"They find the investment opportunity and then they go call the funds from their LPs private credit most of these funds work where they take in the money first and then they go out and find the investments so they're um under much more pressure to find investments." - John Sheen [00:00:47]
"When they go to the private credit market it's just a competition for you know who will jump the highest for the piece of meat." - John Sheen [00:01:12]
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"GE Capital was one of the largest providers of private credit under the GE umbrella for many many many years they were financing lots of different things... it created a large body of really experienced lenders who ultimately splintered off." - Craig Manchuk [00:10:51]
"I'm going to pay 16 or 17 times enterprise value to ebitda for this business and... I will put in equity instead of the typical 20%." - Craig Manchuk [00:39:21]
"Company gets to six times levered you know it's very very difficult to get out from under that." - Craig Manchuk [00:44:12]
"The double B portion of the market is approaching 60% that used to be about 35% and the riskiest segment the triple C's is now about 9% that used to be over 20%." - John Sheen [00:48:15]
Speakers & Credentials
Tracy Alloway: Co-host of the Bloomberg Odd Lots podcast. Financial journalist with deep expertise in credit markets and macroeconomics.
Joe Weisenthal: Co-host of the Bloomberg Odd Lots podcast. Financial journalist focusing on market mechanics and systemic trends.
John Sheen: Portfolio Manager for the Strategic Income Fund at Osterweis Capital Management. His firm has managed a fixed-income strategy for nearly 24 years, focusing on unconstrained bond mandates since April 2002.
Craig Manchuk: Portfolio Manager alongside John Sheen for the Strategic Income Fund at Osterweis Capital Management. Veteran credit investor with historical perspective on high yield, leveraged loans, and middle-market lending.
1. Executive Summary
The episode serves as a deep-dive autopsy and forward-looking analysis of the private credit boom, tracing its evolution from historical origins to its current state as an asset class larger than the traditional junk bond market.
The fundamental driver of recent risk in private credit stems from a massive structural mismatch: unlike private equity "drawdown" structures, retail-facing private credit funds take in capital upfront, creating intense pressure to deploy money immediately to avoid a "cash drag" on their Net Asset Value (NAV).
This deployment pressure has led to a degradation in underwriting standards, characterized by weaker covenants, lower interest rates, and excessive leverage being extended to increasingly risky borrowers.
The speakers heavily emphasize the historical roots of private credit, tracing it back to asset-heavy financing from entities like GE Capital, and contrasting that with modern private credit which is increasingly funding intangible assets like software-as-a-service (SaaS) companies.
There is a looming risk of significant dispersion in private credit fund returns, with sell-side estimates suggesting potential default rates reaching as high as 15%, driven by floating-rate burdens on companies originally underwritten at structurally unsustainable leverage levels (e.g., 6x or 7x leverage).
Redemption gates (typically capping outflows at 5% per quarter) act as a necessary defense mechanism against "run on the bank" scenarios, but they do not solve the underlying deterioration in asset quality or recovery values in bankruptcy.
2. Chronological Table of Contents
[00:00:00] Introduction: The Competitive Pressures Squeezing Private Credit
[00:03:06] The Osterweis Strategic Income Fund & Unconstrained Mandates
[00:08:03] The Post-2008 Evolution of Corporate Credit
[00:10:39] The Forgotten History: GE Capital and Tangible Asset Lending
[00:15:07] Macro Catalysts: Zero Interest Rates & Private Equity Proliferation
[00:19:51] Structural Mechanics: Sourcing Deals in Public vs. Private Markets
[00:23:19] The Crucial Liability Mismatch in Retail BDC Structures
[00:30:30] Redemption Gates, Liquidity Squeezes, and Contagion Risks
[00:37:15] The SaaS Phenomenon: Lending Against Intangible Assets
[00:41:05] The Bottom Line: Default Projections and Market Quality Shifts
[00:49:00] Hosts' Debrief & Implications for the Macroeconomy
3. Detailed Thematic Summary
The Evolution and Expansion of Private Credit [00:08:03]
The Post-GFC Regulatory Vacuum: Following the 2008 financial crisis, bank regulators explicitly prevented traditional banks from lending to companies with greater than six times leverage [00:09:38]. Highly levered companies didn't vanish; their borrowing needs were absorbed by private credit funds and Business Development Companies (BDCs) stepping into the void.
The Zero Interest Rate Catalyst: The zero-interest-rate environment post-COVID forced a massive desire for yield among investors [00:16:24]. Combined with the legacy of the post-dot-com equity crash—where the cumulative returns of high yield from 1999 to 2019 beat equities—investors naturally gravitated toward private debt [00:16:07].
Historical Origins in Tangible Assets: Modern private credit is not entirely novel. GE Capital was once one of the largest providers of private credit, focusing on tangible assets like rail cars, aircraft engines, and MRI machines [00:10:51]. Former GE lenders splintered off to firms like Heller Financial, which transitioned from equipment financing to middle-market LBOs in the 80s and 90s [00:11:27].
