Speaker 1: Hello, and welcome to Credit Edge, a weekly markets podcast.
Speaker 2: My name is James Crombie. I'm a senior editor at Bloomberg.
Speaker 2: This is a special edition of the show with highlights
Speaker 2: from our Global Credit Forum held in New York on
Speaker 2: June third, including a fantastic group of guests and speakers
Speaker 2: hitting the biggest themes of the day, from distressed debt
Speaker 2: and private markets to the multi trillion dollar AI boom.
Speaker 2: We will discuss a lot of that on this show.
Speaker 2: We hope you enjoy it and remember give us a
Speaker 2: review wherever you are listening to the Credit Edge. Christina Lee,
Speaker 2: managing director and co portfolio manager with oak Tree's Global
Speaker 2: private Debt Strategy.
Speaker 1: How are you doing, Christina?
Speaker 3: I am doing well. Thank you for having me on.
Speaker 2: Thank you so much for joining us. What stood out
Speaker 2: for me when you were talking today at our event
Speaker 2: was this kind of back to basics strategy in terms
Speaker 2: of you know, private credit.
Speaker 1: You like the middle market.
Speaker 2: I have also been saying for some time that is,
Speaker 2: you know, one of the most boring parts of the
Speaker 2: market for a good reason in this environment. To you,
Speaker 2: first of all, what does mid and market mean?
Speaker 4: Yeah?
Speaker 3: I think middle market for us is really driven by
Speaker 3: size range, and so we think about it as kind
Speaker 3: of EBITDA anywhere between twenty five too, we're usually one
Speaker 3: hundred million. But really what dictates the middle market for
Speaker 3: US is also does that company or does that borrow
Speaker 3: have access to the probably syndicate a loan market, because
Speaker 3: once you do have access, you probably are more more
Speaker 3: of a large cap borrower.
Speaker 2: Okay, so they don't have access, they're smaller in size,
Speaker 2: Does that naturally make them more risky?
Speaker 3: I think there's an argument that, yes, they can be riskier.
Speaker 3: Right when you think about mid market versus large cap.
Speaker 3: Mid market tends to have, for example, smaller management teams,
Speaker 3: they might not have as robust IT systems, and sometimes
Speaker 3: they do have some credit risk. Right, they can have
Speaker 3: some more concentration, whether it's by region or by customer. However,
Speaker 3: I wouldn't say for just blanketing all middle market companies
Speaker 3: as more risky than large cap. But that's why in
Speaker 3: the middle market you see structural differences when it comes
Speaker 3: to leverage levels versus large cap. Typically they're significally lower leverage,
Speaker 3: and then to the credit documentation is just tighter. We're
Speaker 3: getting maintenance covenants in mid market versus a large cap
Speaker 3: you don't. So the transaction structure accounts for some of
Speaker 3: the kind of risks that you see in middle market companies.
Speaker 1: And how big are the deals that you're seeing in
Speaker 1: middle market? What's what size of a loan are we
Speaker 1: be talking about?
Speaker 3: Yeah, on average, I would say what we're seeing is
Speaker 3: anywhere between usually one hundred and fifty million to five
Speaker 3: hundred million is usually the financing.
Speaker 2: Package, okay. And the kind of businesses you're lending to
Speaker 2: is it software? Is it technology? Is it you know,
Speaker 2: really risky stuff that you know, we don't know if
Speaker 2: it's all going to go wrong, or is it is
Speaker 2: it something else?
Speaker 5: We love?
Speaker 3: Boring? Boring is beautiful, Boring is better. Right now, when
Speaker 3: we look at middle market companies, we want to look
Speaker 3: at because they're smaller, what is your competitive moat? One
Speaker 3: of the areas that we have found to be really
Speaker 3: attractive in this market is business services tech in truck businesses.
Speaker 3: These are technicians that go around and fix things. It
Speaker 3: doesn't get displaced by software. And also it's regional, right
Speaker 3: you need density for these tech and truck businesses. So
Speaker 3: it's okay that you're smaller, right, You don't need that
Speaker 3: nationwide scale, but you do need to be the largest
Speaker 3: within a particular region. So that's why we look at
Speaker 3: niches and say, what do we find attractive in today's market.
Speaker 3: That's a really boring concept.
Speaker 2: Right, But are they kind of monopolies in their area.
Speaker 3: Or a lot of times they are, right they because
Speaker 3: they have the density and scale within that particular region,
Speaker 3: they can also be very price competitive. For example, if
Speaker 3: you only have two customers in Minnesota, one customer in California,
Speaker 3: and one in Oregon, yeah, you might be a bit
Speaker 3: more nationwide, but that doesn't necessarily mean you're more competitive.
Speaker 2: So it's really just basic stuff that we see every day.
Speaker 2: In the old world economy doesn't look like it's going
Speaker 2: to get displaced by technology or anything like that, and
Speaker 2: they need money for what working capital, that sort of thing.
Speaker 3: So a lot of times that we're looking at is
Speaker 3: either a leverage buyout or for example, we have if
Speaker 3: it's in a portfolio, looking at add ons, right, they're
Speaker 3: looking at maybe doing bulltowns in different regions to grow
Speaker 3: because it is harder for these businesses to typically scale
Speaker 3: organically because again, you want that density and.
Speaker 2: You did mention anyer business services, which a lot of
Speaker 2: people just means it's another word for software, But what
Speaker 2: exactly is that to you?
Speaker 3: Yeah, I think business services you do have to bifurcate
Speaker 3: it because I think there's business services where there could
Speaker 3: be AI displacement. For example, around some of the white
Speaker 3: collar professions. Right, you have seen accounting, legal firms have
Speaker 3: these LBOs, and the question around is they may not
Speaker 3: necessarily get displaced by AI, but what happens to their
Speaker 3: pricing model? Right, We just don't know yet, right, and
Speaker 3: what is their terminal value going forward? And then there's
Speaker 3: business services like blue collar business services like tech and
Speaker 3: truck businesses where they are actually doing something physical that
Speaker 3: can't be displaced by technology. And so we do buyvcate
Speaker 3: business services a bit.
Speaker 2: Right oak Tree, Though it's a big global platform, you
Speaker 2: have a lot of money to deploy.
Speaker 1: How scalable is this.
Speaker 6: Kind of business?
Speaker 3: Yeah, we have seen companies that are smaller, say call
Speaker 3: it twenty million dollars of ibada, really scale up to
Speaker 3: one hundred million beyond because there's a lot of add
Speaker 3: on opportunities for these businesses because there's a lot of
Speaker 3: regions that they can continue to bolt on and that
Speaker 3: provides incremental financing needs.
Speaker 2: And talk to us about the returns, because that is
Speaker 2: something that everyone is questioning in private markets. You know,
Speaker 2: why do I need to sacrifice liquidity if the returns
Speaker 2: really aren't there? And a lot of people on the
Speaker 2: liquid side is saying that, you know, they just it
Speaker 2: just isn't enough to compensate for that lack of liquidity
Speaker 2: and transparency.
Speaker 3: Yeah, I would say from there is still a premium,
Speaker 3: But are we on the kind of low end of
Speaker 3: the premium Probably in today's market, I would say we're
Speaker 3: about one hundred and fifty basis points higher than public
Speaker 3: markets on a.
Speaker 2: Broadly syndicated loan to middle market private loan basis that
Speaker 2: sort of thing. Is there anything out there that worries
Speaker 2: you right now for the let's say the second half
Speaker 2: of this year.
Speaker 3: I think what will worry me a bit is just
Speaker 3: kind of where the pipeline is and where the deal
Speaker 3: flow is. We've had, in reality kind of two to
Speaker 3: three years of a slower pipeline. And when there's a
Speaker 3: slow pipeline and this increase needed to deployer what I
Speaker 3: call sometimes fomo, that's when you see people kind of
Speaker 3: loosen their underwriting skills right, Like for example, last year,
Speaker 3: first nine months it was very slow from a deal pipeline,
Speaker 3: and so it seemed like Q four when that pipeline
Speaker 3: picked up, everyone rushed from the sidelines and you saw
Speaker 3: looser underwriting, higher larvage, lower spreads, all the things that
Speaker 3: you don't want to see. And so that's what I'm
Speaker 3: worried about. It's been pretty slow, but if there's kind
Speaker 3: of a pop in a quarter, you do you see
Speaker 3: that frothy market conditions come back space.
Speaker 2: Christina Lee with oak Tree, thank you so much for
Speaker 2: joining us on the credit Edge.
