Speaker 1: Hello, and welcome to The Credit Edge, a weekly markets podcast.
Speaker 1: My name is James Crumby. I'm a senior editor at Bloomberg.
Speaker 1: This week, we're very pleased to welcome Bruce Richards, chairman
Speaker 1: and CEO of Marathon Asset Management, a twenty three billion
Speaker 1: dollar asset manager.
Speaker 2: How are you, Bruce, I'm doing well.
Speaker 3: Hello, James, Thank.
Speaker 1: You so much for joining us today. We're really looking
Speaker 1: forward to getting your take on credit markets and real estate.
Speaker 1: Also delighted to see Bloomberg's very own Lisa Lee covering
Speaker 1: credit markets from London. How's it going, Lisa.
Speaker 4: Going well here? Thank you so much.
Speaker 1: James, and our banks guru, Arnold Kakuda with Bloomberg Intelligence,
Speaker 1: also here in the studio in New York. How's it going, Arnold?
Speaker 5: Awesome, excited to be here.
Speaker 1: So let's start with you, Bruce. It's great to have
Speaker 1: you on the Credit Edge. You're a real estate bear,
Speaker 1: particularly when it comes to offices and all the debt
Speaker 1: that's outstanding. There's almost a trillion dollars of commercial real
Speaker 1: estate loans coming due this year and banks are mostly
Speaker 1: on the hook. They hold a lot of those loans.
Speaker 1: But recently we've heard FED Chair j Powell and Treasury
Speaker 1: Secretary Janet Yellen talking about commercial real estate risks, as
Speaker 1: well as executives at regional banks and analysts. They're all
Speaker 1: using the word manageable. It's going to be okay. What
Speaker 1: do you make of that, Bruce? Are they protesting too much?
Speaker 1: What's your take?
Speaker 2: Well, that's a big subject, Tom, I think it is
Speaker 2: going to be okay. Christianity Jan's drawing the line in
Speaker 2: the sand, and she said she's the facto made a
Speaker 2: statement after March of last year that no deposit will
Speaker 2: lose a penny, and indeed, no deposit will lose a penny.
Speaker 2: So the big banks have never been safer than what
Speaker 2: they are today. I'm talking about the Big four and
Speaker 2: also the largest banks here in the United States. But
Speaker 2: as you know, there is more to it than that.
Speaker 2: And so when you peel back the Onion City, well
Speaker 2: you see that the bigger banks have about ten percent
Speaker 2: exposure of commercial real estate, and the smaller banks and
Speaker 2: the regional size banks have an average about forty percent
Speaker 2: exposure to commercial real estate. That is a huge number
Speaker 2: relative to their capital base. So let me point out
Speaker 2: a few things. Number one is Bosle three endgame, or
Speaker 2: what we call in other parts of the world Basil
Speaker 2: four is going to start next summer, and they're not
Speaker 2: going to push.
Speaker 3: Out the data. I don't believe.
Speaker 2: And despite pal in his most recent statements having softened
Speaker 2: up a stance and opened up the door to potentially
Speaker 2: a little less capital requirement that might take you from
Speaker 2: sixteen to twenty percent capital race increases down to round
Speaker 2: ten to fifteen percent, but it's not going to push
Speaker 2: up to date and it's not going to negate the
Speaker 2: fact that you'll need more capital against risk assets.
Speaker 3: That's number one. And with that, banks.
Speaker 2: Will look to a do asset sales b uh DE
Speaker 2: risk by raising more CT court tier one equity capital
Speaker 2: that's both in the form of long debt as well
Speaker 2: as equity, but mostly in the form of retained earnings
Speaker 2: to build that base, and they'll probably just lend a
Speaker 2: little less and a little bit more selectively at more
Speaker 2: conservative attachment points in terms of where the lt V
Speaker 2: lending points are.
Speaker 3: So what we're seeing as result is a lot of
Speaker 3: these SRT transactions and CRT Transactionally. Sr T is the
Speaker 3: significant risk transfer uh the credit risk transfers as well.
Speaker 3: Where banks are transferring their first loss or mezzanine trances
Speaker 3: of their portfolio of loans to buyers like Marathon. And
Speaker 3: so we've been very, very active dealing with the large
Speaker 3: savvy banks in Europe and the large banks in the
Speaker 3: United States and buying into these pools through CRT and
Speaker 3: s r T.
Speaker 2: You know, last year alone, the European banks did two
Speaker 2: hundred billion of worth of portfolios of credit risk transfers
Speaker 2: last year alone. And you know, in the September, you know,
Speaker 2: just a few months ago, the feveral Lyster statement that
Speaker 2: you talked about the SRT merits and complying with reg Q,
Speaker 2: they basically blested here in the States, and so the
Speaker 2: United States we've seen the banks really ramp up. And
Speaker 2: so with BOSEL three endgames that just set to start
Speaker 2: July next year, we believe that is a huge amount
Speaker 2: probably for US banks, you know, you know that did
Speaker 2: thirty five billion last year upwards of one hundred billion
Speaker 2: this year. And so I think, you know, we have
Speaker 2: all the tools in the toolbox to make the banks safe.
Speaker 2: First of all, again, the biggest banks are perfectly safe,
Speaker 2: but it's the smaller banks than that you now want
Speaker 2: to start to focus in on So in the United States,
Speaker 2: you know, we have four thousand, two hundred banks here
Speaker 2: in the United States, four two hundred.
Speaker 3: Just wrap your head around that for a second.
Speaker 2: So what do you have in Germany and France and
Speaker 2: UK and Korea and Japan and Canada one hundred to
Speaker 2: three hundred banks and we have four.
Speaker 3: Thousand, two hundred.
Speaker 2: You know, back in the nineteen eighties, before the SNL crisis,
Speaker 2: there was over fourteen thousand banks here in the United States,
Speaker 2: fourteen thousand, and we're down to four thousand, four hundred.
Speaker 2: So you obviously need you know, kind of the top four,
Speaker 2: but beyond the top four, or you can drill down
Speaker 2: to the top thirty, which are at the top thirty banks,
Speaker 2: there's an exact number who have one hundred billion assets
Speaker 2: for more. You obviously don't need those banks to be
Speaker 2: strong and viable. But outside of that, do you need
Speaker 2: I don't know, twenty banks per state here in the
Speaker 2: United States, which is one thousand banks.
