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Speaker 1: Hello, and welcome to the Credit Edge, a weekly markets podcast.

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Speaker 1: My name is James Crombie. I'm a senior editor at Bloomberg.

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Speaker 1: This week, we're very pleased to welcome Jimmy Levin, CEO

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Speaker 1: and Chief investment officer of Sculptor Capital. How are you, Jimmy,

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Speaker 1: I am great, Thanks for having me. Thank you so

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Speaker 1: much for joining us today. We're very excited to get

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Speaker 1: your credit market views, and we're also delighted to have

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Speaker 1: back on the show Stefan Koba, chef from Bloomberg Intelligence. Hello, Stefan. Hi, James,

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Speaker 1: and from Bloomberg News, Renne Garthia Perez, who covers distressed

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Speaker 1: debt and of course football from London. How are you Rene?

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Speaker 2: Hello, I am freezing in our studio in London.

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Speaker 1: Okay, Well, I hope it warms up with there. But

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Speaker 1: just to set the scene a bit here from New York.

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Speaker 1: Credit markets are rallying after taking a bit of a

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Speaker 1: hit at the start of August. Investors are bracing for

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Speaker 1: volatility in the run up to FED easing, which is

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Speaker 1: expected to start this month. Lower rates will take some

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Speaker 1: of the pressure off weak companies that were struggling with

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Speaker 1: high borrowing costs. Over the last few years, and there's

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Speaker 1: a lot more debt issuance. Companies are taking advantage of

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Speaker 1: very strong investor demand for corporate bonds and loans, with

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Speaker 1: yields at historically high levels, and September is typically a

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Speaker 1: heavy month for bond isshuents. We are off to a

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Speaker 1: record start today, but there's still a lot more demand

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Speaker 1: than net supply of corporate debt, which is a technical boost.

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Speaker 1: Credit markets are supported by resilience in the economy and

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Speaker 1: investors are betting on a soft blanding. However, there is

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Speaker 1: a lot to worry about in debt markets. We're seeing

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Speaker 1: more creditor on creditor violence, aggressive liability management exercises, and

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Speaker 1: cooperation agreements, as well as defaults and bankruptcies. Then there's

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Speaker 1: commercial real estate stress war, the US election, global geopolitics

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Speaker 1: plus recession risk hasn't really gone away. So Jimmy, what's

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Speaker 1: your take? Are you bullet for the rest of twenty

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Speaker 1: twenty four?

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Speaker 3: Well, maybe we have to zoom out a little bit

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Speaker 3: from that. You listed a handful of great sounding things

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Speaker 3: for the economy and markets. In a handful of items

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Speaker 3: that could be a problem for economies and markets, I'd

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Speaker 3: start by saying there's usually that list on both sides,

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Speaker 3: and today's no different. There are some tailwinds, there are

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Speaker 3: some headwinds, but I think to set the stage for

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Speaker 3: credit investing more broadly, you've heard, whether it's from US

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Speaker 3: firms like ours, you've heard talk over the last couple

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Speaker 3: of years that it's a great time to be a

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Speaker 3: credit investor. You've probably heard that over and over again,

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Speaker 3: and it always has a different phrase. Sometimes it's equity

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Speaker 3: like returns for credit like risk or some derivative of

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Speaker 3: that sort of concept. Golden age, Yeah, golden age. You know,

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Speaker 3: we've heard them all. So let's start with what is

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Speaker 3: that backdrop and why is everybody saying that? And from

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Speaker 3: our perspective, we try to frame it as the perspective,

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Speaker 3: returns on offering credit come from the risk free rate,

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Speaker 3: the i'll call it generic non investment grade credit spread,

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Speaker 3: and then the complexity premium, and people call that last bucket.

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Speaker 3: Sometimes that's called alpha, sometimes that's called excess return, excess spread.

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Speaker 3: But it's those three pieces. And so if you take

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Speaker 3: those three pieces today, and this has kind of been

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Speaker 3: true for the last couple of years, moving around up

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Speaker 3: and down for each of the three, but the risk

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Speaker 3: free part, depending on your rate view, it's in the

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Speaker 3: four or five range. The non investment grade credit spread

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Speaker 3: it's in the three four five range, and that complexity

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Speaker 3: premium is also in the three four five range. So

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Speaker 3: depending on which where we pick in these different ranges,

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Speaker 3: you're getting to a load to mid teens gross on

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Speaker 3: levered rate of return to generally take pretty reasonable credit risk.

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Speaker 3: So before we talk about anything else, we kind of

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Speaker 3: pause there if returns on offer are in the low

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Speaker 3: amid double digits to take reasonable credit risk. And we're

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Speaker 3: on radio, so you can't say you can't see the

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Speaker 3: reasonable in air quotes, right, Everyone's got their own version

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Speaker 3: of reasonable. But to take pretty reasonable credit risk and

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Speaker 3: make that kind of return, that generally counts as a

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Speaker 3: good time to be investing. Right, even at the simplest level,

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Speaker 3: Compare that to a few years ago. Risk free was

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Speaker 3: zero or one, and the credit spread component was two

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Speaker 3: or three or four, and that complexity premium was one

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Speaker 3: or two or three. And so the Old World's six, seven,

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Speaker 3: eight became the New World's eleven, twelve, thirteen, fourteen, fifteen.

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Speaker 3: And I think that generically is what have what has

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Speaker 3: credit market investors excited before we even talk about what's

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Speaker 3: what and what are the categories?

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Speaker 4: Hi, Jimmy, very interesting complexity premium view. I would agree.

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Speaker 4: I was curious to hear your views on interest rate

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Speaker 4: cuts from the Fed or across the globe more generally

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Speaker 4: as well. Do you see a risk rates remaining elevated

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Speaker 4: for longer to fight inflation or do you think the

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Speaker 4: central banks will do a good job at supporting growth

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Speaker 4: by steadily cutting rates in the next twelve months.

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Speaker 3: Well, I'll start with a disclaimer, which is that we're

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Speaker 3: generally not in the business of predicting the path of rates.

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Speaker 3: It matters a lot. We have to have review We

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Speaker 3: from time to time have a view, but trying to

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Speaker 3: figure out if the next meeting ought to be priced

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Speaker 3: at one or two or one point three, that's not

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Speaker 3: our exact skill set. I think what we try to

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Speaker 3: do as as investors, and I think this applies today.

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Speaker 3: Everything in the real world moves a little slower than

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Speaker 3: the market wants it to be. So again, if we

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Speaker 3: think about the last couple of years where interest rates

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Speaker 3: have been topics number one, two, three, four, and five

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Speaker 3: on everyone's list. For every conversation, there have been moments

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Speaker 3: in time where the market moves to and I'm exaggerating,

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Speaker 3: you know, one hundred percent probability of rates staying high forever,

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Speaker 3: and then it moves to a one hundred percent probability

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Speaker 3: of rates being dramatically cut instantly, and it oscillates back

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Speaker 3: and forth between those. I think what's realistic is rates

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Speaker 3: are pretty high right now. They're generically in the restrictive zone,

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Speaker 3: and they're going to go from that to something more

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Speaker 3: normal over a couple of years. And I know that's

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Speaker 3: a cop out answer, but I think it's not really

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Speaker 3: possible to predict. And I also think it doesn't hugely

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Speaker 3: matter for being a credit investor, Meaning if one is

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Speaker 3: doing a type of fundamental credit investing today, that works

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Speaker 3: out fabulously if there's six cuts, but it's a disaster.

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Speaker 3: If there's three cuts and it's the greatest thing of

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Speaker 3: all time. If it's the opposite, something's gone wrong already.

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Speaker 3: We shouldn't be that sensitive to that level of granularity.

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Speaker 3: But inflation is largely gotten under control and rates are

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Speaker 3: likely to come down over time. There is always a

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Speaker 3: risk of a reacceleration of inflation. Do we have an

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Speaker 3: ability to predict that better than the market, probably.

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Speaker 4: Not very clear. And on the back of normalizing rates

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Speaker 4: and inflation, just to follow up on the recession risks,

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Speaker 4: if you have a view on that, And the last

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Speaker 4: time I checked, the probability of the United States entering

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Speaker 4: recession the next twelve months stands at about thirty percent

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Speaker 4: according to Bluebird Sensus, and this is still relatively high,

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Speaker 4: but I believe this time last year the probability was

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Speaker 4: maybe about fifty to sixty percent. So I was wondering,

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Speaker 4: what's your take on these normalizing rates? Will they help

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Speaker 4: us avoid our recession in the US?

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Speaker 3: In your view, it's all circular, but inflation remaining under control,

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Speaker 3: are coming down further, rates beginning to normalize from being restrictive,

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Speaker 3: and all of that happening kind of slowly and smoothly

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Speaker 3: and under control helps avoid a recession. And so similar

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Speaker 3: to that rate comment that I made, where the market

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Speaker 3: flip flops between one hundred percent probability of one thing

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Speaker 3: and a one hundred percent probability of the other thing,

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Speaker 3: we see that with recession talk as well. And I

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Speaker 3: found last month the beginning of August during that selloff,

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Speaker 3: to be a bit of a head scratcher. Essentially, there

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Speaker 3: was a technical event in the Japanese market overnight and

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Speaker 3: by I don't know, five or six or seven am

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Speaker 3: New York time, there was there were calls for an

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Speaker 3: emergency FED meeting to make a cut to avoid this

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Speaker 3: impending recession. That seemed a little extreme. So I don't

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Speaker 3: think the probability moves as quickly like rates. It's this

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Speaker 3: is a slower moving machine. The economy has been growing

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Speaker 3: really well, both nominally and real. The rate of that

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Speaker 3: growth is slowing, which is what the FED and other

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Speaker 3: central banks have been trying to achieve for the last

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Speaker 3: couple of years. So it's not a surprise that the

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Speaker 3: rate of growth is slowing down. That's been the goal,

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Speaker 3: that's the point of the restrictive monetary policy. So we

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Speaker 3: are getting that slowing in growth so far, and again

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Speaker 3: this is not incredibly insightful. It's backward looking. So far,

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Speaker 3: so good. It's worked, inflation is kind of moderating. The

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Speaker 3: economy remains fairly strong, albeit slightly less strong. So we

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Speaker 3: are definitively on the soft landing path. Can we be derailed? Absolutely,

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Speaker 3: And again it could sound like a cop out, but

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Speaker 3: this is the beauty of being a credit investor, Especially

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Speaker 3: if you're a credit investor at a time where low

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Speaker 3: double digit or low to mid teens rates of return

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Speaker 3: are on offer. Credit investments shouldn't be that sensitive to this.

