Fortress' Drew McKnight talks private credit investing opportunities

Key Concepts:

• Private Credit: Evolving definition, encompassing LBOs, consumer finance, mortgage finance, and asset-based credit.
• Asset-Based Credit: Lending secured by specific assets, seen as a significant growth area.
• Disintermediation of Regional Banks: Shift of lending from regional banks to private credit firms due to balance sheet pressures and deposit flights.
• Floating Rate Interest Risk: Interest rates that adjust periodically based on a benchmark rate, like SOFR.
• Loss Curves: Scenarios projecting potential losses under different economic conditions.
• Private Wealth Allocation: Shifting portfolio allocations to include private credit for diversification and returns.

1. Defining and Expanding Private Credit

• The definition of private credit is evolving and expanding beyond traditional leveraged buyouts (LBOs) and buyout financing.
• Post-GFC, private credit initially filled the void left by the shadow banking system.
• The private credit "pie" is growing to include consumer finance, mortgage finance, and asset-based credit.
• While buyout financing is becoming competitive, asset-based credit presents significant growth opportunities.

2. Opportunity in Asset-Based Credit

• Disintermediation of regional banks, exacerbated by the Silicon Valley Bank and Signature Bank failures in 2023, is creating opportunities in asset-based credit.
• Banks are pulling back due to extended real estate durations caused by interest rates, deposit flights, and reassessment of liquidity.
• Fortress Investment Group has originated $7 billion in asset-based credit since the fall of 2023, indicating significant activity in this area.
• The potential opportunity set in asset-based credit is estimated to be around $6 trillion.
• The movement of capital from small and regional banks into private credit is still in its early stages.

3. Returns and Portfolio Allocation

• Private credit offers the potential for high single-digit to low double-digit returns with low volatility.
• Private credit can be a valuable addition to traditional 60/40 stock and bond portfolios, especially for risk-averse investors.
• The ability to achieve consistent returns is a key factor driving interest in private credit.

4. Managing Interest Rate Risk

• Jamie Dimon's prediction of a "crack in the bond market" highlights concerns about interest rate risk.
• Asset-based credit can mitigate interest rate risk through floating rate structures tied to benchmarks like SOFR.
• Floating rate interest risk provides downside protection if interest rates collapse.
• Structures are being designed with conservative credit assessments, running loss curve scenarios at two to three times the severity of the Global Financial Crisis.
• Asset-based credit is seen as a potential "place to hide" from the volatility in the stock and bond markets.

5. Private Equity and IPO Markets

• The slowdown in private equity is partly due to a closed IPO market, but this is starting to change with some high-profile deals.
• The main issue for private equity is the gap between the prices at which they want to sell companies and the market clearing price.
• Many private equity firms bought companies in 2020-2021 at high multiples with low interest rates, making it difficult to achieve desired returns in the current environment.

6. Notable Quotes

• "We believe it's like a $6 trillion opportunity set." - Drew McKnight, referring to the potential in asset-based credit.
• "I'm telling you it's going to happen." - Jamie Dimon, predicting a crack in the bond market.

7. Technical Terms and Concepts

• LBO (Leveraged Buyout): Acquisition of a company using a significant amount of borrowed money (leverage).
• SOFR (Secured Overnight Financing Rate): A benchmark interest rate used as an alternative to LIBOR.
• Loss Curves: Scenarios projecting potential losses under different economic conditions, used for credit assessment.
• Disintermediation: The removal of intermediaries (like banks) in a financial supply chain.

8. Logical Connections

• The discussion starts with the evolving definition of private credit and then focuses on the specific opportunity in asset-based credit.
• The disintermediation of regional banks is presented as a key driver of growth in asset-based credit.
• The conversation then shifts to managing interest rate risk in the context of Jamie Dimon's prediction about the bond market.
• Finally, the discussion touches on the challenges facing private equity and the role of the IPO market.

9. Synthesis/Conclusion

The private credit landscape is evolving, with asset-based credit emerging as a significant opportunity due to the disintermediation of regional banks and the potential for attractive, relatively stable returns. While concerns about interest rate risk persist, structures with floating rates and conservative credit assessments can help mitigate these risks. The private equity market faces challenges related to pricing and IPO availability, but the overall outlook for private credit remains positive.