Absolute Credit Series: Private Credit Has Grown Up — Moody’s on What Comes Next

LT (00:07)
Good morning and welcome to Absolute Credit. I’m Lindsay Trapp. I’m a partner in Kirkland’s New York office, but joining you today from very sunny Phoenix, Arizona. I’m really excited today. We have a very special guest with us, Marc Pinto from Moody’s Ratings. Hi, Mark. How are you?

MP (00:23)
Hi Lindsay, good to see you. We’ve got a little sun here in New York as well.

LT (00:27)
Excellent. Well, thank you for joining us today. We have lots of fun things to talk about, but I suppose I just wanted to get your views on, you know, private credit generally this year, rated funds, CFOs, you know, have been pretty hot products. So what are you guys seeing over there at Moody’s?

MP (00:48)
Yeah, I would say on the fund finance side, we’ve seen a lot of rated note feeders, ABLs, NAVs, sublines a little bit less, but a lot of activity. Private credit though, as you know, is a really big space. And it seems like the hot topic today is all about the perpetual non-traded BDCs and the redemption requests that are going on there. But that’s a whole ‘nother story.

LT (01:11)
It is indeed. So where are you guys seeing a lot of the drive for ratings? Is it largely in, say, more the traditional fund finance or are we still seeing quite a bit from the rated funds and CFOs or is it just all of them are having a bit of a boom for ratings?

MP (01:27)
It’s all of the above, to tell you the truth. I mean, there’s still a big institutional drive to get into this space, particularly the insurance companies. They’re very interested in what the fund finance world can offer them in terms of duration, diversification and higher yield, quite frankly. And, yeah, the train has left the station, and interest just keeps rising, quite frankly.

LT (01:54)
Indeed. And are you guys seeing a lot of other assets or are we still just kind of pretty heavily in the private credit realm these days?

MP (02:03)
No, you know, I think the market has really started to evolve, and we talked a little bit about this in our private credit outlook for this year. You know, we really started this business looking at direct lending, middle-market direct lending, and it’s morphed into real estate, infrastructure. And then what we’ve been seeing and what we’ve been hearing at a lot of conferences, probably what you’re hearing at your conference as well is, you know, the esoterics, but the esoterics are becoming everyday, right? So by esoterics I mean royalties, music royalties, sports — there are sports assets now that we are seeing going into fund finance vehicles. So the number and the types of assets just continue to grow. I mean, I can’t even imagine what we’ll be talking about 12 months from now.

LT (02:52)
Absolutely, we are seeing quite a lot of things as well — stuff like aircraft, definitely royalties as well. So it’s interesting to see the expansion of these kind of things that would be more traditionally in ABS now kind of making their way into more of a fund format. But you mentioned your private credit outlook for 2026. So I know you guys put out these great publications. Do you want to take us through some of the findings that you guys had there?

MP (03:20)
Yeah, some of the big picture items are, again, this asset class changing, right? From middle-market direct lending to more asset-based finance and esoterics. We’re seeing the business become much more global. I mean, the U.S. has really been the epicenter for private credit, but we’re starting to see more and more interest in Europe, the Middle East and also Asia. And I would say as well, when we started and it was sort of the nature of the asset class, it was more high-yield in nature, speculative grade in nature. And we’re seeing a much broader spectrum of risk within the context of the private credit assets and what’s going into the fund. So more investment-grade, quite frankly, and that makes a lot of the investors who are seeking investment-grade assets very excited about more opportunities in terms of getting involved in this space. So those are some of the high-level things that we’ve been focusing on. Maybe just one other thing to mention here as well: Not only is the asset base changing, but the investor base is changing with more and more retail investors getting involved in this market as well. And I think that’s changing the nature of the products as well as just how this market is functioning, quite frankly.

LT (04:41)
Yeah, I would agree with that. We’re certainly seeing some more interest from the retail side, but also retail assets as well, with different types of registered funds becoming collateral in CFOs, in particular, and also in rated feeders. That’s certainly been an interesting thing. But also, I think there’s quite a lot of innovation and activity happening in sort of the underlying structures of a lot of retail products as well with JVs and other types of financing mechanisms that we’re certainly seeing. I’m not sure if that showed up in your outlook as well.

