1 00:00:17,920 --> 00:00:20,320 Speaker 1: Hello, and welcome to the Credit Edge Weekly Markets Podcast. 2 00:00:20,360 --> 00:00:23,440 Speaker 1: My name is James Crumbie. I'm a senior editor at Bloomberg. 3 00:00:23,400 --> 00:00:25,600 Speaker 2: And I'm John if Cooper, a senior credit analyst at 4 00:00:25,600 --> 00:00:28,840 Speaker 2: Bloomberg Intelligence. This week, we are very pleased to welcome 5 00:00:28,920 --> 00:00:31,640 Speaker 2: Christina Patchett, Associate Managing Director at Moody's. 6 00:00:31,760 --> 00:00:34,320 Speaker 3: How are you, Chris Good pleased to be here. 7 00:00:35,560 --> 00:00:37,720 Speaker 2: Christina, with whom I had the privilege to work a 8 00:00:37,720 --> 00:00:40,919 Speaker 2: few years ago, as a unique perspective on the credit markets. 9 00:00:41,320 --> 00:00:44,400 Speaker 2: Form of her many credit cycles at Moody's and previously 10 00:00:44,400 --> 00:00:47,760 Speaker 2: as an investment banker at JP Morgan, she regularly meets 11 00:00:47,800 --> 00:00:52,120 Speaker 2: with investors, regulators, bankers, and she also chairs many high 12 00:00:52,159 --> 00:00:55,680 Speaker 2: yel rating committees across a broad range of industries. In 13 00:00:55,720 --> 00:00:58,920 Speaker 2: her research, she covers the trends in the credit market, 14 00:00:59,120 --> 00:01:04,160 Speaker 2: including corporate defaults, liquidity, and more recently, the growing private 15 00:01:04,200 --> 00:01:05,039 Speaker 2: credit markets. 16 00:01:05,400 --> 00:01:07,759 Speaker 1: Credit markets are hot, with bond spreads at the titles 17 00:01:07,760 --> 00:01:10,319 Speaker 1: in almost twenty seven years. As demand's sows and net 18 00:01:10,319 --> 00:01:13,720 Speaker 1: new supply remains thin, the buying hasn't been entirely indiscriminate, though, 19 00:01:13,720 --> 00:01:16,080 Speaker 1: with spreads on the riskiest part of the market triple 20 00:01:16,120 --> 00:01:19,280 Speaker 1: C rated bonds staying quite wide. That highlights concerns about 21 00:01:19,360 --> 00:01:21,800 Speaker 1: missed debt payments as rates stay high and the economy 22 00:01:21,800 --> 00:01:24,880 Speaker 1: comes under pressure from tariffs and immigration reform. But it's 23 00:01:24,920 --> 00:01:26,920 Speaker 1: a quite small part of the market and investors don't 24 00:01:26,920 --> 00:01:28,560 Speaker 1: really expect blow ups there to have much of a 25 00:01:28,640 --> 00:01:32,440 Speaker 1: ripple effect. Moody's had a recent report showing that the 26 00:01:32,480 --> 00:01:35,360 Speaker 1: number of companies rated B three and lower hit the 27 00:01:35,400 --> 00:01:38,039 Speaker 1: highest level in almost a year. For our listeners, not 28 00:01:38,120 --> 00:01:41,120 Speaker 1: aware that B three rating is equivalent to B minus 29 00:01:41,120 --> 00:01:43,520 Speaker 1: from other rating agencies, So it's just one notch higher 30 00:01:43,560 --> 00:01:46,360 Speaker 1: than triple C, which is the grade given to companies 31 00:01:46,360 --> 00:01:49,280 Speaker 1: that probably won't pay you back. So Chris break it 32 00:01:49,320 --> 00:01:51,400 Speaker 1: down for us, Why are there more of these very 33 00:01:51,480 --> 00:01:52,680 Speaker 1: risky companies right now? 34 00:01:53,400 --> 00:01:56,960 Speaker 3: Well, there's a number of dynamics at work here, some 35 00:01:57,040 --> 00:01:59,400 Speaker 3: from the past and some from the more recent past. 36 00:02:00,120 --> 00:02:04,080 Speaker 3: So over time, the B three negative list has become 37 00:02:04,320 --> 00:02:08,799 Speaker 3: longer as a consequence of higher rates, really weighing on 38 00:02:08,800 --> 00:02:11,560 Speaker 3: some of the most highly leveraged companies that we follow 39 00:02:11,600 --> 00:02:15,440 Speaker 3: in the specuative grade universe. After April, we had another 40 00:02:15,440 --> 00:02:19,680 Speaker 3: set of challenges around the tariffs and what has happened 41 00:02:19,680 --> 00:02:24,160 Speaker 3: since then is companies that are either cyclical or vulnerables 42 00:02:24,200 --> 00:02:31,440 Speaker 3: to specific tariffs have experienced volatility, uncertainty, and rising costs. 43 00:02:31,600 --> 00:02:34,880 Speaker 3: So there's been a combination of factors, and going forward 44 00:02:34,919 --> 00:02:38,800 Speaker 3: they may also feel pressure on the revenue side as 45 00:02:38,880 --> 00:02:40,600 Speaker 3: consumers become more selective. 46 00:02:41,120 --> 00:02:43,920 Speaker 2: So I guess in terms of sectors, I mean, which 47 00:02:43,960 --> 00:02:45,880 Speaker 2: one are the more exposed and why? 48 00:02:46,520 --> 00:02:51,000 Speaker 3: Well, I think what we see is on the industry side. 49 00:02:51,200 --> 00:02:56,160 Speaker 3: You might think of consumer durables, automotive, We've had some 50 00:02:56,200 --> 00:03:00,640 Speaker 3: pressure in a chemical sector, retail and apparel, and I 51 00:03:00,680 --> 00:03:02,839 Speaker 3: could go on. But there's another way to think about 52 00:03:02,880 --> 00:03:07,519 Speaker 3: this population, and that is LBO versus non a LBO, 53 00:03:07,840 --> 00:03:11,000 Speaker 3: because the majority, the vast majority of the population on 54 00:03:11,040 --> 00:03:15,279 Speaker 3: our distress list are actually LBOs and they've made themselves 55 00:03:15,440 --> 00:03:19,480 Speaker 3: to some degree more vulnerable by virtue of being concentrated 56 00:03:19,520 --> 00:03:22,920 Speaker 3: in floating rate debt, which has put a bigger burden 57 00:03:22,919 --> 00:03:25,560 Speaker 3: on those companies as rates have stayed high. 58 00:03:26,000 --> 00:03:29,720 Speaker 2: But I suppose with you know, tariffs and potential, you 59 00:03:29,720 --> 00:03:33,760 Speaker 2: know margin squeeze effects from those, you know, some subset 60 00:03:34,560 --> 00:03:38,440 Speaker 2: some industries will will probably be more exposed. Is a 61 00:03:38,480 --> 00:03:41,240 Speaker 2: market differentiating that at the moment or are you seeing 62 00:03:41,520 --> 00:03:44,640 Speaker 2: you know, significant difference in terms of you know, default 63 00:03:44,680 --> 00:03:47,120 Speaker 2: rate by by industry or is it pretty homogeneous. 64 00:03:47,680 --> 00:03:52,160 Speaker 3: Well, I think it is very easy to discern where 65 00:03:52,240 --> 00:03:55,640 Speaker 3: there is more skepticism on the part of investors, and 66 00:03:55,720 --> 00:03:59,000 Speaker 3: so you do see weakness in those industries that are 67 00:03:59,000 --> 00:04:04,200 Speaker 3: exposed to as more specifically, and conversely you see demand 68 00:04:04,800 --> 00:04:08,240 Speaker 3: for for example, software companies, and the reason being is 69 00:04:08,280 --> 00:04:11,120 Speaker 3: that they tend to not be cyclical. They don't have 70 00:04:11,160 --> 00:04:15,160 Speaker 3: a lot of a capital expenditure requirements, they're embedded in 71 00:04:15,800 --> 00:04:18,360 Speaker 3: many companies, so the revenue source is a little bit 72 00:04:18,400 --> 00:04:22,440 Speaker 3: more secure. They tend not to be so cyclical. So yes, 73 00:04:22,680 --> 00:04:26,400 Speaker 3: you know, there's winners and losers here for sure. 74 00:04:27,040 --> 00:04:29,760 Speaker 1: Beyond fundamentals, there's also liquidity to consider. I mean, the 75 00:04:29,800 --> 00:04:32,960 Speaker 1: idea generally is that liquidity is very ample for all 76 00:04:33,000 --> 00:04:35,719 Speaker 1: borrowers and they've got many different options, including private credit. 77 00:04:35,760 --> 00:04:37,960 Speaker 1: Is that the case all the way down to B three? 78 00:04:38,600 --> 00:04:41,159 Speaker 3: I would say more than it used to be, because 79 00:04:41,200 --> 00:04:43,239 Speaker 3: that is one of the things that's been notable about 80 00:04:43,240 --> 00:04:46,920 Speaker 3: this market is even with all the uncertainty, there is 81 00:04:46,960 --> 00:04:50,560 Speaker 3: still a fair amount of liquidity. We have seen though 82 00:04:50,680 --> 00:04:54,560 Speaker 3: some different kinds of discrimination. For example, we see that 83 00:04:54,640 --> 00:04:59,520 Speaker 3: the COLO investor has actually decided to more orient towards 84 00:04:59,560 --> 00:05:02,040 Speaker 3: B two A higher ratings, So these be quite comfortable 85 00:05:02,040 --> 00:05:05,160 Speaker 3: with the B three B three structure. Now maybe appeals 86 00:05:05,240 --> 00:05:09,560 Speaker 3: more to private credit B three negative and below distress. 