Speaker 1: Hello, and welcome to the Credit Edge, a weekly market podcast.
Speaker 1: My name is Ida Agathia Perez, and I'm a team
Speaker 1: leader at Bloomberg.
Speaker 2: And I'm David Haven's, a senior credit analyst a Bloomberg Intelligence.
Speaker 2: This week, we're delighted to welcome Michael Gatto, a partner
Speaker 2: and head of private side businesses at Silverpoint Capital. Michael,
Speaker 2: how are you?
Speaker 3: I'm great, Thanks for having me excellent.
Speaker 2: We're delighted to have you here, as if being head
Speaker 2: of privates at Silverpoint weren't enough. Michael is also an
Speaker 2: adjunct professor at Columbia Business School in Fordham's Gibelli School
Speaker 2: of Business, where he teaches credit analysis and distressed special
Speaker 2: Situation investing. Now let me toss it back.
Speaker 1: To your Silverpoint has its origins in distress debt, founded
Speaker 1: by Edmulay and Boboshi, who came from GOLDMANSAC Special Situations Group.
Speaker 1: You work with them at Goldman then joined them shortly after,
Speaker 1: so you you're not a founding partner, but as close
Speaker 1: as it gets. Pretty much of silver Point in recent years,
Speaker 1: though it has expanded. I guess expanded is more accurate
Speaker 1: than pivoted to private credit because of the stress strategy
Speaker 1: is still a relevant one. But I wanted to ask
Speaker 1: you you're under the private credit strategy, tell me more
Speaker 1: about this expansion. What is the cell point or what's
Speaker 1: the edge that your private credit strategy has, and how
Speaker 1: have you convinced How difficult was it the conversation with
Speaker 1: borrowers that yes, you have a loan to own strategy,
Speaker 1: but you do more things on that.
Speaker 3: Yeah, it's a great question, and I think it's a
Speaker 3: little misunderstood in the maocket. And you know, as the
Speaker 3: three of us was discussing earlier at silver Point, we
Speaker 3: never really talked about ourselves a lot to the press
Speaker 3: or other than our investors and our barwers. But we
Speaker 3: started we were Amulet and Barboa Change said they started
Speaker 3: all of the credit functions investing at Goldman Sachs and
Speaker 3: they left two thousand and two and started silver Point,
Speaker 3: and in that we are a credit fund. The press
Speaker 3: has called us a distress debt fund, But in two
Speaker 3: thousand and three we were doing private credit along with
Speaker 3: investing in the secondary markets. So how we view ourselves
Speaker 3: are we are investors in credit and that could be
Speaker 3: performing credit, that could be originating new loans in private
Speaker 3: credit and buying in the secondary market of credits that
Speaker 3: are having problems. So what I want to make a
Speaker 3: clear We've been in that private credit business since two
Speaker 3: thousand and three, and in fact, coming into the Great
Speaker 3: Financial Crisis, we had five billion dollars of our originated lots.
Speaker 3: We had gone through the life into the financial crisis
Speaker 3: about nine billion, and we had five billion that we
Speaker 3: worked through successfully and in fact got very good returns
Speaker 3: on our that they came in and out of the crisis.
Speaker 3: But you're right, you have a perception of your distressed
Speaker 3: that fund, so people will say on occasion, why would
Speaker 3: I borrow from you? And if it's okay, I'd like
Speaker 3: to break it up into two components. One is right now,
Speaker 3: our fund has thirty eight billion of a vestible capital.
Speaker 3: North of half of it is for performing credits four
Speaker 3: billion dollars colos, sixteen billion dollars private credit. That's twenty
Speaker 3: and the remainder is our special opportunities. When we're going
Speaker 3: to the market in the private credit, we're trying to
Speaker 3: fill a gap that's greatly appreciated. And as you know, David,
Speaker 3: you follow private credit, a lot of lenders have a
Speaker 3: very distinct box they lend it to. They want to
Speaker 3: lend to a new LBO. They have a loan to
Speaker 3: value they want, and they have industries that they like
Speaker 3: and industries they don't like, and the minute something fits
Speaker 3: in that box, they're gonna win. They're gonna go after it.
Speaker 3: And they basically are saying, hey, tell me where I
Speaker 3: need to be to win. And that's an overbank market.
Speaker 3: Today won't be through cycles, but today it is. We
Speaker 3: have a different conversation. One we're going to try to
Speaker 3: target thirty forty percent of our loans will be two nonsponsors,
Speaker 3: which is very underbanked because it's harder. You have to
Speaker 3: be comfortable doing full due diligence. You can't rely on, Hey,
Speaker 3: an equity sponsor's buying this company for a billion, they
Speaker 3: want a five hundred billion dollar loan. I could go
Speaker 3: to cent committee with a straight face, fifty percent loan
Speaker 3: to value plus they're going to give me go all
Speaker 3: their work, and then I could cut in paste that summarizon.
Speaker 3: We we will do our own credit work, and we're
Speaker 3: comfortable doing full level private and wey like due diligence
Speaker 3: for a loan, and that allows you to attack that
Speaker 3: our non sponsor space. Then that's not to say we're ignoring.
