More History Rhyming

It looks like we are headed for a crackup in the private credit market. (archive link)

Strain is spreading across private credit portfolios, with some of the largest funds taking writedowns and warning about problem loans as the industry faces its biggest challenge in almost a decade.

The value of troubled loans held by some of the biggest private debt investors has reached levels last seen in 2017, when the industry was dealing with a hangover from an oil price crash, an FT analysis of figures from fixed-income data provider Solve has found.

Loans placed on non-accrual status by the 20 largest publicly traded business development companies (BDCs) — listed funds that invest in private credit loans — climbed to a median 2.8 per cent of their cost in the second quarter, up from 2 per cent at the end of March.

The non-accrual demarcation is one signal of stress in the private credit industry, indicating borrowers have either stopped making payments on their loans or that a fund believes a borrower may soon default on its obligations.

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Listed vehicles managed by KKR and Blue Owl, as well as one run by Apollo Global known as MidCap Financial, were among the funds in which repayments outstripped new lending in the quarter, with executives at KKR pointing to limited dealmaking and its push to exit certain loans.

The firm’s listed fund, FS KKR Capital Corp, reported that 7.1 per cent of its loan book was troubled in the second quarter, a slight improvement from the prior quarter but still far above the industry average.

The figures underscore the challenge facing the private investment industry, which wagered heavily on private credit as a major source of growth as it looked to invest money for insurers, retirees and wealthy individuals.

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But many executives across the $2tn asset class believe that the alarmism surrounding private credit’s troubles is overblown, with several blaming the media — including the FT — for the outflows weighing on the asset class.

They would say that it is just alarmism, their paychecks depend on their saying this. 

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Much of the pain already seen has been centred on investments the funds helped finance between 2020 and 2021, when interest rates were near zero and private equity groups went on a buying binge while valuations were elevated.

Many of those companies are now struggling to service their debt as interest rates have climbed, with executives on earnings calls repeatedly pointing to that cohort as the source of trouble.

Yeah, this is econ f%$#ing 101.  When interest rates go up, loan payments go up. 

………

Mitchel Penn, an analyst at Oppenheimer, noted that the sell-off in BDC share prices meant funds were “priced for death”. His own research showed that on average over the past five years, funds in the bottom quartile were generating returns on equity below the yield on a 10-year Treasury.

“Underwriting wasn’t as good as it should have been,” he said. “They weren’t as picky.”

Gee, apart from that Mrs. Lincoln, how was the play?