1 00:00:13,039 --> 00:00:15,960 Speaker 1: Hello, Welcome to The Credit Edge, a weekly markets podcast. 2 00:00:16,160 --> 00:00:18,880 Speaker 1: My name is James Crumbie. I'm a senior editor at Bloomberg. 3 00:00:19,600 --> 00:00:21,479 Speaker 1: This week, we're very pleased to have on the show 4 00:00:21,800 --> 00:00:25,200 Speaker 1: Cat Hidalgo, who covers private credit for Bloomberg News in London. 5 00:00:25,480 --> 00:00:27,280 Speaker 1: How are you, Kat, I'm well. 6 00:00:27,320 --> 00:00:28,960 Speaker 2: Thanks so much for having me on, James. 7 00:00:29,680 --> 00:00:31,720 Speaker 1: We're very excited to get your take on the markets. 8 00:00:31,720 --> 00:00:34,440 Speaker 1: Thanks very much for joining. We're also delighted to see 9 00:00:34,479 --> 00:00:38,320 Speaker 1: Andrew Chan, a credit analyst with Bloomberg Intelligence in Hong Kong. 10 00:00:38,800 --> 00:00:40,519 Speaker 1: We'll be coming back to Andrew a bit later in 11 00:00:40,520 --> 00:00:42,919 Speaker 1: the show to talk about the brewing mess in Chinese 12 00:00:42,920 --> 00:00:46,480 Speaker 1: debt markets. So do stay with us. But first, Cat 13 00:00:46,520 --> 00:00:50,080 Speaker 1: Hidalgo with bloom Bloomberg News, You've been all over the 14 00:00:50,120 --> 00:00:53,519 Speaker 1: private debt story. The deals are getting bigger and bigger, 15 00:00:53,640 --> 00:00:56,760 Speaker 1: breaking all records. There's a five point three billion dollar 16 00:00:56,840 --> 00:00:59,760 Speaker 1: loan package in the market right now. At the same time, 17 00:01:00,040 --> 00:01:03,400 Speaker 1: fundraising is ramping up. Oak Tree looking to raise eighteen 18 00:01:03,440 --> 00:01:05,920 Speaker 1: billion dollars for a single private debt fund, which would 19 00:01:05,920 --> 00:01:08,920 Speaker 1: make it the largest ever, and pensions are being urged 20 00:01:08,920 --> 00:01:11,840 Speaker 1: to allocate more to the strategy, which is enjoying what 21 00:01:11,920 --> 00:01:16,320 Speaker 1: Blackstone has called a golden moment. However, we're starting to 22 00:01:16,319 --> 00:01:19,319 Speaker 1: see evidence of growing risk, similar to the signals we've 23 00:01:19,319 --> 00:01:22,560 Speaker 1: been getting from the public bond and loan markets. There 24 00:01:22,600 --> 00:01:26,720 Speaker 1: are risky companies obviously involved in this private credit market, 25 00:01:26,760 --> 00:01:29,040 Speaker 1: and they're borrowing a lot of money where there's a 26 00:01:29,040 --> 00:01:33,160 Speaker 1: lot a lot of transparency or regulation. Rates of sword 27 00:01:33,360 --> 00:01:37,080 Speaker 1: earnings are slowing as recession looms. Some of those borrows 28 00:01:37,120 --> 00:01:40,920 Speaker 1: just can't keep up. What's the situation, cap How bad 29 00:01:41,000 --> 00:01:44,280 Speaker 1: is it out there? When we look at private credit defaults. 30 00:01:44,480 --> 00:01:48,440 Speaker 3: Well, it's a really interesting situation. The problem is that 31 00:01:48,480 --> 00:01:52,440 Speaker 3: we don't really know. It really is a very opaque 32 00:01:52,520 --> 00:01:56,960 Speaker 3: and private market. So we can rely on some surveys 33 00:01:57,080 --> 00:01:59,440 Speaker 3: and a bit of data here and there. For example, 34 00:02:00,200 --> 00:02:02,880 Speaker 3: pros Goauer, which is a law firm, releases a private 35 00:02:02,920 --> 00:02:06,400 Speaker 3: credit default index, and their Q two. 36 00:02:06,320 --> 00:02:08,280 Speaker 2: Iteration, which came out recently. 37 00:02:08,000 --> 00:02:10,520 Speaker 3: Shows that there was actually a decrease in the number 38 00:02:10,520 --> 00:02:13,880 Speaker 3: of defaults, and that's amongst US companies. But that was 39 00:02:13,919 --> 00:02:17,919 Speaker 3: after two consecutive quarters of an increasing rate. Right now 40 00:02:17,960 --> 00:02:20,320 Speaker 3: their default rate is at one point six y four 41 00:02:21,000 --> 00:02:23,840 Speaker 3: sent and so that's in the US, and that is 42 00:02:23,880 --> 00:02:27,520 Speaker 3: still considered quite low. But other than that, we really 43 00:02:27,600 --> 00:02:30,240 Speaker 3: just have to rely on the anecdotes and things like 44 00:02:30,240 --> 00:02:32,680 Speaker 3: the general default rate, which you mentioned is kind of 45 00:02:32,720 --> 00:02:35,880 Speaker 3: ticking up, and these things do indicate that there is 46 00:02:36,040 --> 00:02:39,720 Speaker 3: more stress in the market, but not by an overwhelming sum. 47 00:02:39,880 --> 00:02:42,920 Speaker 3: And there's also a difference between loss rates and default 48 00:02:43,000 --> 00:02:46,560 Speaker 3: so there's a lot of different things happening. What I 49 00:02:46,600 --> 00:02:48,400 Speaker 3: can say is that what we're gathering from the people 50 00:02:48,440 --> 00:02:51,040 Speaker 3: that we speak to, from fund managers and investors in 51 00:02:51,080 --> 00:02:55,079 Speaker 3: those funds, is that there has been a noticeable increase 52 00:02:55,120 --> 00:02:58,440 Speaker 3: in stress, but it's not dramatic or worse than other 53 00:02:58,520 --> 00:03:01,280 Speaker 3: parts in the market. The kind of the typical thing 54 00:03:01,320 --> 00:03:03,000 Speaker 3: that you'll hear from a fund manager is that they'll 55 00:03:03,040 --> 00:03:07,000 Speaker 3: say they're hearing other portfolio struggling, but that their portfolio 56 00:03:07,120 --> 00:03:07,760 Speaker 3: is doing great. 57 00:03:08,639 --> 00:03:08,799 Speaker 4: Right. 58 00:03:08,960 --> 00:03:11,200 Speaker 1: As you mentioned, we just don't know in some cases, 59 00:03:11,240 --> 00:03:13,320 Speaker 1: so it's very difficult to actually measure this stuff, and 60 00:03:13,360 --> 00:03:16,920 Speaker 1: that from markets is problematic. Usually, is there something you 61 00:03:16,960 --> 00:03:19,000 Speaker 1: think that that's you know, we're just not able to 62 00:03:19,080 --> 00:03:21,160 Speaker 1: track that that you know could be worrying. Is there 63 00:03:21,200 --> 00:03:23,040 Speaker 1: something blowing up somewhere that we just can't see. 64 00:03:24,440 --> 00:03:27,680 Speaker 3: I think it's again I mean, it's really difficult to 65 00:03:27,720 --> 00:03:30,280 Speaker 3: say there's a there's a possibility of that, but one 66 00:03:30,400 --> 00:03:35,840 Speaker 3: hopes that most of these funds are small enough and 67 00:03:35,960 --> 00:03:40,400 Speaker 3: the allocations that pension funds and insurance companies have to 68 00:03:40,480 --> 00:03:43,680 Speaker 3: these funds are small enough that if there was to 69 00:03:43,720 --> 00:03:46,680 Speaker 3: be a major blow up, we wouldn't see too much 70 00:03:46,960 --> 00:03:47,880 Speaker 3: systemic risk. 71 00:03:49,360 --> 00:03:51,600 Speaker 2: But you know, we're keeping our eyes out for it. 72 00:03:51,640 --> 00:03:54,680 Speaker 3: And and I don't I don't want to call out 73 00:03:54,680 --> 00:03:58,280 Speaker 3: and say that I'm sure there's nothing nothing huge or 74 00:03:58,320 --> 00:04:02,240 Speaker 3: wrong in the market. It's something that we're following very closely. 