Private Credit Is the Fuse, Insurance Companies Are the Bomb with Nick Nemeth

Josh Brown (0:17)

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All right, you guys, we're going to learn something today. And maybe be scared out of our wits. Private credit is the fuse. The bomb is underneath the life insurance industry. That's my guest, Nick Nemeth, the author of Mispriced Assets on Substack, where he's been writing extensively about risks inside the private credit markets and the growing connection between those markets and the life insurance industry. Believe it or not, private credit is now a multi-trillion dollar asset class. The US life insurance industry sits on roughly $10 trillion of assets. And increasingly, those two worlds are intercepting with private credit moving onto insurance balance sheets. Nick, I'm so glad you're here to explain your ideas to the audience. Say hello for us.

Nick Nemeth (1:47)

What's up, Compound? Thanks for having me on Downtown.

Josh Brown (1:50)

All right. We're thrilled to see you. I think investors keep hearing about how there are, quote, how there are problems with private credit, right? So they hear it on TV all day. They read about it in The Wall Street Journal and in Bloomberg. I think because it grew so fast, and maybe one of the major concerns is that any time something grows as quickly as this has, it sort of sneaks up on people. And then when they hear that there is maybe shortcuts in the way money was raised, maybe miscommunications, whether intentional or unintentional, between the primary conduits of that money being raised, in this case, it would be financial advisors and the wealth channel, etc., etc. Sometimes you just have like this general sense of unease, but people have trouble putting their finger on what the problems actually are. And that's what I hope we can do today. So we're going to start with the foundation of the private credit issues that you have identified. And then we'll get into what you say is the fuse that's triggering this financial crisis. And we're going to do this at the end, but just for people to understand, Nick has been writing furiously about this issue at Mispriced Assets, and I think has become one of the primary voices on this particular topic. So we're really getting in from the horse's mouth. So let's start at the foundation. You've argued that private credit returns look smoother than they really are because they're not marked to market, they're manager marked. So I would say that that is like the best place to start for an audience of investors and financial advisors. What is that problem?

And why is it a problem in the first place?

Nick Nemeth (3:39)

Well, people talk about volatility laundering for a long time on private equity and that's, you know, originally you got paid for the illiquidity and now it seems like that's more of a feature than a bug. So there's a lot of stuff that's been said before and then you have to kind of follow it to what it means. We've seen an asset grow from essentially nothing to multi-trillions. And whenever you have explosive growth, especially in credit, you have to worry about are the valuations correct?

And if the valuations aren't correct on the equity, you know, private equity, the majority of this asset class is just LBOs. So they're talking about LTVs, loan to value, how much of the total value is debt, and, you know, people are specifically talking about software. It's been well covered. Everyone says it's not systemic, and the further you look into it, you realize, okay, this is not central to the banking system. This is not huge on bank balance sheets, but it's still a huge issue.

Josh Brown (4:51)

Okay. So people are saying, so people like yourself are saying, look, you've got funds out there that are invested in hundreds, in some cases, thousands of individual credits. Many of these particular loans were loans made to an industry, the software industry, that is now under siege. We see this distress in the public equity markets every day. The stock market opens. Some of the largest SaaS software companies are trading down 10, 20, 30, even 40% from their highs, and there's this constant drumbeat of all of these companies are facing this disruption from AI, et cetera, et cetera. Now you're going a step further and you're saying, well, if the public equity markets look this way, then why do we feel good about the loans and the private credit side of this? Because it's the same companies or smaller companies. If we think Salesforce, for example, is in some degree of distress, what is a $50 million privately held software company's loan actually worth relative to what the lender is saying it's worth when they report to the credit investors? Is that the heart of that issue?