Speaker 1: Hello, and welcome to The Credit Edge, a weekly markets podcast.
Speaker 1: My name is James Crombie. I'm a senior editor at Bloomberg.
Speaker 1: This week, we're very pleased to welcome Simon Drake Brockman,
Speaker 1: co founder and managing partner of Pemberton, a London based
Speaker 1: private credit manager.
Speaker 2: How are you, Simon, I'm great, Thanks, James.
Speaker 1: Great to have you on the show. We're very excited
Speaker 1: to hear your credit market views. Also delighted to welcome
Speaker 1: back co host Juruon Julius from Bloomberg Intelligence. Hello are
Speaker 1: you run? Hi James, and join us from Bloomberg News.
Speaker 1: Silas Brown, our private debt expert in London. Great to
Speaker 1: see you again, Silas. How's it going.
Speaker 3: I'm doing very well, Thanks James.
Speaker 2: Great.
Speaker 1: Okay, So, just to set the scene at the top pier,
Speaker 1: credit markets are hot. Borrows a globally art taking advantage.
Speaker 1: This month could set a record for debt issuance by
Speaker 1: US companies and banks. Most of it is for refinancing.
Speaker 1: There's a lot of debt coming that means more cash
Speaker 1: returning to investors who have already received a ton of
Speaker 1: inflow over the past year and are very keen to
Speaker 1: buy Given how high all in yields are. You can
Speaker 1: get almost five and a half percent right now on
Speaker 1: US high grade publicly traded corporate bonds with a very
Speaker 1: low chance of default. That's the highest in six months,
Speaker 1: and it makes you wonder why you need to venture
Speaker 1: into private markets or leave the US at all to
Speaker 1: get good returns in credit. But there's not enough supply,
Speaker 1: so investors are having to look elsewhere. Structured finance and
Speaker 1: private debt are very popular and spreads are higher outside
Speaker 1: of the US. Some people fear that the demand supply
Speaker 1: and balance is also leading to complacency and mispricing of
Speaker 1: risk throughout credit markets, which is only expected to get
Speaker 1: worse in twenty twenty five. Is more money piles in. Meanwhile,
Speaker 1: everyone's loaded up on assets in the US, which is
Speaker 1: growing faster than other parts of the world and expected
Speaker 1: to get a boost from a new market friendly administration. Europe,
Speaker 1: by contrast, faces multiple economic and political challenges which make
Speaker 1: global debt investors very nervous. In some private debt is hot, Europe.
Speaker 3: Not so much.
Speaker 1: But what's your view, sigmon, Are we being too negative
Speaker 1: on Europe? What's the opportunity as you see it?
Speaker 2: Yeah, I think James. You know, most people look at
Speaker 2: the headline numbers in Europe and question, you know, the
Speaker 2: growth and sometimes the politics in that space. But I
Speaker 2: think if you actually get down into the numbers of
Speaker 2: what's going on inside of Europe, it's quite an exciting story.
Speaker 2: Europe is going through sector consolidation in the mid market,
Speaker 2: which is probably twenty maybe thirty years behind the United States,
Speaker 2: and what it's doing is it's starting to bring together
Speaker 2: a group of companies in different parts of the market
Speaker 2: to build large pan European champions And if you look
Speaker 2: at the opportunity set that creates, there's growth through both
Speaker 2: synergies are bringing these companies together, and there's growth through
Speaker 2: client acquisition. So these companies in five maybe ten years
Speaker 2: time are going to look very very similar to the
Speaker 2: US companies with billion to three billion turnover in that space.
Speaker 2: Do that you need to bringing them together and building
Speaker 2: an interesting Pan European platform, and I think that's where
Speaker 2: private equity sees a great opportunity. They're bringing a lot
Speaker 2: of money in and I think if you then look
Speaker 2: at the returns that we can offer inside of Europe,
Speaker 2: you're getting you know, as you touch on at the beginning,
Speaker 2: wider margins, better documentation and covenance inside the deals, and
Speaker 2: larger upfront fees. And that's driven by the fact that
Speaker 2: the demand for financing is greater than the actual capital
Speaker 2: available today because of the changes that are going on
Speaker 2: in the banking industry. So I think super positive tailwinds
Speaker 2: for the industry inside of Europe, and I think a
Speaker 2: very very attractive investment environment for investors.
Speaker 3: For direct lending, fund managers, people who haven't yet launched
Speaker 3: private debt strategies in Europe.
Speaker 2: Is it too late for them now?
Speaker 3: Are the incumbents too far ahead, too scaled, two staffed
Speaker 3: up already, those fledgling firms too far behind.
Speaker 2: It's good questions, Elis. You know, certainly if you want
Speaker 2: to be a very niche, niche player, you know, I
Speaker 2: think the opportunity set still there. But I think Europe
Speaker 2: has already got a number, you know, probably ten of
Speaker 2: us who have large scale platforms. You know, we have
Speaker 2: ten offices across Europe, two hundred people focused on originating
Speaker 2: and investing in these opportunities. And I think that scale
Speaker 2: servicing two hundred plus private equity firms really creates a
Speaker 2: massive competitive advantage, and Europe is a different market to
Speaker 2: the US. You know, it's important to be in Germany,
Speaker 2: it's important to be in France, Italy, explain etc. Where
Speaker 2: we are, and I think having local nationals on the
Speaker 2: ground really is a competitive advantage to sourcing transactions and
Speaker 2: building that deal flow and in credit, the most important
Speaker 2: thing is you've got to have a big pipeline of
Speaker 2: opportunities so you can pick the ones that you really
Speaker 2: want to do. And I think most people starting from scratch,
Speaker 2: that's an awful lot of infrastructure you've got to put
Speaker 2: in place to try to catch up with a group
Speaker 2: of us.
