Speaker 1: Hello, Welcome to the Credit Edge, a weekly markets podcast.
Speaker 1: My name is James Crumbie. I'm a senior editor at Bloomberg.
Speaker 1: This week, we're very pleased to welcome Randy Schwimmer, vice
Speaker 1: chairman at Churchill Asset Management.
Speaker 2: How are you, Randy, James. It's great to be with you.
Speaker 1: Thank you so much for joining us today. We're very
Speaker 1: excited to hear your views. Also delighted to have back
Speaker 1: on the show as a co host. Mike Holland with
Speaker 1: Bloomberg Intelligence.
Speaker 3: Hello, Mike, Hey, James, thanks for having me.
Speaker 2: Welcome Randy, Mike. Great be with you.
Speaker 1: Thank you so Just to set the scene of it here,
Speaker 1: credit markets appear very calm and invests a long risk
Speaker 1: going into US election that some analysts say could be
Speaker 1: ruinous for the economy. It seems that there's a bit
Speaker 1: of complacency plus more demand than supply. Private debt has
Speaker 1: experienced a meteoric rise over the last few years. It's
Speaker 1: now a one point seven trillion dollar market, but it
Speaker 1: could well be worth tens of trillions of dollars when
Speaker 1: you wrap in all of the asset based finance. That
Speaker 1: looks like the next big wave rate cut expectations are
Speaker 1: being dialed down as the US economy stays hot. That
Speaker 1: will boost the appeal to investors of loans to companies
Speaker 1: which are floating so they pay more if treasury yields
Speaker 1: stay high. On the other hand, there are plenty of risks.
Speaker 1: Private credit critics worry about extremely fast growth and lack
Speaker 1: of transparency. Large portfolio managers like Pimco tell us that
Speaker 1: there's just not enough of a pickup in returns to
Speaker 1: make direct lending more appealing than public bond markets, which
Speaker 1: are also offering very high yields, and bonds are a
Speaker 1: lot easier to trade. At the same time, we're seeing
Speaker 1: more signs of private credit stress in the form of amendments,
Speaker 1: extensions and increasing number of loans being repaid with more debt,
Speaker 1: plus a rise in defaults. Regulators are also looking at
Speaker 1: the industry amid concerns any big blow up in private
Speaker 1: credit would hit banks which lend to private credit managers,
Speaker 1: and there are fears that yield chasing retail investors could
Speaker 1: get hurt. Some fear of major reckoning as too much
Speaker 1: money chases too few deals. As talk of the golden
Speaker 1: age in private credit continues and in the background, we
Speaker 1: have a lot of geopolitical risk and the threat of
Speaker 1: inflation and recession hasn't really gone out of the narrative
Speaker 1: at all. So a major downturn in the economy would
Speaker 1: obviously cause more distress in credit markets. Let's start there, Randy,
Speaker 1: what's your take? Is private credit still the place to be?
Speaker 2: James? That is a laundry list of things. And I
Speaker 2: will say that having been in the business for almost
Speaker 2: forty five years now, and when I started, it didn't
Speaker 2: have the very dignified name of private credit. It was
Speaker 2: actually called middle market lending. And I was doing it
Speaker 2: in the backwater of JP Morgan's sort of regional offices,
Speaker 2: lending to medium sized companies that the regional banks and
Speaker 2: some finance company, but mostly the regional banks were servicing.
Speaker 2: And in those days, in the early eighties, you know,
Speaker 2: there wasn't a lot of leverage. Leverage was a later discovery,
Speaker 2: later invention. It was mostly these medium sized companies who
Speaker 2: didn't necessarily have access to the big desks on Wall Street.
Speaker 2: And but what happened over time, and by the way,
Speaker 2: it was a great business. It was a very sleepy business.
Speaker 2: Commercial ending was relatively low risk. You were secured by
Speaker 2: all the assets you had. Amortization actually you know remember
Speaker 2: those remember that term actually repaying principle over time and
Speaker 2: in financial tests. And what happened, you know, as the
Speaker 2: banks started to consolidate, and it wasn't just a regulatory issue,
Speaker 2: it was actually you know, smaller banks merging with larger banks.
Speaker 2: And so you know, the JP Morgan is actually the
Speaker 2: Chase Manhattan part of the JP Morgan enterprise that I
Speaker 2: was part of what got merged into for Chemical and
Speaker 2: then JP Morgan. And this happened across the country. So
Speaker 2: you had you know, tens of thousands of banks, you know,
Speaker 2: now just a few thousand. And what happened during that
Speaker 2: period is that these regional banks who were lending to
Speaker 2: those medium sized companies kind of went away. And in
Speaker 2: that same period, people realized that there was all of
Speaker 2: this capital that needed somehow to be accessed by somebody,
Speaker 2: and the private credit market was really given birth by
Speaker 2: finance companies like ge Capital is a perfect example, or
Speaker 2: hell Or Financial that started up businesses and Churchill had
Speaker 2: its roots, our business had had its roots in that
Speaker 2: back in the early two thousands, you know, as a
Speaker 2: private equity backed business that saw an opportunity to we
Speaker 2: were not necessarily starting something new, we were taking business
Speaker 2: from the banks that were jettising it. And that what
Speaker 2: I call the great migration of loans that went from
Speaker 2: the banks regulated environment to the non regulated, the non
Speaker 2: bank environment, which really started probably in the kind of
Speaker 2: late eighties early nineties, definitely accelerated during the Great Recession,
Speaker 2: and then in the last ten years has really, you know,
Speaker 2: kind of finalized to the point where very little of
Speaker 2: leverage loans are actually held by banks anymore, the vast
Speaker 2: majorities in the hand of non banks, and as you recall,
Speaker 2: in twenty twenty two and twenty three, the bank market
Speaker 2: for lending was non existent. So what's happened has really
Speaker 2: not been an overnight success. We've gone from private credit,
Speaker 2: has gone from the backwater when I started to nounce
Speaker 2: the beachfront, and it's the beachfront for many reasons which
Speaker 2: I look forward to talking to you about. But a
Speaker 2: lot of those reasons were really driven by many needs
Speaker 2: won by the regulatory agencies who were saying, we want
Speaker 2: to get this off the balance sheets of banks onto
Speaker 2: non regulated lenders who don't aren't carrying deposits for customers
Speaker 2: that we have to worry about, and private equity sponsors
Speaker 2: and frankly, medium sized businesses who people forget. You know,
Speaker 2: the middle market in the United States is a very
Speaker 2: you know, it's a job creation engine. Half of the
Speaker 2: jobs that are created in the United States are coming
Speaker 2: from that middle market, and so financing those businesses is
Speaker 2: pretty critical to the healthy of the economy. If you
Speaker 2: took all of the say three hundred thousand companies that
Speaker 2: are between say five million in revenues and a billion
Speaker 2: in revenues, it would equal the it would be the
Speaker 2: third largest GDP on the planet, Okay, behind China and
Speaker 2: head of Japan. That's a huge market. And so what's
Speaker 2: happening is private credit quote unquote, which is now what
Speaker 2: this new middle market is being called, is being asked
Speaker 2: to finance all of these opportunities because the banks aren't there.
Speaker 2: So I think that you know, it is it's not
Speaker 2: something that I think should be viewed with alarm, but
Speaker 2: you know, frankly, as a constructive thing for the economy
Speaker 2: and for the capital markets as a whole.
Speaker 3: It's interesting you put it that way. You know, I
Speaker 3: think as we look back over the arc of financial
Speaker 3: innovation and what happened in the eighties with the jump
Speaker 3: bonds and Michael Milkin and maybe in the late nineties
Speaker 3: with market value CDOs which didn't go so well, and
Speaker 3: then we had clos which actually really ramped up in
Speaker 3: the early aughts. You had this increase of capital available
Speaker 3: to companies, right, So there was an augmentation of credit
Speaker 3: availability through the new structures of those clos which survived
Speaker 3: really well right during the financial crisis. I mean there
Speaker 3: was maybe one or two that had I don't think
Speaker 3: there are any corporate clos that had a triple A
Speaker 3: that was impaired, right.