The Structural Mismatch: Why Underwriting Standards Are Degrading [00:23:19]
The "Cash Drag" Phenomenon: In traditional Private Equity, funds secure commitments and only execute a capital call when an investment is found [00:22:22]. In modern retail-facing private credit funds, money is taken in as subscriptions upfront. This uninvested cash creates an immediate drag on the Net Asset Value (NAV), placing managers under intense pressure to deploy the capital rapidly into income-earning assets [00:25:00].
Scale of the Problem: Some funds have grown 10x over the last 5 to 10 years, yet their sourcing capabilities have not scaled proportionally [00:22:10]. When issuers enter the private credit market, it becomes a "competition for who will jump the highest for the piece of meat," directly translating to lower interest rates and weaker covenants [00:22:54].
The Retail Illusion of 2022: During the 2022 interest rate hikes, investment grade and high yield bonds took severe hits. Conversely, private credit funds appeared to perform exceptionally well simply because they were not taking market-to-market marks, leading to a stable NAV illusion that drove massive retail inflows [00:25:44]. A prime example of asset proliferation in this space is the Cliffwater Corporate Lending Fund (CCLFX) [00:25:27].
The SaaS Valuation Bubble and High-Tech Lending [00:37:15]
From Turbines to Intangibles: A critical divergence occurred when private credit began heavily financing software-as-a-service (SaaS) companies. Unlike a natural gas turbine that holds residual value in bankruptcy, an obsolete software business has a recovery value nearing zero [00:37:41].
Aggressive LBO Dynamics: Private equity sponsors have pushed valuations to extremes, routinely paying 16 or 17 times enterprise value to EBITDA for software businesses [00:39:21]. To justify the math to lenders, sponsors are injecting unusually large equity checks—up to 40% down instead of the historic 20%—persuading credit managers to overextend on leverage [00:39:50].
PIK (Payment-in-Kind) Danger: In instances where companies cannot cover their interest expenses with cash flow, private credit lenders are increasingly accepting Payment-in-Kind (PIK) terms, where the interest is added to the principal. This gives lenders a "quasi-equity like feel" but dramatically increases the underlying risk profile [00:40:31].
Systemic Stress, Redemption Gates, and Market Quality Shifts [00:30:30]
The Math Behind Redemption Gates: Many interval funds impose strict withdrawal limits. A structural rationale is that the average loan duration is roughly five years, meaning approximately 20% of loans mature annually, or 5% per quarter. Therefore, gates capping redemptions at 5% a quarter theoretically align the liquidity of the liability structure with the natural maturity of the assets [00:30:10].
Contagion Through Quality Degradation: If redemptions persist, funds must either raise expensive leverage or sell their highest quality, most liquid assets to meet demands. This leaves the remaining fund pool highly concentrated in lower-quality, distressed assets [00:33:40]. Opportunistic funds like Oaktree are already positioning to raise specialized $10 billion funds specifically to scoop up these stressed loans from over-levered credit funds [00:34:31].
Looming Defaults and Up-Tiering of High Yield: Because private credit is absorbing the riskiest tiers of corporate debt, the traditional high-yield market has paradoxically become safer. The Double-B portion of high yield is now 60% (up from 35%), and the riskiest Triple-C tier is only 9% (down from 20%) [00:48:15]. However, Wall Street analysts estimate that default rates within the private credit space itself could hit 15%, driven largely by legacy 2020/2021 LBO vintages struggling under the burden of floating rate resets breaking past the 6x leverage sustainability threshold [00:43:42].
The Reference Vault
4. Data & Figures
Data Point
Value
Context
Timestamp
High Yield Returns (1999-2019)
Beat Equities
Post dot-com crash, high yield cumulatively outperformed the S&P 500 over a 20-year span.
