Why So Many Private Credit Investors Want Out

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1:32Olivia Fishlow:Bloomberg Audio Studios. Podcasts.

1:36Brian Chappatta:Radio. News.

1:38Olivia Fishlow:It's been a rough few weeks for private credit. Investors are just pulling out to the tune of billions. Private credit is kind of a different beast. The$1.8 trillion industry makes loans directly to private companies, using money from institutional investors and more recently, retail investors. And as the private credit market has boomed, it's positioned itself as a go-to lender for the tech industry and for its data center construction spree, which means private credit has a lot of exposure to AI risks. Financial firms grappling with signs that private credit issues are starting to emerge following a series of blows from the threat of AI.

2:20Olivia Fishlow:Private credit money isn't just backing the AI infrastructure build-out. It's also invested in the very software companies that the technology threatens to displace. So as jitters over AI hit the market, these lenders are under a magnifying glass, too. In February, squeamish investors started trying to pull some of their money out of private credit funds, managed by companies like Blue Owl, Blackstone, and BlackRock.

2:45Sarah Holder:Concerns over the industry have mounted after Blue Owl halted redemptions in one of its funds and decided to sell some assets to help pay investors.

2:52Olivia Fishlow:The problem is, the private credit industry isn't designed to offer on-demand liquidity the way that, say, banks can. Investors in these funds are supposed to be comfortable with having their money locked up for a while. So when investors came knocking, major private credit firms handled their requests in different ways. And that scramble is exposing cracks across the entire private credit industry at a particularly sensitive time.

3:20Sarah Holder:There was an executive order signed by President Donald Trump last year that basically makes it easier for these retail investors to get into alternative assets such as private credit. And it's what they were counting on. And now that all of a sudden you're seeing an exodus from these funds and it's raising all these kind of questions about the asset class in general and whether it can withstand the kind of pressure that it was never really intended to face.

3:47Olivia Fishlow:I'm Sarah Holder, and this is The Big Take from Bloomberg News. Today on the show, Bloomberg's Brian Chapada and Olivia Fishlow take us inside the recent tumult in the world of private credit. How cracks formed in this$1.8 trillion market, how companies are trying to tamp down investor anxiety, and what it could all mean for your 401k.

4:13Olivia Fishlow:Today, the nearly$2 trillion private credit market is central to the global financial system. It powers hundreds of billions of dollars worth of loans to companies of virtually every size. But when private credit first emerged, it was pretty niche.

4:28Brian Chappatta:The market actually started after the financial crisis and after banks were sort of limited in the lending that they could do. That's Olivia Fishlow, who covers private credit for Bloomberg. The basic idea was to move risk away from the banks, which obviously caused a huge crisis, and sort of move it into more individuals. Some investors from the banks left and started their own firms called private credit firms, where they had third-party capital and started to give loans to businesses that weren't really able to access financing. So they were mainly focused on, you know, small businesses in the Midwest, maybe like HVAC businesses, things of that nature.

5:04Brian Chappatta:And, of course, because these businesses were a bit riskier, right, they were able to get more money for these loans. They were able to be paid a higher rate. So then, of course, it became a very successful strategy. They started to raise a lot of money and started to very aggressively market these funds to retail investors. And then as they got more and more money, now we can see they're financing some of the largest companies in the world and, you know, focusing on financing data centers.

5:31Olivia Fishlow:Over time, private equity firms like Blackstone and Apollo set up their own private credit shops, becoming some of the largest firms in the space.

5:40Brian Chappatta:You know, they thought it was a good opportunity. But what really started happening is private equity became less lucrative. The returns came down and, you know, businesses aren't really selling anymore. They're not really transacting. So credit became sort of the backbone of these businesses, which like for a long time were only known as private equity businesses.

5:58Olivia Fishlow:For businesses, private credit can be attractive for two reasons. Maybe the company is considered too risky to qualify for a loan from a bank, or would face a high borrowing cost if they do qualify. A loan from a private credit firm can be expensive too, but it typically establishes a longer-term relationship for everyone involved— the borrowing business, the private credit firm, and their investors. This can give businesses time to grow and hopefully eventually turn the kind of profit that's attractive to private credit firms and investors. Bloomberg's Brian Chapata, who edits coverage of leveraged finance and distressed debt, says that for investors, putting money in a private credit fund can be a pretty good deal.