Speaker 2: Maybe or even double A.
Speaker 3: Even double A, right, So, but it provided a massive
Speaker 3: amount of capital for M and A and for acquisitions
Speaker 3: over those years. And I wonder what your perspective is
Speaker 3: on on this latest innovation. Will this create a more
Speaker 3: benign credit environment because we'll have fewer defaults? Is the
Speaker 3: is the business default cycle? The corporate default cycle? Declient
Speaker 3: is the top of that coming down a little bit.
Speaker 2: Yeah, James mentioned default rates, and that's a probably good
Speaker 2: place to start because one of the things that's different
Speaker 2: in the private markets than in the public markets is
Speaker 2: that handling troubled situations. And you and I had my
Speaker 2: co conversation before we started about the challenge of doing
Speaker 2: that in a public environment where you have investors or
Speaker 2: lenders or you know, vulture funds who come into these
Speaker 2: troubled situations at a discount, right, that's their job. They
Speaker 2: look at opportunities and they say, I'm going to buy
Speaker 2: into forty cents on the dollar, and their job is
Speaker 2: to get out at fifty cents on the dollar, sixty
Speaker 2: cents or more. Their job is not necessarily to get
Speaker 2: out of par whereas the direct lenders, the middle market
Speaker 2: lenders such as ourselves, you know, we're not in it
Speaker 2: to trade. We're in it to create growth and to
Speaker 2: create financing opportunities for investors, but also support our private
Speaker 2: equity clients. And so it's really a par market for us.
Speaker 2: And what we seek to do with our other lending
Speaker 2: partners is to create a situation where all the lenders
Speaker 2: are acting in an aligned manner to maintain value and
Speaker 2: preserve value, and if there's a problem with the company,
Speaker 2: to extract value out of that and the beauty of
Speaker 2: that in this in the middle market, by that, I
Speaker 2: mean companies whose financings are say one hundred million to
Speaker 2: five hundred million on average, that the lenders are all
Speaker 2: there to make sure that they can get out of
Speaker 2: this with their money back. Because in the credit market,
Speaker 2: it's not about the you know, an equity gain. It's
Speaker 2: not about you know, making money beyond the private the
Speaker 2: principal and interest that you're getting back. Your your job
Speaker 2: is to you know, get your money back with your
Speaker 2: interest in fees and that's it. And so you're not
Speaker 2: trying to do anything heroic. However, Mike, as you mentioned,
Speaker 2: in a sophisticated market that has technology surrounding it, there
Speaker 2: are many opportunities to create both kind of a syndicated
Speaker 2: similar to the COLO market, a syndicated product that allows
Speaker 2: investors to pick and choose among tranches depending on risk
Speaker 2: and return. The even syndicating within a private credit context.
Speaker 2: You know, liquidity trading within a private credit context is
Speaker 2: probably the next generation, and I think we're seeing that developing.
Speaker 1: It's kind of exciting, but also it's kind of assumes
Speaker 1: that you know, you're always doing the right sort of deals,
Speaker 1: You're always doing the diligence to pick the right sort
Speaker 1: of companies to see that there is some value We've
Speaker 1: had guests on this show over the last few months
Speaker 1: talking about the massive opportunity but also flagging the potential
Speaker 1: risks of what they have called tourists coming in who
Speaker 1: maybe aren't so sophisticated, not have such a long track
Speaker 1: record as you do, doing you know, quote unquote the
Speaker 1: wrong kind of deals which can go bad. Maybe there
Speaker 1: isn't the value there that people have ascribed to it
Speaker 1: going in. Do you think that there's more of that
Speaker 1: kind of activity now because there's so much demand for
Speaker 1: this product.
Speaker 2: Yeah, and it's so hard in this market as everyone
Speaker 2: has scaled, you know, and you've seen that happen, and
Speaker 2: I think commentators have talked about the growing dispersion of managers,
Speaker 2: and I think we're going to see that going forward.
Speaker 2: Scale really matters now. And if you come into this
Speaker 2: market today as a new entrant with no track record,
Speaker 2: I think it's really really hard to raise money. And
Speaker 2: if it's hard to raise money, then what that means
Speaker 2: is that you're probably going to be more of a
Speaker 2: you know, small desk that's looking for very specialized opportunities
Speaker 2: and those are really tricky. And I think that the
Speaker 2: beauty of where we are, which is very mainstream, very
Speaker 2: traditional middle market. These are companies that are like I say,
Speaker 2: you know, medium sized businesses, not upper middle market, not
Speaker 2: the broadly indicated market, and not in this in the
Speaker 2: small cap market, but businesses where you have enough scale
Speaker 2: so that private equity sponsors can create growth and can
Speaker 2: start with a platform business and then add on to
Speaker 2: create value for their shareholders, but not so large that
Speaker 2: you get into the large market where you start to
Speaker 2: see more of the excesses in terms of you know,
Speaker 2: what we see in the broadly syndicated market, what we
Speaker 2: see in the bond market, you know, covenant light, some
Speaker 2: of the you know, idiosyncrasies with collateral packages and trading
Speaker 2: value in and out of companies, and so it tends
Speaker 2: to be much more of a conservative playground. And I
Speaker 2: think if you stick to your knitting, you know, you
Speaker 2: can avoid some of the big problems that we've seen
Speaker 2: in other situations.
Speaker 1: But I'd say there is that potential for access is
Speaker 1: in the larger parts of the loan market and coding
Speaker 1: private credit. We were hearing, you know, some time ago
Speaker 1: that this was probably going to spread to the middle
Speaker 1: market in terms of you know, week of covenance, West pricing,
Speaker 1: west protections, all that stuff. Would you say right now
Speaker 1: that that's not the case, that they still better, you know,
Speaker 1: lenders market for the middle market than the broadly syndicator.
Speaker 2: It hasn't, and it's been a bit of a surprise,
Speaker 2: but in part the classic traditional middle market is inhabited
Speaker 2: by lenders such as ourselves that have long relationships with
Speaker 2: these private equity companies. So just to give you a
Speaker 2: little sense we have as part of our kind of SEP.
Speaker 2: You know, the thing that makes us different from the
Speaker 2: competition is we have about three hundred relationships as an
Speaker 2: LP as a limited partner and investor in three hundred
Speaker 2: different private equity sponsors. They're probably the krem de la
Speaker 2: creme of the middle market in North America out of
Speaker 2: probably you know, over twenty twenty five hundred maybe overall
Speaker 2: private equity sponsors. So we're in the sort of top
Speaker 2: tier as an LP and on their on their advisory boards,
Speaker 2: and so we have a special relationship really as a
Speaker 2: client as an investor to these sponsors. And when you're
Speaker 2: when you're in that relationship, you're getting all of their
Speaker 2: deal flow, and then you can be selective from that
Speaker 2: deal flow. So it's kind of like credentialed pipeline that's
Speaker 2: coming at you. We get about a thousand deals a
Speaker 2: year in our senior pipeline, and we end up getting
Speaker 2: about fifty or sixty that we like. So that's a
Speaker 2: pretty selective ratio. And so not only picking from the
Speaker 2: best of the sponsors, we're also picking the best industries
Speaker 2: that we like over over cycles that are going to
Speaker 2: be you know, created with all weather portfolio. But also
Speaker 2: then in the best industries, what are the best companies,
Speaker 2: what are the survivors, what are the businesses that really
Speaker 2: will be able to exist no matter what cycle or
Speaker 2: what rate environment you're in. So you end up with
Speaker 2: a sort of I think kind of I call it
Speaker 2: a triple filtered portfolio, which you can't get anywhere else.
Speaker 2: And so if you look at the way that we've
Speaker 2: constructed our business, it's very hard to come from the
Speaker 2: outside as a new entrant with no track record and
Speaker 2: try to get that relationship with that private ecory sponsor,
Speaker 2: build up the trust that you need in order to
Speaker 2: develop that relationship. Because in this market where you're actually
Speaker 2: financing these businesses that are hard won, I mean the
Speaker 2: auctions and the purchase base multiples is still relatively high
Speaker 2: for good companies. The sponsor is not going to hand
Speaker 2: over their keys to a lender that they don't trust.
