Transcript: Should we worry about private credit?

This is an audio transcript of the Unhedged podcast episode: ‘Should we worry about private credit?’

Ethan Wu
When you have piles of borrowed money, we like it where we can see it — in the light, visible, where regulators can look and say, hey, what’s going on here?

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But a big change in financial markets that we’ve talked about in the show is the rise of shadow banking and especially private credit. This is lending that goes on not in the light but in the darkness. Today on the show, more on private credit. This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I am reporter Ethan Wu here in the New York studio. A little bit sick, a little bit of a cold. Joined from London by Katie Martin, who also is a little bit sick and has a little bit of a cold, don’t you, Katie?

Katie Martin
Yeah. We should apologise in advance to our listeners if we start coughing and spluttering.

Ethan Wu
Nonetheless, we will power through.

Katie Martin
We will power through. Yeah.

Ethan Wu
It’s the FT way. We’ve talked about private credit on the show before with Alex Scaggs, but it’s always good to revisit. This is a big topic in financial markets, but it is a little bit inevitably, you know, dense and there’s a lot of terminology and there’s a lot of moving parts. So I mean, maybe it behoves us, Katie, to just take a step back, let’s establish what we’re talking about and then we can kind of get into some of the stuff that’s happening more recently. So just high level, Katie, what is private credit?

Katie Martin
So it’s one of those phrases actually, that people use a little bit loosely and can mean a number of different things to different people. But broadly speaking, we’re talking about lending to companies that doesn’t come from banks, right? These aren’t just bank loans like we know we’ve had in the global banking system for like 500 years or something. And they’re also not like bonds. So they’re not going to public markets and issuing bonds with prospectuses that like anybody can read.

It’s the stuff in the middle. It’s bilateral loans from organisations that are not banks or that come from little sort of small clubs of, you know, pockets of lenders. And, you know, this isn’t new, but it’s grown incredibly quickly over the past, particularly over the past sort of 30 years, but particularly over the past 10 years or so, this thing has just exploded. And suddenly everyone’s talking about private credit just like everyone’s talking about private equity. Just like, you know, there’s a lot more private money in markets than they used to be.

Ethan Wu
And just to give people kind of a lay of the land before we go any further, this is a $2tn market globally, including invested and uninvested capital. The biggest player probably is Blackstone in the US, which is primarily a private equity and real estate company. But they do have a big private credit arm. And then there are some other, you know, private credit native players that are pretty big in the space, like Ares, Blue Owl, HPS, a couple of others. It’s very much a market dominated by a single-digit or maybe low double-digit number of big players. Private credit was, I think, the hot asset class du jour in 2023. It was absolutely inescapable. All these pieces, all this press coverage about private credit’s moment in the sun, etc, etc. You know, we on the Unhedged newsletter contributed to that media coverage frenzy for sure.

Katie Martin
It’s all your fault, yeah.

Ethan Wu
It is. And, you know, part of the back-story, right, is that these are loans made by non-banks. But what changed a lot in 2022 and 2023 is that private credit kind of took some turf from the banks, right? So, you know, you’re a mid-sized company, you’re a little bit indebted, you maybe don’t have the strongest balance sheet. Traditionally, you go to JPMorgan, you go to Citi, you go to Goldman Sachs and you go to their bank loan department and you say, hey, can you round up a club of lenders to give me some money. Like, we’ll pay up, right? So that’s the traditional way — you go to a bank and you do it.

What happened though is after interest rates went up — a lot, because the Fed is fighting inflation — the banks had a lot of problems, right? They had a lot of debt that was stuck on their balance sheet. It clogged up the system at the banks and they didn’t wanna lend any more, right? So these private credit guys who, like you said, Katie, have been around for decades, but, you know, were smaller and occupied a smaller role in the financial system, they looked at the banks struggling with all of this bad debt on their balance sheets they couldn’t do stuff with. And they said, we’re gonna take some market share here. And that’s exactly what they did. That’s exactly what they did.

