Back in 2008, executives at Goldman Sachs Group Inc. were zealots for valuing their assets at exactly the prices where they could be sold. Critics said this fervor for fair value inflamed the financial crisis, while supporters argued it helped investors and lenders at least know where they stood. A similar debate seems to be coming to private credit now that Apollo Global Management Inc. and JPMorgan Chase & Co. are leading the way in marking down the value of their loan portfolios.
Two things are certain: The strongest firms will benefit most from the pressure on funds to take hits sooner rather than later; and these moves are another sign of a likely tightening supply of private credit. Today’s weaker players — the ones without the vast resources of an Apollo or who’ve maybe lent too much to ailing software companies — are just as likely to end up as zombies.
Apollo is gearing up to report monthly net asset values for its credit funds, John Zito, co-president of its asset-management arm, told Bloomberg News on Wednesday, and is working toward ultimately providing daily marks (what the loan is deemed to be worth in cents on the dollar). The private-capital giant already cut values in one credit fund last month. JPMorgan, meanwhile, has been telling private credit funds who borrow from the bank that it has marked down the value of some of the software debt they own, the Financial Times reported the same day. The US bank is doing this to cut its own risk as these funds often use their loan portfolios as collateral to borrow yet more money.
Apollo’s private credit rivals and JPMorgan’s peers will likely feel pressure to follow. Fears of a surge in corporate defaults and threats of disruption from artificial intelligence have already prompted rich clients to start demanding money back where they can. Managing demands for liquidity from funds that are illiquid by design is proving a challenge for a string of big firms.
Back in 2007 and 2008, Goldman’s mark-to-market philosophy helped it get ahead of the crisis in subprime mortgages and complex bonds. That led some to question whether it had been betting against its own clients. It did make sense for a firm so focused on trading to always know the price of everything. But its transparency put pressure on other banks and investors, who planned to hold loans and bonds until they matured, to take market-value losses on similar assets even if they expected to be fully paid back eventually.
In a febrile atmosphere, worries about what trouble is hiding in financial firms that don’t regularly mark their books can put off investors, hurting share prices, raising their cost of borrowing, or leading clients or depositors to pull their cash. For Goldman and other US banks also in favor of marking to market at the time, the key judgment was that it was better for their stock- and bondholders to know where asset values were than fear where they might be.
Apollo isn’t a trading firm — it’s an asset manager created to hold investments for the long term. And yet it seems to be making a calculation similar to Goldman’s. If fears are building among its clients about potential losses and defaults, it’s much better to keep them updated than leave them guessing. Wealthy individual investors should be less likely to demand their cash back if they are confident of what their funds are worth.
In 2008 and after, critics said marking assets too quickly exacerbated the crisis by forcing banks to take losses, which weakened their capital bases and led to more assets sales, falling prices and a vicious downward spiral. This critique was more popular among weaker lenders and in Europe. But the harsh light of mark-to-market accounting led to bad assets being cleared out sooner and a quicker recovery in banking and markets in the US than in Europe, where many banks staggered on like the walking dead for years.
The approach definitely favors stronger firms. Those who are less able to bear losses are less willing to confess to them. Over time, weaker players either get bought out at heavy discount, or their stronger rivals simply grab more market share. This will surely be as true of private credit as it was of banks. Apollo no doubt expects to be a long-term winner from this cycle.
Private credit funds are unlike banks because most of their clients agree to lock up their money for years — so the pressures of markdowns shouldn’t ever play out the same way, or with such speed. But roughly $250 billion of the $1.8 trillion market is in the special unlisted funds run by companies like Apollo, Blue Owl Capital Inc. and Blackstone Inc. that were targeted at individual investors and are now facing redemption demands. It’s a significant enough part of the industry to matter.
The other big difference is that most of today’s private credit is barely traded, even by the likes of Goldman and JPMorgan. The risky loans that fund private-equity buyouts, the core of the “direct lending” business, mostly have no market at all. There are proxies in leveraged-loan markets, offering some price comparison for the debt of certain companies, but these are imperfect.
Meanwhile, investment-grade private credit — much bigger loans to large, often listed companies — is also rarely traded despite efforts by Apollo, JPMorgan and others to get things moving. But these borrowers usually make more financial disclosures and have other public securities, so it’s easier to be confident in their private-debt valuations.
Of course, there are valid questions about whether loans are properly being marked to market even by the firms that claim they’re doing so. In truly bad times, using proxies or a firm’s own models for valuation has been derisively called “mark-to-myth.”
We’re not yet in such a spot, but the growing doubts are another sign that private credit supply is set to tighten. JPMorgan is explicitly marking down loan values because that in turn reduces the amount it will lend against what it sees as riskier fund portfolios. Also, falling loan prices and less leverage from Wall Street will hurt private credit funds’ returns and make it harder for managers to raise new money in future.
Many private equity-owned companies — especially in the AI-menaced software sector — will find refinancing their debt much tougher in a couple of years if current trends persist. The buyout world and its private lenders will then end up with their own population of zombies.
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