75 00:04:03,200 --> 00:04:05,360 Speaker 1: So based on what we can see and what we 76 00:04:05,400 --> 00:04:07,960 Speaker 1: can measure, what kinds of companies are struggling at the moment, 77 00:04:08,320 --> 00:04:09,480 Speaker 1: and why are they struggling now. 78 00:04:11,240 --> 00:04:16,800 Speaker 3: So I think one interesting area is actually that businesses 79 00:04:16,880 --> 00:04:19,920 Speaker 3: that suffered in COVID are falling out of favor. Of course, 80 00:04:20,040 --> 00:04:22,200 Speaker 3: they just can't handle the amount of stress that they've 81 00:04:22,200 --> 00:04:25,440 Speaker 3: had over such a long period of time, but also 82 00:04:26,279 --> 00:04:28,880 Speaker 3: that businesses that might have done really well in COVID, 83 00:04:29,520 --> 00:04:32,520 Speaker 3: that kind of really enjoyed those tailwinds that they saw 84 00:04:32,600 --> 00:04:35,720 Speaker 3: out of COVID are now no longer enjoying them and 85 00:04:36,240 --> 00:04:41,119 Speaker 3: struggling as a result. I think also the other trend 86 00:04:41,160 --> 00:04:44,240 Speaker 3: to watch out for is that you're also more likely 87 00:04:44,320 --> 00:04:47,800 Speaker 3: to see assets that have been held onto for a 88 00:04:47,839 --> 00:04:52,320 Speaker 3: long time by their private equity firm that probably should 89 00:04:52,320 --> 00:04:55,880 Speaker 3: have been sold off previously and been able to refinance 90 00:04:55,960 --> 00:04:58,280 Speaker 3: their debt, but because of the slowdown in M and 91 00:04:58,360 --> 00:05:02,320 Speaker 3: A and refinancing, because of higher interest rates, they no 92 00:05:02,400 --> 00:05:06,520 Speaker 3: longer have access to those lifelines. So it's those kind 93 00:05:06,560 --> 00:05:07,800 Speaker 3: of older businesses. 94 00:05:08,560 --> 00:05:10,600 Speaker 1: Are they in any particular sector and are they particularly 95 00:05:10,720 --> 00:05:12,880 Speaker 1: kinds of businesses that we've we're more focused on, are 96 00:05:12,920 --> 00:05:14,760 Speaker 1: they I mean the ones that did well in COVID 97 00:05:14,760 --> 00:05:16,839 Speaker 1: are the ones that we were using because we were 98 00:05:16,839 --> 00:05:18,400 Speaker 1: all locked in our house and we couldn't get out. 99 00:05:18,880 --> 00:05:21,640 Speaker 1: But what kinds of When we talk about the kinds 100 00:05:21,640 --> 00:05:23,920 Speaker 1: of company, what sectors are they and what kind of 101 00:05:23,920 --> 00:05:24,720 Speaker 1: businesses are they? 102 00:05:25,520 --> 00:05:29,960 Speaker 3: So there's the usual suspects. We've retail businesses, the obvious ones, 103 00:05:30,040 --> 00:05:34,320 Speaker 3: things like casual dining. But what's interesting about private credit 104 00:05:34,360 --> 00:05:37,640 Speaker 3: is that they really don't focus on those on those sectors. 105 00:05:37,720 --> 00:05:40,360 Speaker 3: You know, we've got the odd specialized fund and the 106 00:05:40,400 --> 00:05:43,360 Speaker 3: odd investment in most funds, but typically a private credit 107 00:05:43,360 --> 00:05:47,240 Speaker 3: fund will focus on things like technology and healthcare, which 108 00:05:47,320 --> 00:05:49,760 Speaker 3: is why I thought that this one example that we 109 00:05:49,880 --> 00:05:54,480 Speaker 3: tracked down of a business being taken over by its lender. 110 00:05:55,240 --> 00:05:58,520 Speaker 3: It's called Enva, it's a care home or operator in Germany. 111 00:05:58,640 --> 00:06:00,919 Speaker 3: I thought this one was really interesting because people have 112 00:06:00,960 --> 00:06:03,479 Speaker 3: written ad nauseum about how bets in the healthcare space 113 00:06:03,520 --> 00:06:06,080 Speaker 3: could go billy up, But it would be actually really 114 00:06:06,120 --> 00:06:08,760 Speaker 3: detrimental to see a whole sale shift in the credit 115 00:06:08,800 --> 00:06:12,359 Speaker 3: quality of healthcare businesses on the private credit industry, just 116 00:06:12,400 --> 00:06:13,920 Speaker 3: because they're so exposed. 117 00:06:14,720 --> 00:06:15,560 Speaker 2: After technology. 118 00:06:15,560 --> 00:06:18,040 Speaker 3: It's the biggest area of focus for private credit funds, 119 00:06:18,200 --> 00:06:21,039 Speaker 3: and we know that sector is getting squeezed by labor 120 00:06:21,200 --> 00:06:26,120 Speaker 3: inflation and regulation. We've just got to see what happens 121 00:06:26,160 --> 00:06:28,600 Speaker 3: there and see if it becomes a wider vider trend, 122 00:06:28,600 --> 00:06:31,680 Speaker 3: because we've really only seen of this one example, maybe 123 00:06:31,720 --> 00:06:33,800 Speaker 3: a couple of others in the past, but it would 124 00:06:33,839 --> 00:06:36,520 Speaker 3: have a very interesting impact if that became more serious. 125 00:06:37,400 --> 00:06:40,640 Speaker 3: I guess the country to focus on is that we've 126 00:06:40,680 --> 00:06:43,960 Speaker 3: noticed the larger concentration of depth F equity swaps in Germany, 127 00:06:44,760 --> 00:06:46,520 Speaker 3: but we haven't yet been able to discern if that's 128 00:06:46,560 --> 00:06:50,200 Speaker 3: because the situation is generally worse out there, or there 129 00:06:50,200 --> 00:06:53,960 Speaker 3: are specific dynamics there, or if it has to do 130 00:06:54,000 --> 00:06:57,680 Speaker 3: with technical factors in the market, kind of surrounding reporting 131 00:06:58,000 --> 00:07:00,120 Speaker 3: that allow us to actually pick them up more more 132 00:07:00,120 --> 00:07:04,360 Speaker 3: easily than we could elsewhere. Obviously, PMI came out yesterday 133 00:07:04,400 --> 00:07:07,680 Speaker 3: with really bad numbers for the sector in manufacturing sector 134 00:07:07,680 --> 00:07:10,720 Speaker 3: in Germany, and there was a recession recently there, So 135 00:07:11,160 --> 00:07:13,240 Speaker 3: it kind of could be either factor. 136 00:07:15,520 --> 00:07:17,960 Speaker 1: One thing that jumps out there when you're talking debt 137 00:07:18,040 --> 00:07:20,840 Speaker 1: for equity swaps, what is that? Why are we talking 138 00:07:20,840 --> 00:07:21,880 Speaker 1: about that in this context? 139 00:07:22,840 --> 00:07:27,200 Speaker 3: So debt for equity stops is a kind of a 140 00:07:27,240 --> 00:07:31,640 Speaker 3: method of last resort for a private credit fund. They've 141 00:07:31,680 --> 00:07:33,680 Speaker 3: got all of these leaders that they can pull when 142 00:07:34,040 --> 00:07:37,200 Speaker 3: a portfolio company is under stress. But the final thing 143 00:07:37,200 --> 00:07:39,920 Speaker 3: that they'll do is they'll have a conversation with the 144 00:07:39,960 --> 00:07:41,360 Speaker 3: private equity sponsor. 145 00:07:42,000 --> 00:07:42,840 Speaker 2: The sponsor will. 146 00:07:42,760 --> 00:07:44,960 Speaker 3: Say, we're not willing to put any more money into 147 00:07:45,040 --> 00:07:47,640 Speaker 3: this business, so we're going to hand over the keys 148 00:07:48,160 --> 00:07:53,880 Speaker 3: to you, and you can exchange all of the debt 149 00:07:54,200 --> 00:07:58,520 Speaker 3: that you're owed into equity and now you private credit 150 00:07:58,560 --> 00:08:03,320 Speaker 3: fund are the sole of this business. And we wrote 151 00:08:03,480 --> 00:08:07,360 Speaker 3: my colleague and I Silas Brown wrote a piece about 152 00:08:08,280 --> 00:08:11,679 Speaker 3: seeing a couple a few more examples of this happening, 153 00:08:11,680 --> 00:08:15,160 Speaker 3: and it's an indicator of serious stress in the market. 