[cs702]

Trouble has been brewing in private credit for quite a while, but lenders and investors have been reluctant to write anything down, resorting to all kinds of "extend and pretend" games to avoid write-downs.[a]

tick-tock, tick-tock, tick-tock...

---

[a] https://news.ycombinator.com/item?id=47351462

[strangattractor]

You can always tell when there is a problem. When things are fine the companies keep the profits to themselves. When things start to get dicey - foist it off onto retail investers.

Private equity (PE) is increasingly being introduced into 401(k) plans, driven by a 2025 executive order encouraging "democratization" of alternative assets. - Google AI

[chii]

It's why as a retail investor, never buy things that would otherwise have not been available to you (but was to those "elite"/institutional investors previously).

Think pre-IPO buy-in. Investors in the know and other well connected institutional investors get first dibs on all of the good ones. The bad ones are pawned off to retail investors. It's no different with private credit and private equity. These sorts of deals have good ones and bad ones - the good ones will have been taken by the time it flows down to retail.

[rd]

This can't be a to-die-on rule though. Retail would've never bought GOOG, or TSLA, or AAPL if that were the case. Maybe I'm just being pedantic.

[Analemma_]

Google and Apple didn't go through ten funding rounds like today's startups do. Apple had one angel and three rounds, Google had one angel and literally just an A round after that; then retail investors could capture all the upside. Now there's way more time for private investors to pick the bones clean before it gets dumped on the public.

[marcusverus]

I think you're both right. Those were great opportunities, but the proportion of such opportunities which are made available to retail traders has greatly diminished over time.

There's a great chart out there somewhere (I couldn't find it) which breaks down the impact of private equity on the availability of such opportunities in public markets. It showed a dozen or so companies (like Google, Apple, Uber, Stripe, etc) and broke down their market cap gains into two parts, "pre IPO" and "post IPO" gains. Of course, the pre-IPO gains were only available to private equity (or, at best, accredited investors), whereas the post-IPO gains were available to retail traders as well.

"Older" companies like GOOG & AAPL were much more likely to have experienced that vast majority of gains after their IPOs, meaning retail investors could have made big money by betting on them early. Meanwhile newer companies (like Facebook, Uber, Stripe, etc) were much more likely to have yielded the vast majority of their gains before their IPOs, meaning retail investors didn't have the opportunity to benefit from big returns.

[chii]

That's quite an interesting observation.

I suspect that the reason those "newer" companies were able to have the majority of their gains reaped pre-IPO was that during that time period, it was easy to acquire capital from investors without resorting to public market IPOs, where as the era of google and apple have not got the same level of private investment.

And i think it has to do with low interest rates. During the google early years, it is difficult to obtain low-cost loans (for private investors that is). Therefore, public markets look like an easier path for companies to raise money.

The "newer" companies in your list are mostly post-GFC, during a period of ultra-low interest rate. This makes money easy for private investors to obtain, and so companies have an easier time getting funding from those private sources. The IPO is realistically not a funding mechanism, but an exit mechanism for those early private investors.

[marcusverus]

Yep, I think you're spot on.

If you're familiar with Ray Kurzweil's work, I wonder whether this phenomenon might be related. Kurzweil notes that better technology begets better technology in a self-reinforcing and ever-accelerating cycle of technological advancement. His thesis implies rapidly evolving capital requirements. Massive amounts of nimble private capital, secure in the hands of highly competent people with relevant domain expertise, may well be an important precondition for continual acceleration.

[aardvarkr]

Survivorship bias and the corporate finance world of today is completely unrecognizable from the world of Google and Apple. Just look at the resulting performance of the SPAC craze

[wmf]

Even for good assets there's a price you shouldn't pay. People are joking(?) about triple-layer SPVs where you can get pre-IPO exposure but at higher-than-IPO price.

[grep_name]

> Private equity (PE) is increasingly being introduced into 401(k) plans, driven by a 2025 executive order encouraging "democratization" of alternative assets

Thanks for the reminder! I need to switch my plan away from a TDF to avoid this.

[xenadu02]

Funny enough Chinese State owned banks have been doing much the same for quite some time. No one ever defaults, loans are extended as long as it takes. Presumably the threat of being called into the next party meeting to explain yourself is sufficient motivation for the people running the business to pivot as many times as it takes until they find a way to make money. Worst case the state swaps someone else into leadership.

I say this to say... who knows? I guess if you shuffle deck chairs fast enough everything works out fine (?)

[solatic]

The larger you are, the larger the rounding errors are, the more money that can disappear due to a failure and explained away or extended or written off or whatever euphemism you want to pick. But the sum of rounding errors is less likely to itself be a rounding error. It works until it doesn't, and Evergrande collapsing with $300 billion in Chinese real estate debt will be a case study for years to come.

[ethbr1]

Isn't the real underlying risk here concentration, as opposed to diversification?

