Some people call them Shadow Banks they Themselves prefer the term private Credit funds whatever you call them They're just non-bank companies who give Loans to other companies that's all Private credit is well there's your Deep Dive thanks for tuning in don't forget To like And subscribe and I'll see it Now I'm just Kidding but look Trad five squares from Bloomberg to the IMF won't stop talking About this private credit thing and they Sound worried I'm worried we wanted to Know why and more importantly if a Catastrophe in private credit could send Crypto lower if you want answers you Better keep Watching companies giving loans to other Companies without a bank involved is Nothing new but it wasn't until around 15 years ago that the market for private Credit really started to heat up this is Believed to be as a result of the 2008 Financial crisis whose subsequent Regulations put restrictions on Bank Lending natural This just moved the risk to a different Sector now nobody actually knows how big The private credit Market is because as The name suggests it's private like Really private there's no centralized Database that governments Regulators Investors or even the private credit Funds themselves can use to find out the
Market size or for that matter any other Data about the market at all there's no Shortage of estimates but according to The leading researchers in the study of Private credit none of them really stand Up to scrutiny in a recent paper Entitled when the credit markets go dark Harvard Law School Professor Jared Elias And Duke University School of Law Professor Elizabeth defont found Themselves grasping at straws for lack Of a better option they went with the Most conservative current estimate which Places private credit funds total assets Under management at $1.5 Trillion for an indicat of how fast the Market is expanding we found estimates Saying that it grew from $320 billion in 2010 to $875 billion in 2020 before Reaching its current size although how Reliable these numbers are is apparently Anyone's guess and what's the future Outlook well Morgan Stanley forecasts The market to grow to $2.8 trillion by 2028 and according to Michael zsky Global Chief investment officer at Blackstone one of the biggest private Credit funds the market could eventually Balloon to $25 trillion or even $50 Trillion zawadsky declined to put a date On this claim though so we're not quite Sure what to make of it at any rate Private credit is growing rapidly and is Already big enough to be of significance
To the global economy the imf's current Estimate of $1.7 trillion would make Private credit about 7% of of the credit Non-financial sector and about 10% of Bank credit so the private credit Market Is booming but what's driving it well to Understand you need to know a little About how Corporate debt has evolved According to professors Elias and defont The private credit boom is part of a Broader trend of debt retreating away From public markets and into shadowy Private ones an earlier face of this Trend was described as the Incredible Shrinking stock market basically large Companies are staying private for longer Either delaying or foregoing the IPO Process the number of publicly listed Companies traded on us exchanges peaked In 1996 at more than 8,000 but by 2023 That number had dropped by more than 50% To just 3,700 even as stock market indices have Repeatedly hit record highs in 1999 the Average US tech firm went public after 4 Years but by 2019 this had increased to 11 years so what happened well if you Want to raise Capital by issuing Publicly traded Equity or corporate Bonds for that matter you're going to Have the SEC breathing down your neck And demanding extensive public Disclosures about your business Complying with the regulations involved
Here can be costly and timec consuming But more important importantly companies Have become incredibly shy about these Disclosure requirements that's because The most valuable corporate assets are Now intangible and easily imitated so Guarding them closely is a high priority For example code can be copied and Pasted design schemes can be leaked and Supply chains can't exactly be patented As such many companies are now in no Rush to go public or issue corporate Bonds to raise capital and by the way if You're enjoying this video so far go Ahead and drop a like subscribe and ring That notification Bell you'll be the First to know when we post another video And it'll give our Channel a boost too Crypto Podcast okay welcome to the Bro crypto Podcast I'm chadam Miss Maximus go by Max Chad 100 on Twitter and I am Giga Dick the dude with the biggest pnl in All of crypto bro bro say what my pnl is 100% bigger than yours bro please I was Longing Doge and drinking neat badier While you are still spot buying BTC on Mount GX bro bro you're still driving a 2020 Aventador where's your Bugatti at Bro bro when Bon hits a dollar I'm going To be rocking a super yacht while you're Still stuck in traffic bro the Bro Crypto podcast is sponsored by the coin Bureau deals page if you're looking for
Trading fee discounts of up to 70% and Sign up bonuses of up to $100,000 and amazing discounts on Hardware wallets then don't be a bro be In the no and check out the link in the Description below and now back to the Show Crypto bro bro bro bro Bro Bro now a common alternative to going Public or issuing bonds is the broadly Syndicated loan which doesn't come with The same public public disclosure Requirements for reference this is a Loan that's arranged by a bank which Slices up the debt and sells it to a Large number of institutional investors The borrower ends up with a large pool Of creditors and the debt becomes a Financial instrument that's traded on The public market this has various Advantages over a bank making a large Loan and holding it on its balance sheet The risk is dispersed across the many Creditors reducing stress on the banking System in the event of a default this Makes it possible to make much larger Loans than any one lender would Otherwise be willing to make but more Importantly trading of syndicated debt On the public market provides continuous Price signals which are an important Macroeconomic indicator Trends in the Corporate debt Market can indicate when
