Speaker 1: Hello, and welcome to The Credit Edge, a weekly markets podcast.
Speaker 1: My name is James Crumbie. I'm a senior editor at Bloomberg.
Speaker 1: This week, we're very pleased to welcome Anna Arsof, global
Speaker 1: head of private credit at Moody's Ratings. How are you, Anna, great?
Speaker 2: Thank you, super excited to be here.
Speaker 1: Thank you so much for joining us today. Were very
Speaker 1: excited to have you on the show and also delighted
Speaker 1: to have us our guest, David Haven's with Bloomberg Intelligence.
Speaker 3: Hello David, James, excellent to be with you as always,
Speaker 3: and you two, Anna.
Speaker 1: So We're here to discuss private credit, a hot topic.
Speaker 1: Everybody's talking about it. Just to set the scene a bit.
Speaker 1: Private debt has experienced a meteoric rise over the last
Speaker 1: few years. It still has plenty of fans. I don't
Speaker 1: think it's going away, but there are plenty of risks
Speaker 1: building in this one point seven trillion dollar market. Last
Speaker 1: week's rate cut from the They're kicked off what could
Speaker 1: be a significant easing cycle, which would undermine the appeal
Speaker 1: to investors in loans which are floating so they pay
Speaker 1: less when rates go down. Regulators also have the industry
Speaker 1: in their sites amid growing concerns about how any big
Speaker 1: blow up in private credit would hit banks, which tend
Speaker 1: to lend to private credit managers. Fundraising is meanwhile slowing
Speaker 1: as falling oil prices effect flows from the Middle East
Speaker 1: and new US measures may make it harder for insurers
Speaker 1: to invest. And there's still a risk in the US
Speaker 1: economy that it may tip into recession, which could mean
Speaker 1: more distress broadly in debt markets, including private credit. We're
Speaker 1: already seeing signs of private credit stress in the form
Speaker 1: of amendments, extensions and increasing number of loans being repaid
Speaker 1: with more debt and arise in defaults. Some fear a
Speaker 1: big reckoning as too much money chases too few deals.
Speaker 1: So let's start there, and is this still a golden
Speaker 1: age or time now to curb all that enthusiasm about
Speaker 1: private credit?
Speaker 2: Well, golden in it's from a credit person. It's very
Speaker 2: hard for me to say that. You know, if I
Speaker 2: was an equity investor, I would have been a little
Speaker 2: bit too excited. But as we try and tend to
Speaker 2: say in credit, there is no upside to paying a
Speaker 2: principle back, so I have to be a little bit
Speaker 2: more tained in my response. So where are we look,
Speaker 2: this market got its real i would say golden age
Speaker 2: period between twenty twenty one and twenty twenty two, and
Speaker 2: probably half of twenty twenty three. And why that was
Speaker 2: the case, Well, at that time we had an extraordinary
Speaker 2: influx of liquidity. Twenty twenty one was the biggest market
Speaker 2: in originating leverage finance loans, both in the private and
Speaker 2: in the public syndicated market. And then we got something
Speaker 2: extraordinary rate hikes and we got to have a base
Speaker 2: rate in order five percent, which we haven't had in
Speaker 2: a long time. So what that meants is that seal
Speaker 2: investors were the largest purchasers of really syndicated owns, got
Speaker 2: scared basically, you know, issuance and claws got really tempered,
Speaker 2: and the bordly syndicated law market pretty much died, if
Speaker 2: you will, for two years. So this was the golden
Speaker 2: moment of the folks out they're the large asset managers
Speaker 2: and others who had BDC's already set up, who had
Speaker 2: raised capital, permanent capital ready do we deployed? So yeah.
Speaker 2: So that was the period that between twenty twenty one
Speaker 2: and twenty three was the golden age, and then the
Speaker 2: market opened this year in twenty twenty four in the
Speaker 2: borodly syndicated lawn market, it's around three hundred billion dollars
Speaker 2: that have been already executed, so it became quite competitive,
Speaker 2: and I'm sure we're going to touch about that.
Speaker 1: What do you think, David golden Age?
Speaker 3: Still, I think I tend to side with Anna on
Speaker 3: this one. It seems like we've probably moved through the
Speaker 3: Golden Age, although we have seen a pretty significant uptakeing
Speaker 3: growth over the past year in asset loan formation, at
Speaker 3: least on the balance sheets of BDC's sort of focusing
Speaker 3: on that. That's up about twenty percent on a year
Speaker 3: over year base. So they did take a pause and
Speaker 3: growth as rates began to rise and as there were
Speaker 3: all sorts of questions about the economy. Seem to have
Speaker 3: moved through that. So there's still a lot of dry
Speaker 3: powder being put to work in private credit and private equity.
Speaker 3: The two go hand in hand together. So I think
Speaker 3: that we're going to see a lot of opportunity to
Speaker 3: add assets. But the question is is this's the right
Speaker 3: time to be adding these assets? You know, have spreads
Speaker 3: spreads have come in, have they come in too much?
Speaker 3: There's a lot of competitions on a noted and it
Speaker 3: seems as though the possibility of accidents, which I think
Speaker 3: we've largely missed over the past couple of years, might
Speaker 3: be on the rise now.
Speaker 2: If I may just to add to some numbers, our
Speaker 2: estimates show that around one hundred billion dollars of worth
Speaker 2: of transactions order of three hundred million dollars to executed
Speaker 2: in the private credit market here to date, from which
Speaker 2: seventy billion were notorder for a billion dollars. Why mentioning this
Speaker 2: is because that was the sweet spot of the broadly
Speaker 2: syndicated loan market and everybody thought, well, the BSL market
Speaker 2: is going to open, so that's the debt for private credit.
Speaker 2: The show is over. But obviously that did not happen.
Speaker 2: There is a significant number of transactions that you know,
Speaker 2: in two, three, four years ago would have gone to
Speaker 2: the BSL market, particularly these ones that I mentioned a
Speaker 2: billion dollars and above. But private credit, I guess showed
Speaker 2: it's worth over the last few years. And what I
Speaker 2: mean by that is, you know, they're much more flexible
Speaker 2: in execution. Therefore the rating process that's one and then
Speaker 2: also can can attend to much more flexible terms like picking.
Speaker 2: For example, you know, the whole concept of default is
Speaker 2: not the same. So a lot of that B three
Speaker 2: credits that traditionally would have been originated and placed in
Speaker 2: clo clos became more conservative seal information. Also, although his
Speaker 2: pick top was you know, his slow still was very
Speaker 2: slow in the first quarter, so they were looking for
Speaker 2: better quality credits like B two. So anything that's a
Speaker 2: B three or would have been basically originated in the
Speaker 2: private credit market and more definitely more flexible around this.
Speaker 2: So what's interesting for us is thinking about what's the
Speaker 2: new norm. Is this an an normally or this year
Speaker 2: still part of the anomally of twenty twenty one twenty
Speaker 2: three cycle, or truly private credit is here to stay
Speaker 2: and going to share the stage would be asl forever.