87 00:05:10,400 --> 00:05:13,919 Speaker 3: Everybody kind of hesitates there, although we have seen direct 88 00:05:14,000 --> 00:05:19,000 Speaker 3: lenders at times step in on these weaker credits, whether 89 00:05:19,040 --> 00:05:22,240 Speaker 3: they ask the private equity sponsor to kick in more equity. 90 00:05:22,760 --> 00:05:25,520 Speaker 3: You know, that may be the case. We see that 91 00:05:25,680 --> 00:05:30,120 Speaker 3: much less frequently on the public side. There, we see 92 00:05:30,160 --> 00:05:32,240 Speaker 3: we're more likely to see a distressed exchange. 93 00:05:32,920 --> 00:05:35,920 Speaker 2: Could you maybe be more specific in terms of maybe 94 00:05:35,920 --> 00:05:39,200 Speaker 2: for our listeners what moodies define as a distressed exchange 95 00:05:39,200 --> 00:05:42,640 Speaker 2: as opposed to default of missing an interest payment for instance. 96 00:05:42,920 --> 00:05:46,880 Speaker 3: Sure, because I would say that one person's distressed exchange 97 00:05:46,920 --> 00:05:51,600 Speaker 3: is another person's pick right. For example, in our world, 98 00:05:51,800 --> 00:05:55,599 Speaker 3: if a company has committed to at inception of the transaction, 99 00:05:55,720 --> 00:05:59,760 Speaker 3: committed to servicing their debt and then, due to cash 100 00:05:59,760 --> 00:06:03,960 Speaker 3: flow pressure, converts to picking payment in kind. In other words, 101 00:06:04,000 --> 00:06:07,440 Speaker 3: you build up your debts as opposed to actually providing 102 00:06:07,480 --> 00:06:13,560 Speaker 3: cash interest. For us, that is a default. Secondarily, if 103 00:06:13,600 --> 00:06:17,080 Speaker 3: you amend and extend your credit agreement. That can also 104 00:06:17,120 --> 00:06:21,360 Speaker 3: be considered a default. Not everybody would across Wall Street 105 00:06:21,440 --> 00:06:24,080 Speaker 3: assume that, but for us, it means that you're not 106 00:06:24,200 --> 00:06:27,920 Speaker 3: meeting your original commitment. I think we would all agree 107 00:06:28,320 --> 00:06:31,839 Speaker 3: in regard to distressed exchanges that when somebody gives you 108 00:06:31,920 --> 00:06:34,279 Speaker 3: less than one hundred cents on the dollar to exchange 109 00:06:34,279 --> 00:06:37,200 Speaker 3: your debt, that that's a distressed exchange. 110 00:06:37,400 --> 00:06:39,720 Speaker 1: But that's become so widespread. You know, these what the 111 00:06:39,800 --> 00:06:42,679 Speaker 1: bank is like to called liability management, you know, which 112 00:06:42,760 --> 00:06:45,560 Speaker 1: ultimately is I think a default in disguise, But it 113 00:06:45,600 --> 00:06:49,120 Speaker 1: has become such a common practice, and even I don't know, 114 00:06:49,320 --> 00:06:52,040 Speaker 1: six months ago on this show, one of the investors 115 00:06:52,080 --> 00:06:54,760 Speaker 1: involved was calling it capitalism at work. You know that 116 00:06:54,960 --> 00:06:56,680 Speaker 1: you're just going to see this continue, and it's going 117 00:06:56,720 --> 00:06:59,560 Speaker 1: to get more aggressive. It's going to, you know, ultimately 118 00:06:59,600 --> 00:07:03,000 Speaker 1: impact invests even more. Where do you see this going? 119 00:07:03,080 --> 00:07:04,880 Speaker 1: Is it something that you think is going to spiral 120 00:07:04,960 --> 00:07:06,400 Speaker 1: from here or is it under control? 121 00:07:08,200 --> 00:07:10,120 Speaker 3: Well, I guess the way I would describe it. First 122 00:07:10,120 --> 00:07:12,720 Speaker 3: of all, it is the majority of our defaults. Maybe 123 00:07:12,920 --> 00:07:14,960 Speaker 3: in the last round we looked at it was about 124 00:07:15,040 --> 00:07:18,320 Speaker 3: sixty five percent of total defaults. Were what we would 125 00:07:18,320 --> 00:07:23,560 Speaker 3: call a distressed exchange. Liability management transactions can emerge in 126 00:07:23,560 --> 00:07:29,920 Speaker 3: a variety of factions, some much more punitive to certain 127 00:07:29,920 --> 00:07:33,520 Speaker 3: investors and others, and some of that's been addressed with 128 00:07:33,720 --> 00:07:39,320 Speaker 3: more recent credit agreements trying to prevent these challenges in 129 00:07:39,400 --> 00:07:44,040 Speaker 3: terms of getting primed getting ahead of other lenders for example. 130 00:07:44,960 --> 00:07:49,360 Speaker 3: Whether this will continue, I think absolutely. Law firms are 131 00:07:49,480 --> 00:07:52,760 Speaker 3: very anxious to make as flexible a credit agreement as 132 00:07:52,800 --> 00:07:56,640 Speaker 3: possible for their sponsor clients, and I think there's nothing 133 00:07:56,680 --> 00:07:59,240 Speaker 3: that suggests to me, especially in an environment like this 134 00:07:59,320 --> 00:08:03,120 Speaker 3: where demand is high for paper, that that's going to change. 135 00:08:03,680 --> 00:08:06,360 Speaker 3: One point that we would like to make is there 136 00:08:06,480 --> 00:08:09,440 Speaker 3: is a little bit more movement on the debt investors 137 00:08:09,520 --> 00:08:13,640 Speaker 3: side to maybe cooperate with each other so that it's 138 00:08:13,680 --> 00:08:17,800 Speaker 3: there's less tension between investors, that they aren't feeling vulnerable 139 00:08:17,880 --> 00:08:20,160 Speaker 3: to one pitting one against the other. 140 00:08:20,640 --> 00:08:23,400 Speaker 2: Another theme is is covenants, and I guess maybe they're 141 00:08:23,560 --> 00:08:28,720 Speaker 2: both related. We've seen you know, looser covenants, I guess 142 00:08:28,720 --> 00:08:30,720 Speaker 2: o our time, and that is also on the one 143 00:08:30,720 --> 00:08:34,240 Speaker 2: hand encouraging or creating maybe this kind of face liquidity 144 00:08:34,559 --> 00:08:37,800 Speaker 2: like liquidity. At the same time, those loose covenants may 145 00:08:38,040 --> 00:08:41,920 Speaker 2: also create down the line a much bigger problem for investors. 146 00:08:43,080 --> 00:08:46,520 Speaker 2: What's your opinion or what's your view on the current 147 00:08:46,520 --> 00:08:49,280 Speaker 2: state of the covenant pretiction. 148 00:08:50,000 --> 00:08:52,439 Speaker 3: I think I would say, you know, broadly speaking, they're 149 00:08:52,480 --> 00:08:55,920 Speaker 3: week and they're going to stay weak. That is, if 150 00:08:56,000 --> 00:09:00,319 Speaker 3: you think that the majority of credits that default are 151 00:09:00,559 --> 00:09:05,720 Speaker 3: private equity back to LBOs, they are the borrowers most 152 00:09:05,840 --> 00:09:11,160 Speaker 3: committed to building flexibility into their credit agreements, and they 153 00:09:11,240 --> 00:09:14,880 Speaker 3: frequently succeed, especially in a market where there is demand. 154 00:09:15,720 --> 00:09:19,599 Speaker 3: I think it is probably worth noting that if you 155 00:09:19,679 --> 00:09:24,400 Speaker 3: do a distressed exchange once fix your balance sheet and 156 00:09:24,480 --> 00:09:28,640 Speaker 3: move forward, you actually have a pretty decent recovery, better 157 00:09:28,679 --> 00:09:31,840 Speaker 3: than the long term average if I'm speaking in broad averages. 158 00:09:32,640 --> 00:09:36,360 Speaker 3: But what we sometimes see with companies is they incrementally 159 00:09:36,440 --> 00:09:40,720 Speaker 3: have subsequent distressed exchanges and potentially ending up in a 160 00:09:40,800 --> 00:09:45,600 Speaker 3: chapter eleven that kind of destroys value unequivocally, and those 161 00:09:45,720 --> 00:09:47,320 Speaker 3: recoveries are often the worst. 162 00:09:48,559 --> 00:09:50,599 Speaker 1: Seen one study that suggests it's fifty to fifty. You 163 00:09:50,640 --> 00:09:52,520 Speaker 1: know that half of these things don't actually work out, 164 00:09:52,559 --> 00:09:54,040 Speaker 1: in which case you know the lawyers are getting paid, 165 00:09:54,080 --> 00:09:56,400 Speaker 1: but the problem is not being solved. Is that sort 166 00:09:56,400 --> 00:09:59,679 Speaker 1: of a fair amount, fair assessment of what's going on. 167 00:10:00,720 --> 00:10:03,120 Speaker 3: It's pretty close to true. About half the time you 168 00:10:03,160 --> 00:10:06,000 Speaker 3: do it as stressed exchange, you fix your balance sheet. 