Speaker 2: So that's why it's hard to break in.
Speaker 3: Going to back to the regulatory side for a little
Speaker 3: bit with the focus on the banks and you know,
Speaker 3: having been at Credit Swiss when they were going through
Speaker 3: leverage lending guidelines and you know, being told by the
Speaker 3: OCC and the FED that you can't model this company
Speaker 3: out to six times.
Speaker 2: We had a lot of rules.
Speaker 3: I did a lot of work that was sent to
Speaker 3: them basically telling them about our leverage lending position, which
Speaker 3: I thought was really interesting. Since that time, the bank
Speaker 3: is no longer really doing that anymore. It's had its
Speaker 3: own issues and it's you know, it's kind of progressed.
Speaker 3: I wonder, you know, also as a healthcare analyst, looking
Speaker 3: at what the way the regulators look at private equity
Speaker 3: right now, you know, how does how do you envision
Speaker 3: the regulators putting in place a regime that would monitor
Speaker 3: and really be able to keep track of these loans
Speaker 3: that are out there, and would they go down to
Speaker 3: that certain level of looking at like you know, leverage,
Speaker 3: you know, over a specific time frame, you know.
Speaker 2: Yeah, well it's hard to predict what they will do,
Speaker 2: but and they're certainly aware of it, right, I think
Speaker 2: that's pretty clear. I think it's it's probably a misnomer
Speaker 2: to say that we are in an unregulated market. I
Speaker 2: know that, you know, we are owned by an insurance
Speaker 2: company TIA and New Veen, who are you know, regulated
Speaker 2: by the SEC and by the Insurance Can Mission and
Speaker 2: so forth, So there's plenty of regulations around our business.
Speaker 2: I think the thing that that has been the big focus,
Speaker 2: and we saw that a year and a half ago
Speaker 2: with the you know, failure three key banks that what
Speaker 2: you know, the focus you know, is often on the
Speaker 2: depository community, right, and what happens when they don't realize
Speaker 2: that their bank is investing in or you know, playing
Speaker 2: in leverage loans. And in the case of those failures,
Speaker 2: you know, that was not an issue, right, Silicon Valley
Speaker 2: Bank was not involved in playing right, So it was
Speaker 2: a mismatch of assets and liabilities. And I think the
Speaker 2: beauty of the non bank world and what we discovered
Speaker 2: twenty years ago and when we started Churchill was that
Speaker 2: if you match your your assets, your long term assets
Speaker 2: with long term liabilities with investors in the institutional market,
Speaker 2: where you can go out and raise tenure money that
Speaker 2: matches the ten years of your assets, then you're locked
Speaker 2: in for a long period time. And the beauty of
Speaker 2: that is through the cycles we found that out going
Speaker 2: through the Great Recession, when we survived that through COVID,
Speaker 2: through the mini cycles that we've seen, is that having
Speaker 2: that match on the asset and liability side really creates
Speaker 2: real strength. And I think the issues that have come up,
Speaker 2: so for example, having defaults in the middle market that
Speaker 2: would migrate to the banks or migrate to the to
Speaker 2: the banking system, all of that I think has been
Speaker 2: really disproven. Nobody really seriously thinks that. I think that
Speaker 2: that middle market loans that are held in our case
Speaker 2: in a very diverse portfolio where no one name represents
Speaker 2: more than you know, one or two percent of the
Speaker 2: total portfolio, that if something goes wrong with one or two,
Speaker 2: or three or five of those names, that that's going
Speaker 2: to spread out through the system. I think the more
Speaker 2: and this is really the focus of what we do
Speaker 2: in our newsletter that you guys read, the Lead Left,
Speaker 2: which I've been publishing every week since March of two
Speaker 2: thousand and eight, we have about fifty thousand subscribers. And
Speaker 2: the thing that people tell me about it is that,
Speaker 2: you know, we tend to demestify and educate, which is
Speaker 2: really the goal of private credit, and the goal of
Speaker 2: these kinds of you know podcasts and the work that
Speaker 2: I do with your radio team is to get the
Speaker 2: word out for what private credit really is and what
Speaker 2: it isn't. And the only way that you can kind
Speaker 2: of tell is to talk to practitioners, because these are
Speaker 2: not public entities. There's no yet, there's no Bloomberg you
Speaker 2: know app that says, Okay, here's here's Churchill's you know portfolio.
Speaker 2: Now one day maybe we'll get there. But I think
Speaker 2: the understanding the differences between private markets and public markets,
Speaker 2: between liquidity and illiquidity, between correlation and non correlation, which
Speaker 2: is one of the things that's a real virtue of
Speaker 2: private credit that it does not trade when the rest
Speaker 2: of the market does. And one of the reasons that
Speaker 2: it has grown over the last fifteen years is that
Speaker 2: investors have seen, during periods of volatility, how the valuations
Speaker 2: of the loans that are held by lenders like Churchill
Speaker 2: and that they own don't move around in the same way,
Speaker 2: and so there's some comfort there. It doesn't mean that
Speaker 2: they're going to put all of their capital into private credit,
Speaker 2: but it means now that it's become really a core
Speaker 2: asset of their alternatives allocation.
Speaker 1: You've told to me, and you know, before we started
Speaker 1: recording this about the biggest misguided conclusions in private credit.
Speaker 1: Hopefully not too many of them on mine. I won't
Speaker 1: be offended if they are. But but can you expand
Speaker 1: a bit on that. What do you mean by that?
Speaker 2: Well, we talked about liquidity, right, and middle market loans
Speaker 2: are not liquid, right. You can't trade them. There's no
Speaker 2: real index, you can't call up even I mean, there
Speaker 2: are some larger direct lenders who will make a market,
Speaker 2: you know, in their own asset if they have the
Speaker 2: loan on their books. You know, they will work hard
Speaker 2: to find a buyer if you're a seller or vice versa.
Speaker 2: But they're not liquid in the sense that you the
Speaker 2: way the public markets are liquid. And I think it's
Speaker 2: import to know that because you know, as we start
Speaker 2: to go, you know, we get the retailization of private credit,
Speaker 2: that the understanding that these are really different types of assets.
Speaker 2: Then the public markets will help educate investors as to
Speaker 2: the you know, what's possible and what's not possible. So
Speaker 2: getting your money out instantly the way you can, you know,
Speaker 2: out of your you know, checking account is just it's
Speaker 2: not the same kind of thing. I think that. So
Speaker 2: liquidity is really important to understand. Along with that, I
Speaker 2: think is valuation. So one of the myths about private
Speaker 2: credit is that you know valuations because they're not public,
Speaker 2: are therefore suspect that is not true anymore than if
Speaker 2: you have a public valuation out there, that it is
Speaker 2: a real valuation. And I you know, Mike, like you've
Speaker 2: worked on a trading desk, and I know that if
Speaker 2: you know, I have a particular loan that's marked at
Speaker 2: a certain price, it doesn't mean that somebody calls me
Speaker 2: up can get it at that price. And so often
Speaker 2: it's just a a guess, an indication, you know, well,
Speaker 2: we think this is where it's going to trade. And
Speaker 2: as we also know, in times of high volatility, liquidity
Speaker 2: can evaporate, and when that happens, what you think is
Speaker 2: worth part can be worth far less. And we've seen
Speaker 2: in the public markets periods, and COVID was a perfect example,
Speaker 2: when you had this huge what I call an emotional
Speaker 2: discount in the values of loans in that period in
Speaker 2: March April of twenty twenty when you couldn't get a bit,
Speaker 2: and when that happens, their liquidity evaporates. And interestingly, in
Speaker 2: that same period, the valuations of private loans were very
Speaker 2: stable because they couldn't trade, they were sort of locked in.
