Can Private Credit Remain Secure in Today’s Market? | Louis Navellier

Private credit is becoming a major concern for a lot of players in the market and the economy. Today we sit down with Louis Navalier to find out what he thinks about what's going on with the private credit markets. I'm Siamak, welcome to Market Insider. Can you tell us what's going on with private credit right now? Well, I think I should start how all this evolved. It evolved because they passed a law called Dodd-Frank. And Dodd-Frank made it very hard for the banks to lend unless you're perfect. And how you can be perfect is you can take out a lot of credit and only use 10% of it and pay it off all the time. That'll get you a credit score above 800, okay? But for all those people below 800, a lot of the lending now goes through private credit. And about 12 years ago this was a $400 billion industry and now it's three trillion. What facilitated its explosive growth was Morgan Stanley. Morgan Stanley was run by McKinsey people. Mr. Gorman was a McKinsey guy and a lot of his lieutenants were McKinsey people. And they are experts at taking a business and squeezing more profit out of it. So they put a guy in charge named Mike Baker as their chief strategist. And what Mike Baker said for over six years is get out of stocks, go into alternatives, namely private credit and private equity. And it worked. If you talk to your average Morgan Stanley broker or any bar house broker, they sell a lot of this stuff. And they can get up to a 2% placement fee and about 1.5% of your trail. So let's just say you run into a financial advisor and there's a lot of them. And he has $100 million under management and most of it's in private credit and all his clients are happy because they're getting 11% yields. If he has to move them out of private credit and go back to something traditional like stocks, he will not be able to make a percent and a half a year off that portfolio. So the industry today is trapped in what we call Y2B, yield to broker. And they don't want to give it up. But what's happening is as the industry grew, some of the new players weren't as good as the old players. So I would argue the Cadillac in private credit is Aries Capital. They make loans to Oracle to build the data centers and Oracle's clearly a very reputable client. Obviously, you have all the problems with Blue Owl. The Financial Times in the UK is all over them. Bloomberg's been all over them. And they tried to merge a fund with another fund and people lost 20% of their principal. So they called that off. Now, the insiders of Blue Owl were buying the stock when it went down. And I actually know one of the PR guys for them and he says it's still fine. But they have a loss, they're eating it. It's not showing up to the clients. But then it spread to BlackRock, the late entrance to this business because BlackRock sells everything. And Morgan Stanley just put restrictions on Cliffwater. So all these funds have five to 7% redemption limits each quarter. And they're now starting to impose the limits. And so no one's losing money, but they can't get their money out and they're making people very nervous. And you might wonder how in the world can they get 11% yield? And what they're doing is they're leveraging loans. So apparently it's only like two to one. But the other thing that's going on and why the banking industry has been taking down with the private credit industry is banks were investing in private credit. Because they have money to invest. And probably the biggest skirmish is between Western Alliance, a regional bank out west, and Jefferies. And thanks to Jefferies, they got exposure to First Brands, which is one of the, which was a big auto parts supplier. They supplied Napa and AutoZone. Anyway, you know, Fram Oil Filters, all kinds of auto parts. And the First Brands fiasco involves a Department of Justice investigation because there might have been some fraud in the county. So you're having these issues out there, okay? And it's hurting Jefferies. It's hurting Western Alliance. But it hasn't hurt your average investor yet. But just imagine, you know, you retire and, you know, it's hard to retire. You know, things are expensive. And, you know, your financial advisor's offering 11% yield. That's why it sells, okay? And I do think the industry's gonna have to do a timeout for a while. I think they're gonna have to eat the losses and not pass the losses on to their investors. But some of the institutional investors are clearly losing money. And so BlackRock's gonna eat a little bit. And so is Jefferies and JP Morgan lost $170 million one quarter on Tricolor, the subprime auto lender that went broke. You know, the banks can buy in these pools of these loans and they might have to inspect the pools a little more closely. So it's just tarnished the whole industry. And that's why we're not having a financial, rallying financial stocks. Can you explain, you mentioned they are leveraging these loans and then