Speaker 3: So if you were, if you were kind enough to
Speaker 3: offer advice to appear, would you say it's too late
Speaker 3: to join the party?
Speaker 2: You know, you can never say it's too late, but
Speaker 2: you know, and you know, we've seen in the banking
Speaker 2: industry people come in and build platforms. But what I
Speaker 2: would say is, if you're going to do it, you
Speaker 2: need to really have the investment capital to put boots
Speaker 2: on the ground and have a scalable platform. I don't
Speaker 2: think you can come into this industry today with half
Speaker 2: a dozen people and say I'm going to build a
Speaker 2: platform because I think you're competing with true scale with
Speaker 2: the rest.
Speaker 3: Of us, and you touch on the dispersion in terms
Speaker 3: of scale. Are we also starting to see dispersion in
Speaker 3: terms of performance?
Speaker 4: We've been through COVID, We've been through are we're going through.
Speaker 3: A prolonged period of high interest rates and people's portfolios
Speaker 3: have been tested arguably for the first time in European
Speaker 3: direct lending kind of writ large, are you going to
Speaker 3: see a dispersion in performance? And also attached to that,
Speaker 3: how flight are your investors? Do they move from fund
Speaker 3: manager to fund manager depending on performance?
Speaker 2: Yeah? I mean the industry has now been going for
Speaker 2: ten plus years inside of Europe, so people have an
Speaker 2: ability to really look back over a period of time
Speaker 2: and look at the type of businesses, the performance of
Speaker 2: those businesses, how the managers have managed with a fairly
Speaker 2: volatile environment since twenty twenty with COVID and inflation and
Speaker 2: price increases and all of that. So there is definitely,
Speaker 2: you know, a reordering of in people's minds of who
Speaker 2: are the ones the managers they want to work with.
Speaker 2: And you know, I think there's been a number of
Speaker 2: managers inside of Europe whose businesses haven't gone as well
Speaker 2: as they would like over the last three or four years.
Speaker 2: But I think if you look at it fundamentally as
Speaker 2: an asset class, I think it's been incredibly robust. And
Speaker 2: I think if you talk to LPs, even the managers
Speaker 2: that they feel haven't done as well, the returns are
Speaker 2: still positive, maybe not as positive as they want, but
Speaker 2: still significant and certainly still probably better than fixed income.
Speaker 2: So you know, I think we've gone through a fascinating
Speaker 2: period of really validating an asset class. And people often
Speaker 2: say to me, has it been tested? And you know,
Speaker 2: if you go back, I mean, when was the last
Speaker 2: time you had inflation at ten percent? Interest rates go
Speaker 2: up four hundred basis points, and you know, salaries and
Speaker 2: other inflationary products going through as well as a energy
Speaker 2: crisis all hit at the same time. And you know
Speaker 2: that happened a couple of years ago now and the
Speaker 2: companies have got through that. So I think it's a
Speaker 2: very different underwriting environment to what we saw in two
Speaker 2: thousand and five six where Euphorio you know, got to
Speaker 2: a point where we had a lot of problems in
Speaker 2: eight nine.
Speaker 3: So for the sort of super cynics he would speak
Speaker 3: about private credit blowing up or some you know, big
Speaker 3: catastrophic problem with private credit. I think what you were
Speaker 3: saying is that, Yeah, why are there to be any
Speaker 3: catastrophic stress or whatever. It should be isolated to a
Speaker 3: fund that has done kind of odd underwriting or kind
Speaker 3: of offbeat underwriting that actually the market as a whole. Yeah,
Speaker 3: the mainstream of the market has performed basically quite robustly
Speaker 3: through this.
Speaker 2: Absolutely, you know, is going to be selective funds and
Speaker 2: selective managers who have underperformed. It's not an asset class
Speaker 2: issue like we saw in US mortgages in you know,
Speaker 2: two thousand and seven in that space. And I think
Speaker 2: if you want to just characterize why it's different, if
Speaker 2: I put it that way. You know, if you look
Speaker 2: at what happened in the US residential mortgage market, it
Speaker 2: was an original warehouse and then hand it over to
Speaker 2: Wall Street to distribute, so the actual underwriter didn't really
Speaker 2: hold on to it very long. If you look at
Speaker 2: us today, we own these assets for seven years, and
Speaker 2: we're fully accountable and monitoring these companies on a day
Speaker 2: to day basis. So our business is reliant on the
Speaker 2: performance of those businesses as well. So you have massive
Speaker 2: alignment between the manager and the LP because we need
Speaker 2: to be selecting good companies for our businesses to flourish
Speaker 2: and grow.
Speaker 4: Can I then perhaps ask assignment about risk management? And
Speaker 4: then I suppose credit risk is the biggest risk that
Speaker 4: we focus on. If you compare the risk management function
Speaker 4: within the typical private credit company or Palmton, if you
Speaker 4: compare it to the traditional banking model, do they are
Speaker 4: they broadly similar? Are the key differences?
Speaker 2: It varies quite a bit between managers. We we've followed
Speaker 2: a slightly different model to our peer group. So you know,
Speaker 2: we have dedicated originators talking to the private equity firm,
Speaker 2: so we get to make sure that we know everything
Speaker 2: that they're up to on a day to day basis,
Speaker 2: so that we have a pretty good sign side of
Speaker 2: light of where the deal flow is going to come from.