Speaker 1: Thanks for having me. Matt Brill, head of North America
Speaker 1: investment grade credit at Investco, which manages more than two
Speaker 1: trillion dollars. Matt, how are you doing doing great? Thanks
Speaker 1: thanks coming on the show.
Speaker 2: Whenever I think of investment grade credit nowadays, I hate
Speaker 2: to use the word, but I am thinking bubble. It
Speaker 2: just gets tighter and tighter the more supply we see,
Speaker 2: the more demand there is. There just seems to be
Speaker 2: this wall of cash pushing against it. And I'm worried
Speaker 2: about downgrades. I'm worried about the macro outlook. I'm worried
Speaker 2: about liquidity. I'm worried about all sorts of you know, things,
Speaker 2: fallen angels. You know, there are so many things that
Speaker 2: worry me about that picture when everybody just wants to
Speaker 2: buy more. What's your view, where do we go from here?
Speaker 5: I think you need to relax, James. There's not that
Speaker 5: much to worry about. There's plenty of good things that
Speaker 5: are still happening in the investment grade market. So overall, yes,
Speaker 5: spreads are tight. They've been tight for a number of
Speaker 5: years now, and we think that continues because the fundamentals
Speaker 5: are really good and in fact, the fundamentals you know,
Speaker 5: possibly are.
Speaker 6: Better than ever.
Speaker 5: Downgrades are low, the higher quality names continue to do
Speaker 5: very well. Earnings beats are at essentially record pace. So overall,
Speaker 5: you know, we think that spreads are tight, but they're justified.
Speaker 5: So plenty to worry about at some point, but right
Speaker 5: now is really not the time.
Speaker 1: How much tights could they go, Well.
Speaker 5: We had a year ago we said maybe they could
Speaker 5: get to somewhe around fifty five basis points, and they
Speaker 5: keep hitting this wall in the high sixties. But they're
Speaker 5: really supported by all in yields where they are, so
Speaker 5: if all in yields stay high. With treasure yields where
Speaker 5: they are, we do think that spreads can continue to
Speaker 5: grind here. If the yields were on the ten yere
Speaker 5: Tursey were actually going materially lower, that would probably be
Speaker 5: a negative. But if ye'ld stay up here and you
Speaker 5: continue to get five percent furning ten year investment grade bonds,
Speaker 5: six percent for earning thirty year investment grade bonds, I
Speaker 5: think there's a real chance you could go another five
Speaker 5: to ten tighter and we could get into those high fifties.
Speaker 5: It's it's kind of a pain trade because nobody thinks
Speaker 5: that it can happen, and so no one's really positioned
Speaker 5: for that.
Speaker 1: And you think it right that we should just look
Speaker 1: at yield, don't care about spread.
Speaker 5: Well, I think you have to look at both because
Speaker 5: at the end of the day, you could just buy
Speaker 5: a treasury and get that that yield. But would you
Speaker 5: rather have a high quality company and get five percent
Speaker 5: or the US government getting four point four percent four
Speaker 5: point three percent? You know, there's still it still does
Speaker 5: give you that incremental yield, and maybe sixty basis points
Speaker 5: isn't a lot, but it's still important to everybody and
Speaker 5: every last dollar does count, and you have to figure
Speaker 5: out what are you sacrificing my doing it? Are you
Speaker 5: sacrificing liquidity? You know, we generally don't think so that
Speaker 5: the IG market is not quite as liquid as the
Speaker 5: US Jersey market, but it's pretty darn close. They mentioned
Speaker 5: of the portfolio trade means you can trade bonds by
Speaker 5: the billions very very easily. Are you sacrificing quality? And know,
Speaker 5: most of these companies are really really high cash flow generating,
Speaker 5: you know, so at the end of the day, don't
Speaker 5: really sacrifice liquidity and you don't really sacrifice credit. So
Speaker 5: I think that incremental more yield that you're going to
Speaker 5: get it is important. So overall, yes, we do look
Speaker 5: at yields, but I think the incremental spread that you're
Speaker 5: getting is still enough to be attractive.
Speaker 2: And maybe some of these companies are actually run better
Speaker 2: than the US government. Do you think we'll get to
Speaker 2: a negative spread on any of this debt?
Speaker 5: You know, that's always been that's been the holy grail
Speaker 5: or the thought of what could that actually occur? I
Speaker 5: think you could certainly see in two to three year
Speaker 5: bonds at certain times that it could happen very very
Speaker 5: short end, just given the technicals or certain things. But
Speaker 5: overall that generally doesn't make sense. The US government could
Speaker 5: always print more money. They do have a larger balance
Speaker 5: sheet at.
Speaker 6: The end of the day that they have at their disposal.
Speaker 5: But yeah, we do believe that you need to get
Speaker 5: paid something to own corporate credit. But how much is
Speaker 5: certainly up for debate.
Speaker 2: What about the supplies, either, there is a ton of
Speaker 2: new issuance, There's a ton of net new issues that
Speaker 2: we haven't seen in a well. Golden and Sax predicts
Speaker 2: eight hundred and fifty billion in net new IG supply
Speaker 2: for this year, which is the highest we've ever seen.
Speaker 2: We're also, you know, we're getting a lot of AI related,
Speaker 2: We're getting a lot of M and A related. Does
Speaker 2: that not push the market into a balance that therefore
Speaker 2: pushes spreads out? Is there not a point which by
Speaker 2: just say that's enough.
Speaker 5: Yeah, So the gross supply and the net supply are
Speaker 5: both large. So the gross supply is going to be
Speaker 5: probably pretty close to two trillion. The net supply, depending
Speaker 5: how you look at if it's just maturities or if
Speaker 5: it's maturities and coupons, it is going to be still elevated.
Speaker 5: It's more that it's growing. Right at the end of
Speaker 5: the day, it's definitely growing, but the cash flow is
Speaker 5: growing even faster for one. But the demand is really
Speaker 5: what we're looking at and the demand. It's a supply
Speaker 5: demand dynamic, and the supply is higher, but the demand
Speaker 5: is even greater than the supply growth. The reason for
Speaker 5: that is that all those all in yields being where
Speaker 5: they are on all in five to six percent range.
Speaker 5: So if you look at insurance companies pension plans, they're
Speaker 5: seeing that this is a tremendous opportunity to own investment
Speaker 5: grade credit. A lot of balance funds or pension plans
Speaker 5: that are overfunded, so they have if you take the
Speaker 5: present value of all their liabilities in the future, because
Speaker 5: the equity market has done so well, they actually have
Speaker 5: more money than they need for the future. So what
Speaker 5: they're doing is they're taking money off the table in
Speaker 5: the equity market and they're reallocating it to fixed income
Speaker 5: and locking in those year so locking in those present values,
Speaker 5: and we're seeing more and more of that. So that's
Speaker 5: that shift out of equities in over to fixed income.
Speaker 5: It's not at a large scale, but it's on the
Speaker 5: on the margin over and over, and that's creating a
Speaker 5: premituous amount of demand, so annuities, pension plans, insurance companies.
Speaker 5: It's a wave of demand that is more than offsetting
Speaker 5: the growth and supply.
Speaker 2: And specificly on the AI side of it, all of
Speaker 2: this news supply there is you know, a sort of
Speaker 2: a hope trade there that you know they'll get all
Speaker 2: this stuff right in terms of the data centers and
Speaker 2: the hyper scales everything else.
Speaker 1: We just don't know. It's kind of a shot in
Speaker 1: the duck. But is this risk being properly priced?
Speaker 2: Do you think so?
Speaker 1: I think the football told us.
Speaker 5: I think there's two sides of the coin. There's one
Speaker 5: is the unsecured hyperscalers, and then two is the structured
Speaker 5: vehicles that they're using. So let's start with the unsecured.
Speaker 5: You just saw a large equity raise for one of
Speaker 5: the hyper scalers this week, one of the largest raises
Speaker 5: in history, maybe the largest public rais in history, and
Speaker 5: that was to defend their balance sheet. And this is
Speaker 5: a double A company. They're going out and basically saying
Speaker 5: we're going to solidifier balance sheet. Let's go ahead and
Speaker 5: issue more equity. Companies can always do this, So I
Speaker 5: think people a lot of people forget that this is
Speaker 5: an option for butanies who saw it previously from Boeing,
Speaker 5: who saw it from Oracle. This is on the table
Speaker 5: for all these companies at all times. They generally don't
Speaker 5: like to do this, but if they feel like it's
Speaker 5: prudent and the best use of their best use of
Speaker 5: their capital and best way to defend their balance, that's
Speaker 5: a great thing for them to do. So it's not
Speaker 5: just hoping that they're going to do all the right things,
Speaker 5: but I think that there's good signs that they could
Speaker 5: do that and have done that. On the structured side
Speaker 5: of things, we really take the approach that AI could
Speaker 5: be a complete flop and you're still going to get paid.
