Private Credit Funds (3 Articles)
~ Sunday, November 26, 2023 Blog Post ~
Article #1: Private Credit Funds Are Hot. Here Are Their Strengths — and Weaknesses. (From Barron’s)
By Amey Stone, November 3, 2023
Wealthy investors with a financial advisor whispering in their ear are hearing a lot more about private credit funds lately. These funds typically make direct loans, which have floating interest rates and, thanks to Federal Reserve hikes, boast yields in the low double-digits.
Private credit funds have characteristics that should allow them to hold up well even if the economy turns south — though the rush of assets these days makes some advisors cautious. “We’ve been putting clients in private credit for years and it’s been a wonderful asset class for us,” says Leo Kelly, founder and CEO of wealth management firm Verdence. “But I get nervous when things get hot.”
Like other alternative investments, private debt funds were mainly the purview of institutional investors until the past few years (see chart). There are now many more ways for retail investors to take part. Fidelity, BlackRock, KKR, as well as numerous smaller players, are offering new funds. Many private credit funds only allow for quarterly redemptions, and even those can be restricted if too many investors head for the exits all at once. Plus, they may have high minimums and fees.
A big reason for their popularity is how well they held up last year when both stocks and bonds fell sharply. Private debt funds returned 4.2% in 2022 compared with declines of 18% for the S&P 500 index and 15.7% for investment-grade corporate bonds, according to PitchBook.
Brad Marshall is global head of private credit strategies at Blackstone, which offers the $48 billion Blackstone Private Credit fund, known as BCred. Coming up on three years since its inception, BCred boasts an annualized total return of 9.8% and a current yield of 10.5%.
Marshall sees two phases in private credit’s growth. In 2020–22, investors were thirsty for yield and wanted to be in a floating-rate fund while the Fed was hiking rates. “Today something else is going on,” he says. Now investors are looking for defensive qualities that private credit offers, he says.
BCred, as well as most direct-lending funds, makes senior secured loans to midsize companies, meaning they’re first in line to get paid back in defaults. Direct-lending funds often make hundreds of loans, so they are diversified. Since they lend directly to borrowers — mostly companies with strong cash flows in growing industries — they can often negotiate strong investor protections, or covenants, says Brad Schneider, head of private credit at Cresset Partners. One of the benefits of private credit is that when a company hits a snag, lenders can figure out a way to solve the problem — perhaps adding more protections or getting a bit higher rate, he says.
“These funds invest high up in the capital structure,” says Torsten Sløk, chief economist at Apollo Global Management, which has its own private debt vehicles. “They stay away from names that will get hit by recession. They have the best protections because they have the right covenants in place.”
Since the securities aren’t publicly traded, private credit funds tend to be less volatile than their publicly traded counterparts, such as business development companies, or BDCs, says Mike Terwilliger, portfolio manager of the Alternative Credit Income fund (ticker RCIIX), which can move between private and public credit. Right now, he says he is finding a “deeper arsenal of opportunities” in private credit but may shift to buying more public credits, which in a downturn can typically get very cheap. Private credit isn’t subject to swings in market sentiment. “Those valuations faithfully represent the fundamentals of the business, not the whims of the market,” Terwilliger says.
Kelly is watching to see if too much investor money starts chasing too few private credit deals, which could lead to weaker credit terms. But the opposite seems to be the case now. Companies are turning to direct lending more than ever, and the pipeline is expected to continue to grow.
The biggest risk for private credit investors is tied to risks facing credit investors more broadly: The economy is slowing while higher interest rates are eating into cash flows of many companies, making it harder for them to pay back loans. Richard Daskin of RSD Advisors is wary of credit risk in general — and private credit in particular — because investors in gated funds might not be able to pull their money out in a downturn.
“There are attractive opportunities, but you have to be careful and selective,” says Mariia Eroshin, a managing director at Certuity, which provides financial guidance to wealthy families. “We’re looking for short duration and low leverage. Investors get a premium for the illiquidity risk of private investments, but that risk needs to be taken wisely and thoughtfully,” she says.
Clearly, private credit isn’t for everyone. The funds can feel like a black box. Dan Pietrzak, global head of private credit at KKR, notes there is increasing diversity in the asset class. “Private credit is broader than direct lending,” he says. KKR in fact, is launching a new fund that has a sizable allocation to asset-based lending, according to a filing reviewed by Barron’s.
Many investors are worried about high stock valuations in a slowing economy, and private credit looks like a good alternative. “It seems like it solves a problem,” says Evan Lorenz, deputy editor at Grant’s Interest Rate Observer. “But those higher yields come with some risk.”
A small allocation may make sense for wealthy investors who don’t need to worry about tying up their money for a longer time, Eroshin says. Even then, “there are a lot of things to consider. You need a thoughtful and careful approach.”
Source:
https://www.barrons.com/articles/private-credit-funds-alternative-assets-carry-risks-12ab8a09
Article #2: How Risky Is Private Credit? Analysts Are Piecing Together Clues (From The Wall Street Journal)
By Ben Foldy, November 10, 2023
A recent analysis offers a view into the booming market
A boom in private credit has been moving a huge portion of corporate borrowing away from public view, taking it from the world of banks and the bond market and into the more opaque realm of private funds.
Now analysts are piecing together clues showing how risky those loans might be.
A recent analysis by S&P Global Ratings used the firm’s confidential credit assessments for clients to offer a rare view of roughly 2,000 private corporate borrowers with more than $400 billion in debt between them. Without identifying the companies, the firm ran stress tests to see how they might fare in varying economic scenarios.
The findings offer a glimpse into the private credit market, which grew in popularity after the financial crisis in 2008–09 and surged more recently after conventional lenders pulled back following this year’s banking crisis.
