The Bloomberg This Weekend Podcast News. Politics and the lighter side of Bloomberg. The Great Wealth Transfer includes $570 billion in classic cars. I'm not in the position to be inheriting any classic cars for you. No, but my brother didn't inherit my non-classic car when I moved to New York, so. Ooh! He still has not paid me for it! I'm in for you, Joey. The Bloomberg This Weekend Podcast. Subscribe today on Apple, Spotify, or wherever you listen. [Music] Hello and welcome to a special edition of The Credit Edge, a weekly markets podcast. My name is James Crumby. I'm a senior editor at Bloomberg, and I'm joined by David Havens and Paul Gulberg. Two of our ace analysts at Bloomberg intelligence. How you doing, guys? Great to be with you. Yeah, thank you. So we're here to talk about private credit, which is getting a lot of attention these days. Most of it negative. We've been through a bit of a panic over the last few months. Direct lending has a lot of exposure to software, which is being replaced by AI. The value of direct loans is in question. Some portfolios are being aggressively marked down. The SEC is probing where the black rock, the world's largest asset manager, is accurately valuing its loans. Business development companies, which give retail investors access to the high returns, promised by private credit are meanwhile, seeing massive redemption requests. I could go on, but let me start by asking you both, firstly, with David, what do you make of all this fear and how justified is it really? Well, James, what's the bad news? Yeah, there's been a slew of not so great news out about business development companies, direct lending and private credit in general over the past couple of months. From my perspective, I think that there's a lot of noise, and I think maybe the signal is being lost to some extent out there. Because if you go and look at the performance of BDCs in the first quarter, which is the easiest and quickest way for us to find public information on these companies, you definitely see a little bit of deterioration, but you don't see massive deterioration. If you look at, you know, we sort of go through about 30 of the largest BDCs, probably 80% of the industry, we're looking at non-accruals. They ticked up, they ticked up to 1.6% of the portfolio from 1.2%. That's a reasonable increase, more than we've seen in the past, but it's not a dramatic increase. And then if we look at other things like payment in kind income, it actually declined a little bit on a percentage basis in the first quarter of the year. So there's definitely been a lot of bad news. There's been a lot of negative media attention. But when you go and look at the portfolio, there's not a tremendous amount of distress in them. Paul, what's your view? Are you more worried than David? Or do you think we're ever estimating the actual extent of the damage? I don't think so. I think it's worth sizing sort of that market that's allowed to be redeemable. So if you think about $1.8 trillion of private credit, the funds that are redeemable, probably about 10% to 15% or so, if you add the asset banks and all these other things into the equation, that number is a single digits. So we went through the eight largest managers, including a blue aisle, blackstone and KKR, and except for blue aisle that has a slightly higher exposure, and blackstone that has a somewhat higher exposure because of the B-credit and B-read, to the funds that you can redeem. The actual funds for all the other ones that you can redeem, we're talking about less than 5% of credit assets, and even the smaller single digit number of the overall asset of those managers. So the institutional money is still coming in. The flows were pretty healthy in the first quarter, and as we walked out of the first quarter with the guidance, the guidance is still looking to fundraise in the cross-the-business potentially more than them in last year. I also think it's important to add on about the redemptions that the, you know, there's a lot of attention given to the gates coming down and people being restricted from getting money out of funds, which is that that's obviously not an ideal situation, but a much less ideal situation would be people being able to take money out of these funds whenever they wanted to, because you'd have a significant mismatch of assets and liabilities. You'd have fundamentally illiquid assets being backed by liquid liabilities. That would be a recipe for disaster for these funds. So the gates are actually a defense mechanism for the funds. But for people who are not very deep in the weeds of private credit or even know what it is, I mean, just the idea that there are thousands of retail investors trying to get out all of a sudden, you know, from a market that had grown very, very quickly, it's immediately, you know, concerning that, you know, what do they know about what all this, you know, what's in these portfolios, what are they worried about, and do they know something that's terrible that we should know, and I'm not asking any questions. I'm going to leave. I'm going to get out now. Well, I can do, do you not think that that kind of fear, you know, has it has a kind of ability to feed on itself and also bring in institutional outflows at some point. So what, so what we got from the survey and the survey that we've done a while back in the middle of April, where all the headlines were out there, that's an institutional survey across the investors, the LPs, the managers, the GPs and the bankers who support that space. And on the institutional site, yes, they fully acknowledge the risks that come from the wealth space, they also acknowledge potentially slower inflows from the wealth space in the shorter term. But what they're not seeing is necessarily