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Speaker 1: Bloomberg Audio Studios, podcasts, radio news.

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Speaker 2: Our next guest says that highly leveraged software default rates

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Speaker 2: could hit fifteen percent in private credit. Joining us now

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Speaker 2: is Bruce Richards. He's the chairman and CEO of Marathon

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Speaker 2: Asset Management. And you've just put out a link LinkedIn

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Speaker 2: post this morning. Danny and I were reading it before

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Speaker 2: the program, likening what happened in energy in twenty sixteen,

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Speaker 2: twenty seventeen, twenty eighteen to what we're looking at it

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Speaker 2: in software now. Is it fair to compare those two industries,

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Speaker 2: because I think Scott was saying, hey, there's a different

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Speaker 2: ball of wax here.

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Speaker 3: It is a bit different ball of wax.

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Speaker 1: And Scott's right to say there's no comparison between the industries.

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Speaker 3: Well, let me explain why I come to that parallel.

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Speaker 1: So back in twenty fourteen, a new technological change happened

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Speaker 1: for oil and guts is called horizontal drilling or fracking.

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Speaker 1: And that technological chan change to the couple of things.

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Speaker 1: Number one, it changed the pricing structure for how oil

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Speaker 1: and gas and oil gas services would work. And number two,

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Speaker 1: based upon all the capital that was raised, now, all

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Speaker 1: of a sudden capital dried off because the pricing structure collapsed,

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Speaker 1: and so what we have in software is very similar.

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Speaker 1: We have a technological change which is forever going to

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Speaker 1: change how software is going to be priced, and that

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Speaker 1: we should think about that industry and based upon that

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Speaker 1: technological change, and how much leverage is in the broadlys

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Speaker 1: medicated low market and then more importantly in the direct

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Speaker 1: lending market leveraging up these software companies, the capitals now

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Speaker 1: drying off. And so what did we see as a

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Speaker 1: result of that technological change in oil and gas? We

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Speaker 1: saw a fifteen percent of fault rate in the subsequent

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Speaker 1: years twenty sixteen and twenty seventeen. So for me to

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Speaker 1: say that software, which is the biggest sector within the

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Speaker 1: direct lending business, couldn't get to a fifteen percent default rate,

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Speaker 1: I think is actually missing the mark because I think

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Speaker 1: that's exactly what's going to happen in years twenty seven,

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Speaker 1: and it has the chance of happening in twenty seven

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Speaker 1: and twenty eight to have back to back years.

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Speaker 3: SOLI industries are very different.

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Speaker 1: There's a lot of similarities because of technology, technology changing

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Speaker 1: how pricing structure works at a time when too much

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Speaker 1: capital has been flooding into the sector.

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Speaker 3: Just think about this for a second, Matt.

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Speaker 1: Only one percent of companies in the US to software companies,

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Speaker 1: and only seven percent of all publicly listed companies or software.

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Speaker 1: Yet twenty three percent of the direct lending business is software.

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Speaker 3: How did we get there?

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Speaker 1: It was a goal rush to financie software companies in

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Speaker 1: these buyouts.

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Speaker 3: And the public companies are sitting in good shape because

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Speaker 3: their debt.

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Speaker 1: When we look at NASDAK SMP Russell two thousand, the

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Speaker 1: debt that these software companies have with really good margins,

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Speaker 1: the debt that they have is only zero point five

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Speaker 1: one turn of leverage, and the quality syndicated loan market,

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Speaker 1: you have five turns of leverage, ten times leverage. Right

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Speaker 1: in the direct lending business, you could have twenty times leverage.

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Speaker 3: So you don't have the companies that can.

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Speaker 1: Generate the free cash flow to reposition for AI.

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Speaker 3: They're in a very tough position.

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Speaker 2: So Bruce, what is the effect of that. I think

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Speaker 2: a lot of investors are reading your research and starting

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Speaker 2: to wake up to the fact that this could become

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Speaker 2: a reality, and as a result, we're seeing redemptions. You know,

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Speaker 2: people are trying to get out of these ill liquid

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Speaker 2: private credit funds. And what we see some of these

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Speaker 2: companies doing blue Out for example, is Okay, we're gonna

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Speaker 2: sell a ton of these assets.

