Why is everyone so worried about PC?
75% of LBOs are done by private credit.
Most private credit loans are to non-public companies.
If private credit is in trouble, how does that not mean PE is in way more trouble?
At least PC has a lien on the company assets
Private credit (PC) and private equity (PE) are deeply interconnected, especially given that private credit funds often finance a significant portion of leveraged buyouts (LBOs). However, the dynamics of their risks and exposures differ, which explains why concerns about private credit don't necessarily translate into equal or greater trouble for private equity.
Key Points to Consider:
Lien on Assets vs. Equity Risk:
Default and Restructuring Dynamics:
Private Equity's Risk Exposure:
Private Credit's Current Challenges:
Interdependence and Divergence:
In summary, private credit's challenges don't automatically translate into greater trouble for private equity. The two asset classes have different risk exposures and recovery mechanisms, with private credit benefiting from asset liens and PE relying on operational value creation. However, significant distress in private credit could signal broader economic or market issues that would eventually impact PE as well.
Sources: Private Equity vs. Private Credit, Are private debt funds getting fucked right now?, Private Equity vs Megafund Credit, Credit Fund to PE: Is it Doable, Private Equity vs. Private Credit
You're right, but the two strategies have different pitches to LPs. The reality of private credit is going to be jarring to many people who thought they were picking up a spread to public didn't realize they were doing CCC lending.
Also, if you're the sponsor who pays the CEO and has control over the operating business, would you give the lender any narrative, data, or color that would possibly lead them to any conclusion except "oh wow everything's lovely I should relax"?
By the time lenders are aware there is a problem, it's usually way too late. Look at this MFS shitstorm as an extreme example. It is not helpful to be a secured lender after you discover that the business is a fraud.
Lot of noise is created from fintwit and bloomberg headlines that distort reality. PC does have problems and I think PC firms that have more exposure to LMM or software would experience some losses on their portfolio. The issue is that no one knows what the contagion impact would be, although PC doesn't impact the banking system directly as it shifts risk away from banks to nonbank lenders, the banking system is exposed through lending to PC funds. Halting redemptions turns into a big headline but PC was never meant to provide daily liquidity but the blame goes both to LPs who ignored the legal terms and to GPs that couldnt stop talking about golden age of PC 3 years ago. Some funds have experienced deteriorated loan book and announced reduction in dividends and higher utilization of PIK toggle from borrowers.
But you're right if we are gonna complain about PC then PE should get more attention as credit impairment theortically implies 0 recovery for equity.
What’s your take on LMM? You talking software or painting with a broad brush? Typically have way more control via covenants in LMM. liquidity needs if issues arise are smaller dollars and easier to solve. There is def a lot of business risk but I would say the true recourse for a senior secured lender is there unlike upmarket or even MM deals.
If you’re a non bank and you have the stomach to get into the muck, you should generally be ok from a recovery standpoint in the bad deals. It’s less of a relationship business in the sense that you’re not dropping trou for Mr Sponsor to bend you over and boondoggle you because you want to get the call when they raise the next big fund
Detachment is usually much shallower. Spreads higher. Reporting requirements stricter. Covenants tighter. Sponsors, if there even is one, are less sophisticated or versed in the dark arts of knifing their lenders.
LMM lending does almost always have real covenants, minimal threat of destructive LME, and better attachment points. However, the quality of an asset that's not going well is typically much scarier to even think about acquiring via debt restructure etc. They almost always require new money as the adjusted "EBITDA" to CF bridge tends to be quite large while revolvers have typically been a big source of funding the business as trouble brews. The space also skews heavily roll-up which is usually quite ugly on the way down - especially true in the popular segments (resi services, vet, medical, etc) where roll-over equity/options have been sprinkled everywhere and are no gone. Meanwhile even in the non roll up segment you have are left with a declining 15-20mm asset that isn't generating cash. What do you do with that? Need to hold it in hopes of stabilizing it in hopes of being able to sell to another LMM PE fund but in like 3 years with a not great backstory. Long way of saying loss given defaults are likely to be very high for the LMM space despite some reasons that might initially make you think otherwise (small software companies are a whole other bad story). Note that you are seeing this in the smaller BDCs that focus on LMM. V bad recoveries (though usually don't see that till the 2nd or 3rd restructure over 1-2 yrs).
