WEBVTT - Bull Run in Loans Slams CLO Equity Buyers, Says Eagle Point’s Majewski 0:00:18.120 --> 0:00:20.640 Hello, Welcome to the Credit Edge, a weekly markets podcast. 0:00:20.720 --> 0:00:23.800 My name is James Crombie. I'm a senior editor at Bloomberg. 0:00:23.480 --> 0:00:26.000 And i am Ruder Backman, chief structured finance strategist at 0:00:26.000 --> 0:00:29.720 Bloomberg Intelligence. This week, we are very pleased to welcome 0:00:29.760 --> 0:00:33.240 Tom Moyevsky, a founder of Eagle Point Credit, their fourteen 0:00:33.240 --> 0:00:36.360 billion dollar pride credit manager. How are you, Tom? 0:00:36.400 --> 0:00:37.479 Doing very well? Thank you. 0:00:37.840 --> 0:00:40.559 Tom set up Eagle Point in twenty twelve, turning it 0:00:40.600 --> 0:00:43.600 into one of the world's largest coo Ikady investors. The 0:00:43.680 --> 0:00:47.400 film has also explained to special definance, significant brisk transfers, 0:00:47.400 --> 0:00:50.159 and infrastructure credit, as well as other opportunities. 0:00:50.400 --> 0:00:54.160 So lots to discuss there. Let's start with software. You 0:00:54.240 --> 0:00:57.040 buy loans to software companies. That sector is under a 0:00:57.080 --> 0:00:59.320 lot of pressure. The fear is that a lot of 0:00:59.320 --> 0:01:02.400 the businesses will be replaced by AI and that the 0:01:02.440 --> 0:01:06.240 assets underlying the debt are actually worthless. Loan prices fell 0:01:06.280 --> 0:01:07.560 a lot at the start of the year as the 0:01:07.600 --> 0:01:10.280 AI story really took off. They've recovered a little bit, 0:01:10.600 --> 0:01:12.600 but the debt market still seems to be telling us 0:01:12.600 --> 0:01:15.319 that there's a big problem. Where do we go from here? 0:01:16.520 --> 0:01:20.720 The concerns are fair, the timing may be subject to question. 0:01:21.040 --> 0:01:24.080 In my opinion, I'll draw an analogy back to a 0:01:24.080 --> 0:01:27.880 little ipo I think in nineteen ninety seven Amazon dot Com. 0:01:28.000 --> 0:01:30.560 It's all worked out for them. Today you could read 0:01:30.640 --> 0:01:34.199 on Bloomberg probably every day six months after that IPO 0:01:34.280 --> 0:01:36.000 of the death of retail. I'm sure there was some 0:01:36.040 --> 0:01:39.240 story or something that talked about how retail was over. 0:01:40.160 --> 0:01:45.479 And indeed Amazon's just their retail revenue was over two 0:01:45.560 --> 0:01:49.320 hundred billion dollars last year, a lot of money. It 0:01:49.440 --> 0:01:53.280 fundamentally changed retail, but it didn't end it. And if 0:01:53.320 --> 0:01:57.280 you look across many CMBs transactions, the lowest vacancy rate 0:01:57.360 --> 0:02:01.240 is actually in the retail sector compared to US industrial 0:02:01.320 --> 0:02:04.640 or other things like that. That's from twenty nine years ago. 0:02:04.920 --> 0:02:08.800 Just to kind of put in context another significant shift 0:02:08.960 --> 0:02:12.920 in an ecosystem. Bring forward today to the rollout of 0:02:13.000 --> 0:02:17.240 AI for businesses like ours. Unfortunately, AI is still an 0:02:17.240 --> 0:02:20.239 additional cost. We're hopeful it'll be a savings over time, 0:02:20.280 --> 0:02:22.160 and that's what we're telling ourselves as we spend a 0:02:22.200 --> 0:02:24.480 lot of money and we see checks going out to 0:02:24.560 --> 0:02:28.359 all these different AI providers. When we think about software 0:02:29.240 --> 0:02:33.560 and its potential obsolescence or software as we knew it 0:02:33.639 --> 0:02:38.959 proverbially yesterday. I think answers very based on quite a 0:02:39.040 --> 0:02:43.239 number of things. First, how essential is the software picture 0:02:43.240 --> 0:02:46.960 a company like American Airlines, They're probably not going to 0:02:47.000 --> 0:02:51.000 have a clawed app replace their central reservation system. I'll 0:02:51.000 --> 0:02:52.920 go so far as to say there's probably some green 0:02:52.960 --> 0:02:56.760 screens somewhere still involved in their reservation system. On the 0:02:56.800 --> 0:03:00.360 other hand, a company like us, in our vacation tracking tool, 0:03:01.200 --> 0:03:03.720 should we have a little clawed app that can gin 0:03:03.840 --> 0:03:04.760 that up very quickly? 