Comment by adam_arthur | Hacker News Reader

Comment by adam_arthur | Hacker News Reader

There is so much misinformed fear-mongering about private credit right now.

Important Facts:

1) The majority of private credit funds are classed as "permanent capital". When you put money into these vehicles, you give the Asset Manager discretion over when to give the money back. Redemptions are often gated at ~5% per quarter.

(So there cannot, by definition, be a run on the bank)

2) Credit is senior to equity, so if you expect mass defaults in private credit, it means the majority of private equity is effectively wiped out. Private equity has to be effectively a 0 before private credit takes any losses.

3) The average "recovery rate" for senior secured loans is 80%. Even if private equity gets wiped to 0, the loss that private credit incurs is cushioned significantly by the collateral backing the loan. These are not unsecured loans the borrower can just walk away from.

(The price of senior secured loans dropped by ~30% in 2008, as a worst case datapoint)

4) Default rates on many of the major private credit managers is ~<1% in recent years. There are other estimates stating higher default rates, but that often classifies PIK income as a default. A loan modified and extended with added PIK that ultimately gets repaid is not a "true" default.

5) Finally, it's true that NAVs are likely overstated, but generally it's by a modest amount. Every Asset Manager today could go out tomorrow, mark NAVs down by 20% and suddenly there is no crisis.

(The stocks of Asset Managers have already traded down such that this seems expected and priced in anyway)

> Private equity has to be effectively a 0 before private credit takes any losses

Technically yes. But the overlap between private equity as it's commonly described and private credit is slim.

> average "recovery rate" for senior secured loans is 80%

Oooh, source? (I'm curious for when this was measured.)

> A loan modified and extended with added PIK that ultimately gets repaid is not a "true" default

True. It's a red flag, nonetheless.

> Every Asset Manager today could go out tomorrow, mark NAVs down by 20% and suddenly there is no crisis

Correct. The question is if 20% is enough, and if a 20% markdown creates a vicious cycle as funding for e.g. re- or follow-on financing dries up.

You seem knowledgable about this. I'm coming in as an equities man. Would you have some good sources you'd recommend that make the dovish cash for private credit today?

> Oooh, source? (I'm curious for when this was measured.)

It depends when you measure, but you can Google around and find figures in the 60-80% range. 80% may have been a bit on the optimistic end of the range. But it's important to note that a "default" doesn't imply a 0.

Of course this will depend on the covenants, underwriting standards, type of collateral.

I would guess software equity collateral recovery rates are lower than hard assets like a building. (Which is why I personally don't like Software loans, nothing to do with AI)

> Correct. The question is if 20% is enough, and if a 20% markdown creates a vicious cycle as funding for e.g. re- or follow-on financing dries up.

I think it's almost certain that new fundraising for private credit will be materially hindered going forward. But this just limits the growth rate of these firms, does not introduce any "collapse" risk.

They may move from net inflows to net outflows and bleed AUM over a period of some years.

If NAVs were inflated previously, they may be forced to mark down the NAV to meet redemptions rather than using inflows to payoff older investors.

In the world of credit, 20% is an enormous haircut. Again, senior secured loans fell by around 30% peak to trough in 2008.

We have the public BDC market as a comparison point where the average price/book is around 0.80x. So the public market is willing to buy credit strategies at a 20% discount to stated NAV.

The real systemic risk here, if we were to reach for one, is really that these fears become self fulfilling.

If investors pull funds out of credit strategies en-masse, there is no first order systemic issue, but it means borrowers of many outstanding loans may not be able to secure refinancing as money is drying up.

This could lead to a self-fulfilling default cycle. But this would be a fear driven default cycle, there is no fundamental issue with cash flows of borrowers or otherwise (in aggregate, currently).

Finally, in regards to the asset managers themselves, many are quite diversified.

Yes, they have private credit funds, but many have real estate funds, buyout funds etc. OWL is one of the biggest managers of data center funds, for example (which they also got hammered for on AI bubble fears)

Given how depressed pricing is in public REITs, for example, I expect a lot of asset managers to pivot towards more real asset funds.

So, if I hold a bunch of Private Equity, and my holdings need a continuity of business loan, would I:

(a) have the holding take out the debt, exposing 100% of my stake

or,

(b) have the holding divest a piece of itself, giving me control of the existing and new entities, then have that piece take out the debt, exposing 0% of my stake?

I imagine any PE firm worth its salt would go with option (b).

Presumably regulators would sometimes try to block such deals, but I cannot imagine that happening during the current administration. (Do the regulators even still work for the US government? I thought they were mostly fired.)

Similarly, I can imagine the banks refusing to lend in scenario (b), but I cannot imagine bank leadership being allowed to make such a decision if the PE firm is politically connected to the current administration.

It sounds like you're effectively describing some fraud scheme.

A smart lender will not issue loans without real collateral. If you create a subsidiary, that subsidiary has to have sufficient collateral and cashflow to secure a loan.

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