WEBVTT - Blackstone Sees Big Yield Opportunity; BDC Focus 0:00:18.280 --> 0:00:21.120 Hello, and welcome to The Credit Edge, a weekly markets podcast. 0:00:21.400 --> 0:00:24.120 My name is James Crumby. I'm a senior editor at Bloomberg. 0:00:24.760 --> 0:00:28.160 This week, we're very pleased to welcome Rob's Abel, global 0:00:28.200 --> 0:00:30.560 head of liquid credit Strategies at Blackstone. 0:00:30.880 --> 0:00:33.519 How are you, Rob, I'm great, Thanks for having me. 0:00:33.960 --> 0:00:35.760 Thanks so much for joining us today. And we're also 0:00:35.800 --> 0:00:38.040 delighted to welcome back on the show Lisa Lee, who 0:00:38.080 --> 0:00:40.560 covers credit markets from London. Great to see you, Lisa, 0:00:41.479 --> 0:00:43.800 thanks for having me. Also on the show, we're going 0:00:43.800 --> 0:00:46.200 to be talking to David Haven's who covers non bank 0:00:46.360 --> 0:00:48.880 lenders for Bloomberg Intelligence in New York. So do stay 0:00:48.920 --> 0:00:53.040 with us. But first Rob's Abel with Blackstone. Great to 0:00:53.040 --> 0:00:55.920 have you on the Credit Edge. You look at bonds, loans, 0:00:56.080 --> 0:00:59.360 clos all the exciting stuff. Let's start though with an 0:00:59.360 --> 0:01:02.280 easy one. It was supposed to be the year of 0:01:02.320 --> 0:01:04.479 the bond, but most of the fixed income has been 0:01:04.480 --> 0:01:08.800 hammered by rapidly rising yields. Meanwhile, higher funding costs and 0:01:08.920 --> 0:01:11.240 an economic slowdown was supposed to cause a lot of 0:01:11.240 --> 0:01:13.759 trouble for the riskiest companies, especially those with a lot 0:01:13.760 --> 0:01:18.120 of debt, particularly if it was floating rate I leveraged loans, 0:01:18.840 --> 0:01:22.119 and yet if you look at the returns bonds from 0:01:22.160 --> 0:01:25.360 the worst rated companies and leverage loans have actually done 0:01:25.400 --> 0:01:27.880 really well. What do you make of that, Rob? How 0:01:27.920 --> 0:01:29.520 surprised are you by this outcome? 0:01:30.600 --> 0:01:35.240 Sure? Well, I think what you described was is accurate. 0:01:35.920 --> 0:01:40.280 The performance of the underlying fundamentals of the loans that 0:01:40.319 --> 0:01:45.160 we're lending to has generally been very very good. The 0:01:45.200 --> 0:01:48.680 performance going into this period of rising rates and the 0:01:48.760 --> 0:01:54.840 growth trajectory was really strong, and so it's not surprising 0:01:56.000 --> 0:01:58.840 that when you look at at most metrics, total return 0:01:59.000 --> 0:02:02.200 for the loan as the classes is up over ten percent, 0:02:03.280 --> 0:02:08.000 defaults are and continue to be pretty pretty minimal. So 0:02:08.040 --> 0:02:11.079 the performance characteristics have been good. But the most important 0:02:11.120 --> 0:02:14.160 thing to us, I think is that the underlying fundamentals 0:02:14.160 --> 0:02:17.200 have been have been really strong and supportive of those 0:02:17.360 --> 0:02:18.400 those metrics. 0:02:19.240 --> 0:02:21.440 Rob, Do you think those fundamentals will keep onmb being 0:02:21.480 --> 0:02:25.720 strong as we have a longer for higher for longer period. 0:02:26.639 --> 0:02:28.880 Sure, I think it's a good It's a good question. 0:02:29.080 --> 0:02:33.560 And for sure, you know our team, and I'm sure 0:02:33.560 --> 0:02:37.560 most managers their teams are and continue to shock their 0:02:37.600 --> 0:02:41.200 portfolios for different rate scenarios. But in a period of 0:02:41.320 --> 0:02:44.480 rising rates, you know, in what we're seeing in our 0:02:44.520 --> 0:02:47.200 companies is that the performance has been strong, but performance 0:02:47.200 --> 0:02:50.680 has been slowing. As a credit investor, that's not necessarily 0:02:50.720 --> 0:02:53.440 the worst thing in the world, but I think that 0:02:53.520 --> 0:02:57.960 we should continue to see that performance, you know, continue 0:02:58.000 --> 0:03:00.480 to moderate. And then the question is, oh case, so 0:03:00.480 --> 0:03:02.840 so what what does that mean as a credit investor? 