| Problems Brewing in the Private Credit Market Increasingly, the private credit and private equity worlds have become intertwined. The private credit industry now charges big management fees and shares profits with its managers, which builds out private credit markets with the private equity industry. The insurance industry is also increasing its investments in private credit.
Case in point: The private credit soared from $432.9 billion in 2014 to $1.7 trillion in 2023 and is on track to hit $2.0 trillion this year.
That’s a big problem.
And I’m not the only one concerned… JPMorgan CEO Jamie Dimon recently stated that he expects problems to emerge in the private credit market and even warned “there could be hell to pay.”
The fact is the average financial advisor doesn’t sell stocks anymore. Instead, they sell private credit. Investors can get an 11% yield now and get their money back in two years. They usually give investors 25% back every six months. But financial advisors are now leveraging debt and leveraged debt is basically what caused the 2008 financial crisis.
Back in 2008, financial advisors were doing arbitrage on the yield curve when the yield curve was normal back then. They were leveraging it 10-to-1 for a money market instrument packaged in offshore commercial paper that was called a structured investment vehicle.
Those who parked money in these leverage municipal products were getting 13% to 16% of tax-free yields. The products were sold by all the big banks, but the biggest culprit was Citibank, Inc. (C). I still remember when I went to one of Citigroup’s presentations and the person that ran alternative investments for Citibank was very proud of the bank’s leverage municipal business.
However, this broke when the credit default swaps failed. As a result, the banks had to unwind all the leverage and municipal bonds. In turn, Wall Street dropped their bids on the bonds. I know at Citibank those leverage municipal products and A-rated municipal bonds lost 97% of their principle. Things are Getting Out of Control I’ve been following the private credit market closely over the years, and it looks like it’s getting out of control again. As an example, Vista Equity Partners bought Pluralsight, Inc., a workforce development company, in 2021 for about $3.5 billion. This leveraged buyout was supported by more than $1.0 billion of debt financing by direct lenders. Unfortunately, Vista Equity Partners recently wrote off the entire equity value of Pluralsight, as its debt service costs soared.
In an effort to pay a $50 million interest payment that was due, Pluralsight moved its intellectual property into a new subsidiary and used those assets to obtain additional financing from Vista Equity Partners. Whether or not this private debt band-aid will hold is highly questionable.
What’s equally concerning is that the syndicate leaders behind the more than $1.0 billion worth of debt behind the Pluralsight leveraged buyout are a “who’s who” in private credit. This includes Ares Management Corporation (ARES), Benefit Street Partners, BlackRock, Inc. (BLK), Blue Owl Capital, Inc. (OWL), Goldman Sachs Capital Management, Golub Capital BDC Inc. (GBDC) and Oaktree Capital Management.
So, I recommend folks avoid all private credit sold by Ares Management, Benefit Street Partners, BlackRock, Blue Owl Capital, Goldman Sachs Capital Management, Golub Capital and Oaktree Capital Management.
I should also add that Blackstone, the biggest alternative asset manager in the world, is huge in the private credit industry, and it’s been trying to offload some debt recently.
The good news is I don’t see 6-to-1 or 10-to-1 leverage like we had in 2008. But there’s definitely 2-to-1 leverage. It’s getting to be a little kinky.
But the bottom line is that Wall Street always sells what makes them money. And there’s more money in selling private credit and alternative investments today than there is in selling stocks because commissions are free now. In my opinion, the 11% yield that the private credit industry pays investors is not sustainable. And as the Pluralsight dilemma demonstrates, bad loans are going to be made and potentially “prick” the private credit bubble. If Vista Equity Partners becomes a full-fledged “Black Swan” that causes a run on private equity assets, the Federal Reserve may need to step in and rescue the private credit industry. A “Repeat” of the Dot-Com Boom Coming Soon While there is potential for another Black Swan event in the private credit market, there is also potential for the kind of moneymaking opportunity that I haven’t seen in two decades in a different pocket of the market. I’m talking about the next generation of AI companies.
As I mentioned in Thursday’s Market 360 , Wall Street is still focused on the old story of first-generation AI (the chipmakers and AI apps released by Big Tech), but just like the dot-com era, that’s not where the real big money will be made.
Instead, the winners will be the companies that use AI to reinvent or automate some of our oldest business models. In other words, the next-gen AI companies.
This is the Real AI Boom. The closest comparison to what’s coming next is what happened 25 years ago: the dot-com boom.
When this happens, it will launch the kind of transformational change we only see once every 25 years. And these changes will roll out across society and reshape America on the same historic scale we saw in the late ‘90s.
Unfortunately, it will likely be the last financial mania of my lifetime. And yours, too, if you’re over the age of 50. The good news is we’re in the early innings of the Real AI Boom, which means there’s still time to position your portfolio now to profit.
Click here to watch a replay of my Prediction 2024 event now to find out how . Sincerely, |
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