0:03:05.200 --> 0:03:05.480 Yes? 0:03:06.520 --> 0:03:09.480 Our order management and portfolio management system. Is that going 0:03:09.520 --> 0:03:11.800 to be replaced by some sort of AI developed app 0:03:11.840 --> 0:03:16.080 anytime soon? Probably not. That's the DNA of the lungs 0:03:16.120 --> 0:03:18.880 and heart and nervous system of our company. So when 0:03:18.880 --> 0:03:22.360 you look at the impact of AI, both on software 0:03:23.160 --> 0:03:27.560 and more broadly, you have to think of the essentialness 0:03:27.680 --> 0:03:30.839 of that software, that legacy software tool and I'm sorry 0:03:30.880 --> 0:03:33.720 to use the word legacy to describe most software those 0:03:33.840 --> 0:03:39.320 designed proverbally yesterday. How important is it? How critical is 0:03:39.360 --> 0:03:42.360 it to a business? Every company wants to save money, 0:03:42.560 --> 0:03:45.200 Every company wants to use AI to do better. Whether 0:03:45.240 --> 0:03:49.680 you're in the software business or otherwise. I think the 0:03:49.720 --> 0:03:54.080 market has the trend right the direction, but in my 0:03:54.200 --> 0:03:57.920 experience the slope is far less steep in the beginning years, 0:03:58.440 --> 0:04:01.840 but may ultimately be more severe even than people are predicting. 0:04:02.200 --> 0:04:06.640 But I think of that as worst case five potentially 0:04:06.680 --> 0:04:09.880 fifteen years out in the future. To frame it in 0:04:09.920 --> 0:04:13.080 the I guess I joined a large bank in two thousand, 0:04:13.720 --> 0:04:16.280 you still had to apply to get an email account. 0:04:16.800 --> 0:04:20.480 Unthinkable today, but back you know, that was twenty five 0:04:20.520 --> 0:04:23.360 years ago. Those were still things that we were getting 0:04:23.440 --> 0:04:26.480 rolled out, even though email had widely been around. So 0:04:26.520 --> 0:04:30.520 when we look when we're looking at any software credit 0:04:30.640 --> 0:04:34.359 or any credit, frankly, one of the things is impact. 0:04:34.480 --> 0:04:38.040 Assessing the potential impact of AI. I think it's real. 0:04:38.320 --> 0:04:41.080 I think it will happen, but I do not think 0:04:41.120 --> 0:04:42.200 it happens overnight. 0:04:42.800 --> 0:04:44.240 So what does that mean for the loans? So for 0:04:44.279 --> 0:04:49.760 those who don't know, you know, duration, the maturity schedule 0:04:49.800 --> 0:04:51.919 of a lot of these things. You know, why is 0:04:52.000 --> 0:04:54.599 the length of time important in this context? 0:04:54.960 --> 0:04:58.080 Sure so, most syndicated loans and even private credit loans 0:04:58.120 --> 0:05:01.160 typically have maturities six seven, eight years. We can move 0:05:01.200 --> 0:05:04.520 around a little bit from there that said, I don't 0:05:04.520 --> 0:05:07.640 remember the last loan that paid off at maturity, and 0:05:07.720 --> 0:05:10.040 that very few companies want to have their long term 0:05:10.040 --> 0:05:12.360 debt move to the current portion of their balance sheet. 0:05:12.560 --> 0:05:15.960 I'm sure it's happened once or twice, but typically you'd 0:05:16.000 --> 0:05:19.480 expect to see a syndicated or private credit loan refinance 0:05:19.600 --> 0:05:23.440 sometime between two and four years after it's originated. And 0:05:23.520 --> 0:05:27.160 what that means is quite a few companies that our 0:05:27.600 --> 0:05:31.280 borrowers are debtors at the market today probably have one 0:05:31.279 --> 0:05:34.200 more bite at the apple to refinance before they face 0:05:34.360 --> 0:05:36.600 a real problem. That's not one hundred percent the rule, 0:05:36.600 --> 0:05:39.640 but I think it's significantly the case. One of the 0:05:39.680 --> 0:05:42.360 things we like in the market, and we've certainly you know, 0:05:42.520 --> 0:05:45.560 you've talked about and others others here have written about 0:05:45.920 --> 0:05:49.159 the give or take two trillion dollars private credit market, 0:05:49.920 --> 0:05:52.279 and for a while there were some articles getting written. 