Howard Marks, the co-founder of the $172 billion investment group Oaktree Capital Management, has warned that the private credit boom will soon be tested as rising interest rates and slowing economic growth put pressure on American companies.
The 77-year-old billionaire told the Financial Times that big asset managers had been competing aggressively to lend to the biggest private equity groups as money poured into their coffers in 2020 and 2021, raising questions about the due diligence the funds conducted when they agreed to provide multi-billion dollar loans.
“[Warren] Buffett says it’s only when the tide is out that you find out who’s been swimming naked,” he said. “The tide hasn’t turned yet on private lending, which means wallets haven’t been tested.”
He added: “Did the managers make good credit decisions, ensuring an adequate margin of safety, or did they invest quickly because they could accumulate more capital? We will see.”
Private credit has soared since the 2008 financial crisis prompted regulatory reform that moved banks away from speculative lending, and new lenders have stepped in to fill the gap, including many backed by private equity titans such as Blackstone, Apollo and KKR.
Data provider Preqin estimates that the private credit market, which includes loans for corporate acquisitions, has grown to about $1.5 trillion from about $440 billion a decade ago. Fundraising has been brisk, eclipsing $150 billion annually since 2019.
But some of that capital influx was lent when markets were in a seemingly unstoppable upward march, before the US Federal Reserve began aggressively raising interest rates. Competition between private lenders drove down borrowing costs at the time.
Investors have raised questions about a number of loan deals signed during that time, including some based on a company’s revenue growth relative to its profitability. Higher interest rates are also starting to put pressure on companies, eroding profits, with some companies asking their lenders to waive their cash interest payments.
Moody’s analysts, who are calling for an increase in corporate delinquencies as economic growth cools, have separately warned that a lack of understanding of the private credit market suggests “that the sector may be harboring risks that are not currently visible”.
Signs set Oak in 1995 with chief investment officer Bruce Karsh and three others. Known for his famous investing memos, he is an unequivocal contrarian, bargain hunter, and follower of market psychology who tries to live by Buffett’s investment maxim: be fearful when others are greedy and greedy when others are fearful.
Right now he sees a fertile environment for lenders like Oaktree to step in and provide financing where banks are further downsizing following the collapse of Signature Bank and two other US regional lenders. The Fed said this month that banks are tightening lending standards for businesses and warned of a potential credit crunch.
“You now have significant interest rates and a certain scarcity of capital as banks are limited,” Marks said. “This is good weather. . . now you can get equity returns from debt, and when you invest in debt you have a much higher level of certainty of return than with equity ownership.
Marks said this contrasted with the investment landscape from 2009 to 2021, when interest rates were low and “everyone was eager to invest.”
“If everyone is eager to invest, you’re not going to get a deal,” he said. “It’s simple supply and demand. For more than a decade, it hasn’t been a good time to be a lender. Now is a much better time.”
Oaktree has expanded beyond its roots in distressed debt and now invests in credit, private equity, real assets and publicly traded equities. The company is in the midst of a boost to fundraising as it seeks to raise $10 billion to finance large private equity-backed acquisitions.
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