1 00:00:19,040 --> 00:00:21,600 Speaker 1: Hello, Welcome to the Credit Edge, a weekly markets podcast. 2 00:00:21,680 --> 00:00:24,520 Speaker 1: My name is James Crumbie. I'm a senior editor at Bloomberg, and. 3 00:00:24,480 --> 00:00:27,640 Speaker 2: I'm Tim Riminton, a senior credit analyst covering basic materials 4 00:00:27,680 --> 00:00:30,480 Speaker 2: here at Bloomberg Intelligence. This week, we're really pleased to 5 00:00:30,520 --> 00:00:34,160 Speaker 2: be joined by Jackson Craig, who co heads HIG Bayside, 6 00:00:34,360 --> 00:00:37,080 Speaker 2: the credit focused arm of HID Capital, which is a 7 00:00:37,120 --> 00:00:40,760 Speaker 2: global alternative investment firm with about seventy four billion of 8 00:00:40,800 --> 00:00:44,360 Speaker 2: capital under management across a range of strategies including private 9 00:00:44,400 --> 00:00:48,080 Speaker 2: equity and of course special situations. Jackson, welcome, How are 10 00:00:48,120 --> 00:00:48,720 Speaker 2: you doing today? 11 00:00:49,040 --> 00:00:51,559 Speaker 3: Very well, very well, Thanks for having me pleasure. 12 00:00:51,840 --> 00:00:54,600 Speaker 2: Jackson is part of the Senior leadership team at HIG, 13 00:00:54,760 --> 00:00:58,240 Speaker 2: where he focuses on special situations, overseeing all aspects of 14 00:00:58,240 --> 00:01:03,680 Speaker 2: the investment process, sourcing, transaction, structuring, financing, post closing, growth strategies, 15 00:01:03,800 --> 00:01:07,120 Speaker 2: looking at both public and private credit opportunities. He's been 16 00:01:07,160 --> 00:01:09,760 Speaker 2: at HIG for over fifteen years now. Prior to that, 17 00:01:09,880 --> 00:01:13,840 Speaker 2: he co managed private equity at DDJ Capital Management that's 18 00:01:13,880 --> 00:01:16,160 Speaker 2: now Pollen Capital, and was also a desk analyst with 19 00:01:16,200 --> 00:01:19,240 Speaker 2: Morgan Stanley's Special situations team. It's great to have you here. 20 00:01:19,280 --> 00:01:22,240 Speaker 2: With us, Jackson, special situations are becoming ever more topical 21 00:01:22,280 --> 00:01:25,280 Speaker 2: than certain sectors, including in my focus chemicals. So we're 22 00:01:25,319 --> 00:01:27,920 Speaker 2: all keen to hear your insights, especially as you see 23 00:01:27,920 --> 00:01:30,280 Speaker 2: both the private and the public side. And I'm going 24 00:01:30,280 --> 00:01:32,600 Speaker 2: to hand over to James now to get things kicked off. 25 00:01:32,760 --> 00:01:33,480 Speaker 3: Thanks Tim. 26 00:01:33,520 --> 00:01:35,560 Speaker 1: So Yeah, as we keep saying here, debt spreads just 27 00:01:35,640 --> 00:01:38,920 Speaker 1: keep grinding tighter, the stock market just keeps hitting new highs, 28 00:01:39,200 --> 00:01:41,600 Speaker 1: and the US economy is chugging along at a steady 29 00:01:41,640 --> 00:01:44,119 Speaker 1: pace with a high likelihood of government stimulus to keep 30 00:01:44,120 --> 00:01:48,320 Speaker 1: it going. And yet your business sounds like it's booming, Jackson. 31 00:01:48,360 --> 00:01:50,640 Speaker 1: There are a lot more bad loans out there, including 32 00:01:50,640 --> 00:01:53,480 Speaker 1: private credit, and the lenders seem quite keen to get out. 33 00:01:53,920 --> 00:01:56,760 Speaker 1: So I'm interested if you could break it down for us. 34 00:01:56,800 --> 00:01:59,440 Speaker 1: Why is there so much distress right now when the 35 00:01:59,480 --> 00:02:01,440 Speaker 1: economy seems to be doing so well? 36 00:02:01,880 --> 00:02:04,520 Speaker 3: Yeah, good question. And I got this question yesterday from 37 00:02:04,560 --> 00:02:07,160 Speaker 3: one of urlps asking the exact same thing and pointing 38 00:02:07,200 --> 00:02:11,320 Speaker 3: to the exact same macrostats, stocks and spreads, which are 39 00:02:11,360 --> 00:02:13,600 Speaker 3: both at the highs and the tights. As has been 40 00:02:13,639 --> 00:02:16,720 Speaker 3: well reported. If you look at our investible market, I'll 41 00:02:16,720 --> 00:02:21,120 Speaker 3: break it into two pieces. The first is purchasing loans 42 00:02:21,120 --> 00:02:23,959 Speaker 3: in the secondary market. We're a stressed and distress strategy. 43 00:02:24,000 --> 00:02:27,239 Speaker 3: That's where we spend our time and buying stress and 44 00:02:27,240 --> 00:02:30,240 Speaker 3: distress debt in the secondary market, typically from Colos is 45 00:02:30,280 --> 00:02:33,840 Speaker 3: our bread and butter. That universe of loans, which is 46 00:02:34,080 --> 00:02:37,080 Speaker 3: a little over a trillion dollars in size, has had 47 00:02:37,240 --> 00:02:42,639 Speaker 3: a notable degradation and credit quality really since rates collapsed. 48 00:02:43,040 --> 00:02:46,080 Speaker 3: The low interest rate environment led to increased risk taking 49 00:02:46,320 --> 00:02:50,200 Speaker 3: in that forum, and it's resulted in a population of 50 00:02:50,280 --> 00:02:55,200 Speaker 3: loans which have a historically low average credit quality. Right now, 51 00:02:55,320 --> 00:02:58,320 Speaker 3: the portion of the loan market that is rated B 52 00:02:58,440 --> 00:03:01,920 Speaker 3: three B minus and below is right around twenty five percent. 53 00:03:02,280 --> 00:03:04,480 Speaker 3: SMP has a little higher, Moodies has at the lower 54 00:03:04,520 --> 00:03:07,760 Speaker 3: but that's a good yoidstick that is maybe two x 55 00:03:08,160 --> 00:03:11,359 Speaker 3: what it was ten fifteen years ago. And so when 56 00:03:11,400 --> 00:03:13,280 Speaker 3: you look at the at the level of stress and 57 00:03:13,280 --> 00:03:16,120 Speaker 3: distressed in the loan market right now, and as a 58 00:03:16,360 --> 00:03:19,560 Speaker 3: as a benchmark, there's over one hundred billion dollars of 59 00:03:19,720 --> 00:03:22,760 Speaker 3: loans trading below eighty cents right now. That's about seven 60 00:03:22,800 --> 00:03:26,919 Speaker 3: percent of the overall market. It's the result of that 61 00:03:26,960 --> 00:03:31,480 Speaker 3: degradation and credit quality that drift towards lower ratings, coupled 62 00:03:31,520 --> 00:03:34,280 Speaker 3: with an extended period of higher interest rates. I won't 63 00:03:34,280 --> 00:03:37,040 Speaker 3: call them high because historically they're probably closer to average, 64 00:03:37,440 --> 00:03:40,200 Speaker 3: but higher interest rates than maybe these capital structures were 65 00:03:40,200 --> 00:03:43,600 Speaker 3: anticipated to see. And so just the passage of time, 66 00:03:43,960 --> 00:03:47,960 Speaker 3: low credit quality, high rates equals elevated stress and distressed, 67 00:03:48,120 --> 00:03:50,800 Speaker 3: and so that's the first piece. The second piece is 68 00:03:50,840 --> 00:03:53,600 Speaker 3: on the private credit side, they're seeing a slightly different 69 00:03:53,640 --> 00:03:56,400 Speaker 3: story where you've had a number of years of very 70 00:03:56,440 --> 00:03:59,000 Speaker 3: strong secular growth in that asset class, which has been 71 00:03:59,120 --> 00:04:02,080 Speaker 3: very well reported. Fundraising has been strong, deployments have been strong. 72 00:04:02,080 --> 00:04:05,520 Speaker 3: They're taking share from the syndicated loan market, especially at 73 00:04:05,520 --> 00:04:09,200 Speaker 3: the lower end. But as those loans get issued, they 74 00:04:09,920 --> 00:04:13,240 Speaker 3: it's just a natural seasoning. The average period from issuance 75 00:04:13,280 --> 00:04:15,760 Speaker 3: to default for a loan is about three years, and 76 00:04:15,840 --> 00:04:19,440 Speaker 3: so if you track back five four, three years from now, 77 00:04:19,520 --> 00:04:23,239 Speaker 3: you see that acceleration in issuance, and so the increase 78 00:04:23,279 --> 00:04:26,000 Speaker 3: in stress and distress we're seeing that market today is 79 00:04:26,080 --> 00:04:29,680 Speaker 3: just the application of a normal seasoning process coupled with 80 00:04:29,760 --> 00:04:32,440 Speaker 3: a default rate which seems to be on par with 81 00:04:32,560 --> 00:04:36,080 Speaker 3: the B three bs credit quality and just the passage 82 00:04:36,120 --> 00:04:39,760 Speaker 3: of time, that three year average period having elapsed, and 83 00:04:39,839 --> 00:04:44,279 Speaker 3: so two slightly different drivers in the market, but they're 84 00:04:44,440 --> 00:04:47,680 Speaker 3: together are creating a pretty good stress and distressed dead 85 00:04:47,720 --> 00:04:51,560 Speaker 3: opportunity against what you noted is a pretty strong macro backdrop. 86 00:04:51,880 --> 00:04:54,600 Speaker 2: And what are the balance in terms of those opportunities 87 00:04:54,600 --> 00:04:58,320 Speaker 2: you're seeing between public and private and has that balance 88 00:04:58,400 --> 00:04:59,479 Speaker 2: changed over recent years? 89 00:05:00,120 --> 00:05:03,080 Speaker 3: It has, I would say right now in terms of activity, 90 00:05:03,160 --> 00:05:06,600 Speaker 3: it is weighted more towards the private markets. Eighteen months ago, 91 00:05:06,640 --> 00:05:08,560 Speaker 3: two years ago, we would maybe get a call a 92 00:05:08,640 --> 00:05:13,120 Speaker 3: month about as stressed and distressed private credit opportunity. Sometimes 93 00:05:13,160 --> 00:05:15,840 Speaker 3: it was a lender looking to sell a piece of debt, 94 00:05:15,960 --> 00:05:19,840 Speaker 3: usually on the eve of liquidation. There is I haven't 95 00:05:20,000 --> 00:05:23,719 Speaker 3: know teenagers, they procrastinate, but there's no procrastination like a 96 00:05:23,800 --> 00:05:26,120 Speaker 3: lender looking to avoid a loss, and so they would 97 00:05:26,160 --> 00:05:29,200 Speaker 3: call us at the absolute last minute. Fast forward to today, 98 00:05:29,920 --> 00:05:33,480 Speaker 3: you're looking at maybe a call a day, certainly three 99 00:05:33,560 --> 00:05:37,200 Speaker 3: or four a week. And these are private credit deals 100 00:05:37,560 --> 00:05:42,000 Speaker 3: that have underperformed, not necessarily deep distress, but the growth 101 00:05:42,080 --> 00:05:46,080 Speaker 3: hasn't materialized. Maybe there's been a setback in the company's 102 00:05:46,279 --> 00:05:52,200 Speaker 3: financial trajectory coupled with an increasing cadence of maturity schedules, 103 00:05:52,720 --> 00:05:55,920 Speaker 3: and so the lenders will work with the sponsors and 104 00:05:55,960 --> 00:05:58,400 Speaker 3: overcome a lot of obstacles, but that maturity data is 105 00:05:58,440 --> 00:06:02,000 Speaker 3: hard to overcome. It has been well reported that capital, 106 00:06:02,360 --> 00:06:04,359 Speaker 3: both on the private equity and private credit side is 107 00:06:04,400 --> 00:06:06,200 Speaker 3: kind of stuck in the ground right now. So these 108 00:06:06,240 --> 00:06:09,360 Speaker 3: maturities are becoming a little more of a roadblock than 109 00:06:09,400 --> 00:06:11,359 Speaker 3: they have been in the past, and so we're getting 110 00:06:11,360 --> 00:06:14,880 Speaker 3: a lot of calls to provide either stretch senior or 111 00:06:15,080 --> 00:06:18,200 Speaker 3: junior capital to help facilitate a tough refinancing. And that 112 00:06:18,760 --> 00:06:22,320 Speaker 3: has just it's very strong growth in that space, the 113 00:06:22,360 --> 00:06:25,839 Speaker 3: secondary markets. There's good opportunities out there. It's a little 114 00:06:25,880 --> 00:06:27,640 Speaker 3: steadier in private credit. 