Speaker 3: Yeah, I mean I think that there's a a you
Speaker 3: mentioned the word flexibility. I think that word flexibility is
Speaker 3: something that's pretty attractive to the to that sort of
Speaker 3: private private capital. I wouldn't just limit it to private credit,
Speaker 3: but I think it's attractive to the private capital ecosystem
Speaker 3: where private equity providers you know, are often you know,
Speaker 3: kickstarting some of the transactions that are going on private
Speaker 3: credit steps in provides funding. Uh, they do provide ease
Speaker 3: of execute shan as opposed to the BSL market, You're
Speaker 3: dealing with one or a small club of lenders, very
Speaker 3: easy to sort of make changes and amendments and you know,
Speaker 3: sort of shift gears on the fly in a debt
Speaker 3: transaction given that limited number of lenders, as opposed to
Speaker 3: the BSL market or structured market where you've got far
Speaker 3: less flexibility and you're dealing with more people and have
Speaker 3: more hurdles to cross. So that's pretty attractive to the borrowers.
Speaker 2: Yeah, and then if I am a d I was
Speaker 2: looking actually at FED research paper and private credit yesterday
Speaker 2: preparing for this discussion and just to kind of mention
Speaker 2: this whole point of typically it was a one lender market. Actually,
Speaker 2: the FED shows that what traditionally was a one lender
Speaker 2: typical private credit market has increased to two point eight
Speaker 2: on medium for most of private credit deals. And we
Speaker 2: know that this particular transactions nord of a billion or so,
Speaker 2: they really become very much a club of six an
Speaker 2: aid sometimes private credit lenders. So there is quite a
Speaker 2: convergence for sure in terms of the structure convergency in pricing.
Speaker 2: You know, the private credit loans used to you know,
Speaker 2: generate like a six hundred and fifty bases points spread
Speaker 2: just a year ago, and now that has shrinked. In
Speaker 2: some latest deals, we're looking at around five point fifty,
Speaker 2: which is pretty much within the norm of the broadly
Speaker 2: syndicate in law market. So we step back and say, okay,
Speaker 2: so it's very clubbish, meaning more banks are participating. So
Speaker 2: that's similar to the broadly syndicated lawmarket. Spreads have compressed.
Speaker 2: So what makes the secret sauce? And I think it
Speaker 2: goes back to the terms and the flexibility that if
Speaker 2: a loan ends up being in trouble, it doesn't have
Speaker 2: to exit a CLO structure immediately because as the rating
Speaker 2: agencies will claim that as a default. Even you know,
Speaker 2: infusion by a sponsor capital, which was a norm in
Speaker 2: private credit over the last two years, they would have
Speaker 2: been potentially a trigger to call it a default and
Speaker 2: downgrade to C DOUBLEA, which immediately becomes disadvantaged from asset
Speaker 2: quality in a colo versus in the private credit market,
Speaker 2: that's a performing loan that luckily got a sponsor in fusion.
Speaker 2: So I'm glad you know, we're we're kind of comparing contrasting,
Speaker 2: but I think we will also discuss how we compare
Speaker 2: those default straight shortly as well.
Speaker 1: What are your expectations for growth of this market? I mean,
Speaker 1: it's sort of doubled over the last couple of years
Speaker 1: in size, But what you were saying is it kind
Speaker 1: of grew very quickly at the expense of broady syndicated loans,
Speaker 1: which kind of shut down. Now that those are back,
Speaker 1: Does that mean that the pace of growth of private
Speaker 1: credit just slows or stops altogether.
Speaker 2: Well, we you know, back many people out there, pundits
Speaker 2: have estimated various numbers out there have been a two
Speaker 2: point eight to three trillion over next three to five years.
Speaker 2: We look at it a little bit more simple than that.
Speaker 2: If today's one point seve and trillion, and we have
Speaker 2: a three trillion dollars of private equity dry powder, and
Speaker 2: we looked at statistically, depending on the rate cycle, equity
Speaker 2: versus debt on media, and let's say it's around fifty
Speaker 2: percent equity versus dead which means that that three trillion
Speaker 2: dollars of private equity capital will need to be invested
Speaker 2: with the equivalent of the three trillion dollars of debt.
Speaker 2: So now exactly the conversation we just had is where
Speaker 2: this new norm is private created is going to be
Speaker 2: thirty fifty percent of all leverage trainians credit provisions. Let's assume,
Speaker 2: you know, for sake of simplicity, fifty percent fifty split
Speaker 2: up the market share with BSL. You end up basically
Speaker 2: with need of roughly three or and a half of
Speaker 2: CREAD provision over the next five to seven years to
Speaker 2: deploy that private equity dry powder. So you know, again
Speaker 2: it's all about timing and how long horizon you want
Speaker 2: to have, but certainly, based on this very simplisticalcualation, you
Speaker 2: can get to three trillion market you know, by of
Speaker 2: the decade.
Speaker 1: And in terms of deal size on a single deal level,
Speaker 1: you know, we've seen some very big deals in a
Speaker 1: five billion plus. It is going to continue to get
Speaker 1: bigger in private credit, do you think.
Speaker 2: Yeah, exactly, as I said, I mean, seventy of the
Speaker 2: one hundred billion a year to DAT has been executed.
Speaker 2: That's our estimates. Point two seventy billion has been these
Speaker 2: transactions nord of a billion, with a few obviously exceeding
Speaker 2: even two and a half billion kind of medium size.
Speaker 2: So for sure it becomes what we are hearing from
Speaker 2: the banks, from the private credit managers is pretty much
Speaker 2: every deal nord of a billion actually now goes through
Speaker 2: a dual process. Private credit almost like arrived and it's
Speaker 2: not leaving. And the banks are like, you know, are
Speaker 2: obviously not liking it. But the private equity managers and
Speaker 2: sponsors are you know, indulging in it.
Speaker 3: Yeah, and the you know, and a lot of those
Speaker 3: sponsors are advising the private credit lenders, so you know,
Speaker 3: there is that sort of ecosystem of private capital out
Speaker 3: there that they cross over from private debt to private
Speaker 3: equity and keeping everything you know, within the ecosystem I
Speaker 3: think is pretty attractive to certainly to the advisors.
Speaker 1: You mentioned the banks, though I know you cover the banks,
Speaker 1: you have a very broad mandate moodies, which is is
Speaker 1: interesting to me.
Speaker 2: How are the.
Speaker 1: Traditional banks affected by this big boom in direct lending.
Speaker 1: On the one hand, they were competing, as you say,
Speaker 1: you know, they lost out on business in the broadly
Speaker 1: syndicated market, but now they seem to be lending more
Speaker 1: to the private credit managers, you know, sort of doubling
Speaker 1: the leverage in some cases in some of the fundraising,
Speaker 1: how much risk is building on the bank side because
Speaker 1: of this market growth?