MP (05:20)
No, it absolutely did. And you and I saw each other in Vegas at the Structured Finance Conference. And what I was impressed by there was how much the fund finance world is merging or converging with the structured finance world. And I know that you guys have been involved in a lot of deals as well. Things that we’re seeing in fund finance today, we weren’t seeing 12 or 24 months ago. You’re seeing more tranching, right? You’re seeing more unique structures that combined lots of different aspects of the structured finance world and bringing it over into fund finance. So I think that’s a new innovation as well. There’s more complexity to this market. Complexity doesn’t mean more risk per se, but it does mean more due diligence and more in-depth analysis for investors who get involved in this market. And quite frankly, for us who are rating a lot of this market as well.

LT (06:18)
Yeah, absolutely. So I guess in some of those other instruments, for instance, subscription facilities, there’s always been information that you guys would need and that kind of stuff. Has the way that this has been changing or even the asset mix within the structures, has that changed what you guys are looking for or needing in regards to information? And has the change in investor mix helped that in any way?

MP (06:45)
Yeah, I would say the more investors that can get involved in this market, the more transparency that’s being required and more information that needs to flow, particularly when you involve retail. There can be no slips or falls when you get retail investors involved in a market. This market hasn’t been very transparent. It’s been fairly opaque in many regards. But I think, again, new investors and new structures are creating more questions. And so we need to come up with the answers. One of the things that maybe you’re alluding to, in the past, when we were often presented with information, we couldn’t get everything that we wanted because, for example, when limited partners sign agreements to be involved in these funds, they protect their information. I think the new documents that are being written understand that these funds may have a life of their own and move into lots of different areas within the financial services investment community. And so we’re seeing even the initial documents for limited partners saying, “We will protect your information, but if we need to disclose it with an NDA to a rating agency, for example, to be able to analyze that data as these assets move into another form, that’s being allowed.” When we didn’t have that, we couldn’t rate the deal.

LT (08:11)
Yeah, certainly, having documents drafted that way has been something we have seen an evolution of over the last many years, you know, going from what used to just be sort of investor letters to now having very broad-based information on what will be shared within the LPAs themselves or the indentures, depending on how we’ve got them structured. That’s certainly something there. I guess in...

MP (08:02.414)
You know what, Lindsay, just one point. I think this is great for the market, though. Right? More information allows this market to mature, people to have more confidence in this market. And I think when it was a small portion of either institutional or even retail portfolios, you sort of get a pass on, “Well, okay, it’s just a small portion of my portfolio.” But as it grows, having more information, having third-party assessments, all of these types of things help this market grow in a mature, responsible way.

LT (09:07)
Yeah, for sure. I think given particularly in sort of the private assets market and as insurance companies started investing in this market, that was a lot of the push originally, at least in my view, from the NAIC when they started discovering how much in the private asset market that insurers were involved in. It was kind of, “Well, there’s not a lot of information on these assets. How do we get information on these assets? What do they look like? How do they behave in this market that we have been involved in for very long time,” but it is very true. Very different from maybe more liquid loans, you know, so I think that that’s been helpful and good. I think it helps regulators understand a bit more about how things are going, but it also creates, let’s say, more market precedent as it goes, right? Because the more information that’s out there, things start to standardize a bit more than they maybe have been.

MP (10:10)
More consistency, exactly. And more comparability. I think those are really important things. And as you said, the insurance industry, if I look at the U.S. life insurance industry, if we sort of divide their portfolio into the public bonds and then everything else, kind of the private credit world, we used to call it alternatives. It now seems that everything’s kind of pushed into that market. Roughly a third on average of U.S. life companies general accounts are in private assets. So I think it’s really important, as you mentioned, the regulators are very focused on this. They’re looking for more transparency. I’ve been involved, as you mentioned as well, with the NAIC. They’re looking at this very closely and making sure that the risk that’s on the insurers’ balance sheet is appropriately capitalized and appropriately accounted for.

LT (10:59)
Yeah, absolutely. You mentioned some other things around the way that assets, maybe they start out in one form or they start out in one way, and then they evolve into different parts of the sort of fund finance ecosystem. So I wanted to talk to you a little bit about something that we’ve, you know, seen a little bit of and maybe our folks are looking a little bit more for. So things like using some of these loans, we can talk about, you know, subscription finance lines, maybe for for some of that or even just some of the private credit loans that maybe are originated by funds themselves being packaged then into something else like a securitization? Are you seeing some of that type of development more so than just traditional continuation vehicles, but actual asset bases being changed into a different type of product?

