The private credit headlines for months have covered peculiar defaults, write-downs, building redemption pressures and some seemingly encouraging one-off asset sales. Each story lands with a kind of technical thud. They’re important, apparently, but hard to translate into anything that feels either urgent or concrete.
But if private credit is genuinely in trouble, what does that mean for the broader market and specifically for private equity?
Private credit and private equity aren‘t the same thing, but are often intricately linked in the financing of the same companies. Private equity may indeed be the bigger, untold part of this story.
Private credit is lending that happens outside traditional banks – funds that provide loans directly to companies, often mid-sized businesses that don’t have easy access to public debt markets. It has grown dramatically since the 2008 financial crisis, as banks pulled back from certain kinds of lending, and institutional investors – pension funds, endowments, insurance companies and, more recently, retail investors – went looking for yield. It is now a multitrillion-dollar market globally, embedded into how thousands of companies are financed.
Multiple Canadian private lenders have been marked by issues in recent years, including Bridging Finance, which was placed into court-ordered receivership in 2021 amid allegations of fraud, and Romspen Investment Corp., which froze investor redemptions in 2022 because of troubles with loan repayment.
Numerous headlines have highlighted U.S. private credit firm Blue Owl Capital – a major player turned poster child for industry fears – capping withdrawals for a second straight quarter as investors sought to pull US$3.6-billion from its US$34-billion flagship credit fund.
When expected returns became minimum acceptable returns
Many of the companies relying on private credit didn’t borrow it on their own. They were acquired by private equity firms – funds that buy companies, often layer them with debt to finance that purchase, operate them for several years then sell them at a profit. Private credit frequently lends to the companies that private equity owns. They are different, but they’re partners at the same table.
Their connection matters when losses are realized. Debt sits ahead of equity in any company’s financial structure – lenders get paid before owners. So when a business runs into trouble, the equity stake absorbs the damage first and fastest. When debt prices fall by five per cent, equity may drop by 40. So if a private credit fund reduces the recorded value of a loan, is it not also signalling that the equity ownership below it is impaired too? Aren’t the private credit headlines likely early indicators of private equity losses that simply haven’t been recognized, or disclosed, yet?
Broader market effects must follow from this too. Institutional investors hold both the private credit and private equity. If they are under pressure simultaneously, investors will change allocation decisions, shift their risk appetites and slow the flow of capital into the next generation of deals. The companies that depend on that capital, many of which cannot simply walk into a bank for an alternative, may find themselves with fewer options at precisely the wrong moment.
There seem to be dozens of articles about private credit stress for every one that even mentions private equity. Given how connected they are, it seems that private equity is genuinely hard to see into or understand – and I’m reasonably sure that opacity isn’t accidental.
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Private equity valuations are not set by markets. They are set quarterly, by private equity firms, using methodologies that usually involve judgment, selected comparisons and assumptions about future performance.
A private equity fund managing a stressed portfolio can, within limits, choose when and how much to acknowledge that stress in its reported numbers. And the incentives to delay reporting that stress seem pretty powerful: Lower valuations mean lower management fees, slower carried interest – the profit share that fund managers collect – and hard conversations with the investors whose capital they are hoping to raise again in a few years.
Private equity has tools that public markets don’t. Firms can borrow against their portfolios to return cash to investors without selling assets, avoiding the price discovery that a sale would impose. They can also “roll” aging investments into new vehicles rather than exiting at disappointing prices. These are legitimate, widely disclosed practices. But they can also delay price discovery, creating a picture that appears considerably calmer than the underlying reality.
Almost everyone in the stakeholder chain shares an interest in that calm. The private equity firm protects its economics and its fundraising. The institutional and, more recently, retail investors prefer a predictable reported return. The auditors legitimately work within frameworks that allow for latitude in private asset valuation. The collective result presents very well: An industry that has become remarkably good at absorbing stress in an orderly fashion.
Layered on top of these questions is a rising interest rate environment that doesn’t help. Many of these deals were structured when borrowing was cheap, with debt loads that looked much more manageable.
It’s time to stop calling investments ‘alternative’
For a publicly traded company, there are options such as issuing equity, or refinancing through a bank. Many private-equity-backed businesses don’t have those alternatives. If their private credit lender tightens or walks away, the event that forces a write-down becomes visible: debt maturities that can’t be refinanced, exits that the market prices lower than the fund’s books, redemption demands that require selling real assets at available market prices.
The image I keep returning to is of a duck on a pond. The private credit headlines are the ripples. We don’t doubt that the duck is kicking – but we’re left questioning how hard.
There are well-run private equity funds with disciplined managers who will navigate this cycle too, and it is entirely possible that the buffers are thicker and the risks more contained than my outside view may suggest. But if I have the reasoning wrong, I genuinely hope someone who knows this world explains it clearly – we’d all be better off for it.
Until then, I’ll be watching the water.
Kevin Foley is Managing Director, Institutional Accounts at YTM Capital, a Canadian asset manager specializing in credit and mortgage funds. He spent two decades trading and managing fixed income at a major Canadian bank and serves on several Canadian foundation boards and investment committees. Kevin.Foley@YTMCapital.com