Speaker 1: So much information in that, and it's you know, that
Speaker 1: opened up so many questions. But first of all, on
Speaker 1: the banks you mentioned, there are a lot of banks,
Speaker 1: and maybe there are too many in the US. Do
Speaker 1: you expect bank failures as a result of this, commercial
Speaker 1: real estates, mess, trouble, whatever you want.
Speaker 2: To call it.
Speaker 1: And to what level does it go? Is it just
Speaker 1: very small regional banks, is it like savings and loans,
Speaker 1: or does it rise to a level of a much
Speaker 1: larger institution.
Speaker 2: I think now that the deposits have been backstopped by
Speaker 2: the Treasury Secretary at the ELM, which I thought was
Speaker 2: a brilliant move.
Speaker 3: Sorry I applaud her for that.
Speaker 2: I think you're not going to have any run on deposits,
Speaker 2: So that takes a lot of risk off the table
Speaker 2: and panic off the table, and now it becomes just
Speaker 2: a matter of are you solvent or are you not solvent?
Speaker 2: How many banks do I think are not solvent today?
Speaker 3: I don't know.
Speaker 2: My best guesstimate is around three hundred based upon and
Speaker 2: these are small regional banks. There's over four thousand of them,
Speaker 2: and I think anywhere around two to three hundred are
Speaker 2: not solvent today. And I think if the fault rates
Speaker 2: and commercial rows, they go up to ten percent, and
Speaker 2: they've currently you know, just increased from two percent where
Speaker 2: it was two years ago, actually less than two percent
Speaker 2: just two years ago. To over six percent today. But
Speaker 2: if they go to ten percent, which I think it
Speaker 2: will be what they get to, I think that number
Speaker 2: rises to four hundred. So what happens there, it's just
Speaker 2: simply a resolution. The bank just gets wound down. It
Speaker 2: won't be a panic, it'll just be FDIC comes in
Speaker 2: and you know, takes over, the bank, sells off their assets,
Speaker 2: transfers deposits, you move on. And so there's a lot
Speaker 2: of cleanup that the regulators have to do.
Speaker 3: They know that.
Speaker 2: And so in the you know, National Bureau of Economic
Speaker 2: Research working paper series it just came out on c
Speaker 2: e ORE and bank fragility, you know, it highlights this
Speaker 2: exact this exact point talking about the forty percent exposure
Speaker 2: that small and regional banks have to commercial real estate.
Speaker 2: So let's all about commercial real estate. I mean, you know,
Speaker 2: you know, delinquency rates are up and property values are down,
Speaker 2: and difically, when cap rates go up, you know, one
Speaker 2: hundred to one hundred and fifty basis points on a property,
Speaker 2: then the value can decline twenty five to thirty percent,
Speaker 2: and so all that extra you know, one hundred million
Speaker 2: dollar properties, seventy million dollars loan, you decline thirty percent,
Speaker 2: there's no equity left, and so there's a lot of
Speaker 2: that resolution to do. Taking the pick through the python
Speaker 2: is going to take some time in terms of working
Speaker 2: this all out. I think commercial real estate represents a
Speaker 2: lot of distress in the marketplace, but also one of
Speaker 2: the greatest opportunities in the marketplace right now. So as
Speaker 2: the banks pull back from because remember banks are fifty
Speaker 2: percent five zero fifty percent of all commercial real estate
Speaker 2: lending is five point six trillion dollars of commercial real
Speaker 2: estate loans here in the United States, and they're fifty
Speaker 2: percent of that book.
Speaker 3: And so why did the debt wall.
Speaker 2: The maturity debt wall just increase from five hundred and
Speaker 2: forty billion this year on commercial real estate loans to
Speaker 2: nine hundred billion Because all the loans coming due last year,
Speaker 2: very few of them paid off, most of them got
Speaker 2: extended into this year, and so it's extending pretend game
Speaker 2: going on right now, and a lot of that's going
Speaker 2: to get resolved, and as it gets resolved, losses are
Speaker 2: going to get pushed through to the system for both
Speaker 2: the lender as well as you know, as well as
Speaker 2: the prior owner. And so it's an opportunity for firms
Speaker 2: like Marathon to step up as banks exit commercial real
Speaker 2: estate lending and exit. When I say exit, not go
Speaker 2: from forty percent to zero, but go from forty percent
Speaker 2: to where they should be fifteen to twenty percent. That's
Speaker 2: where they should be. So that holds it, so that
Speaker 2: big void, we're going to step up and make these loans.
Speaker 2: And so the amount of the amount of capitalists needed
Speaker 2: from private crapal capital to solve.
Speaker 3: For this is enormous.
Speaker 2: And so we're getting paid really nice returns and I
Speaker 2: love it because it's at the current cap rates with
Speaker 2: the current cash flow, not at the bubble pricing periods
Speaker 2: that we had.
Speaker 4: I'm sorry, Lisa, Oh, yes, you mentioned the SRT and
Speaker 4: CRT some of these balance sheet movements that banks are
Speaker 4: doing to raise their capital. Are all of these sort
Speaker 4: of performing credits or is some of the distress stuff
Speaker 4: that you just mentioned right now?
Speaker 2: No, No, it would never at least it would never
Speaker 2: be distressed. It all has to be performing. If it's
Speaker 2: not performing, crystal clear clean like, none of us are
Speaker 2: going to touch it. So we're scrubbing these portfolios. You're
Speaker 2: talking about hundreds of loans to thousands loans that we're
Speaker 2: scrubbing through at a low level detail to make sure
Speaker 2: everything is performing going and you're talking about an average
Speaker 2: of a triple B credit going in and then triple
Speaker 2: triple B minus, so nothing is not performing.
Speaker 4: No, And then you said two hundred billion last year
Speaker 4: from Europe and then US banks are wrapping up. Given
Speaker 4: the size of the US market, where do you think
Speaker 4: the greater opportunity would be this year to continue from
Speaker 4: the europeans or where with the new US mandate twos
Speaker 4: to do these kind of deals.