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Speaker 3: So obviously certain credit investments are. And I'm speaking very

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Speaker 3: generically now, if if one is investing in a zero

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Speaker 3: to fifty percent LTV loan, whether the economy grows at

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Speaker 3: three or shrinks at one, sure it's going to feel

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Speaker 3: better growing at three than shrinking at one. But that

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Speaker 3: loan ought to be protected. So as credit investors, we

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Speaker 3: don't have to be as precise.

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Speaker 2: Jimmy, for the soft lending that you were describing, is

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Speaker 2: it impacting the opportunity set of what you were saying?

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Speaker 3: Not really, so it has. So if I took that

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Speaker 3: generic rate plus spread plus premium, and I just said

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Speaker 3: four plus four plus four equals twelve. If we looked

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Speaker 3: a year ago at this time, we would have said

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Speaker 3: five plus five plus five, and so fifteen was the

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Speaker 3: number on offer, again wildly genericizing across asset based finance

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Speaker 3: and corporate credit and real estate finance and so on.

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Speaker 3: So why did fifteen go to twelve? Because every day

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Speaker 3: the soft landing remains in effect. Is a data landing

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Speaker 3: remains in effect. So the smoother the landing, the better

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Speaker 3: the narrative, and the longer it persists for allows the

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Speaker 3: market to take some return out of the market. So

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Speaker 3: would credit investors rather be investing against fifteen than against twelve? Sure,

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Speaker 3: but twelve works works nicely as well.

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Speaker 1: So you see return staying in the double digits range

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Speaker 1: for the foreseeable that say year or more.

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Speaker 3: Yeah, I think as long as the base rate is high,

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Speaker 3: there's some correlation between all this, right. Some people quote yield,

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Speaker 3: some people quote spread. There's always been correlation between those

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Speaker 3: three components of return. Yeah, But while base rates are

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Speaker 3: in the zone of where they are now, again, forget

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Speaker 3: if they're twenty five high or lower, fifty high or lower.

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Speaker 3: As long as they're in the zone of where they

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Speaker 3: are now, we ought to stay in the type of

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Speaker 3: return environment that we're in. But to your point, if

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Speaker 3: it's a quarter and then a year and then two

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Speaker 3: years where it turns out the economy grew really nicely

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Speaker 3: and earnings have growth has been strong, and inflation got

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Speaker 3: back to target, then yeah, the returns on offer to

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Speaker 3: be a credit investor probably won't be as good then

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Speaker 3: as they are.

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Speaker 4: Today, right, Indeed, good times to be in credit. But

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Speaker 4: then similarly, I want to ask about the state of

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Speaker 4: the US consumer. I cover container shipping, which is very

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Speaker 4: much driven by consumer demand and by the number of

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Speaker 4: containers filled with goods bit clothing, shoes, furniture shipped from

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Speaker 4: Asia to the US personally, with interest rates going from

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Speaker 4: zero to five percent, I'm rather surprised that the consumer

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Speaker 4: demand seems to be holding on at least for now,

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Speaker 4: and this is what container shipping companies that I cover

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Speaker 4: tail investors. But I was curious to hear your views

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Speaker 4: on the state of the UNS consumer going into Q

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Speaker 4: four and next year as well.

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Speaker 3: So the consumer started all this in a really good place.

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Speaker 3: And by the way that's circular, maybe part of the

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Speaker 3: reason that we were in this inflationary environment and that

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Speaker 3: such restrictive monetary policy rates were required is because the

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Speaker 3: consumer was so strong, meaning there was this accumulation of

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Speaker 3: savings post COVID, both from stimulus and from lack of

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Speaker 3: the opportunity to spend as much. Employment stayed really good,

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Speaker 3: and so the consumer came into this period of time

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Speaker 3: with a better financial position than it had had in

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Speaker 3: a really long time. And again on this the real

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Speaker 3: world moves more slowly than the Bloomberg screen we all

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Speaker 3: stare at all day. Takes a while for that to

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Speaker 3: burn off. But you see it in particularly in consumer credit,

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Speaker 3: within asset based finance, you see that that excess has

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Speaker 3: started to burn off, and like it does historically, it

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Speaker 3: starts at the most challenged consumer at the lowest end

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Speaker 3: and then kind of slowly works its way up. But

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Speaker 3: you've seen that in consumer lending delinquencies, You've seen that

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Speaker 3: in subprime audo versus prime auto. So yeah, some of

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Speaker 3: the air is coming out of the ball, and again

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Speaker 3: that shouldn't be a surprise because that's how this all

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Speaker 3: was designed. It was designed to take air out of

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Speaker 3: the ball. And there was a period time at the

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Speaker 3: beginning of the inflation rate period that we're in where

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Speaker 3: inflation was in excess of wage growth, and now you're

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Speaker 3: kind of seeing that catchup. So you're getting the wage

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Speaker 3: growth in excess of the now moderating inflation. And again

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Speaker 3: maybe that's just kind kind of getting back to new.

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Speaker 2: Going into specifics, how does sculpture trade this macro rates view?

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Speaker 2: Where do you see opportunities.

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Speaker 3: So to be clear, we don't intentionally trade the macro

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Speaker 3: rates view. If anything, Our funds generally run duration neutral,

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Speaker 3: or we try to have them be duration neutral, meaning

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Speaker 3: we try not to take the interest rate risk. What

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Speaker 3: we try to take is well selected credit risk, and

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Speaker 3: we try to harvest that complexity premium or that excess

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Speaker 3: spread or that alpha where whether it comes from process

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Speaker 3: or from sourcing, or from complexity or from illiquidity, that's

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Speaker 3: what we're trying to take out of the market, so

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Speaker 3: to speak. And maybe it's worth for a second just

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Speaker 3: laying out the three categories of the credit world that

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Speaker 3: we try to invest in, or the way we define it.

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Speaker 3: There's the corporate credit market. I'll say everyone knows that one.

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Speaker 3: It's when companies are money more or less. There's the

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Speaker 3: real estate credit market, which is think of that as

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Speaker 3: loans on a building or loans on a real estate asset.

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Speaker 3: It's conceptually similar to corporate credit in that it's a

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Speaker 3: single name underwriting. And then there's asset based finance, which

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Speaker 3: is the hardest to define. It's probably the most topical

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Speaker 3: today and maybe the easiest way to start with the

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Speaker 3: definition is asset based finance is everything else so it's

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Speaker 3: all types of credit risk that aren't corporate credit and

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Speaker 3: aren't single name real estate credit. So that includes generally

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Speaker 3: pooled assets or pooled cash flows, or pooled loans of

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Speaker 3: residential real estate, commercial real estate, consumer credit, auto loans,

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Speaker 3: credit card loans, student loans, transportation, aviation, infrastructure. Those are

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Speaker 3: all the underlying feedstock for this asset based finance market.

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Speaker 3: And it includes taking that feedstock or those pools of

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Speaker 3: assets and turning them into securitized products, or turning them

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Speaker 3: into SRTs or CRTs or even unlevered asset pools. So

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Speaker 3: there's the type of risk, which is all those categories

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Speaker 3: I laid out, and then there's the structure of that risk,

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Speaker 3: which can be varied again cash synthetic, thicknches, thin tronches,

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Speaker 3: safe trunches, risky tranches. But it's pooling all those underlying

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Speaker 3: risks into pools that can then be analyzed and assessed.

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Speaker 3: That's what we call asset based finance. I'd say the

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Speaker 3: words it used to be called would include securitized products,

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Speaker 3: structured credit, principal finance, specialty finance, acid based finance reg CAP.

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Speaker 3: All that today we'll put into that ABF bucket.

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Speaker 2: In that acid in that broad universe of acid basin

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Speaker 2: an sid you were just describing wearing partique or do

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Speaker 2: you see the opportunities like are there any specific areas

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Speaker 2: or products that you like more than others? And are

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Speaker 2: there any corners or pockets of that market that you avoid?

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Speaker 3: So it's the common question, and I wish I had

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Speaker 3: a fancier answer to it, which is you know a

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Speaker 3: kind of sector with a bow on it that looks

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Speaker 3: perfectly dislocated. I guess the spoiler alert is that there's

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Speaker 3: not one. And really the inefficiency is in the asset

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Speaker 3: class itself. Well, I'll start with this anything that takes

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Speaker 3: like two or three minutes to even start to describe

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Speaker 3: at a high level, the asset class we're talking about

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Speaker 3: is probably not the world's most efficient asset class. So

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Speaker 3: because there's so much different collateral and so much different structure,

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Speaker 3: and so many different forms of origination, it's an imperfect market.