that's why they can give a higher interest rate. So if somebody is putting a million dollars to these funds and getting the 11% return, what happens to that money? Where does it go? How does it generate the returns? Well, most of them are consumer loans or sometimes they're private equity loans. My son's in the private equity business. I'm shocked at what they pay to leverage up a business, but they borrow at 7%, a lot of these outfits. But yeah, they're just leveraged two to one. That's not too bad. But once you get in the consumer loan issues or subprime loan issues, remember the consumers are only going to private credit because they don't have a perfect credit score. The banks will still lend to those people. Two to one is tolerable, but they plan a certain default rate, which is up to 7%. And when it gets to 9, 11, it becomes problematic. But right now they're all eating those losses internally and not pass them on the clients because once somebody loses money, it destroys the whole industry. And the banks do this all the time. You know, when Silicon Valley Bank had to be bought out or the other banks come to the rescue because it tarnishes the industry. And that's kind of what's happening in private credit right now. They're all trying to protect each other. I'm in Reno right now, but I do live in Palm Beach, Florida. And we watched leveraged loans destroy that area back in 2008. Back then it was leveraged munis. People were bragging they were earning, you know, 13 plus percent of your tax free. And I went to one of the presentations and in that case, they would buy A-rated munis six to one. And they were using the AIG credit default swap to do it. Anyway, when AIG fell, the credit defaults broke and so they had to unwind all the leverage at once. And they had this thing called a black swan event where they dropped the bids and everybody got fleeced. Those A-rated munis are still fine to this day, but if you're forced to sell abruptly, you have a problem. And that's what private credit's doing is they're hitting the brakes on the redemptions. Say, hey, you signed a contract. You can only get out five to 7% of your money a quarter. There's no way you can take out all your money. And I think that's the right thing to do. I'm not trying to defend the industry, but you don't want to create any kind of panic or forced selling because no one wins in that scenario. So I guess they now know that when they get these yields, they're not entirely liquid. Is it clear what these funds own when somebody's investing into these funds, how much equity they have and what companies or what's the portfolio look like? I'm glad you said that. I have clients that are accountants that hate the K-1s they get because they do disclose everything they've invested in and all the states these loans are in and they just go nuts filing all the state tax returns. So you better have an, your accountant's going to charge a lot of money if you invest in this stuff because, and so the good news is when you get your K-1 it is transparent and obviously they file documents and do presentations. But yeah, it's a big pool of loans and it's a shadow banking system and it was all caused by Dodd-Frank. I'm an ex-banking regulator. What I used to do in the late 70s and early 80s, we had an inverted yield curve and a lot of banks were underwater because they would borrow short and lend long and anyway, we would have to merge two banks together and we would always take the big one and merge it in the little one and we'd reamortize its loans. We could never fix the problem. What we would do is we'd kind of kick the can down the road and my goal was really to get them FDIC or FSLIC insurance. And so I don't buy financial stocks because that experience scarred me for life. You just don't know the maturity or the quality of a lot of financial stocks, even the banks. Who knew that Western Alliance got exposed to first brands through Jefferies? That's a classic example but there's a good Wall Street Journal article discussing that. Who knew that Silicon Valley Bank put too much of their money in longer term treasuries that weren't performing well? Under Janet Yellen, the yield curve got inverted and the long end was people were losing money. And because of mark-to-market accounting, I still remember when Silicon Valley Banks sold its treasury portfolio to Goldman on a Thursday, there was a dramatic change in treasury yields and they would have been solving on a Tuesday. So I think mark-to-market accounting is a mistake for any financial institution. I think that's what started this, it created a shadow banking system. But now we just gotta make sure the people in charge of the private credit industry stick to their charter and their redemptions. And I'm telling you right now, the financial advisors are still gonna be selling it because the people want those 11% yields and they're diversified and they're not gonna just get first brands or tricolor and those obviously are gone now. And