Private Credit Faces Reality Check
Blackstone’s $48 billion private credit fund reported a 0.4% loss in February, its first monthly loss since 2022.
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Blackstone’s $48 billion private credit fund reported a 0.4% loss in February, its first monthly loss since 2022. Private credit is lending by non-bank financial companies, like Blackstone, directly to companies in need of loans that do not want to deal with the hassle of highly regulated bank lending. Over the past decade, the private credit market has been booming, as traditional banks have been more cautious with lending since the 2008 financial crisis. This is what makes Blackstone’s loss interesting, suggesting private credit may be facing its first big obstacle.
Analysis
Wealthy individuals and financial institutions like pension funds have been pouring money into private credit investments, being promised attractive annual returns and the ability to withdraw their money at regular points throughout each financial year. However, problems have started surfacing with these investments, due to recent macroeconomic changes, mirroring the impact on returns for the private equity sector too.
What are these problems?
- Firstly, private credit funds had aggressively lent to software companies that were experiencing rapid growth at the time, but with intensified competition and AI disruption the growth of these software companies has stalled.
- Secondly, private credit funds promised investors they could withdraw money regularly, but this does not match up to the reality of loans that will keep cash locked up for a number of years.
- Thirdly, the system of valuing private credit loans has always been questionable: private credit institutions are incentivised to value loans highly to appease investors
How to use this in applications
An issue with investors asking for their money back early is that private credit funds will literally not have enough cash to pay these investors after lending to borrower companies. Whilst the private credit funds theoretically have assets (the loans), this money is with the borrowers that will eventually be paying the funds back.
To deal with this issue, private credit funds limit investor withdrawals (known as gating). Law firms will have to advise funds on the process of setting these gates up, how long such gates can last, and what must be disclosed to investors. This gating will often also lead to angry investors that will launch lawsuits, so law firms will have to advise on litigation in defending fund managers.
On the flipside, law firms will have to support borrower companies that are in distress. Legal teams will have to negotiate with the private credit lenders to extend the loan dates (known as maturity), reduce interest payments, etc. This is called debt restructuring, and will be more complex if there are multiple lenders that cannot agree on a restructuring plan.
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