Katie Martin
Yeah. They said, you don’t wanna lend to them? Sure, we’ll lend to them. And also, it’s become trickier since the financial crisis, you know, 15 years ago because for regulatory reasons for banks to lend as freely as they did in the past. So yeah, lots of new players have come into the space. And the reason that this kind of matters beyond, you know, that kind of discrete space is that this debt gets kind of packaged up and sold on into all kinds of investment products all over the world. So it ends up in all sorts of different portfolios. And so one of the reasons why some people are looking at this sort of stuff, you know, with a bit of a sort of side-eye, a bit of kind of hang on, what’s going on over here is that you’re ending up with these private credit risks, these quite risky borrowers with loans that are written on kind of quite bespoke terms that we might not all properly understand, you know, how risky it is and what’s really going on here. This is getting sort of salted throughout the entire financial system, throughout investment portfolios, throughout your pension plan and mine. And that’s one of the things that makes, you know, bankers and investors and regulators and all sorts of different people say, hang on, do we really have a handle on what’s going on over here?

Ethan Wu
Yeah. And just to add one more note of alarm to what you just said, Katie, it’s the situation has arguably gotten a little bit more nerve-racking in 2024. So I laid out private credit took market share in lending to companies in 2023. But what’s happened in 2024, as we talked about on the show, is some of the hottest credit markets that we’ve ever seen across public credit and across private credit. And so what that’s meant is now banks are like, hey, we gave up all this business and for what? We’ve dealt with the issues on our own balance sheets in our own companies, we’re getting back into this market. We’re taking our turf back, right? So you’re now seeing more and more competition between banks and private credit for the business of lending to companies. And that’s leading to falling prices on loans. You know, companies can get cheaper and cheaper loans that the spreads are compressing, in other words. And, you know, there’s a concern if you’re in a really tight market for lending to companies, maybe the lenders get a little aggressive. Maybe they start to water down how many protections they have on those loans. Maybe they start to, you know, get a little more generous than maybe it’s due. That’s always the concern when credit markets get hot.

Katie Martin
And meanwhile, this market as a whole is like $2tn globally. Like, that’s pretty big. That’s like comfortably as big as the high-yield bond market. So this is like becoming something that we have to consider alongside standard corporate bond markets as something that could have implications for the economy and for macro and also for markets.

Ethan Wu
That’s the backdrop. What happened recently, Katie, is we got a fresh new report from one International Monetary Fund.

Katie Martin
Those guys. Yeah.

Ethan Wu
(Laughter) Those guys. They actually warned about, you know, just what we’re talking about, that there’s all this lending. It’s happening in the shadows.

Katie Martin
Yes. So the IMF put out its global financial stability report. And the whole point in financial stability reports, whoever they come from, is to kind of cast an eye across like the waterfront, right? Everything that’s going on in financial markets and in banking and saying, hmm, these are the parts where problems could arise. And they’ve looked at private credit and they’ve said, you know, there’s some reasonably scary language in there if you look in the right places. They talk about severe data gaps. So there were just like massive chunks of the market where they don’t really know what the hell is going on. They’re talking about this market being, and I quote, “macro-critical”. (Ethan laughs) Or at least becoming macro-critical. And that sounds kind of serious, right?

Ethan Wu
Name of my band.

Katie Martin
(Laughter) They’re talking about stuff like there’s a lot of volatility in public markets that is not properly reflected in private credit markets. So you don’t see the value of, like, funds attached to private credit markets moving up and down as readily as you do in public markets. And that matters because it leads to the suspicion that losses are not properly embedded in the system, that you can’t really see where the cracks are because money tends to be locked up differently and for a longer period of time in private credit funds. And so it doesn’t enable people on the outside to see how bad problems potentially are. Now, maybe the problems aren’t really there, and maybe because private credit tends to be done on bespoke terms and that there tends to be a better, closer relationship between borrowers and lenders, that they work it out when stuff goes wrong rather than allowing companies to default and go bust.

But what the IMF is saying is a lot of the time, we just don’t know. And on top of that, because this market is now so big and because it’s become so interconnected with the rest of the financial system because of the involvement of pension funds and insurance companies and sovereign wealth funds and all these kind of massive pots of institutional money, we have to think about if something were to go wrong, would that chip away at the stability of the rest of the system? And that is exactly what financial stability reports are there to explore. This doesn’t mean they’re saying, run to the hills, abandon hope all ye who enter here, this is a terrible thing that’s definitely going to go wrong. They’re simply saying we need a better handle on what’s going on here.

