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Speaker 1: Hello, Welcome to the Credit Edge, a weekly markets podcast.

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Speaker 1: My name is James Crombie. I'm a senior editor at Bloomberg.

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Speaker 2: And i am Ruder Backman, chief structured finance strategist at

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Speaker 2: Bloomberg Intelligence. This week, we are very pleased to welcome

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Speaker 2: Tom Moyevsky, a founder of Eagle Point Credit, their fourteen

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Speaker 2: billion dollar pride credit manager. How are you, Tom?

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Speaker 3: Doing very well? Thank you.

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Speaker 2: Tom set up Eagle Point in twenty twelve, turning it

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Speaker 2: into one of the world's largest coo Ikady investors. The

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Speaker 2: film has also explained to special definance, significant brisk transfers,

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Speaker 2: and infrastructure credit, as well as other opportunities.

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Speaker 1: So lots to discuss there. Let's start with software. You

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Speaker 1: buy loans to software companies. That sector is under a

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Speaker 1: lot of pressure. The fear is that a lot of

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Speaker 1: the businesses will be replaced by AI and that the

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Speaker 1: assets underlying the debt are actually worthless. Loan prices fell

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Speaker 1: a lot at the start of the year as the

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Speaker 1: AI story really took off. They've recovered a little bit,

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Speaker 1: but the debt market still seems to be telling us

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Speaker 1: that there's a big problem. Where do we go from here?

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Speaker 3: The concerns are fair, the timing may be subject to question.

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Speaker 3: In my opinion, I'll draw an analogy back to a

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Speaker 3: little ipo I think in nineteen ninety seven Amazon dot Com.

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Speaker 3: It's all worked out for them. Today you could read

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Speaker 3: on Bloomberg probably every day six months after that IPO

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Speaker 3: of the death of retail. I'm sure there was some

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Speaker 3: story or something that talked about how retail was over.

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Speaker 3: And indeed Amazon's just their retail revenue was over two

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Speaker 3: hundred billion dollars last year, a lot of money. It

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Speaker 3: fundamentally changed retail, but it didn't end it. And if

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Speaker 3: you look across many CMBs transactions, the lowest vacancy rate

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Speaker 3: is actually in the retail sector compared to US industrial

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Speaker 3: or other things like that. That's from twenty nine years ago.

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Speaker 3: Just to kind of put in context another significant shift

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Speaker 3: in an ecosystem. Bring forward today to the rollout of

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Speaker 3: AI for businesses like ours. Unfortunately, AI is still an

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Speaker 3: additional cost. We're hopeful it'll be a savings over time,

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Speaker 3: and that's what we're telling ourselves as we spend a

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Speaker 3: lot of money and we see checks going out to

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Speaker 3: all these different AI providers. When we think about software

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Speaker 3: and its potential obsolescence or software as we knew it

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Speaker 3: proverbially yesterday. I think answers very based on quite a

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Speaker 3: number of things. First, how essential is the software picture

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Speaker 3: a company like American Airlines, They're probably not going to

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Speaker 3: have a clawed app replace their central reservation system. I'll

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Speaker 3: go so far as to say there's probably some green

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Speaker 3: screens somewhere still involved in their reservation system. On the

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Speaker 3: other hand, a company like us, in our vacation tracking tool,

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Speaker 3: should we have a little clawed app that can gin

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Speaker 3: that up very quickly?

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Speaker 2: Yes?

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Speaker 3: Our order management and portfolio management system. Is that going

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Speaker 3: to be replaced by some sort of AI developed app

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Speaker 3: anytime soon? Probably not. That's the DNA of the lungs

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Speaker 3: and heart and nervous system of our company. So when

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Speaker 3: you look at the impact of AI, both on software

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Speaker 3: and more broadly, you have to think of the essentialness

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Speaker 3: of that software, that legacy software tool and I'm sorry

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Speaker 3: to use the word legacy to describe most software those

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Speaker 3: designed proverbally yesterday. How important is it? How critical is

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Speaker 3: it to a business? Every company wants to save money,

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Speaker 3: Every company wants to use AI to do better. Whether

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Speaker 3: you're in the software business or otherwise. I think the

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Speaker 3: market has the trend right the direction, but in my

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Speaker 3: experience the slope is far less steep in the beginning years,

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Speaker 3: but may ultimately be more severe even than people are predicting.

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Speaker 3: But I think of that as worst case five potentially

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Speaker 3: fifteen years out in the future. To frame it in

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Speaker 3: the I guess I joined a large bank in two thousand,

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Speaker 3: you still had to apply to get an email account.

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Speaker 3: Unthinkable today, but back you know, that was twenty five

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Speaker 3: years ago. Those were still things that we were getting

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Speaker 3: rolled out, even though email had widely been around. So

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Speaker 3: when we look when we're looking at any software credit

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Speaker 3: or any credit, frankly, one of the things is impact.

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Speaker 3: Assessing the potential impact of AI. I think it's real.

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Speaker 3: I think it will happen, but I do not think

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Speaker 3: it happens overnight.

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Speaker 1: So what does that mean for the loans? So for

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Speaker 1: those who don't know, you know, duration, the maturity schedule

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Speaker 1: of a lot of these things. You know, why is

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Speaker 1: the length of time important in this context?

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Speaker 3: Sure so, most syndicated loans and even private credit loans

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Speaker 3: typically have maturities six seven, eight years. We can move

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Speaker 3: around a little bit from there that said, I don't

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Speaker 3: remember the last loan that paid off at maturity, and

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Speaker 3: that very few companies want to have their long term

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Speaker 3: debt move to the current portion of their balance sheet.

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Speaker 3: I'm sure it's happened once or twice, but typically you'd

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Speaker 3: expect to see a syndicated or private credit loan refinance

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Speaker 3: sometime between two and four years after it's originated. And

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Speaker 3: what that means is quite a few companies that our

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Speaker 3: borrowers are debtors at the market today probably have one

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Speaker 3: more bite at the apple to refinance before they face

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Speaker 3: a real problem. That's not one hundred percent the rule,

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Speaker 3: but I think it's significantly the case. One of the

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Speaker 3: things we like in the market, and we've certainly you know,

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Speaker 3: you've talked about and others others here have written about

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Speaker 3: the give or take two trillion dollars private credit market,

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Speaker 3: and for a while there were some articles getting written.

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Speaker 3: Is the private credit market eating the syndicated market's lunch?

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Speaker 3: And for listeners, the syndicated credit market is going to

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Speaker 3: be larger companies. This is going to be Hilton Hotels,

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Speaker 3: Dell computer companies of that size and scale. Private credit

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Speaker 3: typically smaller, but not always and there were a number

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Speaker 3: of companies maybe a year or two ago that were

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Speaker 3: in the syndicated market that refinanced their debt into the

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Speaker 3: private credit market. In many cases they paid, greed to

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Speaker 3: pay a higher spread over base rates. And why did

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Speaker 3: they do that. Their revenues or EBADA had fallen twenty

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Speaker 3: to thirty percent. They needed to be more levered. There

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Speaker 3: were aggressive firms, maybe even vultures, buying up their debt

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Speaker 3: in the syndicated market, and they just wanted to get

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Speaker 3: to a spot where they could work things out privately

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Speaker 3: with two or three lenders who would hopefully be more understanding,

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Speaker 3: but they'd have to pay them more. At the same time,

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Speaker 3: as companies do better, private credit companies all want to

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Speaker 3: graduate to the syndicated market because your cost of debt

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Speaker 3: is lower. If private credits five hundred or six hundred

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Speaker 3: over syndicated credits in action directionally three hundred bases points over.

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Speaker 3: There's no one in the world who wouldn't like lower

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Speaker 3: debt costs. So what we see is, even if it's

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Speaker 3: a large cap company that might be facing some AI headwinds,

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Speaker 3: I see the potential for the private credit market to

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Speaker 3: refinance them out and other companies will probably achieve some

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Speaker 3: significant cost savings and might be able to move from

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Speaker 3: private credit up to the syndicated credit market. That companies

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Speaker 3: have a couple of years of runway on their debt.

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Speaker 3: We look across and we publish this and are on

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Speaker 3: our website of all the loans we have exposure to

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Speaker 3: in our syndicated programs, I'm going to say less than

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Speaker 3: two or three percent mature in the next eighteen months.

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Speaker 3: So companies in general have a good bit of runway

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Speaker 3: on their debt. They might not like the terms they

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Speaker 3: have to refinance that, but in general, I believe there'll

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Speaker 3: be a market for most, if not all companies to

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Speaker 3: continue refinancwer.

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Speaker 1: So it's a company that's kind of in long term declimb,

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Speaker 1: but short term there's an opportunity on the debt.