Speaker 2: No, absolutely great question and yeah when we set up
Speaker 2: the private Credit Analytical franchise, said Moodies. And why it
Speaker 2: lended with me leading it is because I've covered it
Speaker 2: was the quota of all being creatings globally responsible for
Speaker 2: capital markets being seem particular the ones who are the
Speaker 2: largest in in this space and provisioning credit to to
Speaker 2: private credit and sponsors. And it became evident as part
Speaker 2: of our diligence into the banks and or risk meetings
Speaker 2: that the line that was growing the fastest in addition
Speaker 2: to the commercial real estate for for a number of years,
Speaker 2: was the exposure to non bank financials. And when we
Speaker 2: tried to dig in into that particular exposure, because that
Speaker 2: can be anything from origination of mortgage stray to be
Speaker 2: securitized or traditional COLO or auto loans, et cetera. Really
Speaker 2: the most significant subcomponent of that exposure to non bank
Speaker 2: financials was indeed exposure to private credit and private AQ
Speaker 2: with you. And as a matter of fact, there are
Speaker 2: two particular business lines within that segment that had the
Speaker 2: fastest growth. One was the subscription line of credit that
Speaker 2: obviously had both to private equit but also increasingly over
Speaker 2: the last few years, to private credit funds. And the
Speaker 2: second line was something called asset bak finance or asset
Speaker 2: back lending, which ultimately is what you just mentioned is
Speaker 2: the leverage provisioning into the BDCs and other similar funds.
Speaker 2: So how do the BDCs, maybe just let devistify this
Speaker 2: for our audience here, The BDCs typically fund themselves in
Speaker 2: when they start, when they're kind of a smaller entity,
Speaker 2: into the secured market solely as they basically typically you know,
Speaker 2: let's say cross five hundred million dollar size, they issue
Speaker 2: private placements and anord of a billion, they actually seek
Speaker 2: usually a public rating, and issue senior and secure dead
Speaker 2: So in addition to the senior and secure debt, they
Speaker 2: actually also still maintain a secure debt that's provided by
Speaker 2: the banks. And we estimate that that size of that
Speaker 2: exposure and banks balance is around four hundred plus billion dollars,
Speaker 2: which is quite significant. But the change is really the
Speaker 2: most significant, and what our data shows is that the
Speaker 2: growth of the bank's exposure in that particular asset by
Speaker 2: clending to private credit, has outpaced the fundraising of the
Speaker 2: alternative acet managers private credit lenders, so they have increased
Speaker 2: the exposure higher than what the capital raising activity it is.
Speaker 2: So that might be simply a ketch up, but it's
Speaker 2: a severy lucrative business, an attractive business for the banks,
Speaker 2: and we think this is going to be this is
Speaker 2: going to continue growing because there's always going to be
Speaker 2: a secured component as part of the banks, as part
Speaker 2: of the private credit funds originating these kind of loans.
Speaker 3: Yeah, and it sort of goes back to, you know,
Speaker 3: changes and regulations that have been going on since the
Speaker 3: since the financial crisis, where banks had to de risk
Speaker 3: you know, vast ways of their of their lending portfolios.
Speaker 3: So they did draw back from from lower quality corporate
Speaker 3: credit middle market lending. Uh. And it's easier for them
Speaker 3: to go in from a regulatory perspective and make a
Speaker 3: secured loan to an investment grade or near investment grade
Speaker 3: rated entity than it is to a B three C
Speaker 3: doa A one rated entity. And you know, you should
Speaker 3: probably cueue the foreboding background music now because we are
Speaker 3: talking about the specter of shadow banking. And you know,
Speaker 3: if you look through the report, for example, that the
Speaker 3: IMF did earlier this year, taking I think they dedicated
Speaker 3: twenty to thirty pages on private credit in their Global
Speaker 3: Financial Stability Report. One of their you know, sort of
Speaker 3: key recommendations is stepping up regulation and disclosure around private credit,
Speaker 3: particularly within the banking system. So well, I'm sure everybody's
Speaker 3: going to love that, but we'll see how that goes.
Speaker 2: No, absolutely, you know, we we have quite all significant
Speaker 2: engagement with variety of regulators globally. Everybody's trying to understand
Speaker 2: what does this disruption, if you will, will mean for
Speaker 2: the banks, both from a of course competitive perspective, but
Speaker 2: also from a risk perspective, and you know, you know,
Speaker 2: there's just a few arguments on that side, on both
Speaker 2: sides of the argument, if you will. So for example,
Speaker 2: you know, if you think about a leveraged loan and
Speaker 2: that has six seven times leverage, a lot of the
Speaker 2: private asset manager, private asset managers, alternative asset managers will
Speaker 2: originate this private credit loans would say, isn't that better
Speaker 2: that risky loan to be funded with a permanent capital
Speaker 2: at one to one leverage versus set a bank that
Speaker 2: has nine to ten times leverage and funded with you
Speaker 2: know forty you know, media for US banks and particularly
Speaker 2: large banks, you know anywhere from thirty to sixty percent
Speaker 2: of deposits, which have proven, particularly in the last years
Speaker 2: regional bank crisis, to be quite flighty. So yes, there
Speaker 2: is an argument to that. And however, you know, with
Speaker 2: the loans moving into the private credit ecosystem and funded
Speaker 2: only on banks balance sheets or or in the dark,
Speaker 2: if you will, because we don't know on what terms.
Speaker 2: Every banks has its own risk management standards that are
Speaker 2: proprietary to a bank, and there's very little disclosures as
Speaker 2: it is set to day about the breakout of that
Speaker 2: particular non bank financial exposure line that has been growing.
Speaker 2: It certainly creates concerns about on what terms are those
Speaker 2: loans being made and what's the ultimate leverage in the system.
Speaker 2: And so definitely we've been calling as well for better transparency,
Speaker 2: particularly from the bank's perspective, about their exposure because you
Speaker 2: know this in the larger scheme of things. So four
Speaker 2: hundred billion, let's say, which is our current estimate based
Speaker 2: on a survey that we are executing, and we'll be
Speaker 2: writing more about it. It's it's not significant. We take
Speaker 2: a twenty seven trillion US assets banking systems and this
Speaker 2: was by the way global banks number so but the
Speaker 2: pace and again the terms and is there not a
Speaker 2: hidden leverage behind it is what concerns regulators.
Speaker 1: But it's just basically fair of the unknown. Again with you,
Speaker 1: David Sinister, music playing in the background. I mean, you
Speaker 1: know what we can't see. We worry about you sumbly
Speaker 1: can see more than a lot of other people because
Speaker 1: you know you have the access. Is there anything that
Speaker 1: you're worried about right now?
Speaker 2: Not particularly today, because it gives us comfort that a
Speaker 2: lot of that exposure is in these two particular business lines,
Speaker 2: as I said, and the particularly asset back finance line
Speaker 2: is a super senior protection for the banks, whereby they
Speaker 2: have quite a lot of coverage. Typical the loan to
Speaker 2: values around sixty percent. And these are all senior loans
Speaker 2: that have been mostly senior loans that have been supporting
Speaker 2: as a collateral. And therefore it has to have a
Speaker 2: major correction first and foremost, and the value of both
Speaker 2: the private equity kind of enterprise value of the companies
Speaker 2: that senior loans support, and think about these are senior
Speaker 2: loans that even if private equity is necessarily losing their value.
