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- [00:06]
A
In what seems like a matter of months, private credit has gone from one of the hottest asset classes to perhaps one of the coldest concerns. That the rapid growth in private credit funds has come at the expense of underwriting standards and that these funds are far too exposed to the software companies now in the crosshairs of AI innovation have precipitated this sentiment shift. And as retail investors rush to exit these funds and run up against redemption limits, there are serious questions about the private credit push to access flows from retirement accounts. So what's really going on in private credit and what will it take to restore faith in this asset class? I'm Allison Nathan and this is Goldman Sachs Exchanges. A little bit later I'll be speaking to Vivek Bantwal, Global co head of Private Credit and Goldman Sachs Asset Management. But let's start this episode with Alex BLAustin, who covers U.S. asset managers and other financial companies for Goldman Sachs Research. Alex, welcome back to the program.
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B
Great. Thank you for having me.
- [01:02]
A
So, Alex, let me take a stab at trying to summarize this very bearish narrative we have right now around private credit. The idea is that private credit firms took in a lot of money and they rushed to deploy it as quickly as possible, which meant there were some frauds they maybe have overallocated into potentially risky sectors. Software, which we have discussed on this podcast, looks vulnerable. So there's a lot of factors playing into some negativity around the space. Did I get it right first of all? And is there any truth to any of this, most importantly?
- [01:36]
B
Yeah, well, look, this is certainly the narrative, but like with anything, there's a lot of nuance to it. And I think it is really important to unpack what's actually going on versus what are the headlines and then ultimately what are the risks? Because there's definitely some valid risks in some of the things that you mentioned. So there are really three big sort of issues that I think the market is grappling with. The first one is private credit has been a great asset class and has grown really quickly over the last several years. And we've talked about in similar settings in the past. We think it's about three and a half plus trillion dollar asset class. It's grown at about 15% a year for really the last five plus years. And it's relatively opaque. Right. I mean, there is definitely some disclosure that we can see, but for the most part it's not as clean and clear to the public market versus what we're generally all used to. The second question and Sort of the risk out there is the ultimate credit. You mentioned that there's certainly questions around software exposure and we'll get to that in a couple of minutes. But the underlying credit quality, the fact that the asset class has not been tested through a fully kind of full economic cycle is ultimately a question as well. And what is the lost content here could really look like? And then the third point which is probably most acute to today's environment is liquidity. And what is going on with some of these retail products which have been in the headlines really I feel like every day for the last month that are starting to see pretty sizable withdrawals and what effect that's going to have on asset pricing if any of these funds have to actually sell down assets to meet redemptions. And how does it all come together? So those are the three issues. There's a lot of nuance to all of that, which I'm sure we'll get to, but those are definitely top of mind for a lot of folks on the street.
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A
So let's unpack some of that and let's just start with software, which I mentioned. You just mentioned how concerned should private credit investors really be about exposure to software companies being disrupted by AI and potential losses related to that in the space?
- [03:30]
B
Yeah, so let's talk about some of the numbers. So the software related question is predominantly sitting in the direct lending part of the private credit ecosystem. So when we talked about $3.5 trillion plus the direct lending piece of that is about 1.6, 1.7. Software is a big part of that. We think it's roughly 25ish percent of exposure in terms of the assets that have been allocated to this part of the market. Now all software is created the same and the challenge is going to be some of the software companies that will have terminal value questions. We won't see that for several years because today these credits are performing just fine. And if you look at the underlying quality of the portfolio companies, we have not really seen a deterioration in things like non accruals. They've been fairly stable. We have not seen a significant increase in pick or payment in kind dynamics across the space. So that's been the challenge. Now I would say though, credit is credit, it's not equity. So there is significant amount of subordination that exists below these credits. So if we look at the space today, the LTVs are currently at around 30 to 40%, which clearly means there is significant amount of cushion beneath the loan. In other words, almost 70% of the value of the company. Has to go away before you lose any capital as a loan provided to this ecosystem. Now they could be wrong. And we've seen the public markets obviously discount these companies at 50 plus percent. So when we think about what is the actual loan to value on some of these loans, it is probably significantly higher than what we're used to seeing. At the same time, you have publicly traded BDCs and you have some loans that are trading at pretty wide discounts to their stated values. To be clear, BDCs or business development companies are just pools of capital that buy lever loans. So I think the market is looking at that and saying, hey, we can take that as a proxy to think about what are some of the potential losses that could exist in these portfolio companies and in these funds. All that said, we still think that the cumulative loss rate and the context historically really matters. So when we go back through prior periods of dislocation and we think about direct lending as an asset class, the cumulative default rate in the global financial crisis across the entire levered lending space reached 10% and recoveries were 50. So your cumulative loss was about 5 to 6 points. No one obviously is playing for that. That's not a great outcome. But keep that in the context of these loans is still paying a coupon of 9 to 10%. So I think it's a balance. I think there's going to be a lot of dispersion for sure. I think that what channel you playing will matter. Institutional versus retail. And who is sort of like the forced buyer in this part of the market cycle because they relied on a lot of retail capital versus maybe who was a bit more patient and who relies more on institutional business for this kind of product.