Speaker 3: If that's thirty forty percent, well if I do the
Speaker 3: math one hundred minus forty, that'd be sixty percent will
Speaker 3: be sponsors. But we break sponsor's need for financing into
Speaker 3: three buckets. Bug. The number one is that core LBO
Speaker 3: it's fairly vanilla, and that we will look at all
Speaker 3: of those we want to see it, but we're only
Speaker 3: going to do very few. Now you say, well, why
Speaker 3: would you even look at it if it's overbanked, Because
Speaker 3: when the cycle turns, we want the relationships and we
Speaker 3: want to be in that. And I'll give you an example.
Speaker 3: A lot of people say, well, there aren't a lot
Speaker 3: of cycles. You had nineteen ninety eight, two thousand and two,
Speaker 3: two thousand and eight and COVID, but you've got a
Speaker 3: lot of mini cycles. So we were maybe doing ten
Speaker 3: to fifteen percent in LBOs and then two thousand and
Speaker 3: three hat men and the market shut down short period
Speaker 3: of time. But you had our real fear of inflation.
Speaker 3: You had interest rates going off for the first time
Speaker 3: in a long time. You had banks with hung deals,
Speaker 3: Twitter was stole hung, and you had all of a sudden,
Speaker 3: Silicon Valley bank blows up. So you had this short
Speaker 3: period of time where the market shut and we went
Speaker 3: in and aggressively filled that cap. The golden moment, Yeah,
Speaker 3: it's the golden moment, but you gotta have the capital,
Speaker 3: the confidence, and the relationship. So that's one part of
Speaker 3: how we're attacking the sponsor market. The second component is
Speaker 3: what we call specialty LBOs, and that's where the sponsor
Speaker 3: does not want to go to the broadly syndicated low
Speaker 3: market or go to ten and fifteen lenders and play
Speaker 3: one off the other. It could be a take private.
Speaker 3: I'll give you just an example. Company has four billion
Speaker 3: market cap goes down to a billion because it was
Speaker 3: growing at high rates, their core business matured and the
Speaker 3: throwing a lot of cash into potential growth businesses, none
Speaker 3: of which are working. A sponsor comes in sees where
Speaker 3: the prices knows, the industry knows, the management team knows,
Speaker 3: the board and says, you shouldn't be a public, you
Speaker 3: should be private. Wi'll pay a thirty percent premium and
Speaker 3: cuts the deal. They got to go announce it, get
Speaker 3: shareholder votes to close. They are not looking to fight
Speaker 3: about every basis point. What they're fearful of. What if
Speaker 3: this leaks before the shareholder meeting. What if the stock
Speaker 3: price goes above our thirty percent premium. What if some
Speaker 3: investment banks start calling the board and saying, I have
Speaker 3: a buyer who could do better. They might be fishing,
Speaker 3: but the board gets nervous, Oh, maybe I need They
Speaker 3: want to go to one lender who they trust.
Speaker 2: They want to have the assurance of getting the deal.
Speaker 3: Done, deal done quietly. It's both exactly David is and
Speaker 3: someone who the confident could step up and write a
Speaker 3: check for three four hundred million. And if they're paying
Speaker 3: a little more upfront, a little more call, a little
Speaker 3: more coupon stronger docs. It's small in the overall thing
Speaker 3: of private equity funds auctions. They know they paid more
Speaker 3: than everyone else a proprietary deal that they might have
Speaker 3: spent a year, two years developing the relationship. Everything falls
Speaker 3: in line. They want to come to someone like us,
Speaker 3: So we have core LBOs. We're going to attack that
Speaker 3: in market dislocations, MIDI and major specialty finance. That's what
Speaker 3: we're marketing and things that don't fit everyone's box.
Speaker 2: Is that specialty finance component that the sort of the
Speaker 2: private element that you just described is that pretty much
Speaker 2: a niche.
Speaker 3: Are there only a few places in that for sure? Okay,
Speaker 3: it's a big niche. Yeah, you have to have you
Speaker 3: have to have the capital, you have to have the relationships.
Speaker 3: And when you go through it and you have to
Speaker 3: drop everything and get it done quietly in a short
Speaker 3: period of time, there are ready that many players that
Speaker 3: could do that. That the sponsors are confident and when
Speaker 3: I look at our core relationships they repeat. And then
Speaker 3: finally there's a lot of deals in the sponsor world
Speaker 3: that are not for new LBO add on acquisition refinancing.
Speaker 3: The incumbent lender always has a massive advantage if everything
Speaker 3: was going well, if there were a lot of hiccups
Speaker 3: and all of a sudden it's three or four years later,
Speaker 3: and the original incumbent lenders were reliant on the sponsor's
Speaker 3: loan to value from three years ago. It's sort of
Speaker 3: irrelevant now because things did not go as plan and
Speaker 3: we market ourselves, come to us, we'll re underwrite it.
Speaker 3: And while we're known to do much more due diligence
Speaker 3: than most and structure more than most, we fit this
Speaker 3: need so we're embraced by the sponsor community in it.
Speaker 2: So you obviously have tremendous perspective on the market. I
Speaker 2: mean you fledged from Goldman in two thousand and two
Speaker 2: and got going in two thousand and three. Really at
Speaker 2: silver Point, Techrek was winding down. Enron just happened. Financial
Speaker 2: crisis was a few years away. Europe languished right after that.
