Mark to market: Opposing views of private credit
Mark answers a question about his views on private credit
Question:
Mark,
Whilst I agree with your general thesis about the capital cycle, private credit is simply not in a bubble & to jump on the bandwagon that it is, shows a complete misunderstanding of:
(i) the long term, regulatory driven, structural drivers
(ii) the sophistication of the majority of investors in the assets class &
(iii) the material differences between private credit in the US/Europe & in Australia.
You could have easily substituted “unlisted infrastructure” for “private credit” had you written this article 20 years ago & yet that “bubble” hasn’t burst.
You could have easily substituted “private equity” for “private credit” had you written this article 10-20 years ago & yet that “bubble” hasn’t burst.
Perhaps replacing “private credit” with "digital assets” would be more relevant today ? I don't know, not being an expert.
However, jumping on the populist bandwagon that “the private credit bubble is about to burst” is not helpful, when based on intuition, not facts. Where’s the analysis, where’s the data? Which private credit experts have you spoken to form your opinions? Why are industry super funds & the Future Fund allocating increasingly to this asset class? Do you consider them uninformed/unintelligent /poor stewards of capital? Because that has to be the conclusion - that they don't know what they’re doing? Which beggars belief given their process & people.
I’m not impressed & suspect this is a case of a little knowledge being very dangerous.
Answer:
For readers, this question is referring to this article on private credit. It is part of a two part series, the first part being 'Scepticism can be beneficial when navigating the capital cycle'.
It goes without saying that I have no idea what will happen with private credit. I certainly could be wrong and tried to lay out my case about why private credit worries me.
I certainly understand and respect your argument. My response is that I have heard to just trust the “experts” many times. In the run-up to the GFC I heard many people say that the bankers were experts at lending money and they had sophisticated risk management processes. I heard that the “expert” regulators had control of the risk posed by the huge increase in lending. I heard the investors that purchased mortgage backed securities were “experts” and the ratings houses giving them AAA ratings were “experts”. The “experts” said there would never be high levels of defaults on residential real estate.
It turned out that everyone along that line from the homeowners to the mortgage brokers to the bankers to the rating agencies and the investors were just greedy. And they made foolish decisions driven by that greed.
That is just one example of many throughout history. And as you pointed out there are multiple instances when people called something a bubble and it didn’t eventuate. My concern is that most of the people championing private credit are self-interested. That doesn’t mean we should disregard their view. But we need to keep that in mind. I have talked to private credit investors and we run opposing points of view on Firstlinks often.
There is just something that doesn’t make sense about private credit to me. The narrative is that profit motivated banks have had to pull back on lending. They have selected certain loans to keep making and certain loans to stop. Private credit just filled that gap.
The thing that I can’t figure out is why the loans the private credit investors are making are so much more attractive. They have higher interest rates. They default less. How is this possible? If these are the perfect loans that pay high interest rates and don’t default why didn’t the banks choose to keep them?
My fear is that private credit advocates are using results from a very specific period of time when huge levels of governement and central bank support helped the economy. My fear is that the results are from a time period when there was a relatively small amount of capital in private credit which meant lending standards were high. Banking booms and busts have happened throughout history. When too much credit is available standards drop. Maybe this really is different. We will have to wait and see.
As previously stated I have no idea what will happen with private credit. But all investors should understand what they are investing in. And I personally don't understand private credit. I don't understand who is borrowing money. I don't understand the terms of the loans. I don't how they are valued or how many loans are being renegotiated to prevent defaults. That is just me although as I pointed out in my article it doesn't appear as though the regulators understand any of this either.
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