WEBVTT - Marathon Asset Management CEO Bruce Richards Talks Software

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<v Speaker 1>Bloomberg Audio Studios, podcasts, radio news.

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<v Speaker 2>Our next guest says that highly leveraged software default rates

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<v Speaker 2>could hit fifteen percent in private credit. Joining us now

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<v Speaker 2>is Bruce Richards. He's the chairman and CEO of Marathon

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<v Speaker 2>Asset Management. And you've just put out a link LinkedIn

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<v Speaker 2>post this morning. Danny and I were reading it before

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<v Speaker 2>the program, likening what happened in energy in twenty sixteen,

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<v Speaker 2>twenty seventeen, twenty eighteen to what we're looking at it

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<v Speaker 2>in software now. Is it fair to compare those two industries,

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<v Speaker 2>because I think Scott was saying, hey, there's a different

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<v Speaker 2>ball of wax here.

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<v Speaker 3>It is a bit different ball of wax.

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

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<v Speaker 3>Well, let me explain why I come to that parallel.

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<v Speaker 1>So back in twenty fourteen, a new technological change happened

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<v Speaker 1>for oil and guts is called horizontal drilling or fracking.

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<v Speaker 1>And that technological chan change to the couple of things.

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<v Speaker 1>Number one, it changed the pricing structure for how oil

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<v Speaker 1>and gas and oil gas services would work. And number two,

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<v Speaker 1>based upon all the capital that was raised, now, all

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<v Speaker 1>of a sudden capital dried off because the pricing structure collapsed,

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<v Speaker 1>and so what we have in software is very similar.

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<v Speaker 1>We have a technological change which is forever going to

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<v Speaker 1>change how software is going to be priced, and that

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<v Speaker 1>we should think about that industry and based upon that

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<v Speaker 1>technological change, and how much leverage is in the broadlys

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<v Speaker 1>medicated low market and then more importantly in the direct

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<v Speaker 1>lending market leveraging up these software companies, the capitals now

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<v Speaker 1>drying off. And so what did we see as a

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<v Speaker 1>result of that technological change in oil and gas? We

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<v Speaker 1>saw a fifteen percent of fault rate in the subsequent

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<v Speaker 1>years twenty sixteen and twenty seventeen. So for me to

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<v Speaker 1>say that software, which is the biggest sector within the

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

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<v Speaker 1>I think is actually missing the mark because I think

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<v Speaker 1>that's exactly what's going to happen in years twenty seven,

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<v Speaker 1>and it has the chance of happening in twenty seven

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<v Speaker 1>and twenty eight to have back to back years.

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<v Speaker 3>SOLI industries are very different.

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<v Speaker 1>There's a lot of similarities because of technology, technology changing

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<v Speaker 1>how pricing structure works at a time when too much

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<v Speaker 1>capital has been flooding into the sector.

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<v Speaker 3>Just think about this for a second, Matt.

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<v Speaker 1>Only one percent of companies in the US to software companies,

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<v Speaker 1>and only seven percent of all publicly listed companies or software.

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<v Speaker 1>Yet twenty three percent of the direct lending business is software.

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<v Speaker 3>How did we get there?

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<v Speaker 1>It was a goal rush to financie software companies in

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<v Speaker 1>these buyouts.

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<v Speaker 3>And the public companies are sitting in good shape because

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<v Speaker 3>their debt.

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<v Speaker 1>When we look at NASDAK SMP Russell two thousand, the

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<v Speaker 1>debt that these software companies have with really good margins,

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<v Speaker 1>the debt that they have is only zero point five

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<v Speaker 1>one turn of leverage, and the quality syndicated loan market,

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<v Speaker 1>you have five turns of leverage, ten times leverage. Right

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<v Speaker 1>in the direct lending business, you could have twenty times leverage.

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<v Speaker 3>So you don't have the companies that can.

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<v Speaker 1>Generate the free cash flow to reposition for AI.

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<v Speaker 3>They're in a very tough position.