- [06:19]
A
So I think that's really helpful in framing the potential negative outcome here. And if I'm hearing you correctly, yes, there's a negative outcome, but it's a little bit more insulated than some of the other assets tied to some of these themes. And the fundamentals still look like they're holding up reasonably well.
- [06:35]
B
Right. It's credit, it's not equity. And do I think fundamentals will likely deteriorate from here? We're going to see more headlines. Yeah, I think it's likely partially because defaults have been zero. They have literally nowhere to go but up. But when I think about the timing of that, the work these companies can do to help themselves on the other end of the cycle, as well as what the cumulative loss size could be at the ecosystem level, it doesn't seem as draconian as Some of the things are being made out to be in the press.
- [06:59]
A
So even if that is the case with the fundamentals, the sentiment still matters, as we've discussed, a lot of negative sentiment. If we think about that. How is that potentially shifting demand for private credit strategies in. In the retail channel, in the institutional channel? And could that be a factor?
- [07:16]
B
Yeah, it certainly is a factor today for sure, especially with the retail channel. But I like the fact that you've framed it in both retail and institutional, because I think these are quite important and they're different. So let's talk about both. When we think about liquidity and the redemption trends that we're seeing in the space today, all of that is effectively coming on the retail side because the institutional part of the market physically doesn't have the mechanism to redeem the same way. So the retail channel is a little bit less than 20% of the assets in indirect lending space as a whole. So said another way, over 80% of the assets that are sitting in these funds do not have this liquidation mechanism that could result in this fire sales and then downward spiral in prices, which is what everybody's worried about. So I would put that issue as front and center to think about where could liquidity become a real problem? So that's one part of the market now in terms of the size of the retail space. We've done some work around this, and effectively you're seeing slowdown in gross sales, which are now running at about 50% lower run rate versus what they were in 2025. So clearly there's a significant less appetite on the sales front. And we've seen a pretty meaningful pickup in redemptions that are running on average in the first quarter at around 10% unannualized now. So these are big numbers. All of these funds have the ability to cap redemptions at 5%, which at this point we think most probably will. So that, well, puts people in the queue and it will take my guess a year plus to resolve some of these outflow issues. And we broadly think that evergreen retail funds in private credit will remain in net outflows throughout 2026 and likely 2027, based on, frankly some of the experiences we've seen with other similar products. Now, when you pivot to the institutional side of the equation, I actually think things could be quite different. We've talked in the past that spreads have really compressed indirect lending, partially because there's a lot of competition, there's a lot of money, more money chasing fewer deals, and the returns have not been as attractive. As they've been in the past. If you're starting an institutional business today or you're raising capital for institutional product and indirect lending, your returns for the next couple of years could arguably become a lot more attractive at better terms and better covenants. That to us suggests that just like we've seen in prior periods of this location, subsequent vintages tend to be actually quite good. So I would anticipate that businesses with either one large institutional dry powder, so capital that's available on the sidelines will get deployed here. And then secondly, you are probably going to see more institutional fundraising over the next two years as spreads become more compelling.
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A
Okay, so institutional sites holding up a bit. But let me just go back to something you mentioned which was fire sales in illiquid loans. So just to be perfectly clear.
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B
Yeah.