115 00:06:27,800 --> 00:06:31,560 Speaker 1: When we talked to you know, most people who you know, 116 00:06:31,839 --> 00:06:34,760 Speaker 1: supposed to be the experts in this, they just tell 117 00:06:34,839 --> 00:06:36,960 Speaker 1: us that these loans don't actually trade, you know, they 118 00:06:37,000 --> 00:06:39,839 Speaker 1: hold them to the maturity their partners with the company. 119 00:06:39,920 --> 00:06:43,120 Speaker 1: But if you're buying them in the secondary, how exactly 120 00:06:43,240 --> 00:06:46,680 Speaker 1: are you sourcing these trades? Who makes the market and 121 00:06:46,880 --> 00:06:49,360 Speaker 1: you know, what's the process by which you get hold 122 00:06:49,400 --> 00:06:50,080 Speaker 1: of these loans. 123 00:06:50,400 --> 00:06:53,040 Speaker 3: We're not buying private credit in the secondary market. You know, 124 00:06:53,120 --> 00:06:55,520 Speaker 3: exception every rule, but that's not an everyday occurrence. The 125 00:06:55,560 --> 00:06:58,840 Speaker 3: opportunity set we're seeing is on the primary capital side, 126 00:06:59,080 --> 00:07:03,760 Speaker 3: so perfect example sponsor portfolio company Business Services, a little 127 00:07:03,839 --> 00:07:07,440 Speaker 3: labor intensive but maybe abated a GDP of less than one, 128 00:07:07,440 --> 00:07:11,040 Speaker 3: so a little less cynical, little less capital intensive, nice business. 129 00:07:11,600 --> 00:07:13,480 Speaker 3: As a firm, We've got a lot of familiarity with 130 00:07:13,520 --> 00:07:16,000 Speaker 3: the space and also some history with the managing team. 131 00:07:16,720 --> 00:07:19,560 Speaker 3: They're levered due to some other performance and a bad acquisition, 132 00:07:19,640 --> 00:07:22,800 Speaker 3: around seven times through their senior debt. The market clearing 133 00:07:22,880 --> 00:07:25,200 Speaker 3: level of leverage is maybe five times, and so they've 134 00:07:25,240 --> 00:07:28,600 Speaker 3: got a two turn problem. It's in an old fund. 135 00:07:28,600 --> 00:07:32,000 Speaker 3: The sponsor would strongly prefer not to contribute additional capital, 136 00:07:32,160 --> 00:07:35,680 Speaker 3: and so there's a two turns of vadah whole air 137 00:07:35,720 --> 00:07:39,040 Speaker 3: bubble that they need to fill. That's inside of enterprise 138 00:07:39,160 --> 00:07:42,120 Speaker 3: value but outside of senior debt capacity. That's where we 139 00:07:42,120 --> 00:07:45,600 Speaker 3: would come in. Provide junior capital price to somewhere between 140 00:07:45,600 --> 00:07:48,640 Speaker 3: that senior debt and pure equity, so think mid teens 141 00:07:48,680 --> 00:07:51,960 Speaker 3: the low twenties, and help facilitate a refinancing of the 142 00:07:52,000 --> 00:07:54,880 Speaker 3: existing debt that's the type of opportunities we're seeing in 143 00:07:54,920 --> 00:07:59,040 Speaker 3: private credit today. Those when that debt does trade, which 144 00:07:59,080 --> 00:08:02,360 Speaker 3: is very infrequent, it tends to be end of fund life, 145 00:08:02,800 --> 00:08:06,240 Speaker 3: where there's a handful of stress and distressed assets that 146 00:08:06,280 --> 00:08:08,440 Speaker 3: the manager's trying to get rid of in a portfolio sale. 147 00:08:08,520 --> 00:08:10,640 Speaker 3: We've seen a couple of those, but it's it's a 148 00:08:10,640 --> 00:08:12,559 Speaker 3: significant minority of the overall deal flow. 149 00:08:12,800 --> 00:08:14,240 Speaker 1: How big are we talking about in terms of the 150 00:08:14,280 --> 00:08:16,480 Speaker 1: ticket size for you, in terms of the average level 151 00:08:16,560 --> 00:08:17,760 Speaker 1: that you're buying. 152 00:08:17,680 --> 00:08:19,680 Speaker 3: For us, I'm going to give a longer answer to 153 00:08:19,760 --> 00:08:23,240 Speaker 3: a shorter question. Our focus is on a small MidCap space, 154 00:08:23,440 --> 00:08:27,760 Speaker 3: and so think ebitdas of thirty five to one hundred 155 00:08:27,800 --> 00:08:29,880 Speaker 3: and fifty. The reason for that is that's where we 156 00:08:29,920 --> 00:08:32,120 Speaker 3: have overlap with the rest of the firm. That's where 157 00:08:32,120 --> 00:08:36,160 Speaker 3: we have an incumbency advantage. Given our platform and history, 158 00:08:36,720 --> 00:08:40,560 Speaker 3: and our connections and knowledge and experience and portfolio companies. 159 00:08:40,600 --> 00:08:43,360 Speaker 3: All that come to bear. That peters out at the 160 00:08:43,440 --> 00:08:45,720 Speaker 3: upper end of the deal range of the overall firm, 161 00:08:46,280 --> 00:08:49,040 Speaker 3: and so if you track that back, we're typically looking 162 00:08:49,120 --> 00:08:51,200 Speaker 3: at two hundred and fifty to seven hundred and fifty 163 00:08:51,200 --> 00:08:54,760 Speaker 3: million dollar credit facilities and call it three hundred and 164 00:08:54,760 --> 00:08:57,840 Speaker 3: fifty two billion and a quarter enterprise values. That's the 165 00:08:57,920 --> 00:09:02,319 Speaker 3: opportunity set for us. Check size. For US, it's really 166 00:09:02,360 --> 00:09:06,040 Speaker 3: deal dependent. Within our strategy, you're probably looking at twenty 167 00:09:06,040 --> 00:09:09,160 Speaker 3: five to one hundred. But advantage of being part of 168 00:09:09,200 --> 00:09:12,720 Speaker 3: the broader platforms, there's lots of pockets of capital inside 169 00:09:12,760 --> 00:09:15,800 Speaker 3: the firm to size up when the opportunity provides itself, 170 00:09:16,120 --> 00:09:17,880 Speaker 3: and so that's the part of the market that we 171 00:09:17,960 --> 00:09:18,520 Speaker 3: focus on. 172 00:09:18,920 --> 00:09:21,560 Speaker 2: When you're looking at these opportunities. What makes a good 173 00:09:21,600 --> 00:09:28,520 Speaker 2: candidate versus a bad candidate. That's hours of conversation onto itself. 174 00:09:28,559 --> 00:09:32,720 Speaker 2: I would say some level of dependability or stability. I mean, 175 00:09:32,760 --> 00:09:35,960 Speaker 2: we are credit folk at heart. You'd like to see 176 00:09:36,280 --> 00:09:40,560 Speaker 2: confidence in enterprise value. You'd like to see an ability 177 00:09:40,679 --> 00:09:44,840 Speaker 2: to persist in a downside case, especially in a junior 178 00:09:44,880 --> 00:09:48,960 Speaker 2: capital scenario. For US, we need to have some locusts 179 00:09:49,320 --> 00:09:53,840 Speaker 2: with the borrower, some experience, some perspective above and beyond 180 00:09:53,880 --> 00:09:57,120 Speaker 2: coming upon it cold. That gives us that incremental confidence 181 00:09:57,120 --> 00:10:00,440 Speaker 2: because when we're seeing these situations, they're stressed into stress. 182 00:10:00,480 --> 00:10:03,400 Speaker 2: There's a problem, right, They're not up into the right performers. 183 00:10:03,440 --> 00:10:04,880 Speaker 2: Those don't come our way. 184 00:10:05,080 --> 00:10:07,800 Speaker 3: And so, in addition to all the challenges that all 185 00:10:07,840 --> 00:10:11,720 Speaker 3: businesses face every day, between raising capital and facing competition 186 00:10:11,800 --> 00:10:14,920 Speaker 3: and pricing inflation, all the things we're familiar with, there's 187 00:10:14,960 --> 00:10:17,800 Speaker 3: some other problem or maybe one of those things has 188 00:10:17,880 --> 00:10:20,200 Speaker 3: become a greater problem that the companies dealing with. So 189 00:10:20,360 --> 00:10:22,280 Speaker 3: for us to get over that and deploy capital and 190 00:10:22,320 --> 00:10:24,760 Speaker 3: have confidence, there needs to be something for us to 191 00:10:24,800 --> 00:10:26,800 Speaker 3: hang our hat on. At the end of the day, 192 00:10:27,160 --> 00:10:30,360 Speaker 3: HIG are strategy and as a firm, we are very 193 00:10:30,480 --> 00:10:33,560 Speaker 3: much cash flow centric lenders and we don't really subscribe 194 00:10:33,559 --> 00:10:38,040 Speaker 3: to non cash flow based valuation metrics or investment thesises. 195 00:10:38,720 --> 00:10:42,520 Speaker 3: And we're absolute value investors, meaning public comps are not 196 00:10:42,600 --> 00:10:46,200 Speaker 3: necessarily dictating the enterprise values that we're ascribing when we're 197 00:10:46,200 --> 00:10:47,040 Speaker 3: deploying capital. 198 00:10:47,520 --> 00:10:50,520 Speaker 2: So you mentioned you in these situations, you wouldn't necessarily 199 00:10:50,559 --> 00:10:52,760 Speaker 2: come to a bar unless you're familiar with them already. 