0:05:52.360 --> 0:05:55.960 Is the private credit market eating the syndicated market's lunch? 0:05:56.080 --> 0:05:59.400 And for listeners, the syndicated credit market is going to 0:05:59.440 --> 0:06:02.200 be larger companies. This is going to be Hilton Hotels, 0:06:02.360 --> 0:06:06.839 Dell computer companies of that size and scale. Private credit 0:06:07.000 --> 0:06:09.800 typically smaller, but not always and there were a number 0:06:09.800 --> 0:06:11.760 of companies maybe a year or two ago that were 0:06:11.760 --> 0:06:14.880 in the syndicated market that refinanced their debt into the 0:06:14.920 --> 0:06:18.200 private credit market. In many cases they paid, greed to 0:06:18.200 --> 0:06:22.720 pay a higher spread over base rates. And why did 0:06:22.720 --> 0:06:27.120 they do that. Their revenues or EBADA had fallen twenty 0:06:27.120 --> 0:06:30.560 to thirty percent. They needed to be more levered. There 0:06:30.600 --> 0:06:34.400 were aggressive firms, maybe even vultures, buying up their debt 0:06:34.400 --> 0:06:37.680 in the syndicated market, and they just wanted to get 0:06:37.720 --> 0:06:39.680 to a spot where they could work things out privately 0:06:40.440 --> 0:06:43.240 with two or three lenders who would hopefully be more understanding, 0:06:43.920 --> 0:06:46.640 but they'd have to pay them more. At the same time, 0:06:46.760 --> 0:06:50.479 as companies do better, private credit companies all want to 0:06:50.560 --> 0:06:53.279 graduate to the syndicated market because your cost of debt 0:06:53.320 --> 0:06:55.919 is lower. If private credits five hundred or six hundred 0:06:55.960 --> 0:06:59.960 over syndicated credits in action directionally three hundred bases points over. 0:07:00.200 --> 0:07:01.960 There's no one in the world who wouldn't like lower 0:07:02.000 --> 0:07:05.080 debt costs. So what we see is, even if it's 0:07:05.120 --> 0:07:08.919 a large cap company that might be facing some AI headwinds, 0:07:09.600 --> 0:07:11.920 I see the potential for the private credit market to 0:07:12.000 --> 0:07:15.280 refinance them out and other companies will probably achieve some 0:07:15.320 --> 0:07:18.040 significant cost savings and might be able to move from 0:07:18.080 --> 0:07:21.880 private credit up to the syndicated credit market. That companies 0:07:21.960 --> 0:07:24.360 have a couple of years of runway on their debt. 0:07:24.640 --> 0:07:26.640 We look across and we publish this and are on 0:07:26.680 --> 0:07:29.040 our website of all the loans we have exposure to 0:07:29.680 --> 0:07:33.640 in our syndicated programs, I'm going to say less than 0:07:33.640 --> 0:07:36.120 two or three percent mature in the next eighteen months. 0:07:36.360 --> 0:07:38.840 So companies in general have a good bit of runway 0:07:38.840 --> 0:07:41.160 on their debt. They might not like the terms they 0:07:41.240 --> 0:07:43.880 have to refinance that, but in general, I believe there'll 0:07:43.880 --> 0:07:46.160 be a market for most, if not all companies to 0:07:46.200 --> 0:07:47.280 continue refinancwer. 0:07:47.600 --> 0:07:50.080 So it's a company that's kind of in long term declimb, 0:07:50.080 --> 0:07:51.960 but short term there's an opportunity on the debt. 0:07:52.480 --> 0:07:55.200 Yes, yeah, what are you describing with your exposures. That's 0:07:55.200 --> 0:07:58.600 actually very common across CROs. You do find that when 0:07:58.600 --> 0:08:01.160 you look at klatropool and you track it over time, 0:08:01.800 --> 0:08:04.480 the maturity is the new maturities. They'll always disappear from 0:08:04.480 --> 0:08:08.440 the pools several years, sometimes ahead of the time before 0:08:08.440 --> 0:08:11.360 they actually come due. So there's sort of their wave 0:08:11.600 --> 0:08:14.840 of maturities in the collateral pool that moves forward in 0:08:14.880 --> 0:08:17.520 time as we move forward in times, so we never 0:08:17.560 --> 0:08:20.000 actually get to the point where we have a wall 0:08:20.040 --> 0:08:23.760 of maturities hitting the CLO market all at the same 0:08:23.800 --> 0:08:28.320 time in the collateral pools. I think the difficulty with 0:08:29.400 --> 0:08:33.080 the