Ethan Wu
Yeah. Like if you got like a panic attack every time you read something scary in an IMF financial stability report, you would be dead because it happens all the time.

Katie Martin
Yeah. That’s literally what this is for.

Ethan Wu
But I wanna dig a little deeper in that. Like I think there are two components to the shadows, to the privateness of private credit, right? One is that there’s no ticker. You can’t go in your Bloomberg terminal or your Refinitiv or what do they call it now — LSEG? Whatever.

Katie Martin
Google . . . Let’s say Google Finance.

Ethan Wu
Yeah. You can’t Google the market, right? Like the S&P 500, I can tell you within five seconds of googling if the market’s up, down or sideways, right? Private credit’s not like that. If you wanna get a sense of where the market’s at — is it hot, is it cold, are lending standards aggressive, are they conservative? — you have to just ask people and like collect, you know, little bits and bobs of data. There’s no central expression of where the market’s at. So that’s like privateness element number one. Privateness element number two is that the actual details of individual loans are also private, right? You know, we don’t know exactly what the terms are on which A has lent to B. We don’t know what the valuation of those loans are. We don’t know if they’re getting marked down or not.

Katie Martin
It’s not as if, you know, the lenders in this space are completely unregulated, but what the IMF, for example, is saying is that regulators should be encouraged to be more intrusive in terms of figuring out what kind of loans are there and what kind of risks are embedded in them, that we need much better data, that we need to think about whether there could be potential liquidity shocks from private credit funds or from providers of private credit all running to the exit at one time, you know; what could that mean if it were to happen? And just generally, to kind of strengthen regulatory oversight of what’s going on in the sector. And I think it’s actually quite hard for lenders in this space to argue with that, right? You know, if they’ve got nothing to hide, then we’re all good. Once you get to a certain size, with great size comes great responsibility, right? And once you get to a point where you are a market that’s large enough to potentially cause problems if everything were to go wrong all at once — not saying it will, but if it did, then you kind of have to open yourself up to somewhat more scrutiny.

Ethan Wu
We’ve laid out some reasons to be concerned. Let me talk through where we are personally on this, because I sense that we may be a little bit apart on how concerned we are. So where are you at? You read the IMF report. Quaking in your boots or feeling OK?

Katie Martin
Well, you know, one thing that stuck with me from the report, but also there was like a panel session afterwards that you could see online and you can probably still dig it out if you want to, is that one point that was made was that, you know, in like March 2020, everything went wrong with the Covid shock, yadda yadda. We’re all very familiar with that. Public corporate bond markets needed a big helping hand from the Fed. Private credit did not. And, you know, public credit markets just totally froze up. If you’re a company that wanted a new chunk of cash for whatever reason, and heaven knows we all needed cash at that particular time, the public markets, like the corporate bond markets, were like, no mate, no, we’re closed. (Laughter)

Ethan Wu
Yeah.

Katie Martin
Whereas companies with the right sort of relationship with the right sort of private lender could still get deals done, maybe not on the best terms in the world, but it didn’t . . . You know, the Earth didn’t sort of stop spinning in quite the same way. So I think, you know, regulators and investors and all the rest of us are entirely right to be keeping, casting a very sceptical eye over this whole space and figuring out what can go wrong and how. But my personal sense is this is just like how markets work now. Private money is a thing. You look at the growth of private equity. You look at the number of companies that are leaving stock markets around the world. We just have to get better at monitoring it.

Ethan Wu
To me, I think there’s two ways of thinking about it. One is, is it riskier than the banking system? And the answer is like, almost certainly no. Like banks are uniquely risky institutions, right? They’re leveraged like 10 to 1. You know, depositors can leave out the door any minute. Like the banking system has been like generating failures and financial crises for centuries. So that’s like a pretty high bar for financial stability, right?

Then there’s like a second question, which is, is private credit, you know, risky or concerning? And I think it is or at least it is on par with any other lending pocket in the financial system. You know, we wrote today in the Unhedged newsletter about a new academic paper that goes into private credit managers will argue, well, we have a structural source of higher returns from the fact that, yeah, these are bilateral, these are private. We can talk to the borrower, work stuff out.