Speaker 2: I think there's suspicion though, that not being able to
Speaker 2: trade means that there's uncertain value. And so the way
Speaker 2: that direct lenders have combated that is they have hired
Speaker 2: third party valuation experts. We have at least three separate,
Speaker 2: independent to companies who come in and value all of
Speaker 2: our three hundred loans every quarter. And when they do that,
Speaker 2: they're basically applying certain methodologies regarding the fundamental performance of
Speaker 2: those companies. They're also looking at the mark to market
Speaker 2: in the liquid market and saying, all right, if things
Speaker 2: are moving the liquid market, it probably will have some
Speaker 2: impact on medium sized loans, and then they make a
Speaker 2: determination based on the formula as to what that value is.
Speaker 2: And if you have three independent including your own Churchill
Speaker 2: led group that's doing those valuations, you're probably going to
Speaker 2: get a pretty good assessment of what that real value is.
Speaker 2: But if you're not an investor and you don't have
Speaker 2: access to that information, it's a little bit like you know,
Speaker 2: a helicopter above a factory. You don't really know what's
Speaker 2: going on to go inside.
Speaker 1: Right, So sort of underlying hard assets that what they're
Speaker 1: valued at, and all of that contributes to what the
Speaker 1: ultimate value of the loan is. It's not just like.
Speaker 2: The well it's it's in our case it's mostly cash flows.
Speaker 2: Cash flows repay debt because you know, they're not the assets.
Speaker 2: But and really what happens in the real world is
Speaker 2: that as these companies perform, you keep track and all
Speaker 2: the good direct lenders have teams dozens of people in
Speaker 2: our case who track these loans on a monthly basis,
Speaker 2: and and if they go off their budget, you you know,
Speaker 2: rate them lower. If they're higher than budget, you rate
Speaker 2: them higher, and you track them and if they're if
Speaker 2: they go off performance. And this goes back to sort
Speaker 2: of the the third myth, which is defaults. You know,
Speaker 2: the the the idea of having a default in a
Speaker 2: private credit deal is very, very different than in the
Speaker 2: large cap market. The large cat market. As we've talked about,
Speaker 2: there are no financial tests in the sense of being
Speaker 2: maintenance tests. They're in currence tests, which means that they're
Speaker 2: not measured until you actually, as a bar or, try
Speaker 2: to get more debt, and then they say, okay, what's
Speaker 2: the leverage. So if you don't raise me more debt,
Speaker 2: the performance of the company could deteriorate to zero and
Speaker 2: you wouldn't know it until your interest payment to faults.
Speaker 2: It's typically not the case in the market their financial tests,
Speaker 2: and so what happens is there are stops along the way.
Speaker 2: There's elevator stops along the way where you can assess, okay,
Speaker 2: how's the company doing now? And if you trigger those stops,
Speaker 2: then everybody gets to gather around the table and say,
Speaker 2: all right, what's going on to the private equity sponsor,
Speaker 2: what are you doing about it? How can we help you?
Speaker 2: And the stops along the way allow you to take
Speaker 2: steps that will modify or mitigate whatever's going on with
Speaker 2: these businesses. So the result of that historically has been,
Speaker 2: and there's long data that supports this, that defaults and
Speaker 2: losses in smaller companies is better than in the larger companies.
Speaker 2: For that very reason, lenders tend to cooperate in these
Speaker 2: medium sized businesses. And as I mentioned earlier, the desk
Speaker 2: mike that you were on, where you might take advantage
Speaker 2: of an opportunity. If you get out and force everybody
Speaker 2: else to get out seventy cents, then those people who
Speaker 2: got in at par kind of stuck. And so I
Speaker 2: think defaults have a very different dynamic in the middle market.
Speaker 2: And what we've seen in the last nine months has
Speaker 2: been the defaults for middle market companies have actually gone
Speaker 2: down this year, which is surprising given the high rate
Speaker 2: environment that we're in, but it's an indication that for
Speaker 2: experienced investors and lenders like ourselves, we have a playbook
Speaker 2: that we've been using for a long time.
Speaker 1: And do you think that holds despite all of this competition,
Speaker 1: all of this money coming in, all this new money
Speaker 1: coming in, that you think these god rails, these stuffs
Speaker 1: will not be eroded.
Speaker 2: So there's two issues. One is and we'll talk about
Speaker 2: the money coming in separately, but one is the hot
Speaker 2: Let's take the high rate environment that we're in. I
Speaker 2: don't think that rates are going to be going down
Speaker 2: as swiftly as some I think that the strength in
Speaker 2: the economy, which I don't know about you two, but
Speaker 2: has really surprised me that, in light of the fact
Speaker 2: that rates are so high and the FED is determined
Speaker 2: to keep inflation at bay, that the economy seems to
Speaker 2: be humme and along at a two and a half
Speaker 2: three percent clip. So they may be a little more
Speaker 2: careful about dropping rates quickly to not ignite inflation. And
Speaker 2: if that happens, we're going to be in a high
Speaker 2: rate regime longer than we think, which means that the
Speaker 2: portfolios that people have out there with benchmarks that are
Speaker 2: at five percent are going to have to endure that
Speaker 2: because that's if you add this loan spreads on top
Speaker 2: of that, that's a you know, ten eleven, twelve percent
Speaker 2: cost of capital. Now, if you've already, as we do,
Speaker 2: you know, assume that those rates are going to be
Speaker 2: higher for longer, you've probably inoculated your portfolio against trouble.
Speaker 2: But for those who have not, or have overlevered companies
Speaker 2: and now suffering from result, that's where you're going to
Speaker 2: see the issue, not from necessarily competition come in coming in.
Speaker 2: I think where the competition element, which is I think
Speaker 2: a really good one, because it's always coming up as
Speaker 2: an issue in private credit. But if you look overall,
Speaker 2: there are plenty of people who are doing different things,
Speaker 2: and that's really I think part of the understanding that
Speaker 2: hopefully I can get across here in our newsletters is
Speaker 2: that private credit is a big tent. And in fact,
Speaker 2: direct lending, which is really the sub specialty that we inhabit,
Speaker 2: is maybe fifty percent of the trillion and seven that's
Speaker 2: in the asset class. The rest is comprised of special situations,
Speaker 2: you know, it's subdebt, junior capital workout, asset based lending,
Speaker 2: venture debt.
Speaker 3: I had a question just you know, you're talking about
Speaker 3: rates for higher for longer. There's been a pivot in
Speaker 3: the last couple of weeks, pretty hard, right, So since
Speaker 3: since the eighteenth of September the fifty a half point cut,
Speaker 3: you know, treasuries have kind of gapped out by about
Speaker 3: seventy seventy basis points across the curve except for the
Speaker 3: front end, and the front end obviously is inverted, but
Speaker 3: you've seen the frontend come in a little bit. I
Speaker 3: think going forward, what's your expectation on SOFA how that
Speaker 3: impacts your portfolio companies. You know, if they're getting sofa
Speaker 3: plus five hundred plus four hundred, you getting eleven percent?
Speaker 3: Are you modeling twelve thirteen percent? Are you keeping it static?
Speaker 3: And the other question too, I would have is follow
Speaker 3: on that is, if rates do continue to elevate, can
Speaker 3: you singularly modify your agreement? So could you change the
Speaker 3: margin on one of your loans who won the companies
Speaker 3: you're in your direct lending portfolio?
Speaker 2: So that's an easy one, typically not in a normal situation.
Speaker 2: Pricing is one of those things that you know you
Speaker 2: need the cooperation of the bar and the other lenders.