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Speaker 3: It's a market that's nowhere near as mature as the

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Speaker 3: corporate credit market, and so the opera ortunity comes by

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Speaker 3: waiting for what falls through the cracks. Now, at different

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Speaker 3: points within the last couple of years, has there have

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Speaker 3: there been more distinct themes. Yes, you know, at the

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Speaker 3: beginning of the rate rise, it was, well, home prices

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Speaker 3: must be going down, so you know, anything residential real

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Speaker 3: estate related could be an opportunity. And then at some

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Speaker 3: point it was, you know, commercial real estate is crashing

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Speaker 3: and there's a regional bank crisis, and so anything related

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Speaker 3: to commercial real estate must be the opportunity. And I

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Speaker 3: could kind of keep going with each one, but there

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Speaker 3: isn't a specific dislocation that The prevailing principle across the

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Speaker 3: board in all of asset based finance is that it's

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Speaker 3: generally a wholesale funded market. So when rates go from

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Speaker 3: low to high and spreads go from tight to wide,

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Speaker 3: it's disruptive to a wholesale funded market. And so it

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Speaker 3: doesn't matter if the underlying asset classes a non QM

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Speaker 3: loan or a single family rental pool, or a portfolio

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Speaker 3: of aircraft, whatever it is at that moment in time.

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Speaker 3: It's more that the market structure has been disrupted, and

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Speaker 3: it's disrupted today cyclically, meaning the high rates and the

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Speaker 3: inflationary environment and the regional bank consequences over the subsequent

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Speaker 3: couple of years, and it's disrupted secularly, which is the

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Speaker 3: twenty year trend of more and more regulation on both

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Speaker 3: big banks and small banks.

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Speaker 1: The stuff that falls through the cracks, as you put it,

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Speaker 1: is it falling through the cracks because no one else

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Speaker 1: wants it, because it's toxic, it's distressed, it's something you

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Speaker 1: should be worried about.

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Speaker 3: I would say, falling through the cracks because the market

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Speaker 3: is more immature, and so I'll give you maybe some

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Speaker 3: numbers that would help. When I started in the business,

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Speaker 3: private credit meant direct lending, which meant small to middle

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Speaker 3: market lending, and it was tiny. Today, as we all

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Speaker 3: know and you all cover probably daily, private credit is

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Speaker 3: close to two trillion dollars and direct lending is seventy

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Speaker 3: five percent of that round numbers. So it sort of

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Speaker 3: goes with logic that that market's now more efficient. When

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Speaker 3: a financial sponsor buys a company and they want to

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Speaker 3: borrow the first sixty percent of the capital structure, they

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Speaker 3: can go to the investment banks that have been doing

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Speaker 3: it for eternity. They can now go to the direct

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Speaker 3: lending market, which has trillions of dollars and growing by

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Speaker 3: the day, with I don't know dozens or hundreds of

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Speaker 3: players and so there's going to be some efficiency to

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Speaker 3: that market. Well, the private ABF market today is deminimus,

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Speaker 3: and so it looks a lot from an efficiency standpoint,

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Speaker 3: or from a falling through the crack standpoint, it looks

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Speaker 3: a lot like the direct lending market looked fifteen years ago.

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Speaker 3: It's niche, it's smaller, there are less players, every deal

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Speaker 3: is different, relationships matter, all of that. It's the direct

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Speaker 3: lending from fifteen years ago.

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Speaker 2: And how much do you expect to see this market

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Speaker 2: grow in the next I don't know, five to ten years.

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Speaker 3: So I think because the playbook's already been written by

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Speaker 3: the direct lending market, it won't take as long as

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Speaker 3: that took. Right, So if that took fifteen years to

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Speaker 3: get from a number close to zero to a number

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Speaker 3: close to a couple a trillion, it won't take fifteen years.

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Speaker 3: I don't know if it'll move twice as fast or

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Speaker 3: what the coefficient is, but it'll go faster because the

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Speaker 3: playbook's been written and the players who wrote the playbook

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Speaker 3: are doing it again here. So it's coming to a

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Speaker 3: theater near you.

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Speaker 2: Do you expect it to be I don't know, like

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Speaker 2: five times private credit or seven times the size of

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Speaker 2: private credit quote.

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Speaker 3: And I think that's probably where maybe some of those

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Speaker 3: the numbers you were just thrown out come from. If

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Speaker 3: you look at the underlying markets. The underlying credit markets

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Speaker 3: upon which ABF are based are five to seven times

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Speaker 3: the size of the non investment grade corporate credit market.

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Speaker 3: So it's not illogical to think that it would have

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Speaker 3: to move in that ratio. Right. And again this is

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Speaker 3: these are all widely quoted numbers now. But if you

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Speaker 3: take the direct lending market, the high yield market, and

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Speaker 3: the bronze syndicated loan market and you get to five

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Speaker 3: or six trillion, do that same math on REZI, consumer, commercial, corporate,

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Speaker 3: hard asset, infra, etc. And that five or six is

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Speaker 3: more like twenty five or thirty trillion. And that's what

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Speaker 3: kind of creates some of these eye popping figures as

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Speaker 3: far as predictions for the future. But to be clear,

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Speaker 3: that's happening with or without us, with any of us.

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Speaker 3: It's not a path. What we're focused on is when

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Speaker 3: you start with that market that's five or seven times

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Speaker 3: the size of the corporate market that doesn't yet really

390
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Speaker 3: have an established private credit market, and you're in an

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Speaker 3: environment where the base rates four or five and credit

392
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Speaker 3: spreads are four or five and complexity premiums four or five.

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Speaker 3: We think we've got a good few years ahead of

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Speaker 3: us to go after that opportunity and create some return.

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Speaker 2: Do you have dedicated funds for debt strategy or does

396
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Speaker 2: it come from opportunistic credit or other funds that you

397
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Speaker 2: already have?

398
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Speaker 3: All of the above, all the above, So we do

399
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Speaker 3: it in a few different formats. But you're certainly seeing

400
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Speaker 3: from a again maturation or the very beginnings of maturation,

401
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Speaker 3: the marketplace is now clearly more accepting of the idea

402
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Speaker 3: of an ABF fund. Whereas you know, when we were

403
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Speaker 3: doing this close to twenty years ago, that didn't really exist,

404
00:25:02,960 --> 00:25:05,479
Speaker 3: and so it was very niche and very small, and

405
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Speaker 3: the capital for that had to come from the flexible, tactical,

406
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Speaker 3: opportunistic bucket of an allocator. It wasn't an official allocation

407
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Speaker 3: in the world, It wasn't in a consultant model, it

408
00:25:16,680 --> 00:25:20,639
Speaker 3: wasn't anywhere. What you're seeing today is that it's starting

409
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Speaker 3: to make its way again. It's at the leading edge,

410
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Speaker 3: but it's making its way into the mainstream allocation model.

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Speaker 2: Right. Just to clarify, do you already have a dedicated

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Speaker 2: fund to this or are you fundraising for this strategy?

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Speaker 3: If you can say, I think we can't talk about

414
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Speaker 3: fundraising and I forget exactly how that works, so I'm

415
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Speaker 3: going to avoid it. But suffice it to say, we've

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Speaker 3: been doing it for close to twenty years, we are

417
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Speaker 3: actively doing it today, and we are doing it across

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Speaker 3: a variety of fund structures in the world. Is moving

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Speaker 3: towards ABF as a standalone allocation?

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Speaker 2: And are there any tangible examples on that space that

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Speaker 2: you could provide? And also if you could see what

422
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Speaker 2: kind of returns to they do they offer?

423
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Speaker 3: Yeah, so, so the returns on offer are consistent with

424
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Speaker 3: that that four plus four plus four you know again

425
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Speaker 3: called that low to mid teens returns in terms of example.

426
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Speaker 3: So this is a classic this this this one sort

427
00:26:26,320 --> 00:26:29,680
Speaker 3: of catches all elements of what's topical today in terms

428
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Speaker 3: of pressures on banks, in terms of uh S, r T,

429
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Speaker 3: c RT, you know, again, using all the buzzwords that

430
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Speaker 3: are out there. We were involved in a transaction where

431
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Speaker 3: a bank had been providing warehouse financing for an aggregation

432
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Speaker 3: of single family rental properties that were meant to be

433
00:26:50,840 --> 00:26:55,680
Speaker 3: aggregated until they got large enough to securitize. And as

434
00:26:55,680 --> 00:26:59,280
Speaker 3: the securitization market became disrupted by rates going up and

435
00:26:59,320 --> 00:27:02,440
Speaker 3: spreads going up and the world becoming less comfortable with

436
00:27:02,760 --> 00:27:07,800
Speaker 3: warehouse financing and banks becoming less comfortable with holding risk

437
00:27:07,880 --> 00:27:11,639
Speaker 3: against that, the bank decided that it would like to

438
00:27:11,800 --> 00:27:16,160
Speaker 3: have less of that risk. And so the bank said, Okay,

439
00:27:16,280 --> 00:27:19,720
Speaker 3: if we're lending the first seventy five percent against the

440
00:27:19,800 --> 00:27:24,640
Speaker 3: value of these homes, let's lay off the bottom ten

441
00:27:24,680 --> 00:27:28,560
Speaker 3: points of that. But that sort of transaction is so

442
00:27:29,320 --> 00:27:31,880
Speaker 3: customized that it can't be done in one of these

443
00:27:31,920 --> 00:27:36,040
Speaker 3: broadly syndicated SRTs or CRTs that again we read about

444
00:27:36,040 --> 00:27:39,760
Speaker 3: we hear covered kind of every day. That's a bespoke transaction,

445
00:27:39,960 --> 00:27:42,760
Speaker 3: and so that means the bank can really only call

446
00:27:43,359 --> 00:27:46,119
Speaker 3: a handful of players because it's just too cumbersome to

447
00:27:46,200 --> 00:27:50,240
Speaker 3: do it broadly. And so step number one be one

448
00:27:50,240 --> 00:27:54,679
Speaker 3: of a handful. Step number two be able to be flexible,

449
00:27:54,720 --> 00:27:59,640
Speaker 3: to structure, to work quickly through that collateral. The punchline

450
00:27:59,720 --> 00:28:04,480
Speaker 3: is that for doing all that, we can create what

451
00:28:04,520 --> 00:28:07,639
Speaker 3: we think is safe risk against a portfolio of homes

452
00:28:07,680 --> 00:28:10,040
Speaker 3: with plenty of enhancement by the way. As it turns out,

453
00:28:10,040 --> 00:28:12,120
Speaker 3: home prices didn't go down, they actually kind of kept

454
00:28:12,119 --> 00:28:15,560
Speaker 3: going up and do that for that kind of load

455
00:28:15,560 --> 00:28:17,359
Speaker 3: to mid teens rate of return.