Speaker 2: COVID nineteen happened. Private credit is sort of described or
Speaker 2: thought of as a new thing. It's not really a
Speaker 2: new thing. I went through a chemical bank training program
Speaker 2: back in nineteen eighty seven to do leverage loans to
Speaker 2: middle market companies. But how have you seen this market evolve?
Speaker 2: You've been here since the very beginning of what sort
Speaker 2: of is referred to as private credit. So two decades
Speaker 2: in two decades plus in how has it changed.
Speaker 3: Oh, it's changed tremendously in the amount of capital. So
Speaker 3: I agree. I was in I taught those training programs,
Speaker 3: and we had, like I said, at Goldman Sachs, we
Speaker 3: did private credit. I think what's changed the most is
Speaker 3: how many players have come in since the Great Financial Crisis.
Speaker 3: It was viewed the Great Financial Crisis opened this window
Speaker 3: as banks had to worry about their own liquidity solvencies.
Speaker 3: Regulators clos were not getting the same type of leverage
Speaker 3: they needed to make their business model worked, and people
Speaker 3: jumped in, which is great, And I actually think, you
Speaker 3: know all this the private credit is somehow bad for
Speaker 3: the economy. I don't get that in that it's phenomenal there.
Speaker 3: When you think of economic crisises, they're driven and magnified
Speaker 3: by a lack of capital to refinance loans to fund growth.
Speaker 3: Private credit will fill has filled that vacancy. The real
Speaker 3: question that people ask is it has gotten overheated, especially
Speaker 3: in that core LB oh, and is it a bubble
Speaker 3: that's gonna blow up? And the answer is, you know,
Speaker 3: it's the warring buffet quote that everyone loves. When the
Speaker 3: tide goes out, we're gonna see who's when we get
Speaker 3: into the next cycle. There will be people who do fine.
Speaker 3: There will be people who don't do well, and they
Speaker 3: will work down their portfolio and go out of business,
Speaker 3: and there will be a third category that not only
Speaker 3: does fine, but has the dry powder and the expertise
Speaker 3: to lean into that. What I love, what silver Point
Speaker 3: loves is when the market is driven by fear of
Speaker 3: missing out risk on to just constantly be saying, when
Speaker 3: it changes, how is our portfolio going to do? Do
Speaker 3: we know every potential problem and have a plan of attack,
Speaker 3: and do we have the dry powder and the expertise
Speaker 3: that when we go from fear of missing out to
Speaker 3: fear that's where you want to be. And if you
Speaker 3: have capital, don't you're not playing triage and you have
Speaker 3: the confidence to step up when most people are not.
Speaker 3: That's how you really win, and that's how you build
Speaker 3: the long term relationships. When the market's heated, it's odd
Speaker 3: everyone will do that deal. This monster in a core
Speaker 3: LBO is not saying thank you, thank you, thank you.
Speaker 3: They're saying you say thank you, thank you, thank you
Speaker 3: to me because I have twenty term sheets. It's when
Speaker 3: you're attacking the markets, in the segments that aren't as competitive,
Speaker 3: or when everything shuts down, then you build the long
Speaker 3: term relationships.
Speaker 1: Right, speaking of dry powder, that combined with added pressure
Speaker 1: to deploy, I'm not speaking about silver point sell, but
Speaker 1: about like funding private credit in general that seems to
Speaker 1: add to the risk to the bottom to just sign
Speaker 1: any type of deal to some extent in terms that
Speaker 1: are very favorable for favorable for borrowers, but not necessarily
Speaker 1: the best terms for creditors with the best protections for creditors.
Speaker 1: Are you seeing any opportunities from this type of loans
Speaker 1: that for private credit loans that you know, offer very
Speaker 1: few protections for creditors. And now I don't know if
Speaker 1: you're seeing opportunities in perhaps private credit secondaries or other
Speaker 1: sorts of like ways in for re.
Speaker 3: No, I mean, I think that there's a lot and
Speaker 3: you guys have written a lot, you guys meaning bloomberk
Speaker 3: and trading of private credit, you know, And we're gonna
Speaker 3: have a discussion around that because that's sort of interesting
Speaker 3: because the whole idea and the whole part of the
Speaker 3: benefit of private credit is I'm dealing with self appoint
Speaker 3: you're my lendo. When we need to amend the doc,
Speaker 3: I'm calling you. I know who universe is it? I
Speaker 3: don't know who's the person I need to talk to.
Speaker 3: But no, we're not seeing a lot of opportunities in
Speaker 3: buying private credit, whether over time that trades or not.
Speaker 3: What I would say is the race to the bontom
Speaker 3: phenomenal is there. You got to avoid it. And it
Speaker 3: goes back to We're not gonna know the winners and
Speaker 3: the losers until things get bad. What you know? And
Speaker 3: or investors will ask me, well, what questions should I ask? Well, One,
Speaker 3: I look at it and say, what scares me the
Speaker 3: most is a couple of things. One, small companies ten million,
Speaker 3: fifty million EBDA doesn't have significant market share when there's
Speaker 3: a problem. You might not have the senior secure downside protection.
Speaker 3: You might be taking equity risk getting debt like returns.
Speaker 3: So small business is scamming two documents. I'm like almost
Speaker 3: shocked at how loans sometimes and this is also the
Speaker 3: worldly syndicated loan market. The focus on the loan to
Speaker 3: value day one the company, But then there's the docs.
