Taking the “risk” out of “risk capital”
Ignoring the dumpster fire taking place south of the border, there was plenty of content for credit and market junkies to take in this week. I enjoyed reading about Goldman joining the lending parade: in 2024 their lending business was a bigger earner than their traditional investment banking pillar, and it is now one-third of their markets business revenue. It seems like lending is the new home for Masters of the Universe, but I don’t think we’ll see any movies about private credit. Although I would pay to see a film called “Creditor on Creditor Violence”. Whoever coined that term deserves a raise.
Jeff Gundlach of DoubleLine gave a restrained talk on rates and credit at a Bloomberg conference. He said that the private credit environment reminds him of the CDO market in 2006-2007. I was working in securitization at that time, and I agree with Jeff: back then a new CDO shop was opening every week, and still there was demand for the coupon, especially when everything was AAA-rated (oy, bad memories flooding back). When they ran out of assets to package, shops created CDO-squared, which struck all of us as insane, but if there was fee income to be earned, and league tables to climb, you had to play. Now, we read about new entrants to private credit, with concern about lending quality being compromised in order to actually deploy LP funds.
Speaking of LPs, my favorite reading has been about the proliferation of private equity and private credit managers raising new funding rounds specifically to return money to their investors. Or, they raise money to lend to portfolio companies, who then turn around and pay a special dividend back to the asset manager, who presumably will then return most of it to their investors. It’s at this point that a reasonable person could ask “can they really do that?” And the answer is yes, mainly because of the word “private” in the asset class name. And fine, it’s not my money they’re playing three-card monte with, but still, it’s annoying to read about these steps, because I thought capital markets were all about risk and reward, creative destruction, personal responsibility etc. If you’re a private equity company, you’re getting paid to deploy capital and eventually get it back plus a windfall. If something macro happens like historic uncertainty due to self-inflicted policy choices, you’re supposed to take your lumps, manage your way through it and learn some lessons. If you’re an investor in private equity, you’re taking extra liquidity risk, and it’s equity, so it’s supposed to be “risk capital”, not money in your FDIC-protected account at Wells Fargo. So if you don’t get that windfall, again that’s the risk part of the equation. But nooo, if you can get your “dequity fund” or “continuation fund” to kick the can further down the road, or pass the parcel to a greater fool, you’ll be ok. It’s enough to make you lose faith that the markets are efficient.