AI exposure of SAS companies is that AI is 0:08:33.160 --> 0:08:35.320 fairly new, so I think a lot of people are 0:08:35.320 --> 0:08:40.000 trying to figure out what exactly the scenario is that 0:08:40.040 --> 0:08:44.640 will play out, and different people have different concerns in mind. 0:08:44.760 --> 0:08:47.160 I mean, some people have the concern or have the 0:08:47.200 --> 0:08:50.320 concern that the pricing models that the SaaS companies are 0:08:50.400 --> 0:08:53.560 using it's no longer going to work because currently their 0:08:53.679 --> 0:08:56.959 pricing proceed and if you have an AI like a 0:08:57.440 --> 0:09:02.120 cloud Cowork, then you might have far fewer employees as 0:09:02.120 --> 0:09:04.840 a result of fewer seats, and so for the SaaS companies, 0:09:04.880 --> 0:09:07.080 the seat pricing is so long ago going to work. 0:09:07.679 --> 0:09:10.679 Other companies then, or other investors have the concern that 0:09:11.559 --> 0:09:14.640 we may see a situation where people who currently buy 0:09:14.720 --> 0:09:17.280 software will just build it internally, which you alluded to before, 0:09:17.320 --> 0:09:20.920 which might happen for smaller applications. Another concern is that 0:09:21.840 --> 0:09:24.720 it might actually be very easy and cheap and quick, 0:09:25.280 --> 0:09:30.280 using AI to replicate some of the largest SaaS companies offerings, 0:09:31.000 --> 0:09:34.480 and that in turn would result in an increased competition 0:09:35.160 --> 0:09:38.600 that in turn would put pressure on margins as SaaS companies. 0:09:39.600 --> 0:09:42.800 So there's a variety of concerns and it's difficult to 0:09:42.840 --> 0:09:45.440 figure out what exactly this scenario is going to be 0:09:45.559 --> 0:09:47.599 that will end up in I think it's difficult to 0:09:47.640 --> 0:09:51.160 make a great assessment as earlier as now because the 0:09:51.200 --> 0:09:53.280 field that's just so wide open with AI, because it's 0:09:53.320 --> 0:09:56.360 so new, and because the improvements in in AI are 0:09:56.400 --> 0:09:57.079 so fast. 0:09:57.520 --> 0:10:00.720 I think what you're saying is fair direction. I agree 0:10:00.760 --> 0:10:04.840 with the sentiments you've shared. That maturity wallpoint is actually 0:10:05.000 --> 0:10:08.040 very very true. If you look at our public filings 0:10:08.080 --> 0:10:11.240 over the last ten years, the maturity wall chart basically 0:10:11.280 --> 0:10:13.280 looks the same every single year. We just changed the 0:10:13.360 --> 0:10:17.200 dates one year. I'm sure we actually recalculated, but we 0:10:17.320 --> 0:10:22.160 probably don't have to and could convey the same message broadly. Though, 0:10:22.280 --> 0:10:25.160 what you're talking about is in line with what I'm 0:10:25.200 --> 0:10:29.840 talking about of we need a little more time to 0:10:29.920 --> 0:10:32.520 see the real impact of this. We know there will 0:10:32.559 --> 0:10:35.040 be an impact. I actually think it will be more 0:10:35.120 --> 0:10:39.200 severe than maybe many of the naysayer say. However, I 0:10:39.240 --> 0:10:43.040 think it will be later. The pace of innovation or 0:10:43.080 --> 0:10:47.800 the implementation of innovation just takes longer. I saw a 0:10:47.840 --> 0:10:49.960 stat recently, and I don't remember the source, but it 0:10:50.000 --> 0:10:51.839 was it was something on the lines of seventy percent 0:10:51.840 --> 0:10:55.520 of Fortune five hundred companies still use mainframes for calculations. 0:10:56.320 --> 0:10:58.840 I'm not in data and operations. I'm sure they're not 0:10:58.920 --> 0:11:01.199 using punch cards and real to real tapes that you 0:11:01.280 --> 0:11:04.160 might have seen in a nineteen sixties James Bond movie 0:11:04.240 --> 0:11:08.400 or something like that. But that's still technology that's used, 0:11:08.400 --> 0:11:10.640 and certainly there's more efficient ways to do things. And 0:11:10.800 --> 0:11:14.000 you know, probably my iPhone has more computing power than 0:11:14.160 --> 0:11:17.319 mainframes did ten or twenty years ago. So I agree 0:11:17.360 --> 0:11:20.920 with the sentiment you're sharing. I think we