154 00:08:15,240 --> 00:08:16,520 Speaker 2: So that's why we're talking about this. 155 00:08:17,280 --> 00:08:22,520 Speaker 1: So the debt side, that's when a private lender will 156 00:08:22,520 --> 00:08:26,720 Speaker 1: give money to a private company in a bilateral sense, 157 00:08:26,720 --> 00:08:32,200 Speaker 1: almost like privately negotiated deal that is alone, but because 158 00:08:32,200 --> 00:08:34,400 Speaker 1: this company can't pay the money, but they end up 159 00:08:34,440 --> 00:08:37,000 Speaker 1: just owning the company exactly. 160 00:08:37,080 --> 00:08:39,840 Speaker 3: Yeah, it doesn't necessarily happen on a bilateral basis every time. 161 00:08:39,880 --> 00:08:42,320 Speaker 3: Sometimes you've got maybe three lenders, which is what happened 162 00:08:42,360 --> 00:08:45,760 Speaker 3: in a case called Unza in Germany recently. But yeah, 163 00:08:45,800 --> 00:08:47,760 Speaker 3: that's pretty much the principle. 164 00:08:47,800 --> 00:08:51,880 Speaker 1: That's the idea a bank or a lender, they don't 165 00:08:52,040 --> 00:08:53,920 Speaker 1: generally want to own a business. They don't want to 166 00:08:53,920 --> 00:08:57,480 Speaker 1: operate a healthcare company or a retail company or a 167 00:08:57,559 --> 00:09:00,560 Speaker 1: fine dining establishment. What happens in this case, I mean, 168 00:09:00,880 --> 00:09:03,320 Speaker 1: do they just suddenly shift their business model or what 169 00:09:03,360 --> 00:09:05,800 Speaker 1: do they do with the assets? 170 00:09:05,800 --> 00:09:07,439 Speaker 2: It's a really interesting area. 171 00:09:07,960 --> 00:09:10,199 Speaker 3: Can I give you a bit of context on this actually, 172 00:09:11,240 --> 00:09:13,640 Speaker 3: just to kind of flesh out my answer, So we 173 00:09:13,640 --> 00:09:15,920 Speaker 3: could do a whole podcast just on the. 174 00:09:15,920 --> 00:09:17,520 Speaker 2: Dynamics of these arrangements. 175 00:09:18,520 --> 00:09:21,199 Speaker 3: But what's interesting to me is that there's this narrative 176 00:09:21,280 --> 00:09:24,640 Speaker 3: emerging when we speak to direct lenders and private credit 177 00:09:24,640 --> 00:09:29,000 Speaker 3: for managers that it's not necessarily bad to have a 178 00:09:29,600 --> 00:09:34,079 Speaker 3: debt for equity swap. That because you know, the fund 179 00:09:34,160 --> 00:09:36,520 Speaker 3: is now the equity owners of a business that has 180 00:09:36,600 --> 00:09:40,320 Speaker 3: no debt because it's all been shifted into equity. There's 181 00:09:40,520 --> 00:09:43,960 Speaker 3: huge potential for upside, much more so than when you 182 00:09:44,000 --> 00:09:47,560 Speaker 3: were just debt holders with an expected yeald. The flip 183 00:09:47,600 --> 00:09:50,920 Speaker 3: side of that, of course, is that you know, this 184 00:09:51,120 --> 00:09:54,080 Speaker 3: is not what private debt funds were created for. Kind 185 00:09:54,080 --> 00:09:58,000 Speaker 3: of to answer your question, many of them aren't equipped 186 00:09:58,120 --> 00:10:00,760 Speaker 3: to deal with a large number of restructuring And while 187 00:10:00,760 --> 00:10:03,520 Speaker 3: there is that potential for upside that's being talked about 188 00:10:03,559 --> 00:10:06,880 Speaker 3: more and more, there is huge potential for downside. They 189 00:10:06,880 --> 00:10:10,439 Speaker 3: could lose their entire investment, and most funds wouldn't be 190 00:10:10,480 --> 00:10:12,960 Speaker 3: able to make a profit if they had even two 191 00:10:13,160 --> 00:10:16,120 Speaker 3: or three situations where they couldn't recover their money. The 192 00:10:16,360 --> 00:10:19,559 Speaker 3: entire fund would not make a profit if that happened. 193 00:10:20,520 --> 00:10:22,680 Speaker 3: But you know, it depends on the fund, and there's 194 00:10:22,720 --> 00:10:26,360 Speaker 3: a huge amount of variation on this topic. Typically larger 195 00:10:26,400 --> 00:10:30,920 Speaker 3: funds have a more substantial restructuring or workout department. We've 196 00:10:30,920 --> 00:10:34,120 Speaker 3: definitely seen some major funds hiring more and more in 197 00:10:34,160 --> 00:10:38,040 Speaker 3: this field recently. I can't speak to whether they actively 198 00:10:38,080 --> 00:10:40,680 Speaker 3: want to own these funds. No one's ever said that 199 00:10:40,800 --> 00:10:43,280 Speaker 3: to me. You know, I actively want to own these 200 00:10:43,320 --> 00:10:48,000 Speaker 3: portfolio companies, but we sorry not funds portfolio companies. But 201 00:10:48,080 --> 00:10:51,760 Speaker 3: we do know that some of these larger funds have 202 00:10:51,840 --> 00:10:55,439 Speaker 3: taken over the keys to more and more businesses, and 203 00:10:55,840 --> 00:10:59,560 Speaker 3: they are this idea about their being potential for upside 204 00:11:00,440 --> 00:11:03,880 Speaker 3: is is kind of on their radar. Smaller funds would 205 00:11:03,880 --> 00:11:08,680 Speaker 3: struggle more in the area. But I think what the 206 00:11:08,720 --> 00:11:10,520 Speaker 3: final thing that I'll say on this is that at 207 00:11:10,559 --> 00:11:13,440 Speaker 3: the end of the day, big or small, these funds 208 00:11:13,840 --> 00:11:16,640 Speaker 3: were not made to own and operate the companies that 209 00:11:16,640 --> 00:11:19,079 Speaker 3: they lend to. That's not what was pitched to investors, 210 00:11:19,559 --> 00:11:22,480 Speaker 3: and it offers a completely different risk profile, much closer 211 00:11:22,520 --> 00:11:26,360 Speaker 3: to something like a special situation sund But. 212 00:11:26,320 --> 00:11:28,160 Speaker 1: It's interesting in that, you know, they're on the one side, 213 00:11:28,160 --> 00:11:30,200 Speaker 1: they're lending this money at very high rates, they're making 214 00:11:30,200 --> 00:11:32,480 Speaker 1: a good return there, and then when things go bad, 215 00:11:32,920 --> 00:11:35,480 Speaker 1: they're actually you know, potentially making even more money because 216 00:11:35,480 --> 00:11:39,559 Speaker 1: they're becoming equity owners. So so sort of win win situation. 217 00:11:40,320 --> 00:11:42,000 Speaker 1: But at the same time, I mean I do worry 218 00:11:42,040 --> 00:11:43,920 Speaker 1: because you know, we see this all the time in 219 00:11:43,960 --> 00:11:46,800 Speaker 1: the public markets. There is a you know, the risk 220 00:11:46,840 --> 00:11:49,840 Speaker 1: of complete wipeout in some of these firms, right, I mean, 221 00:11:49,880 --> 00:11:52,480 Speaker 1: you must have to risk losing all your money. 222 00:11:53,000 --> 00:11:57,199 Speaker 3: Absolutely, that's that's that's completely the case. And I think 223 00:11:57,760 --> 00:12:01,920 Speaker 3: we're in private equity funds, you've got the potential for 224 00:12:02,040 --> 00:12:06,360 Speaker 3: huge upside on every one of your investments, and you 225 00:12:06,400 --> 00:12:10,160 Speaker 3: only need a couple of winners, of big winners to 226 00:12:10,240 --> 00:12:13,800 Speaker 3: make the whole fund profit overall. But that's just not 227 00:12:13,880 --> 00:12:17,120 Speaker 3: the case in private credit funds. That's not the way 228 00:12:17,120 --> 00:12:19,880 Speaker 3: that the dynamics work. And so if you do, if 229 00:12:19,920 --> 00:12:22,560 Speaker 3: you do not recover any of your money on a 230 00:12:22,559 --> 00:12:26,240 Speaker 3: few investments, it can be really detrimental to the returns 231 00:12:26,240 --> 00:12:27,079 Speaker 3: of the entire fund. 232 00:12:28,160 --> 00:12:31,440 Speaker 1: So looking back to where we started this conversation, you know, 233 00:12:31,480 --> 00:12:34,120 Speaker 1: there are more defaults, We are seeing more problems in 234 00:12:34,160 --> 00:12:37,000 Speaker 1: private credit. What is the outlook for more of this? 235 00:12:37,080 --> 00:12:39,280 Speaker 1: You know, do we expect a big default wave to happen? 