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Speaker 2: Yes, yeah, what are you describing with your exposures. That's

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Speaker 2: actually very common across CROs. You do find that when

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Speaker 2: you look at klatropool and you track it over time,

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Speaker 2: the maturity is the new maturities. They'll always disappear from

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Speaker 2: the pools several years, sometimes ahead of the time before

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Speaker 2: they actually come due. So there's sort of their wave

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Speaker 2: of maturities in the collateral pool that moves forward in

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Speaker 2: time as we move forward in times, so we never

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Speaker 2: actually get to the point where we have a wall

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Speaker 2: of maturities hitting the CLO market all at the same

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Speaker 2: time in the collateral pools. I think the difficulty with

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Speaker 2: the AI exposure of SAS companies is that AI is

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Speaker 2: fairly new, so I think a lot of people are

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Speaker 2: trying to figure out what exactly the scenario is that

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Speaker 2: will play out, and different people have different concerns in mind.

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Speaker 2: I mean, some people have the concern or have the

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Speaker 2: concern that the pricing models that the SaaS companies are

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Speaker 2: using it's no longer going to work because currently their

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Speaker 2: pricing proceed and if you have an AI like a

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Speaker 2: cloud Cowork, then you might have far fewer employees as

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Speaker 2: a result of fewer seats, and so for the SaaS companies,

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Speaker 2: the seat pricing is so long ago going to work.

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Speaker 2: Other companies then, or other investors have the concern that

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Speaker 2: we may see a situation where people who currently buy

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Speaker 2: software will just build it internally, which you alluded to before,

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Speaker 2: which might happen for smaller applications. Another concern is that

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Speaker 2: it might actually be very easy and cheap and quick,

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Speaker 2: using AI to replicate some of the largest SaaS companies offerings,

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Speaker 2: and that in turn would result in an increased competition

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Speaker 2: that in turn would put pressure on margins as SaaS companies.

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Speaker 2: So there's a variety of concerns and it's difficult to

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Speaker 2: figure out what exactly this scenario is going to be

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Speaker 2: that will end up in I think it's difficult to

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Speaker 2: make a great assessment as earlier as now because the

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Speaker 2: field that's just so wide open with AI, because it's

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Speaker 2: so new, and because the improvements in in AI are

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Speaker 2: so fast.

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Speaker 3: I think what you're saying is fair direction. I agree

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Speaker 3: with the sentiments you've shared. That maturity wallpoint is actually

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Speaker 3: very very true. If you look at our public filings

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Speaker 3: over the last ten years, the maturity wall chart basically

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Speaker 3: looks the same every single year. We just changed the

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Speaker 3: dates one year. I'm sure we actually recalculated, but we

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Speaker 3: probably don't have to and could convey the same message broadly. Though,

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Speaker 3: what you're talking about is in line with what I'm

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Speaker 3: talking about of we need a little more time to

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Speaker 3: see the real impact of this. We know there will

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Speaker 3: be an impact. I actually think it will be more

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Speaker 3: severe than maybe many of the naysayer say. However, I

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Speaker 3: think it will be later. The pace of innovation or

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Speaker 3: the implementation of innovation just takes longer. I saw a

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Speaker 3: stat recently, and I don't remember the source, but it

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Speaker 3: was it was something on the lines of seventy percent

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Speaker 3: of Fortune five hundred companies still use mainframes for calculations.

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Speaker 3: I'm not in data and operations. I'm sure they're not

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Speaker 3: using punch cards and real to real tapes that you

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Speaker 3: might have seen in a nineteen sixties James Bond movie

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Speaker 3: or something like that. But that's still technology that's used,

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Speaker 3: and certainly there's more efficient ways to do things. And

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Speaker 3: you know, probably my iPhone has more computing power than

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Speaker 3: mainframes did ten or twenty years ago. So I agree

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Speaker 3: with the sentiment you're sharing. I think we have a

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Speaker 3: longer runway than the market predicts. It doesn't mean it's

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Speaker 3: smooth sailing for the next few years, but it's also

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Speaker 3: not armageddon. One of the other things we've seen in

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Speaker 3: AI or the AI threat coming around a one particular

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Speaker 3: loan an insurance broker called Alliant, which is principally a

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Speaker 3: high net worth of property and casualty insurance broker. Back

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Speaker 3: in January February of this year, there was an article

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Speaker 3: went around or some chatter in the market that AI

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Speaker 3: is going to cost them their business, and the loan

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Speaker 3: traded down three points and you know, in a very

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Speaker 3: short period of time it rebounded those in three points

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Speaker 3: and probably a very similar period of time, and it

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Speaker 3: was a missing opportunity.

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Speaker 2: Frankly, I want to come at this point. I think

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Speaker 2: you have sort of alluded to it already twice, which

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Speaker 2: is not so much a fundamental point which we addressed before,

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Speaker 2: but the sentiment important, and one concern I would have

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Speaker 2: is that we are in a situation where, because it's

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Speaker 2: so uncertain what will happen, these companies will post decent

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Speaker 2: results fundamentally the current contracts are currently have, they're still running,

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Speaker 2: the financials will look fine, but a lot of investors

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Speaker 2: will start to worry that in future they will not

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Speaker 2: be fine, and at that point it will become very

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Speaker 2: difficult for them to refinance make during that. So you

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Speaker 2: sort of alluded to that before when you said, well,

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Speaker 2: you know, some of these companies may have to get

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Speaker 2: refinanced from a different investor base than from their current

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Speaker 2: investor base. But this crazy situation where we might end

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Speaker 2: up in a with a self fulfilling prophecy. Yes, currently

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Speaker 2: things look fine. Yes, eventually thinks might go wrong, be

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Speaker 2: not sure, but that will take time, but the impact

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Speaker 2: on the businesses will materialize earlier simply through the funding market,

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Speaker 2: and we may have the self fulfilling prophecy where the

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Speaker 2: current investor base says, well, I think these businesses could

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Speaker 2: too poorly. I think all the other investors that I

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Speaker 2: know in my market think the same thing. So I'm

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Speaker 2: not going to refinance this company because I'm afraid no

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Speaker 2: one else I know will do and tends the company

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Speaker 2: will go bust, even though different fundamentals currently still look good.

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Speaker 2: And then comes the question of can the company actually

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Speaker 2: find someone else to fund them?

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Speaker 3: And some non AI examples of that. There was a

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Speaker 3: company in the syndicated loan market called Outer Wall which owned,

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Speaker 3: among other things, red Box, which were in supermarket DVD rentals,

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Speaker 3: which was in the state of the art twenty years

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Speaker 3: ago I'm now laughable, but multiple times, even in their decline,

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Speaker 3: they able to refinance another company, am General, that makes

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Speaker 3: hummers for the military and maybe even the commercial ones.

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Speaker 3: I forget similar thing of trend very much in the

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Speaker 3: wrong direction, but able to continue to access the capital

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Speaker 3: markets as long as they have some degree of revenue

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Speaker 3: and EBITDA. That said, there will be a day of

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Speaker 3: reckoning for any of these declining companies. But the mitigant

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Speaker 3: that we see is time is your friend as a lender,

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Speaker 3: even if they have to take their SOFUR plus three

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Speaker 3: hundred loan and refinance at private credit at SOFA plus

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Speaker 3: six hundred and then three years later refinance it into

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Speaker 3: a distress lender at SOFA plus eight hundred. If it's

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Speaker 3: that or default, you're going to you know, you're going

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Speaker 3: to pay up on the debt versus lose all your equity.

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Speaker 3: So it's it's maybe even analogous to real estate when

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Speaker 3: you interest rates moved up, many would have called that

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Speaker 3: a slow moving train wreck. You know, if you have

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Speaker 3: a three percent mortgage and all of a sudden, you know,

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Speaker 3: mortgages are now seven percent and you own a you know,

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Speaker 3: not so fancy office building in midtown, you're fine until

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Speaker 3: you get to your maturity date on your loan. And

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Speaker 3: we could see you know, similar things like that. Not necessarily,

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Speaker 3: that's the corporate owners are going to get to the

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Speaker 3: maturity date, but it will take a long It will

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Speaker 3: take multiple years for all of this to flesh out.

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Speaker 3: And what we're seeing in the credit markets, both the

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Speaker 3: CLO market and actually the BBC market where we're a

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Speaker 3: very large investor in the private credit market in terms

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Speaker 3: of fun financing, we're seeing the baby thrown out with

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Speaker 3: the bathwater, by and large when we look at this,

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Speaker 3: and we have, in addition to our COLO equity position,

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Speaker 3: and we believe we're one of the largest holders of

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Speaker 3: COLO equity in the world, which gives us insight into

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Speaker 3: thousands of different credits all around the world, both in

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Speaker 3: the US and Europe. We're also, we believe, one of

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Speaker 3: the largest at eagle point one of the largest non

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Speaker 3: bank financiers of BDCs and private credit funds. And this

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Speaker 3: is a strategy we set up six or seven years ago.