456
00:28:18,720 --> 00:28:22,480
Speaker 1: So in other than real estate, other opportunities in ABF,

457
00:28:22,480 --> 00:28:25,840
Speaker 1: in consumer infrastructure, transport, that kind of thing. I mean,

458
00:28:25,840 --> 00:28:26,840
Speaker 1: you're looking at those deals.

459
00:28:26,920 --> 00:28:30,639
Speaker 3: Yeah, So we did almost identical to the transaction I

460
00:28:30,720 --> 00:28:36,080
Speaker 3: just described with single family rental pools was one that

461
00:28:36,119 --> 00:28:40,480
Speaker 3: we did in the auto finance space. Again, same idea.

462
00:28:40,600 --> 00:28:43,560
Speaker 3: The you know, people talk about this and we're guilty

463
00:28:43,600 --> 00:28:47,160
Speaker 3: of this sometimes as well, like it's some brand new innovation.

464
00:28:47,640 --> 00:28:50,600
Speaker 3: Structured finance has existed for you know, thirty years in

465
00:28:50,640 --> 00:28:53,760
Speaker 3: modern form, and I think thousands before that. Right, it's

466
00:28:53,800 --> 00:28:56,040
Speaker 3: taken up taking a bunch of risk, pulling it together

467
00:28:56,080 --> 00:29:02,280
Speaker 3: and slicing it. And so they're as a in this

468
00:29:02,400 --> 00:29:06,760
Speaker 3: case a smaller scale auto finance platform. Again, if you're

469
00:29:06,800 --> 00:29:11,360
Speaker 3: a huge auto finance platform, you can do a big, syndicated,

470
00:29:11,920 --> 00:29:16,320
Speaker 3: transparent deal that you know, sort of cookie cutter, and

471
00:29:16,360 --> 00:29:19,239
Speaker 3: you're going to get better execution as an issuer. If

472
00:29:19,280 --> 00:29:21,640
Speaker 3: you're smaller and you have this pool of auto loans,

473
00:29:21,640 --> 00:29:23,640
Speaker 3: and maybe they're kind of unique because you're a lender

474
00:29:23,640 --> 00:29:26,160
Speaker 3: that does something a little different, and you don't have

475
00:29:26,200 --> 00:29:29,520
Speaker 3: the kind of balance sheetter financial wherewithal to access capital

476
00:29:29,560 --> 00:29:33,120
Speaker 3: more cheaply, but you still need to accomplish the same objective.

477
00:29:33,680 --> 00:29:37,240
Speaker 3: What does that mean You're going into that bespoke ABF market.

478
00:29:37,360 --> 00:29:41,600
Speaker 3: You're having a handful of conversations to say, how can

479
00:29:41,640 --> 00:29:45,600
Speaker 3: I get capital relief as an issuer or get liquidity

480
00:29:45,640 --> 00:29:49,160
Speaker 3: as an issuer. We look at that and say, Okay,

481
00:29:49,680 --> 00:29:52,400
Speaker 3: we know where double B auto abs ought to be,

482
00:29:52,720 --> 00:29:55,520
Speaker 3: or we know where triple B auto abs ought to be.

483
00:29:56,120 --> 00:30:01,960
Speaker 3: If we can do something private, bespoke, highly structured, sometimes

484
00:30:01,960 --> 00:30:05,800
Speaker 3: that means less liquid sometimes it doesn't. If we can

485
00:30:06,160 --> 00:30:10,120
Speaker 3: create that same risk, but do it for hundreds of

486
00:30:10,120 --> 00:30:13,520
Speaker 3: basis points wider than what exists in the market, that's

487
00:30:13,560 --> 00:30:15,920
Speaker 3: that last four. I keep talking about the four plus

488
00:30:15,960 --> 00:30:19,080
Speaker 3: four plus four. That last four comes from what I

489
00:30:19,200 --> 00:30:22,320
Speaker 3: just described. And again we've done it in various parts

490
00:30:22,360 --> 00:30:25,000
Speaker 3: of REZI and various parts of auto, and various parts

491
00:30:25,000 --> 00:30:30,080
Speaker 3: of consumer, in various parts of the aviation market. All

492
00:30:30,120 --> 00:30:31,720
Speaker 3: of those are are in play.

493
00:30:31,920 --> 00:30:33,000
Speaker 1: How big can these deals be?

494
00:30:33,920 --> 00:30:34,000
Speaker 4: So?

495
00:30:34,280 --> 00:30:40,640
Speaker 3: Interestingly, the bigger the deal, the more efficient to the pricing.

496
00:30:41,440 --> 00:30:46,440
Speaker 3: So there's a correlation sometimes between size and quality. Right,

497
00:30:46,520 --> 00:30:49,880
Speaker 3: So if you're a European bank and you've been doing

498
00:30:51,320 --> 00:30:56,080
Speaker 3: multiple billion dollar SRT transactions under a standard shelf for

499
00:30:56,120 --> 00:31:00,360
Speaker 3: the last twenty years, you're going to get better execution. Right. So,

500
00:31:00,360 --> 00:31:04,680
Speaker 3: if you're the bank with the five billion portfolio, and

501
00:31:05,680 --> 00:31:09,680
Speaker 3: in order to get capital relief, let's say the bank

502
00:31:09,680 --> 00:31:12,680
Speaker 3: would need to lay off or transform ten percent of

503
00:31:12,680 --> 00:31:16,240
Speaker 3: the risk. So five billion portfolio, five hundred million of

504
00:31:16,320 --> 00:31:19,120
Speaker 3: risk transfer. That's a big deal. And that's going to

505
00:31:19,160 --> 00:31:23,560
Speaker 3: be sort of broadly syndicated or at least broadly reached out.

506
00:31:23,600 --> 00:31:25,880
Speaker 3: It's going to follow a kind of standard form. By

507
00:31:25,880 --> 00:31:29,280
Speaker 3: the way, even with all that still pretty attractive. Meaning

508
00:31:29,800 --> 00:31:32,320
Speaker 3: when we're looking at that, we're not saying, oh my gosh,

509
00:31:32,360 --> 00:31:34,360
Speaker 3: that's such a unattractive risk to take. We're saying that's

510
00:31:34,360 --> 00:31:38,520
Speaker 3: actually pretty good risk too. But then take the financial

511
00:31:38,560 --> 00:31:42,400
Speaker 3: institution that has the five hundred million portfolio that needs

512
00:31:42,440 --> 00:31:44,680
Speaker 3: the ten points of relief, and it's the fifty million.

513
00:31:45,440 --> 00:31:48,800
Speaker 3: There's just less players because the sophistication to do that,

514
00:31:49,160 --> 00:31:53,960
Speaker 3: again correlations means big firm, lots of resources, big capital.

515
00:31:56,320 --> 00:31:58,800
Speaker 3: That group would probably rather work on the five hundred

516
00:31:58,800 --> 00:32:01,000
Speaker 3: million dollar check than the fifty million dollar check. And

517
00:32:01,040 --> 00:32:02,920
Speaker 3: again it doesn't have to be so prescriptive, and the

518
00:32:02,960 --> 00:32:06,880
Speaker 3: truth is kind of somewhere in between. But the bigger,

519
00:32:07,040 --> 00:32:12,520
Speaker 3: more standardized transferences of risk, whether that's the sale of

520
00:32:12,600 --> 00:32:15,640
Speaker 3: loans or an SRT or a CRT or some sort

521
00:32:15,640 --> 00:32:21,160
Speaker 3: of structured financing, the really big tends to be more efficient.

522
00:32:21,400 --> 00:32:23,480
Speaker 1: And they are being held for what five to seven years,

523
00:32:23,520 --> 00:32:24,960
Speaker 1: like a private credit deal, that kind of thing.

524
00:32:25,280 --> 00:32:33,680
Speaker 3: It depends, so you know, the classic version of these

525
00:32:33,720 --> 00:32:39,440
Speaker 3: transactions were really post crisis post financial crisis, were the

526
00:32:39,480 --> 00:32:44,200
Speaker 3: corporate revolvers. Because the bank would, for relationship reasons, or

527
00:32:44,240 --> 00:32:47,440
Speaker 3: for investment banking fee reasons, or for cash management effects

528
00:32:47,480 --> 00:32:49,800
Speaker 3: all the other things banks do to make money with corporates,

529
00:32:50,080 --> 00:32:53,600
Speaker 3: they would also extend these revolvers. Revolvers, it turns out,

530
00:32:54,120 --> 00:32:56,480
Speaker 3: are a tough business to make money on, right, because

531
00:32:56,480 --> 00:32:58,360
Speaker 3: a bank needs to hold the capital in case it

532
00:32:58,400 --> 00:33:00,920
Speaker 3: gets drawn, but they don't get paid much for that risk.