have a 0:11:21.080 --> 0:11:24.640 longer runway than the market predicts. It doesn't mean it's 0:11:24.640 --> 0:11:27.679 smooth sailing for the next few years, but it's also 0:11:27.800 --> 0:11:30.680 not armageddon. One of the other things we've seen in 0:11:30.720 --> 0:11:35.480 AI or the AI threat coming around a one particular 0:11:35.520 --> 0:11:38.559 loan an insurance broker called Alliant, which is principally a 0:11:38.600 --> 0:11:42.680 high net worth of property and casualty insurance broker. Back 0:11:42.720 --> 0:11:45.960 in January February of this year, there was an article 0:11:46.000 --> 0:11:49.679 went around or some chatter in the market that AI 0:11:49.840 --> 0:11:51.520 is going to cost them their business, and the loan 0:11:51.559 --> 0:11:54.360 traded down three points and you know, in a very 0:11:54.360 --> 0:11:56.960 short period of time it rebounded those in three points 0:11:56.960 --> 0:11:59.520 and probably a very similar period of time, and it 0:11:59.559 --> 0:12:00.840 was a missing opportunity. 0:12:00.840 --> 0:12:05.240 Frankly, I want to come at this point. I think 0:12:05.280 --> 0:12:08.280 you have sort of alluded to it already twice, which 0:12:08.320 --> 0:12:11.560 is not so much a fundamental point which we addressed before, 0:12:11.600 --> 0:12:15.439 but the sentiment important, and one concern I would have 0:12:15.600 --> 0:12:17.800 is that we are in a situation where, because it's 0:12:17.800 --> 0:12:23.440 so uncertain what will happen, these companies will post decent 0:12:23.480 --> 0:12:27.640 results fundamentally the current contracts are currently have, they're still running, 0:12:28.280 --> 0:12:32.480 the financials will look fine, but a lot of investors 0:12:32.520 --> 0:12:36.360 will start to worry that in future they will not 0:12:36.400 --> 0:12:38.720 be fine, and at that point it will become very 0:12:38.760 --> 0:12:44.000 difficult for them to refinance make during that. So you 0:12:44.040 --> 0:12:45.920 sort of alluded to that before when you said, well, 0:12:46.040 --> 0:12:47.880 you know, some of these companies may have to get 0:12:47.880 --> 0:12:51.360 refinanced from a different investor base than from their current 0:12:51.400 --> 0:12:55.000 investor base. But this crazy situation where we might end 0:12:55.080 --> 0:12:58.280 up in a with a self fulfilling prophecy. Yes, currently 0:12:58.280 --> 0:13:00.760 things look fine. Yes, eventually thinks might go wrong, be 0:13:00.800 --> 0:13:03.800 not sure, but that will take time, but the impact 0:13:04.240 --> 0:13:08.000 on the businesses will materialize earlier simply through the funding market, 0:13:08.559 --> 0:13:11.720 and we may have the self fulfilling prophecy where the 0:13:11.760 --> 0:13:16.320 current investor base says, well, I think these businesses could 0:13:16.320 --> 0:13:18.840 too poorly. I think all the other investors that I 0:13:18.920 --> 0:13:22.960 know in my market think the same thing. So I'm 0:13:23.000 --> 0:13:26.840 not going to refinance this company because I'm afraid no 0:13:26.880 --> 0:13:29.160 one else I know will do and tends the company 0:13:29.200 --> 0:13:32.560 will go bust, even though different fundamentals currently still look good. 0:13:33.600 --> 0:13:36.960 And then comes the question of can the company actually 0:13:37.000 --> 0:13:39.760 find someone else to fund them? 0:13:40.200 --> 0:13:43.120 And some non AI examples of that. There was a 0:13:43.160 --> 0:13:47.080 company in the syndicated loan market called Outer Wall which owned, 0:13:47.120 --> 0:13:50.960 among other things, red Box, which were in supermarket DVD rentals, 0:13:51.160 --> 0:13:53.720 which was in the state of the art twenty years 0:13:53.720 --> 0:13:59.800 ago I'm now laughable, but multiple times, even in their decline, 0:13:59.800 --> 0:14:03.000 they able to refinance another company, am General, that makes 0:14:03.080 --> 0:14:07.720 hummers for the military and maybe even the commercial ones. 0:14:07.760 --> 0:14:11.520 I forget similar thing of trend very much in the 0:14:11.520 --> 0:14:15.199 wrong direction, but able to continue to access the