MP (10:52)
No, absolutely. And it’s part of the maturation, I think, of the market that you start out originating, you create consistency, then you’re able to monitor the cash flows and understand the consistency of those cash flows, which then make these assets very attractive to either a securitization or a fund finance vehicle. So we’re seeing more and more of that. I think today sponsors and, quite frankly, the investment bankers, they have a lot more roots that they can travel on. In the past it was, “All right, we have this asset consistent, we will now do an asset-backed securitization.” Well, today they can go in that direction; they can go in the fund finance direction. And as I was mentioning earlier, you’ve got attributes of each in both fund finance and securitization. So I think what we’re seeing today, and really this is what private credit is all about, it’s a new tool in the toolbox that we didn’t have previously. And if it results in more asset-liability matching and a better way of segregating and understanding risk and allocating capital within an economy, that’s a better way of thinking about how to grow the economy, quite frankly.

LT (13:08)
Yeah, so what do you guys, if you were looking at something like that from a ratings perspective, would you need those underlying loans themselves to be rated? Is it something that’s more about the consistency of the types of loans and sort of how they work or information, or is it sort of a combination of all of those things?

MP (13:27)
You’ve hit the nail on the head. It’s a great question. It’s a combination of these things. So we’ll look at sector concentrations. We’ll look at underlying loans. To some extent, some of them are already rated. If they’re a big portion of the portfolio, we will go out and get a credit estimate, kind of an internal rating on some of these exposures. And in fact, what we need to do often in a lot of these transactions is bring the entire corporate analyst community within Moody’s to bear. So if we’re looking at a real estate transaction, we’ll go to our real estate group. If we’re looking at music royalties, and we have expertise within the organization, “Hey, we’re looking at music royalties in a fund finance transaction. You guys have done it in structured. Can you bring over your experts to our rating committee? And as we put together the analysis, can you contribute there?” The other aspect to this is maybe a little inside baseball, but at a rating agency, we cannot assign a rating unless it’s associated or hung on a methodology. So in the past, methodologies were quite rigid: “This is the methodology we use for tech companies. This is the methodology we use for real estate mortgage-backed securities.” Today, because of the blurring of lines and maybe multi-asset funds, we might need to use multiple methodologies, and we’re having to update our methodologies or even create new methodologies in order to meet the market where it is today and where it’s going. So I think within the rating agency community at large, we’re all looking at our methodologies to make sure that investors understand how we’re arriving at our ratings by looking at methodology or think of it as a framework.

LT (15:17)
So you guys kind of combine methodologies. I think that seems to be a fairly common theme, right? There’s a funds methodology or an idea that you can then add bits and pieces to. So one of the biggest things we’ve seen in CFOs is a very wide variety of asset classes now being brought in, right? In very olden days, probably pre-crisis, mainly CFOs were LP-led, usually using primarily private equity funds as collateral, but that’s changed substantially over the last kind of five years. Pretty much everything at this point is GP-led that we are seeing and doing anyway. And in doing that, we’re seeing everything from real estate and infrastructure to even multi-asset SMAs within those structures, private credit. How do you guys look at something like that in the context of a CFO? What’s the sort of ratings grouping of methodologies, or how does that kind of factor into a CFO?

MP (16:20)
Yeah, so we currently don’t rate CFOs, but we will be doing so very shortly. And so as we go through the process to get this framework in place, we’re looking at, again, how we view this on the structured side, as well as how we view it on the fund side. And I would say, as well, to your point about multi-strategy, that’s becoming very, very attractive to investors. So they don’t have to choose, all right, “Do I take a little bit of this real estate fund or another fund that has infrastructure assets or middle-market lending?” By investing in a multi-strat fund, some of which the big alternative GP, alternative asset managers or GP sponsors are offering to market, they can say, “We’re gonna offer you the best of our underwriting in a multi-strategy form.” And insurance companies have really cottoned onto this. They really like this. And we’re seeing a lot of success in this area, both from a GP fundraising point of view and how the insurance companies are getting involved in it.

