Is It Really Private Credit’s Time to Shine?
Private credit is likely to become a go -to financing tool for deal makers, especially given the upheaval in the banking sector after the regulatory takeover of Silicon Valley Bank and Signature Bank.
Brad Marshall, global head of private credit strategies at Blackstone Inc., the world’s biggest private-equity manager, said this is “one of the best environments” for the asset class since the firm launched its credit division in 2005.
Mr. Marshall stepped into his new role in January, overseeing strategies that make up roughly half of Blackstone’s $246 billion credit portfolio. He is also co-chief executive of both the Blackstone Private Credit Fund and the Blackstone Secured Lending Fund, as well as a senior managing director at the company.
Blackstone’s credit unit has been part of some recent deals. Last year, a group of lenders led by Blackstone provided debt financing for the acquisition of Zendesk Inc. by a group of private-equity firms for $10.2 billion. The credit unit also participated in a roughly $4.5 billion debt package for private-equity firm Hellman & Friedman’s purchase of a majority stake in Information Resources Inc.
With private-credit managers expected to snatch bigger deals away from banks, Mr. Marshall said he sees more opportunity for so-called club deals, buyouts where several private-equity firms pool funds to acquire a company.
Although the private-credit market is having a moment in deal making, many portfolio companies owned by private-equity firms are under pressure as they struggle with elevated inflation and rising interest rates—leading to a higher likelihood of default and bankruptcy. Blackstone and other private- equity firms might be called to make some tough decisions on their portfolios.
Mr. Marshall recently spoke to WSJ Pro. Here are edited excerpts.
Q: How busy has it been in terms of deployment for private debt and what opportunities are you seeing?
Mr. Marshall: Obviously the start of 2022 was actually quite strong from an M&A environment and as the year went on, as volatility set in, the public markets became more dislocated because of rates, because of recession, because of inflation—there was a pull- back in the public markets. Because public markets were shut down, the private markets were the sole avenue for companies to access the capital markets and so private credit was fairly busy.
The second half of last year was prob ably one of the busiest periods that we have seen in our history, and what drove a lot of that was the larger transactions, where those were the harder deals to get done in the markets. So you saw issuers, companies approach us for very large transactions. Zendesk was a big one where we invested. It was a $3 billion deal and we were about half of it, and there were some others that came to market towards the end of last year.
Q: And how is it now?
Mr. Marshall: This is probably one of the best environments that we’ve seen in private credit since we started Blackstone Credit 18 years ago. And it’s for the following reasons: Base rates are high and most of our loans are floating rate, spreads are wide relative to historical levels and because of both of those things yields are up 50% from where they were this time last year. So last year, yields were around 7% to 8%. Now, we’re closer to 12%.
Because yield is so high, actually capital structures are being set up much more conservatively so leverage is lower, loan to value is lower. So, you’re getting paid more, there’s less risk in the capital structure, and you’re doing it at a time where you’ve got pretty sober views towards the economic outlook in Europe, in the U.S. or elsewhere.
Q: What about existing portfolios and loans that were made two to three years ago? How are they holding up?
Mr. Marshall: One is, interest expenses are up so interest coverage by definition has to go down. But where I see a kind of resilience is on a number of different lines. For example, vintage. Did they make the investment in 2022, where they invested a billion dollars and didn’t expect rates to be at 5%, but nonetheless, they invested a lot of capital based on a thesis. That type of vintage will give the company much more of a runway for the equity to play out. Those sponsors, those companies will look at the current rate environment, growth environment, margin environment, and view those as more transitory headwinds and will continue to support their companies. So I think vintage is going to matter a lot.
I think sectors are going to matter quite a bit. If you take an industrial business that is typically more closely tied to GDP growth or the growth of the economy, and the economy starts to slow, then it is going to be impacted. That same industrial company is probably more impacted by inflation, raw materials, wages and then they also have capital expenditure that they need to spend. And interest rates just went up 50%, so that puts a very tight cash-flow profile for those types of sectors. Compare and contrast that to a business in software where it has much higher cash-flow conversion and is less impacted by raw materials, and less correlated to GDP growth.
