Blackstone ❤️ private credit

Blackstone reported results today, which you can read about here. But FTAV’s biggest takeaway from the subsequent call with analysts is how excited the company is about taking advantage of the US banking mess.

The combination of return-hungry and volatility-shy investors with many US banks having to ratchet back their lending means that it’s a “golden moment” for private credit, according to Blackstone president Jonathan Gray.

Here’s the relevant bit on today’s call, which ended a couple of hours ago. The preliminary transcript is from Sentieo/AlphaSense:

The fundraising environment has become more challenging but the breadth of our firm allows us to continue to raise scale capital, including over $40 billion in the first quarter and $217 billion over the last 12 months. We’re seeing the greatest demand today for private credit solutions given higher interest rates and wider spreads. Coupled with the pullback in regional bank activity, this is a golden moment for our credit, real estate credit and insurance solutions teams, which accounted for 60% of the firm’s inflows in Q1.

Gray returned to the topic later:

. . . Private equity and alternatives business started in the equity space, taking money out of public equity allocations. I think the opportunity today is in fixed income to convince institutional investors to take a little less liquidity and to partner with somebody like us. So I think you could see this with our large institutional clients scaling up quite a bit and certainly in the insurance arena. And that’s why we said we really think it’s a golden moment for private credit.

Here are some quick thoughts, observations, brain-farts etc about the private credit optimism.

1) Banks’ retrenchment clearly opens up opportunities for private credit funds and other non-bank lenders. And the longer-term result is likely to be an extension of more onerous bank regulations beyond the biggest banks, which would likely be another tailwind for the private-credit industry. In fact, in FT Alphaville’s drafts folder there is a never-finished post from March titled “Shadow banks win again” that was supposed to explore this every topic.

2) Look, we can discuss volatility laundering/return manipulation/phoney happiness of accounting gimmicks until the cows come home, but the simple fact is that institutional investors like the smoothness of private markets. Higher bond yields make public fixed-income markets a much more viable tool to hit investors’ return targets, but they only get you part of the way. The promise of smoother, higher returns in private credit is understandably compelling for a lot of pension plans and endowments.

3) A lot of lending probably should drift out of the banking system and into markets! As discussed earlier this week, the risks don’t go away, but as a rule of thumb it’s probably better that they reside in a bunch of investment funds rather than a bank, for a host of obvious reasons. As Gray said today:

Private credit disperses risk outside the government backstop banking sector with capital typically raised in discrete long-term funds rather than a funding model that is reliant on deposits, which demand instant liquidity. This approach to credit extension makes the system safer and also supports the economy in challenging times.

HOWEVER . . . 

4) There’s almost certainly been a lot of silly lending going on in private credit. Most finance types have a natural tendency to defend their own asset classes, but when FTAV has chatted with people in private credit they all admit that things have gone a bit bananas. They all just insist that they have remained sober and careful, it’s everyone else who has lost their minds. This is . . . unnerving.

5) Private credit is extended to corporate borrowers in the form of floating-rate loans. That’s good for investors when rates rise — but only up to a point. At some point, these companies won’t be able to keep servicing their debts. Base rate + 800 bps is a lot easier to handle when rates are near zero than at 4-6 per cent.

6) So if the US economy does slump into a recession, a lot of borrowers in private credit markets will probably be toast. And recoveries in this space are faaar below what they are in large liquid public debt markets. A lot of loans will become zeros very quickly, and getting out is basically impossible because a lot of this is not designed for being traded.

7) It’s hard not to feel a little disquiet over the increasingly incestuous private capital ecosystem where firms with both big private equity and private credit arms are investing and lending into each others’ — and their own — deals. As Bloomberg reported last week:

Private Equity’s Latest Money-Making Trade: Buying Its Own Debt

Some of the world’s top private equity firms are scooping up the debt of their own portfolio companies from banks at steep discounts as they seek juicy returns amid a lull in deal making.

But even beyond the implications for investors in these funds, the private capital world is become increasingly big, increasingly opaque and increasingly interlinked. What could go wrong etc.