Speaker 1: Hello, Welcome to the Credit Edge of Wiki Markets podcast.
Speaker 1: My name is James Crumbie. I'm a senior edge at
Speaker 1: Bloomberg and.
Speaker 2: I'm David Haven's, a senior analyst of Bloomberg Intelligence covering
Speaker 2: non bank financial thing imagigs, including private credit. This week,
Speaker 2: we're very pleased to welcome Sonali Wilson, lead investment director
Speaker 2: for private credit at Wellington Management with one point three
Speaker 2: trillion dollars of assets under management. That's Wellington, not the
Speaker 2: private credit at Wellington necessarily, Sonali, how are you.
Speaker 3: I'm doing great? Thank you both for having me excellent.
Speaker 2: It's great to have you here. Just before we get
Speaker 2: into it, Sonali leads the firm's product and commercial strategy
Speaker 2: for private credit, overseeing the development, structuring, and distribution of
Speaker 2: Wellington's strategies in this area. She has a fantastic career,
Speaker 2: having also spent time at PIMCO, Blue Mountain Capital, Ox, ZIF,
Speaker 2: and Goldman Sachs. And James, I can tell you you're
Speaker 2: already itching to ask a question.
Speaker 1: Thanks David. Great to see you, Snalie. Private credit is
Speaker 1: going through a shakeout after years of stellar growth. Fears
Speaker 1: of software debt defaults, redemptions, from retail funds and bad
Speaker 1: loan marks are just some of the concerns about an
Speaker 1: asset class that expanded very quickly into a multi trillion
Speaker 1: dollar market. Wellington is well known for its participation in
Speaker 1: liquid public credit. You're now pushing into private markets. Why now,
Speaker 1: what's the pitch?
Speaker 3: That is a loaded question, James, So, I guess you're
Speaker 3: starting off and the gloves are already coming.
Speaker 2: Off to James does.
Speaker 3: I often like to say my partner in this business,
Speaker 3: Emily Banister, and I probably have one of the best
Speaker 3: and hardest jobs in private credit today, you know, standing
Speaker 3: up a newer platform and launching products. Quite frankly, it's
Speaker 3: not without its challenges. It does require a firm like
Speaker 3: Wellington to be really deliberate and be really thought full.
Speaker 3: And I think you've alluded to this right. There's been
Speaker 3: a lot of sensationalization in the headlines, but if you
Speaker 3: take a step back, we're actually really excited because private
Speaker 3: credit is not this monolith that everyone reduces down to
Speaker 3: corporate direct lending or where the headlines are. You know,
Speaker 3: from our view, a lot of the baby is getting
Speaker 3: thrown out with the bathwater, and if you can opportunistically
Speaker 3: lean in and we can. We don't have the overhang
Speaker 3: of of kind of priors that many of our peers do.
Speaker 3: We think it's a really interesting time to get into
Speaker 3: these markets and find niches and happy to talk about
Speaker 3: sort of how we're thinking about the build. But I
Speaker 3: think the philosophy, the ethos for Wellington is very much
Speaker 3: anchored in the same way that we've built many businesses
Speaker 3: at the firm.
Speaker 2: Well, why don't we level set just so you know,
Speaker 2: because I think private credit means different things to different people.
Speaker 2: There's direct lending, and there's there's all. You know, it's
Speaker 2: just an enormous ego system. It's much larger than the
Speaker 2: two trillion dollar plus direct lending business. It extends into
Speaker 2: into asset based funding, high grade private credit. So level
Speaker 2: setting from the Wellington perspective, kind of what does your
Speaker 2: universe a private credit entail? And where are you seeing
Speaker 2: sort of the most interesting areas of growth or opportunity.
Speaker 3: I mean that is the question, right, David, You're exactly right.
Speaker 3: Private credit today is what we view as a forty
Speaker 3: trillion plus ecosystem, right, and the headlines are often very
Speaker 3: focused on the corporate segment, which is about two trillion
Speaker 3: dollars of that overall forty trillion dollars.
Speaker 2: And then even more focused on private BDCs.
Speaker 3: Right now, correct, right, which is about a quarter right
Speaker 3: of the of the overall exposure in that universe. And
Speaker 3: so you really do need to peel back the layers
Speaker 3: of that onion and say, Okay, what is it that
Speaker 3: we're talking about. And so for for Wellington, our build
Speaker 3: has really been focused, I'll say, in areas that check
Speaker 3: four boxes for us, and I'm happy to talk about
Speaker 3: the areas that are that are most interesting, but those
Speaker 3: four boxes have and will continue to be first and foremost,
Speaker 3: what do our clients need?
Speaker 1: Right?
Speaker 3: We are a client driven business at the end of
Speaker 3: the day, and so we need to be able to
Speaker 3: provide solutions that are more integrated across public and private markets.
Speaker 3: That is what the market is demanding. But we need
Speaker 3: to be selective about where we build, and so that
Speaker 3: build for us really looks at I'll say two big
Speaker 3: picture items. One where is the market going? And I
Speaker 3: think what's critical for private credit investors to understand today
Speaker 3: is yesterday's returns or not tomorrow's returns. And really looking
Speaker 3: for pockets of the market where the opportunity for private
Speaker 3: capital is opening up and not shrinking in. And that
Speaker 3: might be structural reasons, such as you know, the banks
Speaker 3: continue to rebalance and reallocate in areas like commer real estate.
Speaker 3: It may be reasons that there's just not enough financing
Speaker 3: in traditional markets for the complexity that issuers are looking for.