The bright spot for LMM lending is the hope that you can get the lender to through in 6-12 months of runway via an equity check when trouble starts brewing. The LMM market in general is in somewhat better funding shape due to better inflow dynamics plus optimism towards future raises. I believe that optimism to be mostly misplaced but it doesn't matter, decent chance that you get someone to buy time while the hope to raise another fund. I suspect this behavior will change in 12-18 months as performance from the PE funds becomes an obvious issue but there is a window in the medium term.
I agree with your confusion. The media loves retail outflows stories (very small amount for the majority of PC AUM). That mixed with general tech jitters (that ever asset class faces) was enough to set off a firestorm. Even with tricolor, first brands, and MFS, those are all non sponsored deals with 2/3 being BSL…
Retail investors failed to comprehend the nature of an illiquid investment vehicle. To your point, people should be worried about the equity piece more if they think PC is in trouble.
"Credit has this issue that if a business does really well, your upside is capped, you just get your interest. Then you have the full downside — and this is where this becomes a problem.”
Traditional PE has been around for decades, hence it's not headline material to discuss PE losses. However, the combination of private credit boom (2022/2023) + retail access to illiquid vehicles (accelerated in 2024/2025) at such scale + speed of inflows + macro was untested until now and it's the first time we see its structural weaknesses (redemptions caused by exposure to software businesses that are under threat by AI + laxed credit terms given there was too much credit pursuing good companies 2-3 years ago), hence it's more educational/interesting/noveau than discussing PE failures even if everyone knows that those are the first to go.
Also, if you think about it, the entire allure of retail money flowing into private vehicles was to increase AUMs. They were expecting to enlarge those vehicles to capture as much AUM as possible. 1-2 years have passed since then, and they are hit with a mass request of redemptions (ie. not enough time to harvest $$$ to enrich GPs). So if you know one or two about human psychology, you might start to think that there might be a strong incentive to not let it happen, especially when you factor that valuations are determined widely by the lender + if the lender/GP has some losses and doesn't reach the necessary X% it might not get any carry for that quarter/or might need to cover the previous loses before any carry (read BCRED prospectus for an example, but it's widely similar across all). So when you factor that incentive + still see a high amount of recorded losses (despite that incentive), you might think that there should be more underneath (including some that are not considered bankruptcy and others that are reported with months of delay).
Might also add that in those last years LMEs gained lots of popularity, so credit downturn stories fuel more interest / flow of viewers (+ loss aversion bias), which makes it more discussed across the industry and creates a feedback loop of more discussion to more news to more discussions to again more news over and over.
(1) "Why is everyone so worried about PC?"
Because they are making a lot of bad lending decisions that will create a mess when the market turns.
(2) "If private credit is in trouble, how does that not mean PE is in way more trouble?"
Yeah. A lot of PE is in trouble too.
A credit product losing money is more concerning vs an equity product
"If private credit is in trouble, how does that not mean PE is in way more trouble?"
It's a good question but I don't think it's as cut and dry as you think. It's entirely possible to see a world where there is a lot of pain in PC but PE continues to chug along. When you think about just one credit, you are right, for PC to get impaired, the equity owner needs to get wiped out.
But, you need to think about this from a portfolio perspective. Take software as an example, since that's where a lot of the chatter is on. No one knows yet what the real impact of AI will be on legacy software businesses but it seems reasonable to assume that some will be able to incorporate AI into their current product offering and thus increase their enterprise value. Others will get disrupted and equity owners will get wiped. This dynamic is terrible for PC and okay-ish for PE. For the PE investor, some of their porticos will go to zero; others will outperform and together they will likely average out to a 12%.- 17% IRR. But if you are a PC investor with the majority of your exposure to tech, your loans to the companies that get disrupted are likely to be seriously impaired. But importantly you don't get any of the upside on the companies that do well. It's possible then to see a world where PC returns low-mid single digits.
TLDR: answer to your question is that at a portfolio level, the capped upside of PC could degrade returns more than expectations, while in PE outperformers and underperformers can together potentially average out to a still acceptable return for LPs.
Libero suscipit qui nostrum. Quis dolore consequatur architecto vel aut. Eos dolorum non iure magnam quae molestiae. Et sit quas alias ut praesentium natus impedit. Repellendus quod quasi occaecati laborum. Quidem et asperiores minus voluptatum esse maiores.
Excepturi eveniet eum dignissimos. Amet non accusamus illum ipsam dolores deserunt quod. Consequatur perferendis sunt facere sed quia necessitatibus. Dolor dolores adipisci ab ad quo. In ut optio recusandae veritatis consequatur non tempora.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...