169 00:10:06,160 --> 00:10:09,520 Speaker 3: You know, maybe it was a production problem, maybe it 170 00:10:09,679 --> 00:10:13,240 Speaker 3: was a swift change in the rate environment. But half 171 00:10:13,280 --> 00:10:16,280 Speaker 3: the time, yeah, you can. You'll fix your balance sheet, 172 00:10:16,400 --> 00:10:21,000 Speaker 3: move on, and investors actually, relatively speaking. 173 00:10:21,200 --> 00:10:21,720 Speaker 2: Do better. 174 00:10:22,480 --> 00:10:25,000 Speaker 3: If, on the other hand, that the other half of 175 00:10:25,000 --> 00:10:28,640 Speaker 3: the time, yeah, you're just in for a deteriorating credit. 176 00:10:29,720 --> 00:10:31,800 Speaker 3: With valuation dissipating over time. 177 00:10:32,240 --> 00:10:34,040 Speaker 1: There's a bit of a coin toss. I'm glad you 178 00:10:34,080 --> 00:10:36,960 Speaker 1: mentioned recoveries though, because that's also something that has really 179 00:10:37,080 --> 00:10:39,679 Speaker 1: diminished over time. I mean, I remember some years ago 180 00:10:39,800 --> 00:10:42,240 Speaker 1: it must be that you'd expect to get seventy eighty 181 00:10:42,280 --> 00:10:44,199 Speaker 1: cents back on a loan, for example, but now it's 182 00:10:44,200 --> 00:10:47,040 Speaker 1: more like thirty forty. Is that kind of roughly where 183 00:10:47,040 --> 00:10:48,839 Speaker 1: we are and why is that and where does it 184 00:10:48,880 --> 00:10:49,360 Speaker 1: go from here? 185 00:10:50,559 --> 00:10:54,640 Speaker 3: I would say that's a little bit dramatic. So historically 186 00:10:54,880 --> 00:10:58,240 Speaker 3: senior secured loans did recover probably close to eighty cents 187 00:10:58,280 --> 00:11:00,520 Speaker 3: on the dollar, and that's a long term average. We 188 00:11:00,559 --> 00:11:04,480 Speaker 3: have plenty of history to suggests as much. What really 189 00:11:04,559 --> 00:11:08,160 Speaker 3: changed was the balance sheet. And if your entire balance 190 00:11:08,160 --> 00:11:13,160 Speaker 3: sheet is a first lean loan and average recoveries around 191 00:11:13,160 --> 00:11:16,520 Speaker 3: fifty cents, you're going to get fifty cents if that 192 00:11:16,600 --> 00:11:21,680 Speaker 3: particular issuer decides to default. So it's the change in 193 00:11:21,720 --> 00:11:25,680 Speaker 3: the structure. In the old days, which I was present for, 194 00:11:26,679 --> 00:11:29,040 Speaker 3: you had a senior secured loan and you had high 195 00:11:29,080 --> 00:11:33,240 Speaker 3: yield bonds. Highield bonds were unsecured and below the loans 196 00:11:33,320 --> 00:11:38,239 Speaker 3: and absorbed the majority of the risk. After the financial crisis, 197 00:11:38,720 --> 00:11:43,160 Speaker 3: rates went down and the market decided that they liked 198 00:11:43,679 --> 00:11:48,360 Speaker 3: the loan market, they liked the security, and that market exploded, 199 00:11:48,720 --> 00:11:51,600 Speaker 3: and to the extent that now we have plenty of 200 00:11:51,640 --> 00:11:54,480 Speaker 3: credits in the portfolio that are maybe first lean, second lean, 201 00:11:54,559 --> 00:11:59,040 Speaker 3: but both secured loans or first lean only, and those 202 00:12:00,080 --> 00:12:01,360 Speaker 3: in distress do the worst. 203 00:12:02,880 --> 00:12:06,640 Speaker 2: As you said, this market exploded, and I want to say, 204 00:12:06,640 --> 00:12:10,000 Speaker 2: and to some extent so default rates. I think we're 205 00:12:10,040 --> 00:12:12,840 Speaker 2: close to six percent right now. What's your antlouch for 206 00:12:12,960 --> 00:12:15,120 Speaker 2: default rates and why? 207 00:12:15,679 --> 00:12:19,800 Speaker 3: Well, that's an interesting question because while defaults were relatively 208 00:12:19,960 --> 00:12:23,760 Speaker 3: high over the past year, and certainly well above the 209 00:12:23,840 --> 00:12:27,160 Speaker 3: long term average, our forecast by this time next year 210 00:12:27,640 --> 00:12:30,400 Speaker 3: is quite the opposite. So if you think about the 211 00:12:30,480 --> 00:12:33,800 Speaker 3: default rate today at being close to six percent, it's 212 00:12:33,800 --> 00:12:36,760 Speaker 3: probably going to be down around three percent according to 213 00:12:36,840 --> 00:12:40,599 Speaker 3: our forecast by this time next year. The challenge to 214 00:12:40,720 --> 00:12:44,520 Speaker 3: that assumption are many though. There's so much volatility in 215 00:12:44,559 --> 00:12:48,920 Speaker 3: the market now, there's greater than average volatility. When we 216 00:12:48,920 --> 00:12:52,680 Speaker 3: do our forecast, we usually have an optimistic case and 217 00:12:52,720 --> 00:12:56,640 Speaker 3: a pessimistic case. The optimistic case and the base case 218 00:12:56,760 --> 00:12:58,920 Speaker 3: they're right on top of each other. There isn't any 219 00:12:58,960 --> 00:13:02,960 Speaker 3: more to give there the pessimistic case, things could get 220 00:13:03,000 --> 00:13:03,920 Speaker 3: a lot worse. 221 00:13:05,440 --> 00:13:09,000 Speaker 1: What does that rely on? I mean, what is pessimistic? 222 00:13:09,040 --> 00:13:11,400 Speaker 1: I mean there's so many different views of the economy 223 00:13:11,640 --> 00:13:13,120 Speaker 1: and markets right now. What's pessimistic? 224 00:13:13,760 --> 00:13:16,480 Speaker 3: Well, I will say that just to be clear, our 225 00:13:16,520 --> 00:13:19,960 Speaker 3: forecast isn't bottoms up. We're not looking at every credit 226 00:13:20,000 --> 00:13:22,160 Speaker 3: that we rate and saying what does this look like 227 00:13:22,200 --> 00:13:26,560 Speaker 3: when we aggregate this information. It's called a credit transition model, 228 00:13:27,080 --> 00:13:30,040 Speaker 3: and it's driven by the change in ratings, the change 229 00:13:30,040 --> 00:13:35,480 Speaker 3: in outlooks, the change in the momentum of downgrades, then 230 00:13:35,640 --> 00:13:37,800 Speaker 3: the high old spread, the change in the high old spread, 231 00:13:37,840 --> 00:13:41,680 Speaker 3: and the change in unemployment. So with spreads as narrow 232 00:13:41,720 --> 00:13:44,439 Speaker 3: as they are, with the expectation that we might get 233 00:13:44,440 --> 00:13:47,520 Speaker 3: a couple of rate cuts by the end of this year, 234 00:13:48,200 --> 00:13:52,480 Speaker 3: you actually can imagine that the market will strengthen somewhat 235 00:13:52,559 --> 00:13:57,280 Speaker 3: at the low end and default would go down. But 236 00:13:57,480 --> 00:13:59,880 Speaker 3: there's been so much volatility that you can imagine the 237 00:14:00,080 --> 00:14:04,760 Speaker 3: investors would take a different view over the next twelve months, 238 00:14:04,840 --> 00:14:07,439 Speaker 3: and spreads good widen That would be a big driver 239 00:14:07,840 --> 00:14:11,760 Speaker 3: of a change in our forecast, and unemployment, which is 240 00:14:11,800 --> 00:14:17,800 Speaker 3: pretty has remained relatively at modest levels today, could worsen. 241 00:14:19,160 --> 00:14:23,360 Speaker 1: Those are drivers, right, But now we're in a situation where, 242 00:14:23,480 --> 00:14:26,520 Speaker 1: you know, all those things make sort of rational sense 243 00:14:26,600 --> 00:14:31,200 Speaker 1: in sort of macroeconomic terms, textbook style, that we're in 244 00:14:31,200 --> 00:14:33,440 Speaker 1: a world where, you know, can we trust the numbers 245 00:14:33,480 --> 00:14:36,040 Speaker 1: on the unemployment side, can we you know, do we 246 00:14:36,080 --> 00:14:37,920 Speaker 1: know what's going on at the BLS. There's all this 247 00:14:38,000 --> 00:14:40,400 Speaker 1: immigration reform that's muddying the waters a bit. And then 248 00:14:40,480 --> 00:14:42,640 Speaker 1: the other one is spreads, which you mentioned, which I'm 249 00:14:42,680 --> 00:14:45,000 Speaker 1: fascinated by at the moment because for so long now 250 00:14:45,240 --> 00:14:47,240 Speaker 1: people have been asking me why they're so tight when 251 00:14:47,280 --> 00:14:50,440 Speaker 1: you know the macro isn't isn't amazing, It's not brilliant, 252 00:14:50,800 --> 00:14:52,600 Speaker 1: but they just keep getting tight. And I think it's 253 00:14:52,640 --> 00:14:54,720 Speaker 1: just because there's more demand than supply, as simple as that. 