longer term slow down and demand for the private credit assets, they still see that structure will move into that space. I think you also see in the in the survey, you know, this institutional client base or this institutional group of their not clients, this institutional group takes a longer term strategic views. So they're they're looking out, you know, over the course of several years thinking in terms of what, you know, what their own business strategies might be if you're a bank or what your own investment strategies might be if you're an asset manager. And they don't necessarily respond to immediate headlines. And then if you drill down into the redemptions, the retail investors that have been driving some of this, there tends to be a concentration of, you know, some some kind of whale type investors that are. I think if I'm not mistaken, I think a fair amount of the sort of harder money that we've seen is actually international money as well. Is there a reason why they want to get out now though, what was the trigger? James, a lot of these large investors mostly, most of them are substantial sized family offices that invested in the space. A lot of that was a pure arbitrage because the publicly traded BDCs, they were trading at 20 to plus discounts to net asset values. So you have similar types of assets, one that has a panic and does not have the gates and has a much lower NAV and the public space and other ones that the private BDCs where you cannot get out and do not have to revalue them to the extent of absolutely crazy market. So as an arbitrage, you pull out a one and you get in a 20% discount and a similar types of assets. And this is typically the larger sophisticated family office investors. Okay, I mean, I'm not going to call them done money, but it is on page one of some of those perspectives is that the fund has the has the, you know, the ability, but not actually the obligation to redeem up to 5% and they don't have to do anything. I don't think if they don't want to is that right David, they don't have to redeem. They don't the convention is to limit redemption is to 5% per quarter. We saw blackstone in someone else, them feeling to recall right now, go above that 5% redemption amount. But they don't have to redeem anything. You know, the board of directors, you know, has a discretion to make decisions that are in the best interest of the sort of food judiciary responsibility of the fund, but 5% is a pretty reasonable number, I think. Okay, just taking to this with the same. I mean, we're going to have probably in about a month or so. Another redemption window, they come up every quarter, each fund will have to report how much that they were asked to to get back and how much they actually did get back. Are we going to go through the exactly the same thing again, because you know, those who didn't get out last time, they still want to get out today. I would guess probably yes. So if we think about the experience of the period, the real estate privately managed fund by blackstone, but two years ago when the rate started going out, there was a similar reaction and kind of a panic. Could get out. Took about three plus quarters for those to start turning around to become net inflows from the outflows, but now the fund is doing well till years later. Yeah, and I think that maybe if he just sort of think in terms of net, you know, sort of redemption requests and then, you know, sort of the overall net flows. I think probably where we're going to what we're going to see is maybe a little bit of a buyer strike in terms of terms of the sort of subscription for new shares in these private BDCs. Okay, so we can all put in our calendar another private credit free count in a few weeks or months and just get used to it. But going back to the survey, Bloomberg intelligence in an effort to bring transparency to this market, you did a survey. It was I think first half of April you asked 140 participants.
to answer a range of questions. There was a variety of different respondees throughout the world. What were the surprises for you, David, from that survey? - Yeah, well, I think something that I think comes as a little bit of a surprise is the, is it people maybe weren't gloomier than you would have expected? If you sort of think about when the survey went out and went out, you know, at a point when maybe media attention around private credit direct lending was about as negative as it possibly could be, but I think that what you saw is the, you know, primarily institutional investors that are, or institutionally oriented observers that are looking at private credit. I think they sort of take us over view. And I think that, you know, they recognize that there are, you know, maybe an increased amount of risks around the industry, but I think they also continue to view it as a sector that has sort of long-term attractive features and you know, fits into portfolios and has pretty good long-term prospects. - What jumps out for you, Paul? - I think it's, a lot of it has to do with the actual cyclical reaction from retail investors and how institutional investors are different. So we ran this survey every six months for the last couple of years. Last one, we've done the September, the one before we ran an April. And in April when the tariffs were announced last year, that was a real freak out. So the numbers and the expectation of growth and the penetration of a traditional fixed income market. So almost every metric, it was done very substantially because people were thinking about very serious and certain potential damage to the economy and the real credit issues, right? So now we are in the area where most of the issues are kind of more cyclical have to do with the investor reactions to the headlines and so on. So