200 00:10:53,200 --> 00:10:56,600 Speaker 2: Are you sort of keeping lines of communication open with 201 00:10:56,720 --> 00:10:59,199 Speaker 2: a lot of different companies, you know, sort of an 202 00:10:59,200 --> 00:11:01,800 Speaker 2: ongoing basis to sort of you know, keep tabs and 203 00:11:01,840 --> 00:11:04,120 Speaker 2: you know, to make sure if that opportunity sort of 204 00:11:04,200 --> 00:11:06,160 Speaker 2: a lands on your desk. It's one that you might 205 00:11:06,160 --> 00:11:07,000 Speaker 2: be comfortable with. 206 00:11:08,120 --> 00:11:11,920 Speaker 3: To a degree. There's certainly companies that we have relationships with, 207 00:11:12,000 --> 00:11:14,520 Speaker 3: then we follow We have a long watch list of 208 00:11:14,880 --> 00:11:17,720 Speaker 3: things that have come our way. I would say the 209 00:11:17,800 --> 00:11:21,720 Speaker 3: important relationships for us are on the advisory side, because 210 00:11:21,760 --> 00:11:23,600 Speaker 3: that tends to be the channel through which a lot 211 00:11:23,600 --> 00:11:27,120 Speaker 3: of these deals come through, and specifically the restructuring advisors 212 00:11:27,160 --> 00:11:30,559 Speaker 3: that we've been working with on restructurings, both on the 213 00:11:30,600 --> 00:11:33,040 Speaker 3: primary side and on the secondary credit side for years, 214 00:11:33,120 --> 00:11:35,920 Speaker 3: you know, in some cases decades, and so those are 215 00:11:35,960 --> 00:11:40,000 Speaker 3: the everyday relationships, and then as they get clients and 216 00:11:40,040 --> 00:11:43,040 Speaker 3: bring deals, we go back to the firm and say, Okay, 217 00:11:43,120 --> 00:11:46,000 Speaker 3: here's an opportunity. How does it line up with our 218 00:11:46,080 --> 00:11:50,080 Speaker 3: history and our current institutional knowledge and portfolio. Do we 219 00:11:50,120 --> 00:11:52,440 Speaker 3: have an edge here? Do we have some insight that 220 00:11:52,520 --> 00:11:55,200 Speaker 3: allows us to develop a thesis to deploy capital that's 221 00:11:55,200 --> 00:11:57,600 Speaker 3: not readily apparent on the. 222 00:11:57,559 --> 00:12:00,439 Speaker 1: Private credit side. I just should be clear and correct 223 00:12:00,480 --> 00:12:02,880 Speaker 1: me if I'm misunderstanding you. But it sounds like you're 224 00:12:02,920 --> 00:12:06,160 Speaker 1: buying the loans or you're taking on the loans after 225 00:12:06,240 --> 00:12:10,160 Speaker 1: they mature. The company needs to refinance basically, and the 226 00:12:10,160 --> 00:12:14,079 Speaker 1: existing lender won't do that the constant story around private 227 00:12:14,120 --> 00:12:16,680 Speaker 1: credit is that the lenders in that space are just 228 00:12:16,679 --> 00:12:19,520 Speaker 1: accumulating so much cash they don't have enough places to 229 00:12:19,520 --> 00:12:22,280 Speaker 1: put it. So they would seem to be kind of 230 00:12:22,360 --> 00:12:25,679 Speaker 1: quite keen to keep their existing lenders. Sorry, they're just 231 00:12:26,000 --> 00:12:30,040 Speaker 1: borrowing relationships going and just keep refining, refining, why are 232 00:12:30,040 --> 00:12:32,600 Speaker 1: they not in this case? So they just getting too risky. 233 00:12:32,679 --> 00:12:35,439 Speaker 3: In many cases they are, And I think you're your 234 00:12:35,480 --> 00:12:38,720 Speaker 3: description of the overall state of direct lending is an 235 00:12:38,760 --> 00:12:42,760 Speaker 3: accurate one. The situations that come our way are those 236 00:12:42,800 --> 00:12:46,080 Speaker 3: where the borrower has underperformed and leverage has climbed to 237 00:12:46,120 --> 00:12:49,760 Speaker 3: a level that's beyond what a senior level senior lender 238 00:12:49,840 --> 00:12:52,720 Speaker 3: is willing to undertake. And that that example I gave 239 00:12:52,800 --> 00:12:55,440 Speaker 3: earlier where senior lenders would go to five times ZBIT, 240 00:12:55,800 --> 00:12:59,280 Speaker 3: which is called a fifty to sixty percent LTV loan, 241 00:12:59,480 --> 00:13:01,439 Speaker 3: and that's a they feel pretty good about where the 242 00:13:01,520 --> 00:13:04,880 Speaker 3: spread there that they're getting is adequate compensation for the risk, 243 00:13:05,000 --> 00:13:07,160 Speaker 3: especially in the small and MidCap space where there's some 244 00:13:07,240 --> 00:13:10,680 Speaker 3: inherent level of volatility to all of these companies. For us, 245 00:13:10,880 --> 00:13:13,400 Speaker 3: we're then going from the five times to the seven 246 00:13:13,440 --> 00:13:16,640 Speaker 3: times to help refinance the existing debt load that maybe 247 00:13:16,720 --> 00:13:19,000 Speaker 3: was five times at issuance, but due to the underperformance 248 00:13:19,000 --> 00:13:21,840 Speaker 3: of the borrow or leverage has grown over time and 249 00:13:21,880 --> 00:13:25,320 Speaker 3: it's made that total existing debt load unrefinanciable. 250 00:13:25,800 --> 00:13:27,719 Speaker 1: And you're taking the bet, though, that this borrower can 251 00:13:27,760 --> 00:13:29,800 Speaker 1: sort things out in the longes term, and you're giving 252 00:13:29,800 --> 00:13:32,160 Speaker 1: them like a three to five year loan, that kind 253 00:13:32,160 --> 00:13:33,920 Speaker 1: of thing. You'll and you'll expecting them to work their 254 00:13:33,960 --> 00:13:35,520 Speaker 1: wigh out of this situation. 255 00:13:35,360 --> 00:13:39,319 Speaker 3: Exactly right and sometimes stabilize and sometimes grow. If they're 256 00:13:39,320 --> 00:13:42,439 Speaker 3: facing a particular challenge, be it an integration of an acquisition, 257 00:13:43,280 --> 00:13:46,040 Speaker 3: maybe a change in the macro on their supply chain 258 00:13:46,160 --> 00:13:49,480 Speaker 3: or pricing, whatever the issue is, we've developed a thesis 259 00:13:49,520 --> 00:13:52,000 Speaker 3: that they've got the ability and the resources and the 260 00:13:52,040 --> 00:13:54,840 Speaker 3: time to overcome it, and when they do, they'll return 261 00:13:54,880 --> 00:13:57,640 Speaker 3: to being a stable, growing, cash flow generating business. 262 00:13:57,640 --> 00:13:59,680 Speaker 1: You've been doing this a long time living. How often 263 00:13:59,720 --> 00:14:02,720 Speaker 1: does this let's go right and how often does it 264 00:14:02,800 --> 00:14:04,120 Speaker 1: not pan out? 265 00:14:04,920 --> 00:14:07,520 Speaker 3: Well? I would say nobody abouts a thousand and so 266 00:14:07,679 --> 00:14:10,920 Speaker 3: it certainly goes wrong. Sometimes. It is a truth that 267 00:14:11,040 --> 00:14:14,439 Speaker 3: companies that once they become stressed and distressed and overlevered, 268 00:14:15,160 --> 00:14:18,120 Speaker 3: the forced allocation of the cash flow to servicing debt, 269 00:14:18,200 --> 00:14:22,120 Speaker 3: which kind of sucks resources away from growth initiatives and 270 00:14:22,160 --> 00:14:24,520 Speaker 3: cost cutting initiatives and all the other things that companies 271 00:14:24,560 --> 00:14:28,000 Speaker 3: need to do to evolve and change and prosper. It 272 00:14:28,040 --> 00:14:31,160 Speaker 3: can create a state of almost malnourishment in a company, 273 00:14:31,160 --> 00:14:33,480 Speaker 3: and you have to be very very careful to either 274 00:14:33,520 --> 00:14:35,960 Speaker 3: provide for that or allow for that. That being said, 275 00:14:36,440 --> 00:14:39,840 Speaker 3: if we've done our homework right, there's usually some portion 276 00:14:39,960 --> 00:14:42,600 Speaker 3: of the business that we feel very good about that 277 00:14:42,720 --> 00:14:45,080 Speaker 3: has some level of base stability and cash flow and 278 00:14:45,200 --> 00:14:50,640 Speaker 3: enterprise value. We tend to avoid situations where, absent a 279 00:14:50,720 --> 00:14:54,680 Speaker 3: large trend change or change in trajectory, our investment will 280 00:14:54,720 --> 00:14:56,800 Speaker 3: be in a lot of trouble. What we like to 281 00:14:56,840 --> 00:15:00,200 Speaker 3: see is some level of emerging stability or something some 282 00:15:00,320 --> 00:15:02,040 Speaker 3: part of the business we can hang our hat on 283 00:15:02,520 --> 00:15:05,400 Speaker 3: that gives them the foundation to overcome that challenge. And 284 00:15:05,440 --> 00:15:07,560 Speaker 3: whether or not they do, there's this base level of 285 00:15:07,600 --> 00:15:09,200 Speaker 3: value that we feel pretty good about. 286 00:15:09,680 --> 00:15:12,200 Speaker 2: So, you know, you're talking about sort of getting involved 287 00:15:12,240 --> 00:15:15,600 Speaker 2: in junior debt for quite highly leveled companies. How are 288 00:15:15,640 --> 00:15:18,640 Speaker 2: you structuring these you know, to make sure you're getting 289 00:15:19,720 --> 00:15:21,720 Speaker 2: you know, the right sort of protections, you know what 290 00:15:21,800 --> 00:15:24,440 Speaker 2: sort of returns targets that you're looking at for junior 291 00:15:24,480 --> 00:15:27,880 Speaker 2: debt for you know, taking credits up to seven times leverage. 292 00:15:27,480 --> 00:15:30,640 Speaker 3: Well, at that level you're definitely in the equity class 293 00:15:30,640 --> 00:15:32,560 Speaker 3: for at least a portion of your capital, and so 294 00:15:32,640 --> 00:15:35,840 Speaker 3: it has to be priced appropriately. What we're seeing is 295 00:15:35,960 --> 00:15:40,280 Speaker 3: mid teens to bunching up on low twenties returns for 296 00:15:40,360 --> 00:15:43,600 Speaker 3: that type of paper. In terms of structuring, what you're 297 00:15:43,640 --> 00:15:48,160 Speaker 3: looking for is typically negative protections. The senior lender is 298 00:15:48,200 --> 00:15:50,920 Speaker 3: going to want to be the controlling hand, They're going 299 00:15:50,920 --> 00:15:54,280 Speaker 3: to have the financial covenants. All of the protections and 300 00:15:54,320 --> 00:15:56,640 Speaker 3: covenants that the junior lender is going to get is 301 00:15:56,680 --> 00:15:59,760 Speaker 3: going to be a discount to that. And so if 302 00:15:59,760 --> 00:16:02,920 Speaker 3: they've got a covenanted X, our covenant will be X 303 00:16:02,960 --> 00:16:05,320 Speaker 3: plus a ten or fifteen percent cushion. Where you can 304 00:16:05,360 --> 00:16:09,480 Speaker 3: really protect yourself as a junior creditor is to the 305 00:16:09,520 --> 00:16:14,840 Speaker 3: negative so prohibitions on occurring additional debt, prohibition on disposing assets, 306 00:16:14,960 --> 00:16:19,880 Speaker 3: prohibitions on certain divestments or taking on large corporate actions, 307 00:16:19,920 --> 00:16:24,120 Speaker 3: and so through a construction of negative controls, you can 308 00:16:24,280 --> 00:16:27,200 Speaker 3: establish you know, like we talked about a credit box, 309 00:16:27,240 --> 00:16:30,120 Speaker 3: and within that box you try to trap the cash 310 00:16:30,120 --> 00:16:32,120 Speaker 3: flow and make sure that you're the beneficiary of it, 311 00:16:32,240 --> 00:16:35,080 Speaker 3: understanding that you're junior to the first thing, debt. 312 00:16:35,640 --> 00:16:38,360 Speaker 2: I mean, you know, high teens to twenties. That's a 313 00:16:38,960 --> 00:16:42,600 Speaker 2: big load of interest for companies to be paying. These 314 00:16:42,640 --> 00:16:43,680 Speaker 2: often structured as. 315 00:16:43,600 --> 00:16:46,800 Speaker 3: Picks, Yes, picks, it with some sort of equity component 316 00:16:46,880 --> 00:16:50,560 Speaker 3: and or minimum OIIC. It's it's almost never purely cash pay. 317 00:16:50,760 --> 00:16:53,320 Speaker 3: I think the I don't know what the default rate 318 00:16:53,520 --> 00:16:56,360 Speaker 3: is for cash coupons and the teens, but I would 319 00:16:56,440 --> 00:16:59,680 Speaker 3: positive that it's very, very high. And so no, it's 320 00:17:00,200 --> 00:17:03,800 Speaker 3: that's and as a lender, it feels good to get 321 00:17:03,880 --> 00:17:06,320 Speaker 3: up a high coupon and to get that return of capital. 