0:03:03.760 --> 0:03:05.839 And I think the backdrop and where you started off, 0:03:05.960 --> 0:03:10.520 is that the rate environment has made it such that 0:03:10.560 --> 0:03:15.120 the yield profile of of really first lean protected assets, 0:03:15.160 --> 0:03:19.919 whether it's in a COLO structure or just a broadly 0:03:19.919 --> 0:03:23.440 syndicated loan or even a direct lending loan is basically 0:03:23.720 --> 0:03:26.680 you know, a double digit a double digit yield. So 0:03:26.720 --> 0:03:30.800 I think that the backdrop as a credit investor is 0:03:30.840 --> 0:03:34.559 that performance has been slowing. On fundamentals, we don't necessarily 0:03:34.600 --> 0:03:38.240 need double digit revenue growth for these companies. We just need, 0:03:39.560 --> 0:03:44.400 you know, stability, and the yield profile of of these 0:03:44.440 --> 0:03:47.440 companies given the rate and backdrop, has been really really attractive. 0:03:48.760 --> 0:03:50.520 But are you not surprised there? Well, just going back 0:03:50.520 --> 0:03:52.600 to my original point that you know, rates did really 0:03:52.680 --> 0:03:56.000 jump very quickly and much further than anyone really expected 0:03:56.400 --> 0:03:59.960 that these borrowers can actually keep up with the interest payment. 0:04:01.360 --> 0:04:04.040 We're not surprised because again, I think we look at 0:04:04.040 --> 0:04:08.040 it from a very mathematical perspective, and going into this 0:04:09.240 --> 0:04:14.560 rising rate environment, we were modeling. We're modeling this what's 0:04:14.600 --> 0:04:18.520 happened right now in terms of increasing base rates, and 0:04:18.560 --> 0:04:20.360 then you can model out, Okay, what does that mean 0:04:20.440 --> 0:04:24.800 for cash flow coverage for these companies? Going into this, 0:04:25.000 --> 0:04:27.640 cash flow coverage was at all time highs. And so 0:04:28.120 --> 0:04:31.560 even with so for moving up to where it is 0:04:31.680 --> 0:04:36.960 right now, we're still steing very, very healthy cash flow 0:04:37.080 --> 0:04:40.040 coverage from these companies. And I think we always get 0:04:40.080 --> 0:04:43.400 to ask the question, well, are you worried that somehow 0:04:45.120 --> 0:04:47.240 as rates go up, we're going to see more default 0:04:47.400 --> 0:04:50.839 activity as a result. And my view is that for 0:04:50.880 --> 0:04:55.279 a company that's otherwise a performing business has a higher 0:04:56.440 --> 0:04:59.640 interest expense burden, I don't think that we ever see 0:04:59.680 --> 0:05:03.640 those companies as being default candidates. I think that as 0:05:03.720 --> 0:05:08.120 long as the business is performing, there's sponsors supportive capital 0:05:08.120 --> 0:05:11.320 markets are supportive. I think for those businesses that already 0:05:11.400 --> 0:05:16.799 have their own idiosyncratic issues. For sure, a slow growth 0:05:16.880 --> 0:05:19.240 environment and a higher rate environment will be issues for 0:05:19.240 --> 0:05:21.720 those companies, and we have seen defaults pick up this 0:05:21.800 --> 0:05:25.400 year even though they're still basically in line with historical averages. 0:05:26.480 --> 0:05:28.840 So the thought has been that there might be a 0:05:28.839 --> 0:05:31.560 soft landing. But what if the Federal Reserve can't maneuver 0:05:31.600 --> 0:05:33.599 that and we have a harder landing. How do you, 0:05:33.680 --> 0:05:36.560 as a credit investor brace for that? 0:05:37.400 --> 0:05:40.320 Sure, I think that a couple of things. One is 0:05:41.080 --> 0:05:45.279 now more than ever. Credit selection is just absolutely critical. 0:05:46.080 --> 0:05:48.640 Making sure that we're staying in Blackstone. We'd like to 0:05:48.640 --> 0:05:50.839 talk about good neighborhoods, make sure that we're staying in 0:05:50.880 --> 0:05:54.360 good neighborhoods, and make sure that we're lending to larger 0:05:54.360 --> 0:05:58.719 companies that are more resilient and with good businesses and 0:05:58.760 --> 0:06:02.160 good management teams. So I think, just like any other investor, 0:06:03.240 --> 0:06:07.359 if we think that you know, we're concerned about the 0:06:07.400 --> 0:06:11.080 fundamental backdop, making sure that we're positioned correctly, and I 0:06:11.080 --> 0:06:14.359 think that the yield environment is more than compensating you 0:06:14.400 --> 0:06:15.440 for that for that risk. 0:06:16.400 --> 0:06:18.760 Rob, you're the global head and we're based right now. 0:06:19.040 --> 0:06:22.120 You're in London, So I would love to hear your 0:06:22.200 --> 0:06:25.520 take on the difference between what you see between us 0:06:25.760 --> 0:06:27.480 and European credit at the moment. 