236 00:12:40,440 --> 00:12:47,360 Speaker 3: Right, So that we've mentioned we've mentioned that the bulk 237 00:12:47,400 --> 00:12:49,240 Speaker 3: of these deals are done the laterally. I think you 238 00:12:49,280 --> 00:12:53,560 Speaker 3: said that, but you know so, So a direct lending 239 00:12:53,600 --> 00:12:55,920 Speaker 3: fund might be the only lender to a company. So 240 00:12:56,320 --> 00:12:58,240 Speaker 3: when we talk about a big wave of defaults, we 241 00:12:58,280 --> 00:13:03,760 Speaker 3: have to contextualize that in the relationship aspect of these funds, 242 00:13:03,800 --> 00:13:08,320 Speaker 3: they really kind of focus on their relationship based culture. 243 00:13:09,160 --> 00:13:11,520 Speaker 3: They talk about how that's very much in place, and 244 00:13:11,559 --> 00:13:13,920 Speaker 3: so what this means is that they pride themselves on 245 00:13:13,960 --> 00:13:17,679 Speaker 3: their ability to negotiate and provide flexibility to borrowers. So 246 00:13:18,600 --> 00:13:21,200 Speaker 3: a wave of defaults will always be tempered by the 247 00:13:21,240 --> 00:13:24,719 Speaker 3: funds trying to manage these situations more so. 248 00:13:24,760 --> 00:13:26,400 Speaker 2: Than a bankuard, for example. 249 00:13:26,480 --> 00:13:30,520 Speaker 3: So market participants have told us that this could be 250 00:13:30,559 --> 00:13:32,800 Speaker 3: a factor and why we've seen so few defaults in 251 00:13:32,800 --> 00:13:35,040 Speaker 3: the space so far. But just to give you an 252 00:13:35,040 --> 00:13:37,439 Speaker 3: idea of what these funds can do there, they can 253 00:13:37,480 --> 00:13:40,880 Speaker 3: wave covenants, they can extend maturity, they can negotiate with 254 00:13:40,920 --> 00:13:45,040 Speaker 3: sponsors to provide more equity. As we said, they can 255 00:13:45,080 --> 00:13:48,559 Speaker 3: take keys to the business without it being public or 256 00:13:48,600 --> 00:13:53,560 Speaker 3: calling it a default. So the possibility for a huge 257 00:13:53,559 --> 00:13:58,120 Speaker 3: wave of defaults is definitely tempered by that. What would 258 00:13:58,200 --> 00:14:01,520 Speaker 3: really trigger wave would be a shift in risk appetite 259 00:14:01,600 --> 00:14:04,240 Speaker 3: for these funds where they were no longer willing to 260 00:14:04,320 --> 00:14:07,440 Speaker 3: kind of provide that flexibility. They were more keen to 261 00:14:07,480 --> 00:14:09,640 Speaker 3: kind of crack the whip and be more stringent about 262 00:14:09,800 --> 00:14:13,319 Speaker 3: terms and conditions. And then, of course these companies, we 263 00:14:13,360 --> 00:14:16,960 Speaker 3: can't forget are in the real economy, and if we 264 00:14:17,040 --> 00:14:20,320 Speaker 3: had an overall macroeconomic decline, that could push many of 265 00:14:20,360 --> 00:14:22,560 Speaker 3: these businesses over the edge. 266 00:14:23,440 --> 00:14:25,000 Speaker 1: So it's more like getting a loan from my friend 267 00:14:25,080 --> 00:14:27,320 Speaker 1: rather than having to go and beg the manager of 268 00:14:27,320 --> 00:14:30,800 Speaker 1: Buckley's Bank to better terms and a few more days 269 00:14:30,800 --> 00:14:31,360 Speaker 1: to pay my loan. 270 00:14:31,400 --> 00:14:31,840 Speaker 2: Is that right? 271 00:14:32,400 --> 00:14:34,720 Speaker 3: They might not be quite as nice as your friend, 272 00:14:34,760 --> 00:14:38,120 Speaker 3: but that's definitely kind of the idea that they're going for. 273 00:14:38,200 --> 00:14:38,920 Speaker 2: Yeah. 274 00:14:39,160 --> 00:14:42,080 Speaker 1: Interesting, Okay, So it's still fairly new market though private crediting. 275 00:14:42,200 --> 00:14:44,000 Speaker 1: It's seen such a boom, as we've discussed over the 276 00:14:44,040 --> 00:14:45,960 Speaker 1: last few years, but it's still fairly new. How does 277 00:14:46,000 --> 00:14:49,720 Speaker 1: the current default situation compare to history in terms of 278 00:14:49,720 --> 00:14:51,360 Speaker 1: the level of worry out there right now? 279 00:14:52,560 --> 00:14:55,280 Speaker 2: It's interesting. Again, we do have very little data to 280 00:14:55,320 --> 00:14:55,680 Speaker 2: go off. 281 00:14:55,680 --> 00:14:59,200 Speaker 3: We really can only talk about what we see in 282 00:14:59,280 --> 00:15:05,320 Speaker 3: surveys and anecdotes. Another prosaur report from April showed that 283 00:15:05,800 --> 00:15:08,440 Speaker 3: one hundred and fourteen out of one hundred and fifty 284 00:15:08,440 --> 00:15:12,560 Speaker 3: private credit executive surveyed they expected the faults to rise 285 00:15:12,600 --> 00:15:14,560 Speaker 3: in their portfolios in the next year, which is the 286 00:15:14,640 --> 00:15:17,440 Speaker 3: highest level in the past five years from the survey. 287 00:15:18,520 --> 00:15:23,440 Speaker 3: But that's kind of what makes this phenomenon so interesting 288 00:15:23,560 --> 00:15:25,880 Speaker 3: is that private credit has never been for a proper 289 00:15:25,920 --> 00:15:29,840 Speaker 3: recession before. This is this is uncharted territory. We can't 290 00:15:29,960 --> 00:15:33,360 Speaker 3: we can't really say. I mean, we definitely know that 291 00:15:33,400 --> 00:15:36,840 Speaker 3: we're seeing more defrequity swaps than ever before, more defaults 292 00:15:36,840 --> 00:15:43,360 Speaker 3: than ever before. So and certainly it feels like people 293 00:15:43,400 --> 00:15:46,800 Speaker 3: are worried. This is something that most people that you 294 00:15:46,840 --> 00:15:50,640 Speaker 3: speak to bring up, and it's it's something that people 295 00:15:50,640 --> 00:15:51,360 Speaker 3: watching closely. 296 00:15:52,760 --> 00:15:55,760 Speaker 1: So before we talk to Andrew Chann at Bloomberg Intelligence, 297 00:15:56,120 --> 00:15:59,000 Speaker 1: how do we reconcile that with all the fundraising, all 298 00:15:59,040 --> 00:16:01,720 Speaker 1: of the billions in dry powder being raised for the strategy, 299 00:16:02,040 --> 00:16:04,280 Speaker 1: and the ever increasing scale of some of the loans 300 00:16:04,280 --> 00:16:05,160 Speaker 1: that are getting done. 301 00:16:05,760 --> 00:16:07,520 Speaker 2: Yeah, that's a really interesting question. 302 00:16:07,760 --> 00:16:09,880 Speaker 3: Does feel like a paradox, doesn't it, But the two 303 00:16:10,160 --> 00:16:13,680 Speaker 3: aren't actually mutually exclusive. So yes, private credit is raking 304 00:16:13,720 --> 00:16:17,920 Speaker 3: in records terms of dry powder, especially in Europe. But 305 00:16:18,040 --> 00:16:20,920 Speaker 3: the data shows that more money is going to fewer funds, 306 00:16:21,120 --> 00:16:24,720 Speaker 3: So that kind of implies that investors are plowing money 307 00:16:24,760 --> 00:16:26,520 Speaker 3: into a select few of. 308 00:16:26,480 --> 00:16:29,920 Speaker 2: The largest funds. So this would show that. 309 00:16:30,400 --> 00:16:34,080 Speaker 3: There is a fear among these investors, these pension funds, 310 00:16:34,080 --> 00:16:37,600 Speaker 3: these insurance companies that invest in private debt, but that 311 00:16:37,680 --> 00:16:40,880 Speaker 3: they are they do believe in the asset class, they're 312 00:16:40,920 --> 00:16:43,480 Speaker 3: just a bit more wary of it now, so they're 313 00:16:43,480 --> 00:16:46,720 Speaker 3: more wary of the smaller firms that they would suspect 314 00:16:46,800 --> 00:16:49,440 Speaker 3: would be more susceptible to the fullests that had smaller 315 00:16:49,440 --> 00:16:53,520 Speaker 3: restructuring teams that are less equipped to deal with stress. 