Speaker 5: And so we're looking at ambortization on chips. Are they
Speaker 5: going to go to zero by the time our bond's mature,
Speaker 5: meaning the amborization not the value of the chips, but
Speaker 5: the amborization goes to zero, so that if the value
Speaker 5: of the chips is more than zero, you're good if
Speaker 5: you just continue to get this payment. So we're taking
Speaker 5: a very structured, prudent approach that we're just assuming that
Speaker 5: this is completely worthless at the end of the day,
Speaker 5: but our bonds are still money good And that's the
Speaker 5: way that these are structured. And I think they realize
Speaker 5: they have to do it this way because they need
Speaker 5: so much money. And this really does alleviate our fears
Speaker 5: and all your concerns earlier can go to rest when
Speaker 5: we see these structures done in the way that they are, so.
Speaker 2: The text breaths don't then need to not much from
Speaker 2: it because every deal comes a bit cheaper, the concessions
Speaker 2: are a bit wide. You know, it seems like there's
Speaker 2: a value maybe wasting, but you don't think spreads widened
Speaker 2: out on the tech side.
Speaker 5: So for a while there it seems as if it's
Speaker 5: just going to relentlessly continue to come this equity raise
Speaker 5: from Alphabet, you know. I I do think kind of
Speaker 5: gives us some faith that that maybe there's going.
Speaker 6: To be a mixed going forward.
Speaker 5: But the companies have been very proactive of really trying
Speaker 5: to tell you we're not going to issue until this
Speaker 5: quarter or the next quarter or the next year, and they're
Speaker 5: trying to lay out their plans much greater, which does
Speaker 5: give us ability to plan better on our end too,
Speaker 5: so we can use our our our dollars at a
Speaker 5: more measured pace rather than making sure we don't run
Speaker 5: out of all our all our exposure early. Our ability
Speaker 5: to add more to these in the future, we can
Speaker 5: retain that. So overall we're kind of trying to figure out,
Speaker 5: you know, what are they going to do and then
Speaker 5: they're telling us. But the key is if they then
Speaker 5: do something on the side with a special purpose vehicle
Speaker 5: that's backed by the same credit that does sort of
Speaker 5: double dip, and that can be a little bit of
Speaker 5: a challenge. But if they continue to be rolling at
Speaker 5: the pace that they are, and we're seeing AI happening
Speaker 5: at the way that it is and the earning speeds
Speaker 5: that are happening, we continued to believe that they will
Speaker 5: be able to issue this debt and have it not
Speaker 5: go materially wider.
Speaker 2: Matt Real, head of North America investment grade Credit at Invesco,
Speaker 2: thank you so much for joining us on the credit edge.
Speaker 2: We are here with any Shah, Global head of det
Speaker 2: half of markets at Morgan Sandy responsible for investment grade, leverage,
Speaker 2: finance and securitized products.
Speaker 1: How you doing, any doing great. Thank you so much
Speaker 1: for having me, James.
Speaker 2: Thank you so much for being here. As you know,
Speaker 2: there's a massive AI funding boom going on, something we've
Speaker 2: never seen before in capital markets, in credit it's just
Speaker 2: overwhelming the size of the complexity. Where are we now
Speaker 2: and look ahead into the second half, what more can
Speaker 2: we expect?
Speaker 7: Sure?
Speaker 1: I mean, just to give you a little bit of
Speaker 1: context around it, I would estimate that there's going to
Speaker 1: be four hundred to five hundred billion dollars of new
Speaker 1: financing issue in the credit markets to finance AI and
Speaker 1: all the cappacks around it. You know, that's going to
Speaker 1: be north of ten percent of all of the issue
Speaker 1: in in the credit markets. That's just this year.
Speaker 2: That's just this year, to give you context more than
Speaker 2: the second half, as in to what we've already had.
Speaker 1: For the full year. For the full year, I'd expected
Speaker 1: to be ten to fifteen percent of all the issues
Speaker 1: of the credit markets. Yeah, and to give you context,
Speaker 1: two years ago, this wasn't a sector. So we're going
Speaker 1: from zero to ten to fifteen percent of the market.
Speaker 1: It'll most likely be the largest industry vertical if that
Speaker 1: was an industry vertical non financial in the entire credit markets. Now,
Speaker 1: the good news is there's so much product breadth across markets,
Speaker 1: whether it's investment, great, high yield leverage loans, and then
Speaker 1: across currencies, so there's more than sufficient capacity for it.
Speaker 1: But it is a big deal, right.
Speaker 2: We are talking to investors though that say that, yes,
Speaker 2: it's being spread across markets and currencies. But ultimately, you know,
Speaker 2: we're just one global shop. We're buying all this stuff
Speaker 2: in all the markets, so we internally are going to
Speaker 2: hit some limits on you know, the issue and also
Speaker 2: on the seite. So so what kind of pushback might
Speaker 2: you see from investors.
Speaker 1: Well, the one thing I would tell you is that
Speaker 1: investors were very under indexed big tech going in.
Speaker 6: To this, right.
Speaker 1: So, yes, today, of all of the investment grade issuance,
Speaker 1: about ten percent of it has come from the hyperscalets,
Speaker 1: which a big number, but it was zero percent two
Speaker 1: years ago, right, So I think investors have a lot
Speaker 1: of catching up to do to be invested appropriately in
Speaker 1: the sector. I do think it makes a difference that
Speaker 1: we've been able to broaden out into product categories. So
Speaker 1: you know, we always thought that most of this capacity
Speaker 1: was going to come in the investment grade market. The
Speaker 1: deepest most liquid pool of capital is the US dollar
Speaker 1: investment grade bond market. It's about half of all the
Speaker 1: capital markets issuance in the credit markets, and that has
Speaker 1: played out, we'll probably see two hundred billion dollars plus
Speaker 1: of IG issuance in the US market just from the hyperscalars.
Speaker 1: But there now as you know, tapping into other currencies.
Speaker 1: You know, one of the hyper scalers has issued in
Speaker 1: all six major currencies already this year. So non dollar
Speaker 1: issuance for hyperscalers has gone from ten or fifteen percent
Speaker 1: a year ago to being about a third of their
Speaker 1: issuance this year. So that's that's helping, I think manage
Speaker 1: the capacity a great deal. The other thing is other
Speaker 1: products like the terminal and B market. So the core
Speaker 1: weave three billion dollar termal and B that we syndicated
Speaker 1: for GPU financing, that's a brand new product. That's the
Speaker 1: first time that the institutional loan market has been used
Speaker 1: to finance that asset class. And of course all this
Speaker 1: high yield data center financing, which has been a bit
Speaker 1: of a game changer in financing the ecosystem.
Speaker 2: But the size though, I mean, you know, are they
Speaker 2: going to keep hitting us with you know, twenty billion,
Speaker 2: thirty billion at a shot, or are they going to
Speaker 2: start to dial down that volume in terms of single
Speaker 2: deal size.
Speaker 1: Well, based on all of the capex pronouncements that you've
Speaker 1: heard from the large tech companies, I think the supply
Speaker 1: is going to continue and investors like that the bigger
Speaker 1: the better.
Speaker 5: Yeah.
Speaker 1: I think it is reflected somewhat in credit spreads in
Speaker 1: that there is a bit of divergence between the large
Speaker 1: tech companies and some of the other highly rated industrial
Speaker 1: has just given all of the supply, and so I
Speaker 1: think investors in this raid environment you're seeing more and
Speaker 1: more cash coming in, particularly into investment grade, and find
Speaker 1: it to be a very attractive opportunity to deploy. And
Speaker 1: as I said, they've been underinvested coming into this cycle.
Speaker 1: What though, if it doesn't all go as planned? You know,
Speaker 1: there is a lot of hope in this AI trade.