533
00:33:00,920 --> 00:33:03,400
Speaker 3: It's kind of a loss leader. And so the one

534
00:33:03,400 --> 00:33:07,520
Speaker 3: of the classic forms of these transactions, a bank would say, Okay,

535
00:33:07,560 --> 00:33:09,960
Speaker 3: here's a pool of ten or fifty or one hundred

536
00:33:10,000 --> 00:33:13,680
Speaker 3: of these names, they you know, all started off as

537
00:33:13,760 --> 00:33:17,160
Speaker 3: five year but there's some you know, some runoff in there,

538
00:33:17,240 --> 00:33:19,920
Speaker 3: so it's a you know, it's a four year waited

539
00:33:19,960 --> 00:33:24,800
Speaker 3: average life portfolio. When you talk about things like consumer

540
00:33:24,920 --> 00:33:28,800
Speaker 3: or auto, those are much shorter. Weaightter average life that

541
00:33:28,880 --> 00:33:31,920
Speaker 3: could be one, two, three years. When we talk about

542
00:33:32,320 --> 00:33:36,360
Speaker 3: capital relief transactions off of warehouse financings, those can be

543
00:33:36,800 --> 00:33:40,880
Speaker 3: twelve or twenty four month maturity, So depends on the collateral.

544
00:33:41,040 --> 00:33:43,720
Speaker 3: If you're talking to someone like aviation, those are seven

545
00:33:43,760 --> 00:33:44,360
Speaker 3: year leases.

546
00:33:45,440 --> 00:33:47,200
Speaker 1: What kind of risks are we running into?

547
00:33:47,200 --> 00:33:47,400
Speaker 3: Though?

548
00:33:48,000 --> 00:33:50,280
Speaker 1: You know, you mentioned the crisis, and there was a

549
00:33:50,320 --> 00:33:53,120
Speaker 1: ton of structure finance pre crisis, and there was a

550
00:33:53,160 --> 00:33:55,240
Speaker 1: ton of stuff being done that really no one kind

551
00:33:55,280 --> 00:33:58,320
Speaker 1: of ended up understanding. It got so complex then it

552
00:33:58,360 --> 00:34:02,440
Speaker 1: will blew up. Are we kind of build another big mess?

553
00:34:02,600 --> 00:34:06,560
Speaker 3: No, So in our mind we're we're if that was

554
00:34:06,600 --> 00:34:10,720
Speaker 3: the pendulum swinging to its furthest point left, we're closer

555
00:34:10,719 --> 00:34:15,799
Speaker 3: to the furthest point right, meaning the hangover from the

556
00:34:15,800 --> 00:34:19,520
Speaker 3: financial crisis, which is a wild thing to me, right,

557
00:34:19,520 --> 00:34:23,080
Speaker 3: because financial markets tend to have much shorter memories. Right, somebody,

558
00:34:23,760 --> 00:34:27,759
Speaker 3: somebody gets burned. Give it a day, week, month, year,

559
00:34:27,840 --> 00:34:32,600
Speaker 3: and you know everyone's back in the game. The financial

560
00:34:32,640 --> 00:34:38,160
Speaker 3: crisis had a much more long lasting shadow overhang impact

561
00:34:39,440 --> 00:34:42,760
Speaker 3: on that market, and you see it in tons of stats,

562
00:34:42,800 --> 00:34:44,600
Speaker 3: and there's some of these charts kind of make their

563
00:34:44,640 --> 00:34:47,439
Speaker 3: way around over and over again. But it's bank share

564
00:34:47,440 --> 00:34:53,360
Speaker 3: of securitization, bank's share of origination, it's credit stats around

565
00:34:53,400 --> 00:34:57,600
Speaker 3: what is being securitized or what's being risk transferred in

566
00:34:57,680 --> 00:35:03,239
Speaker 3: some way, and the the moment in time underwriting from

567
00:35:03,239 --> 00:35:06,200
Speaker 3: before the financial crisis, we are at the other end

568
00:35:06,239 --> 00:35:08,680
Speaker 3: of the spectrum. Maybe we're coming back towards the middle now,

569
00:35:08,719 --> 00:35:12,520
Speaker 3: but we are not on that side of the pendulum

570
00:35:12,600 --> 00:35:14,040
Speaker 3: swing at that era.

571
00:35:14,520 --> 00:35:14,600
Speaker 2: Right.

572
00:35:14,680 --> 00:35:16,840
Speaker 3: If you think about how money gets lost in credit,

573
00:35:18,000 --> 00:35:20,440
Speaker 3: an investor either gets it wrong on the asset side

574
00:35:20,760 --> 00:35:23,799
Speaker 3: or the liability side, meaning you think an asset is

575
00:35:23,800 --> 00:35:27,839
Speaker 3: going to recover par that doesn't, or the liability side.

576
00:35:27,880 --> 00:35:29,799
Speaker 3: Too much leverage or the wrong kind of leverage is

577
00:35:29,880 --> 00:35:34,000
Speaker 3: used to take that risk. Pre financial crisis was both right.

578
00:35:34,040 --> 00:35:38,880
Speaker 3: There were loans against houses or against other assets that

579
00:35:39,920 --> 00:35:44,160
Speaker 3: were closer to worthless than being worth par and there

580
00:35:44,239 --> 00:35:49,200
Speaker 3: was leverage upon leverage upon leverage upon leverage. Both of

581
00:35:49,239 --> 00:35:51,600
Speaker 3: those kind of came out of the market and went

582
00:35:51,640 --> 00:35:54,839
Speaker 3: to the other extreme of the pendulum again, maybe now

583
00:35:54,880 --> 00:35:58,600
Speaker 3: working back towards the middle. But today we don't see

584
00:35:58,640 --> 00:36:02,680
Speaker 3: that type of head scratching behavior on the asset or

585
00:36:02,680 --> 00:36:03,680
Speaker 3: the liability side.

586
00:36:03,719 --> 00:36:07,960
Speaker 4: Really, And going back to your point about finding alpha

587
00:36:08,080 --> 00:36:12,239
Speaker 4: in corporate credit markets, do you have a preference when

588
00:36:12,239 --> 00:36:15,520
Speaker 4: it comes to a specific sector or maybe sectors that

589
00:36:15,600 --> 00:36:17,600
Speaker 4: you are avoiding in today's market.

590
00:36:18,360 --> 00:36:22,560
Speaker 3: Not really. We always try to be you know, most

591
00:36:23,080 --> 00:36:25,160
Speaker 3: most of what I'm talking about here is more on

592
00:36:25,200 --> 00:36:28,399
Speaker 3: the private credit side. But to use an old trader's term,

593
00:36:28,560 --> 00:36:30,840
Speaker 3: no such thing as a bad bond, just a bad price.

594
00:36:32,880 --> 00:36:35,479
Speaker 3: There's no there's there doesn't tend to be something we say,

595
00:36:35,560 --> 00:36:37,400
Speaker 3: you know, we always do this or we never do that.

596
00:36:38,360 --> 00:36:42,239
Speaker 3: We're open based on where we see value, where we

597
00:36:42,280 --> 00:36:44,840
Speaker 3: see loan to value, and where we see pricing, I

598
00:36:44,880 --> 00:36:48,520
Speaker 3: would say from a and this can move across industries.

599
00:36:49,719 --> 00:36:52,440
Speaker 3: Where we've been most active in corporate credit again, a

600
00:36:52,440 --> 00:36:57,279
Speaker 3: topic probably well covered by you all, has been on

601
00:36:57,520 --> 00:37:02,759
Speaker 3: the liability management exercise side of the corporate credit market. Right,

602
00:37:02,840 --> 00:37:04,880
Speaker 3: That's one way of saying it. There's a more cynical

603
00:37:04,880 --> 00:37:07,680
Speaker 3: way of saying it, which is the creditor on creditor violence.

604
00:37:07,719 --> 00:37:13,840
Speaker 3: But the provision of new capital, new credit capital to

605
00:37:13,960 --> 00:37:20,000
Speaker 3: an existing capital structure that might not be sustainable. That

606
00:37:20,080 --> 00:37:23,320
Speaker 3: has been the best opportunity in the corporate credit market

607
00:37:23,360 --> 00:37:25,719
Speaker 3: over the last year or two. I'd say at the

608
00:37:25,800 --> 00:37:30,040
Speaker 3: beginning of the high rates, high inflation period, it was

609
00:37:30,080 --> 00:37:34,560
Speaker 3: more classic dislocation, meaning there were hung financings at banks,

610
00:37:34,560 --> 00:37:38,280
Speaker 3: and there was a secondary market that was sort of crashing,

611
00:37:38,760 --> 00:37:41,520
Speaker 3: and there was a primary market that was frozen and shut.