254 00:14:56,400 --> 00:14:58,320 Speaker 3: Yeah, No, I agree with you, and I think the 255 00:14:58,440 --> 00:15:03,040 Speaker 3: issue around the supplied demand dynamic works in the favor 256 00:15:03,080 --> 00:15:07,080 Speaker 3: of the market for existing issuers, and it might be 257 00:15:07,160 --> 00:15:10,520 Speaker 3: a technical that allows for them to be that allows 258 00:15:10,560 --> 00:15:13,520 Speaker 3: for more liquidity, but that can prop up the market 259 00:15:13,560 --> 00:15:18,080 Speaker 3: for a while. So with spreads this narrow, you can refinance, 260 00:15:18,200 --> 00:15:22,040 Speaker 3: you can reprice, and that will support a lot of 261 00:15:22,080 --> 00:15:24,760 Speaker 3: the market. It will take much longer, I think for 262 00:15:25,160 --> 00:15:29,800 Speaker 3: a negative momentum to appear when you have this kind 263 00:15:29,880 --> 00:15:34,680 Speaker 3: of demand. It's interesting. You know, economic fundamentals are very important, 264 00:15:35,200 --> 00:15:38,720 Speaker 3: but so it's just you know, having someone who wants 265 00:15:38,800 --> 00:15:42,000 Speaker 3: to invest in your company, and you know, the clos 266 00:15:42,760 --> 00:15:45,160 Speaker 3: in twenty twenty four and twenty twenty five, I think 267 00:15:45,200 --> 00:15:48,560 Speaker 3: that's been incredibly strong new issuance and so that supports 268 00:15:48,600 --> 00:15:49,280 Speaker 3: this market. 269 00:15:50,640 --> 00:15:54,320 Speaker 2: And to your point, there's also fairly new entrant in 270 00:15:54,360 --> 00:15:58,920 Speaker 2: this market is private demand. Private credit. There seems to 271 00:15:58,960 --> 00:16:03,000 Speaker 2: be occurring up tight from you know, private credits, potentially 272 00:16:03,120 --> 00:16:06,840 Speaker 2: opening this to retail investors. At some point. How do 273 00:16:06,920 --> 00:16:09,520 Speaker 2: you see this playing up in the finance and the 274 00:16:09,520 --> 00:16:11,600 Speaker 2: companies that you rate well. 275 00:16:11,640 --> 00:16:15,760 Speaker 3: I think the part of the market that's public will 276 00:16:15,800 --> 00:16:20,840 Speaker 3: continue to potentially actually move to slightly higher credit quality 277 00:16:21,880 --> 00:16:25,360 Speaker 3: because there will be opportunity to go to the private side. 278 00:16:25,480 --> 00:16:28,200 Speaker 3: So if you think, for example, of the leverage loan index, 279 00:16:29,080 --> 00:16:34,800 Speaker 3: it actually weakened pretty dramatically with the demand from clos 280 00:16:34,920 --> 00:16:40,720 Speaker 3: for low rated paper when rates went down. As rates 281 00:16:40,760 --> 00:16:44,000 Speaker 3: went back up, you know, there was this migration as 282 00:16:44,000 --> 00:16:47,400 Speaker 3: I mentioned earlier, from a B three to a B two, 283 00:16:48,680 --> 00:16:53,760 Speaker 3: and actually loan size in the index got larger. So 284 00:16:53,840 --> 00:16:55,880 Speaker 3: if you think of a larger deal and a higher 285 00:16:55,960 --> 00:16:59,480 Speaker 3: rated deal as probably improving credit quality, that's what you'll 286 00:16:59,520 --> 00:17:04,360 Speaker 3: see within the leverage loan market. And those transactions are 287 00:17:04,440 --> 00:17:08,680 Speaker 3: migrating to the private side. So I don't think they're 288 00:17:08,720 --> 00:17:11,200 Speaker 3: going to get smaller. I think there's still a lot 289 00:17:11,240 --> 00:17:14,600 Speaker 3: of liquidity that needs to be put to work, but 290 00:17:14,680 --> 00:17:17,920 Speaker 3: you could actually see better quality on the public side. 291 00:17:19,040 --> 00:17:22,639 Speaker 1: Does that mean that the private markets are essentially paraphrasing 292 00:17:22,880 --> 00:17:25,119 Speaker 1: and probably being crude but taking all the rubbish that 293 00:17:25,119 --> 00:17:27,800 Speaker 1: the public markets don't want, you know, those weaker companies 294 00:17:27,840 --> 00:17:31,200 Speaker 1: are basically paying up for that access. And how sustainable 295 00:17:31,240 --> 00:17:32,280 Speaker 1: is that for their bounds sheets. 296 00:17:33,359 --> 00:17:35,400 Speaker 3: Well, I'm not going to call it rubbish. I would 297 00:17:35,480 --> 00:17:40,080 Speaker 3: call it higher risk. They and they have a different 298 00:17:40,119 --> 00:17:43,760 Speaker 3: relationship with the issuers. For example. What I did say 299 00:17:43,880 --> 00:17:46,960 Speaker 3: earlier is that when you have a public issuer and 300 00:17:47,000 --> 00:17:50,280 Speaker 3: they're in distress, they tend to do a distressed exchange. 301 00:17:50,920 --> 00:17:54,160 Speaker 3: If you have a bilateral relationship with a direct lender, 302 00:17:54,720 --> 00:17:57,639 Speaker 3: you might actually have to put in more equity in 303 00:17:57,800 --> 00:18:01,119 Speaker 3: order to get that revolver extension or the loan extension 304 00:18:01,640 --> 00:18:05,320 Speaker 3: or you know, the ability to pick. So I think 305 00:18:06,640 --> 00:18:10,840 Speaker 3: I think the answer is more complex and more nuanced. 306 00:18:10,840 --> 00:18:15,840 Speaker 3: In that. That being said, I am certainly concerned that 307 00:18:16,080 --> 00:18:21,840 Speaker 3: there is more liquidity than assets to satisfy investors and 308 00:18:21,920 --> 00:18:25,760 Speaker 3: that that is an issue. And the mystery evaluation is 309 00:18:25,840 --> 00:18:30,440 Speaker 3: much higher with all these private companies. You know, if 310 00:18:30,480 --> 00:18:33,760 Speaker 3: you have a publicly traded entity, you have some sense 311 00:18:34,119 --> 00:18:38,200 Speaker 3: of the value not always right right. Market has psychology 312 00:18:38,200 --> 00:18:41,520 Speaker 3: in it as well, but it is much more complicated 313 00:18:41,800 --> 00:18:45,160 Speaker 3: to value non traded assets, for example. 314 00:18:46,240 --> 00:18:49,760 Speaker 2: And that's sim also to create higher risk because on 315 00:18:49,840 --> 00:18:54,359 Speaker 2: the private credit side, especially private credit with more open 316 00:18:54,400 --> 00:18:57,719 Speaker 2: to retail investors, you may have also different you know, 317 00:18:57,760 --> 00:19:01,040 Speaker 2: liquidity needs or demands that and be created, and maybe 318 00:19:01,119 --> 00:19:05,399 Speaker 2: potentially a mismatch between what people are planning to lend 319 00:19:06,160 --> 00:19:09,639 Speaker 2: and for how long and the need to sell some 320 00:19:09,720 --> 00:19:12,840 Speaker 2: of the assets. So it could it be like a 321 00:19:12,880 --> 00:19:16,399 Speaker 2: bit of fatiguing bomb going forward where you may see 322 00:19:16,720 --> 00:19:21,400 Speaker 2: or may see significantly higher assets being financed when they 323 00:19:21,520 --> 00:19:23,639 Speaker 2: could maybe not be before. 324 00:19:23,920 --> 00:19:27,199 Speaker 3: Well, I think on the retail side, the pickup is 325 00:19:27,240 --> 00:19:32,840 Speaker 3: going to be slower than might otherwise happen as a 326 00:19:32,880 --> 00:19:39,600 Speaker 3: consequence of the financial advisors being cautious about introducing these 327 00:19:39,680 --> 00:19:44,000 Speaker 3: kind of assets to you know, within four on one 328 00:19:44,040 --> 00:19:47,240 Speaker 3: case for example, So the pickup may not be as 329 00:19:47,280 --> 00:19:51,720 Speaker 3: aggressive as on the private side, where you have sophisticated 330 00:19:51,760 --> 00:19:56,280 Speaker 3: investors looking for long term returns. You know, the advantage 331 00:19:56,320 --> 00:19:59,879 Speaker 3: of private credit has been that, for example, you have 332 00:20:00,119 --> 00:20:06,160 Speaker 3: large insurance investors that can tolerate volatility because they can 333 00:20:06,320 --> 00:20:09,399 Speaker 3: ride out weakness in a cycle. They have very long 334 00:20:10,160 --> 00:20:13,840 Speaker 3: horizons that they need to invest. Theoretically, so do four 335 00:20:13,880 --> 00:20:16,760 Speaker 3: on one K investors, but they don't always operate that 336 00:20:16,800 --> 00:20:19,879 Speaker 3: way right. Sometimes you actually need to take that cash 337 00:20:19,880 --> 00:20:23,439 Speaker 3: out and they tend to be less sophisticated. There is 338 00:20:23,480 --> 00:20:26,359 Speaker 3: a potential for that part of the market to grow 339 00:20:26,440 --> 00:20:30,320 Speaker 3: more slowly and for more rulemaking to change before that 340 00:20:30,400 --> 00:20:33,399 Speaker 3: becomes a really dominant part of private credit. 