if there is a loss, hopefully the sponsor will eat it. But it's gonna continue just because it pays so well. The only thing that would kill that industry would be cutting the payment to the financial advisors. And then they'd look around to sell something else. Do you think there's a chance for people to lose a lot because these are leverage loans and do you think this could spill into the economy, to the broader economy? What it would do, it would cause the Fed to slash rates. It's the Fed's job to save the banking system. So if private credit fails, it's gonna take out more banks like Western Alliance and it's gonna cause more problems. So if there is a problem, yeah, the Fed would probably have to cut 100 basis points very, very quickly just to save the banking system and or inject liquidity. Now, they legally don't lend to private credit but they could lend to the banks that invested in them. How did the banks get exposed to this? Because it seems like the purpose of this was to kind of separate the banks from this kind of credit. How are they exposed? Are they invested in them or are they partnering the leveraging part? They're invested in them and they often refer people to the private credit to initiate the loans and they get compensated for the referral and can invest in the pool. It really, again, it was all caused by Dodd-Frank. You know, like in China, there's a shadow banking system. The official banking system, the shadow one. In America, we now have a shadow banking system. Three trillion dollars a year. And Louis, how realistic is it for this industry to pay those kinds of 11% a year? On top of it, you're saying they're paying a fee to the financial advisor. How realistic is it for this to last? It's hard. They have to plan a certain default rate but once it gets up, they have to decide. They probably have to eat it. The private equity is heavily involved with private credit. You know, KKR is one of the private credit firms and then, of course, KKR is private equity and sometimes the private equity guys are facilitating all these loans to companies. It's hard. But yeah, you got to have a healthy, robust economy and the easiest way to fix that is to slash rates and get the consumer spending up and fix everything. You know, the problem with our economy now is it's just too narrow and it needs to broaden out. Louis, last time you were on, you were very optimistic about the growth. We are having these issues with private credit. At the same time, we're having a war. The oil prices have gone up. Can you tell us what you're seeing right now? Well, obviously, when they revised the fourth quarter GDP growth down to 7.10%, that was shocking. They did cite the federal government shutdown and they did cite the resurging trade deficit in November and December for that reason. However, as we go in the first quarter, as I talked to you, the Fed is 2.7 and the January trade deficit fell dramatically because of soaring gold exports. We assume the February trade deficit is also going to be very favorable due to booming energy exports. It was very cold for a while, so LNG exports were at a record level. Prices were high because natural gas is hypersensitive to the weather. And obviously, in America, we refine a lot of petroleum products that we export. And then finally, we export a lot of crude oil. And also, we're influencing the Venezuelan oil now. We're influencing the oil from Guyana. We even got India to give up Russian oil temporarily. Well, because of what happened with the war, we gave India permission to buy the Russian oil. And I think almost 40% of oil that goes through the Strait of Hormuz is controlled by Indian tankers. They were trying to negotiate with Iran. Apparently, Italy and France were trying to get in there, too. Kind of every country for itself. But now that one of the leader of the defense forces has been taken out, and one of his key generals has been taken out, we assume that the fighting's gonna be over very soon. And hopefully, the Strait of Hormuz opens again. It's really more of a food issue now because of the fertilizer shortage. Oman, a lot of countries make a lot of nitrogen-based fertilizer. And we gotta get that fertilizer. Otherwise, it's gonna hurt food production. So the perception is is that oil prices are gonna be low within a couple months when everything gets back to normal. And hopefully, there's new leadership, and we welcome Iran into the international community instead of being isolated. But that's compound complex at this moment. Are you still optimistic about the growth, economic growth, this year? Second quarter growth's gonna be aided by much better weather, to be honest with you. First quarter, the Northeast was a popsicle. When it snowed in, well, it snowed in D.C., New York, Boston, it was ice. You couldn't take a snowblower to it. It was ice. I kept calling it Quebec, okay? That's how it is in Canada. And it just impedes commerce when that happens because they're not geared for all that