Acid test for private credit
PRIVATE credit is at a crossroads.
On the one hand, a spate of bankruptcies and collapses – First Brands and Tricolor in the US last year and, more recently, UK mortgage lender Market Financial Solutions (MFS) – is raising questions about credit quality and poor underwriting standards. In MFS’ case, creditors reportedly face a shortfall of £1.3 billion (S$2.2 billion). On the other hand, there is the liquidity pressure as investors seek to redeem holdings.
Managers of private credit funds have largely dismissed the US bankruptcies as isolated incidents. But the overhang of uncertainty over debt extended to software and services companies can’t be so blithely dismissed.
As at early February, it was estimated that software stocks in the public market shed some US$1 trillion in market value. The selling is likely overdone, and artificial intelligence’s threat to the viability of software companies will take some time to play out.
But developments in the public markets have knock-on effects on the opaque world of private lending, where software firms have been favoured for their recurring revenues. Private credit funds’ exposure to tech and software has been estimated at around 20 per cent.
These pressures are coming to a head in a spate of asset write-downs by even the top-tier names. Until now, investors had believed that putting money with the largest private managers would shield them from market stressors. This may be so in some respects – but only to a degree.
BlackRock TCP Capital expects to write down as much as 19 per cent of its net asset value, partly due to exposure to e-commerce aggregators. A KKR-managed fund, FS KKR Capital Corporation, also reported large losses on its portfolio and is slashing dividends. According to the Financial Times, JPMorgan Chase is tightening lending to private credit groups and has marked down the value of certain loans in their portfolio.
Not surprisingly, many investors want their money back. They are likely first-time individual investors banking on the strength of high historical yields. In the current market downturn, they may also face margin calls on investments elsewhere and are short of cash.
Of course, the reality is that evergreen or semi-liquid funds – touted as the next big thing for private asset managers – grapple with a fundamental asset-liability mismatch. That is, the liquidity window they offer, typically quarterly, is incompatible with the underlying assets which are illiquid. Debt contracts may be three to five years in maturity.
Interestingly, managers have responded in differing ways to the liquidity crunch. Blue Owl Capital has opted to permanently halt redemptions and instead make distributions of capital. BlackRock has allowed redemptions up to the 5 per cent limit for the HPS Corporate Lending Fund. In an unusual move, Blackstone Private Credit Fund is allowing almost 8 per cent in redemptions, by tapping capital from the firm itself and employees.
The events roiling private credit are a wake-up call. Managers of such funds will need to demonstrate their liquidity management strategies. Investors will demand more transparency on credit quality, and may be less eager to dip their toes into an inherently illiquid asset. Ultimately, managers who are committed to meeting redemption obligations – and even going the extra mile for it as Blackstone has – will inspire confidence.