316 00:16:54,200 --> 00:16:56,120 Speaker 3: And I think the larger loans are a symptom of 317 00:16:56,160 --> 00:16:59,880 Speaker 3: the same trend. The funds are fearful of stress and 318 00:17:00,320 --> 00:17:04,000 Speaker 3: are relying on larger companies investing more in them because 319 00:17:04,080 --> 00:17:07,520 Speaker 3: they see those as as safer option. So that's kind 320 00:17:07,560 --> 00:17:10,359 Speaker 3: of how I see it in my head. Does that 321 00:17:10,440 --> 00:17:11,640 Speaker 3: make sense, James to you? 322 00:17:11,760 --> 00:17:14,760 Speaker 1: Absolutely yes, We'll look forward to reading more of your 323 00:17:14,800 --> 00:17:18,560 Speaker 1: analysis and coverage. Thank you so much. Kat Hidelgo from 324 00:17:18,560 --> 00:17:22,480 Speaker 1: Bloomberg News and of course to listeners read all of 325 00:17:22,560 --> 00:17:26,280 Speaker 1: Kat's scoops on the Bloomberg terminal and at Bloomberg dot com. 326 00:17:26,920 --> 00:17:29,480 Speaker 2: So you're going soon, Kat, Thank you, James. 327 00:17:29,680 --> 00:17:31,840 Speaker 1: Moving on to another big topic. As I mentioned earlier, 328 00:17:31,880 --> 00:17:34,440 Speaker 1: we're very fortunate to have with us Andrew Chan, who 329 00:17:34,480 --> 00:17:38,000 Speaker 1: covers credit for Bloomberg Intelligence based in Hong Kong. How's 330 00:17:38,000 --> 00:17:39,360 Speaker 1: it going over there, Andrew. 331 00:17:39,480 --> 00:17:42,879 Speaker 4: Great, Well, I guess like exciting for a SOLS. 332 00:17:43,400 --> 00:17:46,040 Speaker 1: So there's a ton of anxiety right now in markets 333 00:17:46,080 --> 00:17:49,200 Speaker 1: about the state of China's economy, which has a significant 334 00:17:49,600 --> 00:17:54,240 Speaker 1: repercussion for everyone else in the world. The eighteen trillion 335 00:17:54,280 --> 00:17:59,119 Speaker 1: dollar economy is decelerating, the property crisis is deepening, consumers 336 00:17:59,160 --> 00:18:02,440 Speaker 1: seem very beat, exports as struggling, and more than one 337 00:18:02,480 --> 00:18:05,920 Speaker 1: in five young people are out of work. And as 338 00:18:05,960 --> 00:18:09,040 Speaker 1: we talked about last week on this show, Country Garden, 339 00:18:09,359 --> 00:18:13,359 Speaker 1: a company with about three thousand pending property projects up 340 00:18:13,400 --> 00:18:16,280 Speaker 1: and down China, is on the cusp of default on 341 00:18:16,359 --> 00:18:19,919 Speaker 1: its debt. And also at the same time, protesters gathered 342 00:18:19,920 --> 00:18:22,320 Speaker 1: at one of the biggest shadow banks demanding their money 343 00:18:22,320 --> 00:18:26,359 Speaker 1: back as payments were halted. So a lot of issues 344 00:18:26,960 --> 00:18:30,439 Speaker 1: you know across China right now. You know great to 345 00:18:30,440 --> 00:18:32,560 Speaker 1: have you on the show, as you know, as an 346 00:18:32,600 --> 00:18:36,719 Speaker 1: expert based there, and we've we've we've been looking at 347 00:18:36,720 --> 00:18:39,600 Speaker 1: this from different angles on this podcast. But but we 348 00:18:39,680 --> 00:18:42,399 Speaker 1: want to drill down a little bit now into what 349 00:18:42,400 --> 00:18:46,800 Speaker 1: we're calling local government financing vehicles, which is another part 350 00:18:46,840 --> 00:18:51,320 Speaker 1: of this sprawling debt mess you know in China. Can 351 00:18:51,359 --> 00:18:55,320 Speaker 1: you start, Andrew by telling us what these entities are? 352 00:18:55,359 --> 00:18:58,359 Speaker 1: You know, what is what we're calling an lg FV 353 00:18:59,080 --> 00:18:59,880 Speaker 1: and how do they work? 354 00:19:00,359 --> 00:19:03,760 Speaker 4: Yeah? So, right now, the LGFE definition is pretty blurred 355 00:19:03,880 --> 00:19:06,520 Speaker 4: because a lot of these entities they used to provide 356 00:19:06,560 --> 00:19:08,679 Speaker 4: some sort of public service or build some type of 357 00:19:08,680 --> 00:19:12,920 Speaker 4: infrastructure for the local government. But once that purpose was finished, 358 00:19:13,359 --> 00:19:17,280 Speaker 4: I mean, its existence was in doubt, and many evolved 359 00:19:17,320 --> 00:19:22,479 Speaker 4: by foraying into like other businesses, some profit orient mostly 360 00:19:22,600 --> 00:19:26,360 Speaker 4: profit oriented, but they largely still remain in an extension 361 00:19:26,440 --> 00:19:27,520 Speaker 4: of the local government. 362 00:19:27,840 --> 00:19:31,879 Speaker 1: So just but in basic terms, they are entities that 363 00:19:32,160 --> 00:19:36,199 Speaker 1: are phoned to fund infrastructure, schools, that sort of thing 364 00:19:36,200 --> 00:19:36,959 Speaker 1: in China, Is that right? 365 00:19:37,840 --> 00:19:41,240 Speaker 4: Yes, that's correct, not necessarily a school, but definitely like 366 00:19:41,280 --> 00:19:42,200 Speaker 4: public services. 367 00:19:42,800 --> 00:19:44,879 Speaker 1: Okay, so why do they have to set these vehicles up? 368 00:19:44,960 --> 00:19:46,840 Speaker 1: Like don't they just borrow money directly. 369 00:19:47,880 --> 00:19:50,640 Speaker 4: Ah, So say, for example, like I want to build 370 00:19:51,000 --> 00:19:53,320 Speaker 4: a subway, and so they would set up like a 371 00:19:53,359 --> 00:19:57,960 Speaker 4: subway LGFE, so to say, And so it's like somewhat 372 00:19:58,040 --> 00:20:02,200 Speaker 4: run like more on co marcial terms rather than being 373 00:20:02,240 --> 00:20:04,120 Speaker 4: built say by the local government. 374 00:20:05,000 --> 00:20:07,040 Speaker 1: Okay, but who is responsible for that debt? 375 00:20:07,080 --> 00:20:07,159 Speaker 4: Then? 376 00:20:07,200 --> 00:20:09,760 Speaker 1: If you if you're burrowing through through a special purpose 377 00:20:09,840 --> 00:20:13,359 Speaker 1: vehicle like this is, does that mean that you're you know, 378 00:20:13,440 --> 00:20:17,240 Speaker 1: kind of distancing yourself from the ultimately from repaying that debt. 379 00:20:19,240 --> 00:20:22,800 Speaker 4: So the debt is definitely belongs to the LGF, which 380 00:20:22,880 --> 00:20:25,200 Speaker 4: again is an extension of the government, and a lot 381 00:20:25,200 --> 00:20:29,840 Speaker 4: of the lenders that lend to the LGF, whether it's 382 00:20:29,880 --> 00:20:33,080 Speaker 4: like say through offshore notes, on shore notes, or through 383 00:20:33,119 --> 00:20:37,639 Speaker 4: bank lending, they understand that there's some sort of implicit 384 00:20:38,000 --> 00:20:43,200 Speaker 4: government support to this SPV so so to say, or LGFF. 385 00:20:43,880 --> 00:20:47,439 Speaker 1: Okay, And by government you're meaning you're meaning the federal government, 386 00:20:47,480 --> 00:20:50,199 Speaker 1: not not the local or the state government, right, Oh no, 387 00:20:50,240 --> 00:20:53,760 Speaker 1: the local government okay. Okay, So it doesn't necessarily roll 388 00:20:53,840 --> 00:20:54,920 Speaker 1: up to the federal level. 389 00:20:55,800 --> 00:20:57,520 Speaker 4: No, not to the central government level. 