322 00:17:06,359 --> 00:17:08,399 Speaker 3: It can sometimes be self defeating because of what I 323 00:17:08,440 --> 00:17:11,959 Speaker 3: said earlier. You force the companies to allocate their capital 324 00:17:12,000 --> 00:17:14,680 Speaker 3: and cash flow of servicing their debt, and it precludes 325 00:17:14,720 --> 00:17:16,760 Speaker 3: them from doing those other things that they need to 326 00:17:16,800 --> 00:17:19,480 Speaker 3: do to evolve as a business. And so while in 327 00:17:19,480 --> 00:17:22,440 Speaker 3: the short term it feels great to get that cash 328 00:17:22,440 --> 00:17:25,000 Speaker 3: interest and to get that return of basis quickly, in 329 00:17:25,040 --> 00:17:27,040 Speaker 3: the long term it can often be self defeating. 330 00:17:27,560 --> 00:17:29,239 Speaker 1: Yeah, I me, it's only at twenty percent. You kind 331 00:17:29,280 --> 00:17:33,000 Speaker 1: of wonder how sustainable that that structure is for a company, 332 00:17:33,040 --> 00:17:34,280 Speaker 1: right exactly? 333 00:17:34,320 --> 00:17:36,919 Speaker 3: And it's not, it is the short answer. It's not. 334 00:17:37,320 --> 00:17:39,840 Speaker 3: And so you put a company in a position where 335 00:17:39,840 --> 00:17:41,360 Speaker 3: it's almost impossible to succeed. 336 00:17:41,520 --> 00:17:47,400 Speaker 1: Yeah, so the private credit stress to stress, how extreme 337 00:17:47,520 --> 00:17:49,359 Speaker 1: is it? Because again, we talked a lot of private 338 00:17:49,400 --> 00:17:51,920 Speaker 1: credit people on the show. They generally say that there's 339 00:17:51,920 --> 00:17:53,600 Speaker 1: not really much of a problem that you know, their 340 00:17:53,600 --> 00:17:56,120 Speaker 1: returns are great and their losses are very very low, 341 00:17:56,520 --> 00:17:58,600 Speaker 1: and the you know, generally there's this kind of sense 342 00:17:58,640 --> 00:18:01,800 Speaker 1: that is the press making too much fuss out of 343 00:18:01,840 --> 00:18:03,879 Speaker 1: a stress and distress in private credit. But do you 344 00:18:03,880 --> 00:18:06,560 Speaker 1: think it's a bigger problem than what they're admitting to. 345 00:18:08,000 --> 00:18:10,639 Speaker 3: I hear the same things and see this and have 346 00:18:10,720 --> 00:18:15,359 Speaker 3: the same conversations. The numbers that we're seeing, and I 347 00:18:15,359 --> 00:18:17,440 Speaker 3: think there's a handful of sources that everyone seems to 348 00:18:17,520 --> 00:18:21,720 Speaker 3: quote is about a five percent default rate between pure 349 00:18:21,760 --> 00:18:26,240 Speaker 3: defaults and you know what's increasingly being called bad pick accruing, 350 00:18:26,320 --> 00:18:30,600 Speaker 3: which is interesting. In the syndicated loan market, there is 351 00:18:30,640 --> 00:18:33,119 Speaker 3: no concept of pick. You either pay your interest or 352 00:18:33,160 --> 00:18:35,640 Speaker 3: you have a default. In private credit, there's this third 353 00:18:35,680 --> 00:18:39,120 Speaker 3: state that's evolved where you're doing neither, and I think 354 00:18:39,200 --> 00:18:42,280 Speaker 3: most clear headed people would say that the cessation of 355 00:18:42,320 --> 00:18:44,160 Speaker 3: interest is a breach of the contract, and a breach 356 00:18:44,160 --> 00:18:46,080 Speaker 3: of the contract is a default, and so lumping those 357 00:18:46,080 --> 00:18:49,760 Speaker 3: two together, you're looking at about a five percent default rate. 358 00:18:50,440 --> 00:18:52,359 Speaker 3: If you look at the loan market right now, it's 359 00:18:52,440 --> 00:18:55,040 Speaker 3: running at about three percent, and so you've got a 360 00:18:55,119 --> 00:19:00,440 Speaker 3: significant premium in defaults relative to the syndicated loan marketcoveries 361 00:19:00,480 --> 00:19:02,840 Speaker 3: which are hard to observe, but there have been some 362 00:19:02,960 --> 00:19:06,479 Speaker 3: data points seem to be around the forty five to 363 00:19:06,520 --> 00:19:08,879 Speaker 3: fifty cent range, which is right on top of what 364 00:19:08,920 --> 00:19:12,400 Speaker 3: you're seeing in the loan market when you include distressed exchanges, 365 00:19:12,440 --> 00:19:14,560 Speaker 3: which is I think the right way to look at it, 366 00:19:15,240 --> 00:19:19,199 Speaker 3: which getting back to the characteristics of these loans kind 367 00:19:19,240 --> 00:19:22,199 Speaker 3: of mimicking the B three B minus cohort of the 368 00:19:22,200 --> 00:19:24,520 Speaker 3: broadly syndicated loan market, which is I think a pretty 369 00:19:24,520 --> 00:19:28,080 Speaker 3: good proxy. They're behaving the way that syndicated loan markets. 370 00:19:28,160 --> 00:19:30,800 Speaker 3: Private credit is not a new animal onto itself. I mean, 371 00:19:30,840 --> 00:19:34,440 Speaker 3: it's not traded and it's closely held, but otherwise it's 372 00:19:34,440 --> 00:19:36,760 Speaker 3: a loan and has a lot of the attributes of 373 00:19:36,800 --> 00:19:41,280 Speaker 3: BSL and it's increasingly behaving like broadly syndicated loans. Now, 374 00:19:41,320 --> 00:19:44,080 Speaker 3: whether or not that's a problem, it remains to be seen. 375 00:19:45,040 --> 00:19:47,520 Speaker 3: It would be a huge problem in the syndicated loan 376 00:19:47,560 --> 00:19:51,520 Speaker 3: market because syndicated loans are predominantly held by colos, which 377 00:19:51,560 --> 00:19:54,800 Speaker 3: are very highly levered and have teight covenants on asset quality. 378 00:19:55,600 --> 00:19:58,280 Speaker 3: My observation has been that the private credit in the 379 00:19:58,280 --> 00:20:01,720 Speaker 3: industry at large has a much lower level of leverage 380 00:20:01,920 --> 00:20:04,680 Speaker 3: in it, and therefore the lenders have a lot more 381 00:20:04,760 --> 00:20:08,880 Speaker 3: latitude to hold under performing credits except pick in lieu 382 00:20:08,920 --> 00:20:11,880 Speaker 3: of cash interest without getting in trouble with their own 383 00:20:12,119 --> 00:20:16,280 Speaker 3: leverage facilities. I think that's going to change as the 384 00:20:16,320 --> 00:20:20,120 Speaker 3: competitive intensity of direct lending increases, and you're seeing it 385 00:20:20,160 --> 00:20:24,199 Speaker 3: in spread compression. In order to provide the returns to 386 00:20:24,320 --> 00:20:28,760 Speaker 3: their limited partners, their capital providers that they've promised as 387 00:20:28,800 --> 00:20:32,160 Speaker 3: spreads compressed, and if rates continue to fall, they're going 388 00:20:32,200 --> 00:20:35,639 Speaker 3: to need to turn to leverage to cover that gap. 389 00:20:35,760 --> 00:20:39,480 Speaker 3: To return the absolute return that LPs require to provide 390 00:20:39,520 --> 00:20:43,159 Speaker 3: long dated, ill liquid capital. There's some baseline level of 391 00:20:43,240 --> 00:20:46,280 Speaker 3: return that you need to offer in certainly large premium 392 00:20:46,359 --> 00:20:48,800 Speaker 3: to the high yield and syndicated loan markets, because if 393 00:20:48,840 --> 00:20:51,320 Speaker 3: you can get the same return in a liquid instrument 394 00:20:51,400 --> 00:20:54,280 Speaker 3: versus an in liquid instrument, the choice is clear. And 395 00:20:54,359 --> 00:20:57,840 Speaker 3: so I expect the leverage in the direct lending universe 396 00:20:57,920 --> 00:21:01,480 Speaker 3: to increase over time the average that the capital providers 397 00:21:01,560 --> 00:21:05,520 Speaker 3: are employing. That will then lead to lower ability to 398 00:21:05,680 --> 00:21:09,280 Speaker 3: hold underperforming assets. They'll need to be a little stricter. 399 00:21:09,400 --> 00:21:12,240 Speaker 3: Whether bar hors there's a big agency problem there and 400 00:21:12,400 --> 00:21:14,399 Speaker 3: I and if they could persist at a five percent 401 00:21:14,400 --> 00:21:16,640 Speaker 3: the fault rate, then I think it would be problematic. 402 00:21:17,040 --> 00:21:20,600 Speaker 3: So in short, maybe not today, but the conditions exist 403 00:21:20,680 --> 00:21:22,919 Speaker 3: today and the trends exist to cause it to be 404 00:21:22,960 --> 00:21:23,879 Speaker 3: a problem in the future. 405 00:21:24,920 --> 00:21:27,800 Speaker 2: So what is the driver of the slightly hide default 406 00:21:27,880 --> 00:21:31,800 Speaker 2: rate in private credit if it does have this additional 407 00:21:31,800 --> 00:21:35,440 Speaker 2: flexibility and generally lower leverage than syndicated leans. 