Speaker 2: The senior loans should be first to pay, and again
Speaker 2: the bank will be the first one to pay if
Speaker 2: there is an issue with that loan. So it has
Speaker 2: to be a major correction in the asset value of
Speaker 2: senior loans today. If you think about history, recoveries for
Speaker 2: senior loans of leverage finance companies have been around seventy percent.
Speaker 2: We think in this cycle for the broadly syndicated low
Speaker 2: market that may go down as low as sixty And
Speaker 2: what we really are focused on is we haven't had
Speaker 2: a significant default cycle into the private credit loans today.
Speaker 2: And we will talk in a second maybe why that's
Speaker 2: the case, but we haven't. It's the argument of the
Speaker 2: private credit managers that they will manage this asset better
Speaker 2: than the banks or the broadly syne killaw market who
Speaker 2: are here just to originate and distribute versus only to balance.
Speaker 2: It is something that we are watching to see and
Speaker 2: we see how they really perform ultimately relative to BSL market.
Speaker 2: There is a lot of arguments why private credit managers
Speaker 2: will do it better because they have their own They
Speaker 2: have first of all, the benefit of time. At the
Speaker 2: end of the day, they can because they have permanent
Speaker 2: capital funding it that don't have overnight liquidity risks, at
Speaker 2: least the funds that we rate, which is the bulk
Speaker 2: of the BDCs and around ninety percent of the assets
Speaker 2: and investment create Because of the low leverage and no
Speaker 2: immediate funding risks, they can withstand let's at temporary shock
Speaker 2: into the liquidity market and manage that loan for ultimate
Speaker 2: recovery two three, four years from now. And also they've
Speaker 2: been building a lot of the large funds have been
Speaker 2: actually building their own resolution teams, hiring structuring teams, being
Speaker 2: ready for such a cycle. So I think this will
Speaker 2: be This is probably the biggest unknown is is that
Speaker 2: fundraising premise, if you will, of the funds that they're
Speaker 2: going to perform better will come true.
Speaker 3: So I think that sort of gets back to the
Speaker 3: word that I've sort of thrown out there a couple
Speaker 3: of times, is this whole ecosystem idea that you've got
Speaker 3: private capital, not just private debt, not just private equity,
Speaker 3: but sort of private debt and equity working together along
Speaker 3: with the sponsors too, who have that ability to throw
Speaker 3: good money after good if you get to a troubled situation,
Speaker 3: they've got the flexibility to make changes to terms and
Speaker 3: conditions and amendments in a fairly flexible manner that may
Speaker 3: not exist elsewhere. There are people that that view, you know,
Speaker 3: amendments and things of that nature is sweeping problems under
Speaker 3: the rug, which may be true. But again, if you
Speaker 3: can throw good money after good or make an amendment
Speaker 3: for a loan that you think will be good, it
Speaker 3: makes sense rather than being forced to do something you
Speaker 3: don't want to do. Just and on. One of the
Speaker 3: things which I think is kind of interesting and I
Speaker 3: get asset all the time, is why has private credit
Speaker 3: been as or credit generally, I guess, but private credit
Speaker 3: been as resilient as it's been. Like if I go
Speaker 3: back and look at some of the research that you
Speaker 3: guys did, I look back about a year ago, I
Speaker 3: think that we were looking at a trailing default rate
Speaker 3: of about three percent in BA in B three debt.
Speaker 3: I think you and others were forecasting that that was
Speaker 3: going to put perhaps double over the next year. That
Speaker 3: hasn't happened. And so what what do you think is
Speaker 3: going on? I've got my own theories, but curious.
Speaker 2: We'd love to debate that one. Maybe maybe we agree,
Speaker 2: So let me just kind of provide little statistics. You know,
Speaker 2: we were actually close to five percent you know default
Speaker 2: rate that we project is going to be down to
Speaker 2: three point five percent this year and going into next year.
Speaker 2: And that's on the broadly syndicated high yield you know,
Speaker 2: senior loans. If you look at now of the private
Speaker 2: credit loans universe that we rate in the business development
Speaker 2: companies or BDC sector, actually none acrules went from just
Speaker 2: fifty basis points two years ago to nord of one
Speaker 2: percent today. So again this is like comparing apples and oranges,
Speaker 2: which is the big issue of the market because as
Speaker 2: I said earlier, as sponsor can infuse a capital, which
Speaker 2: happened in you know, at least you know, thirty forty
Speaker 2: percent of transactions over the last couple of years in
Speaker 2: the private credit universe, and that is not a default
Speaker 2: versus a non accrule really means that they're not paying interest.
Speaker 2: So the couple of dynamics, there was definitely an ability
Speaker 2: to move transactions from the broadly syndicated loan market when
Speaker 2: they crossed that potential risk of default into the private
Speaker 2: credit market. So in my view, it's very hard statistically
Speaker 2: to prove this is we're trying to actually research it
Speaker 2: at this moment, is how much of that those number
Speaker 2: of loans that actually moved from be a sell into
Speaker 2: private credit And if assumed that big part of that
Speaker 2: maybe would have hit a default, would actually have increased
Speaker 2: the measured default rate. And obviously that is very hard
Speaker 2: to point. There was just an avenue of capital that
Speaker 2: existed in private credit did not exist in prior cycles.
Speaker 2: So that's a big reason of why that happened. Secondly,
Speaker 2: we did have quite a constructive economy. Yes, inflation was
Speaker 2: high as the rate increased, but we did have historic
Speaker 2: very low unemployment. The economy was doing well, which means
Speaker 2: that if you think about the US economy being driven
Speaker 2: by the consumer, two thirds of the US GDP's driven
Speaker 2: by consumer spending, and which means it's highly correlated to
Speaker 2: the unemployment rate more than inflation rate or any other
Speaker 2: or even interest rate. Has proven to be the case.
Speaker 2: So therefore, and you know, we can debate these two
Speaker 2: tails of the consumer and all of that, but generally
Speaker 2: the consumer was had extra liquidity, had jobs, which means
Speaker 2: that was supportive to the economy. So therefore you have
Speaker 2: two factors again influx of capital for private credit that
Speaker 2: basically a lot of firms who could have defaulted in
Speaker 2: a public market went and refinance, so they did not
Speaker 2: default in the official statistic. And then secondly, we had
Speaker 2: a relatively strong economy booming despite the inflation and the
Speaker 2: high rates.
