Private-credit fears are based on four myths

IN CHARLES MacKay’s 1841 book Extraordinary Popular Delusions and the Madness of Crowds, he highlights how mass human behaviour can lead to irrationality: “They go mad in herds while they only recover their senses slowly, one by one.”

That line feels apt today amid a wave of intense conjecture in the media and elsewhere about the risks embedded in so-called private credit.

Private credit is privately negotiated loans and debt sold directly to long-term investors – an alternative to bank lending and publicly issued debt securities.

Most of this noise has come from a misunderstanding of the risk in the market and the funding sources, and from a failure to distinguish “leveraged lending”, a small subset of the market, from private credit.

The market for private credit is an estimated US$40 trillion. It is a big engine for the economy that fuels innovation, growth and the industrial renaissance now under way across the US and around the world.

We and other providers of private capital help finance both publicly traded companies – they are large users of private credit – and private companies, which represent roughly 86 per cent of US businesses with revenue over US$100 million.

Of the US$40 trillion private-credit market, roughly US$38 trillion is debt-rated as investment-grade – about 95 per cent of the market.

This vast pool is split between bank balance sheets and investors, and plays a critical role in financing the economy.

Increasingly, long-dated private credit held by pension funds and insurers is financing the long-term needs of critical infrastructure – from energy transition to data and manufacturing – providing the patient, flexible funding that traditional markets cannot offer.

Simply put, banks generally finance shorter durations while investors finance longer ones.

A small sliver

A much smaller amount, just US$2 trillion of the US$40 trillion private-credit market, is so-called leveraged lending, below investment-grade.

This generally comes in two flavours: broadly syndicated (typically originated by banks for resale) and direct lending (typically originated by asset managers that intend to hold for the long term).

This small quantity also plays a vital role in the financing of markets that provide much-needed capital for less-established companies, or for businesses going through some sort of transition.

Investors in leveraged lending have the ability to generate equity-like returns with more security and less volatility than equities or high-yield bonds.

In fact, investors typically invest in leveraged lending by selling their equity or high-yield bond portfolios, thus reducing their risk and volatility.

This small sliver of leveraged lending is what some market observers believe represents all “private credit”, obscuring the fact that the bulk of the vibrant private credit market is investment-grade.

Further, when discussing the private credit holdings of financial institutions, particularly insurance companies, some in the news media fail to note that almost all of these holdings are of investment-grade credit rather than leveraged lending.

Isolated incidents of corporate bankruptcies within this smaller subset of leveraged lending say nothing about the broader private credit market, and are just that – isolated.

Incidentally, both Tricolor and First Brands, which have received a lot of attention, were originated in the broadly syndicated market by banks.

Myth No 1: Private credit is not rated. Investment-grade private credit is almost always rated, either internally by a bank or externally by ratings companies.

The largest and best-known of these – Moody’s, S&P and Fitch – have the largest share of ratings in this market. Most private credit held by insurers and other financial institutions is rated investment-grade.

At Apollo’s Athene subsidiary, for example, roughly 97 per cent of fixed-income assets are investment-grade, and only 0.35 per cent is levered loans that are below investment-grade – typical for well-run insurance companies.

Myth No 2: Private credit is opaque. It’s actually more transparent than public credit. Private lenders conduct deep due diligence, receive non-public financial information and have direct access to management.

In public credit, by contrast, investors have limited covenants to protect them, limited access to management and limited direct due diligence.

All of the things credit investors say they hate, private credit addresses.

Private credit replaces opacity with information.

Myth No 3: Private credit is not tradable. In fact, Apollo alone traded US$6 billion of investment-grade private credit in the year to date.

And for the State Street exchange-traded fund (an ETF of investment-grade private and public credit that can purchase private credit from Apollo), there’s a price quote every day on every credit.

Myth No 4: Private credit is an emerging systemic risk to the financial system. Since the passage of the Dodd-Frank Act in 2010, some credit provision has left the banking system and moved to the investment marketplace.

This is primarily longer-duration investment-grade and leveraged lending. This shift reduces systemic risk rather than concentrates credit on the balance sheets of government-guaranteed levered institutions with short-dated funding.

Almost every institutional buyer of private credit has the capacity to hold for long periods and has lower leverage than the typical bank.

In short, the growth of private credit in all forms has made our financial system more resilient and less concentrated – and even made banks healthier.

Envy of the world

Ultimately, investors buy private credit because it offers a superior risk/reward to other available investment alternatives. For instance, if you look at the US insurance industry over the last three, five or 10 years, almost all the losses come from public corporate credit and real estate.

Private credit and securitised products, almost all investment-grade, have provided better protection and diversification. What many think is safe has produced the bulk of the losses in the insurance industry, and what is perceived as risky has been safer.

Public and private are both just credit. Good underwriters of both serve an important role in making US capital markets the envy of the world. BLOOMBERG

The writer is the chief executive officer of Apollo Global Management