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Speaker 3: We actually call it our defensive income strategy. And the

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Speaker 3: genesis of it, we were talking about bubbles and private

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Speaker 3: credit long before the headlines were getting written, back when

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Speaker 3: private credit was a one trillion dollar market. Now it's

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Speaker 3: a two or three trillion depending on who's counting, but

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Speaker 3: lots and lots of money what's going on here and

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Speaker 3: what we saw. If memory serves from like twenty fifteen

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Speaker 3: to twenty nineteen, a period when there weren't a lot

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Speaker 3: of credit losses, BDC debt outperformed BDC equity. I might

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Speaker 3: be slightly off on my date on that, but directionally,

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Speaker 3: even if it's the same, if you're the creditor and

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Speaker 3: you're making the same as the shareholder, obviously you're taking

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Speaker 3: less risk as the creditor. And we started looking at this,

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Speaker 3: and we started looking at the BDC market, which is issued.

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Speaker 3: They are forty AC companies that make a special BDC election,

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Speaker 3: and that law became available to BDC's I believe in

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Speaker 3: nineteen eighty, so we're forty six years in. While lots

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Speaker 3: of BDC's, we've talked about them a little bit, the

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Speaker 3: public ones, many if not most, are trading at a

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Speaker 3: non trivial discount to nab the share price on the

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Speaker 3: exchange less than what the books and records say the

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Speaker 3: value of the equity is. On one hand, many non

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Speaker 3: traded BDC's probably I had my the Bloomberg terminals not

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Speaker 3: open right here, but I'm sure there's a headline about

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Speaker 3: some fund that had more than five percent redemptions come

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Speaker 3: in this quarter of a non traded BDC, both of

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Speaker 3: those facing significant headwinds. BDCs that had historically traded at

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Speaker 3: a premium now trading at a discount. Across the forty

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Speaker 3: six years since the BDC laws have been in place,

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Speaker 3: to the best of our knowledge, there have been two

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Speaker 3: defaults ever by BDCs, Allied and ACASS and both of

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Speaker 3: those were one hundred cent recovery to the creditor, even

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Speaker 3: the shareholder's got some leftover value. And so when we

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Speaker 3: look at what's going on in private credit, the thing

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Speaker 3: that's made BDC's work is something called the asset coverage ratio.

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Speaker 3: In our opinion, has been the number one thing, which

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Speaker 3: simply it's there's three different tests. Under the forty Act

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Speaker 3: one percent asset coverage. BDCs are subject to the one

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Speaker 3: to fifty rule, which means there need to be for

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Speaker 3: every dollar of debt one hundred and fifty dollars of

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Speaker 3: assets supporting it. If they were to fail that test,

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Speaker 3: the consequences are severe, but not game over. And this

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Speaker 3: is very important as well. If you fail your asset

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Speaker 3: coverage ratio, you can't declare any more dividends and for

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Speaker 3: people in the tender offer funds or the non traded funds.

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Speaker 3: No more. Forget about getting capped at five percent redemptions.

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Speaker 3: The redemptions go to zero if you're failing the asset

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Speaker 3: coverage ratio because they're not allowed to redeem capital below

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Speaker 3: that ratio. And when we look across what we're seeing

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Speaker 3: in all the different BDCs, and then we've taken that

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Speaker 3: same technology, which I think is some of the most

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Speaker 3: elegant financial regulation ever written, We've applied that to GPLP funds,

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Speaker 3: which we think is the vast majority of the private

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Speaker 3: credit market. Well XYZ non traded BDC gets the headline.

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Speaker 3: We think the traded and non traded BDC universe is

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Speaker 3: probably twenty thirty percent in BDC format or the private

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Speaker 3: credit markets twenty to thirty percent BDC format, which suggests

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Speaker 3: seventy to eighty percent in GPLP format. And when we

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Speaker 3: look across that, what we've begun doing, and we started

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Speaker 3: this six years ago and it's actually our largest business segment.

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Speaker 3: We took the forty Act rules of the asset coverage

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Speaker 3: ratio and started providing long term financing to GPLP funds.

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Speaker 3: And what it gives us, in addition to a very

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Speaker 3: good return on our investments, it gives us insight into

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Speaker 3: hundreds and thousands of private credit loans as well. In

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Speaker 3: many cases, we see the financials on the underlying borrowers,

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Speaker 3: We see the trends and their businesses, and indeed, you know,

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Speaker 3: i'd say software companies are probably the most at risk

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Speaker 3: across that universe. At the same time, well, I think

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Speaker 3: my company were probably. AI is still in the cost

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Speaker 3: center category. We hope it becomes a savings category. There's

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Speaker 3: other companies perhaps where AI is already helping them save

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Speaker 3: money and reduce staff and do things more efficient money.

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Speaker 3: So invariably because of AI and its prevalence and the

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Speaker 3: technology is truly amazing. And I know one one thousandth

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Speaker 3: one one thousandth of a percent of what we can

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Speaker 3: actually do with AI. I'm sure my team knows more.

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Speaker 3: That will hurt some, but it'll actually help others and

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Speaker 3: lower costs and lower prices and increase profits for many businesses.

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Speaker 1: So it comes always back to the software point, and

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Speaker 1: to kind of circle out to something that Reto said,

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Speaker 1: I mean, you know, there is this kind of uncertainty

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Speaker 1: no one really knows so you know, you could be

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Speaker 1: wrong about some of your assumptions. What stops the companies,

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Speaker 1: you know, they face an existential risk? What stops them

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Speaker 1: doing something desperate? You know, they don't pay you back,

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Speaker 1: they just go off and try and save themselves instead.

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Speaker 1: You know, is that not something you see as a scenario.

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Speaker 3: Well, thankfully we do have contract law in the United States,

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Speaker 3: so their ability just to renounce their debt. One or

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Speaker 3: two companies have tried that over my career. A company

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Speaker 3: a long time ago laid law my recollection tried to

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Speaker 3: say this was not valid indebtedness to the syndicated market.

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Speaker 3: That didn't work out for them, But in general, companies

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Speaker 3: have to pay. However, what's another trend in the loan

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Speaker 3: market the default rate? If you were to look up

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Speaker 3: on any of the major publishers corporate loan default rate,

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Speaker 3: you'd probably saye, it's around one percent right now for

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Speaker 3: below investment great credit, well below the long term average. Frankly, wow,

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Speaker 3: that sounds great. What could possibly be going wrong? The

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Speaker 3: little secret of the market, and you've covered it once

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Speaker 3: or twice on this podcast fairly recently, is what i'll

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Speaker 3: call lender on lender violence or liability management exercises or

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Speaker 3: out of court restructurings might be the least salacious way

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Speaker 3: to put it, but it really is a lender on

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Speaker 3: lender of violence and something that's crept certainly well into

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Speaker 3: the syndicated loan market and even somewhat into the private

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Speaker 3: credit market. Are provisions that say fifty one percent of

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Speaker 3: the lenders can pretty much agree to anything. That's a

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Speaker 3: pretty good that's a very very powerful provision, and over

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Speaker 3: the last eighteen months or so, we've seen well over

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Speaker 3: one hundred liability management exercises or out of court restructurings

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Speaker 3: of companies that we're facing. The problems that you're facing.

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Speaker 1: The CLO trade generally, we've had a lot of people

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Speaker 1: talk about it as a big opportunity, but there is

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Speaker 1: a fear about the underlying loans in terms of defaults.

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Speaker 1: As the US phonomy maybe gets more challenged in the

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Speaker 1: second half, the rates maybe they go higher. That puts companies,

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Speaker 1: you know, at risk maybe not being able to pay back,

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Speaker 1: but also the risky trunche that you're in. I mean,

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Speaker 1: that seems to be the most exposed. We've just had

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Speaker 1: a default in Europe, part of European CLO managed by

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Speaker 1: Bain failed to repay investors in full. That's the first

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Speaker 1: such defaults since an overhaul of the market more than

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Speaker 1: a decade ago. Is this a sign of things to come?

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Speaker 3: There's always outliers. And even if you look back to

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Speaker 3: the CLO one point zero era, ninety six percent of

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Speaker 3: clos had a positive return to the equity class and

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Speaker 3: the media and IRR was well in excess of the

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Speaker 3: base case that was marketed. Frankly in the mid two thousands,

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Speaker 3: there are two principal risks that we think of as

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Speaker 3: a CLO equity investor. Oddly, defaults is the second of them.