Speaker 2: We then have a large analytics team credit team inside
Speaker 2: the firm, and you know, we have twenty two analysts
Speaker 2: in that process. Nicole Gates, who runs that, used to
Speaker 2: be the senior credit officer at Dressner responsible for their
Speaker 2: alternatives area, particularly levit finance. She then actually spent nearly
Speaker 2: ten years at GE running their restructuring international Restructuring unit,
Speaker 2: so she's got tremendous depth of experience and looking at
Speaker 2: from a credit underwriting point of view the transactions, both
Speaker 2: primary new ones as well as dealing with some of
Speaker 2: the old problem ones at GE and I think that
Speaker 2: skill set inside the firm gives us a independent function,
Speaker 2: so the portfolio managers work with that credit function to
Speaker 2: really understand the companies, to analyze the cash flows, analyze
Speaker 2: the sector position, look at the growth trajectory, look at
Speaker 2: the business plans that they have inside of that. And
Speaker 2: we've done it that way because I think it's very
Speaker 2: difficult for originator to be out scouring the market for deals,
Speaker 2: to be reading thousands of pages of due diligence on
Speaker 2: a deal that they've got, and to do that ongoing origination,
Speaker 2: and we wanted to create a partnership across the business,
Speaker 2: the originators working with their analytics team, working with our
Speaker 2: portfolio management team so that we could really go quite
Speaker 2: in depth into the companies and understand what they're doing.
Speaker 4: But perhaps to follow up on that point, one of
Speaker 4: the key attractions for a borrower to go with a
Speaker 4: private credit provider as opposed to a bank is sometimes
Speaker 4: that's the speed of the loan decision, if you go
Speaker 4: through the banking process, can be more more of an
Speaker 4: administrative nightmare, whereas a credit provider could perhaps act more quickly.
Speaker 4: Would would you agree with that?
Speaker 3: Yeah?
Speaker 2: I think there's two key differences. I think, you know,
Speaker 2: one is we can tailor a transaction much more to
Speaker 2: the client's demands. So sometimes cash flow is a bit
Speaker 2: tighter in the first year or so, we can give
Speaker 2: them flexibility on you know, picking income in the first
Speaker 2: twelve months. You know why they're executing the integration, etc.
Speaker 2: So I think that's a much more difficult thing to
Speaker 2: go out and explain in a syndication transaction. But if
Speaker 2: you're doing a bilateral between us and the borrower, we
Speaker 2: can put it into a structure that really really suits
Speaker 2: the cash flow and the growth of the company. The
Speaker 2: second part is, you know, we ran a huge syndication
Speaker 2: business when I was at the bank. You know, when
Speaker 2: you're underwriting deals on the concept I'm going to sell
Speaker 2: it to sixty different institutions, Lots of people have different
Speaker 2: views about is it sellable? Is it not sallable? As
Speaker 2: the market rights it's not right. So banks obviously decision
Speaker 2: making process can be quite slow at times because you've
Speaker 2: got to get the sales desk view, you've got to
Speaker 2: get the credits view, you've got to get other people's views,
Speaker 2: and you've got to bring that together. That model works,
Speaker 2: it's been successful for decades, but it can be time
Speaker 2: time consuming. And I think that we have an advantage
Speaker 2: because we have accumulated the capital, we know how much
Speaker 2: we're willing to lend, and we can do it relatively
Speaker 2: straightforward with the borrower.
Speaker 3: Simon, you are one of a collection of beautique lenders
Speaker 3: who got in early in European dirret lending. But if
Speaker 3: you look across the landscape of your fears, you see
Speaker 3: quite a lot of them have actually changed hands now
Speaker 3: and a lot of them have attached themselves to broader
Speaker 3: kind of I guess global asset managers, and you do
Speaker 3: have a steak minority stake from L and G. But
Speaker 3: what would be the criteria or the preconditions for a sale?
Speaker 3: Is it tempting to kind of jump on the bandwagon
Speaker 3: and and sell the business? Do you? What are your
Speaker 3: general thoughts about about setting sale?
Speaker 2: I think if I put it correctly, you know, silas
Speaker 2: the world has been going off talking to insurance companies
Speaker 2: and other people to partner with private credit managers, and
Speaker 2: you know, that seems to be a theme at the
Speaker 2: moment inside the industry. I think we made the decision
Speaker 2: very early on when we set up the firm, we
Speaker 2: wanted to be truly European by being in you know,
Speaker 2: every country with our ten officers. We wanted to have
Speaker 2: a significant European partner inside the business who was well
Speaker 2: known and well regarded. So Ellen g became a partner
Speaker 2: inside the firm. They've been a fantastic partner as we've
Speaker 2: built the business, and you know, we wanted to be
Speaker 2: a truly third party manager. So over ninety percent of
Speaker 2: our capital comes from other institutions. And you know, I
Speaker 2: think we've kind of front loaded I can say that way.
Speaker 2: You know, we made all those decisions up front and
Speaker 2: then focused on building the platform. I think a number
Speaker 2: of our piers went out and kind of started to
Speaker 2: build platforms and then decided they needed to go and
Speaker 2: find a partner in that space. So we're very happy
Speaker 2: the way we are. We think we're on a very
Speaker 2: very strong trajectory. More recently, we've opened up the NAB
Speaker 2: lending businesses, which is going very very well with the
Speaker 2: partnership we announced with Addia coming into work with that,
Speaker 2: We've been growing our working capital solutions business. We just
Speaker 2: announced the partnership in December with Santander where we're setting
Speaker 2: up a joint venture company. So we've really feeled that
Speaker 2: across the platform. With the products we've got RSS, our
Speaker 2: risk sharing SRT business, our COLO business, we have a
Speaker 2: pretty broad based platform. We can bring together those products
Speaker 2: into multi strap SMAs for clients. We can build large
Speaker 2: verticals in each one of those strategies. And we have
Speaker 2: a very supportive shareholder inside the firm who's been very
Speaker 2: helpful as we've grown the business. So we think it's exciting.
Speaker 2: Europe's going to be a great opportunity and we're out
Speaker 2: telling people about that opportunity.
