Morgan Stanley Just Told Investors: Your Money's Locked Up

Private credit was supposed to be built on patient capital. But when investors want out all at once, the structure changes fast.

Morgan Stanley capped redemptions. Blue Owl shut the door permanently. Other funds are hitting limits. Now JPMorgan has reportedly marked down the collateral tied to private credit loans — and that changes the entire game.

In this video, I break down why this is not just a one-fund story, why the good loans can get hit with the bad ones, and how a redemption wave can turn into a full-blown pricing feedback loop across a $3.5 trillion market.

If you want to understand what Wall Street may be underpricing in private credit right now, watch this one carefully.

Transcript

SPEAKER_00 0:00

The exits are closing in private credit, and JP Morgan, the largest bank in America, just quietly marked down the collateral holding this whole thing together. Morgan Stanley cap redemptions, Blue Owl shut the door permanently, Clifforder hit its limit. This is not a one-fund story. This is a feedback loop that has already started spinning. Okay, let's get started. But first, if you like this type of content, please click like and consider subscribing. It's really important to be in the know, and this is exactly how you do it. Okay, let me walk you through what is happening in private credit right now because the headlines are covering the symptoms and not the disease. This is a$3.5 trillion market. It was built on one core assumption patient capital. Investors put money in for the long term. Fund managers lend it out to companies. Everybody earns their yield and nobody panics, at least we hope not. That assumption is now being tested, and the test is not going too well. Yesterday, Morgan Stanley became the latest name to cap investor redemptions. The North Haven Private Income Fund, with nearly$7.6 billion in assets, returned$160 million to investors this quarter alone. Sounds like a big number until you run the math. Investors were asking for nearly 11% of shares outstanding. The fund honored about 46% of those requests. The rest denied, capped at 5%. Sorry, the exits are now full. So, folks, please remember remain seated on this one. Now, if that were isolated, maybe you could chalk it up to one bad fund having a bad quarter, but it's not isolated, not even close. Blue Al permanently halted redemptions at its OBDC2 fund last month, permanently after withdrawal requests surged. BlackRock hit the 5% quarterly cap at its flagship direct lending fund after redemptions spiked recently. Cliffwater, which runs a$33 billion private credit vehicle, capped its own redemptions at 7% after investors tried to pull a record 14% of shares in a single quarter. One after another, the gates are going up and it's getting pretty clear. Before we get into what's really happening underneath, let's walk through how the plumbing works. When you invest in a private credit fund, your money doesn't sit in a vault waiting for you somewhere. It gets lent out directly to companies pretty much right away, mostly middle market firms, software companies, healthcare operators, basically businesses that cannot or don't want to go through traditional bank lending. These aren't publicly traded bonds that you can sell by just hitting the sell button on your app. These are bespoke loans, illiquid by design. And the fund manager will tell you up front the illiquidity premium is why you get so much high yield on these things. Basic finance. And guys, we know how this works, but here is what the brochures are not really saying. When too many investors want their money back at the same time, the fund has to choose between selling those loans at a steep discount or telling investors to wait. In normal times, nobody notices the quarterly gate. In abnormal times, that gate becomes a prison wall. Here's the layer that most people are completely missing. JP Morgan. JP Morgan is the largest bank in America. It just marked down the value of loans it holds as collateral from private credit firms. Listen to that again. Listen to it again. They just marked down loans that it holds as collateral from private credit firms. Hmm. These are the loans that private credit managers use as collateral to borrow more money from the bank. That's why I read it twice in what is called back leverage. Leverage on top of leverage, that doesn't sound too good, does it? Well, it's really not. Only if things are going well, it goes well. Listen, when JP Morgan marks down that collateral, it reduces how much private credit firms can borrow. In some cases, it forces them to post more collateral. Jamie Diamond reportedly told investors last week that the bank was being more prudent in lending against software assets. And one JP Morgan executive was quoted saying that he was shocked that people are shocked. That is Wall Street for we saw this train recoming and we already got off the