6:43Sarah Holder:I mean, the thing you have to understand about credit is that as long as defaults are low, it is effectively a guaranteed return in a lot of ways. Just as bonds that are very safe, such as treasuries, will yield whatever it is on a daily basis, 3%, 4%. You have some of these direct loans that as long as the borrowers pay you back, you get 10%, 11%. And so that's what you can sell these wealthy investors on or institutions. You can get this kind of return as long as we are making creditworthy loans.

7:13Olivia Fishlow:But there are also some real risks with a lending model like this.

7:16Brian Chappatta:What some people say is that because the market is very private and it's very opaque, it's hard to know how much leverage is actually inherent in the system.

7:27Olivia Fishlow:And it's not just that there isn't the same transparency around leverage. Private credit tends to let businesses take on more leverage to borrow more against their debt.

7:37Brian Chappatta:Some critics say that you basically just shifted the risk away from banks, which are regulated and, you know, which have more rules, into a more opaque area, which used to be referred to as sort of shadow banking. That phrase has sort of gone away, but I think the idea of that risk still stands.

7:53Olivia Fishlow:The private credit industry flourished as specific industries that it invested in took off, like software companies.

8:01Brian Chappatta:When software businesses really started to take off, the banks were relatively restricted in lending. And they were dealing with a lot of other crises. So they couldn't really put money out the door. And private credit was coming into its own. And so they really very heavily invested in these software businesses. And at the time, like, this was a great area of recurring revenue. It seemed like the best place ever to lend. And there was basically no competition.

8:26Olivia Fishlow:But in recent years, another industry that private credit heavily invested in has complicated this picture.

8:32Brian Chappatta:And I think what they really did not expect was the level that artificial intelligence could now make that software obsolete. Like, honestly, no one did. And I think it's just sort of a combination of factors that they now find themselves with that.

8:47Sarah Holder:And the thing that we've reported here at Bloomberg is that the software exposure that some of these private credit funds self-report is actually probably lower than reality because so much is software, as we are quickly learning, that a lot of these businesses that maybe are classified as healthcare actually are very much a healthcare software business. If these companies go bust, private credit is on the hook for a large portion of their portfolio, and they may not be as diversified as they seem.

9:18Olivia Fishlow:Concerns about AI have been a big deal for private credit. But the industry had already been under scrutiny, even before the latest AI-related market swings.

9:28Brian Chappatta:Concerns really started towards the middle of last year and where we saw some pretty high-profile collapses with businesses like Tricolor and First Brands.

9:38Olivia Fishlow:Tree Collor is a subprime auto lender, and First Brands is an auto parts company. Both had borrowed from firms that fall under the private credit umbrella, and both went bankrupt in the fall. By that point, J.P. Morgan had invested in Tree Collor. In an earnings call last year, the bank's CEO, Jamie Dimon, commented on the collapse.

9:58Sarah Holder:My antenna goes up when things like that happen. I probably shouldn't say this, but when you see one cockroach, there are probably more. He said, you know, this is not going to be the last time that you see some sort of credit flare up because there's probably more of these out there. Private credit bristles at this because Tricolor wasn't purely a private credit play, as JP Morgan can attest to. But it did kind of raise awareness of the cracks that were forming out there in the markets.

10:27Brian Chappatta:I think that started investor fears, which also sort of added to the idea that as the Fed cut rates, returns would also be coming down.

10:36Sarah Holder:And then you started to see this kind of cascade of missteps, bad news, just general weakness in the market that was able to kind of tip the scales for various credit firms out there into a major share price decline.

10:54Olivia Fishlow:After the break, how these factors came together to create a perfect storm for the private credit firm Blue Owl Capital, how Blue Owl's challenges ricocheted throughout the industry, and where the push to bring more investors into the private credit market stands now.

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