408 00:21:35,680 --> 00:21:39,400 Speaker 3: Average company size. If you think about the volatility in 409 00:21:39,440 --> 00:21:41,960 Speaker 3: the Russell two thousand versus the volatility in the Dow, 410 00:21:42,040 --> 00:21:43,960 Speaker 3: I think everyone went into it that the ball in 411 00:21:44,000 --> 00:21:46,240 Speaker 3: the rustle is much much higher because it includes much 412 00:21:46,280 --> 00:21:50,199 Speaker 3: smaller companies. If you take that same relationship and you 413 00:21:50,320 --> 00:21:54,480 Speaker 3: apply it to just to draw up maybe a better contrast, 414 00:21:54,600 --> 00:21:57,080 Speaker 3: the high yield market or the size of the average 415 00:21:57,080 --> 00:21:59,680 Speaker 3: borrower has gone up over time pretty dramatically. In the 416 00:21:59,680 --> 00:22:03,040 Speaker 3: overall credit quality has increased versus the size of the 417 00:22:03,080 --> 00:22:05,720 Speaker 3: average private credit borrower, which is at the very small 418 00:22:05,800 --> 00:22:09,960 Speaker 3: end of the overall leverage finance universe. If you take 419 00:22:10,000 --> 00:22:13,840 Speaker 3: that increased volatility that small companies inherently have and you 420 00:22:13,880 --> 00:22:16,760 Speaker 3: apply leverage to it, and even constant leverage of call 421 00:22:16,840 --> 00:22:18,639 Speaker 3: it five times, of course you're going to have a 422 00:22:18,680 --> 00:22:21,919 Speaker 3: higher default rate in the higher volatility population. And that's 423 00:22:21,960 --> 00:22:24,240 Speaker 3: pretty much what you're seeing in private credit right now. 424 00:22:25,040 --> 00:22:28,159 Speaker 1: So flipping back to the broadly syndicated market just and 425 00:22:28,200 --> 00:22:31,080 Speaker 1: you are seeing, as you say, more offer, you are 426 00:22:31,119 --> 00:22:34,199 Speaker 1: seeing more discount on the price. So what's going on 427 00:22:34,240 --> 00:22:36,520 Speaker 1: in leverage loans that's causing stress? 428 00:22:36,520 --> 00:22:40,359 Speaker 3: There? A couple of things. You've got some pockets of 429 00:22:40,359 --> 00:22:43,000 Speaker 3: real weakness and tim, I think you mentioned chemicals earlier. 430 00:22:43,000 --> 00:22:46,880 Speaker 3: That's certainly a space that it's in. Every industry participate 431 00:22:46,960 --> 00:22:49,560 Speaker 3: will tell you whether or not you ask that there's 432 00:22:49,600 --> 00:22:52,639 Speaker 3: a prolonged downturn going on there. But this too shall pass. 433 00:22:53,320 --> 00:22:56,600 Speaker 3: The consumer with sustained inflation is under pressure, and that's 434 00:22:56,640 --> 00:22:59,200 Speaker 3: rippling through large parts of the US economy. On building 435 00:22:59,240 --> 00:23:02,760 Speaker 3: has been weeks. You've pockets of weakness that are expressing themselves. 436 00:23:03,080 --> 00:23:05,399 Speaker 3: As I mentioned earlier, the loan market now is over 437 00:23:05,440 --> 00:23:08,080 Speaker 3: a trillion dollars in the US. It's about sixty five 438 00:23:08,160 --> 00:23:11,199 Speaker 3: seventy percent held by colos. JP Morgan would tell you 439 00:23:11,240 --> 00:23:15,960 Speaker 3: that the average COLO triple C basket triple C allocation 440 00:23:16,000 --> 00:23:19,080 Speaker 3: of their portfolio is just under six percent right now. 441 00:23:19,080 --> 00:23:21,560 Speaker 3: It kicked up almost a full percentage point in December 442 00:23:21,600 --> 00:23:24,600 Speaker 3: with a slew of downgrades. The typical COLO has a 443 00:23:24,640 --> 00:23:27,920 Speaker 3: basket limitation on triple C assets of seven and a 444 00:23:27,960 --> 00:23:32,320 Speaker 3: half percent, so five point eight is uncomfortably close. And 445 00:23:32,359 --> 00:23:34,840 Speaker 3: so part of what you're seeing in the discount is 446 00:23:34,920 --> 00:23:39,719 Speaker 3: COLO managers aggressively managing credit quality. Because look, there's been 447 00:23:39,760 --> 00:23:42,159 Speaker 3: a lot of upheaval in the last twelve months in 448 00:23:42,200 --> 00:23:44,720 Speaker 3: the US, certainly in the economy, a lot of cross currents, 449 00:23:44,720 --> 00:23:46,800 Speaker 3: a lot of new things that that people haven't dealt 450 00:23:46,840 --> 00:23:49,680 Speaker 3: with before, between tariffs and everything else. Energy prices have 451 00:23:49,760 --> 00:23:53,040 Speaker 3: been volatile, metals have been volatile, Inflation is uncertain, and 452 00:23:53,119 --> 00:23:55,760 Speaker 3: so there's a lot of cross currents that give creditors 453 00:23:55,760 --> 00:23:59,320 Speaker 3: who are disproportionately focused on the downside reason for concern, 454 00:23:59,520 --> 00:24:02,399 Speaker 3: and of what you're seeing is an aggressive management of 455 00:24:02,440 --> 00:24:05,520 Speaker 3: credit quality. Remember earlier I said that backdrop of B 456 00:24:05,600 --> 00:24:09,840 Speaker 3: three bus being an uncomfortably high proportion of the overall market, Well, 457 00:24:09,840 --> 00:24:13,280 Speaker 3: that's one notch above that triple C bright red line 458 00:24:13,320 --> 00:24:16,040 Speaker 3: that these colos face. And so if we did see 459 00:24:16,040 --> 00:24:20,280 Speaker 3: a downturn in the US economy based on prior cycles 460 00:24:20,480 --> 00:24:23,439 Speaker 3: downgrade behavior by the rating agencies, they can be in 461 00:24:23,440 --> 00:24:26,120 Speaker 3: trouble very quickly. And so that's part of what you're seeing. 462 00:24:26,400 --> 00:24:29,160 Speaker 3: In the last couple of weeks. It's been well reported 463 00:24:29,200 --> 00:24:31,959 Speaker 3: there's been a growing concern about software companies, which are 464 00:24:32,000 --> 00:24:34,560 Speaker 3: a very large part of the leverage finance market. It's 465 00:24:34,640 --> 00:24:38,560 Speaker 3: not coupled with downgrades. The company's historical financial performance is 466 00:24:38,600 --> 00:24:43,320 Speaker 3: generally fine, and so this is fear and uncertainly ungrounded 467 00:24:43,560 --> 00:24:47,639 Speaker 3: in actual fact, but it's taking levels down in some 468 00:24:47,800 --> 00:24:51,440 Speaker 3: cases five, ten, fifteen points on some of the more 469 00:24:51,520 --> 00:24:54,600 Speaker 3: lever credits. And so there's a real market move to 470 00:24:54,640 --> 00:24:57,080 Speaker 3: get ahead of what they think might be some adverse 471 00:24:57,119 --> 00:25:00,240 Speaker 3: developments and get out of these credits. 472 00:25:00,520 --> 00:25:03,240 Speaker 2: You mentioned chemicals there, so I've got to talk about 473 00:25:03,280 --> 00:25:06,960 Speaker 2: my favorite subjects. As you mentioned, huge structural shifts going 474 00:25:06,960 --> 00:25:09,920 Speaker 2: on in the chemicals market right now, you know, causing 475 00:25:10,000 --> 00:25:13,440 Speaker 2: issues for the biggest done the smallest issues right across 476 00:25:13,480 --> 00:25:16,400 Speaker 2: the spectrum. And you know you're also picking up there 477 00:25:16,440 --> 00:25:18,480 Speaker 2: you mentioned sort of you know, fear can sort of 478 00:25:18,560 --> 00:25:20,920 Speaker 2: drive opportunities your way. There's quite a lot of fear 479 00:25:20,920 --> 00:25:23,359 Speaker 2: in the chemical market as well. So I guess you know, 480 00:25:23,400 --> 00:25:25,440 Speaker 2: what are you looking at in the chemical space? What 481 00:25:25,800 --> 00:25:29,439 Speaker 2: are the characteristics that you think make a good chemicals opportunity? 482 00:25:30,200 --> 00:25:33,600 Speaker 3: Oh, you know, it's the change in that industry is 483 00:25:33,640 --> 00:25:37,000 Speaker 3: the global supply basis is evolving in a lot of 484 00:25:37,040 --> 00:25:39,879 Speaker 3: capacities coming on in new markets and really changing the 485 00:25:39,960 --> 00:25:43,560 Speaker 3: relationships that assets have had with their end markets. It's 486 00:25:43,720 --> 00:25:47,359 Speaker 3: it's it's dramatic. What we look for is a defensable 487 00:25:47,359 --> 00:25:51,080 Speaker 3: market position. You need to have an appropriate cost position 488 00:25:51,240 --> 00:25:53,280 Speaker 3: in your cost curve. You need to have access to 489 00:25:54,440 --> 00:25:58,159 Speaker 3: at least table stakes, if not advantaged feedstocks and have 490 00:25:58,240 --> 00:26:03,080 Speaker 3: access prefer domestic access to markets that are stable and 491 00:26:03,119 --> 00:26:06,359 Speaker 3: growing and so a somewhat defensible position. If you're exporting 492 00:26:06,359 --> 00:26:09,240 Speaker 3: to far far away and you're not close to your feedstocks. 493 00:26:09,280 --> 00:26:12,040 Speaker 3: That can be a recipe for disaster. If you are 494 00:26:12,200 --> 00:26:17,080 Speaker 3: competing with new capacity come online and you don't have 495 00:26:17,400 --> 00:26:20,600 Speaker 3: some embedded advantage in the market, be it a low 496 00:26:20,640 --> 00:26:22,880 Speaker 3: cost position or a brand new plan, or you're right 497 00:26:22,960 --> 00:26:26,760 Speaker 3: next to some very cheap feedstock capacity, You're you're finding 498 00:26:26,760 --> 00:26:30,200 Speaker 3: yourself in trouble right now. Yeah, absolutely, I'd agree with 499 00:26:30,280 --> 00:26:32,600 Speaker 3: all of that. I think on the on the on 500 00:26:32,640 --> 00:26:34,919 Speaker 3: the cost position side and being able to compete in 501 00:26:34,960 --> 00:26:37,720 Speaker 3: the market. It's it's really quite interesting because we've seen 502 00:26:37,800 --> 00:26:39,960 Speaker 3: we've seen companies that we all thought would hold up 503 00:26:40,040 --> 00:26:42,360 Speaker 3: quite well that you know, now we're sort of coming 504 00:26:42,400 --> 00:26:44,840 Speaker 3: up for four years into the down cycle that what 505 00:26:44,920 --> 00:26:47,560 Speaker 3: looked like a strong position is no longer looking quite 506 00:26:47,600 --> 00:26:50,560 Speaker 3: as good as it was. It's remarkable. And you know, 507 00:26:50,600 --> 00:26:54,399 Speaker 3: in the States, the plastics subsector, the resin subsector is 508 00:26:54,400 --> 00:26:56,800 Speaker 3: the one I'm a little more familiar with. That wouldn't express, 509 00:26:56,880 --> 00:26:58,879 Speaker 3: you know, claim expertise in any of them, but a 510 00:26:58,880 --> 00:27:03,920 Speaker 3: little more familiarity. And just the downturn in volumes against 511 00:27:04,240 --> 00:27:07,000 Speaker 3: what maybe was going to be a manufacturing renaissance, but 512 00:27:07,160 --> 00:27:10,000 Speaker 3: just the volume declines there, the tide has gone out 513 00:27:10,080 --> 00:27:13,000 Speaker 3: in a very real way. Which is challenging a lot 514 00:27:13,040 --> 00:27:16,800 Speaker 3: of the capital structures, especially the more leveraged producers that 515 00:27:16,880 --> 00:27:19,439 Speaker 3: just aren't producing the cash flow. It's it's a math problem. 516 00:27:19,440 --> 00:27:22,520 Speaker 3: It's at some level where you've got to fixed interest 517 00:27:22,560 --> 00:27:25,600 Speaker 3: burden in the cash that you can generate is no 518 00:27:25,680 --> 00:27:27,520 Speaker 3: longer at the level that makes that comfortable. 