Speaker 1: There is a lot of faith that you know, things
Speaker 1: can be as transformative as everyone really believes. What are
Speaker 1: the risks are not happening? Well, Look, I think investors
Speaker 1: are focused on three things. They're focused on structure, They're
Speaker 1: focused on liquidity, and they're focused on relative value. Those
Speaker 1: three things matter a ton when you're investing in this
Speaker 1: ecosystem or any other industry sector. So we think about structure,
Speaker 1: you think about downside protection and making sure that ultimately
Speaker 1: there is a high quality company that's standing behind whatever
Speaker 1: the credit that's being issued. Liquidity has been a big,
Speaker 1: big driver, and that's why you've seen most of this
Speaker 1: issuance in the one forty four A market and not
Speaker 1: in the four A two market, although that has been
Speaker 1: a viable path. I think most more and more of
Speaker 1: this issue is going to issuance is going to be
Speaker 1: in products that are more liquid and offer that flexibility
Speaker 1: to it investors. And then relative value. I think at
Speaker 1: the end of the day, if you look at how
Speaker 1: some of these financings have traded in the aftermarket, you'll
Speaker 1: see that investors feel like there is convexity and what
Speaker 1: they're investing in there is upside.
Speaker 2: Do they need to pay more terms of spread? Do
Speaker 2: they need to have wider new issue concessions to clear
Speaker 2: all of the rescumen? Because we're very early in the
Speaker 2: cycle and already we're tapping every market. So you know,
Speaker 2: when one investor points out and compares the Canadian market
Speaker 2: to reaching out under the couch Christians to get you know, change,
Speaker 2: because they're so keen they need every market. I mean,
Speaker 2: we're so early on, do we not start to saturate
Speaker 2: and you know, have some kind of issues clearing and
Speaker 2: then have to move the spread up again.
Speaker 1: I think the supply has been met more than adequately
Speaker 1: with demand. In fact, demand has outstripped the supply and
Speaker 1: you can see this in how some of these new
Speaker 1: issues have traded. And so for the foreseeable future, I
Speaker 1: continue to think that spreads are going to remain tight
Speaker 1: and that there's a lot of investor enthusiasm to play
Speaker 1: the sector. Anisha, Global head of dept Catal Markets at
Speaker 1: Morgan Sandy. Thank you so much for joining us on
Speaker 1: the credit edge. Thank you so much.
Speaker 2: James lot Fee Curry multi asset credit stretches at PIMCO,
Speaker 2: which manages more than two trillion dollars.
Speaker 1: How are you doing? Lot Fee doing great? How are
Speaker 1: you very well?
Speaker 2: Thanks so much for coming back on the show. So
Speaker 2: you're at the event here in New York. You just
Speaker 2: mentioned that the biggest risk is the unwind of the
Speaker 2: AI story. How imbalance the buildout is and it's not sustainable.
Speaker 2: I really want to unpat that. I wanted to tell
Speaker 2: me more about that. What God is going on and
Speaker 2: why is it such a big risk?
Speaker 8: Well, I guess there's two two areas that are would
Speaker 8: be focused on. One, as you said, the way the
Speaker 8: economic rent of the AI buildout cycle is currently accruing
Speaker 8: is very imbalanced. Basically, most of the value if you
Speaker 8: look at the equity market performances go to the semis.
Speaker 8: The relative performance of the hyper scalers, while certainly very
Speaker 8: dispersed in aggregate, you know, you don't see a lot
Speaker 8: of our performance actually relative to the indux and so
Speaker 8: that's not sustainable. In the world in which you know,
Speaker 8: the spenders are spending massive amounts of money and that
Speaker 8: are not able to monetize, it is a world that
Speaker 8: doesn't work right, and so that's one one issue. I
Speaker 8: guess the second risk is timing, because we have to
Speaker 8: remember that the buildout is happening at times zero. The
Speaker 8: adoption is going to happen later. What you don't want
Speaker 8: to happen is a remake of the late nineteen nineties
Speaker 8: where the adoption happens much later, and then in the
Speaker 8: meantime you're in a situation where you overbuilt and then
Speaker 8: you have like a classic sort of boom and bust
Speaker 8: type of Catholic cycles.
Speaker 2: Right, and given most of the high interest rates, I mean,
Speaker 2: does that put more pressure on them.
Speaker 8: To well, this capital has to remain accommodative. That's sort
Speaker 8: of the first order condition, you know, and that means
Speaker 8: that yills have to stay sufficiently low in order to
Speaker 8: accommodate the build out, and then spreads obviously have to
Speaker 8: stay at levels that allow it to Right.
Speaker 1: But does that seem like a likely scenario? Well, so far,
Speaker 1: so good, I think.
Speaker 8: You know, you have to remember that as far as
Speaker 8: the hyperscalers go, they're starting from a position of remarkable strength,
Speaker 8: you know, relative to the late nineteen nineties with telecom
Speaker 8: for example, And these are like buy and large undelovered
Speaker 8: balance sheets, and so there's plenty of debt capacity. Now,
Speaker 8: this conversation may look very different a year or two
Speaker 8: from now if we sort of revisit those metrics. But
Speaker 8: so far, I'm not too worried about lack of debt
Speaker 8: capacity among you know, the large debt companies.
Speaker 2: Right, But how much do the spreads have to widen
Speaker 2: out to come, say, investors for all that instead of unknown.
Speaker 8: Way they have in relative terms. You know, if you
Speaker 8: look at the back end of spread curves, for example,
Speaker 8: you know, the excess spread in thirty year bonds relative
Speaker 8: to ten year bonds has actually widened down quite dramatically.
Speaker 8: So in relative terms, every marginal dollar that you're issuing
Speaker 8: at that thirty year part of the curve is costing
Speaker 8: you more money. So investors are definitely paying attention. They're
Speaker 8: not doing the same thing for the broad and non
Speaker 8: financial universe, where actually curves have been flattening, So there's
Speaker 8: some adjustment.
Speaker 5: I mean, every time.
Speaker 8: You add more supply into the market, the clearing mechan
Speaker 8: is is generally via prices or wider spreads.
Speaker 1: In this yes, but there is just so much and
Speaker 1: every deal gets massively over subscribed. It just seems like,
Speaker 1: you know, almost indiscriminate buying this sort of fomo there,
Speaker 1: you know, missing out on this on all of these trades,
Speaker 1: even though they seem to become cheaper every time.
Speaker 2: But if you're flagging, the unwind is a big risk,
Speaker 2: and spreads just you know, remain relatively tight. They did
Speaker 2: sort of widen us a little bit, but they're still
Speaker 2: pretty tight. Are we going to get hit with a
Speaker 2: big correction at some point that's going to burn investors?
Speaker 8: Well, now, what really loads when these things come? But
Speaker 8: I tend to think that, you know, most corrections tend
Speaker 8: to kind of carry a little bit of a macro flavor,
Speaker 8: you know, into them at the moment. I would say,
Speaker 8: you know, obviously there's a lot of literature on the
Speaker 8: K shaped economy and the haves and the have nots, etcetera.
Speaker 8: But to me, the biggest risk at the moment is
Speaker 8: is still that the current sort of situation in the
Speaker 8: Middle East morse into a full blown supply shock. You know,
Speaker 8: you need resolution basically, you need you need, you need
Speaker 8: to get clarity and and and the longer we wait,
Speaker 8: I think the more problematic that becomes.
Speaker 2: Eventually, you you had mentioned software when you paint on
Speaker 2: the panel's still a problem. You know, definitely there are
Speaker 2: issues there. But I'm interested in you if you have
Speaker 2: you know, does it spill over, does it you know,
Speaker 2: take down BDCs or clos, does it rip through credit markets,
Speaker 2: more globy or is there anything else that might cause
Speaker 2: some contagion.
Speaker 8: Look, I've been so that would be sort of a
Speaker 8: remake of the Energy Playbook and high yel back in
Speaker 8: fourteen fifteen or so far. Actually, it's been a very
Speaker 8: pleasant surprise. You're not seeing any sign of the contingent
Speaker 8: to the product market. I mean, if you look at
Speaker 8: the performance of the broadly syndicated law market x software
Speaker 8: versus software market has done a pretty good job kind
Speaker 8: of isolating that. That left tail a little bit for
Speaker 8: the software sector specifically. To me, this is almost like
Speaker 8: a textbook example of the difference between uncertainty and risk.
Speaker 8: You know, risk is when you know the distribution of
Speaker 8: outcomes and can kind of make a call. You can say, Okay,
Speaker 8: I'm I think the asymmetry is positive. In this case,
Speaker 8: we don't really know how the distribution of outcomes look like,
Speaker 8: and so it's uncertainty and I think until you get
Speaker 8: to a place where you're comfortable as signing it traumal
Speaker 8: value of those businesses. Unfortunately, I think that it's very
Speaker 8: likely that the sector will remain stuck in a.
Speaker 2: Lot of the careery With Pimco, thank you so much
Speaker 2: for joining us on the credit Edge.
Speaker 8: Thanks for having me.
