Private Credit Fears Are Spreading. Here's Why KKR Might Be Built to Handle Them.

The private credit market had been a boon for alternative investment firms. KKR (NYSE: KKR) and others raised billions of dollars from investors, which they then invested in private loans. However, the private credit sector has come under pressure over the past year due to high-profile bankruptcies and growing concerns that AI will disrupt software companies, leading to a surge in defaults.

That has investors on edge. They're flooding private credit fund sponsors with redemption requests, forcing these firms to restrict withdrawals. While the sector's growing issues are a concern for KKR, here's why the leading alternative investment manager appears to be in a strong position to weather this storm.

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Not all private credit is the same

There are many misconceptions about private credit. The sector has grown over the last decade due to a combination of rising industry capital needs and traditional lenders pulling back amid rising regulations and capital requirements. This growing gap opened the door for alternative capital providers to underwrite loans for these borrowers.

At the core, private credit is simply a senior loan to asset owners and businesses in return for a prioritized, fixed-income return. The sector's issues all boil down to the lender. Some private credit lenders have looser underwriting standards, while others are stricter. Similarly, some lenders make loans based on a borrower's income, while others make only collateralized loans. A conservative lender making collateralized loans is taking on significantly less default risk than one making unsecured loans based on the borrower's current ability to repay.

Built to mitigate risk

KKR has been investing in private credit for more than 20 years. The global investment firm had $293 billion in credit assets under management (AUM) at the end of the first quarter. However, alternative credit is only $149 billion in its AUM, and direct lending is a mere $39 billion of that amount (which includes loans made by its public and private business development companies (BDCs)). As a result, private credit accounts for a fraction of its total AUM of $758 billion. Further, the company focuses on making lower-risk loans, including senior-secured, first-lien direct lending and collateralized ABF (Asset Backed Financing) loans. KKR has also been very disciplined in its underwriting and diversifies across industries (software is just 5% of its credit portfolio).

The global investment firm's strategy has yielded exceptional results. Every single one of its current vintage of funds is delivering returns that significantly exceed their respective benchmarks. That track record of success is attracting more capital to its funds, even as investors withdraw from other funds. KKR's CFO, Rob Lewin, noted on the first quarter conference call that it was one of its larger quarters for credit inflows, driven by its ABF business.

A compelling opportunity worth capitalizing on

KKR's stock price has lost more than a third of its value over the past year due to concerns about private credit, even though it's a small yet sound part of the business. Meanwhile, KKR is more than an asset manager as it also has a leading insurance franchise (Global Atlantic) and a growing portfolio of strategic holdings. These businesses generated $4.6 billion of adjusted net income over the last 12 months, with only a small portion coming from direct lending. Given its low exposure to private credit (and high-quality operations), KKR's sell-off is a great buying opportunity.

Matt DiLallo has positions in KKR. The Motley Fool has positions in and recommends KKR. The Motley Fool has a disclosure policy.