Speaker 2: But your other question is a good one because we're
Speaker 2: in a very interesting rate environment right now. And I
Speaker 2: like to say that, and Mike, you being on the
Speaker 2: trading floor, you know this just as a regular thing
Speaker 2: of being a trader, that inflection points is where it's
Speaker 2: all at, right, because you can go along when rates
Speaker 2: are stable, the economy stable, expectations are stable. But when
Speaker 2: you come to the point you can kind of census
Speaker 2: if you've been around long enough, when things are going
Speaker 2: to change, right, rates are going to go uprates are
Speaker 2: going to go down. Something different is going to happen
Speaker 2: and what you do when that happens is, if you've
Speaker 2: had enough experience, is you look at look around you,
Speaker 2: and you say, what do I need to do, if anything,
Speaker 2: to change what I'm doing. The beautiful part about private credit,
Speaker 2: if you've been doing it long enough, is that you
Speaker 2: expect inflection points at any time. So for example, in
Speaker 2: twenty twenty, actually in late twenty nineteen, you remember that
Speaker 2: everybody was calling for some sort of recession, right, nobody
Speaker 2: knew when it was going to happen, And I was
Speaker 2: asked it may have been on Bloomberg, you know, whether
Speaker 2: I thought that we were going to head into or
Speaker 2: and I had been I was always wrong. I was
Speaker 2: to think we were. Yes, I said, you know, I'm
Speaker 2: always wrong, but maybe this time I'm right, and maybe
Speaker 2: maybe we will head into recession. Well I was right,
Speaker 2: but for the wrong reasons, because three months later we
Speaker 2: had COVID. But what we in our portfolio had done
Speaker 2: and have been doing since two thousand and six is
Speaker 2: expect a recession in the next twelve months. So when
Speaker 2: we look at alone, we assume that the performance of
Speaker 2: that company is going to go down twenty percent. Revenues
Speaker 2: and cash flow. The following year, and let's see how
Speaker 2: the company does in that environment. We also with rates,
Speaker 2: expect rates to be generally in the forward curve, except
Speaker 2: recently we basically said, okay, we just think it's going
Speaker 2: to be five percent flat. We don't think it's going
Speaker 2: to come down, because what if it doesn't. And so
Speaker 2: what we do is we model those two things a
Speaker 2: recession and a high rate environment, and if the company's
Speaker 2: performance in that projection doesn't cover interest with a cushion,
Speaker 2: we're not going to do the deal. So we actually
Speaker 2: don't care where rates go or whether they're you know,
Speaker 2: what's going to happen with the economy when we pick
Speaker 2: a company. And I talked about the private equity sponsors
Speaker 2: who are trafficking in business services or healthcare or defensive
Speaker 2: sectors that we've learned over time to be playing in
Speaker 2: and not to do more cyclical consumer facing commodity, gaming,
Speaker 2: real estate, and energy, because then if you do hit
Speaker 2: a cycle, those industries tend to do worse. So in
Speaker 2: the more defensive sectors, we feel more comfortable that no
Speaker 2: matter what happens, we're going to be okay. And over
Speaker 2: time we've actually learned to be alert to some private
Speaker 2: equity sponsors who are picking areas. So for example, right now,
Speaker 2: just to pick some interesting ones. Measuring equipment, which is,
Speaker 2: you know, when you have an economy which is generally flat,
Speaker 2: maybe slight growth, companies are looking to improve their performance
Speaker 2: and production lines and so forth. Manufacturaturing facilities, measuring equipment
Speaker 2: all of a sudden has become super important, particularly with
Speaker 2: AI as a guiding technological factor, which help companies do
Speaker 2: things that they couldn't do before. Environmental consulting and engineering companies.
Speaker 2: It's a big area of concern. People are very focused
Speaker 2: on it, big area of growth. Accounting services sounds pretty mundane,
Speaker 2: pretty simple, but we've seen with even some very large
Speaker 2: private equity firms who have been buying large accounting services. Again,
Speaker 2: these are businesses that tend to do well. You owe
Speaker 2: taxes no matter what the rate cycle is, and so
Speaker 2: these are the kinds of areas that sponsors are buying
Speaker 2: and selling. And we find that if we play in
Speaker 2: those areas, regardless of where the rate cycle the economics
Speaker 2: app is going to be, we're going to be okay.
Speaker 2: So at the end of the day, looking at your
Speaker 2: rate scenario, mic, I think we're probably you know, indefferent,
Speaker 2: but we do think that we're going to be higher
Speaker 2: for a lot longer, more than most people think.
Speaker 3: You're on the funding side of the BDCSS permanent capital, right,
Speaker 3: but you know with celos, you have got you've got
Speaker 3: you know so far on both sides, and it kind
Speaker 3: of passes through. How does the how does middle market lending?
Speaker 3: How do BDC's what's their exposure to changes in rates?
Speaker 2: So, yeah, one of the lessons that we and other
Speaker 2: direct lenders learned a long time ago, particularly through the
Speaker 2: Great Recession, was to have a multitude and a variety
Speaker 2: of financing sources, So don't just have one line of
Speaker 2: credit with a bank, but have multiple financing sources and
Speaker 2: also frankly in the form of structures of funds. So
Speaker 2: you mentioned BDC's. We have I think over fifty types
Speaker 2: of fund structures at Churchill, both from our senior and
Speaker 2: junior capital businesses. We have an entire group a team
Speaker 2: that does fund finance, that is responsible for the care
Speaker 2: and feeding of those vehicles for or leverage in those vehicles.
Speaker 2: We utilize and I think you mentioned this earlier. You know,
Speaker 2: we utilize banks to help us with our capital and
Speaker 2: our leverage, so we make sure and all those are
Speaker 2: typically match funded to our assets. And I was asked
Speaker 2: this question by an investor. I didn't know the answer.
Speaker 2: I thought, I, did you know, do your your assets
Speaker 2: that flowers? Do your liabilities have flowers? The answers yes,
Speaker 2: So we're really match funded from that perspective, And that's
Speaker 2: a lesson learned and I think all the large scaled
Speaker 2: direct lenders have that.
Speaker 1: Let me ask you a really basic question, ready, what
Speaker 1: does middle market actually mean? And what does it mean
Speaker 1: in terms of deals? I mean a deal size deal
Speaker 1: ten of that's sort of thing that average you know, that's.
Speaker 2: A great question. So there's three middle markets. There's the
Speaker 2: lower middle market with companies that are say ten to
Speaker 2: fifteen million of cash flow and lower. There's the upper
Speaker 2: middle market there are one hundred million of yabadah and higher,
Speaker 2: and the traditional middle market, the middle middle market, which
Speaker 2: is between kind of twenty and one hundred of you.
Speaker 2: So those that translates to about one hundred million of
Speaker 2: financing to five hundred maybe a billion of financing an
Speaker 2: the average five years, five to seven year. It usually
Speaker 2: doesn't last that long. They usually get refinanced out. These
Speaker 2: are medium sized companies and the in general. These businesses
Speaker 2: are sourced by private equity firms. Not always there, they're
Speaker 2: lenders who have non sponsored and then they have their
Speaker 2: own sourcing mechanisms. But the beauty that we found of
Speaker 2: having private equities doing the sourcing for you is that
Speaker 2: they first of all, you only have to call on
Speaker 2: the private equity sponsors, not actually having hundreds of people
Speaker 2: in branches to actually traffic the United States. And you know,
Speaker 2: that's what I did when I was first in business,
Speaker 2: and it's a lot more efficient this way. So the
Speaker 2: other thing when you have a private equty sponsor that's
Speaker 2: sourcing deals for you, if you're investing in their funds
Speaker 2: is we are you kind of know what they're looking for,
Speaker 2: and they will tell you what their edge is, what
Speaker 2: is their angle, what do they like about this business
Speaker 2: that makes them think it's a good investment. And I
Speaker 2: mentioned some of the sectors that are attractive. One of
Speaker 2: the things that you learn by partnering with these private
Speaker 2: equity sponsors is that there are certain industries in the
Speaker 2: middle market, in these small regional areas where they can
Speaker 2: find a niche and build a platform, buy a business
Speaker 2: and then create acquisitions around it. Car washes, which sound
Speaker 2: very mundane, are opportunities like that for sponsors to be
Speaker 2: able to go into a local market find a car
Speaker 2: wash that's actually automated, right because they are now I
Speaker 2: mean literally there's only a couple of people working there automated.