stuff. And anyways, the weather's warmed up, and the snow's gone now. And the tulips and the daffodils will pop up. That's kind of a Northeast thing. And everybody'll cheer up, and everybody'll get out and about, and spending will go up in the second quarter. But the real key to get to the 5% GDP growth that I predicted on Fox News is to continue the productivity gains, which a lot are AI-related. Continue to shrink the trade deficit with our booming exports, gold, energy, et cetera. And some of it was pharma, too, because we're on 20 more pharma. And then finally, make consumers cheer up. Now, they got a tax cut. They're gonna get more money in their pockets. When you put money in people's pockets, they tend to spend it. But the economic growth in America is uneven, and we just have to cheer everybody up. You mentioned the economic growth is uneven. There were some reports that 10% of consumers are responsible for half the consumer spending. I would say that's close, 10% or 12%, yeah. Scott Bessett said that 88% of the stock is owned by the top 12% of households. The other 12% of stock is owned by the next 38% of households. That's 50% of America. The other 50% of America has debt. That's who we have to help, okay? So no taxes on tips helps, but Vegas is doing very poorly. So they've had a downturn, for example. But no taxes on tips helps. Having tax cuts helps. But we have to get the job market cranking because companies just aren't hiring. They're investing in AI instead of hiring workers. Meta's talking about laying off another 20%. And Amazon has a lot of high-profile layoffs. It's interesting, when Amazon lays people off, then they hire a bunch of temp workers. And so it looks like they're trying to, they really are trying to cut their labor costs. And they're automating their factories like crazy. So it's fascinating to watch what's happening, but any tech company that lays people off, their stock goes up. You're optimistic about the economic growth, but from what it seems like, from what you're saying, it might not really impact the people that are not doing well right now, this economic growth. Correct. So I just flew through Denver, and the big news there is there's a meatpacking plant on strike. So obviously, that's going to put higher prices on food costs. Cattle herds are way, way down. Just east of Denver, that's cattle country, the Sandhills area, Nebraska and Colorado. But it just shows, and there also is a labor shortage for those kind of workers. Trump's acutely aware of the labor shortage. You might have to keep more migrant workers in to do what has to be done. And Trump just wants them to come in the legal channels. But he's going to be running around telling everybody how great things are before the midterms. And I think the problem he's going to face is a disproportionate amount of our economic growth has gone to eight states, maybe 10. So I would count Utah, Idaho, and I would count Texas east, and covering most of the south. And so if you live in Minnesota, you might not see the growth. So it's tough. And he's just going to have to sell it. And so we'll see if he can convince America that things are fine. In terms of the financial markets, where do you see them heading from here? Obviously, we've had some downturn since we discussed in the last few weeks. Can you tell us what you're seeing? The market is obsessed with fundamentals. So this year, your leaders are data centers. Eli Lilly is down today as I speak to you, but that's a very good stock with very strong forecasted sales earnings. The gold stocks were doing very good, and then they slowed down, and they're starting to regroup here. There'll be an oasis. But the earnings are double-digit on the S&P. People like me, I want to do better than the S&P, so my average earnings were up over 100 last quarter, and my average earnings price is 25%. But that's what I do, that's my thing. But I can tell you the overall market, the foundation looks good. I think the other problem, and I'm part of the media, you're part of the media, fear always sells. And so if you just look at Google Analytics and what attracts the traffic, you're always going to have to have a fear theme. And Wall Street always climbs the wall of worry. I personally, just so you know, I hate August. If I ran the economy, I'd shut the stock market down every August. It's a seasonally weak month. With that said, it's gone up the last couple of August for me, so I'm wrong. But I do think it's going to be fine going into midterms. I do think we're going to probably consolidate some next year, because what we call the strong sales and earnings momentum we have now will be slowing next year and next year will be a little tougher. But the longer I look, the fuzzier it gets. So it looks pretty good through November. Going back to private credit, in terms of the people that have invested in these products or are thinking about investing in them, do you have any thoughts for them? I think people got hooked