TOPIC • 29 CLAIMS
Credit Cycles
Lending standards, default rates, and how credit availability drives the wider cycle.
HOWARD MARKS/
The direct lending market grew from a niche into a scale that, by his account, could not have been filled by good borrowers alone.
- about $2 trillion of direct loans made over 15 years
- the entire private credit sector was about $150 billion 20 years ago
HOWARD MARKS/
Direct lending carries far heavier software exposure than the public credit markets do, which turns a sector-specific AI shock into a portfolio-level one.
- software is 4-5% of high yield bonds
- 10-15% of broadly syndicated loans
- 20-30% of direct lending
HOWARD MARKS/
Those software borrowers were financed at multiples and leverage that assumed durable growth.
- often acquired at EBITDA multiples of about 20x, with high leverage
HOWARD MARKS/
He discloses Oaktree’s own restraint in the same strategy he is describing, rather than writing from outside it.
- direct lending is less than 15% of Oaktree AUM
- just over $10 billion in public vehicles
HOWARD MARKS/
His concern is located in the financing of the buildout rather than in the equity multiples.
- roughly $5 trillion of data center buildout
- against about $350 billion held collectively by Microsoft, Alphabet, Amazon, Meta and Oracle
HOWARD MARKS/
His central distinction is between something hardwired into the financial system, as counterparty risk was in the Global Financial Crisis, and a recurring behavioral failure — these clusters are the second, systematic rather than systemic.
COCKROACHES IN THE COAL MINE →HOWARD MARKS/
He reads the sell-off as the usual overshoot from flawless to hopeless, and says he does not think it is necessarily the beginning of a trend, and sets it against the base rate of default he has watched for decades.
- the stock prices of some prominent alternative asset managers were down 5-7% on October 16
- more than 2% of all high yield bonds by value default in a typical year, across 47 years in the market
HOWARD MARKS/
He dates private credit to the post-crisis gap left by bank retrenchment, when the few lenders willing to put money out could demand both high rates and high safety, and argues that the new entrants and incremental capital that followed reduced those advantages — while the sector has still never been tested.
- the sector took root around 2011
- perhaps $2 trillion flowing into the sector in the subsequent years
HOWARD MARKS/
He returns to the chapter of his own book he had not planned to write: prices move far more than intrinsic values because attitudes toward risk are so volatile, so standards fall in good times and are raised only after the losses arrive.
COCKROACHES IN THE COAL MINE →HOWARD MARKS/
He revives Galbraith’s "bezzle" to explain why fraud is cyclical — plentiful money and relaxed diligence raise the rate of embezzlement while lowering the rate of discovery — and says it should not surprise anyone if the years just past turn out to have produced a crop of frauds not yet discovered.
- the last sixteen years of largely uninterrupted economic growth, rising markets, and profitable risk taking
HOWARD MARKS/
The First Brands numbers are the memo’s hardest evidence: what the bankruptcy filing revealed bore little relation to what lenders had been shown months earlier.
- total obligations of $11.6 billion, inclusive of $9.3 billion of debt
- versus the $5.9 billion of debt disclosed during a financing process undertaken in July
- a creditor’s lawyer said $2.3 billion had "simply vanished"
HOWARD MARKS/
He lists the red flags Oaktree found before the filing — none conclusive on its own — to argue that credit work is the assembly of a mosaic rather than a single discovery, and that scale is what pays for it.
- only six years of operating history but already $5 billion of annual sales
- a thorough job of credit research costs the same whether you are investing $50 million or $500 million
HOWARD MARKS/
His argument on volatility is that it is not the risk long-term investors should care about — permanent loss is — and that the reasons people fear price movement are situational, career-related and emotional. Since the same holding is risky for a daily-priced fund and not for a sovereign wealth fund, the risk sits in the investor’s circumstances rather than the asset; a public bond and a private loan from the same issuer carry identical default risk and only one marks to market.
- Buffett would rather earn a lumpy 15% return than a smooth 12%
HOWARD MARKS/
What he chose to preserve from the run-up to 2008 is a sequence of standards warnings rather than a forecast: investors with too much money and too much eagerness bid the terms down, and the specific symptoms he named in mid-2007 were excessive leverage, untested securitization structures and too-easy access to capital.