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A
You don't think that's likely given the
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B
setup on a broad based level? I don't think so. Could there be some funds they don't have enough liquidity at the underlying fund level? Yeah. You might see that now there's a common denominator here, that the 5% redemption limit is the choice of the manager. So they're not necessarily going to be forced to redeem people at what the ask is. So the 5% gives them a little bit of a buffer. When we look at the industry level as a whole, and back to this $230 billion in NAV that is currently sitting in these retail vehicles, to us, this results in a sort of 50, 60, $70 billion in net outflows. Then the industry would have to fund. You compare that against some of the liquid holdings they have, which we think is 40, $45 billion loan maturities, because these loans will mature over the next several years. And also access to things like credit facilities, which there's capacity on those as well. We think at an industry level there's going to be enough to bridge that gap versus having fire sales of tens of billions of dollars that all of a sudden rush to market because there are redemptions.
- [11:07]
A
Understood. But we still expect the demand for redemptions is going to exceed the inflow from the retail base.
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B
Absolutely.
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A
If I'm hearing correctly, how big of an implication will that have for the space? Broadly given, as you said starting out this conversation, that's where a lot of the growth has been for the product.
- [11:25]
B
Yeah. And you certainly seen that with alternative asset managers. And one of the reasons is because the growth algorithm, because these are generally growth companies and they traded at fairly high multiples, has been partially predicated on the idea that hey, wealth is a really new channel. Allocations are 1, 2, 3% and they could go to 10 plus over time. That's potentially over trillion dollars of AUM that could come to these companies over time. So really significant growth driver that is clearly being revalued by the market today. Now private credit has been almost half of that. So when we think about our growth algorithms, we're saying hey, private credit within the retail channel probably net outflows for the near term. It'll take some time to recover like we saw with real estate, but it's probably not in the near future. The other products so far have actually been doing quite well. So when we look at private equity infrastructure secondaries, one we haven't seen really elevated redemptions from any of those vehicles. And the gross sales surprisingly to us have actually been holding up reasonably okay. It's probably going to slow down. I mean it takes a little bit of time. I think volatility in the markets broadly, I mean we've been my only focused on private credit. But there's lots of other things going on in the world that create a lot of market turbulence that will probably impact sentiment for a lot of risk assets. So it will play a role. So the growth will be slower. We think that the management fee growth algorithm for alternative asset managers will reflect that. But as a whole we still actually expected the space to grow, but so
- [12:51]
A
the outlook is shifting a bit. But just to go back again, you don't see the private credit questions that are being raised as presenting real systemic risk to the broader market.
- [13:01]
B
Yeah, and we've said it a number of times too, where it's really easy to make that leap to say, hey, it's an asset class that's opaque, it's grown a lot, there's questionable credit and now I have to worry about liquidity, which really starts to kind of create early innings of a broader systemic problem. I go back to the liquidity issue that could really spiral things exist in a very small part of the market where the manager has the ability to cap redemptions at 5%. So back to the we don't think there is a wave of fire sale of assets that's coming to market which will push pricing significantly lower, remains the case. And that's the first ingredient for a bigger issue on a broad scale systemically. Look, credit is credit, there will be losses and I think the industry obviously will have to work through that. But given the amount of subordination that exists in the system, we think that the ultimate loss rate will be Pretty manageable at a systemic level.
- [13:54]
A
So let's, Alex, try to end on a more positive note. I mean, could there be opportunities that emerge given all the negativity, which to some degree you think could be overdone, at least for some pockets. So could there be opportunities for the asset class and for alternative asset managers broadly?
- [14:11]
B
Yeah, there's silver lining in some of this and that certainly is being lost, I think in a lot of headlines and frankly in a lot of my conversation with investors, I mean there's definitely no one really focusing on any glass half full so far. But I would say a couple of things. For the asset class broadly, the private credit space is a lot more than just direct lending and their pockets of private credit. They've actually been really dormant for the last several years. There's been not a lot of activity in special situations. Opportunistic funds restructuring, mezzanine. So think about the more junior part of the capital structure as we go through the next couple of years and whether it's a software company that needs to refinance their loan, that will not be able to do it in the same terms as they did four years ago, or it's a private equity manager that will require incremental capital to support this company, that's going to require capital from these other parts of the credit market that didn't really participate in this growth at all over the last couple of years. I would think that to me is one of the more interesting things that will probably come with more incremental growth, potentially offsetting some of the pressure points we've seen in other parts of the credit market. And then secondly, when I look at the individual stocks, so the space that I cover, there's been almost no differentiation between these business models. Whether you have a lot of retail versus institutional, whether you're private equity or your private credit, everything is down in a 30 to 40% range. And we're thinking that the next leg of this move will be a little bit more differentiated, really leaning on companies with more durable earnings growth, perhaps the ones that are a lot more institutionally skewed when it comes to private credit broadly. And that could be some of the opportunities for bottom up investors.