0:06:28.160 --> 0:06:30.920 Sure, it's a good question, and we've been spending a 0:06:30.960 --> 0:06:34.039 lot of time looking at that as it relates to 0:06:34.080 --> 0:06:37.960 actually the COLO market, and so looking at the underlying 0:06:38.000 --> 0:06:42.520 positions in US clos VERSUS European clos, and both of 0:06:42.560 --> 0:06:46.800 those markets do have their own nuances. The US market 0:06:46.839 --> 0:06:50.880 tends to have greater diversity in the underlying collateral. The 0:06:50.920 --> 0:06:56.799 European market has relatively less diversity, but there are quality 0:06:56.839 --> 0:07:00.280 differences and biases in each of those portfolios. I would 0:07:00.279 --> 0:07:02.960 say that in Europe what we've seen is also a 0:07:03.080 --> 0:07:07.839 very very benign default environment. We've also tended to see 0:07:07.880 --> 0:07:11.880 higher recoveries in the European market, which I think is interesting. 0:07:12.400 --> 0:07:15.560 And so if you're looking at both structures, the US 0:07:15.600 --> 0:07:22.560 market I think is benefits from greater trading liquidity. I 0:07:22.560 --> 0:07:26.840 think if you look at Europe, you know, the fundamentals 0:07:26.880 --> 0:07:29.920 from a default standpoint or even a triple C standpoint, 0:07:30.000 --> 0:07:31.360 seem to be a bit better. Right now. 0:07:32.520 --> 0:07:35.040 One of the hot topics this year has been private 0:07:35.080 --> 0:07:38.520 credit clos. I know you do both regular way clos 0:07:38.560 --> 0:07:41.800 and private credit clos. What's your thought on the growth 0:07:41.840 --> 0:07:43.880 of the private credit CLO market, and do you think 0:07:43.880 --> 0:07:45.360 there'll ever be one in Europe? 0:07:46.200 --> 0:07:49.840 Well, starting with that last point, I think for sure, 0:07:50.400 --> 0:07:53.560 I think it's an interesting topic. It's just it's showing 0:07:53.720 --> 0:07:59.080 that the markets have continued to evolve. We've seen conversions 0:07:59.320 --> 0:08:04.640 of of financing from on the large side, from the 0:08:04.680 --> 0:08:07.680 BSL market they're probably syndicated loan market into the private 0:08:07.720 --> 0:08:10.360 credit market. And now we're seeing that same convergence in 0:08:10.400 --> 0:08:15.360 the COO side as we're basically lending to larger companies 0:08:15.360 --> 0:08:18.320 and we're secured, we're using that same technology to secure 0:08:18.360 --> 0:08:22.480 ties and finance those companies, and so I don't see 0:08:22.520 --> 0:08:25.120 any reason why we wouldn't continue to see that evolution, 0:08:25.800 --> 0:08:29.640 both from an asset perspective, but also from an investor 0:08:29.680 --> 0:08:32.480 perspective and a geographical perspective as well. 0:08:33.040 --> 0:08:35.680 What about the maturity will for leverage loans and junk 0:08:35.679 --> 0:08:37.400 bonds that needs to be refinanced, it's going to be 0:08:37.480 --> 0:08:38.880 much more expensive. Is that not going to be a 0:08:38.880 --> 0:08:40.160 big problem coming up? 0:08:41.200 --> 0:08:44.480 I'll give the same answer as I gave previously on 0:08:46.080 --> 0:08:49.280 your question around interest expense. I think for companies that 0:08:49.320 --> 0:08:54.079 are otherwise healthy, in performing companies, there is a pretty 0:08:54.120 --> 0:09:00.200 active financing or refinancing market for those businesses, both in 0:09:00.200 --> 0:09:03.000 the broadly syndicated loan market as well as in the 0:09:03.040 --> 0:09:07.520 private or direct market. I think for businesses that are 0:09:07.520 --> 0:09:11.160 already having their own issues, whatever