Third, the scale of businesses. Bigger companies tend to navigate periods of complexity much better than smaller companies....Vintage, sector and scale will create this bifurcation of performance through this year and into next year, in terms of the different sectors.
Q: What does your portfolio look like?
Mr. Marshall: We are, no coincidence given my remarks, much more heavily focused on what we would characterize as growth sectors. So, technology, software, healthcare and sustainable resources.
When we look at our overall portfolio construction, 88% of our sector focus are low-default sectors versus the market at 40%....Technology and healthcare tend to exhibit lower default rates over a long period of time. From a size-of-business standpoint, the average Ebitda of our business is close to $200 million. So we focus on larger businesses for this exact reason.
Q: What are some of the risks in the market?
Mr. Marshall: The risks certainly are navigating in a slower-growth environment....Overall, most companies and sponsors are thinking through their capital structure given how high interest rates have gone and what they need to do to kind of navigate through that period. Most of these companies were set up with less than 50% loan to value, so there’s a lot of equity subordination. But as you kind of roll out through the remainder of the year, if growth does slow, if margins do compress and interest rates have stepped up, then some sponsors are either going to have to think about contributing more equity to their business to move through what we believe is a transitory period of headwinds, or they’re going to have to have come to some resolution with their lenders in order to help them.
Q: Do you expect more bankruptcies and defaults?
Mr. Marshall: I think defaults will increase.
I think most of the market believes defaults will increase, but I do think that those are going to be more concentrated along the lines that I suggested, which are smaller to midsized businesses, more industrial cyclicals, retail consumer-facing companies and older vintages, where a sponsor has maybe owned an asset for four, five, six years and it hasn’t grown or maybe it’s in decline and their equity thesis hasn’t fully played out. Now, they’re hit with a situation where they may be forced to put in capital, they will have to triage and think through their own portfo lios and decide which companies they want to support and not support. And I would suggest they’re more inclined to support their newer investments.
Q: Will there be more distressed opportunities in this environment?
Mr. Marshall: I think you will see a pickup in distress....I think maturity walls were pushed out. The back half of this year and into next year is in my opinion where you will see it first, is in the cyclicals and more retail-oriented businesses.
Q: You are now the largest CLO manager. How are you thinking about that business?
Mr. Marshall: Our CLO platform tends to have a quality bias, so the assets are generally higher quality. But they are going through their portfolios with the same kind of analysis and to make sure that the equity waterfall works in the new issue market, especially because triple-A suppliers or investors are quite limited. That tends to mean the bigger platforms attract most of that capital. We continue to issue new CLOs—we printed our 100th CLO fairly recently—but I think smaller managers are having a hard time accessing that market.
Q: As deals get bigger and bigger, do you expect to work with partners in the future?
Mr. Marshall: There are a handful of folks that can do large deals. We continue to be the largest, and have driven the market into this space. But there are a handful of deals that were done more recently, and will again, that require a handful of us to come together. Even if we’re investing $2 billion, we still may want someone else to come into those assets to help grow that investment to be a little bit larger. So yes, partnership with the right folks is certainly something that we continue to look at.
This is a great interview with Brad Marshall, global head of private credit strategies at Blackstone.
The guy is sharp and knows his stuff, he answers some tough questions head on and explains why vintage, sector and scale will create this bifurcation of performance through this year and into next year, in terms of the different sectors.
Blackstone has significantly ramped up its credit operations in the last five years.
In November 2021, Matt Wirz of the Wall Street Journal reported on how Blackstone turned sluggish credit business into a winner:
Blackstone Inc. towers over most of its private-equity peers with $731 billion in assets, but the firm has had a soft underbelly for years: its sluggish lending business. Now, credit has become one of the firm’s fastest-growing segments, part of a broad shift under the leadership of President Jonathan Gray.
Assets under management in the unit, which makes corporate loans backing leveraged buyouts for other private-equity firms, jumped 22% to $188 billion this year through Sept. 30. Private-equity assets under management rose 17% to $231.5 billion over the same period.