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<v Speaker 2>So Bruce, what is the effect of that. I think

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<v Speaker 2>a lot of investors are reading your research and starting

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<v Speaker 2>to wake up to the fact that this could become

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

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<v Speaker 2>people are trying to get out of these ill liquid

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<v Speaker 2>private credit funds. And what we see some of these

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<v Speaker 2>companies doing blue Out for example, is Okay, we're gonna

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<v Speaker 2>sell a ton of these assets.

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<v Speaker 3>We're gonna sell these loans.

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<v Speaker 2>And they want to be able to say we got,

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<v Speaker 2>you know, ninety nine percent, we got ninety eight percent.

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<v Speaker 3>Of the par value for that.

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<v Speaker 2>So they can't be selling those twenty times even to

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<v Speaker 2>software loans, right, They must be selling their best assets.

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

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<v Speaker 1>not liquidity crisis or requity issue right now in their funds.

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

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<v Speaker 1>I am focused on is the availability of capital on

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<v Speaker 1>the back end of this to extend these loans. And

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<v Speaker 1>I believe that it won't be availability of capital. So

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<v Speaker 1>I think the next round in the year's twenty seven

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<v Speaker 1>to twenty eight, when a lot of these loans come due,

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<v Speaker 1>is in the direct lending business to extend and amend

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<v Speaker 1>or extend and pretend to pick those loans because it

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<v Speaker 1>won't have the cash.

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<v Speaker 2>Flow payment in kind financing and so, and.

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

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<v Speaker 1>And because you've extended loans, you also won't be getting

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<v Speaker 1>paid fast.

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<v Speaker 4>So what does that do to an entire industry that

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<v Speaker 4>is both private credit and private equity that has loved software,

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<v Speaker 4>that has gotten into twenty three percent. If all of

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<v Speaker 4>a sudden they can't go to capital markets and they

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<v Speaker 4>can't get those loans but financing ceases to exist, what

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<v Speaker 4>does that do to the industry.

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<v Speaker 1>I think the industry's fine, because I think direct lending

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<v Speaker 1>is a big industry, and I think that there are

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<v Speaker 1>other sectors of the economy. Again, software is only a

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<v Speaker 1>few percent of the overall economy.

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<v Speaker 4>But it sounds like you're saying software lending is over

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<v Speaker 4>it's done after this episode.

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<v Speaker 1>I think when you lend in software, you have to

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<v Speaker 1>lend it very conservative multiples of business itself is an

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<v Speaker 1>uncertain business, and so four times that ebadops, not ten times,

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<v Speaker 1>is probably the right number. And getting paid a little

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<v Speaker 1>bit more for that risk and extra one hundred base

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<v Speaker 1>points on your loans. Now to the extent that financial

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<v Speaker 1>conditions tightened a little bit on this in the direct

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<v Speaker 1>lending space because of what's going on, we can get

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<v Speaker 1>paid more for loans that we're making in the marketplace

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<v Speaker 1>with tighter covenants, So I think for lenders that aren't

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<v Speaker 1>in a bad position, that actually can extend credit, it's

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<v Speaker 1>actually a good place to be. And so I wouldn't

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<v Speaker 1>let software just like oil and gas when you had

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<v Speaker 1>that problem with those companies back in and sixteen, twenty seventeen,

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<v Speaker 1>twenty eighteen, didn't tank the economy.

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<v Speaker 3>The economies is fine.

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<v Speaker 1>I think Commune will just be fine without having to

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<v Speaker 1>deal with the default rates they are coming, the problems

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<v Speaker 1>they are coming because the economy is so much bigger

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<v Speaker 1>and diverse than this, and so it's not going to

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<v Speaker 1>do anything to cause any kind of destruction to the

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<v Speaker 1>broad up private credit markets or the brought or the

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

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<v Speaker 1>it all is the case, but what it will cause

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<v Speaker 1>is religion to come back in and discipline to come

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

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<v Speaker 1>twenty three percent in software is just too much exposure

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<v Speaker 1>to one industry group when it only represents a very

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

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<v Speaker 1>only one percent of all companies in the use of

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<v Speaker 1>US or software companies, and only seven percent of all

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<v Speaker 1>publicly listed companies in the US are software companies, so

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<v Speaker 1>there's too much exposure for them to have had.