390 00:20:57,840 --> 00:20:58,159 Speaker 2: Okay. 391 00:20:58,600 --> 00:21:01,440 Speaker 1: So just to like put this in perspective, I mean, 392 00:21:01,600 --> 00:21:04,679 Speaker 1: it's a we're hearing huge numbers. How much debt do 393 00:21:04,760 --> 00:21:05,320 Speaker 1: they actually have? 394 00:21:05,920 --> 00:21:08,439 Speaker 4: Okay, So using the termino, we actually use the bottom 395 00:21:08,560 --> 00:21:12,760 Speaker 4: up approach to estimate this China LGF debt, which could 396 00:21:12,760 --> 00:21:16,359 Speaker 4: be around like nine point eight trillion US dollars based 397 00:21:16,400 --> 00:21:19,040 Speaker 4: on the latest available financial data of more than three 398 00:21:19,040 --> 00:21:20,119 Speaker 4: thousand lgfs. 399 00:21:20,440 --> 00:21:24,440 Speaker 1: So to put that in perspective, Andrew, how much debt 400 00:21:24,440 --> 00:21:25,440 Speaker 1: are we talking about here? 401 00:21:27,320 --> 00:21:30,080 Speaker 4: Yeah, So using the terminal, we use a bottom up 402 00:21:30,080 --> 00:21:33,640 Speaker 4: approach to estimate China's LGFF debt which could be around 403 00:21:33,840 --> 00:21:36,960 Speaker 4: nine point eight trillion US dollars based on the latest 404 00:21:37,000 --> 00:21:40,320 Speaker 4: available financial data for more than three thousand lgfs and 405 00:21:40,640 --> 00:21:44,480 Speaker 4: local soees. Now, looking at the overall financing structure, around 406 00:21:44,520 --> 00:21:47,879 Speaker 4: seventy percent of this is funded by financing other than bonds, 407 00:21:47,920 --> 00:21:50,439 Speaker 4: such as bank loans, while around twenty nine percent is 408 00:21:50,480 --> 00:21:53,720 Speaker 4: onshore bonds and another one percent are offshore bonds of 409 00:21:53,760 --> 00:21:55,800 Speaker 4: around one hundred billion US dollars. 410 00:21:56,320 --> 00:21:58,240 Speaker 1: So this is a lot of it is actually sitting 411 00:21:58,320 --> 00:22:00,000 Speaker 1: with foreign investments, is that right? 412 00:22:01,840 --> 00:22:04,680 Speaker 4: Not as much so one percent of their total loans 413 00:22:04,720 --> 00:22:07,480 Speaker 4: or so? Okay, And so the remaining ninety nine percent 414 00:22:07,680 --> 00:22:10,199 Speaker 4: is on shore bank loans or onshore bonds. 415 00:22:10,440 --> 00:22:13,879 Speaker 1: Okay, so mostly held by should I mean is it 416 00:22:13,920 --> 00:22:18,600 Speaker 1: mostly Chinese banks that are that are holding this debt? Yes, 417 00:22:19,600 --> 00:22:21,680 Speaker 1: it is, and then most of those banks actually stay 418 00:22:21,760 --> 00:22:29,520 Speaker 1: owned a majority okay, yes, interesting, So the anxiety has 419 00:22:29,560 --> 00:22:33,840 Speaker 1: been around a default by one of these local government 420 00:22:33,880 --> 00:22:37,840 Speaker 1: financing vehicles. What other chances of that happening and what 421 00:22:38,000 --> 00:22:40,880 Speaker 1: would what would that mean for China? 422 00:22:41,640 --> 00:22:46,119 Speaker 4: Yeah, so I think your question can be rephrased to like, 423 00:22:46,200 --> 00:22:48,600 Speaker 4: what type of debt are we talking about that is 424 00:22:48,640 --> 00:22:49,520 Speaker 4: to be defaulted? 425 00:22:50,040 --> 00:22:50,240 Speaker 3: Now? 426 00:22:50,280 --> 00:22:52,840 Speaker 4: In our view, no LGF wants to be the first 427 00:22:52,840 --> 00:22:56,200 Speaker 4: to default on its offshore or on shore notes. I mean, 428 00:22:56,240 --> 00:23:00,240 Speaker 4: considering the relatively small offshore amount and small proportion in 429 00:23:00,280 --> 00:23:02,640 Speaker 4: their total death structure. I mean, there could be very 430 00:23:02,680 --> 00:23:06,240 Speaker 4: low incentive for lgf's to default because should there be 431 00:23:06,920 --> 00:23:09,960 Speaker 4: a default of a high profile LGF, I mean, investors 432 00:23:09,960 --> 00:23:14,119 Speaker 4: would likely reassess China's SOE and LGF issuing universe on 433 00:23:14,160 --> 00:23:17,320 Speaker 4: a standalone basis without state support. I mean that could 434 00:23:17,359 --> 00:23:22,400 Speaker 4: create a lot of unintended consequences, mainly because there would 435 00:23:22,400 --> 00:23:26,040 Speaker 4: be substance a huge, substantial repricing in risk and subsequent 436 00:23:26,119 --> 00:23:30,560 Speaker 4: refining refinancing risks for not only offshore but likely onshore too. 437 00:23:30,640 --> 00:23:32,960 Speaker 4: I mean, that could lead to a lot of rating downgrades, 438 00:23:33,000 --> 00:23:36,240 Speaker 4: which could transpire to, in a worst case scenario, systemic 439 00:23:36,320 --> 00:23:39,280 Speaker 4: risk for the financial system. I mean, right now we 440 00:23:39,320 --> 00:23:43,560 Speaker 4: calculate around twenty trillion US dollars equivalent of outstanding bonds 441 00:23:43,560 --> 00:23:47,040 Speaker 4: could suffer from some form of repricing risks because a 442 00:23:47,080 --> 00:23:52,960 Speaker 4: lot of investors really when they price these state owned 443 00:23:53,000 --> 00:23:57,640 Speaker 4: bonds or state affiliated bonds, they factor in a form 444 00:23:57,680 --> 00:23:58,440 Speaker 4: of state support. 445 00:23:59,440 --> 00:24:03,919 Speaker 1: Okay, and what right now do you think is the 446 00:24:03,920 --> 00:24:07,440 Speaker 1: probability of one of those government financing vehicles defaulting? 447 00:24:07,720 --> 00:24:07,919 Speaker 2: Is it? 448 00:24:08,000 --> 00:24:11,000 Speaker 1: Is it a high likelihood or is it very very small? 449 00:24:11,200 --> 00:24:11,640 Speaker 2: Do you think? 450 00:24:13,640 --> 00:24:18,480 Speaker 4: Uh, very small for the time being. And it goes 451 00:24:18,520 --> 00:24:20,439 Speaker 4: back to the point that no one wants to be 452 00:24:20,600 --> 00:24:24,040 Speaker 4: the first one because obviously these local governments they have, 453 00:24:24,240 --> 00:24:28,719 Speaker 4: they operate independently, and so if say one province defaults, 454 00:24:28,760 --> 00:24:32,120 Speaker 4: then that pretty much spills over to a read across 455 00:24:32,200 --> 00:24:35,359 Speaker 4: to all the all the other provinces as well because 456 00:24:35,359 --> 00:24:38,879 Speaker 4: of the reassessment of state support. That's why in the 457 00:24:38,960 --> 00:24:43,119 Speaker 4: past actually earlier this year, we saw one example. It 458 00:24:43,160 --> 00:24:46,600 Speaker 4: was called Junyi Road and Bridge Construction in Gueijo Province, 459 00:24:46,600 --> 00:24:49,480 Speaker 4: which is one of the poorest provinces in China. I 460 00:24:49,520 --> 00:24:53,240 Speaker 4: mean they abruptly restructured, and a lot of the debt 461 00:24:53,320 --> 00:24:57,160 Speaker 4: was actually restructured on the bank loan side. But if 462 00:24:57,200 --> 00:24:59,760 Speaker 4: you look at say they're onshore bonds and their offshore bonds, 463 00:25:00,000 --> 00:25:01,280 Speaker 4: they remain close to par. 464 00:25:02,720 --> 00:25:03,280 Speaker 1: Okay okay. 465 00:25:03,320 --> 00:25:05,320 Speaker 4: And of course if we look at say some of 466 00:25:05,359 --> 00:25:08,160 Speaker 4: the old if you've been following the sector, you might 467 00:25:08,280 --> 00:25:11,200 Speaker 4: recall some names such as chun Ching Energy, Beijing, High 468 00:25:11,359 --> 00:25:14,600 Speaker 4: End State owned Assets, Investment in UNN, Health and Culture. 