Speaker 2: An equal opportunity employer, We love it and we love
Speaker 2: both markets. And so dealing with the top banks in
Speaker 2: Europe and dealing with the top banks in US, we
Speaker 2: have all those relationships. They're very very selective who they'll
Speaker 2: go to in you know, these transactions. It's you know,
Speaker 2: signing NDAs, is looking into portfolios and it's being there
Speaker 2: to a price risk appropriately and then take size. I'm
Speaker 2: talking about you know, one hundreds of millions per transaction.
Speaker 3: So it's you know a huge opportunity in Europe.
Speaker 2: Europe has been doing this for twenty plus years, the
Speaker 2: US hasn't. But now the FED has blessed the US
Speaker 2: banks to de risk knowing that the methodology and technology
Speaker 2: UH through these off balance sheet types of curizations and
Speaker 2: risk transfers has been well in trans in Europe, they've
Speaker 2: studied the model, they see the merits in it. As
Speaker 2: the US is just starting this out, so the US
Speaker 2: will converge to I think where Europe is and it
Speaker 2: being hundreds of billions on an annual basis, on a
Speaker 2: go forward basis.
Speaker 5: Great, thanks Bruce. Hey, this is Arnold Cokuda b I
Speaker 5: credit analyst covering banks, and you know, I agree with
Speaker 5: you in terms of these increased regulatory pressures moving some
Speaker 5: of the risk out of out of banks, right and
Speaker 5: let's call it into you know, the shadow bank system.
Speaker 5: So you know, Bruce, you talked about the opportunity there,
Speaker 5: but what do you think is the right amount of
Speaker 5: of you know, this this risk moving to the shadow
Speaker 5: banks and whatnot out of the banking system. You know,
Speaker 5: it's an opportunity for marathon, but but how much is
Speaker 5: too much?
Speaker 2: I view that, Thank you, Arnold, and nice to talk
Speaker 2: to you. I view that as a toolbox or playbook
Speaker 2: that they have. So to Lisa's prior question, when you
Speaker 2: have just trust situations that the banks involved in terms
Speaker 2: of loans built that results in an asset sales, so
Speaker 2: they'll sell those loans. So that's an outright it's not
Speaker 2: a risk transfer per se, it's just a loan sale.
Speaker 2: And so yes, we're involved in that, Lisa and Arnold.
Speaker 2: Second is in terms of these partnerships, these SRT CRT transfers,
Speaker 2: I think kind of the pace that Europe has been running,
Speaker 2: because they're way ahead on this is probably the right
Speaker 2: pace for the Europe to continue running and the US
Speaker 2: to continue running. I don't think it goes up much
Speaker 2: from there. I just think it goes up a lot
Speaker 2: for the US from where it was. And Europe is
Speaker 2: kind of you know, steady Eddy, because they've had such
Speaker 2: an efficient frontier and how they've been managed this again
Speaker 2: for years and years and years to go back, you know,
Speaker 2: twenty years. And so I'll give you an example, so
Speaker 2: you take it. You know, uh, you know, three hundred
Speaker 2: corporate loans are ready to triple B minus and you
Speaker 2: can do this of course with other types of loans.
Speaker 2: Were taking commercial corporate loans in this case, and the
Speaker 2: banks you know, want to keep their relationships right because
Speaker 2: these are important relationships and so although those transfer the
Speaker 2: first cure of risk.
Speaker 3: You know, these relationships for the banks.
Speaker 2: For their clients are important account management, you know, term loans,
Speaker 2: credit facilities, cast management, FX, trade for the investment, banking services, custody,
Speaker 2: payment solutions. There is so much the banks do and
Speaker 2: the bank will never exit. That is the core of
Speaker 2: what they do. But they don't want, given the capital constraints,
Speaker 2: this extra layer of risk. And so how do we
Speaker 2: de risk given the capital charges that the regulators are
Speaker 2: going to impose for that extra layer of risk for
Speaker 2: keeping some of these risk assets or you know non
Speaker 2: government and non agency and you know lower investment greater
Speaker 2: or non investment great risk. So how they do that is,
Speaker 2: let's say they sell to US zero to ten percent
Speaker 2: SRT trunch of the package of those three hundred let's
Speaker 2: say corporate you know loans, they're both funded and unfunded,
Speaker 2: including the revolvers and the loans. So they transferred that
Speaker 2: to us, and you know, it reduces their risk waiting
Speaker 2: from something like x amount to like zero point two
Speaker 2: x amount. It'll go down by like seventy five eighty
Speaker 2: percent reduction of capital by just selling that Tronshof and
Speaker 2: so allows them the banks to originate to continue to
Speaker 2: service their clients, but really arbitrage the capital requirements for
Speaker 2: the lower tier risk as firms like US come in
Speaker 2: to provide that capital. So it's a beautiful marriage of
Speaker 2: you know where banks and you know private credit partner
Speaker 2: and again there's other partnership arrangements, you know, portfolio sales,
Speaker 2: you know them providing the bank providing the senior will
Speaker 2: provide them as on that capital solution as their borrower
Speaker 2: on the commercial real estate loan wants to roll, but
Speaker 2: they want to roll at a more conservative LTV, so
Speaker 2: plug that gap. So there's all kinds of ways that
Speaker 2: we work together us in the banks, and and and
Speaker 2: what you also see is banks also wanting back into
Speaker 2: private credit and striking up partnership agreements with the investment
Speaker 2: managers that do credit to form partnerships to run a
Speaker 2: program together. So it's also something you're starting to see.
Speaker 2: So it's really interesting to see, you know, how the
Speaker 2: banks and private finance are now converging to a degree.
Speaker 5: So pretty interesting on that front. But to go more
Speaker 5: specifically in terms of you know, the increased opportunity in
Speaker 5: US uh, you know, synthetic risk transfers. Do you feel like,
Speaker 5: you know, we have the regional banks that need to
Speaker 5: you know, raise their capital levels right incorporating their unrealized losses,
Speaker 5: and then the potential and capital requirement increases for the
Speaker 5: biggest banks you know going forward. So where do you
Speaker 5: see the you know, bigger opportunities going forward. Is it
Speaker 5: more with the regional banks or some of these you
Speaker 5: know bigger JP Morgans in BA as well.