that's why for institutional investors, you see them very relatively calm reaction. - Yeah, and one of the other things that sort of jumped out is that there was a sharp increase when we sort of talked to people or asked people about the risks that they saw in terms of growth. One of the things that really came from kind of nowhere being flagged to catching a significant amount of attention is the erosion of underwriting discipline. So that was a pretty significant change from previous surveys that we've run to this one. And then the other one that sort of stood out a little bit is regulations. People used to be a lot more focused on regulations and the regulatory impact that you might affect private credit. That's less of a concern today than it was before. It seems to have been supplanted by, you know, credit quality and underwriting discipline. - Erosion of underwriting discipline, though. That's an immediately alarming sentence. David, expand on it. Please tell me more. - I think that there's some concern, and this concern has been, you know, sort of I think growing for a period of time, is that the success of private credit has drawn in, for lack of a better term, tourists into the industry. And I think that there's some concern, you know, out there in the marketplace that maybe some of the newer entrants in order to gain market share and make an impact and grow their businesses, maybe doing loans on terms of conditions that aren't as conservative as maybe some of the longer term players would like to see. - So that's just gonna mean problems down the road, more defaults, more pick, more non-accruals, all of that is yet to come. - Could be. I think all that really links back, I think that primarily links back to what's going on in the economy. But it puts the overall sort of portfolio as a company is in a more vulnerable position. - Because the message I've been getting over the last, you know, a few months while all this noise was going on was that, oh, we've all become much more diligent. We've all, you know, done a lot more work. We're all paying a lot more attention because the risks are there, and we know that the spotlight is on us. But this survey would suggest the opposite that actually people are just as loose with the underwriting terms as they were in the, so-called golden days of, you know, last year and the year before. What do you think about that pool? Is that worrying at all? - Certainly is. I do also think that it has to do with the respondents for the survey versus the actual managers, right? From what, when you hear in the commentary. So the respondents seen some concerns, but the managers not necessarily have been absolutely loose. You're also kind of, they have to think about large managers versus smaller managers. So the ones that David called tourists. So if we do get the cycle going through the industry, it could actually make the larger managers stronger because we did see a lot of the flows and a lot of the action happening within the largest managers, right? So if you think about the other assets that they manage, the insurance money and all these other things that are also in a private credit domain, but not accounts and that $1.8 to $2 trillion private credit number, these are all the businesses that can actually attract the money, all right? That we've seen inflows into opportunistic funds in the secondary credit. So all the other things that these guys do that we're not really necessarily seeing for kind of one product funds. - I think that, you know, one of the things that maybe stood out a little bit more was the focus on market downs. So two, I would say two things. I would say, you know, we asked a question like what do you look at as sort of a leading indication that the problems might be growing in the sector. Mark Downs is the response that came back with the most frequency. Pick was not the answer. - Okay. - And then we also, we also, or something that also came back was a fair amount of concern about the valuations out there at the marks. And, you know, I think that's a pretty recurrent theme that comes back, you know, from a lot of different people. My personal view is that it's somewhat misplaced in private credit because I think that it's two sides of the same coin. In private credit where you've got funds that are sort of being run with assets to maturity where you've got limited redemption capabilities. You don't have that daily, you know, sort of liquidity demand risk in place. And you're dealing with level three assets which are difficult to value assets. The marking to model kind of makes sense. But if you're living in a different world where you've got a trading book and you're trading in and out of securities, then you really do need to make sure that your mark is closely as possible to market. But in the case of some of these assets, there just isn't a daily market for some of them. If they traded them, trade by appointment makes it difficult. - And you've also noticed that some of the loans are valued differently by the same loan by different BDCs, a different valuation. - Yeah, I think there's a famous example in the third quarter last year where there was a significant, a large loan, medallia, which had a 12 or 15 point difference in terms of, in terms of the mark. That came back into alignment later. But if you were trading, I think that one guy should sell or buy to the other or vice versa, if that's the case. - Yeah, it also costs someone $5 billion, isn't it, in terms of losses on medallia? - It's a big one. - It's a big one. - Yeah. - I'll just have to wait for a pilot to deliver in the promise of daily and a V's for the credit fund. So that's common, let's see where and let's see who's followed. - Yes, I look forward to that. The other thing that