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<v Speaker 3>Everyone regrets it now.

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<v Speaker 1>We're thankful that we have one percent exposure and not

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<v Speaker 1>that type of exposure. It's going to represent some really

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<v Speaker 1>good opportunities for us as lenders in the years to

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<v Speaker 1>come down.

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<v Speaker 2>But I'm wondering, you know where those opportunities are going

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<v Speaker 2>to be, and specifically in software, because religion has already

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<v Speaker 2>set in with some of these names. Are there some

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<v Speaker 2>you think that are over sold or there's some that

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<v Speaker 2>you think, you know, the debt is cheap enough to

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<v Speaker 2>go in and pick it up, because that's historically where

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<v Speaker 2>you've made a lot of money.

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<v Speaker 3>Brews.

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<v Speaker 1>First of all, I think in the public public equity markets,

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<v Speaker 1>they're going to be in a really good position.

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<v Speaker 3>They'll buy a lot of.

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<v Speaker 1>This at pennies on the dollar because they're the ones

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<v Speaker 1>that are going to have the capital, the cash flow,

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<v Speaker 1>the margins to be.

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<v Speaker 3>Able to do so. Smart.

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<v Speaker 1>Private equity will also come in and recapitalize and buy

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

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<v Speaker 1>ratings of where you know what multiples you pay for

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<v Speaker 1>the company has come down substantially, and private equity tradiacy

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<v Speaker 1>doesn't pay more than twelve times for a company traditionally,

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<v Speaker 1>and so getting the whole sectory priced based upon this

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<v Speaker 1>existential risk that you have, look private equity have is

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

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<v Speaker 1>thing is private equity has all the upside. Imagine a

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<v Speaker 1>company for creative destruction that they can reposition. Instead of

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<v Speaker 1>making two or three times their money, they make five

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<v Speaker 1>or six times their money, so they can afford a

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<v Speaker 1>few zeros right and still come out okay. Private credit

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<v Speaker 1>can't afford the zeros. They only get paid back. Part

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

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

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

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<v Speaker 3>Are you not buying anything then not right now?

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<v Speaker 1>In software, what we're focused on are businesses where halo

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<v Speaker 1>is the effect.

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<v Speaker 3>Part assets low obsolescence. I'm talking about in lending.

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<v Speaker 1>Our last private credit blending deal in DL was a concrete.

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<v Speaker 3>Deal was Rebard.

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<v Speaker 1>The deal before that was side side for commercial, so

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<v Speaker 1>that you lay there on the lawns, right and so

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<v Speaker 1>these are real asset lending opportunities and our last asset.

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<v Speaker 3>Deals in our abl.

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<v Speaker 1>Business hard assets, low apse lescens our aircraft, maritime assets, turbines,

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<v Speaker 1>cranes and engines.

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<v Speaker 3>Because you're bullish the economy, because we love.

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<v Speaker 1>The economy and we want to be able to lend.

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<v Speaker 1>Say had a three hundred million dollar asset, pull two

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<v Speaker 1>hundred million on an LTV basis the sixty six percent LTV.

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<v Speaker 1>That nice margin of safety with that hard asset where

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<v Speaker 1>we have a perfected interest in that heart asset. It's

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<v Speaker 1>not software where the recovery value will be close to

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<v Speaker 1>zero if there's a default. We get full recoveries in

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<v Speaker 1>the events of a default on most of those assets.

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<v Speaker 3>And so and we very rarely have.

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<v Speaker 1>A default because they're missing critical assets for these companies.

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<v Speaker 3>And so it's a very different dynamic when you talk

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<v Speaker 3>about HALO.

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<v Speaker 1>And with HALO, that's why you see industrials and you know,

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<v Speaker 1>MAI brails up twenty five percent of the year, with

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<v Speaker 1>a lot of the software companies are down twenty five

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<v Speaker 1>to forty percent of the year. Where you talk about

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<v Speaker 1>the mid market software companies, and so we're in a

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<v Speaker 1>very good position at Marathon as a lender with capital

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<v Speaker 1>available to land and with how our position is currently

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<v Speaker 1>positioned