Speaker 2: Jody Lewis senior credit analysts covering travel, restaurants and gaming
Speaker 2: for Bloomberg Intelligence.
Speaker 1: How you doing, Jody.
Speaker 9: I'm doing great, James, excited to be here.
Speaker 2: Thank you so much for coming back on the Credit Edge.
Speaker 2: So talk to me about the consumer. I'm hearing all
Speaker 2: these mixed stories. But our latest guest on the Credit
Speaker 2: Edge tells us that now they're into negative spending.
Speaker 1: What do you make of that?
Speaker 9: And is that real negative spending? Is definitely a bold statement.
Speaker 9: I would say that the issue we're seeing right now
Speaker 9: is that the lower income consumer is definitely trying to
Speaker 9: keep up with the joneses. The higher income consumer is
Speaker 9: still very much spending. We're seeing that in our travel
Speaker 9: survey data which came out just a few weeks ago,
Speaker 9: that they are in fact spending and they are very
Speaker 9: much increasing their spend to match the inflation increase. But
Speaker 9: the lower income consumer definitely a little bit more concerned
Speaker 9: and they're reacting such. They're trading down, they're looking at
Speaker 9: ways to still go and do, but maybe not as
Speaker 9: well as they've done in the past because they are
Speaker 9: filling the pull.
Speaker 2: So it's just the lower income consumer that's suffering, right,
Speaker 2: And that's what we're talking about here. Or is there
Speaker 2: a deeper because you know, I talk to people that
Speaker 2: are not in my classic bucket for low income, who
Speaker 2: are suffering through inflation and through you know, higher fuel costs,
Speaker 2: through everything just being more expensive, they're going to spend
Speaker 2: less on discretionary items. So how much how broad is
Speaker 2: this kind of consumer pressure?
Speaker 9: So I think, James, the key is the amount of
Speaker 9: time that we're in this state. If we're paying over
Speaker 9: four dollars a pump into the end of this year,
Speaker 9: people will be adjusting the way that they're spending. People
Speaker 9: are already adjusting the way that they're buying basic goods,
Speaker 9: but we're not necessarily seeing them holistically pull back on
Speaker 9: experiences because they still do amazingly. Remember the pandemic, They
Speaker 9: see war, they see all these sort of components that
Speaker 9: remind them that they could be dead tomorrow. And so
Speaker 9: thinking of abola, thinking of hantavirus as the most recent
Speaker 9: scares that we're still dealing with, somewhat people are saying, Okay,
Speaker 9: I know that this could all end, and so at
Speaker 9: least for twenty twenty six, as long as I'm able
Speaker 9: to afford it, I will. But something that we added
Speaker 9: in our travel survey this year, which we were excited
Speaker 9: about is asking people how they're paying for their spending
Speaker 9: on travel, and we have a combination. If it's fifty
Speaker 9: three percent of people are paying with credit cards and
Speaker 9: another ten percent is paying with my now pay later,
Speaker 9: So you talk about a credit perspective, that's what's going
Speaker 9: on people's balance sheets. Never mind the fact that twenty
Speaker 9: five percent are dipping into loyalty points, ten percent are
Speaker 9: using tax credits, and then you have, of course personal
Speaker 9: savings that's about forty percent. So people are using all
Speaker 9: parts of their balance sheet to pay for this.
Speaker 1: It's a pretty grim statement. They do it now.
Speaker 2: Otherwise you know you won't be able to do it
Speaker 2: because you'll be dead. But what kind of experience they
Speaker 2: are they are they paying for? I mean, you know,
Speaker 2: travel on an aeroplane to another country has become a
Speaker 2: lot more expensive. But are they just staying at home?
Speaker 2: Are they going to theme parks?
Speaker 1: What are they doing?
Speaker 9: Theme parks are not necessarily catching the wave of the
Speaker 9: consumer spending unfortunately at the moment, well we are seeing
Speaker 9: those people are looking. They want to do beach vacations,
Speaker 9: they want to do national parks. I think that's marrying
Speaker 9: with USA two fifty as well as the FIFA World Cup.
Speaker 9: US consumers however, are looking to say a little bit
Speaker 9: more domestic, so they have paired back their international travel,
Speaker 9: and I think that's a function of the fact that
Speaker 9: airline travel is not as convenient and it's more expensive.
Speaker 9: We already had a few discount airlines drop out of
Speaker 9: the ecosystem. We have a few more where there's merger talks,
Speaker 9: and I think that this discussion then just feeds into
Speaker 9: this fear around air travel and promotes the idea of
Speaker 9: people should just travel locally to the Jersey shore.
Speaker 2: As I like to joke, well, go on a cruise,
Speaker 2: you love cruises, Tell me about cruises.
Speaker 1: How the cruise line's doing in all this.
Speaker 9: Yes, amazingly. For as much as we're seeing people pull
Speaker 9: back on Caribbean, on Mexico, on all the sort of
Speaker 9: key areas Italy that we see usually that dictate cruise travel,
Speaker 9: at the same time we're seeing that people are still
Speaker 9: very much bending on cruises. That the cruise companies are
Speaker 9: talking about advanced booking rates being their highest levels that
Speaker 9: they've ever been, that they're already seeing bookings into next year.
Speaker 9: Very much so, we have Royal Caribbean rolling out on
Speaker 9: their river cruise, and that's something that you sort of
Speaker 9: wonder how they're going to do. And from my understanding,
Speaker 9: the Celebrity River Cruise is doing very well from a
Speaker 9: bookings perspective, and they haven't even really gone to shore yet.
Speaker 9: So I think the key here is that for as
Speaker 9: much as you kind of look for these warning signs,
Speaker 9: as much as you're kind of worried, at the same time,
Speaker 9: the data is indicating that for now we're okay, and
Speaker 9: I think that that will continue through the remainder of
Speaker 9: twenty six because so many people, especially for cruises, pay
Speaker 9: in advance, don't want to back out.
Speaker 2: They do have a little debt as well. Is that
Speaker 2: an opportunity for credit investors who are really hungry for
Speaker 2: yield right now they're looking for opportunities, but is there
Speaker 2: an opportunity to buy into some of that stuff?
Speaker 9: Yes, and no, James, because we so have a few
Speaker 9: names that are what you would call rising stars. So
Speaker 9: Royal Caribbean already got upgraded to investment grade, so that
Speaker 9: price appreciation that you would get from a credit perspective
Speaker 9: is not there so much. Right They're solidly investment grade.
Speaker 9: Carnival just got upgraded again by Moodies, and they aren't
Speaker 9: yet fully investment grade, so there is a component of
Speaker 9: that where if and when they got upgraded by either
Speaker 9: Moodies or SMP so that they're index eligible to investment grade,
Speaker 9: you'll see an uplift just by the fact that there
Speaker 9: are investors who normally can't buy their bonds that all
Speaker 9: of a sudden can And so I think we are
Speaker 9: going to see that. Whether it's this year or next year,
Speaker 9: I think is dependent on the overall economy and dependent
Speaker 9: on how well they do with managing the additional costs
Speaker 9: related to energy, because that will of course affect their margins,
Speaker 9: which will then and delay deleveraging a little bit.
Speaker 1: Jody Lewie with Blueberg Intelligence, thank you so much for
Speaker 1: Johnny's on the credit.
Speaker 2: Edge now Way Global head of the leveraged Finance team
Speaker 2: at bark Is, how you're doing.
Speaker 3: Yes, it's very good.
Speaker 1: Thank you, James, so good to see you. It's such
Speaker 1: an exciting time for credit.
Speaker 2: We have heard all sorts of things today at the
Speaker 2: event about the risky end of credit, the leverage side
Speaker 2: of credit.
Speaker 1: You know, there is a lot of worry about distress.
Speaker 1: There's a lot of worry about default.
Speaker 2: There's a lot of worry about just all the risks
Speaker 2: that's building up, and I'm just wondering, you know, how
Speaker 2: do you see it? Are we heading into a tougher
Speaker 2: second half because we're getting more supply and maybe people
Speaker 2: on the demand side. It's sort of thinking again about
Speaker 2: some of the triple c ras, some of the really
Speaker 2: you know, very challenged credits out there.
Speaker 1: But how are you seeing it? What's the what's the
Speaker 1: trend for the second half?
Speaker 10: I think second half will be busy. From a primary
Speaker 10: supply perspective. We are seeing M and A pipelines building up,
Speaker 10: so we are excited because the first half have been slow.