Speaker 3: Are the docks right? But if I'm landing five hundred
Speaker 3: million dollars to a company that's worth a billion today,
Speaker 3: But the docs say there's a carve out and they
Speaker 3: could move two hundred and fifty million dollars of value
Speaker 3: out of the companies that you're lending to to an
Speaker 3: unrestricted sub that I cannot put a covenant on. I
Speaker 3: can't go after the value. It's misleading to say I'm
Speaker 3: fifty percent loans of value taking five hundred over the billion,
Speaker 3: I would take five hundred divided by seven fifty because
Speaker 3: the sponsor, of course, they should move assets out when
Speaker 3: there's a problem. And unlike being a venture capitalist and
Speaker 3: equity value growth equity, where you worry about good things
Speaker 3: and bad things happening, as a lender, all you care
Speaker 3: about is bad things.
Speaker 2: Yeah, your best outcome is getting repaid what you lent.
Speaker 3: Par plus my coupons. Yeah, that's the game of our men.
Speaker 3: And therefore I have to say, what could go wrong,
Speaker 3: what's the probability of it going how much can value
Speaker 3: deteriorate if that happens, and what does the document allow
Speaker 3: that company to do. You know, I have a lot
Speaker 3: of friends in VC and growth equity, and they'll say, Michael,
Speaker 3: your job so easy, senior secured, And I'm like, no, No,
Speaker 3: your job is so easy because you could do ten deals,
Speaker 3: get a zero on three or four of them, mediocre
Speaker 3: returns on three or four. As long as you have
Speaker 3: of the deals being the next uber the next day,
Speaker 3: are your hero. We can't lose money. We have to
Speaker 3: be paranoid about everything that could go wrong and say,
Speaker 3: if it goes wrong, do I think I'm gonna lose money.
Speaker 3: We will, and that's a tough way to live a life.
Speaker 1: We will go into more detail about liability management exercise.
Speaker 3: Letter liability management as in you love to participate, Oh no,
Speaker 3: I love talking, I love well, I will talk about
Speaker 3: I love talking about it. It's interesting.
Speaker 1: Okay, But before that, do you think investors are adequately
Speaker 1: compensated for the risk of fill liquidity?
Speaker 3: Yes and no. You know, it's gonna be the simple answer.
Speaker 3: Certain segments of the market, I think you're getting fairly
Speaker 3: to overcompensated for it. Again, these parts of the segments
Speaker 3: where they're just less efficient, less capital. Yes, I think
Speaker 3: in certain of the deals you're getting no ill liquidity premium.
Speaker 3: But then again, you have some investors that are fine.
Speaker 3: You know, it's also who are the investors of the fund.
Speaker 3: If the investors of the fund have a very very
Speaker 3: long term their capital, very long term, they don't want
Speaker 3: market vowel of things going up and down just based
Speaker 3: on something the president says. They actually value not having
Speaker 3: all that liquidity. So it depends on a lot of things.
Speaker 3: I think right now the core LBO market is what
Speaker 3: I would call a beta trade. It's not there's no
Speaker 3: excess return in it, and you're probably being adequate for
Speaker 3: those who do it. Well, I think you're getting adequately
Speaker 3: compensated for the risk and the liquidity. And my only
Speaker 3: point before not everyone has the same illiquidity premium. So
Speaker 3: the people who go into these assets aren't aren't going
Speaker 3: to be someone who knew needs day to day liquidity
Speaker 3: and therefore they don't need the same liquidity premium as others.
Speaker 3: Does that make sense?
Speaker 2: Yeah, So just sort of sticking with this liquidity issue
Speaker 2: and pivoting a little bit. Private credit has been a
Speaker 2: hot sector for a while. Is it suitable for retail
Speaker 2: investors via ETFs with a private credit component? Don't we
Speaker 2: have the risk of fundamentally illiquid assets being backed by
Speaker 2: daily liquidity funding sort of?
Speaker 3: Well, it's unambiguously a legitimate concern, right, So if you're
Speaker 3: raising money to the retail market, you need to explain
Speaker 3: what is the liquidity of this. Now you could have
Speaker 3: liquidity backstabs, so allowing you could draw on to pay
Speaker 3: out x percent of the investors, so you know there
Speaker 3: is some liquidity. We're just early on in thinking about
Speaker 3: whether we should or shouldn't raise money from the retail investors.
Speaker 3: So there's a big learning curve of a fund saying
Speaker 3: is that appropriate or not?
Speaker 2: It seems to be a little bit of baby steps too,
Speaker 2: because the private credit component is relatively low in these
Speaker 2: funds so far.
Speaker 3: Yeah, I agree with that. So to answer your question,
Speaker 3: it's going to be I think, yes, it is appropriate
Speaker 3: if it structured correctly and it's disclosed that marketed correctly.
Speaker 3: But I'm not an expert on it.