Speaker 3: So that's critical. I'll say that the other piece that's
Speaker 3: critical for us is where do we have a right
Speaker 3: to win. I don't think as a manager standing up
Speaker 3: a business in twenty twenty six, you can be all
Speaker 3: things to all people, and so we really think long
Speaker 3: and hard about where that intersection between public and private
Speaker 3: markets can create some sort of edge or mote for
Speaker 3: our clients in what we deliver and where we can
Speaker 3: supplement that expertise with At the end of the day,
Speaker 3: individuals that we bring in from the outside, that are
Speaker 3: cycle tested, that know what it is to originate and
Speaker 3: underwrite in private markets. We cannot forget that investing in
Speaker 3: private markets is not the same as investing in public markets, certainly,
Speaker 3: but when you can combine those two things, I think
Speaker 3: you can view the world from a more relative value
Speaker 3: perspective and maybe not fall into some of the fallacies
Speaker 3: of following the herd into what looks like the newest
Speaker 3: and shiniest toy.
Speaker 2: And when you talk about your clients and your client needs,
Speaker 2: just what you know obviously without naming names. Who are
Speaker 2: your clients? You know? And something that sort of comes
Speaker 2: is very important as part of this sort of build
Speaker 2: out of private credit is the liquidity expectations that your
Speaker 2: clients have.
Speaker 3: For sure, I think at Wellington overall our clients are
Speaker 3: pretty much mixed fifty to fifty between institutional clients, so
Speaker 3: think pension funds, sovereign wealth funds, nonprofit type investors, as
Speaker 3: well as the retail side of the business, the individual
Speaker 3: investor right, whether that be through some of the largest
Speaker 3: bank intermediaries or registered investment advisors. And David, I think
Speaker 3: you're hitting the nail on the head right when it
Speaker 3: comes to product developlopment and the mechanisms by which private
Speaker 3: credit will be transcribed into markets and buyers, which is
Speaker 3: the product development that I certainly and my team work
Speaker 3: on for institutional investors is a slightly different delivery than
Speaker 3: maybe with the wealth audience is seeking. Both are focused
Speaker 3: on yield. Both obviously care a lot about fundamental credit underwriting,
Speaker 3: and we can talk about that in terms of where
Speaker 3: the market is going, but how you deliver those and
Speaker 3: the expectation management of liquidity is of paramount importance. And
Speaker 3: I think two things can be true, right, the demand
Speaker 3: for wealth products for alternatives, right, This democratization of alts
Speaker 3: that everyone keeps talking about can and will continue. And
Speaker 3: at the same time, how we manage credit risk and
Speaker 3: liquidity risk still likely needs to evolve visa via the
Speaker 3: expectations of that market, which is what I think you're
Speaker 3: ultimately getting at. And that doesn't come down to the
Speaker 3: fact that these structures are bad. Right. The business development
Speaker 3: company is the interval funds, right that have these liquidity
Speaker 3: gates in place. That's not necessarily a negative. I think
Speaker 3: a big part of this equation is the education that's
Speaker 3: going to be needed and managing expectations and also recognizing
Speaker 3: that portfolio management the people you hire to manage these things.
Speaker 3: It's not just about underwriting credit risk. You have to
Speaker 3: be able to manage liquidity and have that skill set.
Speaker 1: I'm interested in digging a bit more into what you
Speaker 1: describe as the full areas of most interests right now
Speaker 1: that comes from your clients needs your clients' demands in
Speaker 1: terms of what they want to get into. But investment
Speaker 1: grade private, commercial, real estate, structured, and growth lending. Those
Speaker 1: are four start with investment grade private. And you know,
Speaker 1: a question that often comes up when we look at
Speaker 1: public against private in that context is that there is
Speaker 1: an incredibly efficient investment grade bond market that is doing
Speaker 1: very well at funding you know, very large size, very
Speaker 1: very tight spreads. So if you're coming to an issue
Speaker 1: a borrower with a private option, then how is that
Speaker 1: better than just going to the you know, investment grade
Speaker 1: bond market.
Speaker 3: Well, I think James, you're hitting on maybe one of
Speaker 3: the fallacies that we need to break down today. Right,
Speaker 3: It's I don't think the market is any longer about
Speaker 3: private credit competing with public markets, Right. It's one interconnected ecosystem,
Speaker 3: and so I don't think that's what the future is. Right.
Speaker 3: It's borrowers are increasingly able to choose a variety of financing, Right,
Speaker 3: They're able to choose between banks, the public bond market,
Speaker 3: private credit markets all at the same time, Right, And
Speaker 3: having that perspective across those markets think is really valuable,
Speaker 3: and ultimately the choice of which market you want to
Speaker 3: use to finance a project or your company is going
Speaker 3: to be based on I think more factors than just
Speaker 3: pricing right where historically right banks public credit markets might
Speaker 3: have the tightest spreads or the most attractive pricing. Borrowers
Speaker 3: care about flexibility, borrows care about structuring. Oftentimes, investment grade
Speaker 3: private credit borrowers, large multinational corporations might be pursuing an
Speaker 3: m and a transaction that they do not want the
Speaker 3: public to know about, right, they want to finance it quietly,
Speaker 3: and so they'll use the investment grade private credit markets
Speaker 3: to do so. You're seeing more and more project finance
Speaker 3: get done through the investment grade private market, right, these
Speaker 3: these private placements or for a two type of deals.
Speaker 3: And I think that is both a recognition that borrowers
Speaker 3: have had that the ways in which they finance their
Speaker 3: businesses in the past, whether for liquidity reasons or broader
Speaker 3: macro reasons like post COVID World is a great example
Speaker 3: of that those markets may not always be open to them.
Speaker 3: There's just talking to a portfolio manager earlier today who's
Speaker 3: been investing in securitizations of auto loans and some of
Speaker 3: these issuers who have very limited balance sheet, so therefore
Speaker 3: need to sell their loans into the market historically use
Speaker 3: the structured products markets. In COVID, that liquidity wasn't there, right,
Speaker 3: but they still needed to move that risk off their
Speaker 3: balance sheet. They don't have the depth of balance sheet
Speaker 3: to hold on to that type of risk, and so
Speaker 3: they're increasingly looking to the investment grade private debt market.