Speaker 3: And what do you make generally of the consolidation in
Speaker 3: in among private credit firms Now? I mean, obviously there's
Speaker 3: kind of high profile ones ala Blackrock buying HPS. There's
Speaker 3: kind of more regional ones going on, you know, probably
Speaker 3: as we speak, and yeah, what do you make of it?
Speaker 2: Yeah? But I think it all goes back to the
Speaker 2: same point, you know, if I mean, HBS is a
Speaker 2: different situation. I mean, HBS is a very successful firm.
Speaker 2: You know, it had one hundred and forty billion of
Speaker 2: capital in that space, and you know, it was considering
Speaker 2: going down the IPO route, and black Rock came in
Speaker 2: and made a very very attractive offer in that space.
Speaker 2: And I think, you know, that's much more a very
Speaker 2: very mature business, you know, like you see in the
Speaker 2: M and A market. I think the vast majority of
Speaker 2: deals that have been done in the market today if
Speaker 2: I look at it, so you know, have been much
Speaker 2: smaller man probably more around the ten billion mark or
Speaker 2: you know, who are being acquired by insurance groups or
Speaker 2: other investors as a platform for them to bring a
Speaker 2: lot of capital in to try to grow those businesses
Speaker 2: into much bigger businesses. And I think that trend's going
Speaker 2: to happen because I think there is a lot of
Speaker 2: if I can say, subscale managers in the market who
Speaker 2: you know, it's a significant cost to build your institutional
Speaker 2: coverage platform. And so you know, we are now you know,
Speaker 2: twenty six billion. We think we'll grow to probably you know,
Speaker 2: mid thirties over the next twelve months and in that space,
Speaker 2: and I think once you start to get to that
Speaker 2: size and you've got that scale and you've got the
Speaker 2: breadth of products. What we're seeing is people saying, that's
Speaker 2: really interesting. Can I do this with you? And can
Speaker 2: I do that with you? In that space? If you're
Speaker 2: a single product manager just doing you know, unitranch loans,
Speaker 2: I think you need a big brother to really grow
Speaker 2: the business to the next level. And I think that's
Speaker 2: what's driving the M and A activity.
Speaker 1: And the scale numbers you're giving us some simon that's
Speaker 1: in euros, Is it because you were talking a couple
Speaker 1: of years ago about getting to fifty billion by I
Speaker 1: think twenty twenty seven around there in terms of dollars
Speaker 1: dollar amount.
Speaker 2: Yeah, No, that's correct, and you know, I think we're
Speaker 2: still on track for that, James, and working hard with
Speaker 2: our new partnerships that we've announced over the last six months.
Speaker 1: And that's the kind of scale you need to be standalone,
Speaker 1: is it in this business?
Speaker 2: So I know, yeah, I think it's an important piece,
Speaker 2: and I think to me, scale is less of the issue.
Speaker 2: I think you've got to have a range of products
Speaker 2: that people think are relevant and attractive, and I think
Speaker 2: you have to have you know, high performance or high
Speaker 2: quality offerings in those products. I think if you do that,
Speaker 2: then scale comes, you know, naturally, because people are attracted
Speaker 2: to come with you, and you know, I think people,
Speaker 2: you know, if you're a big institution and you want
Speaker 2: to allocate five hundred million, it's hard to go and
Speaker 2: give that to a five billion manager. You know, if
Speaker 2: you're a big institution and you want to allocate five
Speaker 2: hundred million, it's much easier to give that to an
Speaker 2: institution which has got fifty billion. It's got you know,
Speaker 2: three hundred people, it's got the infrastructure, the institutional parts
Speaker 2: of compliance, risk, legal and all of that around it.
Speaker 2: So they kind of go hand in hand.
Speaker 4: Simon. Earlier this week, Donald Trump was inaugurated as the
Speaker 4: forty seventh i think, president of the US. The expectation
Speaker 4: is that the new administration is going to postpone the
Speaker 4: bars of three end game, as it's called for US banks,
Speaker 4: possibly indefinitely. We've already seen a reaction over here in Europe.
Speaker 4: In the UK, the PRA has effectively postponed the introduction
Speaker 4: of BARSA three point one or BARSA four, whichever UK's
Speaker 4: call it, by another year to January twenty twenty seven.
Speaker 4: Is there possibility that the pendulums perhaps swinging back a
Speaker 4: little to bank deregulation, and as a result of that
Speaker 4: is a possibility that banks are going to be able
Speaker 4: to compete more effectively with pride credit.
Speaker 2: I think if you go back, I mean the you know,
Speaker 2: certainly the pendulum of you know, being kinder to banks
Speaker 2: in the United States is definitely happening under the Trump administration.
Speaker 2: But Trump will only be here for four years, and
Speaker 2: if you're a chief executive of bank, you've got to
Speaker 2: make sure the pensulum doesn't swing back the other way,
Speaker 2: you know, in four years time. So it's very difficult
Speaker 2: I think to run your business model by just looking
Speaker 2: at politics. You have to look at the long term trends.
Speaker 2: And I think the long term trends inside of banking is,
Speaker 2: you know, I would say, a movement out of non
Speaker 2: investment grade and asset heavy lending into much more investment
Speaker 2: grade and service providing and distribution and rather than being
Speaker 2: large scale principles. And they'll still have large lending books,
Speaker 2: but you know, I think it's a big shift, and
Speaker 2: that shift isn't going to change in this process. I
Speaker 2: think if you look at Europe and if your ECB.