those are, I think 0:09:11.200 --> 0:09:14.680 for sure they're going to have difficulty refinancing. And I 0:09:14.679 --> 0:09:18.320 think when you look at kind of default activity right now, 0:09:18.360 --> 0:09:21.680 it's basically those businesses. It's not a big part of 0:09:21.720 --> 0:09:25.239 the market, but I think that that's what basically characterizes 0:09:25.280 --> 0:09:28.400 that that tawer risk of the market. But if you're 0:09:28.440 --> 0:09:33.080 talking about a company that's otherwise performing, interest expenses higher 0:09:33.320 --> 0:09:36.360 or the cost of capital is higher, those companies I 0:09:36.360 --> 0:09:39.720 think pretty easily get refinanced in either the BSL market 0:09:39.760 --> 0:09:40.880 or the direct lending market. 0:09:41.760 --> 0:09:44.480 Do you think it's a problem that COLO issuance has 0:09:44.520 --> 0:09:49.160 been less than robust and you look at resets, Your 0:09:49.240 --> 0:09:51.199 forty percent of colos are going to go out of 0:09:51.200 --> 0:09:53.440 the reinvestment periods by the end of the year. What 0:09:53.520 --> 0:09:57.920 does that do to this ability for issue as to refinance. 0:09:58.720 --> 0:10:02.120 Sure? So I think the answer, sure, unfortunately is a 0:10:02.120 --> 0:10:06.120 bit nuanced. And so you're pointing out a data point 0:10:06.160 --> 0:10:08.000 that by the end of this year, we think that 0:10:08.040 --> 0:10:11.000 forty percent of the market will go out of reinvestment period. 0:10:11.400 --> 0:10:14.400 I think that that number ebbs and flows with arbitrage. 0:10:14.440 --> 0:10:17.440 As the arbitrage looks more interesting, which is really a 0:10:17.440 --> 0:10:21.600 function of triple A levels, many of those transactions get 0:10:21.640 --> 0:10:25.080 refined and reset even though at this moment they're not. 0:10:26.320 --> 0:10:31.240 And I think that for companies that are or for 0:10:31.360 --> 0:10:34.839 loans that are in those structures, many of those structures 0:10:34.880 --> 0:10:37.760 have the ability to actually extend or refinance in those 0:10:38.440 --> 0:10:41.400 within within the COLO, even if the CLO is out 0:10:41.440 --> 0:10:44.079 of the the reinvestment period. And I think it all 0:10:44.200 --> 0:10:47.040 just comes down to where we started this conversation, which 0:10:47.080 --> 0:10:49.959 is what's the view of the underlying company and the 0:10:50.040 --> 0:10:53.440 underlying fundamentals of those companies. And for those companies that 0:10:53.480 --> 0:10:57.040 are performing, whether they're in a CLO that's in reinvestment 0:10:57.120 --> 0:11:02.240 or out of reinvestment, there'll be a capital markets or 0:11:02.280 --> 0:11:05.400 there is a capital market's takeout for them, both in 0:11:05.440 --> 0:11:07.160 the BSL side and the direct side. 0:11:07.840 --> 0:11:11.360 When we look at the default risk, you know, we're 0:11:11.400 --> 0:11:14.640 talking a lot about the recession risk well than anything. 0:11:15.360 --> 0:11:19.240 You know, it has continued to be delayed economies. I 0:11:19.240 --> 0:11:24.640 think expects a recession starting later this year. In that case, 0:11:25.080 --> 0:11:27.880 defaults and spreads should be much much higher, shouldn't they. 0:11:28.960 --> 0:11:34.440 I think when we look at the default environment right now, 0:11:34.480 --> 0:11:37.079 we're sort of mid two's in the US, and if 0:11:37.080 --> 0:11:40.239 you that's for the index, if you look at manager's 0:11:40.440 --> 0:11:44.200 default records, I think that's on average below one percent 0:11:44.320 --> 0:11:48.880 right now, depending on what bank estimate you look at. 0:11:48.920 --> 0:11:50.920 I think we think that the default rate in the 0:11:51.000 --> 0:11:54.679 US probably goes somewhere into the threes, which is again, 0:11:54.760 --> 0:11:58.160 I think, essentially align with long term averages, and Europe 0:11:58.200 --> 0:12:06.360 is probably similar. So I think we are focused on 0:12:06.400 --> 0:12:09.840 the tail risk of the market and tail risk of portfolios, 0:12:09.840 --> 0:12:13.400 and making sure that we're positioned with the best companies 0:12:13.440 --> 0:12:17.280 and best borrowers and the best industries that we can be. 0:12:17.760 --> 0:12:22.160 I think that the direction of travel for default rate 0:12:22.240 --> 0:12:25.360 is probably north from here, but I also think that's still, 0:12:25.800 --> 0:12:27.800 you know, a low single digit type of number. 