Speaker 2: Not to mention bank specifically by name, but I think
Speaker 2: you know here in the United States, it's four thy
Speaker 2: two hundred banks that are in existence, and there's thirty
Speaker 2: that's exact number that if you want to drill down
Speaker 2: and look at the total number of assets that they
Speaker 2: have in their balance sheet, there's thirty with one hundred
Speaker 2: billion or more. And so kind of the target list
Speaker 2: for US is really the top and we go a
Speaker 2: little bit below that the top fifty banks in this country.
Speaker 2: What's really critical is credit risk. We don't want to
Speaker 2: have counterparty credit risk with the institution itself, and so
Speaker 2: it have to be a super safe, you know bank
Speaker 2: that is a super regional slash megabank for US to
Speaker 2: do an SRT transaction with if that helps answer your question,
Speaker 2: give you clarity. So it won't be with like the
Speaker 2: next four thousand right now there, when we deal with
Speaker 2: that next four thousand, will buy loans from them, will
Speaker 2: be partners with them. If you know, you know they'll
Speaker 2: do the first out, we'll do this second. You know,
Speaker 2: there's different things we can do together with the banks,
Speaker 2: the partner up to help them think about the risking,
Speaker 2: but not through a national team transaction.
Speaker 1: So in general, Bruce, the opportunity from this commercial real
Speaker 1: estate mess. You're saying it's the greatest opportunity in the
Speaker 1: market right now, you're saying it needs a ton of capital.
Speaker 1: Can you talk a bit about how much capital. We've
Speaker 1: had other guests on this show talk about a trillion
Speaker 1: dollar opportunity in real estate right now. Can you talk
Speaker 1: about how you know what the magnitude of that opportunity
Speaker 1: is and also what are the returns? What are you
Speaker 1: buying these loans off the banks for? I mean, how
Speaker 1: much of a discount are you getting?
Speaker 2: Well, it's multi faster, so let me let me unpack
Speaker 2: it for you for just a second. So how big
Speaker 2: is the opportunity? You know, let's look at the biggest
Speaker 2: framework for commercial real state. And I'll focus on the
Speaker 2: United States for just now. But the biggest framework I'm
Speaker 2: looking commercial state is commercial state has their property value
Speaker 2: across this country, the commercial real estate side of around
Speaker 2: twenty two trillion. That's the number that we have, twenty
Speaker 2: two trillion. And of that twenty two trillion, eight trillion
Speaker 2: has debt on it, fourteen trillion doesn't. So that fourteen
Speaker 2: trillion is not a problem. Like you know, your Bloomberg
Speaker 2: go across town, you know, to your Bloomberg headquarters.
Speaker 3: Do they have a commercial real estate loan against their building?
Speaker 2: No. JP Morgan is building their new headquarter building on
Speaker 2: Park Avenue. Do they have commercial real estate loan against
Speaker 2: that building? Absolutely not. You'll do that at the corporate level.
Speaker 2: You'll have, you know, debt, maybe a corporate level. JP
Speaker 2: Morgan have debt at the corporate level, but they're not
Speaker 2: going to finance the property per se. A lot of
Speaker 2: property here is simply not financed. Some of the biggest
Speaker 2: properties just simply not finance. Is financed at the corporate
Speaker 2: level and through whole code debt are not through a
Speaker 2: real estate loan. So of the five point six trillion
Speaker 2: dollars of debt that's there, you know, outstanding here in
Speaker 2: the United States, that's probably around I don't know, eight
Speaker 2: trillion dollars of property value. That's where the problem is
Speaker 2: and that's where the opportunity is.
Speaker 3: Now.
Speaker 2: Of that five point six trillion of debt, how much
Speaker 2: will be a problem in terms of extending and mending,
Speaker 2: you know, potentially being restructured or default. The number could
Speaker 2: be as high as a trillion. I don't think that's
Speaker 2: an exaggeration. I think that's actually a healthy number. Is
Speaker 2: a trillion where it's gonna have to be recapitalized or
Speaker 2: you're gonna be flipping the keys.
Speaker 3: You know, it's gonna have to get restructured somehow.
Speaker 2: It's about a trillion unless if and it's wishful thinking
Speaker 2: that a lot of commercial estate players have. Unless if
Speaker 2: the FED brings rates down really really quickly and commercial
Speaker 2: estate pops a lot and a lot of capital there
Speaker 2: is available to But we think the numbers up to
Speaker 2: a trillion, so.
Speaker 3: Separate away from that. Of the five point.
Speaker 2: Six trillion two point six trillion, the biggest lender are
Speaker 2: the banks, and the rest of it is in different places.
Speaker 2: The second place that it's in is excuisation. So there's
Speaker 2: over a trillion dollars, like one point zero five trillion
Speaker 2: of commercial real estate loans that are insecure taste excurization today.
Speaker 2: So now your question is where do we see the opportunity.
Speaker 2: Where we see the opportunity is multifests Number one as
Speaker 2: one hundred million dollars. Property that has seventy million dollar
Speaker 2: loan and it's only worth one hundred million. It's no
Speaker 2: longer worth a hundred million. It's now worth seventy million.
Speaker 2: The property that loan. When that rolls, you're not gonna
Speaker 2: get seventy million dollar long because properly is worth seventy million.
Speaker 2: You're gonna get sixty percent LTV. This time around, you're
Speaker 2: gonna get forty two million dollars long. And so that
Speaker 2: gap between seventy million on the old loan and forty
Speaker 2: two million on the new LONGUS twenty eight million dollars gap.
Speaker 3: Who's coming up with that money?
Speaker 4: And so I had to come up with that money?
Speaker 4: Where is What kind of returns are we looking at here?
Speaker 4: You said, this is one of the best opportunities ever.
Speaker 2: I think the returns have have got to be preferred
Speaker 2: equity kind of returns, sweeping all the cash flow from
Speaker 2: the property and basically extracting control while keeping you know,
Speaker 2: the lender will keeping the equity owner in place.
Speaker 4: And so preferred equity we're thinking maybe definitely double digits,
Speaker 4: maybe even in the two handle.