tracks. Okay. The question is whether everyone else can move fast enough to do the same thing. Now, let me break this down into three buckets because not every borrower in private credit is the same story. Bucket one are the good companies. These are borrowers that are doing fine. Revenue is growing, cash flow covers interest payments, the business model is intact and they'll be fine as long as redemption wave does not force fund managers to sell performing loans at distressed prices just to generate cash. That is the cruel irony of the liquidity crisis. The good assets get liquidated alongside the bad ones, not because the credit deteriorated, but because the funds need the cash. If you've ever watched a fire sale, you know that the Rolex goes out the door at the same discount as the knockoff. Actually, Rolexes are never on sale, but it was a pretty good analogy when I wrote it. Bucket number two is the bad company bucket. Credits that were already in trouble before the redemption wave. Maybe the business model was eroding. Maybe AI started eating their lunch. And that's the big one right now. Bloomberg reported that filings from seven major credit private credit firms showed at least 250 software investments worth more than 9 billion bucks that had been quietly recategorized under different sectors and fund filings, mislabeled as retailers, healthcare companies, food producers, raising serious questions about whether the true exposure to AI disruption risk is even being properly disclosed. These are the loans that JP Morgan is marking down. These are the credit fund managers we're quietly planning to work out over time, restructuring here, write down a little there, maybe merge two portfolio companies and hope that nobody looks too closely at the math. Now, in normal times, that playbook works. It's pretty normal. In normal times, nobody's pounding on the door demanding their money back. Now, let's get to bucket number three. Bucket number three is the one that should keep you up at night. It certainly keeps me up at night. Those are companies that are on life support. They're not dead, not exactly thriving either, making interest payments barely, often through what are called pick toggles. PIC stands for payment in kind, which means the interest isn't paid in cash. It's paid in get this, more debt. The DOJ has reportedly issued warnings about what they are calling shadow defaults. Restructuring is dressed up as creative accounting that let everyone pretend that the loan is actually performing when it really is just a zombie. Shadow default rates were nearly three times their 2021 levels by late last year. And that trend hasn't reversed. Left alone, most of these companies would probably survive. Time heals a lot of wounds in the credit markets, but the redemption wave is not giving them time. When a fund manager has to sell assets to meet withdrawal requests, the life support patients are the first, unfortunately, to get unplugged. Too weak to fetch a good price, too expensive to carry on the books when you're scrambling for liquidity. And that is where the real mayhem starts because one force sale becomes a pricing benchmark. And that benchmark reprices every other similar loan across the entire industry. Suddenly, what was a manageable situation for 20 different funds becomes a mark-to-market reckoning that nobody budgeted for. More redemptions lead to more force sales. More forced sales lead to lower marks. Lower marks lead to more redemptions. Can you see it? It's a feedback loop. And once it starts spinning, it's very, very hard to stop. Private credit is not inherently broken. At its core, it fills a real important need. Companies need capital. Banks have pulled back. Private lenders stepped in. That's how the market works. The problem is what happens when an instrument designed to be held to maturity has to be liquidated midstream because investors lost confidence. And confidence, once lost, has a funny way of accelerating the very outcome everyone was afraid of. A$3.5 trillion market built on the assumption of patient capital is now essentially being stress tested by impatient investors, declining software valuations, a war in the Middle East, driving up energy costs and squeezing margins, and a Federal Reserve that cannot cut rates to bail anyone out because inflation is still above target. The Fed is pretty much stuck. The fund managers are also pretty much stuck. And the investors who want their money back are also stuck behind a gate that says 5% per quarter. Best of luck there. So your truth bomb for today is this when the patient capital becomes impatient, the force sales don't just hit the bad loans, they benchmark the good ones too. And a$3.5 trillion market already under pressure from AI, a war, and a Fed that can't flinch, the benchmark becomes the match. Join me every single day for Wall Street Truth Bombs, where I drop them right here before the market figures them out.