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Speaker 3: The first one is what we saw a lot of

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Speaker 3: in twenty two twenty five. A research report that I

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Speaker 3: saw by Nomura suggested that COLO Equity had a negative

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Speaker 3: fifteen percent total return last year. That's one person's judgmental opinion,

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Speaker 3: probably directionally accurate. It was less to do with defaults

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Speaker 3: and more to do with the bull market and credit

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Speaker 3: and spread compression. And what that means is that the

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Speaker 3: spreads on loans were getting repriced tighter and tighter and tighter. Alone,

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Speaker 3: that was three seventy five over got repriced to three

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Speaker 3: twenty five and across many of the colos we've invested in,

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Speaker 3: we saw the spreads come down significantly on the assets,

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Speaker 3: so now we have less money coming into the system.

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Speaker 3: Things we can do as a majority equity investor are

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Speaker 3: proactively resetting and refinancing the right side of our liability

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00:24:50,480 --> 00:24:54,040
Speaker 3: of the COLO balance, directing refis and resets, and I'm

433
00:24:54,040 --> 00:24:55,480
Speaker 3: going to go so far, sos Had, I don't believe

434
00:24:55,480 --> 00:24:58,520
Speaker 3: anyone's done more than us in the last year in

435
00:24:58,520 --> 00:25:00,680
Speaker 3: that space, and where we have such a larg portfolio,

436
00:25:00,720 --> 00:25:03,440
Speaker 3: there's always something to do. There's not enough banks to

437
00:25:03,480 --> 00:25:06,480
Speaker 3: get one typically what we want to do. That said,

438
00:25:06,680 --> 00:25:10,840
Speaker 3: the spread tightening on the COLO debt side was nowhere

439
00:25:10,880 --> 00:25:14,320
Speaker 3: near as much as on the asset side, and so you,

440
00:25:14,840 --> 00:25:18,280
Speaker 3: despite our best efforts, the NIM or the difference between

441
00:25:18,320 --> 00:25:22,240
Speaker 3: the spread and the assets and liabilities just fell significantly

442
00:25:22,359 --> 00:25:25,760
Speaker 3: last year. While there were some credit problems, oddly the

443
00:25:25,800 --> 00:25:29,720
Speaker 3: bigger issue was bull market and repricing of loans, and

444
00:25:29,720 --> 00:25:33,320
Speaker 3: no one really asked us that when we're talking to investors, well,

445
00:25:33,320 --> 00:25:36,119
Speaker 3: what if loans rally hard? Is not a question we

446
00:25:36,240 --> 00:25:39,080
Speaker 3: often get. But when we look at what's gone wrong

447
00:25:39,200 --> 00:25:43,080
Speaker 3: with colos, typically that's been the biggest thing the flip side.

448
00:25:43,119 --> 00:25:44,840
Speaker 3: When we look at the faults. Let's say we have

449
00:25:44,880 --> 00:25:47,520
Speaker 3: a ten percent de fault rate over the next twelve months.

450
00:25:47,560 --> 00:25:50,480
Speaker 3: Not a prediction from me by any stretch, but it's

451
00:25:50,480 --> 00:25:53,560
Speaker 3: always a possibility. If we were to have ten percent

452
00:25:53,600 --> 00:25:57,520
Speaker 3: of faults, James, where would you think loans are trading it?

453
00:25:57,560 --> 00:26:00,679
Speaker 1: Does the index? Yes, probably below ninety.

454
00:26:01,119 --> 00:26:03,760
Speaker 3: Certainly greater than more than a ten percent discount would

455
00:26:03,760 --> 00:26:06,560
Speaker 3: be my expectation. I'd probably put it somewhere in the

456
00:26:06,600 --> 00:26:10,080
Speaker 3: seventy to eighty context to frame it. During COVID, when

457
00:26:10,080 --> 00:26:12,399
Speaker 3: we had five six percent of faults, the loan index

458
00:26:12,400 --> 00:26:15,720
Speaker 3: fell to eighty, and when we saw in the financial

459
00:26:15,720 --> 00:26:18,440
Speaker 3: crisis ten to eleven percent of faults, loans actually fell

460
00:26:18,480 --> 00:26:22,280
Speaker 3: to as low as sixty, give or take on the index. Importantly,

461
00:26:22,320 --> 00:26:24,919
Speaker 3: every loan that doesn't default pays off at par. Just

462
00:26:24,920 --> 00:26:27,399
Speaker 3: because the index is at sixty of ten percent default,

463
00:26:27,480 --> 00:26:30,280
Speaker 3: that means all the others paid off at one hundred.

464
00:26:31,400 --> 00:26:34,120
Speaker 3: Colos typically do the best, and I look at our

465
00:26:34,200 --> 00:26:38,920
Speaker 3: performance across our different portfolios. We do the best when

466
00:26:38,920 --> 00:26:43,600
Speaker 3: there's actually periods of high default because in my opinion,

467
00:26:43,720 --> 00:26:47,439
Speaker 3: in my experience. Price volatility in the loan market is

468
00:26:47,520 --> 00:26:49,640
Speaker 3: always greater than actual credit expense.

469
00:26:49,760 --> 00:26:52,960
Speaker 2: So it's true a course various credit astic classes that

470
00:26:52,960 --> 00:26:56,840
Speaker 2: the spreads are there low at the moment, and that

471
00:26:56,920 --> 00:27:01,199
Speaker 2: brings me to a number of questions around turns. So

472
00:27:01,960 --> 00:27:04,800
Speaker 2: one thing that comes up in that context is the

473
00:27:04,880 --> 00:27:08,320
Speaker 2: value of the call option that the that the equity has.

474
00:27:08,840 --> 00:27:11,200
Speaker 2: And of course now we've spread so low, and having

475
00:27:11,920 --> 00:27:15,560
Speaker 2: having been low or as low as maybe two years ago,

476
00:27:16,760 --> 00:27:18,800
Speaker 2: it seems to me like the value of the call

477
00:27:18,840 --> 00:27:21,640
Speaker 2: option is is reduced in terms of what it can

478
00:27:21,720 --> 00:27:26,199
Speaker 2: offer the equity, and so maybe the equity returns that

479
00:27:26,280 --> 00:27:31,560
Speaker 2: we can expect the lowered to that extent. So before

480
00:27:31,560 --> 00:27:34,560
Speaker 2: you comment on that, one thing I've come across again

481
00:27:34,560 --> 00:27:38,280
Speaker 2: and again is that investors who look at colo equity

482
00:27:38,280 --> 00:27:42,080
Speaker 2: investments people haven't done that kind of investment before. They

483
00:27:42,080 --> 00:27:45,520
Speaker 2: actually find it very difficult to find reliable data on

484
00:27:45,600 --> 00:27:49,600
Speaker 2: what the historical performance of equity investments has actually been.

485
00:27:50,920 --> 00:27:55,560
Speaker 2: And I think it might actually be help for the

486
00:27:55,720 --> 00:28:00,600
Speaker 2: entire asset class if that data was more wide available,

487
00:28:00,600 --> 00:28:02,439
Speaker 2: but at the moment it seems to me it's mostly

488
00:28:02,480 --> 00:28:07,080
Speaker 2: private data not very available, and maybe that even keeps

489
00:28:07,119 --> 00:28:10,040
Speaker 2: people who have a long history in equity investments, uh

490
00:28:10,160 --> 00:28:14,000
Speaker 2: a leg up. So so I guess the first point

491
00:28:14,040 --> 00:28:16,760
Speaker 2: was more about what's the current situation in terms of

492
00:28:17,680 --> 00:28:21,040
Speaker 2: expected returns in equity and the second point was more

493
00:28:22,040 --> 00:28:26,159
Speaker 2: how can we back up claims about the value of

494
00:28:26,200 --> 00:28:27,600
Speaker 2: equity investments more generally?

495
00:28:28,040 --> 00:28:30,320
Speaker 3: Well, James could have seen me smiling when he said

496
00:28:30,760 --> 00:28:36,679
Speaker 3: that information about equity values is not broadly available. It's available,

497
00:28:37,280 --> 00:28:39,959
Speaker 3: but you have to have largely created it yourself as

498
00:28:40,080 --> 00:28:43,520
Speaker 3: a general rule to just complete on that second point.

499
00:28:46,200 --> 00:28:50,880
Speaker 3: So the data does exist, it's not published. There's not

500
00:28:51,200 --> 00:28:54,080
Speaker 3: much in the way of a CLO equity index. You know,

501
00:28:54,120 --> 00:28:57,200
Speaker 3: there's a number of bags have debt in that indices,

502
00:28:57,240 --> 00:28:59,840
Speaker 3: but I can't point to a published CLO equity And

503
00:29:01,040 --> 00:29:05,240
Speaker 3: that said, a number of large banks publish annual or

504
00:29:05,240 --> 00:29:09,720
Speaker 3: semi annual total return numbers for the COLO equity asset class.