Speaker 10: And then you heard some of the panelists talking about
Speaker 10: deployment being slow, maybe deliberately so because the bar for
Speaker 10: deployment has been high, But ultimately on the BSL side,
Speaker 10: the technicals are strong. So our investors want to see
Speaker 10: new paper supplies, new investment opportunities, or anything LBOs take
Speaker 10: private carve out I think will be well received and
Speaker 10: look from our perspective as a bank, when they come
Speaker 10: to on the right right, So you're question around how
Speaker 10: do we feel about the market. I guess two aspect.
Speaker 10: One is from our own underwriting perspective. I think we
Speaker 10: are very conscious about some of the macro uncertainties that
Speaker 10: is still very much present, and I don't think any
Speaker 10: of those things will evaporate, and it comes soon. So
Speaker 10: when it comes to underwriting the right credit, pick up
Speaker 10: the right client that we want to bank, I think
Speaker 10: our focus will be high. But on the in terms
Speaker 10: of the distribution into the market, actually acknowledging the type
Speaker 10: of product people want to see, I think the Interestingly,
Speaker 10: you know at the moment that the spread is closer
Speaker 10: to autumn tight, and if anything, both from leverage loans
Speaker 10: and the bond market US and Europe, if you look
Speaker 10: at the spread, it's pretty much at or in the
Speaker 10: in the sense of the European higher bond, actually tighter
Speaker 10: than at the start of the ye around war. So
Speaker 10: it's very clear that the market really want to move
Speaker 10: past the current conflict.
Speaker 1: It's great for the issue, though, but what about the investor,
Speaker 1: because they're not really getting much compensation for macro arias,
Speaker 1: for downgrade, for all the other stuff that you think
Speaker 1: you get more spread for in this environment.
Speaker 10: So interestingly, we had our thirtieth year Higher conference in Austin,
Speaker 10: Texas where we had a record turnout both issuers, investor
Speaker 10: and private equities. And I have to say the sentiment,
Speaker 10: if I can characterize it, probably was one of the
Speaker 10: most optimistic and the level of engagement and energy levels
Speaker 10: were very, very high. So I totally agree with you.
Speaker 10: You know, when you look at the spread and everything
Speaker 10: else from an index perspective, everything's tight. But when you
Speaker 10: look at the underlying credit a lot of the issues
Speaker 10: that we focus on there, current tradings are strong. We're
Speaker 10: not seeing any slowdowns or softness. So I do think,
Speaker 10: notwithstanding the headline news, but when you look at the
Speaker 10: micro level individual issuers, there is a reason why people
Speaker 10: feel optimistic.
Speaker 2: And on the invest side again they are they just
Speaker 2: looking at all in yield and thinking that's high.
Speaker 1: So that's great.
Speaker 2: And also, you know, giving the rates environment, are they
Speaker 2: more key on floating paper than fixed.
Speaker 10: I mean, just pick up your second part of the question.
Speaker 10: I think it depends. The bond market of the recent
Speaker 10: years have been under supplied, certainly from the LBO side,
Speaker 10: because you know, loan as a product is just far
Speaker 10: more superior when it comes to providing flexibility. So whenever
Speaker 10: there is a way to do everything loan. You know,
Speaker 10: a lot of the issuers and this is sponsor owned
Speaker 10: portfolio companies, they will do loans. So so right now,
Speaker 10: given some of the fraction since beginning of the year,
Speaker 10: you know, we've seen more supply into the bomb market.
Speaker 10: So this year the bond market actually from a volume perspective,
Speaker 10: has picked up, so more supply into the bomb market.
Speaker 10: People would like to deploy money there are just because
Speaker 10: it offers convexity, okay, and then the loan market, Look,
Speaker 10: it's slightly different type of investors. The clos. The CLO
Speaker 10: the triple A strip within the clos is still at
Speaker 10: all time time, so I think they're still making money,
Speaker 10: notwithstanding the perception of you know, our things have just
Speaker 10: been too.
Speaker 1: Tight, right. Do you see any stress doing the clos
Speaker 1: figuring the lower rated trunches given all the software concerns
Speaker 1: and other issues that are going on the macroside.
Speaker 10: Not that we're picking up. I mean, as part of
Speaker 10: the panel, we talked about are there any potential distress
Speaker 10: especially around the software as a sector around the corner.
Speaker 10: I think the panelists were in agreement in that not
Speaker 10: in the near future, especially in the BSL space. I
Speaker 10: think the issuers have done a good job when it
Speaker 10: comes to doing a andes and repricings and really pushing
Speaker 10: out maturity. So there is no almost I want to
Speaker 10: talk about. I think I want to say one or
Speaker 10: two percent of all of the software issuance that have
Speaker 10: twenty twenty seven maturity, so no near term maturity issues.
Speaker 10: Probably about just down the twenty percent twenty twenty eight.
Speaker 10: So I think it's still too early to say exactly
Speaker 10: what's going to happen and how is that actually going
Speaker 10: to impact performance?
Speaker 1: Obviously.
Speaker 2: Clos no Way, Global head of Leverage Finance team at Buck's,
Speaker 2: thank you so much for Roonis on the credit edge,
Speaker 2: Shield Hotel, head of the New York private credit practice
Speaker 2: at Mayo Brown.
Speaker 1: How are you doing, Shield, I'm doing well.
Speaker 7: Thanks for having me, James.
Speaker 2: I'm really interested in your view right now. She'll of
Speaker 2: covenants because they are very light. The situation in the
Speaker 2: market is, you know, technically there is a ton of
Speaker 2: demand for yield and there isn't a lot of net
Speaker 2: new supply. That obviously puts the ball in the borrowers court.
Speaker 2: They have been quite aggressive and then we've seen these
Speaker 2: lemies and there have been a lot of issues around that,
Speaker 2: and some of the invests I talked to actually say
Speaker 2: to me that they have so much cash to allocate
Speaker 2: that when they look at the documentation, they don't like it,
Speaker 2: but they have to buy. What kinds of issues are
Speaker 2: you seeing in documentation right now?
Speaker 7: I think you're right. The supply the demand dynamic is
Speaker 7: all a lot of black, right, so there's there's a
Speaker 7: lot of dollars chasing very few good deals. The documentation itself,
Speaker 7: it's tightened a little bit in terms of lum protections
Speaker 7: and things that you wouldn't normally get pre sas apocalypse
Speaker 7: sneaking into these documents, which is good, but not substantially.
Speaker 7: I think the biggest holes in these documents is even
Speaker 7: the definitions, uh, the sizing of some of the financial covenants.
Speaker 7: If there are financial covenants, they're they're cove wide.
Speaker 6: And it seems like a lot of.
Speaker 7: Private credit liners. A lot of what goes into their
Speaker 7: decision making process is sponsor reputation. You know what they
Speaker 7: currently have with that sponsor, industry and size of a deal, right,
Speaker 7: so if it's if it's a significantly sized deal with
Speaker 7: a sponsor that you have a ton of reps with
Speaker 7: and you're in a ton of credits with them, and
Speaker 7: you like the industry, you're going to rely less on
Speaker 7: the documentation for protection and rely on that relationship.
Speaker 2: So the stress on private credit generally the fear of
Speaker 2: you know, defaulse, non cruel's, bad recoveries, you know sas pocalypts,
Speaker 2: all that stuff.
Speaker 1: You think it's overblown in some I do.
Speaker 6: I do.
Speaker 7: We're we're looking at a mature market now, and you
Speaker 7: know stress, stress is normal, it's it's actually healthy. I
Speaker 7: don't think it's it's something that is unique to private credit.
Speaker 7: I think you're you're going to see that that level
Speaker 7: of stress in in all markets, including the syndicated market,
Speaker 7: and it's just part of the credit cycle.
Speaker 2: Still that we've got this fair, we've got big redemptions,
Speaker 2: got a lot of concern around marks, around other aspects
Speaker 2: of private credit. Where are the risks for you in
Speaker 2: this market?
Speaker 7: So I think the biggest risk coming out of all
Speaker 7: of this is regulation, right. I think that as regulators
Speaker 7: start to look at the asset class with a stronger lens,
Speaker 7: that that could take away one of the advantages of
Speaker 7: the private markets in terms of being nimble and being
Speaker 7: able to act quickly.
Speaker 1: She he'll to tell head of the New York private
Speaker 1: credit practice at Mayer Brown, thank you so much for
Speaker 1: joining us on the credit edge.
Speaker 6: Thanks James.
Speaker 2: It's Johnny, head of structured credit at Third Point. She
Speaker 2: sets on the Funds Risk Committee and overseas investments in
Speaker 2: residential and commercial mortgage backed securities as well as consumer finance.