0:12:28.600 --> 0:12:31.600 Are you worried about worried at all about the recovery levels? 0:12:31.880 --> 0:12:34.280 The recovery levels this year's haven't been great, but there's 0:12:34.320 --> 0:12:36.720 some argument that maybe they will pick up because the 0:12:36.760 --> 0:12:39.400 worst companies go first, or is it something that we're 0:12:39.400 --> 0:12:40.600 seeing a secular shift? 0:12:41.559 --> 0:12:44.520 Well, I think that's definitely true, Lisa, and I'm glad 0:12:44.559 --> 0:12:49.040 that you said that, because I think so often there's 0:12:49.440 --> 0:12:52.960 a recovery rate at a trough period of time is 0:12:53.000 --> 0:12:56.360 then compared to a long term average and we say, okay, well, 0:12:56.520 --> 0:13:00.720 recovery rates are low this year in this period of stress, 0:13:00.800 --> 0:13:03.960 whatever the period of stress is, whether it's the GFC 0:13:04.280 --> 0:13:08.000 or COVID, and then they're compared to a twenty year 0:13:08.040 --> 0:13:13.120 long term average. And so I do think that you 0:13:13.240 --> 0:13:15.440 need to look at that point in time exactly is 0:13:15.440 --> 0:13:18.160 the way that you you articulate it. But I would 0:13:18.200 --> 0:13:24.160 also say that particularly in the US, the LME liability 0:13:24.200 --> 0:13:28.280 management exercises that we have seen, even though the number 0:13:28.400 --> 0:13:32.680 of those situations has been relatively small, I think for 0:13:32.720 --> 0:13:36.080 sure that hasn't had an impact on recoveries. And as 0:13:36.120 --> 0:13:39.520 I said before, we haven't really seen that dynamic in Europe, 0:13:39.520 --> 0:13:40.840 which I think is pretty interesting. 0:13:41.600 --> 0:13:43.839 So, just to wrap it up before we talk to 0:13:43.920 --> 0:13:48.000 David Haven's a Bloombak Intelligence, you seem very optimistic, you know, 0:13:48.320 --> 0:13:53.120 the outlook seems very benign, but again, rates do keep rising, 0:13:53.720 --> 0:13:56.600 the earnings are under pressure the recession. You know, maybe 0:13:56.640 --> 0:13:58.960 that doesn't happen immediately, but it is coming. Do we 0:13:59.040 --> 0:14:01.440 not really you know? 0:14:01.520 --> 0:14:01.680 Is it? 0:14:01.760 --> 0:14:04.400 Is it not to to rosy in this in this environment, 0:14:04.400 --> 0:14:06.720 I mean, surely we expect more bankruptcy and distress at 0:14:06.760 --> 0:14:07.120 some point. 0:14:07.840 --> 0:14:10.280 Well, I think Lisa, who knows me, knows that I'm 0:14:10.280 --> 0:14:14.360 not normally a rosy person. But I will say this 0:14:14.480 --> 0:14:19.080 backdrop in credit is, you know, we haven't seen anything 0:14:19.160 --> 0:14:22.440 like this from an opportunity set in in quite some time. 0:14:22.560 --> 0:14:27.120 From a yield perspective and return perspective, I agree. I think, 0:14:27.960 --> 0:14:30.400 you know, in a rising rate environment, that is going 0:14:30.440 --> 0:14:33.640 to translate to slower growth for the companies that we're 0:14:33.720 --> 0:14:39.400 lending to. I think that favors credit selection and sector selection, 0:14:39.760 --> 0:14:43.720 as we talked about, and I think default rates tick 0:14:43.800 --> 0:14:48.600 up mildly. But I think that all of that is 0:14:48.600 --> 0:14:52.640 is you know, mitigated again by selection, and I think 0:14:52.800 --> 0:14:56.760 relative to the opportunity set, it's it's you know, it's 0:14:56.800 --> 0:15:01.280 it's actually a pretty interesting time. And also, you know, 0:15:01.320 --> 0:15:04.640 and we look back at the history of volatility, I 0:15:04.680 --> 0:15:08.600 think some of that those periods have really been our best, 0:15:09.680 --> 0:15:13.240 our best moments for credit opportunity, and we expect that 0:15:13.360 --> 0:15:17.120 we'll continue to see those periods and we're you know, 0:15:17.160 --> 0:15:19.960 from a buying an investment perspective. Again, as long as 0:15:19.960 --> 0:15:23.440 you're making good credit selection, those are great opportunities. 