Speaker 2: Like fifteen to low twenties. Is kind of like that range,
Speaker 2: depending upon the property, depend upon the situation. So that's
Speaker 2: number one. Number two is is, you know, let's say
Speaker 2: the borrower comes up with new money in the bank,
Speaker 2: won't roll you know, us extending that new loan and
Speaker 2: making a really nice return on that, and so being
Speaker 2: the lender, not of last resort, but being the lender
Speaker 2: because the banks are going to be pulling back at
Speaker 2: least a huge portion of the capital go for a basis,
Speaker 2: and so private capital has to step up for that.
Speaker 2: Number Number three, there is new development going on and
Speaker 2: new acquisitions and so being the you know, acquisition finance
Speaker 2: as well as all these refinancings.
Speaker 3: That's next.
Speaker 2: And what I also add is I think CMBs is
Speaker 2: one of the great opportunities because as loans go sideways
Speaker 2: within a deal, you know, there's going to be losses
Speaker 2: going to flow through to some of the junior classes,
Speaker 2: and for us to buy what we consider be above
Speaker 2: the fall from is an amazing opportunity. So the dislocated
Speaker 2: CNBS opportunity, which is liquid you know, T plus two securities.
Speaker 2: We model every single property in each one of the
Speaker 2: one thousand, five hundred and sixty different CMBs transactions. So
Speaker 2: you talk about like six tranches per securization, you're talking
Speaker 2: about like not was it nine three hundred? You know,
Speaker 2: securizations trunches that exist and just cmbas alone and figuring
Speaker 2: out what truants to buy. There's a lot of data
Speaker 2: science that goes with property analysis and cash flow analysis
Speaker 2: that we have modeled out here at Marathon. And what
Speaker 2: we do is we buy the tranche above the folk group.
Speaker 2: We don't want to have anything.
Speaker 4: Right now above the fulcrum, which.
Speaker 2: It could be the double B class, it could be
Speaker 2: the triple V class, would be the signal A class.
Speaker 2: It's not a generic answer to that because it's a
Speaker 2: function of the loan collateral and how the classes were
Speaker 2: cut in terms of the thickness of the securization and so,
Speaker 2: but we're we the.
Speaker 4: Mes level, right, You're thinking in the mes level, well,
Speaker 4: would be triple A and.
Speaker 3: Double as in places. Yes, so it's be somewhere between
Speaker 3: single a's and double b's and.
Speaker 2: And and for that we expect to make a mid
Speaker 2: to upper teams I R R on T plus two
Speaker 2: securities over a multi year holding period. So you're talking
Speaker 2: about like really nice multiple on your money, and it's
Speaker 2: you know, very very specific. It's you know, we have
Speaker 2: our you know, night vision goggles on and we're looking
Speaker 2: for that you know, needle in the haystack by buying
Speaker 2: those tranches off of you know, a very big securitization marketplace,
Speaker 2: knowing full well the information the property, the cash flow,
Speaker 2: the cuts on the train, on the transaction, and where
Speaker 2: the falcon is going to lie based upon how the
Speaker 2: workout is going to flow through in terms of loss
Speaker 2: rates to a securitization.
Speaker 1: So, Bruce, a lot of this stuff is distressed for
Speaker 1: a reason, right, and it is very risky, and it
Speaker 1: really varies by geography and by type, and it's you know,
Speaker 1: all over the map, and you do travel, you do
Speaker 1: have a global view. I was just wondering, you know,
Speaker 1: how you see this breaking down? You know, what what
Speaker 1: what are the good sectors to look at in terms
Speaker 1: of really state what are the ones you absolutely have
Speaker 1: to avoid a country and sector.
Speaker 2: You know, we we we we're avoiding office, and that's
Speaker 2: kind of top a less top of mind. But you know,
Speaker 2: if there's office in a securitization, it doesn't matter.
Speaker 3: Just falls through.
Speaker 2: The loss were just by you know, the right trans
Speaker 2: given that you know that factor. And more important, it's
Speaker 2: not a generic statement. It's very clean math of what
Speaker 2: loss factor you're going to have and how that flows
Speaker 2: through the excusation. In any excusation, you might have some
Speaker 2: losses and loans. It doesn't mean you're run for the
Speaker 2: for the hills. It means you figure out exactly how
Speaker 2: much flows through and what is left, and what is
Speaker 2: left we can buy that diskound of security at a
Speaker 2: nice secretion. You know, when it pulls the par just
Speaker 2: into your cash flow, it'll be a great buy for us.
Speaker 3: But you know, beyond real estate commercial state.
Speaker 2: There's also the dislocation and you know distress that you
Speaker 2: see on the corporate side as well. Uh, maybe not
Speaker 2: as severe, but there's still you know, a healthy case
Speaker 2: load workload on the on the corporate side as well.
Speaker 4: So, Bruce, you mentioned earlier that lenders are in some
Speaker 4: cases extending, extending, and amending what is you can talk
Speaker 4: a little bit about what the impact of that is
Speaker 4: zombie in real estates and also zombie in corporate because
Speaker 4: we have a similar well, as you said, less severe
Speaker 4: issue amount corporate did as well. Default rates are really
Speaker 4: really low because of this tendency to just close take
Speaker 4: a blind eye. Can you address a little bit about
Speaker 4: your thoughts about how, why and how this is happening
Speaker 4: and what the ramifications are.
Speaker 2: Sure, let me just step back for your listeners and
Speaker 2: kind of define the marketplace. When I think about private credit,
Speaker 2: I think are three segments of private credit. Number one,
Speaker 2: and the biggest actionable segment is direct lending, which we
Speaker 2: just to call it middle market lending, but it's also
Speaker 2: you know, lower middle market, upper middle market. Now, these
Speaker 2: are broadly syndicated private deals that are happening. They're taking
Speaker 2: deal full from the broadly syndicated market. So that's the
Speaker 2: first big segment of you know, corporate.
Speaker 3: Private credit.
Speaker 2: The second biggot segment of corporate private credit, which we
Speaker 2: haven't talked about, which is huge and going to get
Speaker 2: much much bigger and I'm super excited about, is asset
Speaker 2: based lending. Now, the third component of private credit is
Speaker 2: what now you know, your question revolves around, which is
Speaker 2: the you know, opportunistic situations in.