469 00:25:14,880 --> 00:25:17,320 Speaker 4: I mean all of them had offshore dollar notes, and 470 00:25:17,400 --> 00:25:21,360 Speaker 4: despite all of the tight liquidity and the very volatile 471 00:25:21,400 --> 00:25:24,639 Speaker 4: bond prices, a lot of them, I mean all of 472 00:25:24,680 --> 00:25:27,840 Speaker 4: them actually repaid their offshore dollar debt without issuing new 473 00:25:27,880 --> 00:25:31,679 Speaker 4: dollar debts. So the local government came out step, stepped 474 00:25:31,760 --> 00:25:34,919 Speaker 4: up and helped them, and in particular, one notable example 475 00:25:34,960 --> 00:25:38,240 Speaker 4: is chum Ching Energy, which actually repaid all outstanding on 476 00:25:38,280 --> 00:25:40,600 Speaker 4: shore and offshore bonds before filing for bankruptcy. 477 00:25:40,880 --> 00:25:41,320 Speaker 2: Okay. 478 00:25:41,600 --> 00:25:45,480 Speaker 4: So that shows you, like the importance of any local 479 00:25:45,520 --> 00:25:48,840 Speaker 4: government to not be the first to default on a 480 00:25:48,840 --> 00:25:49,480 Speaker 4: public note. 481 00:25:49,560 --> 00:25:52,040 Speaker 1: Obviously that it want to, but they might ultimately be 482 00:25:52,240 --> 00:25:54,920 Speaker 1: forced to because of maturity walls or you know, lack 483 00:25:54,960 --> 00:25:59,280 Speaker 1: of liquidity or whatever. I mean, what can the actually 484 00:25:59,280 --> 00:26:02,080 Speaker 1: what can the government to prevent this happening? How can 485 00:26:02,119 --> 00:26:02,920 Speaker 1: they help out here? 486 00:26:03,480 --> 00:26:06,920 Speaker 4: Yes, and so I think the key backstop will be 487 00:26:07,400 --> 00:26:09,840 Speaker 4: the state owned banks, and so they've done most of 488 00:26:09,880 --> 00:26:14,200 Speaker 4: the lending for it, and so, of course the exact 489 00:26:14,400 --> 00:26:18,040 Speaker 4: answer to this question like how much bad loan losses 490 00:26:18,080 --> 00:26:21,600 Speaker 4: can China's banking system absorb, that's for another podcast and 491 00:26:21,680 --> 00:26:24,280 Speaker 4: for the banking team. But again, if we look at 492 00:26:24,280 --> 00:26:28,480 Speaker 4: say the overall picture, the total assets of FI in 493 00:26:28,560 --> 00:26:32,600 Speaker 4: China according to the China Banking and Insurance Commission, I mean, 494 00:26:32,720 --> 00:26:36,399 Speaker 4: is around fifty seven trillion US dollars, with shareholder funds 495 00:26:36,400 --> 00:26:39,520 Speaker 4: of close to five trillion dollars. So again, depending on 496 00:26:39,560 --> 00:26:42,600 Speaker 4: your own NPL assumption, I mean, there appears to be 497 00:26:42,640 --> 00:26:46,600 Speaker 4: a decent capital buffer. Now, of course, the banks would 498 00:26:46,680 --> 00:26:50,120 Speaker 4: likely need to raise additional capital somewhere somehow, but again 499 00:26:50,200 --> 00:26:53,480 Speaker 4: that's another question for the banking experts. But the key 500 00:26:53,520 --> 00:26:55,960 Speaker 4: point remains, and that is the banks can act as 501 00:26:56,000 --> 00:27:01,000 Speaker 4: a temporary backstop. Should lgfs need to urgentily structure their loans, 502 00:27:01,480 --> 00:27:04,160 Speaker 4: of course, such actions will need to be coordinated by 503 00:27:04,240 --> 00:27:05,760 Speaker 4: the local and central government. 504 00:27:06,320 --> 00:27:08,600 Speaker 1: Do we expect losses to those banks? I mean, is 505 00:27:08,640 --> 00:27:10,000 Speaker 1: there going to be a haircut on that debt? 506 00:27:12,119 --> 00:27:15,119 Speaker 4: There will likely be a haircut for that. And so 507 00:27:15,480 --> 00:27:22,239 Speaker 4: it depends on how the banks classified these loans. And 508 00:27:22,280 --> 00:27:26,000 Speaker 4: so say, for example, the Jini example I just gave out, 509 00:27:27,560 --> 00:27:31,280 Speaker 4: it's been restructured, and the principle everything has been extended 510 00:27:31,280 --> 00:27:33,959 Speaker 4: by another twenty years now that can be may not 511 00:27:34,000 --> 00:27:39,119 Speaker 4: necessarily be considered a bad loan in Chinese accounting, so 512 00:27:39,560 --> 00:27:42,880 Speaker 4: to say. And so as long as the LGFE continues 513 00:27:42,920 --> 00:27:46,560 Speaker 4: to pay their interests, I mean, it's considered a performing loan. 514 00:27:48,400 --> 00:27:51,360 Speaker 1: What analogies can we drove between this and the property 515 00:27:51,400 --> 00:27:55,439 Speaker 1: crisis in the sense that, you know, the Chinese government 516 00:27:55,480 --> 00:27:58,000 Speaker 1: right now doesn't seem to be doing much to support 517 00:27:58,160 --> 00:28:02,840 Speaker 1: the property developers, and in fact, it seems that the company's 518 00:28:02,840 --> 00:28:06,960 Speaker 1: party doesn't really you know, want to support them to 519 00:28:07,000 --> 00:28:09,640 Speaker 1: the extent that they want to, you know, bail out. 520 00:28:10,320 --> 00:28:12,040 Speaker 1: You know, there's a moral hazard issue. They didn't want 521 00:28:12,040 --> 00:28:14,960 Speaker 1: to bail out excesses that have gone on in the 522 00:28:15,080 --> 00:28:17,440 Speaker 1: in the real estate market. Is it the similar situation 523 00:28:17,640 --> 00:28:19,560 Speaker 1: for the local government financing vehicles? 524 00:28:20,080 --> 00:28:25,280 Speaker 4: Is it a similar situation? I guess that question is 525 00:28:25,320 --> 00:28:29,639 Speaker 4: more is more interconnected? And now why I say that 526 00:28:29,720 --> 00:28:33,719 Speaker 4: is because if the central government is not helping out 527 00:28:33,760 --> 00:28:38,040 Speaker 4: the property developers and they end up defaulting, I mean, 528 00:28:38,080 --> 00:28:41,000 Speaker 4: I think that sends the wrong message to the entire sector, 529 00:28:41,320 --> 00:28:44,040 Speaker 4: and so pretty much all the home buyers will will 530 00:28:44,120 --> 00:28:48,520 Speaker 4: likely shun future home purchases of state owned developers and 531 00:28:48,600 --> 00:28:51,920 Speaker 4: non state owned developers, and so that will have a 532 00:28:51,920 --> 00:28:55,560 Speaker 4: trickle down effect, which is the property developers they won't 533 00:28:55,560 --> 00:28:58,000 Speaker 4: be buying land from the local government. The local government 534 00:28:58,200 --> 00:29:01,800 Speaker 4: won't have any money to provide support to the lgfs. 535 00:29:02,560 --> 00:29:04,600 Speaker 4: So I mean a lot of this is really hinged 536 00:29:04,680 --> 00:29:08,240 Speaker 4: upon the central government's decision to allow a big player 537 00:29:08,320 --> 00:29:11,000 Speaker 4: like Country Garden to default, And to me, I think 538 00:29:11,040 --> 00:29:13,560 Speaker 4: it just really sends the wrong message because this vicious 539 00:29:13,600 --> 00:29:18,680 Speaker 4: cycle will just not be broken until something substantial comes 540 00:29:18,680 --> 00:29:22,840 Speaker 4: out from the central government. So again, home buyers aren't buying, 541 00:29:23,000 --> 00:29:27,040 Speaker 4: developers aren't buying land. Local governments become poor, they can't 542 00:29:27,040 --> 00:29:31,760 Speaker 4: support their local government lgfe's and again that's the house 543 00:29:31,800 --> 00:29:33,400 Speaker 4: of cards there we're talking about. 