Speaker 1: In the book, one of the things and you were
Speaker 1: discussing now, you mentioned the and you emphasized a lot
Speaker 1: of importance of due diligence, and you were talking about
Speaker 1: it just now. And in the book you mentioned the
Speaker 1: anecdote of Mark Dreyer, the lawyer that was sentenced to
Speaker 1: I think twenty years of prison for fraud. Yes, that
Speaker 1: was you know, I was trying to sell loans that
Speaker 1: were actually non existent. It was a fraud basically, and
Speaker 1: was getting annoyed by the level of due diligence questions
Speaker 1: that Silverpoint was asking. Was meant to have dinner with
Speaker 1: you guys, but was actually the rest in Canada the
Speaker 1: day before? I think is due diligence even more important
Speaker 1: in private credit, equally importantness in public markets? Is there
Speaker 1: something additional that investors would need to take into account.
Speaker 3: Our firm believes due diligence is the core of who
Speaker 3: we are. In fact, we have certain core principles, and
Speaker 3: one is we dig deeper we enjoy due diligence. You know,
Speaker 3: we think it's really important. Now. The less liquid your
Speaker 3: investment is, the more due diligence you need, because if
Speaker 3: you make a mistake, you can't get out. So if
Speaker 3: it's a public investment, you might have done eighty percent
Speaker 3: of your work and say, I am going to start
Speaker 3: to buy because I think I have a unique investment thesis.
Speaker 3: I think I'm ahead of the curve, and even though
Speaker 3: I still have work to do, the price is trading
Speaker 3: at today compensates me for buying without all of my
Speaker 3: due diligence done, because if I wait until I'm done
Speaker 3: and the price moves up ten twenty points, well I
Speaker 3: didn't do my job. So when there's liquidity, you could
Speaker 3: start to buy and then change your mind and get out,
Speaker 3: and you might take a loss. If you're doing on
Speaker 3: the other extreme, your private equity fund, you have to
Speaker 3: finish your due diligence before you invest. So I would
Speaker 3: say if you're lending to private deals, you're going to
Speaker 3: have to do more due diligence because you can't decide
Speaker 3: to make a mistake and move out, or if you're
Speaker 3: doing nonsponsor loans, that even magnifies that because you can't
Speaker 3: piggyback on the work sponsor has done. So I think
Speaker 3: due diligence is really really critical, and it will go
Speaker 3: back to one of the themes when the cycle changes.
Speaker 3: Those who were deep in due diligence have confidence in
Speaker 3: their investment, will not only do better on how their
Speaker 3: existing investments performed, but I also think they'll do better
Speaker 3: in building the relationships with their barers because if you
Speaker 3: did all your work and then there's a downturn in
Speaker 3: the economy, but you have ultimate confidence in the value
Speaker 3: cushion to your loone that this is very temporary, that
Speaker 3: this company is going to have some problems and then
Speaker 3: come out of this recession as good, if not better,
Speaker 3: because some of their competitors might disappear, you are going
Speaker 3: to be more accommodating to that ball. Versus if you
Speaker 3: didn't do a lot of due diligence, you were not deep,
Speaker 3: and then you're worried, which one of your credits are
Speaker 3: high likelihood of impairment versus one you should be leading
Speaker 3: in and support it well.
Speaker 2: Due diligence has to be the name of the game,
Speaker 2: right I believe so, sort of leveraged lending, which sort
Speaker 2: of brings up a question about the way again, the
Speaker 2: way that the market has evolved over time. When you
Speaker 2: were early on getting involved in private credit, it was
Speaker 2: it wasn't terror incognita, but it was not far off
Speaker 2: from that. There seemed to be cruise line liners coming
Speaker 2: in now, you know, bringing tourists to the space. And
Speaker 2: I'm just wondering what sort of an impact you're seeing
Speaker 2: at your business in terms of, you know, sort of
Speaker 2: the underwriting expectations, the documentation, the rationality of pricing, the
Speaker 2: rationality of extending credit in the market today, Like, are
Speaker 2: we overheated? There's certainly a lot of concern we are.
Speaker 3: Yeah, I yes, we are overheated in certain segments, I
Speaker 3: think incerting segments. No, they expect you to come in
Speaker 3: do due diligence. I find, you know, in the non
Speaker 3: sponsored deals, I find you know, we did a deal
Speaker 3: to a family owned business big close to a billion
Speaker 3: dollars of sales or EBDA ranging from eighty million to
Speaker 3: one hundred and twenty million, then a massive pop up
Speaker 3: due to COVID, a massive pop down as a COVID correction.
Speaker 3: But I found like those businesses, they actually embrace due diligence.
Speaker 3: They know every detail of their company, and they actually
Speaker 3: enjoy you coming in and asking. So I think there's
Speaker 3: segments where they understand you're a lender, You're gonna come in,
Speaker 3: you're gonna ask a ton of questions, and that that's
Speaker 3: part of the process, and you're going to have a
Speaker 3: normal document. You know, you're gonna have a loan document
Speaker 3: that says what you can and can't do. So I
Speaker 3: find there's those segments that everything is a good risk
Speaker 3: adjusted return, including the documents. And then but if you
Speaker 3: go back to just pure a very vanilla LBO, the
Speaker 3: sponsors are doing what they should do is saying a
Speaker 3: lot of capital wants to lend to a new LBO,
Speaker 3: and if you want to do it, I need the
Speaker 3: best terms, including the best documents for there. And you
Speaker 3: know it goes back. You know, it's almost I don't
Speaker 3: want to be the repeat. There'll be three sets of
Speaker 3: funds who are in this business, ones that do fine
Speaker 3: continue to exist, ones that are prepared for the downturn
Speaker 3: and wants to fill those void and then they are
Speaker 3: all going to be players who are done. And I'm
Speaker 3: not going to say who zoo. Well, we'll all find out.