the public liquid markets so-called are pushing back on is the kind of value, the liquidity premium of going to direct loans, private credit versus staying in junk bonds or leverage loans, which you can trade. And you get quite a lot of information on the pricing. The spread premium between the two, that's a much argued topic. What does your survey say on that? - Most of the responses are in the range of about 300 to 300 basis points in terms of liquidity premium. So they average somewhere out to 100. And this is what would typically get from the managers, which this is what would typically kind of see in the market in terms of those funds. And it's been extremely stable. That number has been just stuck there. - And the other thing that people are looking at closely now is fees, are they holding up for private credit? - Yeah, fees are holding up reasonably well. I think it's sort of been a little bit eroded by the makeshift because there are a lot more insurance assets, kind of high quality investment. Great assets being originated. They don't carry as much of a fee. The back-to-back up there knew which is, but typically if we look at the product by product, the fees have been very, very stable for the space. - Yeah, what we did see, which was kind of interesting is with FSK, FSKKR, one of the larger public BDCs. It's gotten itself into a little bit of a pickle because it did get downgraded below investment grades. It's a fall and age right now. And that dramatically increases its funding costs. And that's because they've had some lingering problems in their credit problems in their portfolios. The manager, in this case, one of the affiliates of KKR stepped back in center fees over the next year or so. So that's a way of kind of, obviously that reduces the fees, but it also enables the fund to sort of regain a little bit of capital along the way. - So private credit isn't going away even through this massive storm, but I'm guessing it just grows more slowly. Maybe it has more challenges about selling to retail. What was the good news from the survey?
the opportunities? What are people most excited about in terms of growth for this market? So in terms of growth, a lot of the action is what you kind of seen in the few things that I mentioned, one, the opportunistic secondary, all these new things, but more specifically to the survey. So it's the replacement of the fixed-think, a traditional fixed-think, there are still demand and interest in going private in many areas. One of the areas where we've seen an uptick of expectations so was an asset-backed finance and we keep hearing it being a growth area, there is more development happening in its space. So if we look at the replacement potential across US and Europe, Asia does very small extent because it's kind of not happening as quickly, relative to the US, it's kind of US, Europe and then Asia. It's about 15% the expectation for replacement. When we looked at the asset-back, the expectation right now just overcame 20%. So it's in the low 20% expectation much, much higher. And if we take these numbers, so we think about $45 trillion addressable market in the traditional fixed-think on that can be sort of approached by alternative assets by private credit in particular, we put in 15% of it, it's $4 trillion of assets and even some blended fee between all these strategies and so on, that could be $40 plus billion of fees out there in the pipeline. Again, we're not talking about three years out of five years out, it's more like 10, 15 kind of longer term pricing, but there's a lot of opportunity there. Yeah, and the asset-backed deal Citigaine done, you know, data centers, they're an example of them. They check a lot of boxes for sort of all of the parties engaged. It's often insurance companies that are buying the assets because the bulk of the assets that end up being secured has, carry-truple-be ratings. So it works from a regulatory perspective for an insurance company and they get an extra 100, 150 or even more basis points of spread for that asset. The companies that are building the data centers, see a meta or whoever it is, rather than using their own cash from day one or taking them on debt to fund it on their own balance sheet, they're able to do it through this asset-back structure where they agree to a stream of lease payments, which reduces the leverage impact on the corporate entity. So kind of, and then of course the person that arranges at Apollo or whoever, you know, plots would pretty nice feel on the way too. And just to be clear by replacement, we are talking about let's say traditional fixing-come portfolio has some junk bonds and some high grade bonds and some loans in there, but 15% of that could end up going into private credit, is that right? It's a little bit different. It's more of a from a nishier perspective. Okay. Think about a nishier who had a loan from a bank or who issued a bond. They're now trying to diversify the sources, including the asset back and so on. So in about 15% of the cases, people who usually went to this market can turn to the private market for different sorts of solutions. Wouldn't they get better execution by publicly syndicating and making a, you know, as much demand as possible and tension between different buyers and all that that would squeeze the price? It is true that might get a better spread in the public market, but with, for example, David just destroyed the very bespoke structure for the, let's say, data warehouse. Listen, it's something that only you need to work with, like one lender or several lenders, something very uniquely in bespoke to build for you versus a syndicated loan. It also provides other things kind of quickery execution, one-on-one negotiations. And if anything goes different with the