Speaker 2: So you have high efficiencies, high cash lows. They're buying
Speaker 2: from the same vendors for their their soap and whatever
Speaker 2: else they're buying. And if you combine one, two, three, five,
Speaker 2: twelve in the region, all of a sudden, now you've
Speaker 2: got real scale in the business. The same is true
Speaker 2: of things like commercial landscapers. Guess what during COVID, commercial
Speaker 2: landscapers actually did okay. Why because even though the buildings
Speaker 2: were empty, the owners of the buildings wanted to keep
Speaker 2: things going right, and so they had to mow the lawn,
Speaker 2: trim the hedges, you know, plow the snow, and so
Speaker 2: commercial landscaping companies turned out to be very good defensive bets.
Speaker 2: So all of these areas in the middle market become
Speaker 2: have these niche leaders in businesses that tend to be
Speaker 2: very stable through economic cycles, and the beauty of what
Speaker 2: we're doing and what others are doing as well, is
Speaker 2: that being in the ground almost literally with these businesses
Speaker 2: tends to insulate us from the outside world. Meaning when
Speaker 2: you know, even though think about it, we've got two
Speaker 2: kind of rather global wars going on right now, America
Speaker 2: itself has been relatively unaffected by that, and so when
Speaker 2: investors look at a safe haven in the United States,
Speaker 2: they're looking for businesses that are not going to be impacted. Now,
Speaker 2: it's not to say that with three hundred thousand companies
Speaker 2: in the United States that somebody is not going to have,
Speaker 2: you know, some buying buying material from overseas or having
Speaker 2: sales center somewhere where you may be impacted by a war.
Speaker 2: But generally speaking, it's much more of a of a
Speaker 2: less correlated asset class as a result.
Speaker 1: But can you tell us about the price and about
Speaker 1: the returns? I mean, generally the investors like private credit
Speaker 1: because the returns are higher than in public markets because
Speaker 1: you're getting paid for you know, presumably more risk and
Speaker 1: less liquidity. Those are the least that's the perception. I
Speaker 1: know you've debunked some of those myths, But where is
Speaker 1: the price right now? How does it compare to broadly
Speaker 1: syndicates where we're seeing a huge amount of repricing all
Speaker 1: of the issues. You know, they're coming back even a
Speaker 1: month after doing a deal saying we want to reprice
Speaker 1: it lower. Everyone's going to cut. Where is the price
Speaker 1: and where is it going?
Speaker 2: In the private markets, it's not so much price as
Speaker 2: it is as valuation, right of lolans what are they worth?
Speaker 2: But also if you think about from an investor's perspective,
Speaker 2: what is the yield? What's the overall yield of this asset? Right?
Speaker 2: And so Mike's point about the benchmark, So with the
Speaker 2: benchmark being five percent, it's a lot different yield than
Speaker 2: it was when the benchmark was zero.
Speaker 1: Right.
Speaker 2: And what we've seen in this quote golden Age of
Speaker 2: credit is that the benchmark has gone from zero to
Speaker 2: five percent. Right, that's great, And the overall yield now
Speaker 2: is up to almost twelve percent for a middle market, Right,
Speaker 2: It's come back a little bit. And so when you
Speaker 2: see these headlines that say, oh, middle market spreads are compressing, okay,
Speaker 2: there's compressing from all time record highs of maybe six
Speaker 2: hundred and fifty bases points two more in line with
Speaker 2: historic averages kind of five to five fifty. That's been
Speaker 2: what they've been. You know, if you go back for
Speaker 2: twenty years, you need a little perspective. So will the
Speaker 2: yield start to come down as the benchmark comes down? Yes,
Speaker 2: will they come down, maybe a little bit slower than
Speaker 2: we think, That's that's my view, But they will come down.
Speaker 2: And whether they'll come down, whether the benchmark will come
Speaker 2: down to zero, you tell me. I don't know whether
Speaker 2: or not will end up or may ever end up
Speaker 2: with that situation. It feels like with so many things
Speaker 2: going on, we haven't even talked about that, you know,
Speaker 2: the federal deficit, yet, with so many things going on
Speaker 2: that could potentially create inflation down the road, it's very
Speaker 2: possible that we may be in a position where the
Speaker 2: benchmark is going to kind of be in that three
Speaker 2: ish percent longer than anybody thinks, in which case the
Speaker 2: yields on private credit will will stay higher for longer.
Speaker 2: But nevertheless, over many, many years, we've seen what has
Speaker 2: been called, and I think it's a misnomer, but has
Speaker 2: been called an ill liquidity premium. So you, Mike, as
Speaker 2: a public buyer, are going to say, you know what
Speaker 2: I can train and get, you know, a single bo
Speaker 2: fifty over okay, maybe a week single be a three
Speaker 2: fifty over all, right, well, okay, great. If I'm going
Speaker 2: to own a middle market asset, then I want to
Speaker 2: have at least a couple hundred basis points because I
Speaker 2: can't trade it, so I want a premium to that.
Speaker 2: What investors are realizing slowly is that having that two
Speaker 2: fifty or three fifty, you know, as a cheaper version
Speaker 2: when it may go south quickly on, you may not
Speaker 2: be as great a trade as they as they think.
Speaker 2: And so actually having a premium which is called an
Speaker 2: illiquidity premium, which I might call a liquidity rather than
Speaker 2: an inliquidity, but a liquidity premium because by having less
Speaker 2: correlation and being more stable, you know, I'm also getting
Speaker 2: a two hundred basis point premium for that. That's pretty attractive,
Speaker 2: and so over time, if you know, all things being fair,
Speaker 2: you would think that the markets would would us a
Speaker 2: little bit. But it's very hard to shake this feeling
Speaker 2: from the public view that these ill liquid assets are
Speaker 2: somehow trickier to value and therefore I'm just going to
Speaker 2: demand more of a yield.
Speaker 1: And you think the margin on private credit middle market
Speaker 1: stays around five point fifty well.
Speaker 2: Yeah, there's nothing right now to suggest that it's going
Speaker 2: to approach anything close to where the public market is.
Speaker 2: We think that a lot of what happens with spreads
Speaker 2: is more supply demand. And what's interesting now is that
Speaker 2: even though there's supposedly more competition coming into the space
Speaker 2: and more lenders, there's now more which would be more demand, right,
Speaker 2: there's now more supply.
Speaker 1: Right.
Speaker 2: So you can look at some of our favorite content
Speaker 2: providers who on the lead left and elsewhere that are
Speaker 2: showing that the M and A market is actually picking up.
Speaker 2: Effect of the end of the third quarter, we're starting
Speaker 2: to see more deal flow that's being triggered by lower
Speaker 2: financing costs. We think as more deal flow comes into
Speaker 2: the market, that will have a stabilizing effect on spreads.
Speaker 1: But five hundred is set of your expectations for how
Speaker 1: it shakes out at the end of the year and
Speaker 1: keeps going into next year.
Speaker 2: Yeah, I mean, I think there's always particularly for some
Speaker 2: of the larger issuers again close to that upper middle
Speaker 2: market range one hundred million epit done so forth will
Speaker 2: always be subject to poaching, if that's the word from
Speaker 2: the banks, or frankly even from some of the larger
Speaker 2: direct lenders in order to stay competitive because remember they're
Speaker 2: also raising a lot of money and they got to
Speaker 2: put money to work. So you could see a little
Speaker 2: bit of a ragged edge at that lower price point.
Speaker 2: But again, the beauty of our model is that we
Speaker 2: don't have to stretch. You know, we have plenty of
Speaker 2: deal flow coming in to spreads that we like.
Speaker 3: So when I said two fifty over, I was referring
Speaker 3: to unsecured bonds, right, okay, in my head thinking about
Speaker 3: Tavita and some of these names out there in the
Speaker 3: public domain. But your loans are an LTV that's got
Speaker 3: it's a senior secured loan. But what may be the
Speaker 3: sort of Paul Park LTV, you know when we're talking
Speaker 3: about that, So compare that gas the unsecured great question.