Speaker 3: They're increasingly looking to private credit managers to take on
Speaker 3: some of that whole loan origination, right, So they want
Speaker 3: to work with folks or work across lender through the
Speaker 3: liquidity spectrum and then from everything from private to public.
Speaker 3: And I think James, you and I have talked in
Speaker 3: the past about AI right as a big theme and
Speaker 3: data centers. Ten years ago, you probably would have just
Speaker 3: gone to a bank and done that deal by yourself,
Speaker 3: right with a banking institution. Today the banks are financing
Speaker 3: data centers. Investment grade is financing data centers, Infra managers
Speaker 3: or financing data centers. Our commercial real estate guys are
Speaker 3: seeing the construction loans come up. So there's many ways
Speaker 3: in which you're going to finance that ecosystem.
Speaker 2: When you get involved in one of the financings for
Speaker 2: one of these large you know, sort of investment grade
Speaker 2: type issues. How exactly does it work for you? Are
Speaker 2: you originating it or are you part of a syndicate,
Speaker 2: you know, sort of purchasing the club, purchasing the asset.
Speaker 3: So it really depends on what project or asset we're financing.
Speaker 3: So our commercial real estate debt teams as an example,
Speaker 3: which play across sort of on an un levered basis
Speaker 3: what i'll call investment grade like risk, and on a
Speaker 3: levered basis some of that higher yielding risk that's more
Speaker 3: traditional and private credit markets. If they're seeing a data
Speaker 3: center construction loan as an example, oftentimes they are either
Speaker 3: a sole lender or in a very very small group
Speaker 3: of lenders. But having control in those situations is really important,
Speaker 3: So you want to have a significant piece of that
Speaker 3: in some of the more broadly I'll say broadly syndicated
Speaker 3: is the wrong word. But in some of those deals
Speaker 3: that are negotiated off market, where you have multiple players,
Speaker 3: as our IG team often will see, they might be
Speaker 3: not a controlling investor, but a significant investor. And what
Speaker 3: we like about the private investment grade markets is whether
Speaker 3: you're one of the first to show up or you
Speaker 3: come in later on as the syndicate is being formed.
Speaker 3: In those markets, you still have influence your respective of
Speaker 3: your size of structure. And I think when it comes
Speaker 3: to private credit, some of the best protection that you
Speaker 3: get as an investor is in structuring right and really
Speaker 3: getting the deal mechanics and the underwriting right that saves
Speaker 3: you ninety percent of the time in the future when
Speaker 3: things go awry, which inevitably they will, structure and underwrite
Speaker 3: is always first. David and I think whether we're investing
Speaker 3: in investment grade markets, or we're in commercial real estate markets,
Speaker 3: or we're in the COLO markets, we spend a lot
Speaker 3: of time understanding the idiosyncratic risk and then ensuring that
Speaker 3: the structures that we've put in place have the proper
Speaker 3: covenants and protections in place so that if things go sideways,
Speaker 3: we have remedy and we have an ability to work
Speaker 3: through it.
Speaker 1: How does that relate to the current AI data centers
Speaker 1: you're seeing.
Speaker 3: Yeah, I think this is probably one of the areas
Speaker 3: where we will generally agree with the market that this
Speaker 3: is a multi year secular theme, but probably an area
Speaker 3: from a real estate lens as an example, where we're
Speaker 3: less excited maybe relative to other parts of the market
Speaker 3: where that AI theme is continuing to make its way through.
Speaker 3: So in data centers specifically, our real estate team sees
Speaker 3: a lot of the construction lending type opportunities and they
Speaker 3: were an early investor in that space four or five
Speaker 3: years ago, and at that time, spreads were kind of
Speaker 3: in the four hundred plus basis point range. Financing levels
Speaker 3: were very moderate, right, so these were modest levered, know,
Speaker 3: sixty seventy percent loan to value type opportunities. Today, when
Speaker 3: we look at that space, advance rates have gone up, right,
Speaker 3: so there's a lot more leverage ninety percent in some cases,
Speaker 3: and spreads have compressed about two hundred basis points, and
Speaker 3: so when we think about that risk that we're taking
Speaker 3: relative to their return, it's a little less exciting today.
Speaker 3: That doesn't mean all data center construction is off the table.
Speaker 3: What that means for us is that the team, as
Speaker 3: they always have, thinks a lot about the location of
Speaker 3: the data center, access to power. We think a lot
Speaker 3: about sort of the less ye and what the terms
Speaker 3: of those leases are and how long that lease term
Speaker 3: is visa vis the loan, and then importantly, what our
Speaker 3: team has been very focused on lately, is terminal value exit?
Speaker 3: Right if the existing lessee or the tenant that's supposed
Speaker 3: to come in up in leaves, which they can, and
Speaker 3: and we're seeing that in structure, is what is the
Speaker 3: value of that real estate? Is it easy for somebody
Speaker 3: else to come in and take that over or is
Speaker 3: it going to be really difficult because that data center
Speaker 3: was built in a remote area where there's not a
Speaker 3: tremendous amount of demand. So we think a lot about
Speaker 3: that replacement value when evaluating data centers in today. I'll
Speaker 3: say not every situation, but by and large it's a pass.
