Private credit’s sketchy marks get warning shot from Wall Street’s top cop

Wall Street’s top prosecutor has a warning for private-market players getting creative with their numbers. Stark divergences in how competing firms value private assets in their portfolios are drawing increasing attention from market participants, academics — and, now, the Department of Justice, according to Jay Clayton, the head of its Manhattan outpost. “There are definitely some areas of concern for me in private markets,” Clayton said in an interview. “People should know that the financial regulators and the department are looking at those.” Private equity firms have faced increasing questions over the value of their portfolio companies as they hold onto assets for longer. Private credit, meanwhile, has swelled in recent years, as asset management giants unleashed billions of dollars in financing to corporations — filling the void as banks pulled back in an era of stiffer capital rules and low interest rates. But the rush to offer credit has started to show cracks this year amid mounting competition, alleged frauds by borrowers and a growing body of evidence fueling concerns that funds use varying methods to assign values to the assets they hold. One recent academic paper referred to the apparent subjectivity of the numbers as “mark to myth.” Clayton says what he won’t stand for is money managers cherry-picking prices that let them reap higher fees at the expense of their clients. The public will “want to know that private marks, where there’s liquidity offered or an asset value-based fee to be paid, are good marks,” he said. “I expect we will have more to do in areas of our private markets.” Clayton, 59, took over the DOJ’s office for the Southern District of New York after President Donald Trump announced shortly after last year’s election that he intended to make him the de facto sheriff of Wall Street. At the time, Clayton was chairman of Apollo Global Management Inc., one of the most dominant players in private markets. He previously led the Securities and Exchange Commission during Trump’s first term. ‘Vehicle to Vehicle’ One area where authorities could point a finger is how fund managers value private assets when transferring them into another portfolio, such as a continuation vehicle. The popularity of those funds has exploded as a way for private equity managers to offer existing clients opportunities to cash out their stakes even when underlying holdings prove difficult to sell. An industry body representing fund clients has called the transactions “inherently conflicted” and pushed for clear guidelines in such deals. That hasn’t slowed down a boom in continuation vehicles, and they’ve increasingly appeared in private credit as well. But such asset shuffles may be ripe for abuse, Clayton said. An area “to watch out for is marks on assets with no trading when things are moved around from vehicle to vehicle,” he said. “If someone is moving a position from Fund A to Fund B and if you can just name a price internally, the opportunity to pick a price that benefits the house over investors is pretty high.” Recent bouts of stress in private credit have put a spotlight on the speed and degree to which investment firms adjust valuations, sometimes leaving significant gaps — especially on troubled holdings. Academics from Johns Hopkins University and University of California, Irvine released a study questioning whether private fund managers may be overestimating the prospect of fully recouping debts in their portfolios. In response, the Managed Funds Association trade group offered an assurance: Private fund managers do “implement robust internal controls and board-approved procedures, supported by independent pricing experts.” Clayton’s tenure atop the SDNY has coincided with a bumpy patch for credit markets, including the spectacular collapses of borrowers such as First Brands Group, which the Justice Department is investigating. JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon soon warned that more “cockroaches” will probably emerge from the lending frenzy. Private-market executives who fired back included Blue Owl Capital Inc.’s Marc Lipschultz, who suggested Dimon look closer to his own bank for problems. Then last week, Blue Owl took the stage as it scrapped a planned merger of two of its private-credit funds. Clayton cautioned that much of the market — investment-grade lending — probably isn’t at issue. “It’s not all of private credit,” he said. “It’s not IG loans to well-functioning companies.” Apollo CEO Marc Rowan made a similar argument against broad-brushing private credit during an investor presentation on Monday, taking issue with the fixation on the riskiest sliver of the market. The advantage in many cases is that lenders can get more information from borrowers. “You have total access to management,” he said. “It’s not opaque, it’s actually totally transparent.” --By Sridhar Natarajan (Bloomberg)

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