Speaker 2: You were on the show not that long ago, back
Speaker 2: by popular demand. You told us that at that time
Speaker 2: in March that quote, this is probably one of the
Speaker 2: most exciting times to be a credit investor. So I
Speaker 2: just wanted to catch us up on the last three
Speaker 2: months in which you had those exciting times. How exciting
Speaker 2: has it been since we last spoke.
Speaker 8: Thanks for having me back, James.
Speaker 4: I would say probably right after we had our conversation
Speaker 4: is when the credit markets had sort of their first
Speaker 4: blip in the markets, and it wasn't force selling, but
Speaker 4: it was more of companies that needed to still issue
Speaker 4: debt in some form needing liquidity in a span of
Speaker 4: about ten days in March, so there was interesting opportunities there.
Speaker 4: I think some of the activity and credit is more brewing,
Speaker 4: and I think we'll see it probably in the back
Speaker 4: half of this year.
Speaker 2: So when we spoke, you talked about forced selling. Are
Speaker 2: you seeing that?
Speaker 4: So, I think force selling is not coming in the
Speaker 4: exact form yet. I think where you will see it
Speaker 4: is higher rates suggest that commercial real estate will have
Speaker 4: more pain because I think a lot of people were
Speaker 4: waiting for a refinancing wave. Corporate credit, you have a
Speaker 4: lot of lmes that are hitting maturity walls at the
Speaker 4: end of this year and next that will be another
Speaker 4: refinancing pressure. And I think the third is there was
Speaker 4: a lot of focus on BDC's at the beginning of
Speaker 4: the year. A lot of BDCs also have COLO exposure,
Speaker 4: and we think in the back half of the year
Speaker 4: you may see pressure to sell as it's harder to
Speaker 4: sustain dividends and.
Speaker 2: Also they're getting more redemption so they need to fund those.
Speaker 2: Is that going to be another pressure point, I.
Speaker 4: Think potentially, although I think the market has been quite
Speaker 4: resilient in private credit where there are more captive buyers
Speaker 4: out there, whether that be insurance other sorts of longer
Speaker 4: dated funds. So I think you've seen more of a
Speaker 4: rebalancing across fund portfolios out of BDC's and less for
Speaker 4: selling there. I think you can see it though potentially
Speaker 4: in Colos because they are a more liquid market, and
Speaker 4: you might see even equity start to pick in those structures,
Speaker 4: which means it doesn't have any sense in the portfolio anymore.
Speaker 4: So I think it'd probably come more from more publicly
Speaker 4: traded clos and corporate credit that's sitting in BDC as
Speaker 4: opposed to traditional private But.
Speaker 2: When you look at Colos right now, the triple A
Speaker 2: piece at least very very tight, which would suggest not
Speaker 2: a lot of stress or at least concern about it.
Speaker 2: We know about the software issue, we know that's brewing,
Speaker 2: we know that you know there are other issues potentially,
Speaker 2: but what really do you think is something.
Speaker 1: That might tip clos over? I mean, how would that
Speaker 1: actually happen?
Speaker 4: Yeah, So I think since we last spoke, software prices
Speaker 4: have actually rallied and so and you've seen two things happen.
Speaker 4: You've seen anything not software sort of tighten on a
Speaker 4: spread basis, and you've seen software rally as well. So
Speaker 4: the creation costs for a us COLO equity has become tighter,
Speaker 4: which means you're seeing less creation on that side of
Speaker 4: the market, where I think you'll see the pressure in
Speaker 4: clos is more when software starts to play out. And
Speaker 4: also you have other pressures. You have home building pressure
Speaker 4: right now because we're in a high rate and environment.
Speaker 4: You have issue on the chemical sector as well because
Speaker 4: of oil. So I think there will be other defaults
Speaker 4: within colos that cause issues. And I think the triple
Speaker 4: as are type, but they're still one of the widest
Speaker 4: triple a's out in the market. You will see it
Speaker 4: more at the double B triple B type of level
Speaker 4: potentially if there are downgrades in triple b's, because they
Speaker 4: are a big portion of insurance portfolios. So I think
Speaker 4: the force selling comes not from necessarily economic default on
Speaker 4: day one, but could be downgrades for something else that
Speaker 4: forces an uneconomic reason to sell.
Speaker 2: And at that point the cilos have to sell loans
Speaker 2: that are low quality at a steep discount, correct, at
Speaker 2: which point you might jump in on an opportunity if
Speaker 2: it makes sense. But is this a bigger issue for
Speaker 2: the market or is it? I mean the sense that
Speaker 2: we get from talking to investors on the macro level
Speaker 2: is that really all this stuff's contained, we kind of
Speaker 2: know about it. It's not going to affect us. We're
Speaker 2: just going to carry on buying as much as we
Speaker 2: can of everything else, and we'll be Okay, what do
Speaker 2: you how do you see that?
Speaker 4: So I think it's really if you're sitting at a
Speaker 4: very large alternative asset manager right now, you're hitting the
Speaker 4: buy button every day, and so most of those investors
Speaker 4: will say credit spreads are going tighter, and I think
Speaker 4: with what I said in terms of AI spending and
Speaker 4: what we've seen generally with the economy, it feels like
Speaker 4: we could see credit spreads tighter. That being said, I
Speaker 4: do think there are issues beneath the surface where there
Speaker 4: will still be for selling. And if insurance companies are
Speaker 4: buying the entire triple B stack of colos and there
Speaker 4: are a few downgrades, they can't hold that risk anymore.
Speaker 4: And it might be a parallel to what we saw
Speaker 4: in March of twenty three with the banking crisis, where
Speaker 4: CMBs got downgraded from triple B and became a force
Speaker 4: seller product. So you might see a version of that.
Speaker 4: And frankly, for a place like Third Point, we don't
Speaker 4: have to have a huge dislocation in order to make
Speaker 4: a very compelling return across our funds. If you're managing
Speaker 4: two hundred billion much harder to make that depth work,
Speaker 4: so that.
Speaker 2: Effects insurance companies and then presume me that has some
Speaker 2: kind of knock on effect. I mean, certainly in terms
Speaker 2: of sentiment. But is there a bigger full across credit
Speaker 2: markets you think?
Speaker 4: I think it's It may be still more episodic. I
Speaker 4: think the other thing that we haven't seen play out
Speaker 4: fully as what is the strain on the consumer overall?
Speaker 4: And that may cause a little bit of a risk
Speaker 4: off mode or at least a recalibration of risk assumptions.
Speaker 4: But I don't think it's a contagion type of scenario.
Speaker 4: I think you will find dislocated sectors. The COLO market
Speaker 4: also in the US is a trillion dollar so if
Speaker 4: it starts to move, it will have implications on the
Speaker 4: underlying levered loans and the liquidity availability there.
Speaker 2: And private market is also under a love of stress.
Speaker 2: You expect private credit loans to selling it discount just
Speaker 2: because people need to tie up their portfolios.
Speaker 4: Well, we've seen private credit loans traded a discount. Obviously
Speaker 4: you have public BDCs that are trading at a discount,
Speaker 4: but we've also seen private credit loans traded a discount,
Speaker 4: but I think that the again resilience for the asset
Speaker 4: class has been I think stronger than expected. Of course
Speaker 4: you're seeing headlines around redemptions broadly, but actually a lot
Speaker 4: of the paper that's transacting has been a not as
Speaker 4: much of a discount. Outside of software, where you have
Speaker 4: seen discounts that could be twenty thirty points or there.
Speaker 1: Sean Nisam with the point, Thank you so much for
Speaker 1: joining us on the credit edge.
Speaker 4: Thank you James for having me back.
Speaker 2: So I'm here with Scott Goodwin, managing partner of Diameter
Speaker 2: Capital Partners, a twenty eight billion dollar global credit alternative
Speaker 2: asset manager.
Speaker 1: How you doing, Scott, great, Thanks James for having me.
Speaker 6: It's a privilege to be here.
Speaker 1: So you invest across public and private markets, including clos,
Speaker 1: direct lending, asset based finance, and real estate credit. But
Speaker 1: you have said not that long ago that private credit
Speaker 1: portfolios are dangerously concentrated in software and other asset like
Speaker 1: businesses that may be vulnerable to AI disruption. Tell me
Speaker 1: more about that.
Speaker 5: Sure, I mean, if you look at and we're just
Speaker 5: talking here about the left in direct lending market, the
Speaker 5: one point five trillion dollar market, which is about one
Speaker 5: third SASS and if you take the publicly reported portfolios
Speaker 5: from the people who run these portfolios, they'll tell you
Speaker 5: the numbers are pretty low.
