HOLY SH*T! Another Private Credit Fund is BLOWING UP!

Private Credit Market Concerns & Potential Financial Crisis – Detailed Summary

Key Concepts:

• Private Credit: Lending directly to companies by non-bank lenders, often with less regulation than traditional bank loans.
• BDC (Business Development Company): Publicly traded companies that invest in private credit.
• CLO (Collateralized Loan Obligation): Complex financial products that package and resell private credit loans to investors.
• Pick Income (Payment-in-Kind): Interest and principal payments added onto the loan balance, deferring actual cash payments.
• Default Rate: The percentage of loans that are not being repaid.
• Leverage: Using debt to amplify potential returns (and losses).
• Syndicated Loans: Loans funded by a group of banks.
• Volume Profile: A charting tool showing price activity over a specific period, identifying key support and resistance levels.

I. New Mountain Finance & Warning Signs (0:00 – 2:00)

New Mountain Finance recently completed $477 million in private credit loans, but sold them at a 6% discount (94 cents on the dollar). This isn’t due to a desire for portfolio diversification, but because investors are unwilling to purchase these loans, signaling underlying problems. The company’s stock has fallen over 40% in the last year. New Mountain’s stated reasons for selling – diversification, reducing pick income, and enhancing financial flexibility – are viewed as disingenuous. Reducing pick income indicates concerns about borrowers’ ability to repay loans, as these loans defer actual cash payments. The company is simultaneously repurchasing $30 million in shares and cutting its dividend, a concerning pattern suggesting an attempt to artificially prop up the stock price. Blue Owl recently engaged in similar behavior, indicating a broader issue within the sector. This activity is reminiscent of the conditions preceding the 2008 financial crisis.

II. Rising Default Rates & AI Disruption (2:00 – 4:30)

UBS predicts private credit default rates could surge to 15%, a 2% increase from their previous forecast, particularly if artificial intelligence (AI) causes significant disruption to corporate borrowers. The market is already anticipating this, as evidenced by the actions of companies like New Mountain and Blue Owl. Direct lenders heavily financed software companies in recent years, making them particularly vulnerable to the impact of AI, which could automate software development and reduce demand for existing software solutions. Approximately 40% of sponsored backloans are tied to the software industry, representing a significant concentration risk. Companies are attempting to offload loans and buy back stock to avoid being caught with illiquid assets when new business dries up. Current private credit defaults are between 3-5%, with pick income nearing post-pandemic highs, indicating increasing strain. The lack of a strong economic rebound in late 2023 and weakening consumer incomes due to inflation are exacerbating the situation.

III. CLOs & Amplified Risk (4:30 – 6:30)

If BDCs (like New Mountain) can’t find buyers for their loans, they may be forced to sell them to CLOs. This could lead to a significant increase in leverage (potentially tripling it) while masking the underlying risk. This mirrors the events leading up to the 2008 financial crisis. CLOs are essentially loan bundles, with the riskiest slices being highly leveraged (9-10 times). A 15% default rate, as predicted by UBS, could amplify losses tenfold within CLOs, wiping out the riskiest investors. First lien recoveries in syndicated loans have fallen to the mid-50% range, meaning lenders are only recovering 50 cents on the dollar in case of default – a dangerous decline from the typical 70-80% recovery rate.

IV. Bank Exposure & Jamie Dimon’s Warnings (6:30 – 8:30)

Despite claims to the contrary, banks are significantly exposed to the private credit market. The top 20 direct lenders hold approximately 45% of their assets in BDCs, 20% in leveraged loans, and 25% in high-yield bonds. Jamie Dimon, CEO of JPMorgan Chase, has repeatedly warned about “cockroaches” hidden on bank balance sheets, alluding to this exposure. Credit hasn’t rebounded with equities, suggesting the recent stock market rally may be unsustainable. A potential massive top is forming in the NASDAQ, barely holding its long-term trend line. A break of this trend line would be a bearish signal. Corporate buybacks, a key driver of the recent rally, are declining; hyperscalers cut gross buybacks by 15% year-over-year in 2023, reducing the share of cash flow allocated to buybacks from 43% to 16%.

V. Trading Strategy & Protection (8:30 – 11:00)

The speaker outlines a trading strategy based on the potential for a private credit crisis:

• Exit Private Credit Funds: Advise clients to exit private credit funds to avoid being trapped.
• Review Bond Funds: Check bond funds for heavy investment in private credit or CLOs and consider exiting those positions.
• Diversify Out of Tech: Reduce exposure to technology stocks, as they are likely to be negatively impacted.
• Rotate into Defensives: Invest in defensive sectors like utilities, healthcare, and consumer staples.
• Precious Metals (Silver over Gold): Consider silver as a potential hedge.
• Tactical Shorting (For Experienced Traders): Consider tactically shorting big tech and banks.
• Increase Cash Position: Follow Jeffrey Gundlach’s recommendation of holding at least 20% of your portfolio in cash or short-term treasuries.
• Monitor Long Bond: Keep an eye on the long bond, which could be a surprise winner.

VI. Tai Beckley (ATI) – Investment Opportunity (11:00 – 13:30)

The speaker highlights Tai Beckley (NASDAQ: ATI), a clinical-stage biotech company focused on mental health. The company is backed by prominent investors like Peter Thiel, Michael Novogratz, and Steve Jurvetson. Tai Beckley is developing BPL003, a nasal spray for treatment-resistant depression (TRD), a condition affecting approximately one-third of depression sufferers. BPL003 offers a rapid, durable, and convenient treatment option compared to traditional psychedelic therapies, requiring only a two-hour in-clinic session. The stock has recently rallied off its 200-day moving average and is showing signs of a potential breakout. Disclaimer: The speaker emphasizes the need for individual research before investing.

VII. Conclusion (13:30 – End)

The speaker reiterates the potential for a significant financial crisis triggered by the private credit market. He urges viewers to take steps to protect their portfolios and profit from the situation by understanding the risks and implementing the outlined trading strategy. He emphasizes the importance of being prepared for a potential downturn and highlights Tai Beckley as a potentially promising investment opportunity.

Technical Terms Explained:

• Haircut: A discount applied to the face value of an asset when it is sold, reflecting perceived risk.
• Gate Funds: Restricting investor withdrawals from a fund.
• Volume Profile: A charting tool that displays price activity over a specific period, highlighting areas of high and low trading volume.
• Treatment Resistant Depression (TRD): Depression that does not respond to conventional treatments.
• Psychedelic Compound: A substance that alters perception and mood.

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