The Liability Match Framework: A mental model explaining financial contagion. Financial institutions rarely fail because of the assets they own; they fail due to a mismatch in their liability structure (e.g., liquid demand deposits funding illiquid assets). Private credit funds attempt to solve this via redemption gates, transitioning the risk from a liquidity run to a slow realization of asset degradation. [00:41:56]
The "Cash Drag" Deployment Trap: A structural behavioral model explaining poor underwriting. When an investment vehicle takes in subscriber capital before securing assets, the uninvested cash severely dilutes the overall yield (NAV drag). This mathematical pressure forces managers to aggressively buy sub-optimal assets, leading to systemic risk masking as growth. [00:25:00]
The Four-Tier Credit Hierarchy: The fixed income market has structurally shifted from a binary model (Investment Grade vs. Junk) into a four-tiered system: 1. Investment Grade, 2. High Yield (Public), 3. Leveraged Loans, 4. Private Credit. This framework dictates that risk has not left the system; it has simply migrated out of the public domain into the lowest tier. [00:47:53]
The Tangible vs. Intangible Recovery Model: An underwriting framework highlighting the difference in bankruptcy recovery values between industrial companies (where natural gas turbines have physical liquidation value) and modern SaaS companies (where obsolete code yields zero recovery value in liquidation). [00:37:41]
6. Anecdotes
The First Republic Bank Parallels: Craig Manchuk references First Republic Bank to illustrate liability mismatch. First Republic owned safe assets (Treasuries) but faced a $40 billion demand deposit withdrawal over a few days, sinking the bank. This perfectly illustrates why retail private credit interval funds absolutely require rigid redemption gates to survive panics. [00:31:54]
The Illusion of 2022 Performance: John Sheen recounts talking to wealth managers in 2022. While IG and High Yield bond funds were getting crushed due to interest rate duration risk, advisors claimed private credit was "working great." Sheen points out this was a facade: the private funds simply weren't marking their assets to market, allowing advisors to present stable NAVs to clients, which inadvertently triggered a massive, dangerous influx of new capital. [00:25:44]
The Oaktree Distressed Playbook: A forward-looking anecdote regarding how seasoned distressed debt investors operate. While retail funds may be forced to sell top-tier assets to meet liquidity needs, firms like Oaktree will specifically raise massive $10 billion "Special Opportunities" funds to buy out those exact stressed private credit loans at a steep discount, capitalizing on the liquidity squeeze. [00:34:31]
The Conservative Borrower: Sheen highlights a stark contrast in borrower behavior from their own fund's history, noting a specific company they lent to that never actually spent the money. The company kept the cash on its balance sheet as a pure safety net, maintained leverage below 1.5x, and eventually paid it back entirely. This highlights the type of high-quality, old-school credit underwriting that has been largely priced out of the hyper-aggressive modern private credit space. [00:46:23]
7. References & Recommendations
People
Michael Milken: Mentioned historically as the key figure whose innovations helped grow the high-yield market in the 1980s, serving as a precursor to modern leveraged finance. [00:08:50]
Jamie Dimon: Referenced by the hosts early in the podcast as having warned about "cockroaches" emerging in the private credit market amid rising scrutiny. [00:01:48]
Historical Events
The 2008 Financial Crisis (GFC): Cited repeatedly as the regulatory catalyst that pushed leverage and risky lending off bank balance sheets and into the private markets. [00:09:27]
The Dot-Com Meltdown: Referenced as the period triggering three straight years of negative equity returns, which first shifted investor appetite toward high yield and debt. [00:15:55]
COVID-19 Pandemic: Identified as the primary driver behind the zero-interest-rate policies that fueled the recent massive, yield-hungry expansion of private credit. [00:16:31]
Companies & Institutions
Osterweis Capital Management: The firm employing the guests; operating unconstrained bond mandates since 2002. [00:05:41]
GE Capital: Cited as the historic forefather of modern private credit, having run massive tangible asset lending operations for decades. [00:10:51]
Heller Financial: A firm that hired ex-GE lenders and pioneered middle-market LBO financing. [00:11:27]
CIT: Mentioned as a major historical lender that took over aspects of asset financing after institutional consolidation away from GE. [00:12:10]
ILFC / AIG: Mentioned in the context of historical aircraft lending where regulators wanted highly levered risk stripped out of systemically important financial institutions. [00:12:16]
Blue Owl: Referenced as an early seller of assets into an insurance company during periods of mild liquidity stress. [00:34:14]
Oaktree Capital Management: Referenced as the premier distressed asset manager standing by to absorb failing loans from over-levered credit funds. [00:34:31]
Silicon Valley Bank & First Republic Bank: Used as prime examples of liability-driven failures in the financial sector. [00:31:54]
Financial Instruments & Funds
Cliffwater Corporate Lending Fund (CCLFX): A specific, highly visible private credit retail fund cited as an example of massive asset proliferation. [00:25:27]
Collateralized Loan Obligations (CLOs): Noted as the step-function evolution that allowed banks to securitize leveraged loans before the GFC. [00:09:11]
Payment-in-Kind (PIK) Loans: A risky structural feature where interest is deferred and added to the principal, heavily utilized in recent over-leveraged SaaS LBOs. [00:40:31]
Broad Asset Classes
Software-as-a-Service (SaaS): The sector heavily scrutinized for driving aggressive EV-to-EBITDA multiples without backing from hard, tangible assets. [00:37:15]
8. The Bottomline (by AI)
The explosive growth of private credit is masking severe structural vulnerabilities—specifically the "cash drag" deployment trap of retail BDCs that incentivizes poor underwriting and extreme leverage in intangible assets like SaaS. While redemption gates will likely prevent a systemic "Lehman moment" liquidity run, the real crisis will be a slow-burn degradation of returns as 2020/2021 LBO vintages suffocate under floating rates, potentially driving defaults as high as 15%. Watch for the coming era of extreme manager dispersion: legacy firms will survive, retail-heavy interval funds will be forced to cannibalize their best assets to meet redemptions, and distressed-debt titans like Oaktree will sweep the board to buy the resulting distressed debt at steep discounts.
Jul 16, 2026
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Private Credit Portfolio Size
Hundreds to Thousands
Private credit portfolios hold massive volumes of individual loans, making LP capital calls practically impossible.