Much of that private lending has gone to smaller, less-profitable companies that are already loaded with debt. With the market growing, the Securities and Exchange Commission recently approved new rules for private fund managers.
The S&P analysis offers a snapshot of the market in the meantime. The firm’s analysis looked at midsize companies with corporate debt pooled in collateralized loan obligations. Since slices of many of those loans are also directly held by private credit funds, S&P said the sample represents a sizable portion of the private credit market.
S&P used the confidential “credit estimates” that it provides to collateralized-loan managers for companies with private debt in CLOs. The estimates are akin to credit ratings and tend to be updated about every six months on average.
The tests showed that many of the companies that have turned to the private credit markets would struggle with any financial stress if the Federal Reserve’s interest-rate policy was to persist.
“If rates stay higher for longer — or higher forever — then these companies are not equipped,” said Ramki Muthukrishnan, head of U.S. leveraged finance at S&P Global. He said companies would struggle to pay their debt.
Just 46% of the companies in the analysis would generate positive cash flow from their business operations under S&P’s mildest stress scenario, in which earnings fell by 10% and the Fed’s benchmark rates increased by another 0.5 percentage point, the ratings firm said.
Private credit sponsors would be left facing difficult choices over which companies to keep supporting, Muthukrishnan said.
“It needs to make economic sense for them to throw good money after bad, and they have a whole lot of companies in their portfolio,” he said.
S&P has been lowering scores on several of its credit estimates, a move similar to a downgrade on a rated bond. The firm lowered its scores for 87 companies into its “ccc” territory from the start of the year through the end of August, a heightened rate similar to that at the start of the pandemic.
The firm said the downgraded companies often had capital structures it viewed as “unsustainable absent favorable economic and financial conditions, or upcoming loan maturities without a definite plan to extend, refinance, or redeem the debt.”
Separately, analysts at Bank of America said recently that they expect the rate of private debt defaults to reach 5% next year if interest rates remain high.
Some recent higher-profile bankruptcies involved companies that used private credit. The orthodontics company SmileDirectClub filed for bankruptcy in September, after borrowing $255 million in a private loan last year. Bed Bath & Beyond took out a $375 million private loan last year before filing for bankruptcy in April.
S&P’s analysis wasn’t all gloom.
The firm found that many of the companies appear to have some runway left. Under current conditions, the companies in S&P’s sample had a median liquidity of nearly 2½ times as much cash and other assets available to cover their needs, including maturing debt.
Companies also have some time for rates to come down. While roughly $30 billion of debt is set to mature next year, that balloons to north of $60 billion in 2025 and nearly $100 billion in 2026.
Source:
https://wsj-article-webview-generator-prod.sc.onservo.com/webview/WP-WSJ-0001352205
Article #3: Buy Now, Pay Later Lender Is Surfing the Private Credit Wave (From The Wall Street Journal)
By Telis Demos, November 9, 2023
Demand for higher-yielding alternative consumer loans is helping out Affirm
Higher interest rates were supposed to put an end to the fast growth of buy now, pay later lenders. But right now they might actually be helping out.
Unlike banks that fund their loans through their deposits, BNPL players that offer small loans and installments to shoppers need to get that money from the market, as do other nonbank financial-technology companies. So they are, in theory, more exposed to the cost of rising interest rates.
That was a big reason that many investors expected banks to regain the upper hand versus their disrupters, leading to a sharp drop in valuations for many fintech highfliers, including Affirm, over the past couple of years.
Yet things haven’t been quite so straightforward this year. Many banks’ deposits aren’t proving nearly as steady or cheap as they had hoped. Plus, they are being forced to offload or curtail some of their consumer lending as capital requirements rise.
Meanwhile, Affirm appears to be finding demand for its loans from investors looking to tap in to the higher yields it can offer them. Pension funds have been enticed by returns on credit that can now rival what they were expecting from stocks. Similar demand is boosting alternative asset managers, such as Apollo Global Management and Ares Management, which have seen strong flows from investors and insurers that want alternatives to traditional credit.
Affirm said Wednesday, when it reported earnings, that it has added more buyers of loans to its funding platform. This follows comments in September by Chief Financial Officer Michael Linford, who told analysts that many of the largest asset managers were really interested in credit. “Credit right now is an asset class that I think is getting a lot of attention, and we’re the beneficiaries of that,” he said
Gross merchandise volume, or the total dollar amount of transactions, was $5.6 billion in Affirm’s most recent quarter. That was ahead of the $5.4 billion analysts were expecting, according to Visible Alpha. On top of that, Affirm also managed to monetize a larger percentage of that volume, with its revenue net of transaction costs as a percentage of volume rising to 3.8%, from 3.4% the prior quarter. That meant that as much as its funding costs were higher, the revenue it was generating from interest and merchant fees rose more.
Overall, Affirm’s total net revenue grew 37% year over year to $497 million, about $50 million above the consensus estimate, according to Visible Alpha. Affirm shares were up over 20% on Thursday, bringing its year-to-date gain to over 170%.
BNPL credits have a few potential appeals to investors. For one, they can be relatively short-term. Affirm has also been able to boost its yields through higher lending rates. In October, more than 90% of Affirm’s interest-bearing volume was offered with annual percentage rates up to 36%. And it has managed to keep its credit performance steady. Its 30-plus-day delinquency rate, excluding for its pay-in-four installments, was 2.4% in the quarter, down from 2.7% a year prior.
Of course, BNPL hasn’t yet justified the huge expectations of disruption that pushed Affirm’s shares to over $175 back in 2021. It currently trades below $30. Affirm is also still working toward profitability, with a net loss over $170 million in the quarter.
But it is now on a track that might make investors give it a fresh look.
Source:
https://wsj-article-webview-generator-prod.sc.onservo.com/webview/WP-WSJ-0001350947