Speaker 2: ECB has been very vocal that they'd like to see
Speaker 2: much more consolidation in the European marketplace. That seems to
Speaker 2: be taking a long time, and therefore, I think regulation
Speaker 2: will continue to be relatively tight on the European banking
Speaker 2: system around single name, concentration, non investment grade, you know,
Speaker 2: and these type of things. So fundamentally, in a growing
Speaker 2: market where you know, companies need to borrow two hundred
Speaker 2: million first time round, four hundred five hundred million, next
Speaker 2: time round a billion the time round, institutions that can
Speaker 2: bring together large pools of capital are going to be
Speaker 2: very very relevant, very very meaningful for those So you know,
Speaker 2: the banks, as we have with Santander, you know, can
Speaker 2: be great partners and they've you know, there's been other
Speaker 2: bank partnerships announced because I think they see it that
Speaker 2: they have a big origination platform, we have a large
Speaker 2: ability to scale capital together, and they can be a
Speaker 2: very harmonious partnership in working together to serve as clients
Speaker 2: in that space. And our job for the OLPs is
Speaker 2: to make sure we're putting in first class risk management
Speaker 2: around that.
Speaker 4: Can I perhaps follow up on that you're talking about
Speaker 4: regulation or deregulation, whichever way you kind of look at it.
Speaker 4: The ECB has been quite that They've completed a review
Speaker 4: looking at private credits last year and they've highlighted the
Speaker 4: prevalence of leverage which can be upstream, midstream, or downstream
Speaker 4: in the pridate creditor industry. Do you are you concerned
Speaker 4: or do you expect regulators to follow up with with
Speaker 4: with introducing regulations for the proud creditor industry?
Speaker 2: I think, I mean we are already regulated by for example,
Speaker 2: you know, we're most of our funds are based in Luxembourg.
Speaker 2: The CSSF is a very very you know, I think,
Speaker 2: thoughtful and focused regulator and in that space, and so
Speaker 2: you know today there is already regulations and different you around.
Speaker 2: You leverage into funds, it's into you know, where we
Speaker 2: can distribute and things like that. I think the part
Speaker 2: that most people, you know, possibly miss at times is
Speaker 2: if we look at where significant credit losses have happened
Speaker 2: in the banking industry, it is because of concentration issues
Speaker 2: inside you know, the balance sheet, whether that is back
Speaker 2: in the early nineties with real estate, whether that is
Speaker 2: in two thousand and eight with US mortgages, and you know,
Speaker 2: if you actually look at a fund like ours, we'll
Speaker 2: have fifty or sixty LPs in there. You know, if
Speaker 2: we do a loan for four hundred million or two
Speaker 2: hundred million, you know, any LP is going to be
Speaker 2: you know, one million to five million ex exposure inside
Speaker 2: of that. And if you look at the underlying her
Speaker 2: person who's given us the money, they're an insurance company
Speaker 2: for example, or a pension fund which has tens of billions,
Speaker 2: and so the actual exposure in a single name that
Speaker 2: they have coming through us is tiny, and there's no
Speaker 2: risk with us because the money is locked up with
Speaker 2: us for seven years in our actually ten years in
Speaker 2: our fun in that space. So you don't have the
Speaker 2: capital flight risk that the banking system saw in two
Speaker 2: thousand and eight where deposits got withdrawal and banks were
Speaker 2: really under liquidity pressures. And you don't have the concentration
Speaker 2: risk that we saw in the banking market in two
Speaker 2: thousand and eight as well, because it's diversified through fifty
Speaker 2: or sixty institutions. So I think when regulators actually start
Speaker 2: to look at that, we're an incredibly powerful and positive
Speaker 2: source of capital to come in to grow the European economy,
Speaker 2: and that's why you've seen countries like Germany, like Italy
Speaker 2: change regulation to give direct lenders like ourselves direct access
Speaker 2: to clients. Because you know, when I started the business
Speaker 2: ten years ago, I couldn't lend to a German company directly.
Speaker 2: I had to ask a bank to intermediate for a
Speaker 2: day or two and then I bought the loan off them.
Speaker 3: That's interesting if you regulators seem to be interested in
Speaker 3: I guess, different forms of leverage across private markets. They're
Speaker 3: interested in valuations on both the equity and the credit side.
Speaker 3: And if you look at potential risks for private credits specifically,
Speaker 3: I mean, what do you think is the key risk
Speaker 3: that is still for latent?
Speaker 2: I don't mean, you know, so if I go back
Speaker 2: to it, it is really if you look at the
Speaker 2: asset management industry and some of the you know, the
Speaker 2: blowups we've had in hedge funds or anything like that,
Speaker 2: it's primarily being, if I can say, much more, a
Speaker 2: mini match of liquidity or an operational misunderstanding of the
Speaker 2: risks that are actually holding in their balance sheet. And
Speaker 2: I think if you look at it today, the scrutiny
Speaker 2: that we are all put under by our LPs on
Speaker 2: line by line explanation of what we have in our
Speaker 2: balance sheets. You know, the solevency two reporting that we
Speaker 2: do to all of our insurance clients inside of Europe
Speaker 2: and now around the world means that they have a
Speaker 2: very very granular analysis. If you look at what we
Speaker 2: have to do with our regulator independent pricing, using third
Speaker 2: parties to value our assets to make sure that we
Speaker 2: are being factual around what we think the underlying values
Speaker 2: are in that space. I think the industry has come
Speaker 2: a tremendously long way, and I think that scrutiny will
Speaker 2: only continue to grow as we become a bigger part
Speaker 2: of the asset allocation for institutions. So you know, I
Speaker 2: think the establishment of the industry is here. The improvement
Speaker 2: in as you say, risk reporting or pricing and all
Speaker 2: of that will continue to grow. And I think the
Speaker 2: regulators are, if I can say, silas encouraging us by
Speaker 2: talking about this on an active basis that we keep
Speaker 2: making those movements forward, and I think that will happen
Speaker 2: and people, you know, our regulators across Europe will continue
Speaker 2: to make sure that we're moving in the right direction.