0:15:24.320 --> 0:15:27.240 Great stuff. Rob's Abel, Global head of Liquid credit Strategies 0:15:27.240 --> 0:15:29.800 at Blackstone. Thank you so much for joining us. Thanks 0:15:29.800 --> 0:15:32.480 for having me and Lisa Lee with Bloomberg News in London. 0:15:32.560 --> 0:15:33.440 Brilliant to see you again. 0:15:33.560 --> 0:15:36.200 Cheers, great, Thank you so much for having me. Bye bye. 0:15:37.040 --> 0:15:39.240 So, as I mentioned earlier, we're joined by David Havens 0:15:39.240 --> 0:15:42.920 with Bloomberg Intelligence in New York. Besides being highly knowledgeable 0:15:42.920 --> 0:15:45.280 about non bank lenders, he's a football fan who used 0:15:45.320 --> 0:15:47.080 to be a DJ. So this will be good. How's 0:15:47.080 --> 0:15:47.680 it going, David? 0:15:48.320 --> 0:15:49.880 Very good? Thank you great. 0:15:49.920 --> 0:15:51.920 So we're here to talk about middle market lending and 0:15:51.920 --> 0:15:55.560 private credit. It's a rapidly growing market, tons of excitement 0:15:55.560 --> 0:15:57.800 about it at the moment. All the big asset managers 0:15:57.840 --> 0:16:00.720 are in chasing fat returns. It's the golden age, or 0:16:00.760 --> 0:16:02.880 so they say. But break it down for us, David, 0:16:02.880 --> 0:16:04.200 Why all the hype right now? 0:16:04.800 --> 0:16:08.160 Well, it's been one of the fastest growing areas of 0:16:08.640 --> 0:16:11.680 finance for a couple of years. We've seen this sector 0:16:11.720 --> 0:16:16.560 come out of about come from almost nothing not too 0:16:16.640 --> 0:16:20.480 long ago to over trillion dollars in total assets. We've 0:16:20.520 --> 0:16:23.760 also seen the sector perform quite well versus a number 0:16:23.800 --> 0:16:28.320 of different investment sectors. Private credit so far has had 0:16:28.440 --> 0:16:31.840 relatively low volatility and above average return, So it's opened 0:16:31.880 --> 0:16:33.520 a lot of eyes and a lot of people have 0:16:33.560 --> 0:16:37.240 been drawn to it, particularly when rates were extremely low 0:16:37.280 --> 0:16:38.760 and yields are very hard to come by. 0:16:39.480 --> 0:16:41.360 But just so everyone knows what we're talking about, because 0:16:41.360 --> 0:16:43.400 there is I think quite a lot of confusion what 0:16:43.480 --> 0:16:46.280 exactly do we mean by private credit? And also middle 0:16:46.320 --> 0:16:48.000 market lending? What are we talking about here? 0:16:48.200 --> 0:16:51.160 Yeah, so middle market lending is lending to mid sized 0:16:51.240 --> 0:16:53.760 business is just like what it sounds like. It's not 0:16:53.880 --> 0:16:57.240 lending to the fortune five hundred. It's lending to the 0:16:57.240 --> 0:17:00.000 next echelon of companies below that. So you're talking about 0:17:00.120 --> 0:17:03.120 companies and might have five hundred million to a billion 0:17:03.160 --> 0:17:05.960 dollars of total revenues or earnings, however you want to 0:17:06.000 --> 0:17:10.280 measure that. And that area is an area that was 0:17:10.720 --> 0:17:13.320 as a result of some of the changing the bank regulations, 0:17:13.720 --> 0:17:16.840 has sort of fallen between the cracks. Banks aren't really 0:17:16.880 --> 0:17:20.600 being are actually kind of being disincentivized from lending to 0:17:20.680 --> 0:17:24.600 those businesses, and into that vacuum you've gotten some private 0:17:24.680 --> 0:17:27.960 lenders come in, You've gotten business development companies. And it's 0:17:28.040 --> 0:17:31.400 kind of a wide array what private credit really means. 0:17:31.440 --> 0:17:33.679 A lot of it has to do with funding private 0:17:33.720 --> 0:17:37.080 equity deals, and other aspects of it have to do 0:17:37.160 --> 0:17:42.240 with funding regular standalone companies, family businesses, things like that, and. 0:17:42.240 --> 0:17:45.240 The private nature of it. I mean, it sounds all 0:17:45.240 --> 0:17:48.360 a bit shady, but you're just going into a dog 0:17:48.480 --> 0:17:51.520 room somewhere and we're just negotiating why is it private? 