Speaker 3: Yeah, I tend to think that the trillions of helicopter
Speaker 3: dollars of helicopter money that were pushed into the economy
Speaker 3: during the pandemic are having a pretty big influence on
Speaker 3: what we're seeing in individual you know, sort of credit
Speaker 3: trends and in in corporate credit trends. But one area
Speaker 3: which which I think is is drawing greater scrutiny right
Speaker 3: now is the amount of payment and kind income PICK income,
Speaker 3: which is flowing through at least BDC balance sheets. I
Speaker 3: did some research that was published over the past couple
Speaker 3: of days where we go back about five or six
Speaker 3: years look at PICK income as a percentage of total
Speaker 3: investment income, and I think it's gone from less than
Speaker 3: five percent back in twenty eighteen or twenty nineteen to
Speaker 3: just about ten percent now for BDC's And I think
Speaker 3: that you know, a lot of people that I talked
Speaker 3: to are wondering, well, this is it. This is showing
Speaker 3: that there really is stress building up in these private
Speaker 3: credit portfolios, and all it's going to take is a
Speaker 3: little spark for that to sort of explode. I don't
Speaker 3: think that there's going to be explosion, but I do
Speaker 3: think that that's something too to keep an eye on.
Speaker 3: And where where you guys.
Speaker 2: Absolutely, as a matter of fact, we we deep dive
Speaker 2: into this issue quite significantly. Maybe I'll just share some
Speaker 2: of the statistics. Our median picking come as percentage of
Speaker 2: total investment is around actually six and a half percent,
Speaker 2: but there is a big discrepancy around that median.
Speaker 3: You got to make more of this free.
Speaker 2: So yeah, I'll definitely share that. But if you look
Speaker 2: at some some BDCs here are really you know, nord
Speaker 2: of twenty percent, like I'm looking for example at Prospect
Speaker 2: Capital and you know, you know, close to twenty percent.
Speaker 2: So and then we have some that are really well performing,
Speaker 2: you know that you know, have you know less than
Speaker 2: less than three percent. So how we analyze this? What
Speaker 2: was unique feature of the prior crede market was that
Speaker 2: loans can be originated as a peak from beginning, and
Speaker 2: that was for a lot of these state companies who
Speaker 2: wanted to reserve capital for investment, and therefore that simply
Speaker 2: was not you know, both the sponsor and the lenders
Speaker 2: had agreed from origination that it's better for the company
Speaker 2: to invest in cash than pay interest. And there's been
Speaker 2: priced from the beginning of the transaction. So we consider
Speaker 2: that still, you know, not a perfect from a credit
Speaker 2: quality perspective, but something that has been captured and hopefully
Speaker 2: priced for what we look at when you sit in
Speaker 2: created comedian, we evaluate the ratings for a number of
Speaker 2: these BDCs. We actually look at the delta of how
Speaker 2: much of the picks have actually moved from non picks
Speaker 2: into pik loans, and that numbers has basically increased significantly
Speaker 2: over the last year, and we think of that as
Speaker 2: a precursor of increase of non accrules. So hence we
Speaker 2: as we skeptically look at that one point percent non
Speaker 2: acrul medium for the industry, and we look at more
Speaker 2: the delta of Okay, it went from three and a
Speaker 2: half four percent to six percent of the industry in picks,
Speaker 2: So that means that there's a number of transactions that
Speaker 2: potentially are tittering into becoming nonocruals.
Speaker 3: Pick might be a leading indicator, non accruals a lagging indicator. Correct,
Speaker 3: And then maybe one of the reasons we've probably seen
Speaker 3: a significant increase in PICK is because we had a
Speaker 3: five hundred and twenty five basis point increase in base rates.
Speaker 3: Those base rates are going to start to hopefully decline
Speaker 3: after the fifty basis point decline that we've seen or
Speaker 3: cut that we saw on interest rates, maybe that'll mitigate
Speaker 3: some of the increase in PICK activity.
Speaker 2: It felt like we're all ladies in waiting here to
Speaker 2: see that not a cruel increase and transfer that peak
Speaker 2: into non a crules. Not that I'm wishing for the industry,
Speaker 2: is just that we're obviously protecting the interest of creat investors,
Speaker 2: and it just looked like a quite a dramatic change
Speaker 2: of five hundred basis points of interest in the last
Speaker 2: two and a half years would have had a more
Speaker 2: meaningful credit issue for these highly levered companies. But I
Speaker 2: think that's flexibility, as you said, of capital coming from
Speaker 2: the sponsor's ability to peak transfer terms in the more
Speaker 2: invisible part of the credit universe allowed for firms to
Speaker 2: potentially buy time and now the fifty basis points, and
Speaker 2: just to kind of give you our baseline is additional
Speaker 2: one hundred two hundred and twenty five basis points between
Speaker 2: now and the end of next year. So this will
Speaker 2: alleviate interest expands quite significantly and also open the avenue
Speaker 2: for other strategic investors into these companies. As we know,
Speaker 2: the M and A market, the sponsor M and A
Speaker 2: market was pretty much dead over the last two years
Speaker 2: because sponsors simply could not agree on price of their
Speaker 2: companies in a rate environment that is quite elevated. I
Speaker 2: think this will definitely accelerate, particularly towards the end of
Speaker 2: this year. Now we have an election cycle which might
Speaker 2: put people a little bit still in a pause, but
Speaker 2: certainly for next year, we're expecting M and A to
Speaker 2: accelerate and therefore open various avenues of one, first, lower
Speaker 2: interest expense costs. A second coming to an agreement of
Speaker 2: enterprise value for these companies, which can allow firms to
Speaker 2: potentially restructure through to REMNA.
Speaker 1: Were also seeing things like synthetic pick. Do you see
Speaker 1: more of that in private credit?
Speaker 2: You know, we haven't necessarily as much. I think it
Speaker 2: does exist. It's hard in the public domain to be
Speaker 2: honest to distinguish that, and that those are kind of
Speaker 2: the things that we worry about, like is there and
Speaker 2: when we diligence the banks, particularly who provide potentially a
Speaker 2: derivative form for this for these type of activities, how
Speaker 2: much of their exposure is in derillity form has increased
Speaker 2: versus like a total return swap policias or versus a
Speaker 2: traditional you know lending. And we haven't seen significant pick
Speaker 2: up activity with some but not it's not prevalent yet
Speaker 2: in this cycle, like we saw of a synthetic bed
Speaker 2: term in the two thousand and seven six precursor of
Speaker 2: thousand eight crisis, and so.
Speaker 3: You really need to cue that fore voting music for
Speaker 3: terms like synthetic pick.
Speaker 1: And maybe this is too early to see this, but
Speaker 1: we are seeing a lot more in the broadly syndicated
Speaker 1: and public markets more of this credit around credited violence,
Speaker 1: and you know, there's a fear that it will spread
Speaker 1: to private credit as lenders and borrowers clash and borrows
Speaker 1: get more creative about how they do these deals. Are
Speaker 1: you worried about that as a as a phenomenon in
Speaker 1: private credit at all?
Speaker 3: No?