Speaker 6: There's a good chart our in our.
Speaker 5: Sown presentation on this, which is on our LinkedIn page,
Speaker 5: that shows what we think the numbers are using Claude,
Speaker 5: using GPT, using Gemini, looking through each loan, and it
Speaker 5: looks like about half the loans across the private credit
Speaker 5: space on aggregate have some sort of AI risk factor
Speaker 5: their software, their business services, their IT services, their healthcare,
Speaker 5: IT insurance broker. That's not to say these are all
Speaker 5: bad loans. This is just to say, hey, you're lending
Speaker 5: it ninety eight or ninety nine cents, you're trying to
Speaker 5: get your coupon back and par you don't have the
Speaker 5: total return of an equity. Why would you ever have
Speaker 5: half your portfolio exposed to one risk factor? Crazy portfolio
Speaker 5: management and really bad risk management.
Speaker 2: Right, you've actually used the words almost criminal to describe
Speaker 2: the high concentration in a single sector. But on software,
Speaker 2: I mean, we've kind of gone through this whole panic
Speaker 2: and fear and everyone dumping them to it, sort of
Speaker 2: bouncing back a little bit, and people saying, well, hang
Speaker 2: on a minute, there is some value there. Not every
Speaker 2: software firm gets displaced by AI. So what's the trade
Speaker 2: for you? How do you play AI or how do
Speaker 2: you play software?
Speaker 6: We agree with that.
Speaker 5: We don't think all software is bad, but it's going
Speaker 5: to be a very long cycle. I think it's too
Speaker 5: early in software to necessarily know.
Speaker 6: Who the early winners and who the winners and losers are.
Speaker 5: I would much rather buy a service now or a
Speaker 5: Salesforce dot com stock that's down materially, that has a
Speaker 5: real large mode around their business, a big balance sheet
Speaker 5: they can pivot their business. Then by at night, if
Speaker 5: a software loan has gone from say par to ninety
Speaker 5: five cents, I have five points of upside. I don't
Speaker 5: know what the terminal value is of that business, and
Speaker 5: they're levered and they don't generally out of cash. I'd
Speaker 5: much rather buy the public, large public companies. So I
Speaker 5: don't think the debt in that sector is priced right
Speaker 5: relatively to the public equities. Given if you get it
Speaker 5: wrong on the debt, you're going to have very low recoveries.
Speaker 5: Public BSL recoveries in the tech sector have been between
Speaker 5: ten and thirty cents the past five years.
Speaker 1: AH the fullest sellers right now in the market, BBCs, sailors,
Speaker 1: anything else that needs to get out of these things.
Speaker 5: The force selling from the BBC's is episodic. It tends
Speaker 5: to come around their redemptions. There were force sellers six
Speaker 5: eight weeks ago. You're starting to see another round of
Speaker 5: redemptions come through. We are seeing some foreselling. I think
Speaker 5: as the banks start to tighten their terms, the foreselling
Speaker 5: so far as redemption driven. It's not driven by margin
Speaker 5: calls by bank saying you can't have x amount of
Speaker 5: SaaS in your portfolio or x amount of AI factor
Speaker 5: risk in your portfolio. I think as the banks start
Speaker 5: to tighten their terms and we're beginning to see that,
Speaker 5: you will see at an incremental level for selling. As
Speaker 5: far as clos you'd be surprised there has it. If
Speaker 5: you look at the data. We've obviously taken our SaaS
Speaker 5: exposure down materially and have since twenty twenty three when
Speaker 5: we first got worried.
Speaker 6: About the air risk to SaaS.
Speaker 5: But if you look at the public data on cels,
Speaker 5: there haven't been that many COLO managers that have really
Speaker 5: changed their SaaS exposure or really changed their AI factor
Speaker 5: risk exposure. So that tells me that either they're paralyzed
Speaker 5: and they just own the index and they don't know
Speaker 5: what to do, or they don't think it's that big
Speaker 5: of a risk, but.
Speaker 1: At some point it might become a risk sound needs
Speaker 1: to be sold.
Speaker 5: You look at sector sell offs. I'll compare this to
Speaker 5: energy in twenty fourteen. The first leg of a sell off,
Speaker 5: very high correlation. Then you start to sort winners and losers.
Speaker 5: The process that's going on right now in software, both
Speaker 5: private and public loans and the equity market is starting
Speaker 5: to sort winners and losers. I think it's kind of
Speaker 5: too early just to know, so we're treading carefully.
Speaker 6: It's somewhat obvious who the early losers are.
Speaker 5: We don't want to buy the distressed out of the
Speaker 5: early losers, but we have, you know, a lot of
Speaker 5: capitals stored up ready for the opportunity. If some of
Speaker 5: the better companies that we can have real modes start
Speaker 5: to trade it at big discounts, it sounds like.
Speaker 2: A big problem, though, you know, given the extent of
Speaker 2: it that you've mentioned, and also how many people are
Speaker 2: in clos how many people think that they are you know,
Speaker 2: pretty solid in terms of you know, they will survive
Speaker 2: it more difficult macro and rates environment. But if this
Speaker 2: was one revel, is there a bigger, more contagion impact
Speaker 2: to cross credit.
Speaker 5: I don't think it's a systemic problem because it's just
Speaker 5: not a big enough market. So lefin direct lending is
Speaker 5: a you know, a trillion five BSL is a bit bigger,
Speaker 5: you know a little bit bigger than that. SaaS is
Speaker 5: thirty percent of one market, high teens percentage of the other.
Speaker 5: If you think about the AI risk factor, it's a
Speaker 5: larger number. Do I think you start to eat into
Speaker 5: triple A clos No, but certainly the double B and
Speaker 5: Triple B tranches of the clos in those managers that
Speaker 5: aren't prudent, proactive portfolio managers could really be exposed to
Speaker 5: taking losses and we haven't seen that in a long time.
Speaker 5: And then the question is who owns the double B
Speaker 5: and triple B tranches.
Speaker 2: I think a lot of people would yield chasing in
Speaker 2: exactly those places, and the equity as well, so they
Speaker 2: might get get themselves into trouble.
Speaker 1: Yeah, but that is still you think contained, it's not
Speaker 1: gonna rip through.
Speaker 5: I don't think it's a systemic problem if if at
Speaker 5: some point some insurance company has too much triple B
Speaker 5: COLO with SaaS exposure, that will create a scare in
Speaker 5: the insurance space. But I would say that the bigger
Speaker 5: risk factor for for insurance longer term is in the
Speaker 5: asset backspace, where there's a much larger exposure than there
Speaker 5: is in the COLO space. And the asset backed problems
Speaker 5: so far have been contained to basically frauds and cock roaches.
Speaker 5: You haven't seen a more systemic issue there, and and
Speaker 5: and we don't see.
Speaker 6: That in the near term on the horizon either.
Speaker 1: Is it big enough problem for BDCs to take one
Speaker 1: of them down?
Speaker 5: You mean, for a BDC to effectively default and lose
Speaker 5: their I mean they're there, they will think, I think yes,
Speaker 5: is the answer that you know there are some BDCs
Speaker 5: that are trading at you knowero point six point seven
Speaker 5: of gross asset value, the more stress or distressed ones,
Speaker 5: So yeah, I think you could see that. Is is
Speaker 5: it a broad based problem? No, And we actually think
Speaker 5: you know, we were short a lot of BDC's last
Speaker 5: year that had too much SaaS and AI risk factor exposure.
Speaker 5: Now I would say we're pretty neutrably positioned. But there's
Speaker 5: gonna be opportunities when when fear is high to buy
Speaker 5: those BDCs that actually don't have this exposure but are
Speaker 5: just being thrown out.
Speaker 6: Like the baby with the bathwater.
Speaker 3: Right.
Speaker 2: But if you look at the panic right now to
Speaker 2: some redemptions and gates and all that stuff, which you
Speaker 2: know doesn't seem that problem, methtic thun immensely if one
Speaker 2: of them goes down. You can imagine the freak out
Speaker 2: across credit markets.
Speaker 5: But let's see, that'll be an exciting day, Diameter because
Speaker 5: we'll be sitting there looking to buy the high quality
Speaker 5: wrestler it's getting thrown out.
Speaker 1: Great stuff.
Speaker 2: Scott Goodwin with Diameter Capital Partners. Thank you so much
Speaker 2: for being on the Credit Edge.
Speaker 5: Thanks so much, James.
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Speaker 1: week on the Credit Edge.