A certain sector of the economy is in Trouble for example during the pandemic The plunging value of hotels and Airlines debt informed government's Decisions to intervene or or afford them Special treatment in isolated cases Price signals are key indicators for a Company's shareholders regulators and Bankruptcy judges when a company is in Distress price can reflect how severe The markets deem the situation to be Whether there's a root to repair or if a Company should be liquidated and so on All this is supposed to be good for the Economy but it has downsides for Borrowers for example when your debt is Sliced up and sold to 50 different hedge Funds you don't know your creditors from Jack if you're having a bad quarter and You need a favor who are you going to Call and why should they cut you any Slack they're all just a bunch of Strangers not only that but jumpy Creditors can just dump their share of Your debt on the highly liquid public Markets at the first sign of distress if They're so inclined that's certainly an Easier option than sticking around and Trying to negotiate now as mentioned Earlier the trend away from Banks Holding massive loans on their own Balance sheets saw a Quantum Leap Forward after 2008 or rather a Quantum Push by Regulators who responded to the
Financial crisis by constraining Banks Ability to make risky loans the new Regulatory environment in the US Introduced stringent Capital Requirements dictating how much Liquidity a bank must keep on hand for Loans of different risk levels as well As other restrictions on risk-taking of Various forms this made direct lending By Banks become less profitable Particularly if the loan is considered Risky if your company had revenues of Between 10 million $100 million you are Considered part of the lower Middle Market and therefore inherently risky Banks more or less withdrew from this Sector of the market forcing these Companies to look elsewhere for funding However it's not only the lower Middle Market large companies may be considered Safer borrowers but they want larger Loans for banks faced with capital Requirement this means keeping a large Amount of cash idle and it's not a very Attractive business proposition anymore Big banks have retreated from the direct Lending Market in general and moved Towards a fee collecting business model That involves more intermediating deals Advisory and custodial Services they're Not big on putting corporate debt on Their own balance sheets anymore for Borrowers syndicated loans are an option But what if you don't want to be
Indebted to 50 hedge funds you don't Know what if you can borrow on more Favorable terms and what if there were Institutional investors lining up around The corner to offer you exactly that Well as it happens this was another Consequence of the 2008 financial crisis Near zero interest rates created a great Reach for yield where investors Accustomed to Juicy returns suddenly Found themselves dying of thirst they Reached further and further out into the Risky world of junk bonds and leverage Loans in search of any kind of yield Private investors gladly took on all the Risk that Banks were no longer willing Or able to and they competed with each Other to do so and this led to some Really weird outcomes competition for Risky corporate loans turned into a race To the bottom where wouldbe creditors Were lining up around the block to Accept deals with steadily worsening Conditions for themselves borrowers were Emboldened to give lenders a as little As 24 hours to comb through the hundreds Of pages of fine print that govern the Loan some lenders eager to secure stakes In these popular deals didn't even Bother trying and just accepted with Predictable results you can actually Plot the deterioration in loan Conditions for lenders on a graph or Rather credit ratings agencies like
Moody can they have an index that Measures safeguards known as covenants That are written into loan deals to Protect lenders staple Covenants Including enshrining the right of Lenders to seize the borrower's Collateral and sell it to recoup some or All of their investment if the borrower Cannot repay the loan another restricts Borrowers ability to pay old loans with New loans according to Moody's Covenant Quality Index loan conditions have been Worsening for creditors for more than a Decade they fell below the threshold for The weakest category in 2014 and have Continued to decline almost ever since Borrowers meanwhile have had a field day Or rather a field decade exploiting Loopholes in the fine print that Empower Them to abuse their creditors there were Many such cases including the famous Adventures of J crew whose creditors got Jay screwed in cartoonish fashion if you Need a laugh go Google that case anyway All of this created a raging paranoia in The credit Market lenders even started Conspiring against one another in a bid To see who could get screwed Less in a Phenomenon known as creditor on creditor Violence these conditions created the Perfect environment for the rise of Private credit specifically private Direct lending which makes up most of The market in a recent interview with
Bloomberg Elias summed this up with an Anecdote quote one hedge fund manager Told me I can't afford to invest in a Small loan because unless it's a big Loan I won't be able to pay the legal Expenses of Defending it while still Earning a return because it's just Become so expensive and litigious to Invest in debt solution private credit Instead of negotiating with multiple Lenders there's one lender all of the Investors who want exposure to fixed Income they give their money to the Private credit asset manager the private Credit asset manager isn't going to do Bad things to some of its fund investors To the detriment of other fund investors Now to be clear there's not always only One lender it may be a small number of Partnered private credit funds but this Is more likely to to be three five maybe 10 Partners as opposed to a broadly Syndicated loan with 20 50 maybe even a 100 distant creditors this does seem Like an elegant solution proponents of Private credit describe it as a highly Civilized Market where everyone wins It's refreshingly violence-free for Lenders who can enjoy double- digigit Returns in exchange for the premium Service they provide to borrowers for The borrowers this service means no more Going to a bank going through a credit Committee going going through the loan