Speaker 2: And I think that's why you haven't seen anyone turn
Speaker 2: around and say stop doing this, but they just want
Speaker 2: to make sure it's best practices.
Speaker 1: What about the default rate those time? Is it increasing?
Speaker 1: Are you seeing more payment and kind more amendments that
Speaker 1: kind of.
Speaker 2: Thing you certainly you certainly saw, you know, kind of
Speaker 2: coming out of COVID and then getting hit by this
Speaker 2: massive inflation hit and all of that. Companies having certain
Speaker 2: challenges at times on cash flow. I mean, many companies
Speaker 2: couldn't pass on the input pricing inflation as quickly as
Speaker 2: they needed to, and so therefore Ibadah came down quite
Speaker 2: sharply and then has recovered back up in that process.
Speaker 2: But I think if you look at where we are
Speaker 2: in the cycle, you know, you're now a couple of
Speaker 2: years into this process, the companies have held up most
Speaker 2: of the input pricing has moved through to the consumer
Speaker 2: of the goods in that space. So default rates, I
Speaker 2: think most people would say, is much lower than people expected.
Speaker 2: And I think the you know, in cases where you
Speaker 2: recoveries will be done, they're much much higher than people
Speaker 2: have expected. So but it doesn't you know, you will
Speaker 2: have people who have you know, portfolios that don't perform
Speaker 2: that way. So it's a bell curve, but I think
Speaker 2: fundamentally it's come out of it.
Speaker 3: Much better internally institutionally, do you do you look at
Speaker 3: default rates? I mean, do you think there are good
Speaker 3: spell weather for overall risk in the market, Because it
Speaker 3: feels as if the one of the strengths of private
Speaker 3: credit is that it can avoid defaults, and so actually
Speaker 3: the default rate may be less relevant to understanding I
Speaker 3: can know the gyrations of the of the market.
Speaker 2: If I think one of the great strengths of private
Speaker 2: credit is the fundamental alignment between the borrower, the lender
Speaker 2: and the LP has funded it. And you know, I
Speaker 2: think if you start off default rates, you know, it's
Speaker 2: a statistical analysis, but it doesn't tell you who to
Speaker 2: lend to and who not to lend to. It just
Speaker 2: tells you, you know, the trends that are going on
Speaker 2: in the industry. Fundamentally, you have to be very, very
Speaker 2: focused on the industry sector. You've got to look at
Speaker 2: the company's position in that industry sector and the viability
Speaker 2: of their business model in that sector. So you know,
Speaker 2: if I go back to the early two thousands, everyone
Speaker 2: gave you leverage to autoparts, manufacturers today with Tesla and
Speaker 2: you know by d you wouldn't even consider thinking about
Speaker 2: it in that space because technology has completely changed that sector.
Speaker 2: So you know, for me, what keeps us awake at
Speaker 2: night is, you know, product redundancy and the life cycle
Speaker 2: of products. You know, you all may remember we used
Speaker 2: to have a thing called a walkman. You know, today
Speaker 2: it's your iPhone. You would you know, my children probably
Speaker 2: don't even know what a walkman is in that space.
Speaker 2: And I think that change is incredibly fast today. And
Speaker 2: you've got to go into industries and go into sectors
Speaker 2: where you can reliably predict the next seven, eight, ten years.
Speaker 2: And that's why if you look at private equity in today,
Speaker 2: it's you know, outsourced business services. You know, I have
Speaker 2: firewalls in my business today, it's done by third parties.
Speaker 2: I have thirty different programs managing into my company and
Speaker 2: that's done by three different providers in that space. Am
Speaker 2: I ever going to turn that business off?
Speaker 3: No.
Speaker 2: As a percentage of my cost for running the firm,
Speaker 2: it's tiny, and so it's an incredibly stable revenue stream
Speaker 2: for the provider. You know, my big cost is labor
Speaker 2: people in that space. So if you're a private equity
Speaker 2: firm buying a whole series of these companies and rolling
Speaker 2: them up to which will end up looking like some
Speaker 2: of the big data providers in the United States in
Speaker 2: five or ten years time. And these are fascinating industries
Speaker 2: with great growth potential and longevity because cloud computing has
Speaker 2: completely changed how we store data and what we're going
Speaker 2: to do. So you know, to me, as I said,
Speaker 2: life cycle of the product, and you know, and is
Speaker 2: it going to be there in ten years time or
Speaker 2: my inter sector which is going to be completely become
Speaker 2: a dinosaur because of technology change, you know, medical genealogy
Speaker 2: changes and other things like that. That's really where we're heavily,
Speaker 2: heavily focused, and that's where the capital goes.
Speaker 1: Watch out for those dinosaurs making a comeback though time.
Speaker 1: And I'm still listening to my vinyl records. So that's
Speaker 1: another conversation. But I wanted to go back to what
Speaker 1: you said earlier about the relative advantages in the US, sorry,
Speaker 1: in Europe against the US. I'm interested in that concept
Speaker 1: of relative value between the regions because we are so
Speaker 1: loaded up. You know, I'm sitting in New York and
Speaker 1: it's all just everybody wants US assets the dollar and
Speaker 1: they've been paid for it. They've done really really well
Speaker 1: by just sitting here and doing that over and over again.
Speaker 1: But when you talk to someone that's outside of Europe
Speaker 1: about the opportunity, you mentioned better fees, better margins, upfront
Speaker 1: fees as well, I assume better covenants. Well, can you
Speaker 1: put that into some kind of context, maybe give us
Speaker 1: some numbers around that.