loan, especially like AI and everything else, everybody's talking about trillion dollars of cat-backs, but it's still kind of unproven and we don't know how it's going to work. So if at any time in the future you need some sort of renegotiations, some term structure and change. If you took that loan from a bank and the bank's syndicated, it's very difficult to really negotiate this terms of the loans. If you have a bilateral kind of work through with the particular lender, then it's much easier to adjust to change an environment. And James, you'd also asked about the growth outlook and maybe what might be a surprise there, or maybe not a surprise. But we've been through four iterations of this survey. And one of the questions that we've asked each time is to what extent? Can you put numbers on what your growth expectations are over the next five years? And in each of the four surveys that we got back, about 90% of the people, oh, actually, they're only about 10% of the people saw growth of 10% or more annually. That number is kind of held steady. So the most people see growth in the five to 10% range. That's 47% of respondents came back looking at 50% growth. That's up 1% from the previous survey. It's up 5% from our first survey. It's down slightly from our second survey. So the growth expectations haven't changed dramatically. Even though this survey went out kind of when things felt the worst. But it isn't monkey. That was growing at much higher rates, isn't it? So the direct lending side of the market was growing at a much higher rate. Yeah. If you sort of think it turns a private credit overall, it's a larger ecosystem than just direct lending. I want to finish up by asking you whether this thing still works for retail. What kind of read did you get on that? Because that seems to be the one that a lot of big firms, like a poll of Pinder hopes on reaching this multi-trillion dollar part of 401k money in this country, but then also elsewhere in the world, it would seem to make sense that you can use this for your retirement and just put it away and come back in 20 years. But does it still work for retail given the problems that we're facing with BDCs? I should. It probably needs a better education. Maybe those things should not be called semi-liquid, but should be called something else. But essentially, if you think of the alternative assets in retail portfolios and globally, we're talking about a hundred trillion dollars of some estimates of much higher. And it's low single digits. So there is still a way to allocate to those. In terms of the 401k plans in the US, so the defined contribution over the 13th fortune trillion dollars of assets out there, it does make sense exactly as you describe in the Department of Labor just put out some letters for comment in terms of trying to get legal protections for the fiduciary responsibility. So those actually can be going into the response, but yes, liquidity is always going to be a concern. So it would have to be somewhat limited portion and the high fees is definitely going to be always part of the conversation. But logically, there should be a portion of those assets in the retail portfolios. And it seems like there probably needs to be some, obviously some heightened disclosure, changes in the disclosure. But if you look at the performance of retail oriented private credit over the past 10 years or so, it's been relatively low volatility and has been relatively high return. So the track record has been quite good. Obviously, that doesn't predict the future in every case, but the track record has been good. And the survey results would suggest that this big storm, we've been through, we'll blow over and private credit will emerge to the other side and start to grow again. But are there any things out there that kind of worry you at this point that you think we should be paying more attention to in terms of the risks? I think that I've always thought that the biggest risk facing leveraged middle market companies is the economy. There are other risks out there like the impact of AI on software and things like that. But I think that you really need to watch the economy right now. I think that the consensus forecast that we have, not we have, but the consensus that we have put together here at Bloomberg shows about a 30% probability of recession over the next year in the United States and 2% GDP growth in 2026 and 2027. And if that holds true, then I wouldn't expect a tremendous amount of credit deterioration. Totally worried about anything. I don't worry about the headlines. You didn't mention obviously that they'll probably going to have another quarter of those, maybe a few quarters, right? So things are going to keep coming back and headlines are still going to be negative focused on the very small portion of the market. So it's sort of becoming slightly infectious and weighing on the wealth side of the business. So again, I wouldn't ignore it completely as not being a risk. And I think the survey acknowledged that as well. Great stuff. David Havens and Paul Goldberg, two of our ace analysts at Bloomberg Intelligence. Many thanks for being on the credit edge. Great being really James. For more credit market analysis and insight, read all of David and Paul's great work on the Bloomberg terminal. Bloomberg Intelligence is part of our research department with 500 analysts and strategists working across all markets. Coverage includes over 2000 equities and credits plus outlooks on more than 90 industries and 100 market indices, currencies and commodities. Please do subscribe to the credit edge wherever you get your podcasts. We're on Apple Spotify and all other good podcast providers including the Bloomberg terminal.
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