Syndication process and having the bank Look around for dozens of investors to Buy your debt you can just call a Private credit fund and they'll build a Bespoke deal and put a check in your Hand before you know it another feature Of private credit is that there's no Secondary Market where it's traded it's Extremely illiquid this means that even If a loan is split among a club of Private credit funds they are all Generally in it for the long haul to Sell a share of the debt would generally Mean finding a buyer directly and Possibly incurring a large loss in the Process as such it's in the best Interest of all parties to stick with Each other through thick and thin Private creditors tend to be very Flexible if their client finds himself In a tight spot and needs to call in a Favor this kind of service is how Private credit firms compete with one Another and after all they wouldn't have Made a bespoke deal for a highly Illiquid loan if they weren't confident In the company's fundamentals now as you May have noticed many of the the Benefits of private credit come from the Stellar relationships involved but the Problem is relationships are not a System nor a structure they're the Players and not the game so what's to Stop unscrupulous participants from
Entering the market and for that matter Is the private credit game really so Much better than the rest of the credit Market proponents May point to Supposedly low default rates in the Private credit Market as evidence of a More robust structure but this is Arguably only because the Boom in Private credit is such a new phenomenon There's been no full-blown recession in The United States since 2018 meaning Private credit has not been cycle tested As they say and let's suppose low Default rates are indeed an intrinsic Feature of private credit believe it or Not but this might not be a good thing Some companies die for a reason when a Business is in trouble creditors will Sell their share of its publicly traded Debt causing the price to fall if no Buyers step in it suggests the market Doesn't believe the company can be saved The company may be able to negotiate With creditors and refinance their loans To buy some more time and maybe this is Enough to get it through a rough patch But if a company is really no longer Viable default is only a matter of time Their credit rating will be publicly Downgraded and if a bankruptcy is on the Cards the whole world can see it coming Because of these Market signals but when The credit Market goes dark as Elias and Defont put it all of these signals go
Away in the world of private credit There are no ratings and no Mark to Market meaning that the price of debt is Not regularly updated to reflect changes In its value as a result it's difficult To have confidence in valuations which Tend to become stale and when a lender Or borrower are locked into an IL liquid Deal based on a tight and insular Relationship does anyone have an Incentive to admit when a company Actually needs to file for bankruptcy be Restructured or liquidated as a CEO with A flexible line of credit why would you Give up and as a private credit fund Bending the rules of a loan may not be Ideal but it's much better than having One of your portfolio companies go Bankrupt a headline like that could end Up costing you much more in the future Than just amending extending and Pretending that everything is fine in Your portfolio look everyone we really Know how to pick the winners and we're Such great partners to them too the Structure and incentives involved in Private credit theoretically enable all Parties to Kick the Can down the road Until a business is so eroded that Nobody can keep up the act any longer With the private credit Market Apparently becoming so big this could Happen on an industrial scale creating a Wave of zombie companies burning through
Cash and contributing nothing to the Economy if a macroeconomic shock does Come it will likely be the straw that Breaks the zombies backs but unlike Companies with publicly traded debt and Credit ratings nobody will see the Collapse coming until they're too late To be saved as such private credit could Be the house of cards that you only see When it causes the bottom to fall out of The economy much harder than anyone Expected now if private credit does Indeed turn into rocket fuel for a Recession investors will flee from risk Assets and crypto will likely be hit Hard altcoins might be wrecked beyond Recognition but it'll be interesting to See how Bitcoin responds now that we Have Wall Street pedaling the digital Gold narrative it could become a new Candidate for a flight to safety anyway All of this is just one possibility and As professors Elias and defont emphasize It's only conjecture because we're all Just working from anecdotal evidence Nobody has any reliable data about the Private credit Market it's unre ated It's unregulated and if it's really all Sunshine and rainbows they're doing a Damn good job of keeping everyone in the Dark as such hopium might actually be Our only salvation because the only Thing we are sure of is that private Credit is growing extremely quickly
Almost like something inflating and Remember that excited guy from Blackstone saying how it could grow to Be a 50 trillion dollar market sounds Pretty exuberant to me maybe even Irrationally so hm irrational exuberance Now where have I heard that Before right that's all for today folks Let us know what you think about this Private credit thing in the comments and While you're at it smash the like to Give this video a boost subscribe to the Channel and give the old Bell a jangle To stay in the loop with our next upload As always thank you for watching and I Will see you next time this is Guy Signing off [Music]
