What's Going on in Private Credit?

Episode Summary

Executive Summary: Howard Marks traces how credit evolved from bank loans and high-yield bonds into today’s private credit and direct lending boom, arguing that enthusiasm, leverage, and liquidity mismatch often create bubbles. He warns that easy money, weak underwriting, and AI-driven pressure on software borrowers are exposing risks in direct lending, while Oaktree’s more selective, less public exposure leaves it comparatively well positioned.

Main Topics: Historical evolution of credit markets (Priority: 5/5): Marks outlines a decades-long progression from investment-grade bonds to high-yield debt, leveraged loans, securitization, alternative investments, direct lending, and retail distribution of private credit. How direct lending emerged and expanded (Priority: 5/5): He explains that bank retrenchment after the GFC created a gap that private lenders filled, especially for private equity sponsors needing large, fast, flexible financing. Bubble dynamics in new investment products (Priority: 5/5): Marks argues that novel opportunities attract capital because they are new, untested, and initially rewarding, but later suffer from overconfidence, lower standards, and overpricing. Current stress in private credit and direct lending (Priority: 4/5): He says recent bankruptcies, redemption pressures, and valuation concerns have begun revealing weak underwriting and liquidity problems in some direct lending vehicles. AI pressure on software debt (Priority: 5/5): Marks highlights software as a major direct lending category now under scrutiny because AI may reduce coding demand and weaken borrower equity cushions. Private equity’s role and the rate regime shift (Priority: 5/5): He links PE’s historical success to ultra-low rates and argues higher rates now reduce valuations, exits, distributions, and debt service capacity. Oaktree’s positioning and discipline (Priority: 4/5): Marks describes Oaktree as relatively conservative in private credit, with limited direct lending and software exposure, which may create future opportunities.

Key Arguments: Credit markets expanded through successive innovations: high-yield bonds, leveraged loans, securitization, alternative investments, direct lending, and now retail private credit. The rise of high-yield debt in the late 1970s/1980s enabled leveraged buyouts and the later private equity industry. Direct lending grew because banks pulled back after the GFC and private equity needed capital, allowing lenders to demand attractive terms initially. Direct lending risk was often mischaracterized as low-risk-adjusted rather than high-volatility-adjusted because private loans are not frequently marked to market. As capital flooded in, underwriting weakened: spreads fell, protections narrowed, and lenders accepted lower standards to deploy money. Recent stress signals in private credit are partly sentiment-driven, but real underlying issues include AI disruption to software borrowers and liquidity/valuation questions in public vehicles. AI has increased concern about software-company borrowers by potentially reducing the need for human coders and weakening equity cushions. Private equity and the debt funding it relies on benefited enormously from falling rates; rising rates now reduce profitability, refinancing capacity, and exit values. The biggest risk in new investment trends is not the concept itself, but overpaying and relaxing discipline once enthusiasm becomes widespread. Oaktree’s more selective approach, lower public-market exposure, and limited software concentration may improve its resilience and future opportunity set.

Data Points: U.S. high-yield bond market size: ~$1.5 trillion - Marks cites this as the scale of the modern high-yield market enabled by acceptance of non-investment-grade debt. U.S. broadly syndicated loan market size: ~$1.5 trillion - He references this as the current scale of the leveraged/senior loan market. Private credit sector size 20 years ago: ~$150 billion - Marks uses this to show how dramatically private credit has grown. Direct loans made in last 15 years: ~$2 trillion - He says this amount of direct lending was originated over the last 15 years. Fed funds rate change since 2022: 0% to 5.25%-5.5% - Used to illustrate the interest-rate regime shift hurting private equity and leveraged borrowers. Private equity fund returns (2022-Q3 2025): 5.8% annualized - MSCI estimate cited by Marks for U.S. private equity funds. S&P 500 returns (2022-Q3 2025): 11.6% annualized - Compared with private equity returns to show weaker recent PE performance. Software debt share in high-yield bonds: 4-5% - Marks estimates software’s share of U.S. sub-investment-grade credit in high-yield bonds. Software debt share in broadly syndicated loans: 10-15% - Marks estimates software’s share in syndicated loans. Software debt share in direct lending: 20-30% - Marks estimates software’s share in direct lending is highest there. Oaktree private credit exposure to public vehicles: Just over $10 billion - He contrasts this with large public direct lending managers holding $40-$50 billion or more. Leading public direct lending managers' AUM: $40-$50 billion+ - Used to show Oaktree has less public direct lending exposure than peers. Oaktree AUM growth: Doubled over the last decade - Marks says slower AUM growth reduced pressure to compromise underwriting. Private equity leveraged buyout multiple: ~20x EBITDA - Marks notes many software companies were acquired at very high valuations. Direct lending by Oaktree within performing credit: ~20% - He says direct lending is around 20% of Oaktree's investments in performing credit. Direct lending within Oaktree overall AUM: <15% - Marks says direct lending is less than 15% of total AUM. Oaktree private credit on behalf of institutions: 80% - He says most private credit is institutional rather than public capital.

Pivotal Quotes: "what the wise man does in the beginning, the fool does in the end" — Howard Marks: He uses this to describe how investors eventually overdo popular new strategies. "first the innovator, then the imitator, then the idiot" — Warren Buffett: Marks cites this to summarize the life cycle of a bubble in a new investment trend. "for that which a man wishes, that he will believe" — Demosthenes via Charlie Munger: He invokes this to explain how investors embrace attractive promises in manias.

Implications: Direct lending is likely moving from easy growth to a tougher cycle, with weaker players and overextended structures most exposed. Investors should scrutinize liquidity, valuation, and borrower quality, while disciplined managers may find better opportunities as capital becomes scarcer.