capital 0:14:15.240 --> 0:14:17.640 markets as long as they have some degree of revenue 0:14:17.640 --> 0:14:21.840 and EBITDA. That said, there will be a day of 0:14:21.880 --> 0:14:26.240 reckoning for any of these declining companies. But the mitigant 0:14:26.400 --> 0:14:31.040 that we see is time is your friend as a lender, 0:14:32.040 --> 0:14:34.000 even if they have to take their SOFUR plus three 0:14:34.080 --> 0:14:36.720 hundred loan and refinance at private credit at SOFA plus 0:14:36.760 --> 0:14:40.160 six hundred and then three years later refinance it into 0:14:40.160 --> 0:14:43.280 a distress lender at SOFA plus eight hundred. If it's 0:14:43.320 --> 0:14:46.840 that or default, you're going to you know, you're going 0:14:46.880 --> 0:14:49.480 to pay up on the debt versus lose all your equity. 0:14:50.120 --> 0:14:56.000 So it's it's maybe even analogous to real estate when 0:14:56.400 --> 0:14:59.400 you interest rates moved up, many would have called that 0:14:59.440 --> 0:15:01.880 a slow moving train wreck. You know, if you have 0:15:01.920 --> 0:15:04.000 a three percent mortgage and all of a sudden, you know, 0:15:04.080 --> 0:15:06.280 mortgages are now seven percent and you own a you know, 0:15:06.560 --> 0:15:11.880 not so fancy office building in midtown, you're fine until 0:15:11.920 --> 0:15:15.440 you get to your maturity date on your loan. And 0:15:15.480 --> 0:15:18.760 we could see you know, similar things like that. Not necessarily, 0:15:18.760 --> 0:15:20.120 that's the corporate owners are going to get to the 0:15:20.200 --> 0:15:23.600 maturity date, but it will take a long It will 0:15:23.600 --> 0:15:27.040 take multiple years for all of this to flesh out. 0:15:27.240 --> 0:15:29.400 And what we're seeing in the credit markets, both the 0:15:29.400 --> 0:15:32.280 CLO market and actually the BBC market where we're a 0:15:32.400 --> 0:15:35.080 very large investor in the private credit market in terms 0:15:35.120 --> 0:15:38.760 of fun financing, we're seeing the baby thrown out with 0:15:38.800 --> 0:15:42.160 the bathwater, by and large when we look at this, 0:15:42.920 --> 0:15:46.160 and we have, in addition to our COLO equity position, 0:15:46.200 --> 0:15:47.920 and we believe we're one of the largest holders of 0:15:47.960 --> 0:15:50.760 COLO equity in the world, which gives us insight into 0:15:50.840 --> 0:15:53.480 thousands of different credits all around the world, both in 0:15:53.520 --> 0:15:56.800 the US and Europe. We're also, we believe, one of 0:15:56.840 --> 0:15:59.600 the largest at eagle point one of the largest non 0:15:59.760 --> 0:16:05.920 bank financiers of BDCs and private credit funds. And this 0:16:05.960 --> 0:16:08.640 is a strategy we set up six or seven years ago. 0:16:08.680 --> 0:16:12.600 We actually call it our defensive income strategy. And the 0:16:12.600 --> 0:16:17.560 genesis of it, we were talking about bubbles and private 0:16:17.600 --> 0:16:21.560 credit long before the headlines were getting written, back when 0:16:21.600 --> 0:16:23.960 private credit was a one trillion dollar market. Now it's 0:16:24.000 --> 0:16:27.280 a two or three trillion depending on who's counting, but 0:16:27.360 --> 0:16:30.880 lots and lots of money what's going on here and 0:16:30.960 --> 0:16:33.960 what we saw. If memory serves from like twenty fifteen 0:16:34.000 --> 0:16:36.240 to twenty nineteen, a period when there weren't a lot 0:16:36.280 --> 0:16:42.480 of credit losses, BDC debt outperformed BDC equity. I might 0:16:42.520 --> 0:16:44.600 be slightly off on my date on that, but directionally, 0:16:45.120 --> 0:16:47.240 even if it's the same, if you're the creditor and 0:16:47.280 --> 0:16:49.720 you're making the same as the shareholder, obviously you're taking 0:16:49.760 --> 0:16:53.000 less risk as the creditor. And we started looking at this, 0:16:53.040 --> 0:16:56.840 and we started looking at the BDC market, which is issued. 