Blackstone is expanding in the space by launching low-fee funds and selling them to wealthy individuals who might not qualify for products tailored to institutions like pension plans. The strategy replicated a move that Mr. Gray used to turbocharge the growth of the firm’s real-estate investment trust, called BREIT.
It also marks a culture shift, as the hedge-fund operations that once lent Blackstone its Wall Street cachet fall out of favor. And large money managers that traditionally focused on private equity see a bigger opportunity in debt, where the addressable market could be as large as $40 trillion.
The resurgent credit business should help Blackstone in the race for investor dollars against its principal competitors, including Apollo Global Management Inc., Ares Management Corp and KKR & Co.
Debt specialists Apollo and Ares have pledged to boost assets to $1 trillion and $500 billion, respectively, in coming years, while KKR more than doubled its credit business this year, primarily by purchasing insurer Global Atlantic Financial Group Ltd. Only Ares grew its own credit business as fast as Blackstone this year.
Several large credit firms vied to win the lead role providing $2.6 billion of loans this year for private-equity firm Thoma Bravo LP’s leveraged buyout of Stamps.com Inc. Blackstone walked away with the top spot by offering to backstop the entire amount, Dwight Scott, head of Blackstone Credit, said.
The firm historically operated in debt markets through GSO Capital Partners, a hedge-fund manager it acquired in 2008 that was known for large, aggressive and lucrative trades. GSO’s founders—Bennett Goodman, Tripp Smith and Doug Ostrover—all left Blackstone in recent years. The credit business jettisoned the GSO name last year and has shut its hedge funds.
Blackstone’s separate hedge-fund solutions business has shrunk in importance to 11% of total assets, down from 19.4% five years ago, according to earnings reports. John McCormick, co-head of Blackstone’s funds-of-hedge-funds business, told colleagues last month that he plans to resign.
The hedge-fund solutions unit’s “revenues and earnings have doubled in the last three years and the business will continue to expand through new offerings and senior hires,” a Blackstone spokeswoman said.
The rebranded Blackstone Credit is aggressively marketing less-risky, cheaper funds to individual investors.
“It’s all about de-risking the portfolio,” said Mr. Scott. Blackstone believes the lower-fee products allow it to deliver attractive returns to investors without reaching for yield by purchasing debt with a higher chance of default, he said.
The credit revamp is part of Blackstone’s aim to achieve $1 trillion in assets by 2026. To get there, Mr. Gray has encouraged Blackstone’s business heads to embrace a thematic investing approach focused on fast-growing industries. In credit, this translates into more loans to sectors such as technology and life sciences.
Blackstone earlier this year launched BCRED, a business development company, or BDC, which makes direct loans to medium-size companies. BCRED raised $9.4 billion through share sales this year, primarily to individual investors.
Blackstone made its first big foray into credit when it bought GSO for about $1 billion. GSO hedge funds excelled at big risky bets on distressed debt that returned as much as $100 million each.
The firm also joined with Franklin Square Holdings LP, which launched a BDC in 2009. GSO made the loans and split management fees with Franklin Square, which raised money from individual investors. Upfront broker and management fees averaged 9.4% in the BDC’s early days, high enough to attract scrutiny from regulators.
Credit assets jumped about fivefold to $128 billion in the decade after the GSO acquisition as the business built a mixture of BDCs, hedge funds and securitized bundles of low-rated debt known as collateralized loan obligations.
The growth stalled out in mid-2018 when the venture with Franklin Square dissolved over the profit-sharing split and differing growth strategies. Blackstone exited from the business in exchange for a $640 million breakup fee. The last of the GSO founders resigned shortly afterward.
Credit assets under management rose by 3.1% to $144.3 billion from April 2018 to the end of 2019 even as Blackstone’s overall assets swelled by 27%, according to company earnings reports. Apollo’s credit assets grew 30.4% over the same period to $215.5 billion and Ares’s surged 43% to $110.5 billion.
Blackstone spent that time designing the terms and sales engine for its new BDC, from which it earns all of the management fees, said Brad Marshall, co-head of performing credit at the firm. BCRED uses the same brokers that sell BREIT for marketing and charges a 1.25% management fee and a 12.5% performance fee. Most big competitors charge 1.5% and 17.5%-20%, respectively, according to Securities and Exchange Commission filings.