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Speaker 3: We're gonna sell these loans.

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Speaker 2: And they want to be able to say we got,

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Speaker 2: you know, ninety nine percent, we got ninety eight percent.

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Speaker 3: Of the par value for that.

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Speaker 2: So they can't be selling those twenty times even to

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Speaker 2: software loans, right, They must be selling their best assets.

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Speaker 1: So it's I can't speak SEP Well or others of course,

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Speaker 1: not liquidity crisis or requity issue right now in their funds.

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Speaker 3: It's you know, something I'm not focused on when.

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Speaker 1: I am focused on is the availability of capital on

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Speaker 1: the back end of this to extend these loans. And

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Speaker 1: I believe that it won't be availability of capital. So

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Speaker 1: I think the next round in the year's twenty seven

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Speaker 1: to twenty eight, when a lot of these loans come due,

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Speaker 1: is in the direct lending business to extend and amend

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Speaker 1: or extend and pretend to pick those loans because it

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Speaker 1: won't have the cash.

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Speaker 2: Flow payment in kind financing and so, and.

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Speaker 1: You will be getting you won't get paid back in interest.

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Speaker 1: And because you've extended loans, you also won't be getting

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Speaker 1: paid fast.

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Speaker 4: So what does that do to an entire industry that

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Speaker 4: is both private credit and private equity that has loved software,

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Speaker 4: that has gotten into twenty three percent. If all of

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Speaker 4: a sudden they can't go to capital markets and they

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Speaker 4: can't get those loans but financing ceases to exist, what

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Speaker 4: does that do to the industry.

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Speaker 1: I think the industry's fine, because I think direct lending

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Speaker 1: is a big industry, and I think that there are

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Speaker 1: other sectors of the economy. Again, software is only a

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Speaker 1: few percent of the overall economy.

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Speaker 4: But it sounds like you're saying software lending is over

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Speaker 4: it's done after this episode.

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Speaker 1: I think when you lend in software, you have to

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Speaker 1: lend it very conservative multiples of business itself is an

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Speaker 1: uncertain business, and so four times that ebadops, not ten times,

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Speaker 1: is probably the right number. And getting paid a little

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Speaker 1: bit more for that risk and extra one hundred base

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Speaker 1: points on your loans. Now to the extent that financial

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Speaker 1: conditions tightened a little bit on this in the direct

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Speaker 1: lending space because of what's going on, we can get

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Speaker 1: paid more for loans that we're making in the marketplace

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Speaker 1: with tighter covenants, So I think for lenders that aren't

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Speaker 1: in a bad position, that actually can extend credit, it's

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Speaker 1: actually a good place to be. And so I wouldn't

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Speaker 1: let software just like oil and gas when you had

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Speaker 1: that problem with those companies back in and sixteen, twenty seventeen,

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Speaker 1: twenty eighteen, didn't tank the economy.

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Speaker 3: The economies is fine.

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Speaker 1: I think Commune will just be fine without having to

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Speaker 1: deal with the default rates they are coming, the problems

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Speaker 1: they are coming because the economy is so much bigger

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Speaker 1: and diverse than this, and so it's not going to

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Speaker 1: do anything to cause any kind of destruction to the

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Speaker 1: broad up private credit markets or the brought or the

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Speaker 1: broadup credit markets, or the economy. I don't believe that

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Speaker 1: it all is the case, but what it will cause

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Speaker 1: is religion to come back in and discipline to come

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Speaker 1: back in, because it's quite simply, you know, Danny and Matt,

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Speaker 1: twenty three percent in software is just too much exposure

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Speaker 1: to one industry group when it only represents a very

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Speaker 1: small part of the overall you know, equity markets. It's

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Speaker 1: only one percent of all companies in the use of

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Speaker 1: US or software companies, and only seven percent of all

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Speaker 1: publicly listed companies in the US are software companies, so

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Speaker 1: there's too much exposure for them to have had.