Speaker 3: We would rather play that AI theme and I'll stick
Speaker 3: to the real estate analogy, like the way we work,
Speaker 3: the way we live, the way we travel, the way
Speaker 3: we consume right, is all being upended by AI and
Speaker 3: by the transformation that's that's here to come from our
Speaker 3: seat that means real estate's going to have to be redesigned,
Speaker 3: it's going to be reimagined. We would rather invest and
Speaker 3: play the quote unquote AI theme through some of that
Speaker 3: transition that's about to take place and lean into where
Speaker 3: we see a lot of alignment between our borrowers and
Speaker 3: ourselves versus maybe getting the top of the iceberg. That
Speaker 3: being said, James, there is a place for data center
Speaker 3: credit in client portfolios, particularly if you're viewing it as
Speaker 3: a replacement to buying the corporate issuer as an example, right,
Speaker 3: and you're getting paid some incremental spread to take on
Speaker 3: Microsoft risk or Meta risk, and there is that relative
Speaker 3: value in fixing come portfolios. We've seen it, We're investing
Speaker 3: in it, but from a private credit lens, not our
Speaker 3: highest conviction opportunity. We like beds and sheds instead.
Speaker 1: There's no pressure to deploy just because it's Microsoft and
Speaker 1: you need to get in on all the other deals
Speaker 1: that are coming down from that. You don't feel that price.
Speaker 3: We don't feel that pressure. I think as a private
Speaker 3: credit investor, what we really pride ourselves on is in situations, right,
Speaker 3: these are relationship businesses, as many of these things are.
Speaker 3: Right when you're getting access to deals you're underwriting, being
Speaker 3: able to say no is actually a superpower, and I
Speaker 3: think people forget that. Our teams are quick to say
Speaker 3: this makes sense for the type of capital that we're running,
Speaker 3: or for the portfolio that we're building, and I think
Speaker 3: for many sponsors in this business, a quick not is
Speaker 3: actually as valuable as a yes, because you're building relationships
Speaker 3: for the long term. So not everything that a certain
Speaker 3: sponsor is going to originate is going to work for
Speaker 3: our pool of capital, and that's okay. They want to
Speaker 3: know that when you are there and you show up,
Speaker 3: that there is the ability to execute. There's the flexibility
Speaker 3: in the struct suring to work with the barrower to
Speaker 3: kind of meet the needs that they have and to
Speaker 3: do it quickly and to be there when when the
Speaker 3: opportunity arises and there is alignment. And so I think
Speaker 3: quick nos are just as good as quick yesses.
Speaker 1: But just on the AI theme, you know, it is
Speaker 1: a massive, multi trillion dollar funding effort that's going to
Speaker 1: go on for several years. We're already seeing pushback in
Speaker 1: the public markets always already some you know, bad trading
Speaker 1: in names like SpaceX, and that's worrying some people. But
Speaker 1: is there any sign of indigestion on the private side
Speaker 1: for all this AI funding that's going on.
Speaker 3: I think it depends on the pool of capital right
Speaker 3: there still seems to be you know, every time I'm
Speaker 3: out talking to various clients, there's certainly an eye towards
Speaker 3: I'll say, we've seen a lot more infrastructure allocations from
Speaker 3: the client side this year to buy into the long
Speaker 3: term theme. Ultimately, James like it, and I don't mean
Speaker 3: for this to be a cop out, right, but it's
Speaker 3: about aligning your expectations and your time horizon with the
Speaker 3: return right. And so I think for those that view
Speaker 3: this as sort of that core opportunity where you're going
Speaker 3: to get kind of mid single digit type returns, there's
Speaker 3: a lot of opportunity. And I don't think that you've
Speaker 3: seen the tissue rejection, but it's just recognizing it for
Speaker 3: what it is. Right, if you, as an allocator or
Speaker 3: an investor, say, look, I'm looking for my fifteen plus
Speaker 3: percent return, I'm not sure that you're going to get
Speaker 3: that from a data center loan today, given where the
Speaker 3: market is, and if you are or that is what
Speaker 3: one is promised, there's probably some other risk that's permeating
Speaker 3: in the system. So I don't think there's been any
Speaker 3: sort of oversaturation of the market. I think you're just
Speaker 3: seeing more segmented pools of capital for the various opportunities
Speaker 3: that are out there, and that's where we as investors
Speaker 3: need to be really disserting of am I getting compensated
Speaker 3: for the risks that I'm taking and for the time
Speaker 3: horizon upon which I'm investing.
Speaker 2: Yeah, I was going to ask what you've seen just
Speaker 2: from trend to wise on a year to date basis
Speaker 2: for spread premiums between private financings and public financings for
Speaker 2: high grade assets.
Speaker 3: For high grade assets, I think it certainly ebbs and flows.
Speaker 3: In the more syndicated parts of the market. I'm certainly
Speaker 3: still at a premium relative to history, but you can
Speaker 3: see things in the one hundred to two hundred basis
Speaker 3: point range. I think as you get out on the
Speaker 3: more risky, the heavier transitional side of the world in
Speaker 3: areas like real estate, that premium today is probably somewhere
Speaker 3: between two to four hundred basis points, depending on what
Speaker 3: part of the spectrum that you're playing on, and what.
Speaker 2: What is the risk premium compensating you for it. Is
Speaker 2: it all liquidity or is it complexity? Is it you know,
Speaker 2: like if I were an insurance life insurance company with
Speaker 2: sticky liabilities and you know, a pretty good actuarial level
Speaker 2: of certainty around how long they're going to stick around for,
Speaker 2: I should be waiving this in every.
Speaker 3: Day and some are, and they are right because I
Speaker 3: think they certainly see the opportunity and they have the
Speaker 3: duration of the capital didd To answer your question directly,
Speaker 3: it's all of the above, yeah, right, And and that's
Speaker 3: why I say there's an illiquidity premium and there's a
Speaker 3: complexity premia. I think we often think about them and aggregate, right,
Speaker 3: And many of our clients in this space when they
Speaker 3: think about private credit really are looking at what is
Speaker 3: the premium relative to public markets that I'm getting right.