612
00:37:41,600 --> 00:37:47,240
Speaker 3: And so that's more traditional dislocation. So by good bonds

613
00:37:47,239 --> 00:37:50,040
Speaker 3: and loans in the secondary getting thrown out with the market,

614
00:37:50,680 --> 00:37:55,600
Speaker 3: make safe loans to good companies that have to pay

615
00:37:55,680 --> 00:37:57,960
Speaker 3: up for capital because markets are shut. You know, that

616
00:37:58,080 --> 00:38:02,120
Speaker 3: was maybe the parts of twenty two twenty two. That's

617
00:38:02,160 --> 00:38:05,799
Speaker 3: not the case anymore. I think sometimes it still gets

618
00:38:05,800 --> 00:38:07,439
Speaker 3: talked about it like it's the case, but I would

619
00:38:07,480 --> 00:38:11,120
Speaker 3: say that's not really the case today. Where the opportunity

620
00:38:11,200 --> 00:38:15,320
Speaker 3: set really got to from late twenty three into twenty

621
00:38:15,360 --> 00:38:20,400
Speaker 3: four was more of the existing capital structure, typically in

622
00:38:20,480 --> 00:38:25,440
Speaker 3: a you know, a buyout situation, meaning a leverage buyout

623
00:38:25,600 --> 00:38:30,359
Speaker 3: where when rates were zero. Cash Flow was fine when

624
00:38:30,440 --> 00:38:33,480
Speaker 3: rates were five. Cash flow was not fine when the

625
00:38:33,520 --> 00:38:38,759
Speaker 3: economy was sort of growing massively and margins were peak.

626
00:38:38,840 --> 00:38:41,600
Speaker 3: Maybe it was okay. When the economy slowed a little

627
00:38:41,600 --> 00:38:44,080
Speaker 3: and margins came off peak, maybe not okay. So you

628
00:38:44,160 --> 00:38:48,120
Speaker 3: had this accumulation of cash flows not as good as

629
00:38:48,800 --> 00:38:54,320
Speaker 3: everyone had hoped. Interest eating up most of free cash flow,

630
00:38:54,360 --> 00:38:57,080
Speaker 3: if not more than all of free cash flow i e.

631
00:38:57,280 --> 00:39:01,120
Speaker 3: You know, companies becoming free cash flow negative. And instead

632
00:39:01,120 --> 00:39:05,200
Speaker 3: of the old fashioned way to resolve this, which used

633
00:39:05,200 --> 00:39:08,600
Speaker 3: to be some sort of insolvency proceeding for a whole

634
00:39:08,600 --> 00:39:11,520
Speaker 3: host of reasons, the world evolved to a different way

635
00:39:11,560 --> 00:39:14,560
Speaker 3: of resolving that, which is some version of an extension,

636
00:39:14,680 --> 00:39:17,200
Speaker 3: some version of a moving assets around, some version of

637
00:39:17,239 --> 00:39:23,000
Speaker 3: a moving the capital structure around, and so that that

638
00:39:23,080 --> 00:39:26,040
Speaker 3: premium I keep talking about the third the third four,

639
00:39:26,120 --> 00:39:29,720
Speaker 3: if you will. The best place to find that third

640
00:39:29,800 --> 00:39:32,680
Speaker 3: four in the corporate credit market over the last year

641
00:39:33,200 --> 00:39:40,120
Speaker 3: has been from either the complexity structure sourcing alpha sort

642
00:39:40,120 --> 00:39:45,480
Speaker 3: of tech wherewithal on the technology for this to participate

643
00:39:45,520 --> 00:39:48,759
Speaker 3: in that amend and extent market, or that provision of

644
00:39:48,840 --> 00:39:52,760
Speaker 3: new capital to a stressed capital structure.

645
00:39:54,840 --> 00:39:57,480
Speaker 4: It just maybe a quick follow up on corporate credit

646
00:39:57,800 --> 00:40:01,320
Speaker 4: would be curious to hear your views on six industrials,

647
00:40:02,080 --> 00:40:04,919
Speaker 4: at least from the universe of cyclical names that I cover,

648
00:40:05,040 --> 00:40:08,279
Speaker 4: mostly in Europe, some of them are in the US.

649
00:40:08,280 --> 00:40:12,880
Speaker 4: Spreads are tight compared to historical levels, and credit metrics

650
00:40:12,880 --> 00:40:16,520
Speaker 4: seem to be going in the wrong direction, so to speak.

651
00:40:17,320 --> 00:40:20,800
Speaker 4: Do you think that we're past the peak of the cycle,

652
00:40:21,280 --> 00:40:23,759
Speaker 4: and would you just be maybe more defensive in your

653
00:40:23,800 --> 00:40:27,480
Speaker 4: portfolios going twenty twenty five or is it a question

654
00:40:27,520 --> 00:40:31,640
Speaker 4: of being more selective as you said earlier on cyclical

655
00:40:31,800 --> 00:40:33,040
Speaker 4: industrial names.

656
00:40:33,680 --> 00:40:37,360
Speaker 3: I would say selective, and that's kind of always the answer,

657
00:40:37,400 --> 00:40:42,480
Speaker 3: to be honest. It's about selecting the It's about selecting

658
00:40:42,520 --> 00:40:46,480
Speaker 3: the right names. And so I think there's a broader

659
00:40:46,520 --> 00:40:52,120
Speaker 3: phenomenon that you touched on there, which is hey wire

660
00:40:52,239 --> 00:40:58,320
Speaker 3: spread seemingly tight in cyclical names. If half the time

661
00:40:59,120 --> 00:41:01,760
Speaker 3: we're all talking about an impending recession, that doesn't seem

662
00:41:01,760 --> 00:41:05,399
Speaker 3: to make sense. Two answers to that. One, maybe there's

663
00:41:05,400 --> 00:41:09,200
Speaker 3: not an impending recession, but two, a lot of the

664
00:41:09,200 --> 00:41:14,040
Speaker 3: world of credit investors are yield buyers, so spreads might

665
00:41:14,080 --> 00:41:18,200
Speaker 3: be tighter than opportunistic credit investors want them to be,

666
00:41:18,560 --> 00:41:21,920
Speaker 3: whether that's in European industrial names or just in aggregate.

667
00:41:23,200 --> 00:41:25,840
Speaker 3: But a lot of the world needs a total return,

668
00:41:25,960 --> 00:41:30,799
Speaker 3: needs a total yield, and so whether that part of

669
00:41:30,800 --> 00:41:32,759
Speaker 3: the yield is coming from the base rate or the

670
00:41:32,800 --> 00:41:36,800
Speaker 3: credit spread, maybe isn't as important to a lot of

671
00:41:36,840 --> 00:41:41,960
Speaker 3: those buyers, and so the tighter spread then you'll want

672
00:41:42,000 --> 00:41:44,600
Speaker 3: it to be. So to speak, is an output, not

673
00:41:44,680 --> 00:41:45,240
Speaker 3: an input.

674
00:41:46,600 --> 00:41:49,240
Speaker 2: I wanted to ask you on lme's you were mentioning

675
00:41:49,280 --> 00:41:52,600
Speaker 2: how they have provided great opportunity incorporate credit the last

676
00:41:52,640 --> 00:41:56,160
Speaker 2: couple of years. I wanted to ask your views on

677
00:41:56,800 --> 00:41:59,960
Speaker 2: cooperation agreements because here and here we're starting to see

678
00:42:00,200 --> 00:42:05,440
Speaker 2: them in some situations influenced by US accounts, in situations

679
00:42:05,440 --> 00:42:09,280
Speaker 2: where it's either a cross border like LDS or Altis

680
00:42:09,320 --> 00:42:15,080
Speaker 2: Friends or others like Klogner Pentoplease that it's a German

681
00:42:15,200 --> 00:42:19,799
Speaker 2: name but has US debt, and investors here seemed to

682
00:42:21,600 --> 00:42:25,280
Speaker 2: look at those co op agreements with at least skepticism,

683
00:42:25,320 --> 00:42:30,600
Speaker 2: if not concerned. What's your view on those cope agreements

684
00:42:30,640 --> 00:42:33,760
Speaker 2: that we're also seeing them being longer and longer.

685
00:42:34,600 --> 00:42:39,400
Speaker 3: Sure, so I would say here to stay and just

686
00:42:39,520 --> 00:42:44,200
Speaker 3: the next evolution in the marketplace. So again, if I oversimplify,

687
00:42:45,360 --> 00:42:48,759
Speaker 3: the way it used to work was the first lean

688
00:42:48,880 --> 00:42:51,279
Speaker 3: lender got paid back first, and then the second lean

689
00:42:51,320 --> 00:42:54,040
Speaker 3: lender got paid back, and then the unsecured and then

690
00:42:54,080 --> 00:42:57,600
Speaker 3: whoever was below that, and there was really simple priority

691
00:42:57,600 --> 00:42:59,880
Speaker 3: of payment, and it was really hard for that to

692
00:43:00,160 --> 00:43:04,400
Speaker 3: become altered in any way. And then over a period

693
00:43:04,440 --> 00:43:08,480
Speaker 3: of years, documents became much looser, particularly the ability to

694
00:43:08,560 --> 00:43:11,759
Speaker 3: amend a document with majority as opposed to super majority

695
00:43:12,080 --> 00:43:19,600
Speaker 3: or super duper majority. Market participants meaning borrowers, lenders, banks,

696
00:43:19,640 --> 00:43:25,399
Speaker 3: advisors all got smarter on this technology, and all got

697
00:43:25,440 --> 00:43:30,160
Speaker 3: smarter on how to optimize, and so sponsors started doing

698
00:43:30,520 --> 00:43:36,680
Speaker 3: very aggressive maneuvers. Then new lenders started to take advantage

699
00:43:36,719 --> 00:43:41,880
Speaker 3: of that through the provision of new capital, and sponsors

700
00:43:42,320 --> 00:43:45,920
Speaker 3: then sought a different angle, and the response to that

701
00:43:46,360 --> 00:43:49,359
Speaker 3: was the co op. And so it's just it's this

702
00:43:49,600 --> 00:43:58,200
Speaker 3: ping ponging of capitalism. There's old lenders, new perspective lenders,

703
00:43:58,680 --> 00:44:01,080
Speaker 3: and the borrower. Those are three parties in there. Now,

704
00:44:01,239 --> 00:44:04,920
Speaker 3: a typical situation is way more complex because old lenders

705
00:44:05,000 --> 00:44:08,680
Speaker 3: might be five, six, seven different layers of a capital structure.