If you have unlimited capital and time horizon, because you're a nation with the power to tax and print money, then you can keep this game going for a long time.

The only thing that mandates it stops are if (a) too many of your loans are correlated with the same thing that crashes (e.g. energy, tulips, AI, etc) or (b) too many of your loans are tied together in a single entity (either because it combined multiple smaller entities or because it tied itself into all their financial arrangements).

[lokar]

The only problem is allowing regulated US banks with an implicit gov guarantee to lend money to them.

[boringg]

There are limited ways to short these positions which would probably add some fuel to the fire.

[metrix]

I don't see it as adding fuel to the fire. I see it as helping the market price companies correctly

[boringg]

Its a balancing act.

[sciencesama]

But what will break the clock ?

[JumpCrisscross]

> what will break the clock ?

So unlike money-market funds, these private-credit funds can gate withdrawals and extend and pretend by turning cash coupons into PIKs. So I don't actually see credit concerns directly driving liquidity issues for the banks that didn't hold the risk on their balance sheet glares Germanically.

Instead, I think the contagion risk is psychological. Which is an unsatisfying answer. But if there are massive losses on e.g. DBIP and DB USA halts withdrawals, then the 2% stock loss Morgan Stanley suffered when it capped withdrawals [1] could become a bigger issue.

[1] https://www.wsj.com/livecoverage/stock-market-today-dow-sp-5...

[boringg]

I believe the gated feature can be waived though it causes a precarious situation. It ends up with same psychology of a bank run -- people (institutions) concerned because they can't access funds or they think that the queue to exit a failing fund is too long - filled each quarter (i.e. by the time they redeem NAV has collapsed).

[JumpCrisscross]

> the gated feature can be waived

Or never invoked. It's a safety feature for the fund and, arguably, systemic stability.

[boringg]

Totally - its supposed to prevent a collapse of confidence but at the same time can signal a collapse of confidence. Double edged sword.

[epsteingpt]

You can't gate redemptions forever amigo.

People eventually want to spend their money.

[themgt]

As Buffett said, "only when the tide goes out do you learn who has been swimming naked" - luckily, skimming the news, there's no obvious huge exogenous macroeconomic shocks on the horizon that could cause "the tide to go out" so to speak, so everything should be ok for now.

[Ekaros]

Umm... Couldn't whole Iran debacle be such shock? If the effects are not contained?

[ethbr1]

Woosh.

[RobRivera]

What kind of trouble is brewing from the migration of partner capital committment to credit based on NAV?

What is the risk, probability of actualizing the risk, and the outcome of actualized risk?

The ticktock ticktock routine reads like baseless fearmongering to me.

[cs702]

My understanding is that many private credit funds have been very lax about conducting basic due diligence on the creditworthiness of borrowers.

For example, take First Brands, a multi-billion-dollar company which filed for bankruptcy last year. First Brands had pledged the same assets as collateral for loans from multiple private-credit funds. Those loans were being carried at a fantasy NAV of 100 cents per dollar, until suddenly they were not. Did none of these lenders submit UCC filings so other lenders could check which assets had already been pledged as collateral? Did none of these lenders ever check to see which assets had already been pledged? Did all these lenders make loans based on blind trust?

Failing to check and verify that assets have not been pledged as collateral to other lenders is an amateur mistake. It's reckless, really. The equivalent in home-mortgage lending would for a mortgage lender never even bothering to check that a homeowner isn't getting multiple first-lien mortgages simultaneously on the same home, then forgetting to put the first lien on the property title.

My take is that for many private credit funds, NAVs are basically fantasy.

[vmbm]

Do you know if First Brand's actions are considered fraud? Or was this entirely on the lenders to make sure they were in the clear regarding the collateral? Doesn't excuse the lack of diligence, but curious if there was some assumption of good faith that may have played a role in what diligence was or was not done.

[cs702]

Only a court can decide if the actions are fraud, but they sure look like it to me. Fraud doesn't excuse the lack of due diligence.

[RobRivera]

If lenders are in fact not performing due diligence and passing off good credit as bad...sounds suspiciously like a 2008-like era where noone cared about the credit worthiness but just wanted to generate lines of credit.

Oh boy, if this is the case, oh boy.

Lessons not learned indeed.

[gymbeaux]

Remember, the lesson was that Daddy Government won’t let you fail. Barring any federal regulations, there’s no reason for financial entities to not repeat the exact “mistakes” that caused the 2008 (2007) Great Recession.

The lesson isn’t being ignored- it’s being used as justification.

[bombcar]

Once you get outside of things that are highly standardized (like home loans to individuals) you quickly find out that no matter how regulated, finance is done on a handshake.

[cs702]

That's true, but only to a point. Due diligence is not uncommon, especially with more traditional forms of credit.

I resorted to the mortgage-lending analogy so others could quickly grok what multi-pledging means.