on them. I don't think they can get off of them. And the financial advisors certainly got hooked because it pays so well. So it's kind of a self-reinforcement loop. And the people that organize these private credit know that they can't have a default, otherwise they'll ruin it for everybody. And they'll hurt the private equity industry and the Fed will have to come and rescue everybody. So I do think they're going to do all they can to make sure no one gets a default, unless you're an institution like Western Alliance, which is a bank, or you're the sponsors yourself. But it's going to stick around because just ask your neighbor. So if your financial advisor has $100 million under management and he's making a million and a half a year selling private credit, he's not going to put everybody in stocks because he can't make that kind of money. Maybe he can make 700 grand a year, you know what I mean? But he's not going to make a million and a half. And then he's going to get in trouble with his firm because his production is going to go down. So the alternatives are here to stay because of what we call Y2B, yield to broker. And they have to self-enforce, self-police, for lack of a better word. But you know, Jamie Dimon has called them out, called these things cockroaches. Even though Jamie Dimon buys into these pools. So, you know, Jamie Dimon is an interesting character. So they've sent that warning shot across the bow. Everybody knows they got to clean up their pools. And offer better stuff. And maybe the yields will be dropping to 7, 8, 9%. But you know, people are hooked. And the distributors on Wall Street are hooked. So I don't see it going away. Before we did this, I sent you a chart that UBS is predicting up to a 15% default rate. I don't think we'll get that high, but we'll see. That would be a disaster. Would that spill into the markets? Or do you think it will not happen? Yeah, that would cause the Fed to cut. Because banks have invested in this. The problem with banking now, they don't know who we are. We're just a number and a credit score. They don't know who we are. And I still remember my son, he only went to Stanford, he's got a couple of masters. He's the private equity guy. I still remember them explaining how they can do lending with their algorithms and things. You know, it looks easy. It looks like you can make lending without a bunch of staff. And that's kind of how lending works in America right now. Again, if you want a perfect credit score, go out and get a few hundred thousand in credit. Use less than 10%, pay it off every month, and you'll be over 800. And they will lend you money. But everyone else gets out to an intermediary and they start marking up the loans. You see it in the auto business. You know, you can go on GM's website and say, I want to lease this vehicle. And like, what do you mean it only has a 10% residual after five years, you know? And why do I have to pay those rates? So, you know, even on the GM website, they're not offering you the good loans, okay? Because they sell to the masses, okay? And of course, you know, a lot of the auto companies have finance departments that make a lot of money, you know? So I find that interesting. That was the problem with the U.S. auto industry. The finance people were running instead of the engineers, and I think they got some engineers running it now. But yeah, no, it's very interesting. But it's helped my performance this year because I don't own financials. There was a day the Dow was down 814 points and my large cap portfolio was up 0.2 and I have an all-cap portfolio that was up 0.3. And it had 80 stocks in it, the big all-cap portfolio. And people would say, well, how come you're up when the market's down? Well, at that time, gold was rallying and the NVIDIA and some of the data center things were resilient and Lilly was doing good. And then I said, because I don't own financials. So the whole sector's been demonized and I feel sorry for them, but it's time for them to get their act together and self-police. Now, Jamie Dimon is more powerful than the Fed chairman. So he hasn't really policed it yet. He's just sent out warning shots. And hopefully they don't come true. But if we get a robust economy going because of tax cuts, and I do think things will get better. But it's time for everybody to cheer up and hopefully we get a consumer-led economic recovery. It's just so hard. It depends where you live. It's hard to live in Florida and not realize the economy's good, okay? It's hard in Texas to not realize the economy's good. But there's other states that are just left behind. Louis Navalier, it was great to have you back. I'm Market Insider. Thank you. What do you think about this conversation with Louis Navalier? Do you agree with Louis that this may not be a big issue for us going forward? Or do you think private credit is gonna be a big challenge for the economy? Let us know in the comments. I'm Siamak, this is Market Insider. We'll see you next time.