LT (17:25)
Yeah, so how are you guys thinking about this methodology as you’re coming through to it? I forget it hasn’t come out yet. So how are you guys kind of working on developing that one?

MP (17:34)
It’s on its way. It’s on its way! Yeah, I mean, we did have a collateralized fund obligation methodology in the past, and it was not used very much for the last decade or two, quite frankly, and so we retired it. So what’s new was old, or what’s old is new. So it’s really brushing this off and thinking about how cash flows are going to move in various scenarios. I always like to say the market has been quizzed, but it hasn’t been tested. So we’re really trying to run lots of different scenarios to make sure that the resilience of those ratings is there when we assign them.

LT (18:24)
Excellent. So let’s maybe move a little bit more toward, specifically, rated feeders. You guys are definitely making great advances in the context of specifically real estate debt. So I wanted to talk a little bit with the audience about what you guys are looking at in the context of ratability for something that’s, let’s say, largely or all a blind pool of real estate debt.

MP (18:54)
Yeah, I mean we have a lot of history at Moody’s about how these assets will perform. You know, you’re looking at trophy assets in some cases. You’re looking at different parts of the real estate market. And as I mentioned, we have a very good sense for the consistency of cash flows, the value of these assets and, quite frankly, what’s also very important is the manager of these funds. Manager performance is very, very key to our overall rating outcome. So these three things, as well as how leveraged you have, you know, we’re looking at loan-to-value ratios, we’re looking at any additional leverage that the fund might employ to increase the overall return. All of these things are very, very important, and we can use decades of experience looking at this asset class, and I think that’s really important, again, in developing the scenarios and understanding where the rating should come out based on the resiliency of the cash flows and the values that are underlying the overall obligation.

LT (20:02)
Is it important in those structures to have, let’s say, a quite set or tight geographic set of locations where some of the underlying could be, or can it be a little bit more broad, and the managers can say it’s maybe more of a regional area or something like that?

MP (20:22)
Yeah, I think each one of those considerations bring different risks, whether you’re in a major metropolitan area or there are still some very resilient regional areas, for example, within the United States that have performed quite well. But that’s part of the calculus of the number of assets, the type of assets, the geographic location of the assets. You know, quite frankly, diversification is often your friend. They say it’s the only free lunch in investing, right? Diversification, diversification, diversification. It’s like location, location, location in real estate, right? We need diversification within a lot of these funds. But it doesn’t mean you can’t have a single asset. But again, that’s a different analysis and a different way of thinking of things. Diversification typically improves the overall ratings outcomes, I would say.

LT (21:05)
Excellent. Yeah, I think that certainly in some of the things we’ve seen, particularly I think in the esoteric assets, it seems to be that, you know, at least a quite widely diversified portfolio by number, at least, maybe not necessarily sectors or areas, but by number seems to be quite important as well. Is that also kind of what you’re seeing, say something in royalties or something?

MP (21:27)
Yeah, mean, think about, you know, we talk about esoteric music royalties, you know, who is it? Is it ABBA or is it, you know, somebody who I might listen to but no one else listens to? You really need to figure out what are the quality names within a portfolio, what is the consistency and what is the durability of that music versus maybe something that’s more on the fringe and might not have as long a shelf life or have a strong as a cashflow generation as some other asset. So yeah, the devil is in the detail. The devil is absolutely in the detail.

LT (22:07)
It’s always in the detail. Excellent. Well, one of the things I wanted to just sort of give folks maybe a little bit of a flavor for is how you guys do your ongoing surveillance of the portfolios as the market changes and kind of what that process is like, you know, just for folks who are interested in maybe coming into this market for the first time. What is the ongoing surveillance process once you’ve issued a final rating?

MP (22:38)
Right, once we’ve issued a final rating, we get either monthly or quarterly valuations on the underlying portfolio of assets. We work very closely with the risk professionals at the organization to understand what is their process. Process is very, very important to the overall ratings. And we want to make sure that we understand any changes in the process, that the process is being implemented. Again, around the frequency and valuations, which I just talked about, understanding how they value. Do they use third-party valuers to come at the ultimate valuation? Are they using models? So really, again, understanding the process, which can include outside contributors or outside service providers, is very key. What we also look at is when we’re looking at the valuations, we’re making sure they’re consistent with what we had anticipated when we set the ultimate rate when we assigned the rating. And if the valuations start moving such that LTV or something else is moving outside our band of what we expect, then we might go, for example, to committee and review the numbers again, and then either change the outlook or the ultimate rating. But it’s a very rigid process, and one that’s followed very closely, as you would imagine, to make sure that the rating is always correct.