Speaker 3: But there's plenty of LBO deals where they tell the
Speaker 3: lenders zero access to management, can't even have a conversation.
Speaker 2: Yikes. So so you've got this specialty area, you've had
Speaker 2: it for a while that I would say probably gives
Speaker 2: you an edge over people that are sort of a
Speaker 2: little bit less established or haven't been doing it as long.
Speaker 2: Does that business come to you through long term relationships
Speaker 2: that you guys have with sort of succession planners and
Speaker 2: sort of firms like that, or where does it come from?
Speaker 3: I would wreak it up. It comes from a lot.
Speaker 3: We we want to see everything and that's why we're
Speaker 3: doing the core LBOs. We're doing but very few of them, right,
Speaker 3: but we want to see them. We're doing what we
Speaker 3: call this specialty LBO. One lene that come to us
Speaker 3: the RIVA and the nons sponsor. So it'd say on
Speaker 3: the sponsor side we have seventy five core relationships. You know,
Speaker 3: a third of those were doing that repeat deal. It
Speaker 3: always is where we're coming to us and they understand.
Speaker 3: And then when you go outside of that, it is
Speaker 3: a lot of advisory firms, It is a lot of
Speaker 3: legal firms. You know, we are You have all these
Speaker 3: banks that are dealing with these large family owned non
Speaker 3: sponsor companies and when they come in like the one
Speaker 3: I described to you, they are needed alone. They were
Speaker 3: only using an ABL revolver from a bank. That advisor
Speaker 3: called us and said would you be interested? And we
Speaker 3: got into a dialogue and I don't think they called
Speaker 3: anyone else, And if they did, it wasn't we were.
Speaker 3: It was not a situation where there were ten term sheets.
Speaker 3: It was more normal. Again, if we didn't price it appropriately,
Speaker 3: we would be opening the door for ten term sheets.
Speaker 3: So you're pricing it at a level you feel you're
Speaker 3: getting a premium because it's under banked, but not such
Speaker 3: that it's where the their their advisor and the family says, well,
Speaker 3: this is selling.
Speaker 1: For the funds that won't make it. What do you
Speaker 1: think could be the triggers in the medium term.
Speaker 3: I don't see. I think in the medium term you
Speaker 3: will have it will be hot you're going to need
Speaker 3: the event, right. I think if you look at funds
Speaker 3: and say, how much of your loans were originated with
Speaker 3: pick interest paid in kind? How much of your loans
Speaker 3: today is paid in kind? The first, the first red
Speaker 3: flag of problems is for funds that are dealing with
Speaker 3: problems but not directly, is pick interest the barrow. And
Speaker 3: it's different if you originated a loan, they're integrating an acquisition,
Speaker 3: you're giving them a holiday on a covenant. You're saying
Speaker 3: you could pay x percent and Pick you came in
Speaker 3: making that decision. It's different when it's all of a
Speaker 3: sudden it wasn't pick and today it's Pick. It's come
Speaker 3: to maturity and you're refinancing it, not because you want
Speaker 3: to extend the maturity, but because you have no choice.
Speaker 3: They can't pay you and the market is in there.
Speaker 3: So I think you will see red flags out there.
Speaker 3: And the vests that a vest in these funds have
Speaker 3: a checklist and they should be asking how much pick
Speaker 3: how much is not on performing? But then when the
Speaker 3: cycle changes, I think that the game will be over
Speaker 3: for those funds. And I want to be clear, I
Speaker 3: don't think it's everyone. I don't think it's close to everyone.
Speaker 3: But we see every deal that's getting done. There's some
Speaker 3: good deals and there's some bad deals. And if someone
Speaker 3: is doing too many bad deals, they won't exist. And
Speaker 3: that's every cycle. That's nothing like I'm not saying anything
Speaker 3: that is controversial. Of course, money comes in, then you'll
Speaker 3: see who does well with it, and then money will
Speaker 3: come out.
Speaker 2: Yeah, it's actually you know, I follow the BDC is
Speaker 2: and it's actually quite interesting to look at the data
Speaker 2: that I've been able to compile on unpick and non accruals.
Speaker 2: Non acrules have remained I would say surprisingly low, particularly
Speaker 2: after five hundred and twenty five basis points at base
Speaker 2: rate hikes in twenty two and twenty three. I think
Speaker 2: that probably has something to do with base rates coming
Speaker 2: off a zero boundary. Yes, but pick rates have also
Speaker 2: remained pretty steady in the six to seven percent range.
Speaker 2: Are you seeing sort of similar trends in your own portfolio?
Speaker 3: Yeah, we're not. We our portfolio is holding it in
Speaker 3: very well, are so. Yeah. I don't follow like you
Speaker 3: do all the BDCs. So my point was, really that's
Speaker 3: where you start to see the potential red flags. But
Speaker 3: when there is markets where there's a lot of capital,
Speaker 3: the mistakes are less easy to spot because more money
Speaker 3: constantly comes in. It is when that tide goes out
Speaker 3: that you figure out who's doing a good job and
Speaker 3: who is it.