Speaker 2: So the dynamic, and this goes back to some of
Speaker 2: the things about purchase price multiples and competition. So as
Speaker 2: by the way, I'll give a shout out to my
Speaker 2: friends at Lincoln International. They do a great job of
Speaker 2: both valuations but also keeping track of purchase price multiple
Speaker 2: So because they're valuing all the loans in private credit
Speaker 2: portfolios BDCs and so forth, so they've got thousands of
Speaker 2: loans that they value, and they also keep track of
Speaker 2: the purchase price multiples that private equity sponsors are paying.
Speaker 2: And even though over the last several years, since twenty
Speaker 2: one twenty twenty one, which was kind of a high
Speaker 2: water mark in terms of M and A, the number
Speaker 2: of M and A deals has come down, the deals
Speaker 2: that are getting done are getting done in sectors that
Speaker 2: are actually more growthy, so the business sector, business service
Speaker 2: sectors that I mentioned earlier, healthcare, software and so forth.
Speaker 2: And the purchase price multiples therefore, of these businesses that
Speaker 2: have tended to do well through cycles has actually been
Speaker 2: sustained more than I would have thought. So it peaked
Speaker 2: at I'm going to say somewhere in the twelfth to
Speaker 2: twelve and a half times cash flow level for these
Speaker 2: businesses back in twenty one, it's come down to maybe
Speaker 2: eleven and a half ish eleven, low eleven, something like that.
Speaker 2: So it's not actually deteriorated that much. But because of
Speaker 2: the high cost of debt capital, the leverage that is
Speaker 2: being applied to these businesses had to be lower. So
Speaker 2: what was you know, like a five or six times
Speaker 2: multiple now is more like four times four to four
Speaker 2: and a half, four to maybe five. The result of that,
Speaker 2: to your question, is that the loan to value has
Speaker 2: gone from kind of forty fifty percent maybe three years
Speaker 2: ago to thirty five percent today. That's a record low
Speaker 2: as far as I remember. And so the value proposition
Speaker 2: for people who are you know, like ourselves, who are
Speaker 2: enjoying record years this year, is that the portfolio we're
Speaker 2: building has much greater cushion in it relative you know,
Speaker 2: the cash equity that these sponsors are putting in relative
Speaker 2: to the amount of debt that they can apply on
Speaker 2: these balance sheets, just because of the high cost of debt.
Speaker 1: Kapital the record yeah, for fundraising or for returns.
Speaker 2: Well pretty much both for us. I'm just speaking for Churchill.
Speaker 2: I mean we I wake up January first thinking it's
Speaker 2: going to be a miserable year. I'm sort of, you know,
Speaker 2: just expecting the worst. Yeah, and then you know, lo
Speaker 2: and behold, our model actually works. And now you know,
Speaker 2: we've had some tailwinds we have. You know, we we
Speaker 2: have great partnership with our parent company at TIA Neuvene
Speaker 2: that we work well with. We have our our new
Speaker 2: addition to the family, Archmont that we added to the
Speaker 2: Navine Private Capital business a year and a half ago.
Speaker 2: We're great partners with them. They are European direct lending
Speaker 2: partner and work you know, really hand in hand with them.
Speaker 2: So I think that, look, the opportunity set for private
Speaker 2: credit has never been better. I think that we're entering into,
Speaker 2: going back to the inflection point issue, a really interesting
Speaker 2: world right now because high rates are going to linger,
Speaker 2: which means that people have to be careful. Nevertheless, M
Speaker 2: and A is picking up, which means that for investors
Speaker 2: who have been starved for distributions, we haven't even talked
Speaker 2: about DPI, we haven't used those letters yet start for distributions.
Speaker 2: They're now starting to see some of the iceberg melting.
Speaker 2: And I think investors LPs who invested in fund six
Speaker 2: and we're you know, we're being asked by this monsor, Hey,
Speaker 2: we'd love you to invest in fund seven, and like, great,
Speaker 2: I haven't gotten any money back on Fund six. Now
Speaker 2: going to start to get money back. When they start
Speaker 2: to get money back, they're going to start putting money
Speaker 2: in fund seven. And when money starts going to Fund seven,
Speaker 2: then those sponsors are going to start investing when they invest,
Speaker 2: they're going to be coming to Churchill for financing. So
Speaker 2: you're going to start to see over the next eighteen
Speaker 2: to twenty four months, I think kind of an unwinding
Speaker 2: of some of the stuck nature of where we've been
Speaker 2: in terms of the cycle. And this tends to be
Speaker 2: going cycles where one thing leads to another, and I
Speaker 2: think freeing up of capital which will lead to more investing,
Speaker 2: which will lead to more fundraising. So I think there
Speaker 2: is a virtuous cycle that we look forward to experiencing
Speaker 2: over the next twenty four months.
Speaker 1: How much of that money coming back comes from cholesterolized
Speaker 1: fund obligations do you think, Oh.
Speaker 2: That's a great question. I think a fair share. Yeah.
Speaker 2: I mean the innovation, as we talked about at the top, Mike,
Speaker 2: you know, James, is you know, really exciting to watch
Speaker 2: in the technology that's being applied to both on the
Speaker 2: fund structuring side as well as on the financing side.
Speaker 2: And one of the things, for example, that we're doing
Speaker 2: at Churchill is the secondary's market. So in the absence
Speaker 2: of realizations from sales of companies, LPs and gps are
Speaker 2: looking for liquidity and so being able to go to
Speaker 2: these LPs and GPS and saying, hey, we have a
Speaker 2: way of actually freeing value of from your portfolios, from
Speaker 2: your fund investments to give you the ability to go
Speaker 2: out and do other stuff with that, both on the
Speaker 2: secondary side as well as on the so called nav
Speaker 2: financing side or friends that to ark one have a
Speaker 2: business that's basically looking at the asset value of the
Speaker 2: of these businesses as a wholesale matter and saying we
Speaker 2: can lend against portfolios, against funds, against the value of
Speaker 2: the companies. That kind of sophistication which is really exciting
Speaker 2: to watch, is you know, in an asset class that's
Speaker 2: growing the way private credit is. I mean, it's you know,
Speaker 2: it's it's fun.
Speaker 1: But when you use those acronyms and you talk about innovation,
Speaker 1: you know, going back to misguided conclusions, people tend to worry.
Speaker 1: People you know, have been asking me for you know,
Speaker 1: probably twenty years, when is the collateralize the COLO market,
Speaker 1: when's that gonna blow up? Because there's this uh you know,
Speaker 1: missed understanding that it's the same as CDOs that caused
Speaker 1: the finish question. But is there is there you know,
Speaker 1: is this innovation does any of it worry? Is there
Speaker 1: any for us out there, Randy.
Speaker 2: That you worry about well, you know, being a part
Speaker 2: time journalist, James, I'm always worrying, you know. I I
Speaker 2: having been in this business for so long and having
Speaker 2: been on the large cap side, worked at big banks,
Speaker 2: I've watched the excess. You know. My sort of favorite
Speaker 2: saying is, you know, in the capital markets, anything worth
Speaker 2: doing is worth overdoing. So it's it is a challenge
Speaker 2: and sometimes you just wish that there would be more restraint.
Speaker 2: But the reality is, and I write about this a lot,
Speaker 2: capital finds its own level. That's the truth. Capital finds
Speaker 2: its own level. It finds It definitely fills a vacuum.
Speaker 2: And the beauty of the system, the capital system in
Speaker 2: the United States is it is so there's so much
Speaker 2: creative capital being put to work today. We tend to
Speaker 2: be spoiled because we don't we don't realize how lucky
Speaker 2: we are. I mean, I look around at you know,
Speaker 2: from the Bloomberg Studio, you know, one of the foremost
Speaker 2: media companies on the planet, and looking at all of
Speaker 2: the exciting stuff going on that you report about every day.
Speaker 2: I mean, we're really blessed in New York City to
Speaker 2: be you know, part of this ecosystem where companies can
Speaker 2: come to capital in all sorts of forms, and it's
Speaker 2: being created every day, not just with private equity firms.