544 00:29:34,160 --> 00:29:37,720 Speaker 1: So ultimately, do you think this ends with government bailing 545 00:29:37,760 --> 00:29:40,640 Speaker 1: everyone else and everything just you know, coming back to 546 00:29:40,640 --> 00:29:41,480 Speaker 1: normal again. 547 00:29:43,600 --> 00:29:46,160 Speaker 4: It will be very difficult. And now I say that 548 00:29:46,240 --> 00:29:50,520 Speaker 4: is mainly because looking at Evergraham, which defaulted two years 549 00:29:50,560 --> 00:29:54,200 Speaker 4: ago already, I mean, this messis continues to drag on. 550 00:29:54,360 --> 00:29:58,480 Speaker 4: So I think they're in my opinion, there may have 551 00:29:58,520 --> 00:30:02,680 Speaker 4: been some bureaucratic miss and hopefully the Chinese government can 552 00:30:04,840 --> 00:30:08,920 Speaker 4: try to reverse this, so to say, because the property 553 00:30:08,920 --> 00:30:12,080 Speaker 4: sector has just been dragging everything down, and if you 554 00:30:12,120 --> 00:30:16,040 Speaker 4: look at say the second order, third order effect coming 555 00:30:16,080 --> 00:30:18,160 Speaker 4: from it, I mean, property accounts for a quarter of 556 00:30:18,200 --> 00:30:23,040 Speaker 4: GDP and if that's dropping, you can't meet your five 557 00:30:23,120 --> 00:30:27,280 Speaker 4: percent target. You're starting to see rising unemployment in the sector, 558 00:30:28,520 --> 00:30:30,640 Speaker 4: not only on the terties on the property level, but 559 00:30:30,680 --> 00:30:33,400 Speaker 4: all the ancillary sectors as well. So it can be 560 00:30:33,440 --> 00:30:37,480 Speaker 4: your cement, your white goods, electronics, and so a lot 561 00:30:37,520 --> 00:30:39,800 Speaker 4: of bad debt will start to pile on the supplier side, 562 00:30:39,840 --> 00:30:44,240 Speaker 4: construction companies with razor razor thin margins, and of course 563 00:30:44,400 --> 00:30:46,880 Speaker 4: you have the declining housing prices which will lead to 564 00:30:46,920 --> 00:30:52,360 Speaker 4: negative wealth effect again, which isn't good, and so everything 565 00:30:52,400 --> 00:30:54,640 Speaker 4: is really hinged upon the central government's actions. 566 00:30:54,640 --> 00:30:59,080 Speaker 1: Now, okay, obviously there's going to be many different parts 567 00:30:59,080 --> 00:31:00,480 Speaker 1: of this and it's going to be, you know, a 568 00:31:00,520 --> 00:31:03,680 Speaker 1: long drama to come. But right now, what are the 569 00:31:03,760 --> 00:31:05,040 Speaker 1: key takeaways for investors? 570 00:31:05,040 --> 00:31:05,680 Speaker 2: Do you think? Andrew? 571 00:31:08,440 --> 00:31:14,360 Speaker 4: The key takeaway for investors. I think the first one 572 00:31:14,520 --> 00:31:20,240 Speaker 4: is that the China high yield sector is unfortunately close 573 00:31:20,280 --> 00:31:24,400 Speaker 4: to uninvestable, as we've seen with the property crisis saga, 574 00:31:25,240 --> 00:31:29,440 Speaker 4: because I don't think we've ever seen a sector be 575 00:31:29,600 --> 00:31:31,640 Speaker 4: decimated in such a way that there are over one 576 00:31:31,720 --> 00:31:36,560 Speaker 4: hundred billion US dollars in investor losses and over two 577 00:31:36,600 --> 00:31:40,240 Speaker 4: hundred something bonds are below ten cents, which pretty much 578 00:31:40,480 --> 00:31:46,720 Speaker 4: assumes very very pessimistic recovery expectations. That's one, and then 579 00:31:46,760 --> 00:31:49,480 Speaker 4: I guess on the second front is that if there 580 00:31:49,520 --> 00:31:52,480 Speaker 4: are r V opportunities on the LGF side, and it 581 00:31:52,520 --> 00:31:55,680 Speaker 4: goes back to our our thinking is that the lgffs, 582 00:31:55,760 --> 00:31:59,640 Speaker 4: no matter what, needs to be saved because one, the 583 00:31:59,800 --> 00:32:02,520 Speaker 4: toll I'm not outstanding on the offshore notes is very 584 00:32:02,560 --> 00:32:05,760 Speaker 4: small in the grand picture. And second of all is 585 00:32:05,800 --> 00:32:09,040 Speaker 4: that a lot of these lgfes are pricing to be 586 00:32:09,200 --> 00:32:13,600 Speaker 4: rather distressed as somewhat over fifteen percent, and so on 587 00:32:13,640 --> 00:32:16,280 Speaker 4: that front over there, there could be r V opportunities 588 00:32:16,320 --> 00:32:19,480 Speaker 4: over there if our thesis is correct that the lgfe's 589 00:32:19,520 --> 00:32:21,920 Speaker 4: will be saved. 590 00:32:21,560 --> 00:32:25,680 Speaker 1: V as in relative value. Yes, okay, So just to 591 00:32:25,680 --> 00:32:27,760 Speaker 1: wrap things up, what's the next big thing to watch? 592 00:32:27,800 --> 00:32:31,000 Speaker 1: I mean, we're looking right now at the country God 593 00:32:31,040 --> 00:32:34,560 Speaker 1: and Grace period everyone's worried about to fill. There are 594 00:32:34,600 --> 00:32:37,360 Speaker 1: there any sort of triggers or any events that you 595 00:32:37,400 --> 00:32:38,960 Speaker 1: think we should be looking out for in terms of, 596 00:32:39,120 --> 00:32:40,440 Speaker 1: you know, the calendar coming up. 597 00:32:40,720 --> 00:32:43,280 Speaker 4: Two things, I guess the first thing would be definitely 598 00:32:43,440 --> 00:32:47,640 Speaker 4: like how the Chinese government is plans to deal with this, 599 00:32:47,760 --> 00:32:50,840 Speaker 4: because obviously there's a spillover effect not just domestically but 600 00:32:50,960 --> 00:32:55,600 Speaker 4: internationally as well. Their demand for commodities will likely be 601 00:32:55,640 --> 00:33:00,920 Speaker 4: adversely affected. All your geopolitical goals such as China's One Belt, 602 00:33:00,920 --> 00:33:04,320 Speaker 4: One Road initiative may definitely slow down on that front. 603 00:33:04,480 --> 00:33:07,840 Speaker 4: That's more of the macro picture on the company and 604 00:33:07,880 --> 00:33:10,400 Speaker 4: sector wise basis. I think a lot of investors will 605 00:33:10,400 --> 00:33:16,040 Speaker 4: start to focus on the remaining survivors and even the 606 00:33:16,200 --> 00:33:23,400 Speaker 4: SOOE developers because again with the country Garden debaco, I mean, 607 00:33:23,480 --> 00:33:26,680 Speaker 4: it seems like no one is safe. And so those 608 00:33:27,520 --> 00:33:29,600 Speaker 4: state owned developers, a lot of them still have bond 609 00:33:29,640 --> 00:33:32,200 Speaker 4: prices in the eighty cents ninety cents levels, and so 610 00:33:32,680 --> 00:33:36,560 Speaker 4: if one of them starts to become a bit shaky, 611 00:33:36,640 --> 00:33:39,000 Speaker 4: I think that would really put the nail in the 612 00:33:39,000 --> 00:33:41,120 Speaker 4: coffin for the entire sector. 613 00:33:43,360 --> 00:33:45,800 Speaker 1: Thanks very much, Andrew Chan of Bloomberg Intelligence. You can 614 00:33:45,840 --> 00:33:48,400 Speaker 1: read all of his great analysis on the Bloomberg Terminal. 615 00:33:48,440 --> 00:33:50,040 Speaker 1: Do check it out and hope see you soon on 616 00:33:50,080 --> 00:33:51,400 Speaker 1: the show again, Andrew. 617 00:33:51,600 --> 00:33:53,840 Speaker 4: Thank you very much, James, and thanks. 618 00:33:53,640 --> 00:33:56,200 Speaker 1: Again to Cat Hidelgo from Bloomberg. Yous read all of 619 00:33:56,200 --> 00:33:59,200 Speaker 1: her great credit scoops on the Terminal and at Bloomberg 620 00:33:59,280 --> 00:34:02,240 Speaker 1: dot com. I'm James Crombie. It's been a pleasure having 621 00:34:02,280 --> 00:34:09,240 Speaker 1: you join us again next week on the Credit Edge.