THE BEST OF . . . →HOWARD MARKS/
He stacks up the behavioral indicators alongside the multiple, including the credit market, where the compensation for giving up Treasury safety has thinned to near its historical minimum.
- the S&P 500 valued at more than 3.3 times sales, an all-time high (Financial Times, July 25, citing Bloomberg)
- a Barclays equity-euphoria indicator at twice its normal level, in territory associated with asset bubbles
- the ratio of US market capitalization to GDP at an all-time high, and understated because companies stay private longer
- yield spreads approaching all-time lows
HOWARD MARKS/
In credit, default fear widened spreads while a flight to Treasurys cut their yields, raising available yields on net.
NOBODY KNOWS (YET AGAIN) →HOWARD MARKS/
He rejects the usual reading: a spread is a fear gauge reporting what investors expect defaults to be, not what defaults will be.
GIMME CREDIT →HOWARD MARKS/
The test he substitutes is whether the spread offsets credit losses — and by his arithmetic today’s would have covered the past.
- a spread around 290 bps, one of the narrowest since high yield issuance began in 1977-78
- against a normal range of 350-550 bps when he managed, revised more recently to 400-600
- default rates averaging 3.5% from 1986 through 2024, costing about two-thirds, or roughly 230 bps a year
HOWARD MARKS/
The historical spread is not necessarily the standard for adequacy, he argues, since it paid holders well beyond their losses.
- high yield returned 7.83% a year from 1986 through 2024 against 5.14% on 10-year Treasurys
- an advantage of 269 bps a year
HOWARD MARKS/
He then discounts his own average, since a handful of crisis years pull it well above the typical experience.
- only 14 of the 39 years at or above 3.5%, and 25 below
- a 3.0% average across the remaining 31 years once the crisis and best years are removed
- a median of 2.7%
HOWARD MARKS/
The universe is also better rated than it was, mostly because triple-B companies chose leverage over holding their rating.
- BB rose from 32.7% at the end of 1999 to 52.6% at the end of 2024
- B fell from 54.6% to 33.7%
- CCC and below barely moved, 12.7% to 13.7%
HOWARD MARKS/
Buying at the all-time tight just before the crisis still worked over ten years, so a narrow entry spread is not destiny.
- the all-time tight of 241 bps on June 1, 2007
- high yield trailed Treasurys by 11.3 percentage points in the first year
- then beat them by about 3 points a year over the following 10 and 15 years
HOWARD MARKS/
On private credit the tide has never gone out, he says, and the risk he names is manager behavior rather than something systemic.
GIMME CREDIT →HOWARD MARKS/
His conclusion is relative, not absolute: credit is no giveaway, but it out-yields equities and its returns are contractual.
- J.P. Morgan Asset Management: from p/e ratios like today’s, the S&P 500 has historically produced ten-year returns averaging between -2% and 2% a year
- the 10-year Treasury yield above the S&P 500’s earnings yield (Wall Street Journal, January 27)
HOWARD MARKS/
Strip everything back and two asset classes remain, ownership and debt, which he says have nothing in common.
RUMINATING ON ASSET ALLOCATION →HOWARD MARKS/
Owners are promised nothing and take what is left; lenders get a contractual return he would rather call fixed outcome.
RUMINATING ON ASSET ALLOCATION →HOWARD MARKS/
Offense is usually played through ownership and defense through debt; not either/or, he stresses, but a question of the right mix.
- no one should buy an 8% bond expecting to make more than 8% a year over the long term
HOWARD MARKS/
His recommendation is a partial step, not a switch: research it, set up a program, begin — better entry points may come again.
- prospective returns starting at roughly 7% on public credit and 10% on private credit
HOWARD MARKS/
He argues the prior decade’s benign default experience was an artifact of the rate regime, not a permanent feature of credit.
- high yield defaults averaged 3.6% from 1978 through 2009
- but an unusually low 2.1% from 2010-19
Claims are restated; figures are the authors' own. Each links to the document it came from, which in turn links to the original in full.