LT (24:05)
Absolutely. How does that interplay in a blind pool with, let’s say, you rate off of a hypothetical scenario, and how does that help with the building of that portfolio?

MP (24:18)
Yeah, so that’s a very good point, a great question, because oftentimes we’ll assign the rating based on the strategy of the fund, and it’s not fully funded as yet. So we watch as assets are built within the fund. And as you can imagine, they don’t all come in exactly, you know, 5% of, you know, 20 different sectors. You might see a sector be 10% or 25% of the portfolio in the early ramp-up stage. So we watch that very closely. If we see it get out of whack, greater than our expectations, we’ll go back to the risk manager and say, “What are you planning? What are the next investments? We’re watching this.” So there’s a little bit of trust and faith as the portfolio gets built up, and the manager knows what we’re watching. So if all of a sudden 20% of the portfolio is in one particular sector, that is ultimately supposed to be 10% or 5%, they’re going to be very careful about making more investments in that one particular sector before they bulk up some of the other sectors. So it is usually a two-to-three year ramp up-period. So it may not be perfectly aligned in those first two, three years with the overall strategy. But again, this is why it’s so important to understand the manager, the credibility of the manager, the track record of the manager, because you’re relying on that manager a lot in the first couple of years as this portfolio gets built up.

LT (25:51)
Yeah. Absolutely. It’s quite an interesting process as folks go through ratings, but very tried and true. I think most managers manage to get to where they sort of expected when they tell you, so I think that’s great. Last question, and this was just something that I saw. You had posted that you recently were part of an SEC roundtable kind of discussion. Anything interesting coming out of that from a rating agency perspective?

MP (26:21)
Yeah, I think we have said this before, as well. As retail investors get into this market, it creates a little bit more risk because retail investors invest in a slightly different way than institutional investors. I like to say institutional investors have ice cold water running through their veins. We as retail investors, we can sometimes engage in animal spirits when we move in and out of markets. And I think one of the things we talked about at the SEC presentation is the responsible inclusion of retail investors in private markets. And there is a lot of disclosure out there, but I think it will take some time for investors to understand that when you invest in a private credit vehicle, this is not like investing in a mutual fund. And it’s not that the retail investor can’t embrace that, because they understand the liquidity features of buying a home. You know, we don’t buy a home one day and sell it the next. They can understand the liquidity features of buying a car. And they very well understand when they’re talking about their investments, the liquidity features of a mutual fund, for example, or an ETF. They haven’t fully embraced the features of investing in a private asset vehicle. And I think the SEC is out there trying to make sure that investors are well-educated and use the information that’s at their disposal. So I think that is an important aspect of what came out of the conference. Private credit is lightly regulated compared to the banking market and compared to the public fixed-income markets. They have certain features which can provide benefits but also provide risks. So I think the more that the market becomes educated, the investor base becomes educated, the more transparency, like we were talking about earlier, the better for this market and the confidence and the maturation and responsible growth of this market going forward.

LT (28:26)
Yeah, absolutely. I certainly think education is a key there. The documents for all of these vehicles are drafted and looked at with the SEC, and they are quite heavy on disclosure about these things. But I think sometimes it comes down to a question of how much folks understand exactly what the impacts of the things that they’re reading necessarily are. So it will certainly be interesting to see where this goes as more folks start getting into this market from the retail side. But it’s great to have, you know, folks like you out there looking at all of these different aspects of the market. Anything else that you’d like to, you know, highlight to our viewers?

MP (29:12)
No, would just say, Lindsay, you’re writing these documents and spending a lot of time and effort on them. People should read them.

LT (29:20)
Thank you. Yes, please do. Please do read them. Excellent. Well, Mark, we really appreciate your time.

MP (29:38)
No, thank you, see you at the next conference.

LT (29:41)
Absolutely. Thank you.