Speaker 3: Uh in the credit market.
Speaker 2: And and I think there's a couple of segments when
Speaker 2: you kind of you know, unpack that that you.
Speaker 3: Really want to focus on.
Speaker 2: Number one is providing capital solutions and creative financing options
Speaker 2: to companies to help them preserve value and to help
Speaker 2: them grow and to help them get over.
Speaker 3: Some type of you know, choppy water. And so it's
Speaker 3: the bridge to the other side.
Speaker 2: And we do a lot of these capital solutions, and
Speaker 2: that's you know, a fantastic opportunity to help companies that
Speaker 2: are you know, maybe a little over leverage or stress or.
Speaker 3: If the two distress you help of the capital solution,
Speaker 3: it'll just go down that path.
Speaker 2: And so you know, in the US and Europe, you know,
Speaker 2: we have hundreds of billions of dollars of debt that's
Speaker 2: existing today whose debt trades below like an eighty dollars price.
Speaker 2: You know, on my radar list today, I have one
Speaker 2: hundred and thirty five companies that we're tracking, tolling around
Speaker 2: three hundred and fifty billion that looks like that on
Speaker 2: top of the one hundred and eighty two billion of
Speaker 2: companies debt, which is one hundred and five companies that
Speaker 2: defaulted the last calendar year in twenty twenty three.
Speaker 3: And so so what's causing this.
Speaker 2: Well, in two thousand and eight, two thousand and eight,
Speaker 2: during a DFC high, you bonds, leverage, loans, you know,
Speaker 2: direct lending on the private side, there was one point
Speaker 2: seven trillion dollar credit market one point seven trillion. Today
Speaker 2: that market size is zie point one trillion, so it's
Speaker 2: growing three times where it was then. And through all
Speaker 2: the exhiberance and the zerp world that we lived in
Speaker 2: when companies borrowed maybe too much and money was too
Speaker 2: free flowing and a lot of people folks chose to
Speaker 2: you know borrow floating rate and you know, realizing that
Speaker 2: you know, FED funds is up five hundred twenty five
Speaker 2: based punts, so the base boring rate, which is now
Speaker 2: sofur is up five hundred twenty five basis points. The
Speaker 2: funny costs have become too high and there's a lot
Speaker 2: of leverage. So the company may have cut you know,
Speaker 2: you know, fifty LTV loan, but given the purchase price
Speaker 2: multiple may been six times that even a finance when
Speaker 2: it was originally issued, but that includes ad backs and adjustments.
Speaker 2: You take out those adbacks and adjustments and your at
Speaker 2: least eternal leverage higher than that. So you can look
Speaker 2: at the software company that came in at like seven
Speaker 2: turns of debt leverage, that really looks closer to ten times.
Speaker 2: Or healthcare company that came in at five and a
Speaker 2: half turns of debt that's really more close than eight
Speaker 2: turns of debt data up today. And so when you
Speaker 2: talk about like ibada is before debt service and now
Speaker 2: debt service has doubled, right, so you know, livebar plus
Speaker 2: a spread has become sofur plus that same spread.
Speaker 3: But the sofa rates.
Speaker 2: Of five hundred and twenty five basbooks, so the financial
Speaker 2: cost that the company occurs is two x what it was.
Speaker 2: And so a lot of these companies are burning cash,
Speaker 2: actual cash flow, burning cash just to service their debt,
Speaker 2: just the service their death. And what segment of the marketplace, Well,
Speaker 2: if you look at the leverage loan marketplace and you
Speaker 2: read what movies have to say, it's over fifty percent
Speaker 2: of the companies are B three rated are now in
Speaker 2: that category.
Speaker 3: Current sofa barn rates.
Speaker 2: And so you know, there is an easy financial conditions
Speaker 2: that have occurred over those last many months, and it's
Speaker 2: fantastic and it's helped companies through finance out and so
Speaker 2: you don't have the same debt maturity wall in corporate
Speaker 2: finance that you do in real estate finance, but you
Speaker 2: still have a lot of cash burner going on. And
Speaker 2: you know, the default rate won't get to ten or
Speaker 2: twelve percent like it was in LA, but it is
Speaker 2: going to get to four percent in this current marketplace,
Speaker 2: and four percent of five point one trillion, the current
Speaker 2: size is over two hundred billion dollars of the faults
Speaker 2: and select of the faults, we're ten percent of one
Speaker 2: point seven trillion. Back in two thousand and eight, you know,
Speaker 2: you know, it took you to about one hundred and
Speaker 2: eighty to two hundred billion, So you'll end up at
Speaker 2: the same place in terms of the sizeable opportunity for
Speaker 2: distress dislocation. And most importantly, what we're doing is capital
Speaker 2: to help these good companies with overlovered balancies make it through.
Speaker 4: What I am more excited about was what you said
Speaker 4: about abs lending, because you seem excited and we haven't
Speaker 4: touched on it, So a lot of people are now
Speaker 4: looking at that as the next frontier private credit. To you, Bruce,
Speaker 4: what does that ABS lending mean to you?
Speaker 2: And where Well, let's talk about WID's coming and then
Speaker 2: let me answer your question, because it's really important to understand,
Speaker 2: like whites come in to kind of put a ribbon
Speaker 2: on it and to kind of, you know, complete the circle.
Speaker 2: So let's go back to the banks for a second.
Speaker 2: The banks have been the biggest ABL lenders and when
Speaker 2: they exited doing a lot of the corporate lending back
Speaker 2: in eight because of the basel free regulations that came
Speaker 2: in that put cop requirements on those type of risk
Speaker 2: loans in place, they then doubled down an ABL lending
Speaker 2: and that's when some of the ABL loans like really
Speaker 2: took off in the balance as a it's a balance
Speaker 2: sheet for these banks. Now fast forward to twenty twenty
Speaker 2: four or twenty twenty five, one buzzle free endgame comes
Speaker 2: into place, and the banks now have to have more
Speaker 2: capital against those types of loans and so to de risk,
Speaker 2: the bank's going to make less of those loans and
Speaker 2: we're seeing it across the system. And so now let's
Speaker 2: talk about ABL. What is ABL as opposed to making
Speaker 2: a loan based upon a company's cash flow, We're making
Speaker 2: a loan based upon the collateral. So it's an senior
Speaker 2: secured asset based loan where we have a perfected interest
Speaker 2: in that underlying collateral at a certain LTV, a tasking point,
Speaker 2: and a certain debt service coverage ratio. A slightly different
Speaker 2: way of thinking about it, but it's opposed to lending
Speaker 2: against op cooho co of company, we're lending against hart assets.
