Long-Term View on Private Credit?
Given the current macro environment with declining interest rates and significant inflows into private credit, how do you view the long-term attractiveness of a career in direct lending? Wouldn't yield compression or increased competition impact underwriting going forward?
Private credit remains an attractive long-term career path, even amidst the current macro environment of declining interest rates and significant inflows. Here's why:
Core Attractiveness of Private Credit:
Yield Compression and Competition:
Evolving Market Dynamics:
Career Prospects:
While yield compression and competition may pose challenges, the long-term fundamentals of private credit, coupled with its growing role in the financial ecosystem, suggest that it remains a compelling career choice for those with the right skill set and adaptability.
Sources: https://www.wallstreetoasis.com/forum/private-equity/qa-non-target-top-bucket-ssg-private-creditdirect-lending?customgpt=1, Private Credit / Direct Lending Comp, Q&A: Non-target → Top Bucket SSG Private Credit/Direct Lending, Q&A: Credit Analyst (Multi-Strat Credit Fund) >$5bn Fund, Private Credit / Direct Lending Comp
There's a horrific mispricing trend from the sheer amount of capital that has been pushed into the industry. Money initially allocated to public markets have turned to private asset managers over the decades. PE funds have failed time and time again to deliver the returns they promised, so Private Credit became a hot new craze when deals were being priced at S+550 and S+600 in an environment where SOFR was 4.5%. To someone used to a 9% average return in public markets was a mouth watering concept. Imagine getting MORE returns than the 50yr average of the S&P with senior priority collateral and a defined payment schedule in a highly volatile macro economic environment. Who wouldn't want that in their portfolio?
Credit funds raised larger funds, had more lofty deployment targets, and the spending just keeps increasing. I've seen deals taken at S+425 when I think their pricing was more somewhere between the S+550-575 range. There's now more lax diligence processes, more workouts, and lower pricing. The larger funds have been expanding their workout teams like crazy, corporate defaults are super high, and the biggest concern I have seen is that there are so many amend and pretend situations, where companies HAVE defaulted and funds are just straight up lying about how bad it is. I would say anything after 3 amendments over a one year period should be considered just as bad as a corporate default. The sheer quantity of cockroaches in private credit right now, I don't even want to imagine what the megafunds workout teams are dealing with right now.
The funds that were chucking money at whatever they can find are feeling it. What you're going to see over the next few years is whoever did the most diligence and care in their investments are the funds that will survive. I don't even want to think about the investing in BDCs or CLOs right now
This administration is completely mismanaging the economy, and the guy is a madman. There is nothing good that has come out of the BBB or any other fiscal policies set in the last year. M&A is still in the gutter, public markets are being propped up by AI, and LMM / MM companies are dropping or being acquired at crap multiples like wildfire. We're testing the structural integrity of American finance pretty much every day. Not to mention the continued spending and adding to the US debt burden.
This isn't just to say that its a bubble, but people need to be more acutely aware that some businesses just don't deserve loans. We're in a bad environment. There's a reason that banks don't lend to the same companies that PC funds do in most cases.
This started off as a reasonable rant but ended up with a lot of inaccuracies. I work in PC and love making fun of this industry (even run a meme account that does so) but lets get some stuff straight
-banks would lend to the vast majority of the companies that private credit lends to. The difference is that private credit is willing to give more debt whereas banks have regulatory restrictions because they hold deposited money. Banks also notoriously do much less diligence than PC (haven’t interviewed many of them and never am impressed). People make fun of PC doing dumb ARR loans but banks like PNC do them as well and have done some of the worst ARR deals I have seen.
-the M&A market is having a historically average year. 2021/2022 were outlier periods, can’t be expected to return to that. My MF PC is going to meet budget and we haven’t been taking insane share or anything, just chugging along. Our defaults are also in line with last year, not any higher. In fact, tight spreads / repricing activity and a gradual come down in rates should facilitate less defaults, not more.
-the supply / demand imbalance is definitely true and PC is at likely unsustainable pricing right now. So some funds are going to leave, and new fundraisers will be less robust. And then pricing will likely normalize. Theres been inflows and outflows of competition in PC since it was started in the late 90’s. This is just another example of that
-Private credit is just a more convenient BSL loan for sponsors and borrowers. It’s not a wildly different product. Insane competition has led to leverage levels that might be up slightly YTD, but not drastically enough to call it a bubble.
drop the meme account @ ?
Most “workout” teams at private credit are woefully understaffed and do a poor job. Some firms have true operating partners on their staff and do a really good job but most workout groups look like bank desks where they just sell the tranche or try to beg the sponsor to run it for them
It's exactly right. Many companies boast about active portfolio management, but as agreements begin to go through, it becomes evident who has a real operations team and who is merely outsourcing to the sponsor. There is undoubtedly a section that divides the best stores from the others.
Have the same question around the combination of yield compression with declining rates and increased competition. Why would a PC fund grow if S+450 suddenly becomes a 6.5% yield vs. 8.5% and equity markets start ripping in a low rate environment? Is this an inherently cyclical asset class from a fund growth perspective that we are reaching the top on?
More of a question for someone who has been an active investor in PC pre-2019 vs. some associate who wants to riff.
Total yields will continue to remain while spreads will widen out
Glorified CLOs:
Pricing down. Rates down. Defaults up. Returns down. Fees down. Carry down. AUM up. Headcount up
PC market will be at +50bps premium to BSLs in the near term. Todays MDs will be well off as golden era fund vintages get in carry. Limited upside for anyone else in this market. Still, more compelling than other areas in the industry.
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