Unfortunately, Blackstone's BREIT has run into trouble this year, limiting its redemptions again in April, the sixth straight month of doing so:
Blackstone Inc on Monday said it had again limited withdrawals from its $70 billion real estate income trust in April as investor redemption requests continued to pile up.
Blackstone said BREIT had received $4.5 billion worth of withdrawal requests in April, but the fund fulfilled only $1.3 billion or 29% of the total redemption requests, the firm said in a letter to investors.
In March, BREIT had also received requests totaling $4.5 billion but it fulfilled just $666 million or 15% of those demands. Redemption requests were $5.3 billion and $3.9 billion in January and February, respectively.
Blackstone has been exercising its right to block investor withdrawals from BREIT since November after requests exceeded a preset 5% of the net asset value of the fund. It has so far paid out $6.2 billion to investors who have been requesting redemptions since November, the firm said.
This is the problem when dealing with individuals, including high net worth ones, they're typically a lot more fickle than large institutions.
BREIT has an added hurdle, the commercial real estate market is undergoing a paradigm shift which is why REITs remain under pressure again this year:
And Manhattan's largest office landloard, SL Green, looks more like a regional bank these days facing collapse:
These are not fun times for real estate firms, many are struggling to survive.
As far as private credit's time to shine, I am a little worried.
No doubt, with big regional banks failing every week, lending standards are tightening in the US, presenting huge opportunities for top private credit funds like Blackstone.
But as I warned earlier this year, I'm increasingly worried that private debt is the next subprime debt crisis, and many Johnny-come-lately private debt funds taking on huge (junior debt) risks are going to get obliterated when the next global recession strikes.
It's coming, I guarantee it, all roads lead to recession and it will be a nasty and long one, never mind what Jay Powell said in his presser today.
So is it private credit's time to shine?
Maybe for Blackstone, Apollo, Ares, KKR and a few other top funds but even they will find it very challenging ahead.
No doubt, there will be great deals, big club deals and I expect Canada's large pension funds to be part of.
I just warn you to temper your expectations and be very concerned about underwriting standards as the global recession storms gain strength.
Below, Joe Bae, KKR co-CEO, joins ‘Squawk on the Street’ to discuss if the regional banking drama has affected KKR, the assets classes Bae is currently seeing ‘tremendous’ opportunity, and why this may be the moment for private lending.
Next, Jon Gray, president and COO of Blackstone Group, joins 'Squawk Box' to discuss the company's Q1 earnings results, the state of the real estate market, and more.
Third, Apollo Global Management Inc. CEO Marc Rowan says the recent US regional banking crisis will cause a "second wave" of losses in the commercial real estate market. "It won't be systemic, in my view, but it will be concentrated," he says at the Milken Institute Global Conference in Beverly Hills, California.
Mr. Rowan also warned that private equity was not immune to ‘the siren song of liquidity’:
"When rates are down and credit is free and liquidity is plentiful, everything moves up and to the right," Rowan told Yahoo Finance at the 2023 Milken Global Conference (video above). "So public equity markets, technology, [and] growth clearly succumbed to the siren song of liquidity. People now have to figure out were they good investors or was this all market beta?"
"Private equity was not immune to that," he added. "While it was happening, it felt really good, and now that it’s not happening anymore, it doesn’t feel so good...We did just fine over 10 years, but this is the period of time when liquidity has been withdrawn, when we’re playing offense and lots are playing defense."
Lastly, watch Fed Chair Jerome Powell's presser from earlier today.
My take? The Fed wants regional banks to fail, concentrating more power in big banks which will tighten lending standards so their big private equity clients can lend at juicy rates.
Moreover, the Fed doesn't seem to care much about financial stability, it seems to want to create a major credit crisis which will benefit elite private equity funds.
Welcome to American Capitalism 2.0. As I keep telling you, read C. Wright Mills' classic book, The Power Elite, if you wan to understand how the world really works and be a better long-term investor.
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