Speaker 2: And let me break it down the four categories for you, Uh, Lisa,
Speaker 2: So a b L I think is a nine trillion
Speaker 2: dollar marketplace, nine trillion and it's a small fraction of
Speaker 2: that now, and what's been put in security form securitizations
Speaker 2: is four trillion, so I think in private form it's
Speaker 2: a five trillion dollar marketplace.
Speaker 3: And what is it?
Speaker 2: Number one, in no particular order. Number one, it's corporate ABL.
Speaker 2: So you're talking about lending its plant, equipment, inventory, uh,
Speaker 2: intellectual property, receivables, trade, it's whatever's in corporate a BL.
Speaker 2: But again, you have a perfected interest against those assets,
Speaker 2: and so if anything has happened, you have a lean
Speaker 2: on it that they're yours. The second category, i'd say
Speaker 2: is what I call, you know, consumers. Last specialty finance,
Speaker 2: and there you have everything from like all those consumers
Speaker 2: you know to you know, s rts and c rts
Speaker 2: that put that there, certain type of you know, royalties
Speaker 2: you can put like music royalties in there, or healthcare
Speaker 2: you know royalties in there, and so specialty finances Category two.
Speaker 2: Category three you mentioned it, so I'll emphasize it. It's
Speaker 2: transportation and under transportations aviation, and we've done not only
Speaker 2: you know, the Airbus and Airbus three twenties and Bowing
Speaker 2: seven thirty sevens and all the series, and we have
Speaker 2: you know four coming through committee you know this week,
Speaker 2: and we've done.
Speaker 3: Over one hundred and fifty aircraft with the big.
Speaker 2: Airlines, you know, the big airlines that everyone travels, and
Speaker 2: we on the we on the metal, we lease it
Speaker 2: to them. We get paid the structure cash flow. We
Speaker 2: also do this with engines, because an airplane has about
Speaker 2: thirty year useful life, and engine you know, last year
Speaker 2: around seven years, and so we've done engine leasing as well.
Speaker 3: You know, when you're buying.
Speaker 2: New, brand new Airbus three twenty neo, you might pay
Speaker 2: sixty five million for it, you know from Airbus. And
Speaker 2: the engines are two engines that you know on each wing,
Speaker 2: one in each one that costs like thirty five million,
Speaker 2: that costs like more than half the plane. And so
Speaker 2: engine leasing is also a segment of what we do.
Speaker 2: We do a lot in maritime. This week, we just
Speaker 2: did it joins that deal, you know, tug and barge.
Speaker 2: We've done international shipping. There's there's rail and road. We've
Speaker 2: done trucking deals, transportation equipment, infrastructure type loans that support
Speaker 2: all this. And then the fourth category is property. And
Speaker 2: I think we had over fifty thousand residential loans, the
Speaker 2: whole loans out of side of the scarization that we
Speaker 2: own to hear at Marathon, Second lean, first lane loans,
Speaker 2: commercial real estate property, everything from parking lots to infrastructure
Speaker 2: we've done here at Marathon and it all fits into
Speaker 2: the rainbow, this beautiful mosaic of ASCID based lending. And
Speaker 2: we have a teams of teams approach because each team
Speaker 2: is dedicated this year. Team's different from the RESI team,
Speaker 2: it's different from the aviation team, different from the maritime team,
Speaker 2: different from those that are doing you know against plant equipment,
Speaker 2: whether it's a crane in the sky or farm equipment
Speaker 2: or forklifts, or whether it's all the loans are all
Speaker 2: different teams rolling up into ABL program here at Marathon.
Speaker 2: So I love ABL and mark my words, it's a forecast.
Speaker 2: So who knows that the one.
Speaker 3: Hundred billion dollar.
Speaker 2: Middle market lending and private credit lending business in OA,
Speaker 2: which grew to one point seven trillion dollars where it
Speaker 2: is today seventeen fold increase, you'll see the same thing
Speaker 2: happening in ABL in this next decade.
Speaker 5: Wow, it's pretty amazing. I think one thing, you know,
Speaker 5: we're in New York. One thing we didn't talk about
Speaker 5: is uh multifamily and you know an NYCB has been
Speaker 5: pretty volatile over the past couple of weeks, so though
Speaker 5: we've had a little mini bailout, what are your thoughts
Speaker 5: on that sector? Bruce, multifamily and and and maybe rent regulated?
Speaker 5: Do you see risk in there or is it just
Speaker 5: kind of one off specific for NYCB.
Speaker 2: You know, I don't want to talk politics. I host
Speaker 2: it as far away as politics possible, But you know,
Speaker 2: rent controlled and got bust people that you know, you
Speaker 2: know reside in all these properties but rent controls a
Speaker 2: problem for you know, investor. When the city comes and
Speaker 2: any city, New York City particularly when any city comes
Speaker 2: and says you can't raise rates rents, then what do
Speaker 2: you think that's sponsor's going to do. They're gonna put
Speaker 2: any money in the property to improve it, They're going
Speaker 2: to try to maintain it. And their model, their financial
Speaker 2: model is based upon raising rates, and they have a
Speaker 2: lot of extra costs to maintain it, including financing costs.
Speaker 2: So it puts them upside down. So it's a real
Speaker 2: problem for you know, banks that have leaned into and
Speaker 2: lenders that leaned into rent control, rents stabilized, and I
Speaker 2: wouldn't touch that sector as a result, wouldn't touch it
Speaker 2: as a lender because I think it's a very difficult
Speaker 2: loan to make. And you know, in terms of multi family, no,
Speaker 2: you got to love multifamily. You know, it's a it's
Speaker 2: a beautiful thing. Talk about home, you know, homes themselves.
Speaker 3: You know.