Speaker 2: Absolutely, Actually, Now, our regular diligence with the funds that
Speaker 2: we read. We have this discussion and I will kind
Speaker 2: of quote what one fund who said, like, look, we
Speaker 2: are probably more careful than ever who we get into
Speaker 2: a club with. It's almost like a marriage agreement, and
Speaker 2: the divorce can be very expensive. So it became I
Speaker 2: think that the awareness is a good thing. Actually, you know,
Speaker 2: folks say, well, would never do underwrite another transaction with
Speaker 2: somebody who would do this to us? For example, we
Speaker 2: and we distinguish which partners are civilized in this market,
Speaker 2: which are not. And again it goes back to this
Speaker 2: ecosystem point David is making. A lot of these firms
Speaker 2: are on Park Avenue or out They all worked at
Speaker 2: at some point at credits fees or Deutsche Bank or
Speaker 2: Goldman Sachs or originating leverage finance loans. It's a relatively
Speaker 2: small universe. We're talking about some funds that have thirty
Speaker 2: forty underwriters to maybe one hundred. These are not major
Speaker 2: couple hundred thousand people investment banks. So yes, there is
Speaker 2: this clubish element that the funds claim that folks will
Speaker 2: be behaving in the market, but certainly people are wary
Speaker 2: and watchful more than ever.
Speaker 1: I mean, it is it is clubbish. But there's also
Speaker 1: this massive increase in demand chasing not that many deals
Speaker 1: city in the US, which kind of leads to, you know,
Speaker 1: everyone who comes on this show who's a private credit
Speaker 1: manager says they only do the good deals. Assumely that
Speaker 1: means someone else is out there hanging on to the
Speaker 1: bad deals and they may suffer for it. Is there
Speaker 1: not a risk that you know, we'll just get, you know,
Speaker 1: similar situation as we are in the public markets.
Speaker 2: Absolutely, you know, we kind of when we analyze the
Speaker 2: balance sheets of the private lenders, we are very wary
Speaker 2: about stressing the twenty twenty one vintage we call it,
Speaker 2: which was the year of exuberance at zero rates or about,
Speaker 2: and both markets were very open. Not as concerned about
Speaker 2: twenty twenty two, and definitely the first half of twenty
Speaker 2: twenty three. But this year we are quite concerned with
Speaker 2: the influx of capital, as I said, three hundred billion
Speaker 2: or so executed in the broadly syndicated one hundred plus
Speaker 2: in the private credit market, spreads coming down, terms coming down.
Speaker 2: We actually did analysis of covenants in both markets, and
Speaker 2: private cred always has argued, well, we get covenants and
Speaker 2: the BSL market doesn't hence why we have better investment.
Speaker 2: That's been their pitch to investors, among other reasons. And
Speaker 2: we actually did the analysis and it's absolutely true that the
Speaker 2: private credit market for transactions that are out of three
Speaker 2: hundred million dollars still has kept both the pricing and
Speaker 2: also of the covenants. However, nor of you know, four hundred,
Speaker 2: particularly the billion dollar plus transactions, those covenant kind of
Speaker 2: light deals are quite converging, and that's what worries us,
Speaker 2: particularly about this exuberance of twenty twenty four.
Speaker 1: Another manager we had earlier this year talked about tourists
Speaker 1: in private credit and also this concept of democratization of
Speaker 1: private credit, you know, bringing more people in. One of
Speaker 1: the ways that the markets traditionally do this is through ETFs,
Speaker 1: and you know we are seeing ETFs, and I know
Speaker 1: you've done some work on it, so I did want
Speaker 1: to ask you about potential problems with that, you know, purely,
Speaker 1: you know, really basic terms. ETFs are supposed to be liquid.
Speaker 1: Private credit isn't.
Speaker 2: Yeah. I mean, if you look at the most recent
Speaker 2: announcement from a Poe, etcetera. And we kind of wrote
Speaker 2: a piece of that, is that the inequidity piece is
Speaker 2: actually relatively small. The bucket is I think fifteen percent,
Speaker 2: no more than that. So yes, it increases risks to
Speaker 2: even have greater than zero percent liquid assets in ATF.
Speaker 2: But this is I think what was advertised out there
Speaker 2: that this is the private creative. It's not quite. At
Speaker 2: the end of the day, It's going to be mostly
Speaker 2: public classes with a small bucket of private that's the beginning,
Speaker 2: because Paul will commit to market make if you will,
Speaker 2: and provide bids for that for those products, which means
Speaker 2: that hopefully there will be more transparency in the market
Speaker 2: building that. But investors need to be wary that potentially,
Speaker 2: you know, you can have your capital locked in and
Speaker 2: you have to stress this for what does that mean
Speaker 2: for that particular bucket. And of course, look, I cannot
Speaker 2: envision an ETF with much greater let's say, fifty percent
Speaker 2: liquid assets simply that kind of asset ability mismatch. I
Speaker 2: don't think that will work. So but broadly, stepping back,
Speaker 2: even outside of dtfs, you know what has worried us
Speaker 2: about democratization point is the retail focus of the BDCs,
Speaker 2: and not only actually the BDCs, but I'm just coming
Speaker 2: back from Europe from IPM, which is the largest private
Speaker 2: capital conference in Europe, and there was a new regulation
Speaker 2: now of called Elative, which will allow for retail investors
Speaker 2: as low as ten thousand dollars to invest in private
Speaker 2: credit there as well. So on one hand, we understand
Speaker 2: very well the macroeconomic premise of allowing retail investors to
Speaker 2: benefit from the growth of private markets and the returns
Speaker 2: the historic turns that have been more favorable, not over
Speaker 2: the last two years, but historically more favorable to the
Speaker 2: public market. So you want to allow folks to get
Speaker 2: access to that building of wealth. But on the other hand,
Speaker 2: education to investors and understanding the risks of capital being locked.
Speaker 2: This is not something that can trade overnight. The whole
Speaker 2: point of private credit is they said, the benefit of
Speaker 2: time and waiting on for better markets to mark your
Speaker 2: transactions if you will. That's something that needs to be
Speaker 2: very well absorbed. And I do worry when majority of
Speaker 2: the BDC is actually fundraising that has happened over the
Speaker 2: last few years has actually come from retail and retail
Speaker 2: non non publicly traded b deses.
Speaker 3: Yeah, I mean, if if you if you really want
Speaker 3: to get a significant amount of regulation foisted on you
Speaker 3: very quickly. A great way to do that is to
Speaker 3: is to overmarket to retail investors have some sort of
Speaker 3: unexpected situation blow up where things didn't quite work out
Speaker 3: is as you'd hoped, and all of a sudden you're
Speaker 3: going to have some pretty onerous regulations. So, you know,
Speaker 3: it just seems like the funds and the marketers in particular,
Speaker 3: I think, have to be very careful about the way
Speaker 3: that they roll out these products to UH to retail investors. Now,
Speaker 3: when you when you talk to a number of the
Speaker 3: sort of large white schee advisors, you know, they're talking
Speaker 3: about sort of a private wealth market where you're talking
Speaker 3: about individuals with more than one million dollars of liquid
Speaker 3: assets to invest. That scenario where you're going to have
Speaker 3: a little bit more you know, leeway going into you know,
Speaker 3: quote unquote retail, but when you're you know, sort of
Speaker 3: getting into UH masters distributed ETFs, it's an area where
Speaker 3: I think caution is warranted.
Speaker 2: Agreed.