And the paper that we wrote about today basically finds eh, not really. I mean, it’s basically just like any other type of lending in terms of returns. And that suggests to me maybe in terms of financial stability we should expect it to be no different than other types of lending too, that it’s just sort of, you know, old wine, new bottle in a certain way, at least from a macro perspective. And so private debt funds are blown up before, and I think we shouldn’t expect anything different from this new incarnation of debt funds. 

Katie Martin
For sure. Like, you know, companies that are recipients of this sort of private money are party to exactly the same economic cycle as everybody else and some of them will go bust. Again, this came through in the report, it’s like, there will be cycles, there will be bad patches. But there are bad patches in everything. The really important question is, as I say, if this goes wrong, does it spoil the party for the rest of us? And it’s not obvious to me that it does.

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Ethan Wu
Yeah. Katie’s party — very hard to spoil.

Katie Martin
Cold or no cold.

Ethan Wu
Katie, we’re gonna cough our way over to Long/Short. We’ll be back in a moment.

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Ethan Wu
Welcome back. This is Long/Short, that part of the show where we go long a thing we love, short a thing we hate. Katie, I am short the coverage of Jamie Dimon’s annual shareholder letter, which I feel like was a little bit, I don’t know. Like it always gets covered every year. And some financial news organisations described him as basically saying like rates could surge to 8 per cent. That was kind of the angle on it. And in the actual letter, you know, he talks about risks to higher interest rates. But he’s mostly kind of saying like, well, you know, we’re prepared for 8 per cent. We’re prepared for 2 per cent. We’re JPMorgan. We’re prepared for everything. Though he, you know, he’s been in the camp of rates being higher. But I thought some of the coverage of it was a little bit sensational, to put it that way. Jamie’s been on the right side of this for the most part though. Like, you know, inflation’s been a little sticky and rates have been higher for longer than most people anticipated, at least, so I gotta give him credit there. But we don’t need to overly hype it.

Katie Martin
Fair. OK, I am long vowels and I think everyone else should be too. So I don’t know whether this has really reached the shores of the US as a story, but there’s a big investment house over in the UK that used to be called Standard Life Aberdeen.

Ethan Wu
Oh, it’s Abrdn, folks. It’s Abrdn.

Katie Martin
It’s the Abrdn story, boys and girls, strap in. So in a big and I think quite expensive rebranding exercise in 2021 after like some mergers and this and that, it called itself not Standard Life Aberdeen anymore but Abrdn. But it took all of the E’s out of Abrdn. So it’s just (laughter) Abrdn. People like in the City in London and I will admit in the media have been taking the mickey out of this (laughter) since 2021. And in an interview this week, a senior executive over there had like had enough of this what he called “corporate bullying” from the media.

Ethan Wu
Corporate bullying.

Katie Martin
Corporate bullying, saying, how would you look at a person who makes fun of your name day in, day out? So what I’m saying is you should have stuck with the vowels in the first place, that’s one thing. And secondly, you know, I’m sure you’re familiar with the thing called the Streisand effect. When you draw attention to something ridiculous, people take the mickey out of it even more. There’s a financial newspaper over in London called City AM, and it had a front-page apology to Abrdn today, I think “Abrdn: an aplgy”, it said and I quote, “Srry we kp tkng th pss ot of yr mssng vwls”. (Laughter) So I think this puts the matter to bed. There’s been an apology. It’s obviously sincere. We can all just move on with our lives.

Ethan Wu
The Abrdn joke, it just gets funnier. Like, I feel like I’ve been laughing about this since I started working at the FT, and it just gets funnier. It’s gonna be 2028 on the Unhedged podcast. We’re gonna be talking about Abrdn. It’s still gonna be funny.

Katie Martin
We’re gonna do the whole podcast with no vowels.

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Ethan Wu
(Laughter) Well, Katie, thank you for pushing through your sickness to be here on the Unhedged podcast. We appreciate you and the vowels in your name. And listeners, we’ll be back in your feed with another episode of the show on Thursday. Catch you then.

Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie, Gretta Cohn and Natalie Sadler. FT premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com/unhedgedoffer. I’m Ethan Wu. Thanks for listening.

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