The Looming Debt Ceiling: A Case for Private Credit

In the world of finance and economics, few topics can stir up as much debate and concern as the looming debt ceiling. With the United States' national debt reaching unprecedented levels, it's a critical issue that demands attention. However, amidst the gloom and doom of mounting debt, there's an alternative avenue that investors can explore: private credit. In this blog, we'll delve into the significance of the looming debt ceiling and discuss how private credit investments can provide a silver lining amid these fiscal uncertainties.

The Debt Ceiling Explained

Before we dive into private credit, let's clarify what the debt ceiling is and why it's a matter of concern. The debt ceiling is a statutory limit set by Congress on the amount of debt the U.S. government can incur. When the government spends more money than it collects in revenue (a common occurrence), it borrows money by issuing Treasury bonds to cover the deficit. However, the debt ceiling places a cap on this borrowing, and once that cap is reached, the government cannot issue more debt to meet its obligations.

The prior debt ceiling was $31.4 trillion.  Since not everyone is gifted at math, let's pause for minute to reflect on this number.  Let's say you woke up one morning and realized you had an unknown trillionaire Uncle that passed away and left you a trust that would pay you $1 per second for the rest of your life.  This is an absolute windfall and you and your family would never have to work again the rest of your life.  You would be earning a cool $1 million for every 11 1/2 days that you stay alive.  Not bad, but how long would it take to earn $1 trillion or even $1 billion?

If you can last another 31.7 years, you would have earned $1 billion - a massive fortune indeed.  But there is no anti-aging program in the world that will keep you alive long enough to see $1 trillion as that will take over 31,709 years to achieve.  And the prior debt ceiling was $31.4 trillion!  Until last week when the Congress agreed to "suspend" the debt ceiling by increasing defense spending to $886 billion while keeping a lid on non-defense spending.  There are no budget caps after 2025 (but no worries, I'm sure they will all work it out lol).

The Benefits of Investing in Private Credit

Now, let's explore how private credit investments can offer a unique advantage in these uncertain times:

  1. Diversification:  Private credit investments provide diversification benefits to investors. Unlike public equities and bonds, which are often correlated with broader market movements, private credit investments can be relatively insulated from stock market volatility. This diversification helps mitigate risk in a portfolio.
  2. Steady Income:  Private credit investments typically offer steady income streams in the form of interest payments. These payments are often fixed or tied to a benchmark, providing investors with a predictable source of income, even in uncertain economic environments.
  3. Low Correlation with Public Markets:  Private credit investments are less sensitive to the whims of public markets. They tend to have lower correlation with traditional asset classes like stocks and bonds, making them valuable for risk management and portfolio stability.
  4. Yield Potential:  Private credit investments can offer attractive yields, often exceeding those available in public markets. Over the long run, there will indeed be short periods (6 to 24 months) where any investment in the world will underperform, but a very well managed private credit fund will usually outperform treasuries and corporate bonds over most rolling 36–60-month periods.

  5. Direct Lending:  Private credit allows you to become a lender, cutting out intermediaries and potentially earning a higher return on your investment.

It's important to note that private credit investments come with their own set of risks, including default risk and illiquidity. Due diligence and careful consideration of your risk tolerance are essential when venturing into this asset class.

Achieving long term investment success in any asset class is not easy and to properly manage risk, it can be quite time consuming and complex.  One alternative is to invest in a diversified and professionally managed private credit fund.  Be sure to conduct thorough research and do your due diligence, though.

Is the fund manager registered with the SEC?  How much experience does the fund manager have? Have they navigated economic downturns and stressed markets in the past?  How long is the track record?  How does the performance look (terrible, too good to be true, or good but realistic)?  Is there any leverage (borrowing money to increase risk and potential return)? What is the Sharpe ratio and standard deviation (to measure the amount of risk taken to achieve the returns)?  How is the portfolio valued? The last question is very important as an improperly valued portfolio can blindside you with unexpected losses in the future (the institutional gold standard is Discount Cash Flow valuation methodology valued by a 3rd party valuation agent).

About Prime Meridian

Prime Meridian Capital Management is an SEC registered Private Credit investment management firm specializing in consumer, real estate, small business loans, and secured credit facilities, as well as insurance assets, litigation finance and royalties. Prime Meridian has deep roots in the FinTech and Private Credit ecosystems. The firm has 23 counterparties, and the funds are valued monthly by a 3rd party valuation agent using a Discount Cash Flow (DCF) methodology.  Since inception the firm has funded over $1.7 billion in private credit assets.

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