706
00:44:08,719 --> 00:44:11,640
Speaker 3: But the pingponging of trying to get an edge, get

707
00:44:11,680 --> 00:44:14,759
Speaker 3: an edge, create a response, create a counter response is

708
00:44:14,800 --> 00:44:19,440
Speaker 3: what led to the co op. And on a no

709
00:44:19,560 --> 00:44:22,080
Speaker 3: names basis, we're in our morning meeting this morning on

710
00:44:22,120 --> 00:44:27,040
Speaker 3: credit debating when a co op might break and there's

711
00:44:27,080 --> 00:44:28,719
Speaker 3: going to be a splinter group off a co op

712
00:44:28,719 --> 00:44:30,480
Speaker 3: that's going to create a new co op. And so

713
00:44:31,200 --> 00:44:34,279
Speaker 3: this is just this is just capitalism at work. It's

714
00:44:34,320 --> 00:44:36,680
Speaker 3: neither good nor bad. It just is. And so the

715
00:44:36,800 --> 00:44:40,600
Speaker 3: job of the credit investor is to make sure you

716
00:44:40,600 --> 00:44:43,600
Speaker 3: can see around that corner again, not every single time,

717
00:44:43,640 --> 00:44:46,279
Speaker 3: but hopefully most of the time, to avoid being on

718
00:44:46,320 --> 00:44:48,440
Speaker 3: the wrong side and hopefully be on the right side.

719
00:44:49,280 --> 00:44:51,719
Speaker 2: And when you say they are here to stay, do

720
00:44:51,840 --> 00:44:54,399
Speaker 2: you see them here to stay in Europe as well?

721
00:44:54,480 --> 00:44:57,200
Speaker 2: Or perhaps director duties are stricter than in the US,

722
00:44:57,280 --> 00:45:02,760
Speaker 2: and this kind of that are typically played in enemies

723
00:45:02,880 --> 00:45:06,120
Speaker 2: like upstreaming are not a thing.

724
00:45:07,560 --> 00:45:10,640
Speaker 3: So yes, I do believe that it's going to be

725
00:45:10,680 --> 00:45:14,840
Speaker 3: there in Europe. Every country in Europe is different. Some

726
00:45:14,880 --> 00:45:17,440
Speaker 3: of the director's duties you're referring to are stronger in

727
00:45:17,480 --> 00:45:22,480
Speaker 3: some countries than other countries, and that director duty angle

728
00:45:23,400 --> 00:45:26,320
Speaker 3: is kind of just for a specific line of attack

729
00:45:26,440 --> 00:45:30,960
Speaker 3: on the creative lme front. So if it's if it's

730
00:45:31,000 --> 00:45:33,719
Speaker 3: not that line of attack, someone will think of a

731
00:45:33,760 --> 00:45:39,800
Speaker 3: really clever new line of attack. So co op agreements

732
00:45:40,640 --> 00:45:43,840
Speaker 3: are as I shouldn't say necessary, are going to be

733
00:45:43,920 --> 00:45:45,960
Speaker 3: as part of the process in Europe as they are

734
00:45:45,960 --> 00:45:49,360
Speaker 3: in the US. Notwithstanding the fact that certain avenues to

735
00:45:49,520 --> 00:45:54,400
Speaker 3: create pressure that are used in the US, and you

736
00:45:54,440 --> 00:45:57,400
Speaker 3: alluded to it, there's fancier ways of talking about it,

737
00:45:57,440 --> 00:46:00,760
Speaker 3: but it's basically the moving of assets up and out.

738
00:46:02,120 --> 00:46:04,080
Speaker 3: It can be harder to do that in certain European

739
00:46:04,160 --> 00:46:08,120
Speaker 3: jurisdictions due to director liability that kind of kicks in

740
00:46:08,520 --> 00:46:12,319
Speaker 3: and around this zone of insolvency concept. But someone will

741
00:46:12,320 --> 00:46:14,279
Speaker 3: think of a new angle and the cop agreement will

742
00:46:14,280 --> 00:46:14,759
Speaker 3: address that.

743
00:46:14,800 --> 00:46:19,600
Speaker 2: One and one thing that we've seen in the restructurings

744
00:46:19,600 --> 00:46:23,440
Speaker 2: in the US in particular with these liability management exercises

745
00:46:23,560 --> 00:46:28,479
Speaker 2: was these creater and creator violence. What are the long

746
00:46:28,560 --> 00:46:34,240
Speaker 2: term negative impacts that you foresee with this kind of trend,

747
00:46:34,840 --> 00:46:35,520
Speaker 2: if any.

748
00:46:36,120 --> 00:46:39,000
Speaker 3: Maybe a cop out, but I view that as not

749
00:46:39,160 --> 00:46:43,400
Speaker 3: our job either, right. Our job is to try and

750
00:46:43,440 --> 00:46:46,080
Speaker 3: make smart credit investments. And so again in the case

751
00:46:46,160 --> 00:46:49,400
Speaker 3: of this specific issue of movement of assets that can

752
00:46:49,480 --> 00:46:51,960
Speaker 3: help one creditor and hurt another. Our job is to

753
00:46:52,040 --> 00:46:54,960
Speaker 3: avoid getting and hurt and to hopefully be on the

754
00:46:55,480 --> 00:46:59,520
Speaker 3: side that gets helped. It's not going away, let's put

755
00:46:59,560 --> 00:47:02,799
Speaker 3: it that way. It's not going away. As long as

756
00:47:02,800 --> 00:47:06,040
Speaker 3: there are contracts, and as long as contract law prevails,

757
00:47:06,320 --> 00:47:09,080
Speaker 3: and as long as there is a capitalist interest on

758
00:47:09,200 --> 00:47:14,640
Speaker 3: all sides amongst all constituents, there will be continued innovation

759
00:47:14,800 --> 00:47:20,560
Speaker 3: in this. So I think there are traditional lenders who

760
00:47:20,600 --> 00:47:22,640
Speaker 3: say this is bad for business, and it's going to

761
00:47:22,719 --> 00:47:25,160
Speaker 3: raise the cost of capital for companies, and everything should

762
00:47:25,160 --> 00:47:26,879
Speaker 3: go back to the simple way it used to be,

763
00:47:27,239 --> 00:47:29,880
Speaker 3: which is if you were the first in line lender,

764
00:47:29,920 --> 00:47:32,760
Speaker 3: you got paid before anyone else, and then the second line,

765
00:47:32,800 --> 00:47:35,400
Speaker 3: second in line lender, and then so on down the line.

766
00:47:35,800 --> 00:47:39,000
Speaker 3: I don't think that's coming back. I think that is

767
00:47:39,520 --> 00:47:41,920
Speaker 3: that is wishful wishful thinking.

768
00:47:42,480 --> 00:47:44,759
Speaker 1: So the year of tit to covenants, that's gone. You can't.

769
00:47:45,520 --> 00:47:51,279
Speaker 3: It'll come and go cyclically. But I don't think that

770
00:47:52,680 --> 00:47:55,799
Speaker 3: we are sort of suddenly all at once going to

771
00:47:55,840 --> 00:48:02,640
Speaker 3: go back to traditional credit document. It's across the board on.

772
00:48:02,520 --> 00:48:05,960
Speaker 1: The structure finance. You launched a platform to invest in

773
00:48:05,960 --> 00:48:09,120
Speaker 1: the riskiest challenges of clos classmized loan obligations earlier this year.

774
00:48:09,120 --> 00:48:10,480
Speaker 1: How's that going? Is that a good business?

775
00:48:11,400 --> 00:48:13,360
Speaker 3: So it's been a great business for a long time.

776
00:48:15,239 --> 00:48:18,239
Speaker 3: It's it doesn't often get discussed this way, but it's

777
00:48:18,360 --> 00:48:21,759
Speaker 3: essentially the arbitrage between the assets spread and the cost

778
00:48:21,760 --> 00:48:24,520
Speaker 3: of liabilities. It's just being a bank, right, That's what

779
00:48:24,560 --> 00:48:27,480
Speaker 3: a bank does. It borrows money in one place and

780
00:48:27,560 --> 00:48:30,239
Speaker 3: lends it in another. And so that's that's what a

781
00:48:30,280 --> 00:48:34,080
Speaker 3: CLO does. It owns a diversified portfolio of loans. Those

782
00:48:34,160 --> 00:48:37,359
Speaker 3: loans pay a spread. That spread is an excess of

783
00:48:37,360 --> 00:48:40,000
Speaker 3: what it costs to finance it on a term non

784
00:48:40,040 --> 00:48:43,040
Speaker 3: mark to market basis. Right, So I'd argue it's it's

785
00:48:43,080 --> 00:48:45,440
Speaker 3: better than the business of banking, because in the business

786
00:48:45,440 --> 00:48:48,640
Speaker 3: of banking, as as people learned over the last couple

787
00:48:48,680 --> 00:48:51,160
Speaker 3: of years, sometimes your funding runs out the door, and

788
00:48:51,200 --> 00:48:53,520
Speaker 3: when your funding can use a mobile phone to do so,

789
00:48:53,560 --> 00:48:58,520
Speaker 3: it runs out even faster. Clos are a term financed

790
00:48:59,480 --> 00:49:05,360
Speaker 3: funding arbitrage. So there are times the arbitrage is wider

791
00:49:05,640 --> 00:49:09,560
Speaker 3: or narrower. There are times where we or others as

792
00:49:09,680 --> 00:49:13,839
Speaker 3: manager do a better or worse job, But fundamentally it's

793
00:49:13,880 --> 00:49:19,360
Speaker 3: a really great tool to extract the assets spread less

794
00:49:19,400 --> 00:49:20,920
Speaker 3: the cost of funds.