505
00:29:10,280 --> 00:29:14,560
Speaker 3: And we've strung together some degree of i'll call it

506
00:29:14,640 --> 00:29:18,240
Speaker 3: simulated index. We'll take as many credible data sources as

507
00:29:18,240 --> 00:29:20,880
Speaker 3: we can and average them. And sometimes the numbers are

508
00:29:20,920 --> 00:29:22,480
Speaker 3: all over the place. You know, one guy might say

509
00:29:22,480 --> 00:29:25,320
Speaker 3: the market's up ten, the other says up fifteen. Okay,

510
00:29:25,360 --> 00:29:26,840
Speaker 3: we'll take the average of the two and say twelve

511
00:29:26,880 --> 00:29:32,120
Speaker 3: and a half, and it's directionally accurate, we believe, and

512
00:29:32,240 --> 00:29:34,040
Speaker 3: I share with you. Last year in Amuro said the

513
00:29:34,040 --> 00:29:38,400
Speaker 3: market was down fifteen percent, which feels directionally pretty accurate

514
00:29:38,440 --> 00:29:42,440
Speaker 3: as well. So there are some published pieces of information,

515
00:29:42,920 --> 00:29:45,120
Speaker 3: there's not specifics.

516
00:29:45,440 --> 00:29:48,000
Speaker 1: So what could you make this year on CLO equity?

517
00:29:48,240 --> 00:29:49,680
Speaker 1: What would the return forecast be?

518
00:29:50,240 --> 00:29:52,720
Speaker 3: Banks have put out some stats for the first half

519
00:29:52,760 --> 00:29:56,440
Speaker 3: that were also non trivially negative, this time a little

520
00:29:56,480 --> 00:30:00,880
Speaker 3: more due to credit volve than to spread compression. Where

521
00:30:00,920 --> 00:30:04,880
Speaker 3: we sit going forward, I'm a little more optimistic in

522
00:30:04,960 --> 00:30:08,840
Speaker 3: that I think we've seen the significant bulk of the

523
00:30:08,840 --> 00:30:13,000
Speaker 3: spread compression play out, and I think we're seeing more

524
00:30:13,080 --> 00:30:19,720
Speaker 3: discipline behavior on issuance in our account. In twenty twenty five,

525
00:30:20,080 --> 00:30:24,480
Speaker 3: the significant majority of the COLO market of new issue

526
00:30:24,520 --> 00:30:28,800
Speaker 3: clos was sponsored by captive or controlled capital by the

527
00:30:28,840 --> 00:30:31,800
Speaker 3: collateral manager, which we think of as generally analogous to

528
00:30:31,920 --> 00:30:35,920
Speaker 3: unsponsored private equity. We're giving management the keys to the kingdom.

529
00:30:37,000 --> 00:30:39,600
Speaker 3: Very few new colos last year were purchased by third

530
00:30:39,640 --> 00:30:42,280
Speaker 3: party equity investors. We're seeing a little bit of an

531
00:30:42,360 --> 00:30:45,280
Speaker 3: uptick in that I think that might increase in the

532
00:30:45,320 --> 00:30:48,440
Speaker 3: second half of the year. So the things that have

533
00:30:48,600 --> 00:30:53,960
Speaker 3: gone wrong last year, spread compression largely abated. It always

534
00:30:54,000 --> 00:30:59,840
Speaker 3: reappear and reappear very quickly. And credit expense. I think

535
00:31:00,040 --> 00:31:03,360
Speaker 3: we saw price declines and loans which adversely impact the

536
00:31:03,360 --> 00:31:06,720
Speaker 3: price of COLO equity, but we haven't seen. While we

537
00:31:06,720 --> 00:31:09,800
Speaker 3: did talk about l ees and modifications and things like that,

538
00:31:10,720 --> 00:31:14,080
Speaker 3: the credit losses going to the things that were said

539
00:31:14,080 --> 00:31:16,760
Speaker 3: earlier in this call haven't been that The realized losses

540
00:31:16,760 --> 00:31:19,480
Speaker 3: haven't been that significant. So it could be a very

541
00:31:19,480 --> 00:31:22,880
Speaker 3: interesting time to get into the market, probably more on

542
00:31:22,960 --> 00:31:27,000
Speaker 3: the secondary side or buying into an existing portfolio than

543
00:31:27,040 --> 00:31:29,080
Speaker 3: saying let's go out and create a bunch of new ones. Today.

544
00:31:29,920 --> 00:31:33,080
Speaker 3: That said, there's always something interesting to be done in

545
00:31:33,120 --> 00:31:33,960
Speaker 3: the market, but.

546
00:31:34,000 --> 00:31:36,560
Speaker 1: It could be another negative year for an equity on the.

547
00:31:36,520 --> 00:31:39,000
Speaker 3: Clos where we stand right now, it's certainly possible.

548
00:31:39,160 --> 00:31:42,360
Speaker 1: Okay, So it doesn't sound so good in terms of

549
00:31:42,400 --> 00:31:44,480
Speaker 1: the BDC's which he talked about. You know, you lend

550
00:31:44,480 --> 00:31:48,320
Speaker 1: to BDCs, you also lend to other private funds gps

551
00:31:48,360 --> 00:31:52,000
Speaker 1: and LPs. I'm interested in your view into that world

552
00:31:52,080 --> 00:31:54,400
Speaker 1: because you know, we get a lot of very negative

553
00:31:55,520 --> 00:31:58,760
Speaker 1: views about private credit, about the sky is falling about

554
00:31:58,800 --> 00:32:00,800
Speaker 1: you know, the reckoning coming about the end of the

555
00:32:00,840 --> 00:32:02,680
Speaker 1: Golden Age, all of that stuff. You've heard it. But

556
00:32:03,160 --> 00:32:05,960
Speaker 1: since you have the visibility, how worried should we be

557
00:32:06,000 --> 00:32:07,760
Speaker 1: about Bdcason about private credit?

558
00:32:07,800 --> 00:32:11,520
Speaker 3: More generally, it's not as bad as the pace of

559
00:32:11,640 --> 00:32:15,680
Speaker 3: headlines suggest in my opinion, when we look at what's

560
00:32:15,720 --> 00:32:19,360
Speaker 3: going on with the underlying portfolio companies of many private

561
00:32:19,360 --> 00:32:23,680
Speaker 3: credit funds, not all. In general, revenue is growing in

562
00:32:23,720 --> 00:32:27,720
Speaker 3: many cases, IBIDA is flat to growing, which is good.

563
00:32:28,760 --> 00:32:32,880
Speaker 3: There might not be hitting plan a fair number of cases,

564
00:32:33,400 --> 00:32:37,320
Speaker 3: but it's not as if we're seeing ten other than

565
00:32:37,400 --> 00:32:41,280
Speaker 3: isolated incidences. We're not seeing ten twenty thirty percent revenue

566
00:32:41,280 --> 00:32:46,680
Speaker 3: declines across companies that are in these portfolios. One of

567
00:32:46,680 --> 00:32:51,560
Speaker 3: the things that frustrates me, and it's gotten attention, and

568
00:32:51,640 --> 00:32:55,160
Speaker 3: I certainly knew a lot of press on the terminal

569
00:32:55,160 --> 00:32:58,200
Speaker 3: and from others. Loans that are marked at one hundred,

570
00:32:58,240 --> 00:33:00,840
Speaker 3: one hundred, one hundred and one hundred and thirty. Yeah,

571
00:33:01,040 --> 00:33:04,800
Speaker 3: that's not supposed to happen, right, you know, absent some

572
00:33:04,960 --> 00:33:08,240
Speaker 3: terrible shock event happening to that company in that quarter.

573
00:33:09,920 --> 00:33:13,160
Speaker 3: One of the things that that frustrates I think quite

574
00:33:13,160 --> 00:33:14,960
Speaker 3: a few people is a little bit of the lack

575
00:33:15,000 --> 00:33:20,640
Speaker 3: of the lack of transparency the opacity in private credit pricing.

576
00:33:21,600 --> 00:33:24,120
Speaker 3: Some research analysts have looked across and said, you know,

577
00:33:24,160 --> 00:33:26,600
Speaker 3: BDC one holds this loan, they've got a marked at

578
00:33:26,640 --> 00:33:29,160
Speaker 3: ninety eight, b DC two holds it at ninety five.

579
00:33:30,360 --> 00:33:33,960
Speaker 3: Things like that, Well, ideally they'd be the same. These

580
00:33:33,960 --> 00:33:37,160
Speaker 3: are level two in level three assets within a few points.

581
00:33:37,200 --> 00:33:40,920
Speaker 3: I think that's a tolerable band. What would be more alarming,

582
00:33:40,960 --> 00:33:43,160
Speaker 3: And there were a few instances like this in the past.