341 00:20:33,600 --> 00:20:38,080 Speaker 2: What about disclosure are we are we looking at with 342 00:20:38,160 --> 00:20:42,040 Speaker 2: a more important role played by private credits? Could we 343 00:20:42,080 --> 00:20:45,199 Speaker 2: go towards a model where we are seeing less disclosure 344 00:20:45,800 --> 00:20:49,480 Speaker 2: transaction that being done away from the public eye. Pricing 345 00:20:49,520 --> 00:20:52,720 Speaker 2: reference might actually disappear in the market or when you 346 00:20:52,800 --> 00:20:55,720 Speaker 2: know it's sort of price discovery mode. Do you think 347 00:20:55,760 --> 00:21:00,560 Speaker 2: that that could translate into less disclosure you're in more 348 00:21:00,600 --> 00:21:02,880 Speaker 2: opescity or more omplix transaction. 349 00:21:03,800 --> 00:21:07,840 Speaker 3: Yes, absolutely, and I think that is something that we 350 00:21:08,760 --> 00:21:12,080 Speaker 3: particularly at Moodies, are sensitive to. We rate most of 351 00:21:12,119 --> 00:21:19,520 Speaker 3: the BDC sector, So BDCs are companies that are direct 352 00:21:19,600 --> 00:21:23,600 Speaker 3: lenders acquiring a lot of these leverage loans to LBOs. 353 00:21:24,640 --> 00:21:28,000 Speaker 3: They do have more reporting requirements than other parts of 354 00:21:28,119 --> 00:21:33,080 Speaker 3: private credit. For example, they are publicly traded, they are 355 00:21:33,200 --> 00:21:37,439 Speaker 3: subject to Securities forty Act, and yet it's still a 356 00:21:37,520 --> 00:21:41,560 Speaker 3: challenge to see the underlying performance. But they do have 357 00:21:41,640 --> 00:21:45,560 Speaker 3: to report where the loans are trading every quarter. It's 358 00:21:45,560 --> 00:21:50,560 Speaker 3: still a relatively illiquid market, but it does provide some insight. 359 00:21:50,680 --> 00:21:54,800 Speaker 3: I think the greater concern is potentially other parts of 360 00:21:54,840 --> 00:21:59,720 Speaker 3: private credit which are still evolving and which have less requirements. 361 00:22:00,040 --> 00:22:02,760 Speaker 3: And what we really see now is an immigration to 362 00:22:02,920 --> 00:22:06,840 Speaker 3: what we would call asset based finance and greater incursions 363 00:22:06,840 --> 00:22:13,480 Speaker 3: into securitizations. Those add not just opacity, but also complexity. 364 00:22:13,880 --> 00:22:16,520 Speaker 3: At the same time, I think there's a real demand 365 00:22:16,600 --> 00:22:17,280 Speaker 3: for capital. 366 00:22:17,359 --> 00:22:17,520 Speaker 1: Right. 367 00:22:17,560 --> 00:22:20,480 Speaker 3: Some of the things that they are intending to finance 368 00:22:20,600 --> 00:22:25,879 Speaker 3: is this momentum towards deglobalization, is the need for data centers. 369 00:22:26,000 --> 00:22:30,480 Speaker 3: You know, there are certainly reasons why there's this opportunity 370 00:22:30,560 --> 00:22:35,040 Speaker 3: for private credit. It just it lacks a certain kind 371 00:22:35,040 --> 00:22:36,720 Speaker 3: of transparency and a. 372 00:22:36,720 --> 00:22:39,120 Speaker 1: Lot of that stuff's actually being rated investment rate, isn't. 373 00:22:38,880 --> 00:22:43,359 Speaker 3: It by some body. That's a tough question for me 374 00:22:43,400 --> 00:22:43,879 Speaker 3: to answer. 375 00:22:45,119 --> 00:22:48,320 Speaker 1: Just changing the topic though, back to private equity. You know, 376 00:22:48,359 --> 00:22:51,320 Speaker 1: you mentioned at the top that that has been a 377 00:22:51,359 --> 00:22:54,879 Speaker 1: source of defaults. You know, the LBOs have done at 378 00:22:54,960 --> 00:22:57,240 Speaker 1: very low rates and now they're having to pay that 379 00:22:57,280 --> 00:23:00,240 Speaker 1: money back. Where do we stand with that and what's 380 00:23:00,280 --> 00:23:02,119 Speaker 1: the outlook from here in terms of you know, does 381 00:23:02,200 --> 00:23:04,639 Speaker 1: private actually come back, do LBOs come back? Do you 382 00:23:04,640 --> 00:23:06,639 Speaker 1: expect that to revive it at any point. 383 00:23:07,240 --> 00:23:09,760 Speaker 3: You know, it's an interesting question. We ask ourselves the 384 00:23:09,840 --> 00:23:13,600 Speaker 3: same question. A couple of things are certainly true, which 385 00:23:13,600 --> 00:23:17,720 Speaker 3: has been there's been a really a much slower turnover 386 00:23:18,200 --> 00:23:23,160 Speaker 3: of these LBOs. And we've looked at private equity investors 387 00:23:23,560 --> 00:23:27,159 Speaker 3: holding on to issuers much longer than they would have 388 00:23:27,400 --> 00:23:32,280 Speaker 3: in a different environment. But they bought in a zero 389 00:23:32,359 --> 00:23:35,440 Speaker 3: right environment at a very high multiple, and it's been 390 00:23:35,600 --> 00:23:39,560 Speaker 3: tough as growth has slowed to grow into that balance 391 00:23:39,560 --> 00:23:43,520 Speaker 3: sheet in a satisfactorily in a satisfactory way. So we 392 00:23:43,720 --> 00:23:48,440 Speaker 3: have seen the slow down in exits, and we've seen 393 00:23:48,640 --> 00:23:52,880 Speaker 3: a slow down also in new LBA formation for similar reasons. 394 00:23:52,960 --> 00:23:58,199 Speaker 3: You know, valuations are tough for sellers as well. I 395 00:23:58,240 --> 00:24:03,320 Speaker 3: think though ultimately everyone will need to adjust to the 396 00:24:03,359 --> 00:24:06,600 Speaker 3: new environment and you will see deal flow come back. 397 00:24:06,640 --> 00:24:08,840 Speaker 3: There's too much capital that needs to be put to work. 398 00:24:09,280 --> 00:24:13,639 Speaker 3: It's not going to stay you sort of immobilized forever. 399 00:24:14,359 --> 00:24:16,520 Speaker 3: When we look at the fall now and the relative 400 00:24:16,520 --> 00:24:19,480 Speaker 3: stability we've seen in the economy, I think you could 401 00:24:19,600 --> 00:24:23,560 Speaker 3: imagine this fall being busier than it has been thus far. 402 00:24:25,000 --> 00:24:28,160 Speaker 3: But as I pointed out earlier, there's just much more 403 00:24:28,359 --> 00:24:32,960 Speaker 3: unpredictability within this economy than maybe many of us are 404 00:24:33,000 --> 00:24:36,560 Speaker 3: accustomed to do, and that has been among the valuation 405 00:24:36,680 --> 00:24:40,920 Speaker 3: issues itself. It's not just where rates are, it's not 406 00:24:41,000 --> 00:24:43,840 Speaker 3: just that growth has slowed, But if you don't know 407 00:24:43,880 --> 00:24:48,960 Speaker 3: what's happening next on the tariffs, it's much harder to forecast. 408 00:24:49,480 --> 00:24:52,359 Speaker 2: Maybe take a step back and look at the credit cycle. 409 00:24:52,400 --> 00:24:57,800 Speaker 2: I mean, you have very extensive experience and monitoring and 410 00:24:57,880 --> 00:25:00,560 Speaker 2: filling with credits. Where do you think we are in 411 00:25:00,600 --> 00:25:03,359 Speaker 2: the creative cycle? Are we kind of have we passed 412 00:25:03,400 --> 00:25:07,800 Speaker 2: a peak or or not? Or is it very difficult 413 00:25:07,840 --> 00:25:09,840 Speaker 2: to say because of all those uncertainties you just. 414 00:25:09,840 --> 00:25:14,000 Speaker 3: Mentioned, I think it's harder to call, so thank you 415 00:25:14,000 --> 00:25:18,080 Speaker 3: for putting me on the spot. But I we do 416 00:25:18,160 --> 00:25:21,679 Speaker 3: feel like we've just gone through a pretty notable default cycle. 417 00:25:22,280 --> 00:25:26,719 Speaker 3: We've we've watched some companies get flushed out, you know, 418 00:25:26,880 --> 00:25:31,720 Speaker 3: where where they the multiples were too high, the forecast 419 00:25:31,800 --> 00:25:35,760 Speaker 3: was too optimistic. And I think we've been in this 420 00:25:35,960 --> 00:25:40,560 Speaker 3: environment potentially long enough that there's just going to have 421 00:25:40,680 --> 00:25:44,160 Speaker 3: to be a more conservative take going forward. I think 422 00:25:44,240 --> 00:25:48,040 Speaker 3: it's possible we'll see more equity in some of these 423 00:25:48,160 --> 00:25:53,080 Speaker 3: LBOs as they try and access the market. I say 424 00:25:53,119 --> 00:25:56,840 Speaker 3: that while I would also observe that, I feel like 425 00:25:56,880 --> 00:26:01,000 Speaker 3: we're still going to see documentation being very much on 426 00:26:01,040 --> 00:26:06,680 Speaker 3: the borrowers to the borrowers advantage, and that's how they'll balance, 427 00:26:07,520 --> 00:26:11,120 Speaker 3: you know, the expectation that potentially they create a more 428 00:26:11,160 --> 00:26:12,320 Speaker 3: conservative balance sheet. 