Private credit investors are wary and now ask more questions about potential “cockroaches” ever since two high-profile bankruptcies in the US raised questions about the health of the $1.7 trillion industry, the chief executive of Golub Capital has said.
Private lending has faced intense scrutiny in recent months, with top US financiers raising concerns about potential erosion in lending standards. However, Lawrence Golub said the industry, especially the secured direct lending segment of the market, is being unfairly targeted.
“We talk a lot more about cockroaches than we used to. Of course, potential investors, seeing all this rowdy press, it's their responsibility to ask about it,” Mr Golub told The National on the sidelines of Abu Dhabi Finance week.
“They should [ask] and I don't mind. I think it's good. I think it helped me in conversations with investors and has given me the opportunity to talk to them about the importance of protection costs and protecting collateral.”
The collapse of automotive parts company First Brands Group and subprime lender Tricolor Holdings in the US has brought the broader private credit industry under the microscope, after JP Morgan Chase chief executive Jamie Dimon said, “When you see one cockroach, there are probably more.”
The failure of two firms shocked Wall Street and Mr Dimon's comments triggered a global debate on systemic risks in the market, which is expected to grow to $2.7 trillion by 2029, according to Fitch Ratings estimates.
The exponential growth of private credit since the 2008 financial crisis has also raised the question of whether private lending is adding new layers of complexity to the financial system and the broader economy.
In a report last month, Moody’s said that private credit providers are increasingly blurring the lines between syndicated and direct lending markets through their co-lending arrangements with conventional banks. This, the ratings agency said, is opening doors for contagion.
Mr Dimon walked back his “cockroach” comment in an interview with The National in Riyadh in October saying it was “blown out of proportion”.
“There have been credit issues in the wider market and a couple of those were frauds,” Mr Dimon said at the time. “I would never blame that on private credit.”
Systemic risk
Opinions, however, remain divided and the IMF's managing director Kristalina Georgieva in October said she is worried about the risks building up in non-bank lending markets.
The fund is concerned as “what we have seen is a very significant shift of financing from the banking sector to non-bank financial institutions to a point that more than half of financing is now there”, she said at the World Bank and IMF meetings in Washington.
Non-bank financial institutions do not enjoy the same level of regulatory oversight that banks do.
“We are asking a question – what should be done to have more oversight, a better view of what is happening there”, she said at the time.
Mr Golub, whose direct lending firm manages $85 billion in capital, said it is natural to closely examine the fastest-growing parts of the financial sector, with private credit among the quickest to expand.
With all the new entrants, abundant liquidity and expanded markets, it is alright to look at whether standards of lending are being compromised or is it “just stupid mistakes by lenders”.
“Our part of private credit is acquisition finance. It's a sliver. It's big business, but it's only a sliver of what one would think of as [broader] private credit,” he said.
Direct lending is financing for companies that are bought by professional investors, such as private equity firms, or for the expansion of companies that are already owned by professional investors, he said.
“We haven't felt any storm. I'm not saying there's no press storm or no concern storm. I'm saying that our business continues to run,” Mr Golub said. “We have a healthy portfolio.”
“There's been a lot of conversation about whether private credit, our sort of direct lending, increases or reduces the systematic risk. In fact, it's a reduction in systematic risk,” Mr Golub said.
Higher default rates across the broader private credit market are also partly due to the credit cycle, with interest rates having risen by about 500 basis points since 2022.
Though default rates are somewhat higher than in recent years, after a decade of near-zero interest rates and very low defaults, the market remains healthy.
In the asset-based lending business, defaults are a normal part of the market, Mr Golub said.
“There's nothing new about it, and it comes up cyclically and it's a good lesson for folks on protecting their collateral, and that has led to more lender-friendly documentation, even though spreads and leverage levels still remain borrower friendly,” he said.
Middle East ambitions
Golub Capital, which has offices in North America, Europe and Asia, in December last year chose Abu Dhabi for its first base in the Middle East.
The move, Mr Golub said, has served the company very well.
“The centre of gravity for decision making is in Abu Dhabi,” he said adding that the company had evaluated several options before setting sights on the UAE Capital for its regional base.
“That was a very good shift for us as our office here has given us real connectivity … we're perceived as being here, and I would say we get an awful lot of credit for that.”
Golub Capital has been serving clients in the Middle East for more than a decade, raising funds from institutional clients, large family offices as well as sovereign wealth funds for its private credit investment strategies across the globe.
Private credit market is still nascent in the Middle East, but Mr Golub said five years from now, “we will have multiple active investment strategies in the region".
“We are exploring, and have been exploring, [regional strategies] for a long time, doing acquisition finance, particularly in the Emirates and in Saudi Arabia,” he said. “[The] Emirates has [a] more vibrant middle-market economy, but the Saudi economy is much larger in scale … [we’re] not ready yet.”
In the near term, the private credit manager aims to partner with banks in the Middle East to help create collateralised loan obligations (CLOs) in asset classes where Golub Capital does not wish to act as the originator.
CLOs are financial products that bundle corporate loans into a portfolio which are then sold on to investors as bonds or equity with varying risks levels.
“We want to be the partner, and we have fund vehicles for this, separate from our direct lending funds. We have great experience at it, and we've done dozens and dozens of these loans,” Mr Golub said. “I suspect that this bank partnership in investing activity will happen first before we are really at scale in the direct lending.”
The third element of Middle East investment is setting up a family office in Abu Dhabi, which does “long-term, multi-generational investing on behalf of my family in the region and in Asia,” Mr Golub said.
“We have gotten off the ground, and we've made our first investments. It's early days, but that's growing.”
Five years down the line, “we'll almost certainly have an office in Riyadh”, and between now and then Mr Golub plans to hire more people to grow fund-raising for its credit strategies and expand the family office investments, he said.