- [15:46]
A
Alex, thanks again for joining us.
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B
Great, thanks for having me.
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A
Let's turn now to Vivek Bantwal, Global co head of private credit and Goldman Sachs Asset Management. Vivek, welcome to exchanges.
- [15:56]
C
Thanks for having me.
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A
So, Vivek, we heard from Alex that while AI could create problems for some software companies, most of them in private credit Portfolios should be relatively insulated. I know you can only speak for the funds you manage, but what's your view as a practitioner? How much has the rise of AI changed the way you're evaluating software companies as credits?
- [16:20]
C
Thanks Alison. Great question. Look, there's no doubt in our mind that AI is going to have a really big impact and is going to disrupt a lot of companies. That said, we do think it's important to really dig in and evaluate each company on a specific basis. We've been evaluating deals from an AI perspective really going back to 2023 when we turned down our first deal due to concerns around AI disruption. I think that I'd say a few things around just how to frame it. The first is if you look at the reaction in just public equity and public credit markets, you see some interesting takeaways. One is that if you look at public equity markets, software stocks are down something like 30%, give or take, depending on the name. But that's an average and there's a range of dispersion around that. If you look at credit markets, single me names that are publicly traded are down about nine and a half points. Double B names are down about two and a half points. But again, those are averages. There are some names that are only down 25 or 50 basis points. There's other names that are down 15% or more. And I think there's a couple of takeaways there. One is that the market is starting to appreciate that not all software is created equally. So different companies based on their business model are going to be impacting differently. And candidly, some might end up actually being beneficiaries depending on their business. The second thing to think about when it comes to credit is we're really only lending. Generally speaking, call it six times or so. Debt to EBITDA and the loan to value on these companies at entry was generally 30% or less. And so one way to think about it is if a company used to trade at 24 times EBITDA and now only trades at 16 times EBITDA, if you're only lending the first six turns of EBITDA against that, on average you should be well covered. But as those stats I gave you earlier suggest, there's going to be dispersion around that. One of the things that we focus on when we evaluate software companies is what are the specifics of that company. And our general view is that if you have proprietary data, and so you own the data and you own the customer, you're going to be less disrupted than A company that doesn't do those things, if you're a company where you provide a software that the cost of failure for your client because there's a regulatory overlay or because it's so critical to the front to back operations of that business, it's really their system of record, that type of company is going to be less impacted than a company that doesn't have those characteristics. And so we have a very robust screening framework that we've developed with the benefit of our internal engineers and with the benefit of outside consultants that we use. When we diligence these things, as we've been doing for several years now, we go through the characteristics of that company on a very granular basis, we vis a vis that framework. But it comes back to this point that on average, when you're lending first dollar in the value of the equity, if you have a big equity cushion, doesn't matter as much. But that's not to say that companies won't be disrupted, and that's not to say that you won't see dispersion.
- [19:06]
A
Interesting. And Alex made some of those points as well. But if you look at that dispersion and some of these have maybe unjustly underperformed substantially, would you say that it's the right time to deploy fresh capital in some instances?
- [19:20]
C
Yeah. Look, I think that one of the things that's happening is because there's a little bit of a tendency early when you have these, these headlines to throw the baby out with the bathwater and then the differentiation happens over time. And so I think that what's interesting is as you see some of these retail outflows in particular, you're seeing spreads start to become more lender friendly in the market. And so if you have an environment where, you know, the last couple of years when you step back, spreads have come down a little bit because there's been such an influx of retail money. And so if you start to see some of that money leave a little bit, the return environment actually becomes more attractive for the incumbents. And some of that has to do with sort of how you set up your business. If you set up your business where you have largely institutional capital and retail has been an add on to that, as opposed to the other way around, you're going to be really well positioned to invest through that cycle and to get the better returns as some of that flood of your money leaves. And so I do think that the opportunity that we see in front of us is actually going to be quite interesting because I think that you are seeing more differentiation, you are seeing more dispersion, and I think you will see a more lender friendly spread environment. And so I think there'll be some interesting opportunities ahead.