0:17:51.520 --> 0:17:54.520 It sounds why the would so. 0:17:54.840 --> 0:17:58.280 The differentiation is really, rather than going to a broad 0:17:58.320 --> 0:18:03.040 audience of public bondholders, the company that's borrowing the money 0:18:03.080 --> 0:18:06.639 is going directly to a lender or several lenders to 0:18:06.680 --> 0:18:09.320 get the financing in place. It's what you would have 0:18:09.359 --> 0:18:13.000 thought of as being traditional corporate bank lending twenty thirty 0:18:13.080 --> 0:18:13.600 years ago. 0:18:14.280 --> 0:18:15.639 I mean, we've both been doing this a while. It 0:18:15.640 --> 0:18:19.440 sounds like old school just loans to me. But let's 0:18:19.440 --> 0:18:23.119 talk about BBC's business development corporations. Are they how are 0:18:23.160 --> 0:18:25.120 they structured? Why are they so hot? 0:18:25.680 --> 0:18:25.880 Yeah? 0:18:25.920 --> 0:18:28.840 So, business development companies, I think achieve a couple of things. 0:18:29.280 --> 0:18:34.040 First off, there's a degree of tax benefit associated with 0:18:34.119 --> 0:18:37.680 business development companies that aren't necessarily available to some other 0:18:37.720 --> 0:18:42.960 funds like Reeds. Business development companies, which actually came about 0:18:43.000 --> 0:18:46.159 at about the same time under US tax codes and 0:18:46.280 --> 0:18:52.879 investment regulations, don't pay income taxes. The income from these 0:18:53.000 --> 0:18:56.200 entities gets pass through directly to the investors, who then 0:18:56.240 --> 0:19:01.280 pay the taxes on the earnings. And I think that 0:19:01.359 --> 0:19:05.080 what we've seen recently is business development companies have come 0:19:05.160 --> 0:19:08.680 out of the shadows a bit as private equity concerns 0:19:08.720 --> 0:19:13.560 and alter alternative asset managers like Blackstone, kkar Areas and 0:19:13.600 --> 0:19:17.240 others have found sort of a niche where they can 0:19:17.280 --> 0:19:20.000 operate with these business development companies that make sense for 0:19:20.080 --> 0:19:22.200 a group of new investors that they're courting a largely 0:19:22.240 --> 0:19:23.040 retail audience. 0:19:23.560 --> 0:19:26.320 And the BBC is essentially they borrowing in let's say 0:19:26.400 --> 0:19:28.920 public markets they were shing bonds and they're lending to 0:19:29.359 --> 0:19:33.800 smaller companies, middle market companies privately directly bilaterally. Is that right? 0:19:34.000 --> 0:19:37.760 That's right? And the basically what they're doing is they're 0:19:37.800 --> 0:19:41.480 doing some spread arbitrage. They're leveraging their business somewhat, so 0:19:41.560 --> 0:19:45.080 you generally have about two dollars of loans for every 0:19:45.119 --> 0:19:49.040 dollar of equity at a business development company. The business 0:19:49.040 --> 0:19:51.800 development company goes to a group of banks, it goes 0:19:51.840 --> 0:19:55.479 to public bondholders to borrow money. It borrows money at X, 0:19:55.560 --> 0:20:01.000 and then it finds customers. Borrowers them elves come to 0:20:01.000 --> 0:20:04.040 the business development company for loans and rather than paying X, 0:20:04.080 --> 0:20:07.560 they play they generally pay X plus six hundred basis 0:20:07.560 --> 0:20:09.400 points six percent or so. 0:20:09.400 --> 0:20:12.439 So the bonds of the BDC's how are they trading 0:20:12.440 --> 0:20:15.760 against similar debt? Is there some relative value the I. 0:20:15.680 --> 0:20:20.400 Think there's definitely relative value, no question about that. If 0:20:20.440 --> 0:20:23.920 you look at where the investment grade business development companies trade, 0:20:23.920 --> 0:20:28.159 they're generally triple B issuers. Where they trade relative to 0:20:28.240 --> 0:20:31.159 triple B financials. Overall, there's several hundred basis points of 0:20:31.200 --> 0:20:34.480 excess spread at business development companies. I think that that 0:20:34.560 --> 0:20:37.880 probably reflects a couple of different things. One, I think 0:20:37.920 --> 0:20:42.320 that there's some trepidation in the market regarding private credit. 