Private debt is out of control

In financial journalism we have something called the Inbox Indicator — whatever we get the most spurious PR emails about is usually the most egregiously overhyped bullshit of the day.

For a looooong time it was crypto über alles. Nothing else came close. Even after writing a column comparing it to Albanian Ponzi schemes you’d get instant pitches for follow-ups focused on this or that blockchain or some random shitcoin.

Crypto remains a perennial inbox scourge, but for a period it was overtaken by ESG, and more recently anything to do with artificial intelligence. However, over the past few months private debt has emerged from the pack. It is, after all, enjoying a “golden moment”, according to Blackstone’s Jonathan Gray.*

My inbox tells me that I’ve personally received over 100 emails mentioning “private debt” or “private credit” since September 24, and that doesn’t even include the ones I summarily delete.

Now, there are even pitches for actual funding from randos on LinkedIn:

Look, FT Alphaville could certainly do with $50-200mn. We could roll out more pub quizzes, get personal Bloomberg terminals, resurrect the Long Room, restart Markets Live, get Louis a Photoshop assistant, and launch a hostile takeover of Unhedged to make Rob and Ethan our manservants.

But we are not . . . how best to put this . . . very creditworthy. Definitely sub-investment grade. Our balance sheet is optimised for snark, not free cash flow or healthy interest coverage. We once seriously considered buying one of those bull statues they park outside crypto conferences, for no other reason that it would be funny to have next to our desks at FT Towers. (We couldn’t afford the shipping.)

That we are now getting cold funding offers is both hilarious and disconcerting. Sure, it could just be a fraud. But this is an industry that — despite whispers of a lot of extending-and-pretending going on in the background — still seems to be raising money more quickly than it can be invested.

Of the estimated $1.5tn size of the private debt industry, about $400bn is still un-deployed “dry powder”, according to Apollo’s latest private capital markets report.

As the chart indicates, things slowed down a little in 2022, but anecdotally seems to have revved back up again this year.

In its latest five-year private capital outlook, Preqin forecasts that private debt will nearly double in size to $2.8tn by 2028, after most investors it surveyed said they planned to chuck even more money at the asset class.

Responses to the Preqin Investor Outlook Alternative Assets H2 2023 suggest the outlook for private debt remains bright, despite difficulties for the economy. Of respondents, 90% said that private debt met or exceeded expectations. It is the on ly private asset class for which most LPs expect returns to improve over the next year. it is also unique in that most respondents intend to increase their allocations over the longer term.

BlackRock thinks even Preqin’s outlook might be a tad pessimistic, and recently predicted that the industry would hit $3.5tn by then. No wonder Jamie Dimon said earlier this year that the industry was “dancing in the streets”.

In fact, as the recent tie-ups between Wells Fargo and Centerbridge illustrates, finding enough opportunities is becoming an increasingly big challenge. Even JPMorgan is now looking for a partner. LinkedIn pitches add to the anecdotal evidence of ravenous demand.

It’s natural to feel a teensy bit worried by this. The Inbox Indicator’s history is certainly instructive. But to rehash some of the more specific cons Alphaville listed earlier this year:

— There’s almost certainly been a lot of silly lending going on in private credit. Most finance types have a natural tendency to defend their own asset classes, but when FTAV has chatted with people in private credit they all admit that things have gone a bit bananas. They all just insist that they have remained sober and careful, it’s everyone else who has lost their minds. This is . . . unnerving.

— Private credit is extended to corporate borrowers in the form of floating-rate loans. That’s good for investors when rates rise — but only up to a point. At some point, these companies won’t be able to keep servicing their debts. Base rate + 800 bps is a lot easier to handle when rates are near zero than at 4-6 per cent.

— So if the US economy does slump into a recession, a lot of borrowers in private credit markets will probably be toast. And recoveries in this space are faaar below what they are in large liquid public debt markets. A lot of loans will become zeros very quickly, and getting out is basically impossible because a lot of this is not designed for being traded.

— It’s hard not to feel a little disquiet over the increasingly incestuous private capital ecosystem where firms with both big private equity and private credit arms are investing and lending into each others’ — and their own — deals.

It’s not just Alphaville that is a bit worried either. Pimco warned recently that risks are building up, warranting regulatory action, and some of the credit rating agencies reckon it could even become a systemic issue.

Here’s what Moody’s said earlier this autumn:

Risks are rising as major lenders jockey for capital clout and returns. Alternative asset managers are turning to individual investors, introducing liquidity risk into the private fund market where it did not exist before. Increased concentrations, conflicts of interest and lack of regulation underscore risks. The rapid growth of PE has pushed more economic activity into the hands of a few large asset managers, with strategies that increase leverage for mostly middle market businesses. Lack of visibility will make it difficult to see where risk bubbles may be building. These trends could have repercussions for the broader economy.

All that said, we’ll let you know how Alphaville gets on in securing a $50mn credit line at 500 bps above LIBOR.

*Ugh, it was Jon Gray who called it a golden moment, not Marc Rowan. Rowan called it a “great time”.