Speaker 3: So oftentimes the quote unquote benchmark will be, you know,
Speaker 3: high yield or levered bank loans plus some spread of
Speaker 3: two three hundred basis points, and that's how you assess,
Speaker 3: am I getting compensated for that premia. Certainly the duration
Speaker 3: of these loans sort of on the short end can
Speaker 3: be three to five years. On the longer end, there's
Speaker 3: ten to twenty year paper out there as well, and
Speaker 3: so in the longer dated paper it might be more
Speaker 3: investment grade like in terms of the issuer, So your
Speaker 3: aggregate spread is not going to be huge. But in
Speaker 3: those instances, that's where you may see the premia actually
Speaker 3: be wider to the public market because you're taking on
Speaker 3: that additional illiquidity, and then on the complexity of the deal.
Speaker 3: There's multiple dimensions of that. There's the structuring. There's where
Speaker 3: in the capital stack, am I playing right, am I senior?
Speaker 3: Am I? In the mezzanine stack, am I in something
Speaker 3: that's cuspy that looks a little bit more like equity.
Speaker 3: The lower you go, the more you should, as extensibly
Speaker 3: get paid. But the interesting piece about capital flows is
Speaker 3: it doesn't always follow the logic. And some part of that.
Speaker 3: We've talked a lot about real estate. Our team invests
Speaker 3: in what we call transitional real estate, right, so real
Speaker 3: estate that is undergoing some sort of capital plan or
Speaker 3: leasing strategy, right, that's being quote unquote transitioned over time.
Speaker 3: And there's those things that are light, a lighter lift effectively,
Speaker 3: and then those things that are heavy. If you look
Speaker 3: at where spreads have come in, ironically, you should be
Speaker 3: compensated more for taking that heavier transitional risk. You're taking
Speaker 3: more operational risk, execution risk of the sponsor. That's where
Speaker 3: you've actually seen spreads compress a bit more today historically
Speaker 3: than even the lighter side, which again not that these
Speaker 3: things always equate to risk. It's more about how are
Speaker 3: you being compensated for the execution plan you're taking, And
Speaker 3: so in those markets today, we actually think you're being
Speaker 3: better financed from a leverage perspective as well as better
Speaker 3: compensated from a spread perspective to take the lighter transition.
Speaker 3: So that's where we would rather lean in, and I
Speaker 3: think that is purely a function of just capital flows.
Speaker 2: You've also written a fair amount about commercial real estate
Speaker 2: real estate assets at insurance companies. Maybe gain span on
Speaker 2: that a little bit. Why that match is so magical.
Speaker 3: Yes, So we do as a business work with a
Speaker 3: lot of different insurance companies and types of insurance companies.
Speaker 3: I think you know real estate as an asset class
Speaker 3: from their regulatory perspective, and the frameworks in which many
Speaker 3: of the US insurers operate often has positive capital treatment.
Speaker 3: It's an area where insurance companies themselves have been large investors,
Speaker 3: both on the equity side and on the debt side.
Speaker 3: They call CML commercial mortgage loan investing portfolios and so
Speaker 3: visa the other parts of private markets where you don't
Speaker 3: get the benefit of looking through to the underlying asset,
Speaker 3: and they often think of insurance companies often think about
Speaker 3: the risk in real estate very similar to the way
Speaker 3: that we're thinking about the risk, right, are you underwriting
Speaker 3: a core asset profile, a value add profile, and opportunistic profile,
Speaker 3: and their risk ratings actually scale up based on that
Speaker 3: underlying type. And so there's tremendous alignment both from a
Speaker 3: liability matching perspective as we think about the duration of
Speaker 3: many of these insurance companies' liabilities. I think there's a
Speaker 3: familiarity and there's a long standing financing history. Right when
Speaker 3: we look at the real estate markets here in the
Speaker 3: US six trillion dollar market, financing market actually bigger than
Speaker 3: corporate direct lending. Right, half of that has historically been
Speaker 3: financed by the banking sector. Insurance is the second largest
Speaker 3: sort of financier of commercial mortgage loans. So this is
Speaker 3: a business that they've been in for thirty plus years, right.
Speaker 3: They understand the risk, they understand the role it plays,
Speaker 3: and so relative to other parts of private markets for
Speaker 3: insurance companies, this is an area where I think they
Speaker 3: see the compensation for the illiquidity premia. It's capital efficient
Speaker 3: relative to parts of corporate credit, like high yield or
Speaker 3: bank loans that offer similar spreads or even lower spreads
Speaker 3: than what some of these loans are providing. It's senior
Speaker 3: in the capital structure. Right, So you're a first mortgage lender.
Speaker 3: It's like having the bank over the mortgage on your house. Right,
Speaker 3: that's the same thing that we're doing here on the
Speaker 3: commercial real estate side. And so it provides and it's
Speaker 3: a hard asset. Right, So when all is said and done,
Speaker 3: if things go sideways, there's a hard asset backing that loan.
Speaker 3: And I think in insurance companies think in those in
Speaker 3: those frameworks, and so this is a very efficient way.
Speaker 3: And oftentimes in the in the private fund structures, they
Speaker 3: do have the ability to look through to the underlying asset,
Speaker 3: which isn't always the case across all parts of private
Speaker 3: credit market.
Speaker 1: Right, is there a danger that some of these hard
Speaker 1: assets become obsolete or in the same way that you
Speaker 1: describe data centers, you know, and you mentioned the big
Speaker 1: shakeup coming from AI that you know, everything is changing
Speaker 1: the way we work and everything else is you know,
Speaker 1: in the world is supposed to be revolutionized by this
Speaker 1: technology that I have yet to see. Uh, But what
Speaker 1: is the long term outcome for commercial real estate? You know,
Speaker 1: if you get into an office that suddenly becomes redundant.