0:20:42.400 --> 0:20:44.560 It does sound a little bit scary, I think, as 0:20:44.600 --> 0:20:47.920 you mentioned before, and then the second thing is that 0:20:48.080 --> 0:20:53.280 we've seen this over the years, is that some investors 0:20:53.440 --> 0:20:58.720 view business development companies and their alternative asset manager advisors 0:20:58.800 --> 0:21:02.160 as de facto competitors, and there's a reluctance to fund 0:21:02.160 --> 0:21:05.800 some of those competitors. And then finally, the economy is 0:21:05.960 --> 0:21:08.400 a little bit soft. Interest rates have been going up, 0:21:08.720 --> 0:21:15.200 You're beginning to see coverage ratios at the borrower level decline. 0:21:15.359 --> 0:21:17.520 So there's concern that there's going to be an increased 0:21:17.560 --> 0:21:20.280 level of default rate activity from very low levels within 0:21:20.320 --> 0:21:21.120 the portfolios. 0:21:21.600 --> 0:21:23.919 So yeah, let's talk about the scary parts of it. 0:21:24.000 --> 0:21:26.400 I mean, high yield lending in the shadows. We don't 0:21:26.400 --> 0:21:28.280 really know what the risks are. We can't see them, 0:21:28.440 --> 0:21:32.040 you know, the transparency issues. I mean, how worried do 0:21:32.040 --> 0:21:34.040 you think we should be. Let's say we are heading 0:21:34.080 --> 0:21:38.840 into sorry, a recession, how worried should we be about 0:21:38.880 --> 0:21:40.320 a big increase in defaults? 0:21:41.200 --> 0:21:43.480 I think it's definitely going to be coming down the pike, 0:21:43.520 --> 0:21:45.480 and you can look at you know, and you don't 0:21:45.520 --> 0:21:48.080 have to depend on me. Moody's came out with a 0:21:48.160 --> 0:21:52.520 report back in May where they estimate that the default 0:21:52.560 --> 0:21:57.239 rate activity on single B rated credits the sort of 0:21:57.240 --> 0:22:00.399 things that you'd find at a business development company. Expect 0:22:00.440 --> 0:22:02.280 that to go up to about five point six percent 0:22:02.280 --> 0:22:07.720 from three percent over the next year. Our own my 0:22:07.720 --> 0:22:12.200 own equity colleagues here estimate that you're going to see 0:22:12.960 --> 0:22:17.280 BDC portfolio default rates non accrural rates go from a 0:22:17.400 --> 0:22:19.879 less than two percent to three point four percent in 0:22:19.880 --> 0:22:22.240 the next year. So there's definitely going to be or 0:22:22.240 --> 0:22:26.440 there's definitely the expectation that there's going to be deterioration. However, 0:22:26.840 --> 0:22:29.199 it's important to put all of this into context. Like 0:22:29.240 --> 0:22:32.200 I said earlier, there's two dollars of loans for every 0:22:32.240 --> 0:22:35.959 dollar of equity at these business development companies. So if 0:22:36.000 --> 0:22:39.159 you see let's say a four percent default rate, and 0:22:39.200 --> 0:22:42.119 you have a fifty percent loss on each one of 0:22:42.160 --> 0:22:45.560 those loans that defaults, you're only talking a couple of 0:22:45.640 --> 0:22:52.280 percentage points of the business development company's equity capital cushion. 0:22:52.520 --> 0:22:56.720 So these companies have the ability to actually manage these 0:22:56.760 --> 0:22:59.639 losses and probably quite a few more losses. And then 0:22:59.680 --> 0:23:03.600 you can compare that to other lenders. Banks, for example, 0:23:03.720 --> 0:23:07.600 probably have I don't know eight or ten dollars of 0:23:08.119 --> 0:23:10.959 investments or assets for every dollar of equity, so there 0:23:10.960 --> 0:23:13.440 are more highly leveraged business You see that at life 0:23:13.440 --> 0:23:17.119 insurance companies as well, So these are not highly leveraged 0:23:17.200 --> 0:23:21.280 entities of business development companies. They do lend to leverage borrowers, 0:23:21.680 --> 0:23:24.000 but the BDCs themselves are not highly leveraged. 0:23:24.280 --> 0:23:26.080 So is the risk? Then you mentioned that the triple 0:23:26.119 --> 0:23:28.280