429 00:26:13,520 --> 00:26:15,080 Speaker 1: So the default wave is over. 430 00:26:15,960 --> 00:26:20,679 Speaker 3: Oh, you're not going to the default wave is over. 431 00:26:21,960 --> 00:26:26,680 Speaker 3: We are forecasting lower defaults from what we can see today. 432 00:26:27,240 --> 00:26:30,080 Speaker 3: There will always be defaults. You know, we have a 433 00:26:31,000 --> 00:26:35,280 Speaker 3: seventeen zero point five percent of the population is be 434 00:26:35,359 --> 00:26:39,520 Speaker 3: three negative and below. Will continue to see defaults, will 435 00:26:39,520 --> 00:26:41,639 Speaker 3: they be lower than they have been over the past 436 00:26:41,640 --> 00:26:45,200 Speaker 3: twelve months. I think that's what we expect right now. 437 00:26:45,160 --> 00:26:50,199 Speaker 1: And that is essentially speaking to better macroeconomic conditions, better liquidity, 438 00:26:50,320 --> 00:26:53,120 Speaker 1: and the fact that the bad companies have already been 439 00:26:53,160 --> 00:26:58,760 Speaker 1: taken out. Is that yes, fair enough? Sounds quite bullish. Therefore, 440 00:26:59,080 --> 00:27:02,360 Speaker 1: I mean, we debate the what looks like a mismatch 441 00:27:02,359 --> 00:27:08,399 Speaker 1: between economic fundamentals, you know, balance sheets, leverage and the price. 442 00:27:09,119 --> 00:27:11,000 Speaker 1: But it sounds like if we if we're through the 443 00:27:11,040 --> 00:27:13,160 Speaker 1: worst of the defaults and we're coming out and it's 444 00:27:13,200 --> 00:27:15,160 Speaker 1: going to get down to three percent next year, that 445 00:27:15,160 --> 00:27:17,480 Speaker 1: that actually these levels are justified in the market. 446 00:27:17,960 --> 00:27:21,000 Speaker 3: I don't. I don't actually spend most of my day 447 00:27:21,080 --> 00:27:25,960 Speaker 3: thinking about the the right spread for a certain level 448 00:27:26,240 --> 00:27:30,920 Speaker 3: of economic risk. What I would say is that this 449 00:27:30,960 --> 00:27:33,280 Speaker 3: is a heart this is probably and that you can 450 00:27:33,280 --> 00:27:35,800 Speaker 3: speak to CEOs, you can speak to people in the 451 00:27:35,880 --> 00:27:40,320 Speaker 3: in the financial community. This is a hard market to forecast. 452 00:27:41,200 --> 00:27:47,080 Speaker 3: So while I think that we have evidence that you know, 453 00:27:47,119 --> 00:27:51,320 Speaker 3: there's enough stability for for this market, I think that 454 00:27:52,440 --> 00:27:56,440 Speaker 3: it's much harder to say what the longer term impact 455 00:27:57,000 --> 00:28:01,399 Speaker 3: of a materially higher tear for will be on the 456 00:28:01,480 --> 00:28:03,760 Speaker 3: US economy. 457 00:28:03,640 --> 00:28:09,040 Speaker 2: Maybe moving onto the covenants, and you mentioned a couple 458 00:28:09,040 --> 00:28:12,200 Speaker 2: of occasions, but some of the lenders or the investors 459 00:28:12,200 --> 00:28:15,720 Speaker 2: are trying to get together and maybe alter a little 460 00:28:15,720 --> 00:28:20,679 Speaker 2: bit the balance of power between between them. The companies 461 00:28:20,760 --> 00:28:23,480 Speaker 2: or the banks that are bringing deals to the market, 462 00:28:23,600 --> 00:28:26,399 Speaker 2: PE firms and UH and the investors in the end 463 00:28:26,400 --> 00:28:30,720 Speaker 2: support the risk. I also noticed that some companies actually 464 00:28:30,760 --> 00:28:34,880 Speaker 2: have already been pretty aggressive in terms of some examples, 465 00:28:35,119 --> 00:28:40,200 Speaker 2: I think American Greeding Corporation being sold sponsor to sponsor 466 00:28:40,280 --> 00:28:44,680 Speaker 2: without triggering any change of control. Close What are you 467 00:28:45,000 --> 00:28:47,160 Speaker 2: what do you see on your end in terms of 468 00:28:47,280 --> 00:28:50,680 Speaker 2: investors trying to afflict their muscles and and try to 469 00:28:50,760 --> 00:28:53,080 Speaker 2: be maybe a little bit like in the UK, sometimes 470 00:28:53,080 --> 00:28:57,760 Speaker 2: you see maybe more coordination between between investors to try 471 00:28:57,800 --> 00:29:01,080 Speaker 2: to tell the scale to where they're in their favor. 472 00:29:02,680 --> 00:29:06,160 Speaker 3: There's some of that. There's occasions where they decide, you know, 473 00:29:06,240 --> 00:29:09,960 Speaker 3: to you know, coordinate more so that there isn't the 474 00:29:10,080 --> 00:29:13,280 Speaker 3: dispersion in terms of who gets what and who gets primed. 475 00:29:13,760 --> 00:29:17,040 Speaker 3: There's still plenty of opportunities to do that. I think 476 00:29:17,120 --> 00:29:21,040 Speaker 3: also on the sponsor side, they're a little more sensitive 477 00:29:21,080 --> 00:29:26,040 Speaker 3: perhaps and they had been in terms of not alienating investors. 478 00:29:26,600 --> 00:29:30,560 Speaker 3: That being said, I think, to use a cliche, investors 479 00:29:30,600 --> 00:29:34,160 Speaker 3: are often fighting the last war, so you know, some 480 00:29:34,520 --> 00:29:37,200 Speaker 3: part of the covenant gets exploited, they fix that in 481 00:29:37,240 --> 00:29:40,880 Speaker 3: the credit agreement, and then they find a new opportunity. 482 00:29:41,000 --> 00:29:44,080 Speaker 3: That being said, you know, there's also is some discrimination. 483 00:29:44,640 --> 00:29:47,760 Speaker 3: There weren't very many high healed bonds in the market 484 00:29:48,360 --> 00:29:52,680 Speaker 3: in terms of LBOs, but two recent ones I think 485 00:29:52,720 --> 00:29:57,120 Speaker 3: it's called Sizzling Platter that was a B three. They 486 00:29:57,160 --> 00:30:03,320 Speaker 3: tightened up that bond agreement pretty tightly. At the same time, 487 00:30:03,440 --> 00:30:06,760 Speaker 3: there was probably the Sketchers deal. I think they got 488 00:30:06,760 --> 00:30:10,040 Speaker 3: everything they wanted, So now that was a B two. 489 00:30:10,640 --> 00:30:12,800 Speaker 3: I believe actually it might have been a bee too positive. 490 00:30:13,320 --> 00:30:16,120 Speaker 3: So you can see that there is some pressure when 491 00:30:16,200 --> 00:30:21,040 Speaker 3: it comes to better credit quality if there's positive momentum. 492 00:30:21,520 --> 00:30:24,840 Speaker 3: And probably there were a lot of investors interested in 493 00:30:24,880 --> 00:30:28,640 Speaker 3: holding Sketchers, and so they got all the flexibility that 494 00:30:28,720 --> 00:30:32,000 Speaker 3: they asked for pretty much, and Sizzling Platter did not. 495 00:30:34,280 --> 00:30:36,760 Speaker 1: So the covenant outlook is mixed, and it's not really 496 00:30:36,920 --> 00:30:40,240 Speaker 1: like it's getting worse. It's kind of hit a sort 497 00:30:40,280 --> 00:30:42,160 Speaker 1: of stable level. But but I do wonder, you know, 498 00:30:42,200 --> 00:30:44,680 Speaker 1: whether when we see all this, as you said earlier, 499 00:30:44,720 --> 00:30:47,800 Speaker 1: I think excess liquidity not enough to buy, does that 500 00:30:47,880 --> 00:30:50,320 Speaker 1: not just keep the pressure on weaker covenants? Is that 501 00:30:50,400 --> 00:30:52,280 Speaker 1: not going to push it? You know? I mean that 502 00:30:52,320 --> 00:30:54,360 Speaker 1: the lawyer is a key to be as creative as 503 00:30:54,360 --> 00:30:57,239 Speaker 1: they possibly can. So why wouldn't the borrowers jump on it? 504 00:30:57,760 --> 00:31:00,600 Speaker 3: One hundred percent? Yes, I mean I think if you 505 00:31:00,800 --> 00:31:03,920 Speaker 3: have been in this market for as long as I 506 00:31:03,960 --> 00:31:08,560 Speaker 3: have said, you know, twenty five years, covenants are very 507 00:31:08,560 --> 00:31:13,240 Speaker 3: different than they used to be. And I would certainly 508 00:31:13,360 --> 00:31:18,240 Speaker 3: argue that if you want to do something aggressive to 509 00:31:18,400 --> 00:31:26,240 Speaker 3: protect the LBO versus the creditors. You can there are ways. 510 00:31:27,560 --> 00:31:29,959 Speaker 1: Are there any particular areas where we think LBOs might 511 00:31:30,000 --> 00:31:31,440 Speaker 1: make you come back? In terms of sectors, Do you 512 00:31:31,440 --> 00:31:34,000 Speaker 1: think that we're going to see more consolidation in any 513 00:31:34,000 --> 00:31:37,440 Speaker 1: particular and you mentioned software earlier, is that potential an 514 00:31:37,480 --> 00:31:38,040 Speaker 1: area for that. 515 00:31:39,520 --> 00:31:42,320 Speaker 3: I think that that we are going to continue to 516 00:31:42,360 --> 00:31:47,240 Speaker 3: see tech deals for sure. You know, healthcare, we always 517 00:31:47,280 --> 00:31:49,560 Speaker 3: see a lot of service deals. Those are probably the 518 00:31:49,680 --> 00:31:54,680 Speaker 3: three largest exposures, CLOS and BBC's right, both sides of 519 00:31:54,720 --> 00:31:59,560 Speaker 3: the of the LBO market. I think that that will continue. 