519 00:27:27,600 --> 00:27:29,600 Speaker 1: You mentioned the big discounts Jackson in the mukeet. You're 520 00:27:29,600 --> 00:27:33,040 Speaker 1: talking about down fifteen points. What is the level right now? 521 00:27:33,080 --> 00:27:34,720 Speaker 1: Is it in the eighties, is it in the sixties. 522 00:27:34,920 --> 00:27:37,680 Speaker 1: Where are we seeing loans trades that are in distress. 523 00:27:38,720 --> 00:27:40,760 Speaker 3: As I mentioned earlier, over one hundred million dollars below 524 00:27:40,800 --> 00:27:43,879 Speaker 3: eighty I would say paper two years ago, just a 525 00:27:43,880 --> 00:27:47,520 Speaker 3: generic stressed loan that I would have thought would be 526 00:27:47,520 --> 00:27:51,960 Speaker 3: trading between called seventy seven and eighty is maybe sixty 527 00:27:51,960 --> 00:27:54,480 Speaker 3: five to seventy. Now. There's a level of discount in 528 00:27:54,520 --> 00:27:57,960 Speaker 3: these stress credits that we haven't seen for a number 529 00:27:57,960 --> 00:28:01,119 Speaker 3: of years. It's not everyone, but the dislocations that are 530 00:28:01,160 --> 00:28:04,399 Speaker 3: occurring in the discounts that original lenders are willing to 531 00:28:04,440 --> 00:28:07,359 Speaker 3: take to shed troubled assets has grown certainly in the 532 00:28:07,400 --> 00:28:10,199 Speaker 3: last twelve months. I don't have an index that I 533 00:28:10,200 --> 00:28:11,840 Speaker 3: can point to to prove that, But I can tell 534 00:28:11,880 --> 00:28:14,600 Speaker 3: you that's my day to day lived experience, which is 535 00:28:14,600 --> 00:28:16,840 Speaker 3: great for us. I mean we're finding real value there. 536 00:28:17,200 --> 00:28:19,400 Speaker 3: And as rates may be stabilize a little bit, where 537 00:28:19,400 --> 00:28:21,200 Speaker 3: you've got a decent current, most of the debt that 538 00:28:21,520 --> 00:28:24,600 Speaker 3: we focus on is performing in terms of still pain 539 00:28:24,680 --> 00:28:28,160 Speaker 3: current interest. You can find some real value, but there's 540 00:28:28,240 --> 00:28:32,240 Speaker 3: real dislocation. One trend that's emerged recently with the strong 541 00:28:32,520 --> 00:28:37,119 Speaker 3: capital markets, there's been a steady cadence of biwicks or 542 00:28:37,240 --> 00:28:39,800 Speaker 3: lone portfolios coming for sale, which are usually the result 543 00:28:39,800 --> 00:28:42,720 Speaker 3: that will called COLO and the par the performing assets 544 00:28:42,720 --> 00:28:45,600 Speaker 3: and those will trade no problem, but there's always a 545 00:28:45,640 --> 00:28:50,200 Speaker 3: handful of underperformers in every portfolio, and there's been a 546 00:28:50,280 --> 00:28:53,720 Speaker 3: series of occurrences where those assets have failed to trade, 547 00:28:54,040 --> 00:28:55,960 Speaker 3: the sellers have put a reserve price on them and 548 00:28:56,520 --> 00:28:59,320 Speaker 3: just just out of the context in the market, and 549 00:28:59,360 --> 00:29:02,960 Speaker 3: it's caused the loans themselves to reprice. And so a 550 00:29:02,960 --> 00:29:06,200 Speaker 3: failed b Wick for a stressed asset can reprice that 551 00:29:06,280 --> 00:29:10,080 Speaker 3: loan down five, seven ten points in two or three days. 552 00:29:10,320 --> 00:29:12,560 Speaker 3: Because people find out that the quoted levels these are 553 00:29:12,600 --> 00:29:15,360 Speaker 3: pretty liquid assets that the quoted levels just weren't realistic, 554 00:29:15,800 --> 00:29:17,960 Speaker 3: and the actual clearing price for that risk is much 555 00:29:18,040 --> 00:29:21,120 Speaker 3: much lower, And so you're seeing these almost air pockets 556 00:29:21,160 --> 00:29:23,920 Speaker 3: develop credit by credit where there's a failed auction that 557 00:29:24,040 --> 00:29:27,960 Speaker 3: results in a ratchet down of the price, and those 558 00:29:27,960 --> 00:29:30,040 Speaker 3: moves can be large. I mean, a ten to fifteen 559 00:29:30,080 --> 00:29:34,000 Speaker 3: point move in a credit instrument is pretty dramatic. And 560 00:29:34,080 --> 00:29:38,480 Speaker 3: so what that tells me is there's real concern in 561 00:29:38,520 --> 00:29:41,760 Speaker 3: these assets that the actual bid is much lower, and 562 00:29:41,760 --> 00:29:44,440 Speaker 3: the level of stress in the market, that that in 563 00:29:44,560 --> 00:29:47,320 Speaker 3: lack of confidence is maybe a little higher at least 564 00:29:47,360 --> 00:29:50,520 Speaker 3: for this portion of the bubble leverage finance markets than 565 00:29:50,560 --> 00:29:51,840 Speaker 3: the headlines what have you believe? 566 00:29:52,000 --> 00:29:53,880 Speaker 1: And you say, you're seeing more offers as well, You're 567 00:29:53,880 --> 00:29:57,400 Speaker 1: getting more coals to take this stuff on, right, So 568 00:29:57,440 --> 00:29:58,360 Speaker 1: the volume amazing crease? 569 00:29:59,640 --> 00:30:04,160 Speaker 3: We are yep, the volume, the volume of stress and 570 00:30:04,160 --> 00:30:06,840 Speaker 3: distress assets has certainly grown over the last few months. 571 00:30:06,920 --> 00:30:08,720 Speaker 1: And again, the narrative for years was that there was 572 00:30:08,720 --> 00:30:11,120 Speaker 1: all this cash being raised for distress and it was 573 00:30:11,160 --> 00:30:13,560 Speaker 1: piling up on the sidelines, but there wasn't enough to buy. 574 00:30:13,600 --> 00:30:15,760 Speaker 1: So you know, do you are you not finding tons 575 00:30:15,760 --> 00:30:18,920 Speaker 1: of competition for this sixty five cent loan. 576 00:30:19,000 --> 00:30:21,920 Speaker 3: Not in our part of the market. The two to 577 00:30:21,960 --> 00:30:23,720 Speaker 3: three of the four of the five hundred million dollar 578 00:30:24,080 --> 00:30:27,440 Speaker 3: issue in size are pretty small. They're very liquid. The 579 00:30:27,520 --> 00:30:32,080 Speaker 3: large cap players, some of our larger competitors who focus 580 00:30:32,120 --> 00:30:35,840 Speaker 3: on larger capital structures, it's it's uneconomic to focus resources 581 00:30:35,880 --> 00:30:38,480 Speaker 3: on a small opportunity set where maybe you know, five 582 00:30:38,560 --> 00:30:40,560 Speaker 3: hundred million dollar term loan, only one hundred or two 583 00:30:40,600 --> 00:30:43,000 Speaker 3: hundred million of that may come for sale, and so 584 00:30:43,040 --> 00:30:46,480 Speaker 3: your total addressable market that just the dollars and that's 585 00:30:46,520 --> 00:30:48,800 Speaker 3: the face amount that the market value smaller. It's just 586 00:30:48,800 --> 00:30:51,680 Speaker 3: too small, and the ill liquidity prevents some of the 587 00:30:51,720 --> 00:30:54,360 Speaker 3: part time stress and stress players like hedge funds from 588 00:30:54,400 --> 00:30:58,280 Speaker 3: coming in. Coupled with these businesses are hard to find 589 00:30:58,320 --> 00:31:02,240 Speaker 3: in hard to diligence, a great difficulty to this which 590 00:31:02,320 --> 00:31:05,080 Speaker 3: is high, and so you really need to be built 591 00:31:05,120 --> 00:31:07,120 Speaker 3: to do it. Would we would have a hard time, 592 00:31:07,840 --> 00:31:09,680 Speaker 3: My group would have a hard time doing what we 593 00:31:09,880 --> 00:31:13,520 Speaker 3: do absent the advantages of being large part of a 594 00:31:13,600 --> 00:31:16,760 Speaker 3: larger alternatives platform that all focuses on the space, and 595 00:31:16,840 --> 00:31:19,000 Speaker 3: so that keeps some people out. I think in the 596 00:31:19,080 --> 00:31:21,640 Speaker 3: larger cap part of the market, I mean, you haven't 597 00:31:21,680 --> 00:31:26,320 Speaker 3: seen a Silicon Valley bank type situation where you're getting 598 00:31:26,320 --> 00:31:29,560 Speaker 3: tens of billions of dollars that really of credit, a 599 00:31:29,640 --> 00:31:32,080 Speaker 3: single name credit fall off a cliff in a fairly 600 00:31:32,160 --> 00:31:34,160 Speaker 3: rapid fashion. So I think in the top end of 601 00:31:34,200 --> 00:31:36,760 Speaker 3: the market that might be true. It's not in our space, 602 00:31:37,000 --> 00:31:37,480 Speaker 3: all right. 603 00:31:37,560 --> 00:31:40,600 Speaker 1: Okay, And you mentioned the clos. They are obviously dominant 604 00:31:40,600 --> 00:31:42,960 Speaker 1: players in the leverage load market. They buy lots of them. 605 00:31:43,280 --> 00:31:45,760 Speaker 1: We have a lot of people on the show talking 606 00:31:45,760 --> 00:31:48,880 Speaker 1: about how great clos are and they love the investment on. 607 00:31:49,200 --> 00:31:52,240 Speaker 1: One of the big firms investing called them bulletproof and 608 00:31:52,320 --> 00:31:54,640 Speaker 1: they did. You know, they've done really well over time, 609 00:31:54,960 --> 00:31:57,120 Speaker 1: but they seem to be under a bit of pressure 610 00:31:57,160 --> 00:32:01,880 Speaker 1: to offload stuff at presumab a loss, which doesn't sound good. 611 00:32:02,160 --> 00:32:04,160 Speaker 1: At the same time, you know, we're also hearing that 612 00:32:04,200 --> 00:32:06,920 Speaker 1: they are keen to sell out of anything that might 613 00:32:06,960 --> 00:32:10,880 Speaker 1: get into liability management territory because they tend not to 614 00:32:10,920 --> 00:32:13,440 Speaker 1: hold big enough stakes to kind of go through the 615 00:32:13,480 --> 00:32:16,120 Speaker 1: process and have a critical mass such that they'll get 616 00:32:16,120 --> 00:32:18,880 Speaker 1: a good outcome in terms of the LME. Is that 617 00:32:19,080 --> 00:32:23,760 Speaker 1: something another dynamic you'll see in the market. Jackson absolutely absolutely. 