Speaker 3: Yes, I think all of those things, right. It's the
Speaker 3: reason why we've we've written a lot about this. It's
Speaker 3: the reason we like the transitional space. Right. Transition by
Speaker 3: virtue is investing in the thing that is changing. I
Speaker 3: often think the fallacies of those that look at commercial
Speaker 3: real estate markets is when you think of a core
Speaker 3: asset right, probably like this beautiful office that we're sitting
Speaker 3: in today, right, as always being resilient, right, or being
Speaker 3: the safest asset. But in many ways, if we think
Speaker 3: about the real estate life cycle from ground up all
Speaker 3: the way to core, those things that are the most
Speaker 3: what we call stabilized in this space often are the
Speaker 3: ones that are likely to move into obsolescence as their
Speaker 3: next phase if they are not invested in to maintain
Speaker 3: that value. And so absolutely, in real estate, not all
Speaker 3: real estate is created equal. COVID certainly taught us that.
Speaker 2: Now it's all about location. Right now, it's location location
Speaker 2: Like it's a very asset specific.
Speaker 3: Market specific, its assets specific. It is also you know
Speaker 3: there is some wreck. You just have to have a
Speaker 3: recognition and I think a healthy understanding the fact that
Speaker 3: things are going to change and so you are really
Speaker 3: underwriting loan by loan, zip code by zip code, asset
Speaker 3: type by asset type. That being said, there's like structural
Speaker 3: themes in the market that we think will transpire over
Speaker 3: the coming years. Right. I think James, you had somebody
Speaker 3: on your podcast recently that talked about the residential lending opportunity. Right.
Speaker 3: Housing in the United States is consistently and undersupply. Right,
Speaker 3: So if you have the ability to finance from our seat,
Speaker 3: like a multifamily a conversion, right. Of I know there's
Speaker 3: been some press around this recently here in New York,
Speaker 3: but of like office to multifamily, right, and you're underwriting
Speaker 3: the business plan well, and the safety measures and all
Speaker 3: of those things. Well, there is there is opportunity. Right.
Speaker 3: The other piece of this is right we say beds, Right,
Speaker 3: Beds continues to be an opportunity. Sheds is also the
Speaker 3: other opportunity with this this AI and digitization and the
Speaker 3: move to more of a digital economy, the need for
Speaker 3: cold storage, the need for I mean we all live
Speaker 3: in the Tristate area, Right, there's probably a time fifteen
Speaker 3: years ago, ten years ago, right, we all went to
Speaker 3: the grocery store, right, fresh Direct was still relatively nascent
Speaker 3: i venture. All of us in this room probably get
Speaker 3: some form of our goods digitally, right, and living in
Speaker 3: and around New York City, we need industrial space to
Speaker 3: house those goods. There's a lot of older industrial space
Speaker 3: that needs to be refit for what's needed today. And
Speaker 3: so in real estate, if you can lean into that innovation,
Speaker 3: you can lean into where the puck is going and
Speaker 3: most importantly, align yourself with the sponsor. Right. The biggest
Speaker 3: piece in lending from our standpoint is we don't want
Speaker 3: to take what our portfolio manager often likes to call
Speaker 3: kind of the pilot error. Right. You want to be
Speaker 3: in situations where the sponsor is putting money into a project,
Speaker 3: not taking money out of a project, and in that
Speaker 3: transitional space that's in the life cycle of real estate,
Speaker 3: that's where you have the optimal alignment. We would rather
Speaker 3: be there all day long than invest in some of
Speaker 3: these like melting ice cubes of assets that likely will
Speaker 3: need more work but may not have the proper alignment
Speaker 3: to ensure that that asset's dealt with properly.
Speaker 1: So you're lending pretty short turned through some kind of
Speaker 1: development cycle.
Speaker 3: Correct, We're lending over three to five five years in
Speaker 3: many of these loans. So we have a line of
Speaker 3: sight it's a specific project that needs to be financed.
Speaker 3: We have a line of sight into what the sponsor
Speaker 3: is doing to get there, and then what the exit
Speaker 3: opportunity looks like versus the ten fifteen year type of lending,
Speaker 3: where I think there's a lot more that can be
Speaker 3: disrupted through what's happening right now.
Speaker 1: How are the returns in that space.
Speaker 3: They tend to be sort of on a I'll talk
Speaker 3: about it on like an unlevered and then a levered basis,
Speaker 3: because it is a levered levered approach. On an unlevered basis,
Speaker 3: you're probably getting compensated anywhere between two hundred and four
Speaker 3: hundred and fifty basis points today over pub over sofur.
Speaker 3: And then on a total return basis, these things tend
Speaker 3: to be I would say through cycle nine to twelve
Speaker 3: percent net. Well, we tend to think of the world
Speaker 3: an IRR terms net IRR. But I think importantly, because
Speaker 3: you're senior in the capital structure and this is an
Speaker 3: income driven strategy, you're getting paid income and interest throughout
Speaker 3: the life of your loan. Right there's none of the
Speaker 3: pick and things that we've seen elsewhere. So you're actually
Speaker 3: getting your interest payments. They're capitalized as part of the
Speaker 3: loan structures themselves, and so you're getting income distributions somewhere
Speaker 3: in that kind of like ten to twelve percent range.
Speaker 1: Something that has been historical. And we'll say, you think
Speaker 1: it will continue in terms if they were telling you'll.
Speaker 3: Get I think, you know, we talked about this before, right,
Speaker 3: I think it's going to EBB and flow. Today we
Speaker 3: are certainly continuing to see value. And then the other
Speaker 3: piece of this is, you know, the financing markets for
Speaker 3: this type of asset have certainly been quite constructive, this.
Speaker 2: Type of asset being a transitional property correct.