Speaker 2: So it's it's impossible, Michael, impossible to have a podcast
Speaker 2: without bringing up AI. Since we're talking about objects, do
Speaker 2: sure not telling about the seventy six ers Great Alan
Speaker 2: iverson artificial intelligence. We can go lots of ways with AI,
Speaker 2: but maybe you could walk us through the benefits of
Speaker 2: it to the private lending space and the drawbacks. Specifically,
Speaker 2: there's concern that software attack and some services, big components
Speaker 2: of many private lending portfolios may be disrupted by AI,
Speaker 2: but maybe it has benefits too.
Speaker 3: Yeah. Yeah, I mean when we when silver Point discuss risks,
Speaker 3: that's one of the risks of every company. So you
Speaker 3: have all this tariffs, inflation, interest rates, you'll have the
Speaker 3: geopolitical risks of what's going on in the world, but
Speaker 3: you also have the AI risk. And AI risk is
Speaker 3: tough because it is so new, so that every in
Speaker 3: every loan that you make, you have to say how
Speaker 3: vulnerable is this to AI? And you've got to really
Speaker 3: have that discussion and you don't have the seeing the
Speaker 3: story over. Like there's a lot of things between people
Speaker 3: at have Fund that have twenty thirty years, multiple cycles,
Speaker 3: they say, I know how this is going to play out.
Speaker 3: This is very different, this is new. So what I
Speaker 3: would say about it is we're scared of it, but
Speaker 3: in a good way. That's what we do. We get paranoid,
Speaker 3: we talk, We ask a lot of questions, we talk
Speaker 3: to people outside and that's on the investing side. On
Speaker 3: the productivity per hour of work, it's amazing and we're
Speaker 3: embracing it as everyone should. It is another tool so
Speaker 3: that you could quickly go through a doc, find the area,
Speaker 3: issue spot patterns. So it's helpful, but it's scaring.
Speaker 2: Yep.
Speaker 1: Moving on to Lemes. It sounds like reading the docks.
Speaker 1: It's necessary but not sufficient, and you need to to
Speaker 1: take into account like all the game theory that goes
Speaker 1: into the flexibility of the dogs. How have lemies changed
Speaker 1: the way you approach distress investing And in the cases
Speaker 1: where you see that that company will need a second round,
Speaker 1: how do you factor that in?
Speaker 3: Yeah? And as I said before, and I was joking
Speaker 3: but only slightly jumping, I love talking about les because
Speaker 3: they were interesting and they are new and everyone's figuring
Speaker 3: them out are and the press loves them because they
Speaker 3: are new and interesting, right. Creditor on creditor violence, distress
Speaker 3: dead exchanges. I even had someone try to call them
Speaker 3: position enhancing transaction pats. Never caught on because that's a
Speaker 3: part positive tone and I think we all know positivity
Speaker 3: doesn't sell as well. But when you break lmemes, this
Speaker 3: is documents, every loan, every bond, there is a legal
Speaker 3: document between the borrower and the lender of what can
Speaker 3: and can't be done. And an LMA transaction is when
Speaker 3: a company is in search of liquidity to avoid a
Speaker 3: crisis and potentially a bankruptcy. They're going to look at
Speaker 3: every aspect of that doc and says what can I
Speaker 3: do now? There was big two pictures. One is moving
Speaker 3: assets away. That was the J crew walk up and
Speaker 3: the intellectual property was no longer your collateral. The other
Speaker 3: type is the SURTA where half the lenders say we're
Speaker 3: going to change the documents. Whereas prior no debt could
Speaker 3: come ahead of the senior secured, we're going to amend
Speaker 3: the docs as we are allowed a majority to allow
Speaker 3: debt come ahead, and then we're gonna lend money to
Speaker 3: the company senior to the originally broadly syndicated loan, which
Speaker 3: doesn't adversely affect anyone disportionately because it hurts everyone by
Speaker 3: pushing them down. Except the second part of the transaction
Speaker 3: is we're gonna lend you money. Part of it you
Speaker 3: could use to turn around the company, and part of
Speaker 3: it you're gonna use to buy back my debt. That
Speaker 3: effectively primes. So now when you look at that and
Speaker 3: all variations, you have to understand it and you have
Speaker 3: to incorporate that in your investing, and let me go through,
Speaker 3: you have clos. For the most part, this is really
Speaker 3: bad for clos, especially colos that are not linked to
Speaker 3: a special situations, to those that are real experts and
Speaker 3: those that are not large, because in all of this
Speaker 3: it only hurts them. And in an overheated market, if
Speaker 3: the docs allow it, what are you gonna do? Not invest?
Speaker 3: So you got the clos, then you have the special
Speaker 3: situation players like us, And for us it's only positive
Speaker 3: in that we understand it, we can make bets and
Speaker 3: that's what we are paid for it. So in certain
Speaker 3: situations we might think the secure debt is trading at
Speaker 3: an inappropriate discount because we don't think an LME is
Speaker 3: gonna happen, but the market does, and we could buy
Speaker 3: This is like about Shalam an other situation. We could
Speaker 3: be part of the majority and help create a solution
Speaker 3: of liquidity. And then it's less impactful in the private
Speaker 3: credit because there upcheering. Well, that's not an issue if
Speaker 3: you own everything, because you're not gonna change the docs
Speaker 3: to hurt yourself. But it is a big issue in
Speaker 3: the moving the assets the j crew. Some people call
Speaker 3: it trapdoor drop down, and again you have to know
Speaker 3: what you're agreeing to.