- [20:26]
A
Right? I mean, dispersion creates opportunity. Let me switch gears for a moment. You've talked a lot and written a lot about the liquidity premium, which Alex also spoke somewhat about. It seems that investors are really rethinking their perspectives about illiquidity. What do you make of all of that? Are there lessons to be learned here when we think about this concept of illiquidity in this market?
- [20:50]
C
Yes, look, I think a couple things. One is that we've had a strong view from the beginning of the evolution of these products that it's really important that when you're explaining a new product to a customer, that the customer understands exactly what it is that they're getting to the point you just made. These are illiquid assets. Part of the reason that private credit, depending on where you are on the cycle, trades at a 150 to a 300 basis point premium to public credit is for that illiquidity. And so, for example, we don't use the word semi liquid. We understand what people mean when they use that word, but the reality is that it's not semi liquid. It's illiquid relative to a drawdown fund. These structures can offer interim liquidity features, but it's important not to confuse that with being half liquid because that's just not what it is. And so if what's happening is some people are waking up and realizing that they thought they had something that was semi liquid, where actually the liquidity is a bit more nuanced than that. And as a result, they're moving out of the asset class. I think that's healthy for them and for the asset class for those that are staying. We think that if you're allocating a portion of your portfolio where you don't need access to that money, where you're comfortable with that being illiquid, then we think that's a really good reason to be in because again, over cycles we have seen there is a risk premium. There is a 150 to 300 basis point risk premium through the cycle. And so if you don't need the money to pick up immediate diversification in a deployed portfolio, where you're getting that risk premium is attractive. The key is that you don't need that money in the short term. And so that you've sized your portfolio the right way, that you've allocated that Correctly.
- [22:21]
A
Right. So illiquidity, it has benefits, it just, it has to be used appropriately in your portfolio. But put this all in perspective for us more broadly. Vivek, when you see the headlines about private credit concerns and even about the potential for systemic risk related to them, what do you make of them? Do you think there's merit to some of these bigger worries or is this just all overblown?
- [22:44]
C
Sure. So let me take that into two buckets. Let's talk about the risk within credit itself and then let's talk about systemic risk. To just frame the risk and credit. I think it's important to separate the anecdotes from the data and separate what we know is happening right now versus what might happen in the future. Because that's a different conversation in terms of what's happening right now. Notwithstanding some of the anecdotes where you know, as you've seen reported in the press the last six months, there's been a handful of instances across credit markets around instances of fraud and jumps to default and so on. The first point I'd make on that is interestingly, none of those anecdotes have actually happened in the direct lending BDC market. And so one of the things that's happening in the media coverage is you're seeing kind of a conflation between different market, those instances of fraud. Some of them have happened in the bank market, some of them have happened in the broadly syndicated loan market, some of them have happened in more niche aspects of the private credit market and structured credit and receivables financing and so on. But none of them have happened in direct lending. That's not to say that fraud couldn't happen in direct lending, but it's to make the point that some of these initial headlines that created fear around private credit actually didn't have to do with the part of private credit that people actually have exposure to. And so I think that's the first point. The second point is when you look at the data, if you look at the default rate in broadly syndicated loans right now it's about 1.3%. If you add back liability management exercises which obviously are not creditor friendly, then you get to a 4 something percent type number. But both of those numbers are sort of when you zoom out and you look at the last several decades of kind of default data, those are actually at healthy or in some cases lower than historical levels. If you look at the non accrual rate for the top 20 BDCs, that's about 1.54% and so what that means is for every article that you read or that you might read about something going wrong in private credit, for every company in that situation, there's 98 and a half other companies that are paying their bills on time where there's not an issue. And so again that's not to suggest that if you saw a turn in the cycle that, that those numbers couldn't evolve. But I'd point out that one, that that's an average. And so that's if on average for the top 20 BDCs, the non accrual rate's one and a half percent, there's people that are lower than that and there's people that are higher than that. In our last publicly released data, for example, our