When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, we have got to get up and dance. We are still dancing.”¹
Charles Prince, Citigroup CEO, March 17, 2010

Too often this phrase has been taken out of context by the media and, unfortunately for Charles Prince, it has come to epitomize the 2008 mortgage crisis. It had nothing to do with the unfolding mortgage crisis back in 2008 but, rather, his view on the leveraged lending business prior to the Global Financial Crisis. Presented below is the proper context that sets the record straight for Charles Prince:

“And what I was referring to was the leveraged lending business. And you will recall that I said … in the summer of 2007, the problem child focus in our corporate and banking business was on leveraged lending … And the private equity firms had pushed the banks to the point where the terms and conditions of that lending were quite favorable to the private equity firms and were quite unfavorable for the banks … what I was trying to convey was the sense that for a number of reasons, it was impossible … for any one major participant on its own to stop doing those kinds of loans … So … I guess it was either unartfully phrased or too artfully phrased that as long as that situation obtained, as long as the music was playing, that you had to, you had to dance to that music.”

Global central banks’ easy monetary policies that flooded the financial markets with liquidity have pushed the yields and corporate defaults to a nadir, forcing investors to heed the siren song of higher yielding private debt strategies. Exhibit 1 demonstrates what a benign environment it has been for both the investment-grade and speculative-grade credits: the IG credit witnessed no corporate defaults for the past four years; for the same period, B-rated credits² averaged 1.2% in defaults. But, eventually, the music will stop, in terms of liquidity, and things will get complicated for private debt strategies.

Annual issuer-weighted corporate default rates by letter rating, 1920-2018

Source: Moody’s Investors Service

A recent Institutional Investor survey of health care plan sponsors indicated the following troubling asset allocation trends for the next 12 months:

• Approximately 44% expected to increase while 56% expected to retain their allocations to private credit.
• Approximately 89% expected to retain while 11% expected to decrease their allocations to middle market lending.

Different from Charles Prince, health care plan sponsors do not have to continue dancing to that music even if others continue to do so.

1. Financial Crisis Inquiry Commission Interview of Charles O. Prince. March 17, 2010.
2. Single-B used as a proxy credit rating for private debt.