0:16:56.880 --> 0:16:59.960 They are forty AC companies that make a special BDC election, 0:17:00.080 --> 0:17:03.640 and that law became available to BDC's I believe in 0:17:03.720 --> 0:17:09.440 nineteen eighty, so we're forty six years in. While lots 0:17:09.480 --> 0:17:12.280 of BDC's, we've talked about them a little bit, the 0:17:12.320 --> 0:17:16.040 public ones, many if not most, are trading at a 0:17:16.080 --> 0:17:18.960 non trivial discount to nab the share price on the 0:17:19.040 --> 0:17:22.000 exchange less than what the books and records say the 0:17:22.359 --> 0:17:26.560 value of the equity is. On one hand, many non 0:17:26.640 --> 0:17:30.679 traded BDC's probably I had my the Bloomberg terminals not 0:17:30.720 --> 0:17:32.760 open right here, but I'm sure there's a headline about 0:17:32.760 --> 0:17:35.120 some fund that had more than five percent redemptions come 0:17:35.160 --> 0:17:38.439 in this quarter of a non traded BDC, both of 0:17:38.480 --> 0:17:43.119 those facing significant headwinds. BDCs that had historically traded at 0:17:43.119 --> 0:17:47.359 a premium now trading at a discount. Across the forty 0:17:47.400 --> 0:17:49.680 six years since the BDC laws have been in place, 0:17:49.840 --> 0:17:51.560 to the best of our knowledge, there have been two 0:17:51.600 --> 0:17:56.560 defaults ever by BDCs, Allied and ACASS and both of 0:17:56.560 --> 0:18:00.320 those were one hundred cent recovery to the creditor, even 0:18:00.359 --> 0:18:04.080 the shareholder's got some leftover value. And so when we 0:18:04.200 --> 0:18:07.520 look at what's going on in private credit, the thing 0:18:07.600 --> 0:18:11.520 that's made BDC's work is something called the asset coverage ratio. 0:18:11.760 --> 0:18:13.880 In our opinion, has been the number one thing, which 0:18:13.960 --> 0:18:16.960 simply it's there's three different tests. Under the forty Act 0:18:17.040 --> 0:18:21.320 one percent asset coverage. BDCs are subject to the one 0:18:21.359 --> 0:18:23.960 to fifty rule, which means there need to be for 0:18:24.000 --> 0:18:26.960 every dollar of debt one hundred and fifty dollars of 0:18:27.040 --> 0:18:30.760 assets supporting it. If they were to fail that test, 0:18:31.040 --> 0:18:35.040 the consequences are severe, but not game over. And this 0:18:35.160 --> 0:18:37.919 is very important as well. If you fail your asset 0:18:37.920 --> 0:18:41.320 coverage ratio, you can't declare any more dividends and for 0:18:41.400 --> 0:18:44.280 people in the tender offer funds or the non traded funds. 0:18:45.359 --> 0:18:48.120 No more. Forget about getting capped at five percent redemptions. 0:18:48.160 --> 0:18:50.679 The redemptions go to zero if you're failing the asset 0:18:50.680 --> 0:18:53.800 coverage ratio because they're not allowed to redeem capital below 0:18:53.840 --> 0:18:57.119 that ratio. And when we look across what we're seeing 0:18:57.119 --> 0:19:00.199 in all the different BDCs, and then we've taken that 0:19:00.280 --> 0:19:02.399 same technology, which I think is some of the most 0:19:02.400 --> 0:19:08.199 elegant financial regulation ever written, We've applied that to GPLP funds, 0:19:08.240 --> 0:19:10.720 which we think is the vast majority of the private 0:19:10.760 --> 0:19:15.600 credit market. Well XYZ non traded BDC gets the headline. 0:19:16.400 --> 0:19:19.320 We think the traded and non traded BDC universe is 0:19:19.480 --> 0:19:24.760 probably twenty thirty percent in BDC format or the private 0:19:24.760 --> 0:19:27.920 credit markets twenty to thirty percent BDC format, which suggests 0:19:27.960 --> 0:19:32.600 seventy to eighty percent in GPLP format. And when we 0:19:32.640 --> 0:19:35.000 look across that, what we've begun doing, and we started 0:19:35.000 --> 0:19:38.120 this six years ago and it's actually our largest business segment. 0:19:38.880 --> 0:19:41.320 We took the forty Act rules of the asset coverage 0:19:41.359 --> 0:19:45.640 ratio and started providing long term financing to GPLP funds. 