520 00:32:00,760 --> 00:32:03,200 Speaker 3: I think the tougher deals will be anything that has 521 00:32:04,040 --> 00:32:09,520 Speaker 3: a foreign component. You know, until that gets resolved, that's 522 00:32:09,560 --> 00:32:12,640 Speaker 3: going to put a lot of that will create a 523 00:32:12,680 --> 00:32:14,120 Speaker 3: lot of challenges for businesses. 524 00:32:15,680 --> 00:32:18,160 Speaker 1: So kind of given the impact that trade has had 525 00:32:18,280 --> 00:32:22,080 Speaker 1: on tariffs I've had on the market generally on borrowers 526 00:32:22,080 --> 00:32:24,160 Speaker 1: and the weaker borrowers. You know, we are at a 527 00:32:24,160 --> 00:32:26,920 Speaker 1: point where there is one of our guests called stroke 528 00:32:26,960 --> 00:32:29,960 Speaker 1: of the pen risk and that anything could be signed 529 00:32:30,080 --> 00:32:32,320 Speaker 1: or announced on truth social at any time that could 530 00:32:32,640 --> 00:32:35,800 Speaker 1: fundamentally also the landscape for lots of different companies and 531 00:32:36,360 --> 00:32:39,680 Speaker 1: their balance sheetes do you you know that there are 532 00:32:39,760 --> 00:32:42,360 Speaker 1: more vulnerabilities potentially out there, and that there is more 533 00:32:42,400 --> 00:32:45,640 Speaker 1: political risk now in the US market that the will 534 00:32:45,680 --> 00:32:46,920 Speaker 1: affect leverage finance. 535 00:32:47,960 --> 00:32:51,840 Speaker 3: I think that anything that brings greater volatility to the 536 00:32:52,000 --> 00:32:56,120 Speaker 3: market makes a leverage finance issuer more vulnerable. These are 537 00:32:56,280 --> 00:33:00,760 Speaker 3: highly leveraged companies. You know, it can be geo political, 538 00:33:01,520 --> 00:33:05,360 Speaker 3: it can be oil crisis, right, it can be COVID. 539 00:33:06,080 --> 00:33:09,480 Speaker 3: You know, these are vulnerable companies. You know, when we 540 00:33:09,720 --> 00:33:13,320 Speaker 3: rate a company investment grade, it usually means that it 541 00:33:13,440 --> 00:33:18,960 Speaker 3: can muddle through a variety of cyclical downturns. Low single 542 00:33:19,040 --> 00:33:22,640 Speaker 3: big companies, they're vulnerable to it all. So, yes, none 543 00:33:22,680 --> 00:33:23,880 Speaker 3: of that has changed. 544 00:33:25,360 --> 00:33:29,040 Speaker 2: Very much. Back to the basics of cash flo predictability 545 00:33:29,600 --> 00:33:33,640 Speaker 2: and some companies lending themselves to more suited for an 546 00:33:33,800 --> 00:33:37,600 Speaker 2: LBO than others. I mean you mentioned healthcare. Seen a 547 00:33:37,880 --> 00:33:40,960 Speaker 2: record level of transactions in healthcare, but also very high 548 00:33:41,280 --> 00:33:43,760 Speaker 2: to fools a couple of years ago that I've come 549 00:33:44,080 --> 00:33:47,000 Speaker 2: down quite a bit. But there's also reading uncertainty in 550 00:33:47,040 --> 00:33:49,160 Speaker 2: healthcare right now, so we could see a bit of 551 00:33:49,200 --> 00:33:49,640 Speaker 2: a pee cup. 552 00:33:49,640 --> 00:33:51,960 Speaker 3: I would think that's been a tough one because in 553 00:33:52,160 --> 00:33:56,320 Speaker 3: theory it's appealing for an LBO because you know, it 554 00:33:56,400 --> 00:33:58,920 Speaker 3: tends not to be cyclical, right it take out COVID, 555 00:33:58,960 --> 00:34:03,280 Speaker 3: which obviously riag TABOC in that area, but in general 556 00:34:03,800 --> 00:34:08,040 Speaker 3: it should be a relatively stable on the demand side. 557 00:34:08,800 --> 00:34:12,200 Speaker 3: What has troubled a lot of healthcare companies generally speaking 558 00:34:12,640 --> 00:34:16,440 Speaker 3: is change in the regulatory environment on anticipated changes in 559 00:34:16,520 --> 00:34:19,040 Speaker 3: the regulatory environment, and that those are hard to predict, 560 00:34:19,640 --> 00:34:21,560 Speaker 3: but they can be pretty dramatic when they happen. 561 00:34:23,520 --> 00:34:25,919 Speaker 1: But the risk is more on the foreign ownership side 562 00:34:26,000 --> 00:34:28,160 Speaker 1: given the administration. Is that correct? I mean, if you 563 00:34:28,200 --> 00:34:31,040 Speaker 1: see a company that's got a foreign ownship or it's 564 00:34:31,040 --> 00:34:33,120 Speaker 1: got a foreign angle to it, maybe they impose a 565 00:34:33,160 --> 00:34:38,239 Speaker 1: lot of romative. Is that something that is particularly like 566 00:34:38,280 --> 00:34:40,440 Speaker 1: a red flag for ratings? 567 00:34:42,400 --> 00:34:46,200 Speaker 3: Well, so I would say not foreign ownership, but foreign input, right, 568 00:34:46,480 --> 00:34:51,920 Speaker 3: And so will it take them longer to restructure their 569 00:34:51,960 --> 00:34:56,960 Speaker 3: supply chain things like that? You know, as in everything 570 00:34:57,160 --> 00:34:59,160 Speaker 3: in this market, it kind of depends on the price. 571 00:35:00,200 --> 00:35:02,879 Speaker 3: I can't I could certainly see a private equity firm 572 00:35:02,960 --> 00:35:07,200 Speaker 3: looking at a company and saying, you know, if there 573 00:35:07,239 --> 00:35:10,040 Speaker 3: weren't terriff pressure, it would be a twelve times company 574 00:35:10,239 --> 00:35:12,319 Speaker 3: now it's a nine times company, and I see an 575 00:35:12,360 --> 00:35:15,880 Speaker 3: opportunity here, you know, I don't. I don't think you 576 00:35:16,400 --> 00:35:23,640 Speaker 3: will see no manufacturing deals for example. It's just it 577 00:35:23,760 --> 00:35:27,240 Speaker 3: does create a much difficult forecasting environment. 578 00:35:27,200 --> 00:35:29,839 Speaker 1: And it's across the board. It's not just a couple 579 00:35:29,840 --> 00:35:31,840 Speaker 1: of sectism and that there's more of a like a 580 00:35:31,920 --> 00:35:35,680 Speaker 1: widespread impact on leverage, bonds and loans. 581 00:35:36,960 --> 00:35:37,160 Speaker 2: Yes. 582 00:35:38,040 --> 00:35:38,239 Speaker 1: Yeah. 583 00:35:38,480 --> 00:35:41,600 Speaker 2: As a writer, when you look at a transaction, would you, 584 00:35:42,719 --> 00:35:48,879 Speaker 2: given the uncertainty and the difficulty to forecast earnings, would 585 00:35:48,920 --> 00:35:51,880 Speaker 2: you say that you're inclined to take an even more 586 00:35:51,960 --> 00:35:56,440 Speaker 2: conservative or a more conservative approach to the kind of 587 00:35:56,480 --> 00:35:58,680 Speaker 2: forecast that a company can produce. 