From Par To Pennies
Submitted by QTR's Fringe Finance
Private credit’s reckoning is not arriving with one grand, spectacular crash. It is arriving slowly and steadily, one loan at a time.
For years, one of private credit’s great attractions was the remarkable stability (or perceived stability) of its valuations. Public bonds could fall ten points in a week. Leveraged loans could gap lower after a bad earnings report. But private loans somehow possessed the soothing ability to remain at 98, 99 or 100 cents on the dollar through almost anything, all while paying investors a healthy yield.
Incredible, right? Another financial fairy tale…a proverbial unicorn sh*tting rainbows.
Until reality eventually reared it’s head, and now, to the surprise of no one, we are finding out unicorns don’t exist. Imagine that. We are learning that the absence of volatility in a reported mark does not mean the absence of deterioration in the underlying loan. And that is increasingly where the private credit story gets heinous…and why I’ve been writing about it for 2 years now.
The opacity is unlike any other corner of markets. Some borrowers can weaken for months, even years, while their loans remain marked at levels suggesting that most or all of the money is still coming back.
Eventually, though, something happens that makes the deterioration impossible to finesse away. A borrower stops paying interest. A hoped for refinancing disappears. The sponsor declines to put in more equity. A rescue transaction collapses. Or, most decisively, like we are seeing more and more, the underlying company files for bankruptcy.
That is when the soothing stability of private credit can suddenly disappear. A loan that sat near par through months of worsening fundamentals can plunge to 50, 20, five cents or even zero in remarkably short order. The economic deterioration may have been happening all along. The mark simply waited until reality became too difficult to ignore. You then get headlines like this one from Bloomberg yesterday.
And increasingly, the pattern looks familiar. A company struggles, leverage stays high, liquidity deteriorates and interest becomes harder to pay. Yet there is always a reason not to mark the loan too aggressively. Maybe EBITDA recovers. Maybe rates fall. Maybe the sponsor writes another check. Maybe there is a refinancing, an asset sale or a transformational M&A deal just around the corner. Maybe the guy responsible for marking down the loan has set his “out of office” email response to inform people he is taking 2 month vacation on his yacht in Malta.
Hope, conveniently, has a fair value. It’s always 100 cents on the dollar or damn close to it. But then…painstakingly and eventually…reality catches up and 100 cents quickly becomes 20 cents. Or zero cents.
The latest example is....(READ THIS FULL ARTICLE HERE).