Chris Alwine, global head of credit at Vanguard, another asset-management behemoth, did warn last week about a second-half recession in the U.S. that would hit corporate debt, though he didn’t foresee many outright defaults in public markets.
Private credit is attracting the attention of bargain hunters because the loans are rarely traded, meaning any drop in their value might not be immediately obvious to outsiders. Direct lenders also typically charge a floating interest rate linked to central bank rates so many borrowers are carrying the burden of much heftier interest costs than they’d expected.
“The market’s putting all of its chips on rates coming down quickly in 2024/2025,” says Stracke, and that private credit “will hum along just fine.”
A popular metric used for private assets, the “fixed charge coverage ratio,” shows how well a company can cover costs such as rent, utility bills and interest payments from its earnings. This is running at about one times on average right now, according to Stracke, meaning some businesses are barely covering expenses. If rates stay where they are, or fall only slightly, as many as a quarter of private credit portfolios will have difficulties, he estimates.
“We also expect private credit loans, particularly mid-market, to come under some stress this year,” says Isaac Poole of Oreana Portfolio Advisory Service, a large investor in private funds, adding that he expects some situations to even stretch “beyond” distress: “The growth in this asset in the liquidity boom during the pandemic is an area we’ve been very cautious on.”
Eric Jacobson, a fixed-income director at Morningstar Research Services LLC, agrees that it makes sense to take an opposing view when a market’s as overheated as this one. The “standard for good asset managers is to avoid chasing trends and making sales pitches promising investors nirvana with new fund launches,” he says, “but instead to look for areas where they see a lot more value, even if that value isn’t being seen by others.”
Life After Bill
Pimco has been known as a bond firm since the days when famed trader Bill Gross was running things, and was one of the first of its peers to get into the now popular business of “alternative” investments such as private capital and property. But its concerted push into this corner of finance really got going in 2016. Since then its alternative assets have risen from €30 billion ($32.5 billion) to $170 billion in the first half of 2023, according to Charles Graham, a senior analyst at Bloomberg Intelligence. That gives it a lot of firepower.
Its distressed playbook has been paying off in some areas. In 2022 it scooped up billions of euros of buyout debt that underwriting banks couldn’t get rid of. In recent months it has begun selling some of this at a double-digit profit. It snapped up €600 million of debt backing the buyout of British grocer Morrisons in the mid to high 80s percentage range. Those loans are now being quoted in the high 90s cents on the euro, market participants say.
In private credit, though, it’s having to be more patient about an asset class that has roughly tripled in size since 2015 by gobbling up much of Wall Street’s leveraged-loan business. Even as regulators have woken up to warnings—some of them from Pimco—that private markets lack transparency and are far too illiquid, any sustained downturn or signs of real trouble are yet to materialize.
In addition, some of private credit’s leading lights say aggressive firms trying to muscle in won’t find it easy to win over flailing corporate borrowers.