Speaker 1: You've made the point Dave in the past that you know,
Speaker 1: you made these skiing analogy that you know some some
Speaker 1: of these slopes are just too steep for the for
Speaker 1: the you know, the tourists, and you know it should
Speaker 1: be only professionals getting involved. I mean, we're not all
Speaker 1: heading into a world of trouble with with everyone piling
Speaker 1: into private credit right.
Speaker 3: Now, right right, yeah. I mean the way sort of
Speaker 3: that that ski ski analogy is at the I mean there,
Speaker 3: you know, there's a risk everywhere on the on the
Speaker 3: ski slopes, even on on on the the green circles
Speaker 3: where I've dislocated my left shoulder with a with a
Speaker 3: caught edge. But you know that if you come prepared,
Speaker 3: if you've got the right equipment, if you know your
Speaker 3: way around the mountain, if you you know know the slope,
Speaker 3: you know where the rocks are, where the trees are,
Speaker 3: where the cliffs are, then you know you've taken adequate
Speaker 3: precautions and you know, game on, go have some fun.
Speaker 3: If you don't have all of that in your in
Speaker 3: your in your backpack, then you might want all look elsewhere.
Speaker 1: You talked and recently about how pick just go back
Speaker 1: to that point is a kind of a bridge for
Speaker 1: some of these struggling borrowers to you know, get to
Speaker 1: a point where we have lower rates. You talked about
Speaker 1: your outlook for rates to come down and Obviously, the
Speaker 1: FED is embarking on quite an aggressive easing campaign right now,
Speaker 1: but is it enough do you think to avoid further distress?
Speaker 1: I mean there still must be some unsustainable capital stretches out.
Speaker 2: There, right absolutely. I mean when we actually stressed as
Speaker 2: for a rating purpose our BDCs to qualify for the
Speaker 2: investment Great status, we actually use the two thousand and
Speaker 2: seven two thousand and eighty fault cycle, so which means
Speaker 2: that we assume that we're going to get into at
Speaker 2: least you know, you know, eighty percent kind of price
Speaker 2: of the broadly syndicated the leveraginal market defaults increasing to
Speaker 2: at least five and a half percent kind of on
Speaker 2: the crules. And that's how we test the capital cushion
Speaker 2: for the disease. We you know, nobody can really uh
Speaker 2: uh predict where the market can go. What what we
Speaker 2: are doing in our analysis is ensuring that our ratings
Speaker 2: can withstand the test of time and test of what
Speaker 2: the history has shown of where our kind of worst
Speaker 2: case scenarios have been in leverage loans. And I'm talking
Speaker 2: about a market back in two thousand and eight. We
Speaker 2: use a scenario when there was a three hundred billion
Speaker 2: dollars of Hong transactions for a year and a half
Speaker 2: on banks balance sheets. So I think that it's a
Speaker 2: solid test. Of course, things can always get worse geopolitics,
Speaker 2: things that we cannot predict. Think about the COVID market,
Speaker 2: et cetera. How much extra liquidity it can really come
Speaker 2: from FED balance sheet. That's quite leverage we know today.
Speaker 2: But we do believe that what we're seeing today is
Speaker 2: is probably not the worst case scenario. We do believe
Speaker 2: that our base case is avoiding orthorization scenario. However, the
Speaker 2: downside case, when some of this downside risks materialize, make
Speaker 2: the default rate in the leverage finance cycle jumps significantly
Speaker 2: from LESSI three and a half too close to seven
Speaker 2: eight percent. So again, every investor should always do a
Speaker 2: scenario analysis and test their risk appetite based on that,
Speaker 2: and we're trying to do that for benefit or ratings
Speaker 2: and investors.
Speaker 3: So maybe switch gears a little bit. Yesterday you did
Speaker 3: the not you, Moody's did the unthinkable. You upgraded a
Speaker 3: couple of BDCs. You also have done a nice job,
Speaker 3: I think, and I think investors agree, have done a
Speaker 3: nice job of differentiating amongst BDCs You've got some that
Speaker 3: had positive outlooks and some that had negative outlooks, and
Speaker 3: that I think is quite helpful for people to see. What,
Speaker 3: in your view is the ceiling of where a BDC
Speaker 3: rating can go, and how do you think about the
Speaker 3: interplay between Let's use Blackstone as an example because they
Speaker 3: were upgraded yesterday. There are two funds, Blackstone Private Credit
Speaker 3: and Blackstone Secured Lending, one notch to BAA two they're
Speaker 3: associated with. I don't think Moody's rates Blackstone, but it
Speaker 3: is rated A by some of your friendly competitors. Obviously
Speaker 3: A plus a well rated company. Ceiling for BDCs, where
Speaker 3: could it go as kind of monoliine type entities that
Speaker 3: are wholesale funded, And how do you think about the
Speaker 3: interplay between these large white chew advisors and those that
Speaker 3: don't have them.
Speaker 2: Great question. Yes, So we read around the nord of
Speaker 2: thirty BDCs in the public domain, from which we placed
Speaker 2: six on positive outlook while ago and we have three
Speaker 2: your negative outlook and we took an action on three,
Speaker 2: as you noted, two Blackstone entities and one Eras Capital.
Speaker 2: So first a question on ceiling. Look, we have a
Speaker 2: full rating spectrum C A two three ple a. So
Speaker 2: celink in theory does not exist. But maybe I'll try
Speaker 2: to answer that question through the median bank creating today.
Speaker 2: The medium bank creating or what we called baseline create
Speaker 2: assessment without additional support in the US is B double
Speaker 2: A one. So, and we talk about kind of a
Speaker 2: normal regional cohor without significant concentration in commercial real estate,
Speaker 2: A highly in a more concentrated regional bank we have
Speaker 2: with a commercial real estate book would be BA A
Speaker 2: two B doua A three equivalent, if you will. So
Speaker 2: what you can see is a convergence. But there are
Speaker 2: two different factors. One is the low leverage. We just
Speaker 2: talked about the banks on average being levered nine times.
Speaker 2: We're talking here medium leverage on one point one times
Speaker 2: today for the BBCs we just mentioned so significantly. What
Speaker 2: the difference is. It's low leverage, Yes, it's a monoligne.
Speaker 2: But the diverse we're looking at difversification of portfolio across sectors.
Speaker 2: And then key differentiation and with the banks relative to
Speaker 2: the BDCs is the funding aspect. There's no overnight funding.
Speaker 2: The only like two parts of risky if you will,
Speaker 2: funding more risky funding is the secure funding from the banks,
Speaker 2: which is subject to quarterly evaluation. But I know that
Speaker 2: that those margining loans really in order to be effectively
Speaker 2: margined for additional collateral, we have to have a major
Speaker 2: correction talking on average values of sixty percent loan to value,
Speaker 2: which means that a lot of these loans have to
Speaker 2: lose forty percent of their value. So again that's quite
Speaker 2: a tail scenario for a significant margin risk on the
Speaker 2: secured book unsecured credles which is a dominant funding for
Speaker 2: this investment. Greate BDCs a domain basically cannot really withdraw
Speaker 2: their money if you will, and then you have pervonent equity.