Speaker 2: Yeah, And so you know, if you look at Europe today,
Speaker 2: upfront fees for underwriting transactions sit in the two and
Speaker 2: a half to you know, maybe three percent type region,
Speaker 2: where if you look at the United States they're probably
Speaker 2: half that in that space. If you look at margins,
Speaker 2: you know in there there's you know, twenty five to
Speaker 2: fifty basis points I think still premium. And if you
Speaker 2: swap euro assets back into US dollars, you're getting, you know,
Speaker 2: a significant pick up just because of the interest rate differential,
Speaker 2: which has varied between one hundred and fifty and two
Speaker 2: hundred basis points depending on markets. And so you know,
Speaker 2: if you put that whole package together in that space,
Speaker 2: you know, wider spreads, greater upfront fees, the yal curve differential.
Speaker 2: Swapping back into dollars. You know, you can be picking
Speaker 2: up one hundred and fifty two hundred basis points more
Speaker 2: sitting in Europe than you are in the United States.
Speaker 2: And you know, we've seen some of the most significant
Speaker 2: bell Weather institutions very focused on Europe over the last
Speaker 2: twelve months because I think they feel that they are
Speaker 2: heavily exposed to the direct lending market inside of the
Speaker 2: United States and they want diversification. You know, I met
Speaker 2: today with one of the largest asset managers and I
Speaker 2: thought they encapsulated it very, very well. They said, you know,
Speaker 2: everyone looks at Europe through the eyes of equity, and
Speaker 2: US equities are exciting and europe p in equities are terrible.
Speaker 2: But if you look at credit, credit actually looks really attractive.
Speaker 1: And within that are there sectors that are a focus
Speaker 1: right now for non European investments coming in.
Speaker 2: Yeah. And as I touch on through this, it is
Speaker 2: in the new economy. Yeah, I think Europe today is
Speaker 2: a two speed economy. You have its old industrial base.
Speaker 2: You know, if you look at the industrial base of Germany,
Speaker 2: the manufacturers, the car manufacturers and people like that, where
Speaker 2: they're really struggling under Chinese and other markets, pressures of
Speaker 2: imports coming into Europe, and then you have this new
Speaker 2: sector heavily related to technology, heavy rated to healthcare and
Speaker 2: services where you know, there is a very large population
Speaker 2: that needs servicing with you a very unconsolidated suppliers of
Speaker 2: those services, where private equity is coming in and rolling
Speaker 2: those companies up and doing it. And it's all parts
Speaker 2: of the healthcare sector, all parts of the service sector
Speaker 2: in that space. And you know, and still some growth
Speaker 2: areas in industrials, but I think in the US you
Speaker 2: see a lot of core industrials, hospitality, you know, retail
Speaker 2: driven activity. You won't see much of that in most
Speaker 2: of the European portfolios. I think they're very much in
Speaker 2: the new economy and not in the old economy.
Speaker 4: Simon, could I come back to something you mentioned earlier,
Speaker 4: your partnership with the Santander and throughout the private credit industry,
Speaker 4: there are a little for those partnerships that have been
Speaker 4: announced between banks on the one side and private private
Speaker 4: credits firms on the other side. In those instances, who
Speaker 4: actually owns the customer relationship if I can call it that,
Speaker 4: And how do you approach dividing up the economics of
Speaker 4: a partnership.
Speaker 2: Yeah, and I think that's been if I can say,
Speaker 2: some of the stumbling blocks to the partnerships, because you know,
Speaker 2: the traditional way that it used to get done is
Speaker 2: you know, you bring the all the deals and you know,
Speaker 2: I'll give you your customers some money and all of that.
Speaker 2: You know, we recognized when we went into this deal
Speaker 2: with Santander in a very specific area, it needed to
Speaker 2: be a real partnership, and so we set up a
Speaker 2: company together and we're both are shareholders in that company
Speaker 2: that we are working together to serve as that client.
Speaker 2: Santander has a huge product range and so it's got
Speaker 2: lots of other products they're servicing those particular clients, but
Speaker 2: we're a specialist provider in their portfolio in a specific area.
Speaker 2: And because we're both partners and shareholders inside the company,
Speaker 2: we're working together in that process. And I think that
Speaker 2: if I says, you know, dilutes or isn't my customer
Speaker 2: or your customer, it's our customer and we're trying to
Speaker 2: deliver the best service because we're actually partners in a business.
Speaker 3: Fair enough, You've had a remarkable career, Simon in that
Speaker 3: you've been adjacent to Nick Lison in bearings. You've been
Speaker 3: in RBS in America, you've been in private credit, You've
Speaker 3: seen all of these kind of announcements. Didn't just name
Speaker 3: a few, and there's others, but you know, you've been
Speaker 3: I guess at the epicenter of a series of quite
Speaker 3: significant moments in financial I guess, like modern history, what's
Speaker 3: been the most chaotic? Is the most chaotic period still
Speaker 3: to come?
Speaker 2: Yeah, well I can answer that one, you know, quite quickly,
Speaker 2: so you know, touch you on your point. You know,
Speaker 2: I was in the US in nineteen ninety when we
Speaker 2: went through the crisis, and you know, City Group nearly
Speaker 2: went bankrupt and a number of other US banks. That
Speaker 2: was a huge crisis. But you know, I think if
Speaker 2: we look back, two thousand and eight was by far,
Speaker 2: you know, it was something that none of us had
Speaker 2: seen since the Great Depression, and I think still today.