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Speaker 3: Everyone regrets it now.

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Speaker 1: We're thankful that we have one percent exposure and not

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Speaker 1: that type of exposure. It's going to represent some really

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Speaker 1: good opportunities for us as lenders in the years to

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Speaker 1: come down.

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Speaker 2: But I'm wondering, you know where those opportunities are going

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Speaker 2: to be, and specifically in software, because religion has already

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Speaker 2: set in with some of these names. Are there some

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Speaker 2: you think that are over sold or there's some that

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Speaker 2: you think, you know, the debt is cheap enough to

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Speaker 2: go in and pick it up, because that's historically where

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Speaker 2: you've made a lot of money.

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Speaker 3: Brews.

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Speaker 1: First of all, I think in the public public equity markets,

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Speaker 1: they're going to be in a really good position.

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Speaker 3: They'll buy a lot of.

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Speaker 1: This at pennies on the dollar because they're the ones

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Speaker 1: that are going to have the capital, the cash flow,

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Speaker 1: the margins to be.

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Speaker 3: Able to do so. Smart.

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Speaker 1: Private equity will also come in and recapitalize and buy

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Speaker 1: new companies, but they'll pay a lot less. The whole

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Speaker 1: ratings of where you know what multiples you pay for

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Speaker 1: the company has come down substantially, and private equity tradiacy

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Speaker 1: doesn't pay more than twelve times for a company traditionally,

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Speaker 1: and so getting the whole sectory priced based upon this

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Speaker 1: existential risk that you have, look private equity have is

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Speaker 1: important and that's where we're moving towards. And the second

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Speaker 1: thing is private equity has all the upside. Imagine a

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Speaker 1: company for creative destruction that they can reposition. Instead of

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Speaker 1: making two or three times their money, they make five

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Speaker 1: or six times their money, so they can afford a

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Speaker 1: few zeros right and still come out okay. Private credit

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Speaker 1: can't afford the zeros. They only get paid back. Part

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Speaker 1: they don't have the upside. So what you need, Matt

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Speaker 1: is certainty when you lend. It's an uncertain business right now,

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Speaker 1: and that's why capital will not come be become a veilop.

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Speaker 3: Are you not buying anything then not right now?

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Speaker 1: In software, what we're focused on are businesses where halo

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Speaker 1: is the effect.

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Speaker 3: Part assets low obsolescence. I'm talking about in lending.

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Speaker 1: Our last private credit blending deal in DL was a concrete.

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Speaker 3: Deal was Rebard.

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Speaker 1: The deal before that was side side for commercial, so

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Speaker 1: that you lay there on the lawns, right and so

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Speaker 1: these are real asset lending opportunities and our last asset.

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Speaker 3: Deals in our abl.

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Speaker 1: Business hard assets, low apse lescens our aircraft, maritime assets, turbines,

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Speaker 1: cranes and engines.

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Speaker 3: Because you're bullish the economy, because we love.

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Speaker 1: The economy and we want to be able to lend.

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Speaker 1: Say had a three hundred million dollar asset, pull two

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Speaker 1: hundred million on an LTV basis the sixty six percent LTV.

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Speaker 1: That nice margin of safety with that hard asset where

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Speaker 1: we have a perfected interest in that heart asset. It's

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Speaker 1: not software where the recovery value will be close to

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Speaker 1: zero if there's a default. We get full recoveries in

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Speaker 1: the events of a default on most of those assets.

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Speaker 3: And so and we very rarely have.

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Speaker 1: A default because they're missing critical assets for these companies.

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Speaker 3: And so it's a very different dynamic when you talk

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Speaker 3: about HALO.

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Speaker 1: And with HALO, that's why you see industrials and you know,

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Speaker 1: MAI brails up twenty five percent of the year, with

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Speaker 1: a lot of the software companies are down twenty five

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Speaker 1: to forty percent of the year. Where you talk about

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Speaker 1: the mid market software companies, and so we're in a

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Speaker 1: very good position at Marathon as a lender with capital

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Speaker 1: available to land and with how our position is currently

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Speaker 1: positioned