583
00:33:43,320 --> 00:33:45,120
Speaker 3: One guy's got it marked at sixty and the other

584
00:33:45,160 --> 00:33:48,160
Speaker 3: guys got it marked at one hundred. That's clearly the

585
00:33:48,160 --> 00:33:51,960
Speaker 3: wrong answer between two identical instruments. But when we look

586
00:33:52,080 --> 00:33:57,320
Speaker 3: through the things that are bad for credit ultimately are

587
00:33:57,480 --> 00:34:00,920
Speaker 3: drops in revenue and EBITDA. At the end of the day,

588
00:34:01,000 --> 00:34:05,200
Speaker 3: if your EBITA and revenue are growing, it's probably going

589
00:34:05,280 --> 00:34:08,200
Speaker 3: to work out for a company, And by and large

590
00:34:08,200 --> 00:34:11,719
Speaker 3: we're seeing that even in the private credit world, not exclusively,

591
00:34:12,160 --> 00:34:16,400
Speaker 3: but that's not the exception to have that happen. And

592
00:34:16,440 --> 00:34:21,640
Speaker 3: so when we think about BBC stock in general, vast

593
00:34:21,719 --> 00:34:24,959
Speaker 3: majority are trading at discounts to book. There's a couple

594
00:34:24,960 --> 00:34:28,040
Speaker 3: of things going on there. There's the perception of future

595
00:34:28,080 --> 00:34:31,600
Speaker 3: credit losses coming, which I think is a fair perception

596
00:34:31,680 --> 00:34:33,839
Speaker 3: that's probably overpriced in the market.

597
00:34:33,880 --> 00:34:36,239
Speaker 2: I wanted to ask about a third product that you

598
00:34:36,760 --> 00:34:39,080
Speaker 2: seem to be involved in, which is the significant risk

599
00:34:39,120 --> 00:34:43,160
Speaker 2: transfer transactions that has grown over the past few years,

600
00:34:43,520 --> 00:34:48,480
Speaker 2: and I'm wondering how you started to enter that market.

601
00:34:48,600 --> 00:34:51,000
Speaker 2: Was it that you mostly looked at as at transactions

602
00:34:51,440 --> 00:34:55,840
Speaker 2: that are set up as a synthetic secusations? Was that

603
00:34:56,000 --> 00:34:58,879
Speaker 2: the entered point that it became interested in this as

604
00:34:58,920 --> 00:35:01,240
Speaker 2: a media security should optoty.

605
00:35:01,360 --> 00:35:05,000
Speaker 3: So we call them regulatory capital relief. In my opinion,

606
00:35:05,000 --> 00:35:08,759
Speaker 3: that sounds a lot better than significant risk transfer. Yeah,

607
00:35:08,800 --> 00:35:12,480
Speaker 3: who wants to be transferred a significant amount of risks? Indeed,

608
00:35:13,000 --> 00:35:15,120
Speaker 3: and I think it used to be synthetic risk transfer,

609
00:35:15,200 --> 00:35:18,560
Speaker 3: but somehow it changed to significant maybe to appease some regulators.

610
00:35:19,640 --> 00:35:21,560
Speaker 3: But regardless of what we call it, I'm going to

611
00:35:21,600 --> 00:35:27,600
Speaker 3: call it regulatory capital relief for this purpose. We got

612
00:35:27,600 --> 00:35:29,840
Speaker 3: into the market i'm going to say about five years ago,

613
00:35:31,120 --> 00:35:34,400
Speaker 3: and we were intrigued by it in a number of ways.

614
00:35:35,560 --> 00:35:41,320
Speaker 3: The asset pools underlying these regulatory capital transactions that bank issue,

615
00:35:41,360 --> 00:35:43,600
Speaker 3: and the purpose of them is for banks to keep

616
00:35:43,600 --> 00:35:46,200
Speaker 3: owning the loan but get a reduced capital charge or

617
00:35:46,239 --> 00:35:50,560
Speaker 3: substantially eliminate their capital charge from holding assets whilest serving

618
00:35:50,600 --> 00:35:54,799
Speaker 3: the customers being the face to their customers. And it's

619
00:35:54,920 --> 00:36:00,000
Speaker 3: basically a just in time tool for banks to raise capital.

620
00:36:01,040 --> 00:36:03,480
Speaker 3: And we have a team of people focused on this market,

621
00:36:03,520 --> 00:36:05,200
Speaker 3: and I joke with them they could take the first

622
00:36:05,239 --> 00:36:08,200
Speaker 3: forty five days of the quarter off and then work

623
00:36:08,280 --> 00:36:10,760
Speaker 3: NonStop the second forty five days at the quarter because

624
00:36:10,800 --> 00:36:14,080
Speaker 3: typically these issuances closed the dare you know, September twenty

625
00:36:14,120 --> 00:36:17,480
Speaker 3: eighth will be a busy day in the regulatory capital

626
00:36:17,520 --> 00:36:20,520
Speaker 3: market October second, they could probably take the day off

627
00:36:20,560 --> 00:36:23,520
Speaker 3: and play golf if it's nice outside. So it's banks

628
00:36:23,800 --> 00:36:29,440
Speaker 3: using this market to raise capital. A lot of European

629
00:36:29,480 --> 00:36:31,360
Speaker 3: banks are quite active in it. The US banks have

630
00:36:31,400 --> 00:36:34,239
Speaker 3: done it to some degree, but it's principally driven by

631
00:36:34,239 --> 00:36:38,319
Speaker 3: the European and a lesser degree Canadian banks. It can

632
00:36:38,360 --> 00:36:41,600
Speaker 3: include corporate credit, both large cap and middle market. It

633
00:36:41,600 --> 00:36:46,439
Speaker 3: can include auto loans, It can include consumer loans. One

634
00:36:46,520 --> 00:36:49,840
Speaker 3: large bank actually did trade finance loans, and you know

635
00:36:50,040 --> 00:36:53,120
Speaker 3: they've got a business. Someone you know, a merchant, puts

636
00:36:53,120 --> 00:36:55,640
Speaker 3: his goods in a box and shen zen on a boat.

637
00:36:55,920 --> 00:36:59,040
Speaker 3: He wants the money. It gets off the boat in croatio.

638
00:36:59,120 --> 00:37:01,000
Speaker 3: That guy doesn't want to pay, and so he opens

639
00:37:01,000 --> 00:37:03,799
Speaker 3: the box and sees the goods are there. One bank

640
00:37:03,880 --> 00:37:06,640
Speaker 3: is pretty good at doing that financing, and they actually

641
00:37:06,680 --> 00:37:09,400
Speaker 3: do an SRT on that portfolio.

642
00:37:09,640 --> 00:37:11,560
Speaker 2: And where do you take the position? Is it sort

643
00:37:11,560 --> 00:37:13,759
Speaker 2: of a second loss piece because obviously to take the

644
00:37:13,800 --> 00:37:16,399
Speaker 2: first loss piece in a co but do what where

645
00:37:16,480 --> 00:37:17,200
Speaker 2: is your positioning?

646
00:37:17,840 --> 00:37:20,520
Speaker 3: Typically a good, very good question. We're typically in the

647
00:37:20,520 --> 00:37:22,719
Speaker 3: first loss piece. Once in a while the banks will

648
00:37:22,800 --> 00:37:25,840
Speaker 3: keep a teeny tiny sliver beneath us, but by and

649
00:37:25,960 --> 00:37:28,640
Speaker 3: large we're in the first loss piece. Now in nearly

650
00:37:28,680 --> 00:37:31,080
Speaker 3: all of these the banks will also hold a portion

651
00:37:31,200 --> 00:37:33,359
Speaker 3: of the loan unhedged on their balance sheets, so they're

652
00:37:33,360 --> 00:37:36,560
Speaker 3: in the same loan alongside of us, but we are

653
00:37:36,640 --> 00:37:41,839
Speaker 3: typically first loss. What we're looking at is banks are

654
00:37:42,000 --> 00:37:44,640
Speaker 3: very very data rich, and you can see in many

655
00:37:44,680 --> 00:37:48,960
Speaker 3: cases twenty thirty years of loss experience, and like even

656
00:37:49,040 --> 00:37:52,040
Speaker 3: within auto loans, they might rank auto loans in fifteen

657
00:37:52,080 --> 00:37:55,319
Speaker 3: different categories of risk, and you can see with a

658
00:37:55,440 --> 00:37:58,280
Speaker 3: pretty they're pretty darn good at picking this kind of stuff.