Speaker 2: You know, if you talk to the people who were
Speaker 2: at the epicenter of that, the world came incredibly close
Speaker 2: to a major meltdown of the financial services industry. You know,
Speaker 2: if you look at banks in Holland and Switzerland, UK, Ireland,
Speaker 2: US and all that, the entire global banking system apart
Speaker 2: from probably you know, China and Japan, and you know,
Speaker 2: Australia and Canada had to be bailed out in some
Speaker 2: format in the major banking site. But I think, you know,
Speaker 2: that was you know, kind of set up in my
Speaker 2: mind in two ways. You know, I think if you
Speaker 2: look at the kind of equity market expectation of banks
Speaker 2: in the late nineties going into early two thousands, if
Speaker 2: you're a chief executive that wasn't making a twenty percent
Speaker 2: return on your equity, then you know, people felt you
Speaker 2: weren't really performing at the highest level. And the only
Speaker 2: way a bank can get to twenty percent return on
Speaker 2: equity is you've got to give your balance sheet up
Speaker 2: substantially in that space. And then unfortunately, we got hit
Speaker 2: by you know, a very very major asset class. Where
Speaker 2: as I said at the beginning of this podcast, the
Speaker 2: underwriter of the risk just passed it on to someone
Speaker 2: else and just moved. You know, they weren't around for
Speaker 2: all of the problems that came out of that, and
Speaker 2: that got distributed to everyone in the world. You know,
Speaker 2: we had a very large book at RBS, probably you know,
Speaker 2: sixty to seventy billion, and you know, most other banks
Speaker 2: had pretty similar numbers Barclays, et cetera. And that was
Speaker 2: a painful experience. I think the great thing today is
Speaker 2: the lesson has been pretty much learned. I would say
Speaker 2: in every asset class, if you're going to underwrite that risk,
Speaker 2: you need to own it and your business needs to
Speaker 2: rely on it performing, you know. And so if you're
Speaker 2: looking at the banking industry, they're focused now on distribution
Speaker 2: of primarily investment grade risk, and so the risk of
Speaker 2: that underperforming is much much lower. You know. The people
Speaker 2: who are taking over a larger and larger part of
Speaker 2: the non investment grade risk are ourselves who are acting
Speaker 2: as principles in that business, and we're managing that on
Speaker 2: behalf of our clients in that space. And I feel
Speaker 2: that's kind of the old banking world if we go
Speaker 2: back to the seventies and eighties, Yeah, I give you
Speaker 2: fifty million. You know, you and I are now partners
Speaker 2: in that space, and that's what we're doing every day
Speaker 2: across Europe with these business and working with their management
Speaker 2: teams as they grow those firms.
Speaker 1: I think, to follow on from Silus question, I think
Speaker 1: what he's kind of getting at is, you know, you've
Speaker 1: you've really seen inside some really turbulent times in our
Speaker 1: financial history, and you know, you've seen what can happen,
Speaker 1: particularly at times when everyone is most excited and most
Speaker 1: positive and most bullish. And you know, the golden age
Speaker 1: seems to go on forever when you when you're in it,
Speaker 1: and then suddenly it suddenly it's over. Do you think
Speaker 1: that we are getting complacent about credit and that you know,
Speaker 1: people are just too positive and you know that it
Speaker 1: will end up in a reckoning at some point soon.
Speaker 2: I think everyone uses a parallel to US mortgages, you know,
Speaker 2: and if you go and lend billions and billions and
Speaker 2: billions to people who actually can't afford to repay the
Speaker 2: mortgage and then you know you end up with a
Speaker 2: car crash. Will you have underperforming sectors? Of course? You know,
Speaker 2: we saw the oil and gas sector in the US,
Speaker 2: We looked at shale in the US, We looked at
Speaker 2: different things and those are very much, in my mind,
Speaker 2: sectorially driven and demand driven. And in a credit world,
Speaker 2: you're going to have strong sectors and you're going to
Speaker 2: have weak sectors. And you know it's the manager's decision
Speaker 2: and whether they want to go for outsize return in
Speaker 2: the weak sector or whether they want to focus on
Speaker 2: the strongest sectors and be benchmark returns for what they're doing.
Speaker 2: And there will be managers who specialize on the weak
Speaker 2: sectors because they want to be much more closer to
Speaker 2: a kind of equity investor in those areas. And then
Speaker 2: there's managers like ourselves who are looking to be large
Speaker 2: scale fundamental providers of capital in the core sectors and
Speaker 2: the growth sectors in the market. And so I say
Speaker 2: to every LP, you know, you've got to be focused
Speaker 2: on where your manager is putting the capital, both in
Speaker 2: the capital structure but also sectorially to understand the risk
Speaker 2: profile of the manager. And if you do that, then
Speaker 2: you'll work out, you know, do I want to go
Speaker 2: for high octane returns or I want to go for
Speaker 2: core returns. And you know, we have a range of
Speaker 2: fun and our firm, you know where we go all
Speaker 2: the way down to know mezzanine inequity, and that's doing
Speaker 2: mid teens returns, but we're very clear around you know,
Speaker 2: the type of risk we're taking. And then we have
Speaker 2: a variety of funds which are just core generating European
Speaker 2: yield to probably eight to ten percent net us returns
Speaker 2: of ten to twelve percent net and that is just
Speaker 2: core income. And you'll all come back to me and say,
Speaker 2: you know, how do you manage that risk? And you know,
Speaker 2: it's trying to make sure we're in highly resilient industries
Speaker 2: and sectors of the market in that space.
Speaker 1: Great stuff, Simon Drake Bruckman from Pemington. It's been a
Speaker 1: pleasure having you on the Credit Edge money.
Speaker 2: Thanks, thanks so much, Thanks gentlemen, and.
Speaker 1: Of course I'm very grateful to Ruin Unitus from Bloomberg Intelligence.
Speaker 1: Thank you for joining us today. Thank you, James and
Speaker 1: Silas Brown with Bloomberg News. Great to see you, Thanks
Speaker 1: so much, James. Check out all of Silence's great scoops
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