Some of you may remember the old E.F. Hutton television commercials.
"When E.F. Hutton talks, people listen."
I have no idea how many people were actually listening to E.F. Hutton back then.
But when JPMorgan starts talking about risk and risk mitigation, you better damn well listen.
When the most sophisticated risk managers in the banking system start asking harder questions, it's usually worth paying attention.
Their recent comments and actions regarding the private credit market are worth noting.
Here are ten things worth paying attention to:
1. Size matters
Private credit has grown extraordinarily quickly and is now estimated to exceed $1.5–$2 trillion globally.
Private credit has grown extraordinarily quickly and is now estimated to exceed $1.5–$2 trillion globally.
2. Borrower profile
Much of this lending finances middle-market companies, which tend to be inherently riskier than large public borrowers.
Much of this lending finances middle-market companies, which tend to be inherently riskier than large public borrowers.
3. High leverage
Many transactions involve substantial leverage relative to cash flow.
Many transactions involve substantial leverage relative to cash flow.
4. Leverage on top of leverage
Operating companies are leveraged. Private credit funds are frequently leveraged as well, meaning leverage at the fund level sits on top of leverage at the operating company.
Operating companies are leveraged. Private credit funds are frequently leveraged as well, meaning leverage at the fund level sits on top of leverage at the operating company.
5. Banks are still in the system
Banks may not always lend directly to the borrower, but they often provide financing to the investment vehicles that hold these loans.
Banks may not always lend directly to the borrower, but they often provide financing to the investment vehicles that hold these loans.
6. Limited transparency
Because these loans are privately negotiated rather than traded in public markets, information about pricing performance and structure are limited.
Because these loans are privately negotiated rather than traded in public markets, information about pricing performance and structure are limited.
7. Illiquid assets
These loans typically do not trade actively, making price discovery difficult.
These loans typically do not trade actively, making price discovery difficult.
8. Valuation depends on models
Portfolio values often rely on internal valuation methodologies rather than observable market prices.
Portfolio values often rely on internal valuation methodologies rather than observable market prices.
9. Documentation drift
As competition increases, covenant protections and documentation standards appear to be weakening.
As competition increases, covenant protections and documentation standards appear to be weakening.
10. Incentives matter
If you want to understand risk in any financial system, follow the incentives of the people structuring the deals.
If you want to understand risk in any financial system, follow the incentives of the people structuring the deals.
Disaster is not necessarily on the horizon.
But when JPMorgan starts talking about risk, I listen.