0:19:46.200 --> 0:19:48.760 And what it gives us, in addition to a very 0:19:48.760 --> 0:19:52.680 good return on our investments, it gives us insight into 0:19:53.200 --> 0:19:57.679 hundreds and thousands of private credit loans as well. In 0:19:57.720 --> 0:20:00.480 many cases, we see the financials on the underlying borrowers, 0:20:00.560 --> 0:20:05.320 We see the trends and their businesses, and indeed, you know, 0:20:05.640 --> 0:20:08.520 i'd say software companies are probably the most at risk 0:20:08.640 --> 0:20:12.320 across that universe. At the same time, well, I think 0:20:12.400 --> 0:20:15.320 my company were probably. AI is still in the cost 0:20:15.400 --> 0:20:18.800 center category. We hope it becomes a savings category. There's 0:20:18.800 --> 0:20:21.840 other companies perhaps where AI is already helping them save 0:20:21.920 --> 0:20:25.040 money and reduce staff and do things more efficient money. 0:20:25.720 --> 0:20:29.159 So invariably because of AI and its prevalence and the 0:20:29.240 --> 0:20:32.320 technology is truly amazing. And I know one one thousandth 0:20:32.560 --> 0:20:34.600 one one thousandth of a percent of what we can 0:20:34.640 --> 0:20:36.760 actually do with AI. I'm sure my team knows more. 0:20:39.520 --> 0:20:42.760 That will hurt some, but it'll actually help others and 0:20:43.160 --> 0:20:46.720 lower costs and lower prices and increase profits for many businesses. 0:20:46.800 --> 0:20:50.959 So it comes always back to the software point, and 0:20:51.000 --> 0:20:52.840 to kind of circle out to something that Reto said, 0:20:52.880 --> 0:20:56.760 I mean, you know, there is this kind of uncertainty 0:20:56.840 --> 0:20:58.760 no one really knows so you know, you could be 0:20:58.760 --> 0:21:02.119 wrong about some of your assumptions. What stops the companies, 0:21:02.280 --> 0:21:06.600 you know, they face an existential risk? What stops them 0:21:06.640 --> 0:21:09.120 doing something desperate? You know, they don't pay you back, 0:21:09.160 --> 0:21:12.560 they just go off and try and save themselves instead. 0:21:13.080 --> 0:21:15.480 You know, is that not something you see as a scenario. 0:21:15.760 --> 0:21:18.400 Well, thankfully we do have contract law in the United States, 0:21:18.880 --> 0:21:22.639 so their ability just to renounce their debt. One or 0:21:22.640 --> 0:21:25.359 two companies have tried that over my career. A company 0:21:25.359 --> 0:21:28.520 a long time ago laid law my recollection tried to 0:21:28.520 --> 0:21:31.320 say this was not valid indebtedness to the syndicated market. 0:21:31.320 --> 0:21:35.000 That didn't work out for them, But in general, companies 0:21:35.040 --> 0:21:39.560 have to pay. However, what's another trend in the loan 0:21:39.640 --> 0:21:42.080 market the default rate? If you were to look up 0:21:42.119 --> 0:21:45.560 on any of the major publishers corporate loan default rate, 0:21:45.560 --> 0:21:47.680 you'd probably saye, it's around one percent right now for 0:21:47.800 --> 0:21:52.320 below investment great credit, well below the long term average. Frankly, wow, 0:21:52.359 --> 0:21:56.159 that sounds great. What could possibly be going wrong? The 0:21:56.240 --> 0:21:58.720 little secret of the market, and you've covered it once 0:21:58.840 --> 0:22:01.720 or twice on this podcast fairly recently, is what i'll 0:22:01.760 --> 0:22:06.879 call lender on lender violence or liability management exercises or 0:22:07.160 --> 0:22:10.960 out of court restructurings might be the least salacious way 0:22:11.000 --> 0:22:12.680 to put it, but it really is a lender on 0:22:12.800 --> 0:22:17.280 lender of violence and something that's crept certainly well into 0:22:17.280 --> 0:22:20.000 the syndicated loan market and even somewhat into the private 0:22:20.040 --> 0:22:24.679 credit market. Are provisions that say fifty one percent of 0:22:24.720 --> 0:22:30.439 the lenders can pretty much agree to anything. That's a 0:22:30.440 --> 0:22:34.440 pretty good that's a very very powerful provision, and over 0:22:34.480 --> 0:22:39.000 the last eighteen months or so, we've seen well over 0:22:39.080 --> 0:22:42.840 one hundred liability management exercises or out of court restructurings 0:22:42.840 --> 0:22:47.159 of companies that we're facing. The problems that you're facing. 0:22:47.080 --> 0:22:49.280 The CLO trade generally, we've had a lot of people 0:22:49.280 --> 0:22:53.639 talk about it as a big opportunity, but there is 0:22:54.040 --> 0:22:58.840