Pacific Investment Management Co. has been one of the loudest prophets of doom on private credit in recent months. Now it’s saying cracks in the red-hot asset class could appear as early as this year—and that it’s poised to use roughhouse tactics more common to hedge funds to grab bargains.

The investment giant has a history of making chunky contrarian bets going back to a money-spinning punt on cheap mortgage debt after the financial crisis. If it turns out to be right as the Cassandra of private credit, this booming $1.7 trillion market is about to go through a grueling reality check.

As fellow financial big guns such as Blackstone Inc. and Apollo Global Management Inc. have lined up to applaud a “golden moment” for private credit funds, which lend money directly to companies, Pimco has increasingly stationed itself on the other side of the wager. Executive committee member Christian Stracke predicts sharp drops in private loan values if base rates don’t fall quickly in 2024 and borrowers are crushed by their interest payments.

“We expect plenty based on what we’ve seen,” he tells Bloomberg. “We’re getting ready to pick up the pieces when and if there’s a shakeout.”

Whether he’s correct or not has implications that go way beyond the profits, or bragging rights, of wealthy financiers. Private credit funds have taken over much of the riskier corporate lending once done by investment banks, so any emerging distress in these loans could signal a deeper malaise in business. Insurers and pension funds have piled headlong into the asset class, too.

Pimco is also exploring options to use some of the bare-knuckle methods of distressed investing—where funds buy into a struggling company’s debt and try to squeeze existing lenders—to shake up the more polite world of private credit, which usually prefers to resolve things behind closed doors. That threatens to expose direct lenders who’ve been valuing their loans too generously, a source of growing anxiety for financial regulators.

The firm sparked uproar a couple of years back when it and a bunch of funds threw a $1 billion lifeline to ailing hospital staffer Envision Healthcare. The emergency refinancing, like Pimco’s later involvement in aerospace supplier Incora, left other lenders out in the cold and cemented a trend in distressed investing for so-called “creditor on creditor violence.”

Stracke, who oversees Pimco’s operations outside the Americas and its credit research arm, says it’s looking at targeting private credit by dealing directly with a company’s private equity backer or negotiating “super senior loans.” Such moves often disadvantage other creditors, as with Envision and Incora.

Bad Omens
This hunt for any emerging problems in private credit-backed companies is part of a broader sense at Pimco that while the U.S. economy has been robust, it may slow this year, and that Europe and the UK could be headed for a hard landing. That would strain riskier assets. Chief Executive Officer Manny Roman was speaking about downturn opportunities as far back as 2018.

“There’s been a lot of talk from some managers for a while about the rise of distress in private markets, but it hasn’t yet played out,” says Gianluca Lorenzon of risk advisory firm Validus. “These managers have been waiting in the long grass, but the grass has been cut a few times now.”

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