What's Going on in Private Credit?

Bearish:

• $DIRECTLENDING - Howard Marks warns that direct lending has become overdone with low standards, excessive leverage, and concentration in vulnerable software companies facing AI disruption.

  • “I imagine some direct lending managers accepted too much money and invested it too fast, applying standards that were too low and setting the scene for a correction.”

    Howard·11:09

  • “The arrival of many new managers and a great deal of incremental capital caused lenders to compete to make direct loans by accepting lower yields, narrower yield spreads, and reduced safety.”

    Howard·10:15

  • “In the last several months, the tide has begun to go out for direct lending, generalized to all of private credit by those who don't make fine distinctions.”

    Howard·11:18
• $SOFTWARE - Software companies face existential threat from AI disrupting their business models, with high leverage making them particularly vulnerable to credit distress.

  • “Over the last year or two, artificial intelligence has significantly reduced the need for humans to write code. That is program computers or write software, largely relegating coders to instructing AI models what to do.”

    Howard·15:35

  • “while these software companies are generally performing well with a few outliers, there has been a growing concern in the market that they are at risk of significant disruption from AI, which has materially impacted their equity value and reduced the equity cushion for lenders.”

    Howard·17:22

  • “a significant portion of direct loans were made to software companies, which were often acquired at high EBITDA multiples of around 20 x and with high leverage ratios.”

    Howard·15:21
• $PE - Private equity faces structural headwinds from higher interest rates ending its 40-year tailwind, with portfolio companies struggling under debt burdens and exits becoming difficult.

  • “In the last several years, a lot of private equity companies have been saddled with capital structures that didn't anticipate a 400 basis point increase in interest rates.”

    Howard·33:01

  • “According to Claude, MSCI estimates that between 2022 and q three twenty twenty five, an index of US private equity funds saw annualized returns of 5.8% compared to 11.6% for the S and P 500.”

    Howard·34:11

  • “The rate rise threw sand in the gears of private equity, and the picture today is very different from that described above.”

    Howard·33:10

  • “the essential message of SeaChange was that the days of ultra low and secularly declining interest rates were over, and the investment strategies that had benefited most from them would do less well in the future.”

    Howard·32:37