Speaker 2: The simple factor matter is home prices over the last
Speaker 2: three years have increased twenty five percent nationally.
Speaker 3: It's a huge run up.
Speaker 2: That run up is bigger than the run up leading
Speaker 2: into the housing crisis in a way the price appreciation
Speaker 2: that we've seen among homeowners, and so with that, financing
Speaker 2: rates have gone up. And because financing rates have gone up,
Speaker 2: the price to own a home now with your rent
Speaker 2: and that price increase is now eighty percent higher than
Speaker 2: it was three years ago. That is remarkable, and it's
Speaker 2: the highest point to own relative to rent. So I
Speaker 2: love as much as OER as much as that's keeping
Speaker 2: a firm based under CPI, as much of rent roles
Speaker 2: have increased. For a multifamily, it is the cheapest it's
Speaker 2: been that I've ever seen it in tracking. It decades,
Speaker 2: the price to rent versus the price to own.
Speaker 1: I just wanted to follow up on where we started
Speaker 1: the conversation. Banks are going to take losses, and you
Speaker 1: know some are going to disappear potentially, given that you
Speaker 1: think there are too many, what impact does that have
Speaker 1: more broadly on financial markets and the economy. I'm surely
Speaker 1: it's not going to just be contained.
Speaker 3: I think the banks are safe. I think the banks
Speaker 3: are safe.
Speaker 2: I think that the biggest opportunity will be in commercial
Speaker 2: real estate, followed by filling in any void that the
Speaker 2: banks are going to dial back during Basel three endgame,
Speaker 2: which is to be a lender in abl and also
Speaker 2: to play the SRT and asset acquisition game, and that's
Speaker 2: a big part of our playbook. I think there's a
Speaker 2: big opportunity in credit, in liquid credit markets. We run
Speaker 2: a program called MATS, which is a multi asset credit
Speaker 2: strategies and it's across you know, the structured credit world
Speaker 2: em but high yield and leverage loans and its multi
Speaker 2: strategy approach to what is eleven trillion dollar market credit.
Speaker 2: The private credit markets are big, and they're going to
Speaker 2: get bigger and bigger and bigger because the bank's pulling back.
Speaker 2: And although ninety five percent of the corporate credits are
Speaker 2: fine in terms of credit, there's the other five percent
Speaker 2: that needs capital solutions that results in distressed and dislocation.
Speaker 2: But the end of the day, the banking system is solid,
Speaker 2: both in Europe and the US. Not so much in China,
Speaker 2: but in the US and Europe, and so I'm not
Speaker 2: concerned at all about banking. And the most impressive thing
Speaker 2: about this cycle is to fed to raise rates five
Speaker 2: hundred and twenty five piece points, keep it there for
Speaker 2: an extended period of time, and the cracks are actually
Speaker 2: rather minuscule. It tells you how robust the financial system is.
Speaker 2: It's not only because of the strength of the bank
Speaker 2: thanks to Buzzle three and all the regulations and what's
Speaker 2: coming next for Buzzle three endgame, but it's also due
Speaker 2: to the robustness of capital among the private credit lending
Speaker 2: community and the financial markets.
Speaker 3: It's really impressive to see.
Speaker 1: And the last question, Bruce, I know out of time,
Speaker 1: but you've been doing this a long time. As you say,
Speaker 1: when have you last seen such a great opportunity? You
Speaker 1: sound so bullish.
Speaker 2: Well, it's the Goalden there of credit. Right rates are
Speaker 2: five hundred and twenty five basis points. We haven't seen
Speaker 2: this in a generation. So you have to go back
Speaker 2: to earlier in my career when you saw rates as
Speaker 2: high as they are.
Speaker 3: Number one.
Speaker 2: Number two, you've never seen the credit markets as large
Speaker 2: as they are now. Equity market globally it's over one
Speaker 2: hundred trillion of fixed income and credit market globally of
Speaker 2: over one hundred trillion, and we have eleven trillion dollars
Speaker 2: here at Marathon of credit of the credit market that
Speaker 2: we invest in, and so it's a big market at
Speaker 2: the highest rates that you know we've seen.
Speaker 3: In a generation. And meanwhile, the comm is going well.
Speaker 2: Earners have popped back up, and so the earnings recessions
Speaker 2: over equi markets are trading all time highs.
Speaker 3: But when you talk about.
Speaker 2: Our clients, the LPs, we invest money for the pension plans,
Speaker 2: the ariski plans, the sid wealth funds and downments foundations,
Speaker 2: insurance companies, the consultants that advise them, these wealth platforms,
Speaker 2: and the bank private banks and so forth. Look, they
Speaker 2: can invest in the credit markets and along the credit
Speaker 2: curve and liquid credit and get an eight to nine
Speaker 2: percent yield that's magnificent. And in private credit add three
Speaker 2: hundred basis points to that double digit returns. And so
Speaker 2: when you have liability management, you're managing against and your
Speaker 2: actoral return requirements like a six percent return. And if
Speaker 2: you do this in credit, a lot of folks that
Speaker 2: come to conclusion, why do we need the equity risk
Speaker 2: and so well, let me better balance. Finally, because the
Speaker 2: financial repression is over, the zup environment, it is over,
Speaker 2: and rachel returns are rather healthy in credit. Let me
Speaker 2: now better balance my portfolio. And that's what we're doing
Speaker 2: with our clients. That's why We're so jazzed, you know,
Speaker 2: and when you have an error like this the golden
Speaker 2: era of credit, it's just our sweet spot for what
Speaker 2: we do for our clients.
Speaker 1: Great stuff. Bruce Richards, Chairman and CEO of Marathon Asset Management.
Speaker 1: Great to have you on the Credit Edge. Please come
Speaker 1: back again soon.
Speaker 3: Thank you, James, thank you Arnold, and thank you Lisa.
Speaker 1: Also want to say big thanks to Lisa leaving Bloomberg
Speaker 1: News in London. Brilliant to see you again, cheers. And
Speaker 1: to Arnold Kakuda with Bloomberg Intelligence, thank you so much
Speaker 1: for being here. Read all of Ronold's brilliant analysis on
Speaker 1: the Bloomberg Terminal. It's really great. Check it out. Please
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Speaker 1: week on the Credit Edge.