non accrual rate's 12 basis points. So we're lower than that. There's some people higher than that averages to the 1.54%. If the cycle were to turn, we'd expect you'd see dispersion. There's this research report suggesting that maybe in a draconian downside case you could see a 15% default rate in private credit. And that is again relative to where we are now. That's a very significant change. Could that happen? I suppose. But I think it's important to consider that in the global financial crisis, if you look at equities peak to trough The S&P 500 lost 50% of its value. And so if you think about a scenario where you have a default rate that's much worse than what you saw in the crisis, if that were to happen, not only would credit, private credit, equities, all those things will get impacted. So that's the first point. The second point I'd make is in credit again you're lending first dollar in, you're at the top of a capital structure. So if there's a default by definition the equity in that company has gone to zero, any junior debt in that company has gone to zero. And then there's a question of what's the recovery rate. And so one of the things that's been talked about in these research articles is if for some reason the recovery rate were to get worse in the next default cycle, and so it got to be more like 50% as opposed to 75% or higher that you've seen in some other default cycles, if you take a 15% default rate and you have a 50% recovery value, that means that you've lost seven and a half points. And so that means that again in an asset class, if you look at these VDCs, for example, they've all kind of been generally having sort of 10% type returns left to date. So if you make a 2.5% return instead of a 10% return, again, that's not what you're expecting. That would be a bad day. But if you think about what the impact would be in that state of the world would be on equities or in other asset classes, that might not be the worst place to be. And again, that is just an average. As with all of these things, there'll be dispersion around that. So there'll be people, people that do worse than that, there'll be people that do better than that. And so what I'd say is right now the fundamentals of credit are actually quite strong. But if there were to be a recession, obviously those could get worse. And then the question is, how positioned are you as a platform in terms of your selection process and are you going to do better or worse than that average?
- [26:55]
A
That's very useful context. I appreciate that. So in general, I hear you saying that these concerns seem to be somewhat overblown, but are there pockets of the market that you are concerned about?
- [27:06]
C
So look, let's go back to software. I mean, one of the things that we've been cautious on for several years are these ARR loans. But these were companies that were not cash flowing, but that were growing really quickly. And so lenders chose to lend to those on the basis of a revenue multiple as opposed to a EBITDA cash flow type analysis. And in a world of AI, it's possible that some of those loans, depending on their business model, don't actually get to cash flow. And so that's an area of the market that we're very cautious around. Again, that's not to say that every company that's an AR loan is going to have an issue, but that's a theme that we've been very cautious around that we're continuing to monitor very closely.
- [27:39]
A
Zooming out, when we look at all these concerns dominate the headlines. What is going to convince the market to shake them off? What is the path forward for the asset class?
- [27:50]
C
Look, I think in the short term, obviously for mass affluent retail, we're seeing redemptions that have been publicly reported across platforms. And so I suspect you'll see that for a period of time. I think what will cause that to evolve is two things. One is that as that money leaves, returns will get higher for those that stayed and so there'll be that dynamic and then the second dynamic is you'll actually see continued earnings reports and like we're seeing in public markets, the fundamentals of the economy right now are actually continue to be relatively robust. And so these companies are actually performing well. And so we're seeing and you've seen public disclosure around this from various platforms. You're seeing a lot of companies post in double digit revenue growth, double digit EBITDA growth, fixed charge coverage ratios are improving. And so I think if you have an environment where if the economy continues on the trajectory that it's on, where you continue to see that strong performance at the underlying portfolio companies and you see a higher spread environment, then it's possible some of those people come back in. But I think for the next little while here we're going to probably continue to see some of that floody or capital leave and then the capital that remains will have access to presumably a
- [28:50]
A
better return Profile thanks so much for joining us Vivek, and sharing your perspectives and giving us some context.
- [28:56]
C
Thank you.
- [28:57]
A
My thanks to Alex and Vivek and thank you for listening to this episode of Exchanges, which was recorded on March 19th and March 20th, 2020 26. I'm Allison Nathan.
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D
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