659
00:37:59,239 --> 00:38:03,480
Speaker 3: How their portfolios have performed historically based on the bank's

660
00:38:03,560 --> 00:38:07,640
Speaker 3: internal risk category for any pool of assets. So that's

661
00:38:07,680 --> 00:38:09,040
Speaker 3: the kind of stuff we can look at. It's a

662
00:38:09,120 --> 00:38:12,680
Speaker 3: very data rich investment. When I think about putting it

663
00:38:12,719 --> 00:38:16,600
Speaker 3: together with COLO equity, there's a couple of interesting pieces.

664
00:38:17,280 --> 00:38:20,920
Speaker 3: Colo equity has NAV risk, and that when we get

665
00:38:20,960 --> 00:38:22,880
Speaker 3: to the call date, typically at the end of the

666
00:38:22,920 --> 00:38:27,200
Speaker 3: reinvestment period, doing whatever loans haven't defaulted, whatever's in the portfolio.

667
00:38:27,719 --> 00:38:29,960
Speaker 3: If I want to liquidate the portfolio, I get the

668
00:38:29,960 --> 00:38:32,080
Speaker 3: price the market will bear on that day for the

669
00:38:32,120 --> 00:38:34,279
Speaker 3: remaining loans, which could be ninety eight cents on the dollar,

670
00:38:34,320 --> 00:38:37,120
Speaker 3: could be ninety seven cents on the dollar, or along

671
00:38:37,160 --> 00:38:39,800
Speaker 3: the way. If loans trade way down all of a sudden,

672
00:38:41,200 --> 00:38:43,520
Speaker 3: the NAV could be zero in a piece of in

673
00:38:43,560 --> 00:38:46,280
Speaker 3: a piece of col equity, despite still getting cash flows.

674
00:38:47,920 --> 00:38:53,120
Speaker 3: In an SRT transaction or regulatory capital transaction, every loan

675
00:38:53,120 --> 00:38:56,160
Speaker 3: that doesn't default is unwound from the vehicle at par

676
00:38:57,000 --> 00:39:01,240
Speaker 3: in that it's a synthetic contract if it hasn't defaulted. Okay,

677
00:39:01,320 --> 00:39:03,120
Speaker 3: at think you just rip up the contract. There's no

678
00:39:03,239 --> 00:39:06,040
Speaker 3: mark to market on the way out. So one of

679
00:39:06,080 --> 00:39:10,240
Speaker 3: the big things that drives volatility in COLO equity pricing

680
00:39:11,320 --> 00:39:15,520
Speaker 3: NAV volatility is not something you face in regulatory capital

681
00:39:15,560 --> 00:39:19,040
Speaker 3: relief investing, so we like that a lot. What you

682
00:39:19,120 --> 00:39:22,719
Speaker 3: don't get in regulatory capital relief is the ability to

683
00:39:22,800 --> 00:39:27,520
Speaker 3: reinvest cheap. So in a world where in two thousand

684
00:39:27,520 --> 00:39:30,200
Speaker 3: and eight or twenty twenty, loans were trading at deep

685
00:39:30,239 --> 00:39:33,160
Speaker 3: deep discounts and coelos are able to use prepayments or

686
00:39:33,200 --> 00:39:37,080
Speaker 3: make relative value trades to buy things in a distressed market,

687
00:39:37,960 --> 00:39:41,799
Speaker 3: the regulatory capital relief market doesn't really have that concept.

688
00:39:42,200 --> 00:39:44,640
Speaker 3: Even if there's a replenishment period, which many do, where

689
00:39:44,640 --> 00:39:47,960
Speaker 3: the bank can add new assets meeting subject to certain criteria,

690
00:39:48,760 --> 00:39:52,000
Speaker 3: they just go into park. So you get the benefit

691
00:39:52,120 --> 00:39:56,200
Speaker 3: of NAVS stability or you're isolated from NAV risk when

692
00:39:56,200 --> 00:39:59,840
Speaker 3: you're in these regulatory capital pools, but you lose the

693
00:40:00,040 --> 00:40:04,360
Speaker 3: ability to reinvest cheap in distress days. I said earlier,

694
00:40:04,400 --> 00:40:07,080
Speaker 3: we were investing pretty aggressively in this market in twenty

695
00:40:07,080 --> 00:40:10,560
Speaker 3: twenty three and twenty four. If you look at some

696
00:40:10,600 --> 00:40:12,760
Speaker 3: of our public funds, which you can see our schedule

697
00:40:12,760 --> 00:40:14,760
Speaker 3: of investments, and you can see where we mark everything,

698
00:40:14,840 --> 00:40:16,600
Speaker 3: and you can compare it to others marks as well

699
00:40:16,600 --> 00:40:19,719
Speaker 3: if you'd like. You'll see we've added relatively little in

700
00:40:19,840 --> 00:40:23,440
Speaker 3: this space over the last eighteen months. It's still an

701
00:40:23,520 --> 00:40:28,800
Speaker 3: attractive investment in my opinion, but the excess return maybe

702
00:40:28,840 --> 00:40:31,279
Speaker 3: has been taken out of it to some degree in

703
00:40:31,320 --> 00:40:34,560
Speaker 3: that several large players have gotten involved then have just

704
00:40:34,640 --> 00:40:37,640
Speaker 3: gobbled things up and have actually asked for thicker equity

705
00:40:37,640 --> 00:40:41,200
Speaker 3: tranches than is needed just so they can get significant

706
00:40:41,239 --> 00:40:45,000
Speaker 3: sums of capital deployed. So whereas we were deploying a

707
00:40:45,040 --> 00:40:48,520
Speaker 3: lot of capital at fourteen fifteen percent loss adjusted a

708
00:40:48,520 --> 00:40:51,640
Speaker 3: couple of years ago, today it's going to be a

709
00:40:51,680 --> 00:40:54,200
Speaker 3: couple hundred basis points tighter than that. And when I

710
00:40:54,239 --> 00:40:58,320
Speaker 3: look across the ecosystem, and a number of our portfolios

711
00:40:58,360 --> 00:41:01,799
Speaker 3: are are multi strategy, can put we can buy clos

712
00:41:01,840 --> 00:41:03,960
Speaker 3: and then we can do fund financing. We can put

713
00:41:04,040 --> 00:41:07,799
Speaker 3: private infrastructure credit, we can put equipment leasing in, we

714
00:41:07,800 --> 00:41:12,560
Speaker 3: can do any number of things to put into those funds.

715
00:41:13,440 --> 00:41:18,440
Speaker 3: What I'm seeing is, in general, although there's exceptions, regulatory

716
00:41:18,480 --> 00:41:23,600
Speaker 3: capital today is less compelling to deploy capital into, not

717
00:41:23,640 --> 00:41:27,960
Speaker 3: necessarily because of future credit risk that we see, although

718
00:41:27,960 --> 00:41:31,800
Speaker 3: that's a factor more just in terms of the yields

719
00:41:31,800 --> 00:41:34,319
Speaker 3: that other investors are bidding today. No, it's hard to

720
00:41:34,360 --> 00:41:38,840
Speaker 3: say the market's cheap. I think it's still attractive, but

721
00:41:38,920 --> 00:41:40,239
Speaker 3: it's certainly not cheap.

722
00:41:40,680 --> 00:41:43,640
Speaker 1: Briefly because they're almost out of time, tom where do

723
00:41:43,719 --> 00:41:45,759
Speaker 1: you see the best relative value right now? Because you know,

724
00:41:45,800 --> 00:41:48,600
Speaker 1: you describe yourself as the biggest coelo equity investor that

725
00:41:48,640 --> 00:41:53,560
Speaker 1: you expect potential loss this year following a loss last year,

726
00:41:54,080 --> 00:41:55,359
Speaker 1: So you know, how.

727
00:41:55,280 --> 00:41:57,239
Speaker 3: Do you make your money the old fashioned way of

728
00:41:57,600 --> 00:41:59,680
Speaker 3: hopefully picking the best investments. And even if you look

729
00:41:59,719 --> 00:42:02,120
Speaker 3: at our public COLO funds, there's plenty of things that

730
00:42:02,160 --> 00:42:04,880
Speaker 3: are not clos in those funds today, and that's an

731
00:42:04,920 --> 00:42:09,680
Speaker 3: important part of delivering value for our shareholders in those vehicles.