Speaker 2: So the funding risk, one can argue is pretty is
Speaker 2: pretty muted. Where the funding risk comes true is indeed
Speaker 2: the in the retail on the BDCs liking BI cred
Speaker 2: But for us, where we spend a lot of time
Speaker 2: with entity like b credit to be to be eligible
Speaker 2: for upgrade was actually differensification of funding on their secured basis.
Speaker 2: So and also how the provision for that maximum withdrawal
Speaker 2: of liquidity of like twenty percent a year from the
Speaker 2: retail book, and it's about what availability of lines of
Speaker 2: credit for example from number of banks. If an entity
Speaker 2: like this had high leverage or one or two banks
Speaker 2: only providing that liquidity support, that definitely would not have
Speaker 2: been a reason for upgrade up or even investment grade rating.
Speaker 2: But somebody like Blackstone, who has absolutely one of the
Speaker 2: leading relationships with the global banks, we're talking about numerous
Speaker 2: bank clients existing out there to support that liquidity and
Speaker 2: also significant liquid acid bucket to provision for that, and
Speaker 2: in peril with the lowest non a cruel statistic in
Speaker 2: the BDC cocor we read tipped us over that additional
Speaker 2: line of investment grade.
Speaker 1: Just to go back to where we started, and we're
Speaker 1: almost had a time unfortunately, but a lot of people
Speaker 1: still worry about private credit. Our last guest said it
Speaker 1: was the one thing that concerned him. There was an
Speaker 1: insurance company from Asia this week saying that there was
Speaker 1: going to be a reckoning. It's not the first time
Speaker 1: we've heard that from the market, and we're hearing it
Speaker 1: from regulators, We're hearing it from from multilaterals and all
Speaker 1: sorts of people are they is this concern misplaced? They
Speaker 1: just don't understand what it is that we're talking about here,
Speaker 1: or are there really some concerns that we should we
Speaker 1: should be talking about.
Speaker 2: Again, it goes back to the pace of growth and
Speaker 2: where the funding comes from. It's it's going to be
Speaker 2: very important to get more transparency from the banks about
Speaker 2: is there some kind of, as you said, synthetic leverage,
Speaker 2: additional leverage coming to this market and it's not visible
Speaker 2: to us. We're talking about trillion point seven market from
Speaker 2: which you know we moved is very roughly three hundred
Speaker 2: billion of assets through the BDC cohort in the US,
Speaker 2: So there's still lots and the dark and I definitely
Speaker 2: welcome and all of us who are in the industry
Speaker 2: analyzing it, welcome more transparency about what's the leverage outside
Speaker 2: of the BDC coord out there. How much of these
Speaker 2: funds indeed use a leverage that's secured that's potentially more
Speaker 2: margin driven. So in order to answer that question, we
Speaker 2: really need more transparency, particularly from the banks who are
Speaker 2: funding this market.
Speaker 3: Yeah, but I don't think that you've got people are
Speaker 3: going to go back and think about what happened during
Speaker 3: the Financial crisis, where you essentially had unlimited leverage built
Speaker 3: into the system through through CDOs, derivatives and derivatives that
Speaker 3: aren't used in the at least in the same way
Speaker 3: or the same degree in this area part of the world.
Speaker 3: So I think that makes a big difference. It doesn't
Speaker 3: strike me, and I lived through the financial crisis as
Speaker 3: a desk analyst at a large Swiss bank. It just
Speaker 3: doesn't seem like the risk transmission mechanism is nearly as
Speaker 3: potent in the way that private credit is structured today
Speaker 3: as it has been in maybe some other areas that
Speaker 3: have caused systemic problems in the past.
Speaker 2: I tend to agree with that, and as I noted,
Speaker 2: a lot of this is permanent capital by pension funds
Speaker 2: originally who are the largest first investors, insurance companies, sovereign
Speaker 2: wealth funds, and only most recently this more flight confident
Speaker 2: of fuel investors came into the space like the retail investors.
Speaker 2: So hence why we are really looking for those pokts
Speaker 2: and we want to ensure from a systemic stability that
Speaker 2: there is indeed attention about disclosures and particularly for those
Speaker 2: type of investors. But for you know, I would agree
Speaker 2: David that we haven't seen those that kind of exuberance
Speaker 2: of innovative structures that probably exists, but not to that
Speaker 2: level or you know, as I said, overnight risk derivatives,
Speaker 2: leverage and leverage synthetic structures that compare to two thousand
Speaker 2: and seven thousand and eight, Which doesn't mean that will
Speaker 2: not happen, but that's something that we number of eyes
Speaker 2: are still watching and continue to watch, and we will
Speaker 2: be part of that as well.
Speaker 3: Yeah, that whole issue of demand liability seems much more
Speaker 3: contained here, which is a great's that's generally what causes
Speaker 3: a financial institution or sector to get into trouble. You know,
Speaker 3: you saw it with Silicon Valley Bank a year and
Speaker 3: a half ago. It's it's that demand liability issue seems
Speaker 3: to be pretty well stitched up here.
Speaker 1: That's probably what worries me. I've been doing this way
Speaker 1: too long, and I worry about complacency and things that
Speaker 1: we can't see. But if you have to pick one thing,
Speaker 1: and what's the one thing that worries the most about
Speaker 1: private credit right now?
Speaker 2: You know what worries me is that everybody wants to
Speaker 2: be a poll and I'll explain that. You know, in
Speaker 2: the back in the financial crisis also where I worked
Speaker 2: for one of the investment banks, and there was a
Speaker 2: Chase to become Goldman Sachs because Goldman had a premier
Speaker 2: let's say structured credit franchise or deriality franchise, et cetera.
Speaker 2: And then we know that the banks who were trying
Speaker 2: to be Goldman always do not exist these days. And
Speaker 2: there were international n US banks and these days a
Speaker 2: Poll and some of the other in a large asset
Speaker 2: manager just like Blackstone, are leading the way they have.
Speaker 2: They're quite institutionalized, with a lot of capital and a
Speaker 2: lot of great talent. And it only requires, as you say,
Speaker 2: the tourists and and here I'm not referring to the
Speaker 2: retail investors, but you know, everybody wants to raise capital
Speaker 2: to be part of the six y you know, new
Speaker 2: acid class of private credit, and does it in a
Speaker 2: wrong way, and then it vines a shock to the
Speaker 2: system just because it was done in a very inappropriate way,
Speaker 2: either from a leverage or or type of investment, and
Speaker 2: then can create an issue of either overreaction from a
Speaker 2: regular or reaction from retail investors. So that's something to
Speaker 2: watch where the capital is coming from, formation of new
Speaker 2: funds talent. That's how there's limited talent, I would say
Speaker 2: more than limited capital these days, so for sure the
Speaker 2: investors should be watching where it plays their money.
Speaker 1: Great stuff and ours off global head of Private Credit
Speaker 1: at Moody's Ratings. It has been a pleasure having you
Speaker 1: on the Credit Edge and David Havens with Bloomberg Intelligence,
Speaker 1: thank you for so much for joining us today.
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