795
00:49:21,160 --> 00:49:22,799
Speaker 1: And if you look at all the stuff, you get

796
00:49:22,840 --> 00:49:26,520
Speaker 1: to see, which is quite very broad and global, where

797
00:49:26,600 --> 00:49:28,759
Speaker 1: is the best relative value opportunity right now?

798
00:49:28,920 --> 00:49:33,600
Speaker 3: And why credit broadly? And I just can't get away

799
00:49:33,680 --> 00:49:39,439
Speaker 3: from the four plus four plus four math, especially as

800
00:49:39,480 --> 00:49:44,520
Speaker 3: compared to you know, over almost the last twenty years,

801
00:49:46,040 --> 00:49:48,480
Speaker 3: we haven't had that at all. Right, We've had a

802
00:49:48,520 --> 00:49:52,239
Speaker 3: handful of episodes that are huge dislocations, and that's different, right,

803
00:49:52,280 --> 00:49:57,360
Speaker 3: the GFC and the sovereign debt crisis and the energy crisis,

804
00:49:57,360 --> 00:50:00,279
Speaker 3: the twenty fifteen twenty sixteen period, and the COVID sis.

805
00:50:00,360 --> 00:50:04,120
Speaker 3: That's different if you take just a generic period of time.

806
00:50:05,640 --> 00:50:08,960
Speaker 3: There just hasn't been that much return on offer in credit.

807
00:50:09,960 --> 00:50:16,360
Speaker 3: So where we have dollars that can move between asset classes,

808
00:50:17,880 --> 00:50:20,520
Speaker 3: more of those dollars are deployed in credit. Where we

809
00:50:20,600 --> 00:50:26,200
Speaker 3: have credit funds that can draw down capital, they draw

810
00:50:26,239 --> 00:50:30,200
Speaker 3: it down even faster. Where we have evergreen credit funds,

811
00:50:30,400 --> 00:50:33,880
Speaker 3: they're fully invested. So when we have the chance to

812
00:50:33,920 --> 00:50:36,319
Speaker 3: make these types of returns relative to this type of risk.

813
00:50:37,080 --> 00:50:37,920
Speaker 3: We want to take it.

814
00:50:38,400 --> 00:50:40,160
Speaker 1: The credit people. You know, we live in fear with

815
00:50:41,520 --> 00:50:44,640
Speaker 1: permanently paranoid something's going to happen. I mean, you're not

816
00:50:44,719 --> 00:50:48,480
Speaker 1: thinking it's too good to be true.

817
00:50:48,760 --> 00:50:53,840
Speaker 3: No things, surprises do always happen. They absolutely do happen.

818
00:50:54,120 --> 00:50:58,560
Speaker 3: And so getting back to the point I made earlier,

819
00:50:59,480 --> 00:51:01,759
Speaker 3: at any give point, an investor can mess up on

820
00:51:01,800 --> 00:51:04,920
Speaker 3: the asset side or mess up on the liability side.

821
00:51:05,719 --> 00:51:08,120
Speaker 3: We try to take messing up on the liability side

822
00:51:08,120 --> 00:51:16,080
Speaker 3: out of the equation by using minimal financial leverage and

823
00:51:16,120 --> 00:51:19,040
Speaker 3: in the case of private credit, doing it in funds

824
00:51:19,120 --> 00:51:22,200
Speaker 3: that have multi year time horizons. So if you can

825
00:51:22,239 --> 00:51:26,799
Speaker 3: take the liability side off the table, or you can

826
00:51:26,840 --> 00:51:30,839
Speaker 3: reduce the risk of the liability side, now your risk

827
00:51:30,920 --> 00:51:34,880
Speaker 3: is just on the asset side. And so in generally

828
00:51:34,920 --> 00:51:39,560
Speaker 3: making you know, senior type of loans or taking senior

829
00:51:39,600 --> 00:51:43,120
Speaker 3: type of cash flows, we can do worse than we underwrite.

830
00:51:43,120 --> 00:51:48,560
Speaker 3: But it's hard to to catastrophically get that wrong in aggregate.

831
00:51:49,320 --> 00:51:52,719
Speaker 1: And so nothing at all that worries you about the outlook.

832
00:51:53,280 --> 00:51:57,040
Speaker 3: Now, if there's a recession, put it this way, I'll

833
00:51:57,040 --> 00:52:00,880
Speaker 3: give you I'll give you a scenario again, we're not

834
00:52:01,040 --> 00:52:03,680
Speaker 3: like wildly bullish. Sort of where I'm trying to describe

835
00:52:03,760 --> 00:52:06,600
Speaker 3: is we're not wildly bullish or wildly bearish. We're just

836
00:52:06,680 --> 00:52:09,080
Speaker 3: credit investors. And if we can underwrite low LTVs and

837
00:52:09,120 --> 00:52:11,960
Speaker 3: reasonably say for good assets with good structure, we think

838
00:52:12,000 --> 00:52:13,520
Speaker 3: we're gonna do all right if things are good or

839
00:52:13,520 --> 00:52:18,440
Speaker 3: things are bad in the world. And you know, forgive

840
00:52:18,560 --> 00:52:21,040
Speaker 3: the lack of brilliance there, but those are the two options.

841
00:52:21,120 --> 00:52:22,680
Speaker 3: Things might be kind of good or might be kind

842
00:52:22,680 --> 00:52:24,759
Speaker 3: of bad. And if we think we're okay either way,

843
00:52:25,400 --> 00:52:30,160
Speaker 3: you know that's the goal. Where where could the unexpected

844
00:52:30,200 --> 00:52:36,239
Speaker 3: come from? If inflation were to re accelerate, that would

845
00:52:37,440 --> 00:52:41,160
Speaker 3: be highly disruptive to everything, because if inflation were to

846
00:52:41,200 --> 00:52:46,880
Speaker 3: re accelerate, then the entire framework of don't worry that

847
00:52:47,000 --> 00:52:49,719
Speaker 3: rates are high because they're gonna come down, and that's

848
00:52:49,760 --> 00:52:52,719
Speaker 3: what allows commercial real estate values to stay okay, and

849
00:52:52,800 --> 00:52:56,000
Speaker 3: residential real estate values to stay okay, and corporate multiples

850
00:52:56,000 --> 00:53:03,920
Speaker 3: to stay okay. If that foundational factor were to be challenged,

851
00:53:04,640 --> 00:53:09,600
Speaker 3: that would seriously stir the pot Now for existing investments.

852
00:53:10,520 --> 00:53:12,640
Speaker 3: If you were right that you made a fifty LTV

853
00:53:12,800 --> 00:53:16,000
Speaker 3: loan and the value goes down by fifty percent, You're

854
00:53:16,040 --> 00:53:18,400
Speaker 3: still okay. You're not going to feel great while it's happening,

855
00:53:18,480 --> 00:53:22,440
Speaker 3: but you're still going to be okay. But a reacceleration

856
00:53:22,520 --> 00:53:26,719
Speaker 3: of inflation, that is one of the primary risks. Again,

857
00:53:26,760 --> 00:53:29,560
Speaker 3: we can always make the list of there's geopolitical risk,

858
00:53:29,600 --> 00:53:32,080
Speaker 3: and there's election risk and so on and so on

859
00:53:32,160 --> 00:53:36,960
Speaker 3: and so on, but and those you know, no one

860
00:53:37,040 --> 00:53:39,200
Speaker 3: knew the pandemic a year before the pandemic, right, a

861
00:53:39,239 --> 00:53:40,840
Speaker 3: lot of us knew it the month before, but not

862
00:53:40,880 --> 00:53:45,440
Speaker 3: the year before. That would change everything.

863
00:53:46,280 --> 00:53:49,840
Speaker 1: Great stuff, Jimmy Levin, CEO and chief investment officer of

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Speaker 1: Sculpt the Capital. It's been a pleasure having on the

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Speaker 1: credit edge, Manny. Thanks thanks for having me, and of

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Speaker 1: course we're very grateful to Stefan Kovichef from Bloomberg Intelligence.

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Speaker 1: Thank you for joining us today.

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Speaker 4: Thanks James, nice to be here.

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Speaker 1: And tone Gartia Perez many thanks. Follow her coverage on

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Speaker 1: the terminal and at Bloomberg dot com.

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Speaker 2: Thank you James.

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Speaker 1: For more credit market analysis and insight. Read all of

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Speaker 1: Stefan Kovichev's great work on the Bloomberg terminal. Bloomberg Intelligence

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00:54:12,080 --> 00:54:14,400
Speaker 1: is part of our research department with five hundred analysts

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00:54:14,400 --> 00:54:17,799
Speaker 1: and strategists working across all markets. Coverage includes over two

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Speaker 1: thousand equities and credits and outlooks on more than ninety

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Speaker 1: industries and one hundred market indices, currencies and commodities. Please

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Speaker 1: do subscribe to the Credit Edge wherever you get your podcasts.

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Speaker 1: We're on Apple, Spotify, and all other good podcast providers,

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Speaker 1: including the Bloomberg Terminal at bpod Go. Give us a review,

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Speaker 1: tell your friends, or email me directly at jcrombiight at

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Speaker 1: Bloomberg dot net. I'm James Crombie. It's been a pleasure

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Speaker 1: having you join us again next week on the Credit

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Speaker 1: Edge