This episode explores the resilience of private credit markets amidst current macroeconomic uncertainties, particularly concerning tariffs and policy uncertainty. Against the backdrop of growing concerns about corporate credit health, especially in smaller, weaker companies, the discussion analyzes the rising risks in private credit. More significantly, the conversation delves into the impact of tariffs, concluding that while the direct impact may be muted due to the defensive nature of many direct lending loan sectors, second-order effects from decreased confidence and weaker demand could impact a "tail cohort" of vulnerable companies. For instance, data reveals that a significant percentage of direct lending companies exhibit low EBITDA interest coverage ratios or negative free operating cash flow, highlighting their vulnerability. The role of Payment in Kind (PIK) interest is also examined, clarifying that while it can be a leading indicator of default, it's not always a negative sign and its relationship with defaults isn't consistently strong. Ultimately, while acknowledging rising risks, the hosts highlight mitigating factors such as the non-mark-to-market nature of direct lending loans, contained redemption risk, sticky capital from long-term investors, and ample dry powder available for distressed companies. This suggests a mild uptick in defaults is anticipated, but still below previous peaks.