Speaker 3: And so you know, this is an area where we
Speaker 3: know we talk about the banks. You know, I think
Speaker 3: so much of the private credit story historically has been
Speaker 3: anchored in this retrenchment of financial institutions and banks. Right
Speaker 3: the banks are retrenching, they're regulatory costs, regulatory costs, et cetera,
Speaker 3: et cetera. Banks are not retrenching from commercial real estate market.
Speaker 3: They're becoming more selective about where they want to lend
Speaker 3: directly into projects and then where they want to finance
Speaker 3: managers like ourselves in these markets, and so.
Speaker 2: They're not going to be providing the long term.
Speaker 3: Capital and I don't know. And in certain projects, yes, right,
Speaker 3: And you've certainly seen them be active in areas like
Speaker 3: data centers and some of that infrastructure built. So I
Speaker 3: think they're going to be part of the long term
Speaker 3: capital solution. But in certain areas like transitional lending space,
Speaker 3: it's not very efficient. It's not an efficient use of
Speaker 3: their capital. The more efficient use of their capital, or
Speaker 3: they're the higher roe of that capital, is to be
Speaker 3: a back leverage provider, as an example to private credit managers,
Speaker 3: and so they would prefer to take that risk in
Speaker 3: this part of the asset type and then put those
Speaker 3: dollars elsewhere. So we often like to say banks are
Speaker 3: rebalancing and reallocating their balance sheet. They're not retrenching from
Speaker 3: the market. And that's a dynamic that's going to continue,
Speaker 3: we think for certainly for the secular horizon. And so
Speaker 3: when you have a more favorable financing environment and you
Speaker 3: have assets that we think are a bit more resilient,
Speaker 3: that combination I think today is creating a stable return profile.
Speaker 3: But subsectors of the market will continue to EBB and
Speaker 3: flow heavy transitional versus light office, multifamily, you know, industrial,
Speaker 3: so on and so forth, Like we would tell you
Speaker 3: office is troughed a lot. Yeah, Does that mean we're
Speaker 3: running back to be lenders into to office. Absolutely not.
Speaker 3: We joke around the desk that for us to finance
Speaker 3: an office deal today, it needs to check seven out
Speaker 3: of four boxes, right. And that comes back to your
Speaker 3: question on the illiquidity premium, right, which means for one
Speaker 3: hundred basis points of incremental spread, that's probably not a
Speaker 3: risk that's worth taking given all the disruption that's happening
Speaker 3: in the market. But if being compensated and you're in
Speaker 3: a class A location you have inelastic tenant demand, those
Speaker 3: might be interesting on a selective basis, but it's not
Speaker 3: an all.
Speaker 2: It's such that the office is such an asset specific industry.
Speaker 2: Like we're sitting here speaking right now on Lexington Avenue,
Speaker 2: and if you go west from here towards Park and
Speaker 2: Fifth Avenue, that's a vibrant, high quality market from a
Speaker 2: tenant perspective, from a property perspective, And when you go
Speaker 2: east of here, some of those properties exist, but they're
Speaker 2: fewer and further between and some of those properties are
Speaker 2: absolutely positively have to be transitional properties.
Speaker 3: Correct, And that comes back to like what's going to
Speaker 3: do well right, it's if you have well amenditized offerings,
Speaker 3: you have modern buildings. Our offices are just outside of
Speaker 3: Union Square, were between kind of n y U and
Speaker 3: Union Square in a really fantastic building. There's a lot
Speaker 3: of vibrancy, are more and more innovation coming through right
Speaker 3: with like the Google rests shop, good everything, great way
Speaker 3: to recruit right up and coming talent.
Speaker 2: Jazz.
Speaker 3: It's fantastic. So it's like you said, location, location, location,
Speaker 3: you have to really understand, right. We were never big
Speaker 3: investors or our team was never big investors in like
Speaker 3: Class B office and you know these big office park
Speaker 3: type locations, and so real estate is super interesting. We
Speaker 3: probably spend the whole time talking about it, but it
Speaker 3: ultimately comes down to the right property at the right
Speaker 3: financing costs and with what we hope is optimal alignment
Speaker 3: with the borrower. And in those scenarios you end up
Speaker 3: creating we call bend not break profiles. So you need
Speaker 3: structures that bend but that don't break. And importantly, what
Speaker 3: we don't want to take is that pilot air mechanical
Speaker 3: error is going to happen, COVID's going to happen, rates
Speaker 3: are going to go up. You can't plan for those things,
Speaker 3: so you want structures that can be resilient to those things.
Speaker 3: But what you don't want to take is that individual
Speaker 3: pilot risk.
Speaker 1: So for the year ahead, Sonati, when you look at everything,
Speaker 1: you get the privilege to be surveying around the world,
Speaker 1: this forty trillion dollar market, what are you most excited
Speaker 1: about in terms of relative value?
Speaker 3: So we talked about a lot of it. We are
Speaker 3: most excited about that continued convergence across public and private
Speaker 3: markets and being able to play at that intersection, whether
Speaker 3: that's in the investment grade market or the commercial real
Speaker 3: estate markets that we've talked at length about, even in
Speaker 3: pockets of the structured products market, which I think are
Speaker 3: sort of the hallmark of that convergence. I think there's
Speaker 3: going to be continued opportunity there. The themes of AI
Speaker 3: and disruption are going to be investable for multiple years
Speaker 3: to come. And this is an exciting time because I
Speaker 3: think you can still pick and choose what parts of
Speaker 3: the market you want to lean into that theme In
Speaker 3: and we've talked a ton about commercial real estate. I
Speaker 3: think that is probably one of the most exciting and
Speaker 3: compelling parts of the market today.
Speaker 1: Bets and sheds, beds and.