Speaker 2: But you know, think about these medium sized companies that
Speaker 2: are getting capital. The challenge is that we need to
Speaker 2: get more of it out to them. If you think
Speaker 2: about the three hundred, two hundred three and one thousand
Speaker 2: companies that form this middle market in the United States,
Speaker 2: only five percent is are owned by private equity firms.
Speaker 2: That means that ninety five percent of the country's middle
Speaker 2: market companies don't have access to equity capital. They can't
Speaker 2: go publicly, they're too small. And so I think one
Speaker 2: of the big challenges of the next ten years, you know,
Speaker 2: is how to keep the capital growth going. And one
Speaker 2: of the beauties I think of getting more retail and
Speaker 2: wealth exposure to the asset class is being able to
Speaker 2: look more broadly for opportunities in the market to access capital,
Speaker 2: because you know, we are spoiled. The ability to access
Speaker 2: capital the United States is unparalleled.
Speaker 1: Given that, I mean, how do you maintain fair value?
Speaker 1: You know, there is so much demand, there isn't enough
Speaker 1: assets out there. We're seeing spreads all over the place compressed.
Speaker 1: We saw the triple B spread on public bonds at
Speaker 1: the titles since nineteen ninety eight. Last week, everything just
Speaker 1: seems very very tight. But on the other hand, everyone
Speaker 1: just seems really very calm and collected. Those disconnects they
Speaker 1: tend to.
Speaker 2: Worry me a bit. But what about you, Well, you
Speaker 2: used the word the top complacency. I think there's that
Speaker 2: word does not exist in the Churchill vocabulary. There is
Speaker 2: because we're expecting the worst tomorrow. We were but battened down,
Speaker 2: We're ready. Complacency it is not our vocabulary. We are alert,
Speaker 2: and I think this is the true case with many
Speaker 2: of the experienced lenders out there. I think we're in
Speaker 2: a very unusual point. Going back to this inflection point,
Speaker 2: I do not think that this period will last. It
Speaker 2: never does. There's always going to be something, whether it's
Speaker 2: the elections or something else that triggers more of a
Speaker 2: risk off parameter. The thing that we and you've experienced
Speaker 2: this when stuff happens and headline risk emerges from places
Speaker 2: that you could not have imagined. The challenge when you
Speaker 2: own correlated assets, and we saw this in twenty two
Speaker 2: for sure, is that everything trades down right at once,
Speaker 2: because it can there's this emotion that gets into the
Speaker 2: water that's very hard to resist. The thing that we
Speaker 2: like about our asset class is that it resists that
Speaker 2: it's not perfect. It does tend to rhyme, resonate a
Speaker 2: little bit, but it tends to not behave exactly the
Speaker 2: way the liquid markets do. And that's the challenge if
Speaker 2: you're an investor right now and you're looking at this
Speaker 2: market and you're thinking, okay, look at look at how
Speaker 2: far the public markets have gone. Look at the records
Speaker 2: that that down the S and P have set this year,
Speaker 2: and it's really remarkable in an era which I thought
Speaker 2: we'd be headed into the fourth quarter with all the
Speaker 2: election issues and so forth, you know, and with the
Speaker 2: vics much higher than it is, something will happen. And
Speaker 2: when it does, those of us who are, you know,
Speaker 2: again in a little different part of the gym will
Speaker 2: feel better.
Speaker 1: It might be, but there is no hedge to to
Speaker 1: you know, if you if you're staring down this volatility,
Speaker 1: there's nothing you can I mean, you can bitcoin and
Speaker 1: go that sort of thing, but there isn't I mean,
Speaker 1: or as you say, just sit on the loans and
Speaker 1: don't do it do anything.
Speaker 2: Well and again through many, many years, these private loans
Speaker 2: and let's let's even broaden it out to alternatives, right.
Speaker 2: One of the things that has been interesting about the
Speaker 2: alternative space, and Uveen is a multi hundred billion dollar
Speaker 2: investor in alternatives with real estate and infrastructure and timberland
Speaker 2: and various other assets that are extremely important in a
Speaker 2: diversified portfolio when you have fixed income and public equities
Speaker 2: and everything else. And as an investor, diversity is really critical, right,
Speaker 2: And so being in something which doesn't have isn't as
Speaker 2: correlated and private capital is in that category. Investors were
Speaker 2: very sophisticated, are now looking at this as something that
Speaker 2: they need in order to feel like if we go
Speaker 2: into a storm, there will be some stability in a
Speaker 2: portion of their portfolio. So I think the other issue
Speaker 2: is that if you are looking for yield, right, so
Speaker 2: the credit part provides you with income an income stream
Speaker 2: right at that hopefully ten to twelve or wherever we're at now,
Speaker 2: but you know even that a seven to nine percent,
Speaker 2: you know, we have equity options as well, so we
Speaker 2: have co invest options, we have junior capital options. You know,
Speaker 2: we have the secondaries option where you can get more
Speaker 2: of a yield, more of an equity like yield. So
Speaker 2: still coming out of the the core investment thesis that
Speaker 2: we have around private equity sponsors that again we're getting
Speaker 2: this pre approved you know, pipeline of deals coming from
Speaker 2: but instead you know, structuring it more of as an
Speaker 2: equity product. So you know, the more opportunities that we
Speaker 2: have to take the financing options that we're creating for
Speaker 2: our private equity sponsors and creating opportunities for investors to
Speaker 2: benefit from the yield and stability in those products. I mean,
Speaker 2: that's kind of what we live for.
Speaker 1: You've talked about undiscovered value, so I was wondering if
Speaker 1: you could put your finger on what's the best single
Speaker 1: credit market opportunities are the relative value. You know, we
Speaker 1: haven't talked about the rest of the world. We tended
Speaker 1: to be mostly in the US, but bi sector by country,
Speaker 1: is there anything out there that you think people are missing?
Speaker 2: Well, speaking for my European colleagues, what's kind of cool
Speaker 2: right now about what they're doing in Mattison was on
Speaker 2: with on Credit Edge with you previously. You know, the
Speaker 2: spreads in European direct lending is pretty high. Right now
Speaker 2: relative to the US now, their benchmark is lower, but
Speaker 2: the opportunities that they're seeing are and based on my
Speaker 2: visits there and things that I'm hearing from their investors,
Speaker 2: are pretty exciting. I think the what's hiding in plain
Speaker 2: sight for us, the opportunity, the undiscovered in a way,
Speaker 2: is this traditional middle market where we have found that,
Speaker 2: for very odd reasons, there are actually fewer competitors today
Speaker 2: than there were pre COVID. So in part, I think
Speaker 2: it's because some of the larger direct lenders have gone
Speaker 2: up market for opportunities, and we've seen that particularly in
Speaker 2: the twenty two to twenty three timeframe when the laws
Speaker 2: were offline, So a number of the larger managers went
Speaker 2: up market and sort of did kind of the bond
Speaker 2: replacement bank replacement business and left the middle market kind
Speaker 2: of to us and the small cap lenders who weren't
Speaker 2: able to create scale to take you know, these financings,
Speaker 2: you know, with one commitment letter the way we can
Speaker 2: in the middle market. So as a result, we probably
Speaker 2: only have a small handful of lenders that we're competing against.
Speaker 2: So this right now is kind of undiscovered value that
Speaker 2: you know is hiding in plain sight.
Speaker 1: Wait till this goes out. Tons of competition. Randy Schrimer,
Speaker 1: vice chairman at Church Lasset Managements, and pleasure having you
Speaker 1: on the Credit Edge.
Speaker 2: So many thanks James, Mike, thanks so much for having me.
Speaker 1: And of course I'm very grateful to Mike Hollin from
Speaker 1: Bloomberg Intelligence. Thank you for joining Mike. Thanks guys for
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Speaker 1: I'm James Crombie. It's been a pleasure having you join
Speaker 1: us again next week on the Credit Edge.