Private Credit Emerges as Key Portfolio Stabilizer

In Brief: Private credit markets face a critical juncture as traditional lending dynamics shift amid persistent inflation, higher interest rates, and increased market volatility. The asset class has exploded from less than $500 billion a decade ago to over $1.5 trillion today, yet default rates remain near historic lows with only one direction to go. Lawrence Golub, CEO of Golub Capital and four-time consecutive Lender of the Year winner, warns that manager selection and long-term thinking will separate successful investors from those caught unprepared when the inevitable downturn arrives. Speaking on Oppenheimer's Let's Talk Future Podcast, Golub emphasized that the flood of new market entrants—with a new direct lender entering every 5.1 days in 2023—creates both opportunity and significant risk for investors who mistake current market conditions for permanent stability.

Big Picture Drivers:

• Market Maturation: Private credit evolution from niche lending to mainstream $1.5 trillion asset class

• Interest Rate Environment: Base rate stability around 4.25% SOFR supporting 9-10% yields

• New Entrant Surge: Massive influx of inexperienced lenders creating competitive pressure

• Economic Uncertainty: Inflation, volatility, and trade policy shifts driving portfolio reallocation

Key Insights:

• Historical Context: Only 5% of today's direct lenders existed before the Great Financial Crisis, with many new entrants lacking experience managing through economic downturns.

• Competitive Advantage: Scale and incumbent relationships provide the best opportunities, particularly for add-on loans to existing borrowers with proven management teams.

• Default Rate Reality: Current near-zero default rates can only move in one direction, making manager selection and margin of safety critical for long-term performance.

• Liquidity Considerations: Private credit's illiquid nature requires long-term commitment, though BDC structures offer some tactical flexibility for individual investors.

• Risk-Adjusted Returns: Success depends on net yield over loan lifetime after credit losses, not current yield or annual performance metrics.

• Recession Preparedness: The best direct lenders focus on avoiding losses in bad years rather than maximizing returns in good years, with early intervention and broad relationships as key differentiators.

Memorable Quotes:

• "Good, boring. That's almost our strategy. We're looking for steadiness and not too many bad surprises." - Lawrence Golub, explaining his firm's investment philosophy and approach to risk management

• "It's not about how much you make in a good year. It's about avoiding losses in the bad year." - Lawrence Golub, on the importance of defensive positioning in private credit investing

• "Private credit is a relatively new term that's getting applied to a great many different kinds of loans that simply aren't traded publicly." - Lawrence Golub, clarifying common misconceptions about the asset class

• "When treasury rates hit their peak at about 5%, I would talk to investors who would say, well, I can invest in riskless treasury bills at 5%. Why should I consider private credit?" - Lawrence Golub, addressing investor concerns about risk-free alternatives

• "The best direct lenders, the best private creditor folks, are folks who, when the next recession comes, won't lose much money." - Lawrence Golub, emphasizing the importance of defensive capabilities in manager selection

• "You can't get a riskless 5% indefinitely. You can get a riskless 5% for 90 days. But what are rates going to be a year from now or two years from now?" - Lawrence Golub, challenging the Treasury bill comparison and highlighting duration risk

• "In COVID, private equity backed companies did a much faster job of dealing with the new circumstances than either family owned or even public companies did." - Lawrence Golub, defending the resilience of sponsor-backed businesses during crisis periods

• "We only lend to companies we think are healthy. We only lend to companies that we think are resilient. We only lend to companies that have what we think are good capital structures." - Lawrence Golub, outlining his firm's strict underwriting criteria for loan selection

The Wrap: 

Private credit's rapid growth and attractive current yields mask underlying risks that will become apparent when economic conditions deteriorate. While the asset class offers genuine portfolio diversification benefits and superior risk-adjusted returns through economic cycles, success depends heavily on choosing experienced managers with proven track records, strong sponsor relationships, and conservative underwriting standards. The current environment of near-zero defaults and abundant capital creates a false sense of security that could prove costly for investors who prioritize current yield over long-term credit quality and manager alignment.