Speaker 3: Sheds continue to like it. I also think over time
Speaker 3: right asset based finance markets are have and continue to
Speaker 3: be interesting. Those with hard assets, I think are from
Speaker 3: the seats that we sit in. I think can be
Speaker 3: underwritten in a more holistic way and I think provide
Speaker 3: a bit more a bit more resilience. And then I
Speaker 3: also like the benefit of patients at moments like these,
Speaker 3: where you're at sort of crossroads and there's a lot
Speaker 3: of noise, if you can just take a step back
Speaker 3: and say, Okay, how are we going to go back
Speaker 3: to basics? Right, like what do we do best underwrite
Speaker 3: fundamental credit? If you can kind of stick to that
Speaker 3: true north, if you can stick to sort of as
Speaker 3: a wellington for us, where is our greatest value? Our
Speaker 3: greatest value is being able to evaluate that full picture,
Speaker 3: knowing what's happening in public markets, understanding what's happening in
Speaker 3: private markets, and being patient in terms of where we
Speaker 3: lean in and really building conviction on the market opportunity.
Speaker 3: I think we'll serve us and our clients well over
Speaker 3: the long term.
Speaker 2: Is it just US?
Speaker 3: No?
Speaker 1: Where do you think outside the US is a good
Speaker 1: opportunity for private credit?
Speaker 3: So I would say our business primarily has focused on
Speaker 3: the US, certainly because of the deepest markets. Certainly there's
Speaker 3: going to be more to be done in places like Europe,
Speaker 3: and I think you're seeing that pan out in terms
Speaker 3: of both capital flows and where managers are continuing to
Speaker 3: build capabilities. That infrastructure need I think is going to
Speaker 3: be just as significant over there as it is here.
Speaker 3: I think the Asian markets are interesting, but have historically
Speaker 3: been very dominated in many countries by the banks and
Speaker 3: by traditional lenders, and so I think we have to
Speaker 3: wait and see a little bit more. And by the way,
Speaker 3: I think that's where we really need boots on the
Speaker 3: ground to understand local markets, regional nuances. But it's a
Speaker 3: market to continue watching because there's so much growth coming
Speaker 3: out of some of those countries and infrastructure need infrastructure
Speaker 3: build that will happen over time. So this is both
Speaker 3: a global phenomenon as well as i'll say a broader
Speaker 3: asset class one and I think sitting inside of a
Speaker 3: one point three trillion dollar organization. Is that there's no
Speaker 3: shortage of research or data that comes through on a
Speaker 3: day to day basis for us to make what I
Speaker 3: hope are informed decisions. Not always going to get it right,
Speaker 3: It's not always going to be perfect, but what I
Speaker 3: do hope it allows us to do is put that
Speaker 3: keen eye on relative value.
Speaker 1: What do you worry about? Though? I mean, there's so much.
Speaker 1: As we started the conversation, you call it a loaded question,
Speaker 1: but there are lots of things, as credit people that
Speaker 1: we worry about. You know, when you mentioned convergence, people
Speaker 1: immediately assume that just means worse returns. But what do
Speaker 1: you think about in terms of the credit risks in
Speaker 1: terms of the IG private credit market.
Speaker 3: Yeah, well, I look, I think the risks are As
Speaker 3: credit investors, you're always thinking about the idiosyncratic risks, Right,
Speaker 3: what did I miss? What are we what are we
Speaker 3: going to get wrong? Then that's true for the IG
Speaker 3: markets or or the higher yielding markets. I think at
Speaker 3: this point in the cycle, I do worry about just
Speaker 3: the broad I'll say of a few things, one is
Speaker 3: the YEP. There's been a tremendous amount of headlines and
Speaker 3: those don't seem to be abating. I would say what
Speaker 3: that's translated into and the BDC market is right a
Speaker 3: liquidity driven issue. There can be moments in time where
Speaker 3: liquidity issues become credit issues, and I think we have
Speaker 3: to watch that very closely. We don't have direct exposure
Speaker 3: to it, but certainly we invest in and around the
Speaker 3: ecosystem of these companies. So I think that's something that
Speaker 3: we're continuing to watch. I think that is a lot
Speaker 3: of capital that has been formed around this broad private
Speaker 3: credit opportunity, and we want to ensure that we're level
Speaker 3: setting our expectations in terms of what these markets can
Speaker 3: deliver when there is so much capital in these ecosystems.
Speaker 3: And so I think we consistently have honest conversations around
Speaker 3: where is that iliquidity premia? Right? Are we being compensated
Speaker 3: and have return expectations changed for the short term or
Speaker 3: really structurally are going to be different over the long term.
Speaker 3: And so that's certainly something that again we're just continuing
Speaker 3: to watch. And then I think it's it's the fundamentals.
Speaker 2: Right.
Speaker 3: If I ask any of our pms, like what's keeping
Speaker 3: you up up at night? Right, it's the deals themselves
Speaker 3: and making sure that you've turned over every rock, you've
Speaker 3: assessed the risks. And then we're in the risk taking
Speaker 3: business right at the end of the day, and you
Speaker 3: want to take calculated risks and those that are that
Speaker 3: are well thought out. So that's certainly something we think
Speaker 3: a lot about. And then in my seat, I think
Speaker 3: about what am I missing, Like, what haven't I what
Speaker 3: are what are the what are the things I haven't
Speaker 3: thought about as this market continues to grow and evolve,
Speaker 3: and are there places we should be thinking about building
Speaker 3: or leaning in? And so that leads me to just
Speaker 3: ensure that I'm having as many conversations as I can,
Speaker 3: asking questions like maintaining that growth mindset to ensure we're
Speaker 3: bringing good information back to the organization.
Speaker 1: Great stuff, it's Nightlie Wilson with Wellington Management. Thank you
Speaker 1: so much for joining us on the credit edge.
Speaker 3: Thank you so much for having me, and of course.
Speaker 1: Very grateful to David Havens the Bloombok Intelligence.
Speaker 2: Thank you very much, Absolutely my pleasure for.
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