What’s Really Happening In Private Credit?

Courtney Reagan, Senior Editor of Blackstone Insights: I'm Courtney Reagan, and if you've read the paper, watched the headlines, or been in any investing circles, you're probably wondering about private credit. I've got a lot of questions too, but I've got the right guy to ask. Michael Zawadzki, you are the Global Chief Investment Officer at Blackstone Credit & Insurance. So some of the terminology that's inherent in private credit feels somewhat reminiscent to the global financial crisis, leverage, liquidity, defaults, even the idea of credit in loans. How are today's metrics the same or not to what we saw in 2007, 2008, 2009?

Michael Zawadzki, Global Chief Investment Officer for Blackstone Credit & Insurance (BXCI): So I think the analogy is completely misguided, because if you think about what caused the global financial crisis, it was excess leverage in vehicles, excess risk on assets, and asset liability mismatching. Asset liability mismatching, you had banks making loans that were making them with deposits that can be withdrawn in a moment's notice. Asset risk, subprime mortgages were advancing over 90% debt against the value of the asset. If I look at what's happening in direct lending today, it's only 40% advance rate of debt against the value of the asset. And third, leverage in the system. Broker dealers were leveraged 25 to 40 times back at the GFC. If you look at direct lending vehicles, they are less than one times levered. And so the risk profile on all three of those metrics are very different today versus the GFC.

CR: Okay. Some of that makes sense, and I like the numbers behind it, but there's still this criticism of transparency that private credit is not as transparent as public credit. What do you say to those that worry it's a little bit more secretive, and that gives some inherent concern?

MZ: Well, I get it. It, it isn't public credit. It is private credit, but I think people maybe don't appreciate how much transparency and objectivity is in the asset class. If you look at the BDC market, you can go on the SEC's filings and see quarterly reports that show every single loan we own, the terms of that loan, where it's valued. If you think about our valuation process, every single asset gets marked either monthly or quarterly by a third-party provider.

CR: So there is information out there. It may just not be as available as often as public credit. But it's there if you look for it.

MZ: Yeah. 100%.

CR: Private credit isn't as liquid, though, as some other financial investments. I understand it's by design, but if I can't get my money out when I want to, the amount at which I want, it doesn't give me a lot of comfort, especially if there's a time of feeling financially stressed.
MZ: Yeah. Look, this is the inherent value proposition of private credit. You trade a little bit of liquidity as an investor, and you get excess spread, and I think that is something we've been really transparent about. In most markets, you absolutely will be able to get that liquidity, but that's the trade-off you make. And our ability to have locked up capital to actually use that to drive excess spread, excess return, certainty in the market, that is the value proposition that private assets have delivered over decades, and I think will continue to deliver moving forward.

CR: The basic definition of private credit is basically a loan made by a non-bank institution. But the idea is the same. Someone borrows money. They will pay it back on a timetable plus interest, you hope, but sometimes it doesn't happen. So if there are defaults, what does that mean if I'm an investor in private credit? Aren't defaults rising?

MZ: Some normalization is reasonable to expect, but again, this narrative that I see about this huge spike in defaults, that does not happen outside of recessionary periods, and what we see today is a very resilient economy. Corporate earnings are growing. Consumers are resilient. We have a massive CapEx cycle, and we have fiscal and monetary stimulus. Those are good things for the economy. In an environment like that, while defaults may normalize, I don't expect them to surge the levels that sometimes I read about in the press. Being first in line as a first lien lender for repayment, if a loan does default, we can actually go and take over that company and make it better, and I think that's an important point. I think the second important point is companies don't default overnight. When we see underperformance in credits, we start valuing those appropriately with our third-party valuation provider. And then if they do default, that gives us the opportunity to improve the outcome.

CR: There's a fear that AI will take over, and these software as a service companies, or SaaS, will become irrelevant. Blackstone does have some software investments and some of these in their credit portfolio. So how risky is this for an investor in private credit, the exposure to software?

MZ: Number one, not all software is, is created equal. We have 14 different sub-sectors that we invest in in the software space, and some are really well protected. Think about deeply embedded, mission critical, regulatory end markets. That's the vast majority of our exposure. There are some markets that are gonna be disrupted, content creation, low value added, IT services. Number two, where in the capital structure you're invested in software really matters. So being senior secured debt, if we look at our portfolio, we're at 37% loan to value.¹ That means 60% of a company's value needs to be eroded before our loan is impacted. And when I actually look at the performance of our software portfolio, it's performing quite well. It grew double digits last year.² On average, our investments in the software space have about four and a half billion dollars of value, which means about $3 billion of equity sitting subordinated to us. That's a lot of protection. We're not going to be immune, because again, AI will be a disruptive force, but I feel really good about where our portfolio companies are positioned. And in fact, our software companies have actually grown faster in the last year than our overall portfolio at double digit rates.

CR: At the end of the day, investment performance is what matters most. Is Blackstone's private credit portfolio healthy?

MZ: Yeah. Look, when I look at earnings metrics across our portfolio, they continue to be strong overall. EBITDA growth, cash flow growth grew double digits last year, and interest coverage, our company's ability to service their debt, is up 25%. So overall, we see healthy portfolio company performance within a healthy economic backdrop. That's not to say you won't see isolated credit incidents, but we feel really good about the health of our portfolio and our ability to deliver on the promise of private credit, excess spread per unit of risk relative to liquid markets, consistency, high current income, low volatility. All of those attributes continue to be very true in today's environment.

CR: Z, the context and the metrics I think really help a lot here. Appreciate your perspective here today.

MZ: Thanks for having me.

Footnotes:
1. 37% loan-to-value at the time of underwrite.
2. Represents LTM EBITDA Growth year-over-year and generally excludes debt investments that funded after December 31, 2024. Includes all debt investments within BCRED's software portfolio (as classified under the GICS Industry level) for which fair value is determined by the Board in conjunction with a third-party valuation firm and excludes both asset-based investments and quoted investments.

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