588 00:36:00,239 --> 00:36:04,720 Speaker 3: I think analysts are looking at their companies and speaking 589 00:36:04,880 --> 00:36:07,520 Speaker 3: with the CFO and the CEO and trying to come 590 00:36:07,640 --> 00:36:12,480 Speaker 3: up with a realistic scenario. You know, every analyst, probably 591 00:36:12,520 --> 00:36:16,880 Speaker 3: every investor figures out a downside case. You know, determines 592 00:36:16,920 --> 00:36:22,239 Speaker 3: whether the downside case is close to realistic or is 593 00:36:22,320 --> 00:36:26,680 Speaker 3: too dramatic. But I think it's pretty hard not to 594 00:36:26,760 --> 00:36:31,719 Speaker 3: build in a certain amount of conservatism on the on 595 00:36:31,840 --> 00:36:38,319 Speaker 3: the P and L side. But alternatively, you know, there 596 00:36:38,440 --> 00:36:42,120 Speaker 3: is the potential for rates to go down, and that 597 00:36:42,520 --> 00:36:46,760 Speaker 3: means that you might see some increased ability to service 598 00:36:46,840 --> 00:36:50,319 Speaker 3: the debt. So I think everything is being taken into consideration, 599 00:36:50,600 --> 00:36:54,040 Speaker 3: but I think it's fair to say we're pretty conservative 600 00:36:54,200 --> 00:36:57,000 Speaker 3: most of the time. You may remember that, John Eve. 601 00:36:59,880 --> 00:37:01,960 Speaker 1: The reasons, as John you've stated at the top we're 602 00:37:02,000 --> 00:37:04,480 Speaker 1: so delighted to have you on the show, Christina, is 603 00:37:04,520 --> 00:37:06,239 Speaker 1: that you have such a long track record and you've 604 00:37:06,239 --> 00:37:07,879 Speaker 1: seen a lot of things in the market. And I'm 605 00:37:07,880 --> 00:37:11,399 Speaker 1: interested in putting this market into perspective because I've also 606 00:37:11,440 --> 00:37:12,759 Speaker 1: been doing this a fair amount of time. But I 607 00:37:12,840 --> 00:37:15,920 Speaker 1: also find it very confusing in terms of you know, 608 00:37:16,120 --> 00:37:18,560 Speaker 1: what's going on and what the market does in response 609 00:37:18,600 --> 00:37:20,560 Speaker 1: to that, And some of the things that we've seen 610 00:37:20,680 --> 00:37:23,000 Speaker 1: over the last six months would have been enough, I think, 611 00:37:23,080 --> 00:37:26,000 Speaker 1: to cause a major panic, but the market just keeps 612 00:37:26,040 --> 00:37:28,640 Speaker 1: going up. So I'm interested in, you know, if you 613 00:37:28,680 --> 00:37:30,640 Speaker 1: could put it in some kind of historical terms, you know, 614 00:37:31,400 --> 00:37:32,600 Speaker 1: how would you compare this market. 615 00:37:33,600 --> 00:37:36,120 Speaker 3: So a challenging question without having time to think a 616 00:37:36,160 --> 00:37:39,240 Speaker 3: lot about the history. But I would say is most 617 00:37:39,960 --> 00:37:45,040 Speaker 3: pronounced about being involved in leverage finance is it is 618 00:37:45,200 --> 00:37:49,680 Speaker 3: always changing. And I could tell you that you know, 619 00:37:49,760 --> 00:37:52,560 Speaker 3: the first thing that happened when I was following leverage 620 00:37:52,560 --> 00:37:57,400 Speaker 3: finance was Russia defaulted on a response and that impacted 621 00:37:57,480 --> 00:38:00,640 Speaker 3: the US leverage finance market, which was fascinating because you know, 622 00:38:00,800 --> 00:38:05,200 Speaker 3: they seem quite unrelated. So that was in the late nineties, 623 00:38:05,320 --> 00:38:08,880 Speaker 3: and then we went to the dot com bust, and 624 00:38:09,000 --> 00:38:11,919 Speaker 3: there were a couple of other challenges along the way, 625 00:38:12,440 --> 00:38:14,960 Speaker 3: but obviously the big challenge was two thousand and eight, 626 00:38:15,800 --> 00:38:20,600 Speaker 3: and it was very interesting to watch how the change 627 00:38:20,800 --> 00:38:25,760 Speaker 3: in rates really grew this market from what was almost 628 00:38:25,880 --> 00:38:28,520 Speaker 3: exclusively a high yield bond market with a very small 629 00:38:28,600 --> 00:38:31,360 Speaker 3: loan market. The loan market was probably three hundred billion 630 00:38:32,280 --> 00:38:35,600 Speaker 3: prior to the financial crisis to where we are today, 631 00:38:36,360 --> 00:38:38,640 Speaker 3: where if you where the loan market and the bond market, 632 00:38:38,640 --> 00:38:42,040 Speaker 3: they're about the same size, over three trillion dollars together, 633 00:38:43,880 --> 00:38:49,279 Speaker 3: and a real concentration in private equity private companies really 634 00:38:49,360 --> 00:38:52,560 Speaker 3: you know, about half the market or private companies. So 635 00:38:52,719 --> 00:38:58,640 Speaker 3: a lot has changed over time. Not I can't compare 636 00:38:58,760 --> 00:39:03,000 Speaker 3: today to something that we've seen in the past. Almost 637 00:39:03,080 --> 00:39:04,720 Speaker 3: each time it's been quite different. 638 00:39:04,960 --> 00:39:05,080 Speaker 2: Right. 639 00:39:05,560 --> 00:39:09,200 Speaker 3: The last dramatic moment we would probably leave share would 640 00:39:09,200 --> 00:39:13,759 Speaker 3: be COVID that was definitely not foreseen, but the market 641 00:39:13,800 --> 00:39:14,799 Speaker 3: comes back each time. 642 00:39:16,480 --> 00:39:18,640 Speaker 1: And in terms of you know, moodies, we look to 643 00:39:18,680 --> 00:39:23,520 Speaker 1: you to identify risk and I'm keen to know if 644 00:39:23,640 --> 00:39:25,400 Speaker 1: you know, we've we've talked about a lot today, But 645 00:39:25,520 --> 00:39:27,360 Speaker 1: is there anything else else out there that you should 646 00:39:27,920 --> 00:39:30,080 Speaker 1: think we should be more focused on, we should be 647 00:39:30,120 --> 00:39:32,360 Speaker 1: worried about in terms of, you know, potential canaries in 648 00:39:32,360 --> 00:39:33,640 Speaker 1: the coal mine for leverage finance. 649 00:39:34,719 --> 00:39:38,200 Speaker 3: I think what I pay attention to when I think 650 00:39:38,320 --> 00:39:41,480 Speaker 3: broadly about the space as opposed to you know, individual 651 00:39:41,640 --> 00:39:45,960 Speaker 3: ratings or our default forecast, is just given how much 652 00:39:46,040 --> 00:39:50,200 Speaker 3: liquidity there is in the market today, is there a 653 00:39:50,360 --> 00:39:55,240 Speaker 3: concern around valuation broadly? As more of the market is private, 654 00:39:55,360 --> 00:39:58,440 Speaker 3: whether it's in the leverage loan market on the rated 655 00:39:58,760 --> 00:40:04,440 Speaker 3: side or within the direct lenders, it's just tougher to 656 00:40:05,600 --> 00:40:09,080 Speaker 3: get that kind of information, So that I think that's 657 00:40:09,120 --> 00:40:12,319 Speaker 3: something that is probably one of the big differences as 658 00:40:12,400 --> 00:40:15,600 Speaker 3: we've evolved over time in this market that I think 659 00:40:15,640 --> 00:40:16,440 Speaker 3: I keep an eye. 660 00:40:16,320 --> 00:40:20,760 Speaker 1: On that ultimately leads to investors overpaying and then suffering 661 00:40:20,800 --> 00:40:21,880 Speaker 1: losses down the road. 662 00:40:23,320 --> 00:40:26,840 Speaker 3: Could but doesn't have to you know, the problems you 663 00:40:26,880 --> 00:40:30,200 Speaker 3: don't know and when it starts to become a parent 664 00:40:30,400 --> 00:40:32,360 Speaker 3: is later than you're accustomed to. 665 00:40:33,719 --> 00:40:36,319 Speaker 1: Great stuff. Christina Paget, Associate Managing Director with Moodies. It's 666 00:40:36,320 --> 00:40:38,960 Speaker 1: been a pleasure having you on the Credit Edge. Thanks, 667 00:40:39,840 --> 00:40:41,880 Speaker 1: and of course I'm very grateful to Johnny Coupan from 668 00:40:41,920 --> 00:40:44,160 Speaker 1: Bloomberg Intelligence. Thank you very much for joining us today. 669 00:40:44,480 --> 00:40:46,759 Speaker 1: For more credit market analysis and insight, read all of 670 00:40:46,800 --> 00:40:50,200 Speaker 1: Johnny Coupan's great work on the Bloomberg Terminal. Bloomberg Intelligence 671 00:40:50,280 --> 00:40:52,640 Speaker 1: is part of our research department, with five hundred analysts 672 00:40:52,680 --> 00:40:56,399 Speaker 1: and strategists working across all markets. Coverage includes over two 673 00:40:56,400 --> 00:40:59,080 Speaker 1: thousand equities and credits and outlooks on more than ninety 674 00:40:59,160 --> 00:41:04,000 Speaker 1: industries and one hundred market indices, currencies and commodities. Please 675 00:41:04,080 --> 00:41:06,680 Speaker 1: do subscribe to the Credit Edge wherever you get your podcasts. 676 00:41:06,760 --> 00:41:09,600 Speaker 1: We're on Apple, Spotify and all other good podcast providers, 677 00:41:09,640 --> 00:41:13,400 Speaker 1: including the Bloomberg Terminal at bpod Go. Give us a review, 678 00:41:13,680 --> 00:41:16,400 Speaker 1: tell your friends, or email me directly at Jcrombier at 679 00:41:16,440 --> 00:41:20,040 Speaker 1: Bloomberg dot net. I'm James Crombie. It's been a pleasure 680 00:41:20,080 --> 00:41:22,879 Speaker 1: having you join us again next week on the Credit Edge.