618 00:32:24,000 --> 00:32:27,280 Speaker 1: The advent of lem is again widely reported, but it's 619 00:32:27,320 --> 00:32:31,600 Speaker 1: it is a strong influence on investor behavior. Everyone in 620 00:32:31,640 --> 00:32:36,920 Speaker 1: the leverage finance market is changing their approach and incorporating 621 00:32:36,960 --> 00:32:39,720 Speaker 1: a view on these in almost every credit decision you 622 00:32:39,800 --> 00:32:44,920 Speaker 1: make from new issuance. When you're structuring documents and negotiating covenants, 623 00:32:45,000 --> 00:32:47,840 Speaker 1: you know, not financial covenants, but structuring a credit agreement 624 00:32:48,640 --> 00:32:52,440 Speaker 1: to any sort of workout pre workout credit decision. Lemes 625 00:32:52,720 --> 00:32:55,680 Speaker 1: are front and center. Clos individually for sure, do not 626 00:32:55,760 --> 00:32:58,240 Speaker 1: old enough to rise to the level where they would 627 00:32:58,240 --> 00:33:00,520 Speaker 1: be on the right side of the line when that 628 00:33:00,920 --> 00:33:05,280 Speaker 1: bifurcation of majority group and minority group occurs. COLO managers 629 00:33:05,280 --> 00:33:08,080 Speaker 1: sometimes can be the largest players in the capital market, 630 00:33:08,160 --> 00:33:10,280 Speaker 1: and so taken as a whole, they tend to be 631 00:33:10,560 --> 00:33:12,520 Speaker 1: on the right side of that line and large holders 632 00:33:12,520 --> 00:33:15,840 Speaker 1: and we've certainly seen them be participants and sometimes aggressive 633 00:33:15,880 --> 00:33:20,040 Speaker 1: participants in lemes. But the paper that you're left with 634 00:33:20,120 --> 00:33:23,200 Speaker 1: post LME tends not to be COLO friendly. You know, 635 00:33:23,240 --> 00:33:26,160 Speaker 1: it's not going to get a good credit rating. Lems 636 00:33:26,200 --> 00:33:28,760 Speaker 1: are largely band aids that fail to heal the wound 637 00:33:29,000 --> 00:33:31,960 Speaker 1: on The success rate for them is exceedingly low, and 638 00:33:32,040 --> 00:33:35,440 Speaker 1: so the result even if you're a successful participant and 639 00:33:35,440 --> 00:33:37,479 Speaker 1: you're in the majority and you're able to advance your 640 00:33:37,520 --> 00:33:41,160 Speaker 1: claim visa VI the minority group or take some other advantage. 641 00:33:41,520 --> 00:33:44,840 Speaker 1: The resulting paper is not a COLO friendly piece, and 642 00:33:44,880 --> 00:33:47,560 Speaker 1: therefore we have seen them clean up some of their 643 00:33:47,600 --> 00:33:50,120 Speaker 1: portfolios when LMES committed the offing. 644 00:33:50,480 --> 00:33:53,680 Speaker 2: So, I mean, when you're looking at these opportunities, are 645 00:33:53,720 --> 00:33:57,920 Speaker 2: you looking at potentially going through the LME process or 646 00:33:57,920 --> 00:33:59,719 Speaker 2: if you think that's a risk, you're sort of more 647 00:33:59,760 --> 00:34:02,800 Speaker 2: st on the sidelines and waiting to maybe pick up 648 00:34:02,800 --> 00:34:04,040 Speaker 2: this post enemy paper. 649 00:34:04,440 --> 00:34:07,760 Speaker 3: It's part of our underwrite and every credit in understanding 650 00:34:08,160 --> 00:34:12,560 Speaker 3: the landscape, what's possible, who's organizing, where the votes sit, 651 00:34:12,600 --> 00:34:16,439 Speaker 3: where the concentrations sit, if there's groups forming that might form, 652 00:34:16,520 --> 00:34:20,239 Speaker 3: what they would likely be. That is absolutely part of 653 00:34:20,280 --> 00:34:22,120 Speaker 3: our underwright as we look at every credit. 654 00:34:22,320 --> 00:34:24,680 Speaker 1: So you can go through a whole restructuring. Can you 655 00:34:24,680 --> 00:34:25,920 Speaker 1: you can go through the whole process? 656 00:34:25,960 --> 00:34:26,560 Speaker 2: I mean would you? 657 00:34:27,000 --> 00:34:30,360 Speaker 3: We can? Yes? Absolutely, And we've got locked up capital 658 00:34:30,360 --> 00:34:33,080 Speaker 3: that allows us to take that COLO and friendly paper. 659 00:34:33,200 --> 00:34:36,399 Speaker 3: And you know we've been active participants in some we're 660 00:34:36,440 --> 00:34:39,480 Speaker 3: someone agnostic to them. If it's there, we'll do it. 661 00:34:39,560 --> 00:34:42,480 Speaker 3: We sure try to avoid being in the minority group. 662 00:34:42,719 --> 00:34:47,640 Speaker 3: You know, the couple recent examples of lme's you know, Multicolor, 663 00:34:47,840 --> 00:34:49,319 Speaker 3: even though it was a pre pack, there is an 664 00:34:49,360 --> 00:34:51,239 Speaker 3: ad hoc group that's able to roll up some of 665 00:34:51,280 --> 00:34:54,440 Speaker 3: their claim and in Ring Cam was a much smaller case. 666 00:34:54,520 --> 00:34:59,520 Speaker 3: But you're seeing ten to thirty percent premiums earned by 667 00:34:59,640 --> 00:35:02,160 Speaker 3: the the majority group over the minority group, and I 668 00:35:02,160 --> 00:35:04,880 Speaker 3: think that's a pretty good yard stick for the types 669 00:35:04,880 --> 00:35:07,200 Speaker 3: of outcomes. They can be much more to cony in 670 00:35:07,200 --> 00:35:09,319 Speaker 3: its own cases, but that's a pretty good yardstick for 671 00:35:09,360 --> 00:35:11,960 Speaker 3: the bread and butter outcome you might see in an LM. 672 00:35:12,440 --> 00:35:14,960 Speaker 1: So in terms of the outlook for elemies, we did 673 00:35:15,000 --> 00:35:17,440 Speaker 1: SAE kind of a slowdown in terms of the amount 674 00:35:17,480 --> 00:35:20,200 Speaker 1: of them, and there was some talk of that cooling 675 00:35:20,200 --> 00:35:22,920 Speaker 1: off because of the antitrust issues and all of that, 676 00:35:22,960 --> 00:35:24,880 Speaker 1: and the lit lawyers. We're kind of, you know, stepping 677 00:35:24,920 --> 00:35:27,000 Speaker 1: back a bit. But do you do you expect that 678 00:35:27,280 --> 00:35:29,879 Speaker 1: activity top back up in terms of, you know, more 679 00:35:30,280 --> 00:35:31,640 Speaker 1: of those sorts of transactions. 680 00:35:31,800 --> 00:35:34,560 Speaker 3: I do. We we've seen a cooling of them a 681 00:35:34,600 --> 00:35:37,319 Speaker 3: little bit in being announced, not a lot, I would say, 682 00:35:37,320 --> 00:35:40,759 Speaker 3: behind the scenes where they're being set up and negotiated. 683 00:35:40,760 --> 00:35:44,040 Speaker 3: Where groups are forming, they're still very prevalent, and the 684 00:35:44,160 --> 00:35:47,800 Speaker 3: dynamic that leads to them where you've got some subset 685 00:35:47,800 --> 00:35:50,440 Speaker 3: of the creditor group forming an ad hoc group, putting 686 00:35:50,440 --> 00:35:53,400 Speaker 3: in place a co op, and then creating some sort 687 00:35:53,520 --> 00:35:57,600 Speaker 3: of consolidated entity to enter negotiations with the sponsor, who 688 00:35:57,640 --> 00:36:00,399 Speaker 3: is then going out and looking at perhaps to deal 689 00:36:00,440 --> 00:36:02,439 Speaker 3: away and bringing in a third party to raise cap 690 00:36:02,640 --> 00:36:05,759 Speaker 3: or threatening to do that to create leverage with their 691 00:36:05,800 --> 00:36:09,560 Speaker 3: existing lenders. That's in that's very very prevalent. I don't 692 00:36:09,600 --> 00:36:11,719 Speaker 3: I don't see that going away. It will continue to 693 00:36:11,760 --> 00:36:15,880 Speaker 3: evolves as each group kind of tweaks their approach. The 694 00:36:15,920 --> 00:36:19,080 Speaker 3: advent of co ops has been you know, welcome from 695 00:36:19,080 --> 00:36:21,239 Speaker 3: our perspective for our creditor. They're good for us. But 696 00:36:21,280 --> 00:36:24,320 Speaker 3: there's a constant el you know, cat and mouse evolution game. 697 00:36:24,840 --> 00:36:29,200 Speaker 3: There's a really remarkable degree of creativity in the space 698 00:36:29,600 --> 00:36:33,160 Speaker 3: as people find new ways to tweak and new loopholes 699 00:36:33,160 --> 00:36:33,720 Speaker 3: to exploit. 700 00:36:34,360 --> 00:36:37,080 Speaker 1: So in terms of protecting the downside, though, if you know, 701 00:36:37,239 --> 00:36:39,799 Speaker 1: let's say things get a lot worse, I think you 702 00:36:39,880 --> 00:36:42,719 Speaker 1: mentioned the idea of a downsound. In terms of the economy, 703 00:36:42,840 --> 00:36:45,160 Speaker 1: the probability of recession right now is very low, about 704 00:36:45,160 --> 00:36:47,080 Speaker 1: thirty percent for the US, and a lot of people 705 00:36:47,160 --> 00:36:49,960 Speaker 1: think that midterm stimulus will push it, you know, further 706 00:36:50,000 --> 00:36:52,360 Speaker 1: out into the future. But what what do you do 707 00:36:52,440 --> 00:36:55,040 Speaker 1: to protect yourself? How could you hedge your positions? 708 00:36:55,520 --> 00:37:00,760 Speaker 3: Well, we don't. We don't hedge. How doing it requires 709 00:37:00,760 --> 00:37:05,200 Speaker 3: some level liquidity. Hedging in liquid assets with liquid hedges 710 00:37:05,239 --> 00:37:07,239 Speaker 3: tends to be a mistake because you run into tenor 711 00:37:07,280 --> 00:37:11,040 Speaker 3: problems very quickly, and so other than trying to take 712 00:37:11,080 --> 00:37:13,560 Speaker 3: currency risk off the table, we don't hedge. As a rule. 713 00:37:13,800 --> 00:37:17,200 Speaker 3: What we do do is try to position ourselves in 714 00:37:17,280 --> 00:37:23,000 Speaker 3: the capital structure where we can be wrong on timing, 715 00:37:23,719 --> 00:37:26,719 Speaker 3: but as long as we're somewhat correct on outcome, we 716 00:37:26,840 --> 00:37:30,720 Speaker 3: have the standing and the wherewithal to persist to that point. 717 00:37:31,280 --> 00:37:33,440 Speaker 3: And so what I mean by that is we're there 718 00:37:33,520 --> 00:37:36,120 Speaker 3: to be a downturn in the US, and you saw 719 00:37:36,760 --> 00:37:39,040 Speaker 3: just the macro decline in the economy with the resulting 720 00:37:39,040 --> 00:37:43,040 Speaker 3: pressure on companies cash flows. As a junior lender, you 721 00:37:43,160 --> 00:37:46,920 Speaker 3: can be extinguished at that down and that downturn, at 722 00:37:46,920 --> 00:37:50,200 Speaker 3: that low point in the company's financial performance through restructuring, 723 00:37:50,560 --> 00:37:53,440 Speaker 3: where if it's subsequently rebounds the senior lenders who now 724 00:37:53,600 --> 00:37:56,040 Speaker 3: in the equity. We'll take advantage of that and reap 725 00:37:56,120 --> 00:37:58,880 Speaker 3: the benefits. You were, you didn't persist long enough to 726 00:37:58,920 --> 00:38:01,640 Speaker 3: see the rebound, and so we focus a lot on 727 00:38:01,719 --> 00:38:04,960 Speaker 3: making sure we're in a sustainable and protected place in 728 00:38:05,000 --> 00:38:07,880 Speaker 3: the capital structure where we will have the benefit of 729 00:38:07,920 --> 00:38:11,560 Speaker 3: time and that persistence to see the better day, because 730 00:38:11,560 --> 00:38:14,560 Speaker 3: there's nothing worse than being correct on the outcome but 731 00:38:14,680 --> 00:38:17,160 Speaker 3: not having survived and to see it and enjoy it. 732 00:38:17,480 --> 00:38:19,880 Speaker 1: You mentioned that the levels you'll see in terms of 733 00:38:19,920 --> 00:38:24,640 Speaker 1: the loans pricing best in some years. How far do 734 00:38:24,640 --> 00:38:26,960 Speaker 1: you have to go back to kind of put this 735 00:38:27,200 --> 00:38:28,920 Speaker 1: current moment in context? 