732
00:42:09,719 --> 00:42:14,040
Speaker 3: Across the strategies and across the areas where we're investing today,

733
00:42:14,719 --> 00:42:17,839
Speaker 3: what I think of as the two most attractive things

734
00:42:17,840 --> 00:42:24,240
Speaker 3: that are getting the most excitement are middle market infrastructure lending,

735
00:42:24,440 --> 00:42:27,760
Speaker 3: and we have a dedicated team focused on that. Where

736
00:42:27,800 --> 00:42:30,640
Speaker 3: we're not coming in lending on Heathrow Airport or you know,

737
00:42:30,719 --> 00:42:35,160
Speaker 3: these ginormous projects we're coming in at the one hundred

738
00:42:35,160 --> 00:42:39,560
Speaker 3: million couple hundred million dollar financing size, so smaller than

739
00:42:39,600 --> 00:42:43,400
Speaker 3: the but the gigantic groups are going after. We've been

740
00:42:43,440 --> 00:42:47,239
Speaker 3: able to get some very attractive investments done there where

741
00:42:47,239 --> 00:42:51,600
Speaker 3: we're providing i'll call it bespoke solutions for folks. We

742
00:42:51,640 --> 00:42:55,359
Speaker 3: can speak for the whole facility ourselves, but it's not

743
00:42:55,480 --> 00:42:58,520
Speaker 3: big enough to attract the gigantic funds, and it's also

744
00:42:59,280 --> 00:43:02,600
Speaker 3: probably seeing one little tweak to make it bank eligible

745
00:43:02,600 --> 00:43:04,799
Speaker 3: for the project finance market, which is by far one

746
00:43:04,840 --> 00:43:07,960
Speaker 3: of the cheapest markets. So we've deployed probably over a

747
00:43:08,000 --> 00:43:11,759
Speaker 3: billion dollars in infrastructure middle market private credit over the

748
00:43:11,880 --> 00:43:15,680
Speaker 3: last year, and our pipeline there is very robust. We

749
00:43:15,760 --> 00:43:20,000
Speaker 3: also have a joint venture with a large one hundred

750
00:43:20,000 --> 00:43:21,759
Speaker 3: plus year old bank here in New York City for

751
00:43:21,840 --> 00:43:27,480
Speaker 3: equipment financing. And when we think about serving middle market companies,

752
00:43:27,719 --> 00:43:30,600
Speaker 3: many of these are the companies that are borrowing at

753
00:43:30,640 --> 00:43:34,960
Speaker 3: SOFA plus five hundred from these BDCs facing redemptions. In

754
00:43:35,000 --> 00:43:37,359
Speaker 3: many cases, we've been able to go to companies when

755
00:43:37,400 --> 00:43:40,560
Speaker 3: we've seen them issue alone and say would you also

756
00:43:40,560 --> 00:43:43,200
Speaker 3: be interested in doing a sale lease back on some

757
00:43:43,239 --> 00:43:46,320
Speaker 3: of your essential equipment. And we have a dedicated program

758
00:43:46,320 --> 00:43:49,960
Speaker 3: where with outbound calling where we're going and we're actually

759
00:43:50,239 --> 00:43:53,960
Speaker 3: doing sale leasebacks on like a good example of essential

760
00:43:54,000 --> 00:43:58,440
Speaker 3: manufacturing equipment. And what makes that very good In a

761
00:43:58,560 --> 00:44:01,960
Speaker 3: lease the less or you're the owner of the equipment.

762
00:44:03,000 --> 00:44:04,879
Speaker 3: It's good to be a secured lender is great. It's

763
00:44:04,920 --> 00:44:06,480
Speaker 3: better to own the equipment. And the course of a

764
00:44:06,480 --> 00:44:09,360
Speaker 3: bankruptcy and if a company doesn't pay or it goes bankrupt,

765
00:44:09,400 --> 00:44:11,840
Speaker 3: they either reaffirm the lease and keep paying, or you

766
00:44:11,920 --> 00:44:13,640
Speaker 3: go and take your equipment. You've got the title, you

767
00:44:13,680 --> 00:44:16,440
Speaker 3: take the sheriff, and you get your stuff. What's important

768
00:44:16,440 --> 00:44:21,360
Speaker 3: in that strategy is focusing on the most essential equipment.

769
00:44:21,560 --> 00:44:24,840
Speaker 3: There's one company we're involved in that owns a large

770
00:44:24,840 --> 00:44:28,400
Speaker 3: portfolio of gas stations or petrol stations. We own the

771
00:44:28,520 --> 00:44:30,680
Speaker 3: gas pumps and least them back. If they're going to

772
00:44:30,680 --> 00:44:32,279
Speaker 3: be a business, they're going to have these, and if not,

773
00:44:32,520 --> 00:44:35,399
Speaker 3: there's actually a secondary market for used gas pumps, believe

774
00:44:35,400 --> 00:44:38,839
Speaker 3: it or not. A and then be The other thing

775
00:44:38,880 --> 00:44:42,160
Speaker 3: I like about it is knowing not a lot of

776
00:44:42,200 --> 00:44:46,080
Speaker 3: people are sitting here saying inflation's going down, and probably

777
00:44:46,160 --> 00:44:49,160
Speaker 3: inflation's trending up over the long term, we've got more

778
00:44:49,440 --> 00:44:53,560
Speaker 3: geopolitical uncertainty in the world. Commodity and energy inputs are

779
00:44:54,160 --> 00:44:59,400
Speaker 3: you know, probably keep going up, not down. Inflation is

780
00:44:59,440 --> 00:45:03,480
Speaker 3: a G eight factor for equipment financing in that we

781
00:45:03,520 --> 00:45:06,000
Speaker 3: own the equipment at the end of the lease, and

782
00:45:06,080 --> 00:45:09,320
Speaker 3: to the extent inflation is high, residual values will typically

783
00:45:09,320 --> 00:45:12,239
Speaker 3: be higher, and there's a path for significant gain. Of

784
00:45:12,320 --> 00:45:14,720
Speaker 3: some of our earliest leases that have gone full cycle,

785
00:45:14,719 --> 00:45:17,439
Speaker 3: we've actually really crystallized very nice gains at the tail

786
00:45:17,520 --> 00:45:21,279
Speaker 3: end of that. I'm leasing as a specialized market. There's

787
00:45:21,320 --> 00:45:23,960
Speaker 3: other quirks to it, not just straight up corporate lending,

788
00:45:24,640 --> 00:45:26,680
Speaker 3: and we have a dedicated team focused on that. So

789
00:45:26,719 --> 00:45:28,600
Speaker 3: when I think of the things that are exciting us

790
00:45:28,600 --> 00:45:30,759
Speaker 3: that typically move to the top of the pile when

791
00:45:30,760 --> 00:45:34,640
Speaker 3: we're looking at investments, a middle market infrastructure credit is

792
00:45:34,680 --> 00:45:38,799
Speaker 3: one for sure, equipment finance certainly another, and then I'll

793
00:45:38,840 --> 00:45:41,959
Speaker 3: call it esoteric specialty finance. Things that might just fall

794
00:45:42,000 --> 00:45:44,920
Speaker 3: through the cracks where we can apply a little bit

795
00:45:44,960 --> 00:45:47,640
Speaker 3: of abs knowledge and a little bit of structured product

796
00:45:47,680 --> 00:45:50,839
Speaker 3: knowledge and some corporate credit finding things like that, they're

797
00:45:50,840 --> 00:45:53,759
Speaker 3: typically going to be over ten percent type returns. Not

798
00:45:53,840 --> 00:45:55,520
Speaker 3: the kind of thing where we're going to be competing

799
00:45:55,520 --> 00:45:59,640
Speaker 3: with a BBC. Might need a little extra brain power

800
00:45:59,760 --> 00:46:01,759
Speaker 3: to to kind of figure it out and structure it.

801
00:46:01,840 --> 00:46:04,480
Speaker 3: But those are the kind of things that do excite us.

802
00:46:04,520 --> 00:46:08,360
Speaker 1: Great stuff. Tom Yeski, found managing partner at Eagle Point Credit,

803
00:46:08,360 --> 00:46:10,239
Speaker 1: Thank you so much for joining us on the Credit Edge.

804
00:46:10,280 --> 00:46:11,919
Speaker 3: Great, thank you so much for having me, and.

805
00:46:11,840 --> 00:46:14,640
Speaker 1: Of course very grateful to Retto Bachman with Bloomberg Intelligence.

806
00:46:14,680 --> 00:46:17,680
Speaker 1: Thank you very much. Pleasure for more credit market analysis

807
00:46:17,719 --> 00:46:19,640
Speaker 1: and insight, read all of Retto's great work on the

808
00:46:19,680 --> 00:46:22,880
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00:46:22,880 --> 00:46:26,120
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810
00:46:26,360 --> 00:46:28,839
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811
00:46:28,840 --> 00:46:32,280
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812
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813
00:46:35,840 --> 00:46:38,360
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814
00:46:38,400 --> 00:46:41,640
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815
00:46:41,680 --> 00:46:44,600
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816
00:46:44,680 --> 00:46:48,040
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817
00:46:48,640 --> 00:46:50,759
Speaker 1: I'm James Cromby. It's been a pleasure having you join

818
00:46:50,840 --> 00:47:09,160
Speaker 1: us again next week on the Credit Edge