'm Sarah Holder.
Speaker 2: This episode was produced by Adrianna Tapia. It was edited
Speaker 2: by Caitlin Kenny. It was mixed by Ben O'Brien. It
Speaker 2: was fact checked by Tiffany Choi. Our senior producers are
Speaker 2: Naomi Shavin and Jill Duddy Carley. We get editorial direction
Speaker 2: from Elizabeth Ponso. Nicole Beemsterborr is our executive producer. Sage
Speaker 2: Bauman is our head of podcasts. Thanks for listening. Please
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