Speaker 1: It's a documents game, but it's also a size game
Speaker 1: because clearly bigger funds that can.
Speaker 3: Write the big checks have an advantage.
Speaker 1: Have an advantage. Do you think small funds can actually
Speaker 1: like successfully play this game.
Speaker 3: I think they're at a massive disadvantage.
Speaker 2: And then just final thing for me, because we're just
Speaker 2: talking about banks. Are banks friends? Are they friendly foes
Speaker 2: or they the frenemies or they both? We're going to
Speaker 2: see them re engage in direct lending. You know that's
Speaker 2: what banks always did.
Speaker 3: I thought correct, no, with their friends. In fact, we
Speaker 3: really embrace banks because our view is and a lot
Speaker 3: of times we want to partner with them, and we have.
Speaker 3: We have so many of where because we have a
Speaker 3: clo business, we see a struggling deal, we could come
Speaker 3: in and say you make these tweaks, will be the anchor.
Speaker 3: If you want to take it to private, we'll do it.
Speaker 3: We'll do the whole thing. But if you want to
Speaker 3: be involved, you want certain clients. We want banks to
Speaker 3: view us as a creative lender that thinks about solutions
Speaker 3: but isn't looking to box them out, is looking to
Speaker 3: do things where they leave and the happy they made
Speaker 3: a call to us. So virtually every bank we have
Speaker 3: done deals with, some of the time they're leading it
Speaker 3: and we're an anchor, but we help structure it. Some
Speaker 3: cases we said we're fine. Underrated will be a backstop
Speaker 3: that's inside the flex so you could go with confidence.
Speaker 3: We want to be extremely helpful to banks because some
Speaker 3: of the private credit lenders they're going to be really
Speaker 3: fearful of that is saying this is an existential risk.
Speaker 3: So we want to be very commercial and figure out
Speaker 3: ways to work together to do good deals that we
Speaker 3: both are happy with.
Speaker 1: Michael's final question from me because Sally, we have to
Speaker 1: wrap up.
Speaker 3: Yes.
Speaker 1: Another hot topic industress investing is this qualified lenders list.
Speaker 1: In the US it's called the blacklist, and in the
Speaker 1: US they have the white list equivalent. What is your
Speaker 1: view on those and should there be limitations on the
Speaker 1: US for sponsors of those lists?
Speaker 3: Yeah, the disqualified lenders list, they used to be for competitors. Right,
Speaker 3: A company would say, look, if my loan's trading around,
Speaker 3: a competitor or someone who owns a competitor can buy it.
Speaker 3: They've expanded over time or we're not on many of
Speaker 3: those lists because, as I said, we're providing value to
Speaker 3: the sponsor. And even on the side that people call distress,
Speaker 3: which we don't, we call special situation. US buying into
Speaker 3: someone's loan is usually helpful because then we're pitching ideas
Speaker 3: to get in more capital and I know we're running
Speaker 3: out of time. I go through examples, so we don't
Speaker 3: find it a big deal. For silver Point, we end
Speaker 3: up on them every once in a while. More for
Speaker 3: the I think you google us, And that said, we're
Speaker 3: on in most cases. If we talk to the sponsors,
Speaker 3: say reach out to these other sponsors, we get off
Speaker 3: then you go to So that's me answering it from
Speaker 3: my perspective at silver point. The me answering it from
Speaker 3: the market perspective is I think sponsors are really smart
Speaker 3: and they do things that make economic sense. I think
Speaker 3: if you put too much on a DQ list when
Speaker 3: the market gets more normalized, the clos need liquidity. They
Speaker 3: have caps on how much Tripless they could own, They
Speaker 3: have caps on default things, so they need to know
Speaker 3: if a company doesn't do as well as expected, I
Speaker 3: can move out. If one sponsor has every single buyer
Speaker 3: of Triple c's on their DQ list, the clos are
Speaker 3: going to say that's a tougher deal for me, and
Speaker 3: they might now do the deal, or they might demand
Speaker 3: a higher rate. So I think what and Alon winded.
Speaker 3: I think that it gets market regulated. I think sponsors
Speaker 3: will put certain lenders that they think will not be
Speaker 3: supportive of them on those lists. I think if it
Speaker 3: gets too broad, their cost of capital goes up. And
Speaker 3: from our perspective, we do not want to be on
Speaker 3: those lists. We're not on a lot. If we're on them,
Speaker 3: we're going to really engage in a conversation to ask
Speaker 3: why reach stuff.
Speaker 1: Michael Gatto partner at silver Point. Many things for joining
Speaker 1: us on the Credit Edge, and of course we're very
Speaker 1: grateful to David Havens from Bloomberg Intelligence. We appreciate you
Speaker 1: joining us today. Make sure you check Michael Spook. The
Speaker 1: Credit Investor's Handbook has a lot of anecdotes, particularly useful
Speaker 1: for people looking to ramp up their knowledge or get
Speaker 1: into credit investing different It's very focused on elborage, loans
Speaker 1: and how you bonds. There's a part on the stress
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