736 00:38:29,040 --> 00:38:31,240 Speaker 3: You think, well, you know, COVID had that brief period 737 00:38:31,280 --> 00:38:35,040 Speaker 3: of where the technical the leverage unwound and there's a 738 00:38:35,120 --> 00:38:38,560 Speaker 3: number of margin calls, Celo warehouses were being collapsed left 739 00:38:38,560 --> 00:38:41,640 Speaker 3: and right, and you saw and you know the level 740 00:38:41,640 --> 00:38:44,279 Speaker 3: of fear and uncertainty that we all experienced. That led 741 00:38:44,320 --> 00:38:46,520 Speaker 3: to a period of discount, but it was it was 742 00:38:46,560 --> 00:38:50,040 Speaker 3: surprisingly short. If you go back to the GFC, that 743 00:38:50,120 --> 00:38:54,480 Speaker 3: was certainly longer, maybe a greater and more sustained financial fear, 744 00:38:54,560 --> 00:38:57,520 Speaker 3: But there you had a sustained period of discount that 745 00:38:57,640 --> 00:39:00,720 Speaker 3: really persisted in some levels for a couple of years. 746 00:39:00,760 --> 00:39:05,200 Speaker 3: You didn't see the same technical dislocation and supply demanded 747 00:39:05,280 --> 00:39:08,400 Speaker 3: balance that led to really sharp price dislocations. What you 748 00:39:08,440 --> 00:39:13,200 Speaker 3: saw a post GFC was a multiple suppression, valua suppression 749 00:39:13,200 --> 00:39:15,319 Speaker 3: that lasted for a number of years. You know, every 750 00:39:15,360 --> 00:39:17,120 Speaker 3: once in a while, we'll go back and look at 751 00:39:17,160 --> 00:39:21,800 Speaker 3: old investment presentations, and while we're an absolute value investor, 752 00:39:21,880 --> 00:39:24,799 Speaker 3: we're not completely immune from our environment. And we were 753 00:39:24,800 --> 00:39:28,000 Speaker 3: looking at decks in the twenty ten eleven twelve timeframe 754 00:39:28,680 --> 00:39:31,800 Speaker 3: where we were using enterprise value multiples and exit multiples 755 00:39:31,840 --> 00:39:34,240 Speaker 3: that were at a significant discount to where they are today, 756 00:39:34,280 --> 00:39:37,600 Speaker 3: which just shows that the hangover there really suppressed people's 757 00:39:37,680 --> 00:39:40,480 Speaker 3: valuation expectations for a number of years. That's probably the 758 00:39:40,520 --> 00:39:44,040 Speaker 3: period that had the greatest kind of persistent level of 759 00:39:44,120 --> 00:39:46,719 Speaker 3: value where you could really deploy capital and in a 760 00:39:46,800 --> 00:39:50,520 Speaker 3: really nice return. We're not approaching that today, and I'd 761 00:39:50,520 --> 00:39:53,080 Speaker 3: say enterprise values are still very healthy. So we are 762 00:39:53,160 --> 00:39:56,280 Speaker 3: seeing discount, but it is against a much stronger backdrop. 763 00:39:56,320 --> 00:39:58,000 Speaker 1: Do you expect things to get a lot worse though, 764 00:39:58,200 --> 00:40:00,920 Speaker 1: in terms of you know, the state of the the market, 765 00:40:01,160 --> 00:40:03,280 Speaker 1: and they're by your opportunity get much better. 766 00:40:03,520 --> 00:40:05,879 Speaker 3: Well, look, I've been a distressed guy for almost thirty years, 767 00:40:05,920 --> 00:40:07,799 Speaker 3: so if you're going to ask me for sunshine, I'm 768 00:40:07,840 --> 00:40:11,720 Speaker 3: going to disappoint you. All I see is storm clouds 769 00:40:11,760 --> 00:40:15,000 Speaker 3: and rain. And look, I've got a biased view because 770 00:40:15,560 --> 00:40:18,840 Speaker 3: our opportunity set is filled with companies that are facing 771 00:40:18,920 --> 00:40:23,640 Speaker 3: challenges and shortcomings and having problems. And so I wouldn't 772 00:40:23,640 --> 00:40:25,799 Speaker 3: claim to have an objective view of the overall market 773 00:40:25,800 --> 00:40:29,719 Speaker 3: because we only focus on the underperforming segment. I'm not 774 00:40:29,760 --> 00:40:33,280 Speaker 3: in the business of macro forecasts, and I wouldn't venture 775 00:40:33,280 --> 00:40:36,359 Speaker 3: one today. What I will say is the degradation and 776 00:40:36,400 --> 00:40:39,279 Speaker 3: the credit quality of the loan market, coupled with the 777 00:40:39,400 --> 00:40:43,680 Speaker 3: very aggressive behavior and increasing competitive pressures in the private 778 00:40:43,680 --> 00:40:47,680 Speaker 3: credit market, are creating a lot of potential energies in 779 00:40:47,719 --> 00:40:51,640 Speaker 3: those two populations where lender behave lenders are taking more risk, 780 00:40:51,800 --> 00:40:54,320 Speaker 3: they have taken more risk and leverage loans. They're taking 781 00:40:54,320 --> 00:40:58,880 Speaker 3: more risk now in private credit. Increased risk taking is 782 00:40:58,920 --> 00:41:02,160 Speaker 3: the necessary recondition of a credit cycle, and so I 783 00:41:02,200 --> 00:41:04,120 Speaker 3: can't tell you when the cycle will happen and when 784 00:41:04,120 --> 00:41:06,680 Speaker 3: the downturn will come. What I can tell you is 785 00:41:06,760 --> 00:41:10,440 Speaker 3: potential energy is building in those books of loans, in 786 00:41:10,520 --> 00:41:13,319 Speaker 3: those two populations of credit instruments, so that when that 787 00:41:13,400 --> 00:41:16,520 Speaker 3: day does arrive, the backdrop of shaky credits is going 788 00:41:16,560 --> 00:41:20,239 Speaker 3: to be sufficiently high that there and my guess, will 789 00:41:20,280 --> 00:41:22,319 Speaker 3: be some sort of dramatic dislocation. 790 00:41:22,600 --> 00:41:24,719 Speaker 1: How do you stay ahead, jessin what's your edge in 791 00:41:24,840 --> 00:41:27,920 Speaker 1: terms of you know, keeping these high teens twenty percent returns? 792 00:41:28,120 --> 00:41:33,279 Speaker 3: Well? Our edge? Our edge? I do believe we have 793 00:41:33,320 --> 00:41:36,000 Speaker 3: an edge. Everyone claims to it. Some claims are stronger 794 00:41:36,040 --> 00:41:39,160 Speaker 3: than others. In our space, we have an edge. The 795 00:41:40,520 --> 00:41:43,520 Speaker 3: credit markets, especially on the secondary side, but even on 796 00:41:43,560 --> 00:41:47,440 Speaker 3: the primary side, to some degree, are notorious for a 797 00:41:47,520 --> 00:41:51,880 Speaker 3: lack of information. I think the average civilian retail investor 798 00:41:51,880 --> 00:41:57,200 Speaker 3: would be shocked at how little insight institutional credit investors 799 00:41:57,280 --> 00:42:01,319 Speaker 3: have into their underlying portfolio companies. The level of disclosure 800 00:42:01,640 --> 00:42:04,799 Speaker 3: is very limited. It's worse for private companies than it 801 00:42:04,880 --> 00:42:08,279 Speaker 3: is for public companies. There's a somewhat almost adversary relationship 802 00:42:08,320 --> 00:42:11,719 Speaker 3: between the lenders and the borrowers, where the barrowers don't 803 00:42:11,760 --> 00:42:13,600 Speaker 3: want to share too much and certainly don't want to 804 00:42:13,640 --> 00:42:18,160 Speaker 3: share what their future plans are getting three statement three 805 00:42:18,160 --> 00:42:21,680 Speaker 3: statement financial models and maybe a paragraph or two of 806 00:42:21,800 --> 00:42:24,399 Speaker 3: MDA you feel pretty good about as a regular way 807 00:42:24,480 --> 00:42:28,839 Speaker 3: lender today. And so our edge, such that exists, is 808 00:42:28,920 --> 00:42:31,560 Speaker 3: in our space being able to go into the HIG 809 00:42:31,719 --> 00:42:35,800 Speaker 3: portfolio companies and speaking to those CEOs when they're competing, 810 00:42:35,840 --> 00:42:38,799 Speaker 3: which against a company that we're looking at investing in, 811 00:42:39,200 --> 00:42:41,480 Speaker 3: or talking to a DAL team that participated in a 812 00:42:41,520 --> 00:42:43,919 Speaker 3: sale process where the current sponsor bought it, but maybe 813 00:42:43,920 --> 00:42:45,640 Speaker 3: they went two rounds and did a month or two 814 00:42:45,640 --> 00:42:49,960 Speaker 3: of diligence. That's a standard deviation or two deeper than 815 00:42:50,000 --> 00:42:52,839 Speaker 3: we could otherwise go if we were an independent organization 816 00:42:53,360 --> 00:42:55,520 Speaker 3: and having access to that. It doesn't exist everywhere, but 817 00:42:55,560 --> 00:42:58,040 Speaker 3: we focus where we do have it. That allows us 818 00:42:58,080 --> 00:43:00,120 Speaker 3: to go in and invest with confidence in these the 819 00:43:00,120 --> 00:43:03,560 Speaker 3: WISSE troubled situations. That's our edge. It exists where we 820 00:43:03,600 --> 00:43:06,040 Speaker 3: overlap with the rest of the firm. It doesn't exist elsewhere, 821 00:43:06,080 --> 00:43:08,040 Speaker 3: which is why we try very hard to stay in 822 00:43:08,080 --> 00:43:11,440 Speaker 3: our lane. But it's sustainable and as the firm has grown, 823 00:43:11,800 --> 00:43:14,600 Speaker 3: it's grown within the US, it's grown globally, and just 824 00:43:14,680 --> 00:43:17,080 Speaker 3: the passage of time, the more deals that we've looked 825 00:43:17,080 --> 00:43:19,920 Speaker 3: at the more we know, the greater the institutional knowledge grows, 826 00:43:20,400 --> 00:43:22,960 Speaker 3: it grows as well, and so that's our edge and 827 00:43:23,000 --> 00:43:25,360 Speaker 3: we really try to stay within those boundaries. 828 00:43:25,719 --> 00:43:28,680 Speaker 1: Great stuff, Jackson Craig with HIG Bayside. It's been a 829 00:43:28,680 --> 00:43:31,240 Speaker 1: real pleasure having you on the Credit Edge. Many thanks likewise, 830 00:43:31,280 --> 00:43:33,400 Speaker 1: thank you, this was fun. And to Tim Riminton with 831 00:43:33,400 --> 00:43:35,480 Speaker 1: blaiem Book Intelligence, thank you very much for join us today. 832 00:43:35,560 --> 00:43:36,240 Speaker 2: Thanks James