Transcript generated automatically by AI and may contain errors.
Chapter 1: What is the main topic discussed in this episode?
Hello, I'm Stephen Carroll. I'm in Brussels, where many of Europe's biggest decisions get made.
And I'm Caroline Hepke in London. We're the hosts of the Bloomberg Daybreak Europe podcast.
We're up early every weekday, keeping an eye on what's happening across Europe and around the world.
We do it early so the news is fresh, not recycled, and so you know what actually matters as the day gets going.
From Brussels, I'm following the politics, policy and the people shaping the European Union right now.
And from London, I'm looking at what all that means for markets, money and the wider economy.
We've got reporters across Europe and around the globe feeding in as stories break.
So whether it's geopolitics, energy, tech or markets, you're hearing it while it happens.
It's smart, calm and to the point.
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Chapter 2: What is private credit and how has it evolved over time?
So the fund has, over its lifecycle, moved back and forth. But by and large, since the financial crisis, we've been largely in high yield, IG, and convertible bonds. Our client base has predominantly been RIAs and wealth management firms and individuals, some of those are existing private clients of the firm right now.
So fund is about $5.8 billion, and it is structured as a 40-act open-end mutual. So once upon a time, if you were looking to invest in credit, say in 2002, you would have had a limited set of options.
So you basically had investment grade, which are bonds issued by people always use the word blue chip companies, which sounds so old fashioned to me nowadays, but companies with relatively strong bonds.
Balance sheets that are rated by the rating agencies as investment grade, or you would have the option of bonds in the high yield market, aka junk, so companies with weaker balance sheets and weaker credit ratings. Tell us about how the sort of, I guess, menu of credit options has expanded post the 2008 financial crisis.
That's basically a long-winded way of me saying, where does private credit come from? So private credit had been in existence prior to the financial crisis, but really saw expected growth after the financial crisis.
So if you go back into even the 80s with the growth of the high yield market, prior to that, highly levered companies, companies that didn't have investment grade balance sheets, couldn't really borrow much in the public markets. So either they financed internally or relied much more heavily on the bank market.
As the high yield market grew, famously with the help of Milken, it allowed more companies, more highly leveraged companies to access public markets. That evolved into the leveraged loan market. The leveraged loan market, once upon a time, used to be held on the bank balance sheets.
They began to syndicate those loans and what was really the step function there was the evolution of the CLO market, where the banks could take those loans put them into a securitized structure, which became CLOs, which led to the growth there.
Then after the financial crisis, the bank regulators really did not want banks lending to highly levered and or risky entities, both corporations and individuals. So you saw pretty strict capital requirements. There is an explicit prevention from banks lending to companies with greater than six times leverage. That created this need for lending outside of the bank market.
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Chapter 3: What role does private credit play in the current financial landscape?
It'll probably be in like 40 years from now. They do not have to worry at all about a quick run, whatever. And so they can harvest assets. They can harvest that illiquidity premium. They could put their money into assets that do not trade very much. And that's very intuitive to me. Talk to us, though. You're operating an unconstrained fund that is a publicly traded 40-act mutual fund.
Talk to us about what it means. You say you look for opportunity online. Why are there private credit assets that aren't all locked up in these long-term vehicles? Why does it sometimes make sense for private credit assets to be in a vehicle that is just sort of more opportunistic and has a daily quote potentially?
We currently actually right now don't have any private credit. We were involved in it in the past, but I think most of those opportunities have gone to the dedicated private private credit funds, because one of the structural differences of the way they're set up versus the way we're set up is we source our ideas mostly from investment banks.
Now, some of those investment banks used to come to us with transactions that weren't going to fly in the public market. So they would look and say, this is a small deal. We're not going to be able to find buyers from this among our
Investors who are primarily benchmark high-yield investors because it would be outside the index and it would be illiquid And there's been a lot of talk about and problems with investing in illiquid securities One of the real benefits of our strategy is we always have lots of liquidity We have a historically have managed our portfolio in a short duration with a short duration focus that creates cash and we keep a lot of front-end and
ballast. So as our portfolio is always creating cash, we could invest in some pockets of less liquid strategies, but we haven't done that. The private credit guys are set up differently. They need a team of bankers to go out and source all their deals. They have to knock on companies' doors.
It's a very different way in their function of having to source their transactions to try to fill up the asset side of their portfolios. So because of that, over time, I think there's a huge structural difference between the way they approach it and the way we approach it.
But just going back briefly to the insurance company side, insurance companies have long been investors in private assets and they used to have large teams of private debt investors.
And ultimately over time, what they've done is they've shrunken those teams and just said, here, you guys source the transactions for us and then we'll give you guys the money and you can go do it yourselves sort of on an outsource basis. So Naturally, it is a very good fit for them because they do have long duration assets and there's generally not a rush for those assets.
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Chapter 4: How has the growth of private credit impacted corporate debt markets?
So Again, if you think about the legacy businesses, some of these software companies that were in these portfolios, they might be 2020 or 2021 vintage LBOs that haven't monetized yet. They were borrowing versus an historically low treasury rate. Once we raised rates in 2022, all of a sudden the resets on these loans, because they are floating rate, have gone up.
So it's chewing into the equity value of these businesses and it's putting an increasing amount of strain on the companies to have to cover their interest expenses. So I think that all these things filter into more and more pressure on these companies, which could lead us to a spot where we do get to 15% defaults.
I'm not saying that the probability is very, very high, but if it happened, I wouldn't be shocked. And can I just ask, you said earlier that you don't have any private credit exposure in your fund at the moment. Is that right? That's correct. Okay. What made you take that decision? Because you said you'd been involved a little bit earlier.
And then secondly, what would you need to see in the market to potentially get back in? I think the reason that we don't is because we were financed out over time. And it was never a core part of what we did. It was a more ancillary part of our business.
There were a few individual opportunities that came along with companies that needed money for a particular reason, or it was a business that people I don't think widely understood, or it was the size of the borrowing requirement. One of the companies took the money that we lent them and kept the money on their balance sheet the whole time. They just had it as a safety net.
It was less than one and a half times levered for the entire time. They no longer needed it. They paid us off and moved on and went to the next thing. So other times we were financed out by the leveraged loan market or the private credit market where they were going to be much more aggressive on the terms than the ones that we were willing to provide.
And that's typically, we're a bunch of old guys and we have our ways of doing things that have been developed over 30 or 40 years. We're not likely to change our approach to providing credit just because the market now all of a sudden wants to get more aggressive and look past some of the obvious things, particularly as it comes to structure and covenant protections and amounts of leverage.
We look at the business and say, okay, this business is worth seven times. I'm not going to give them six and a half times leverage to do something. It just doesn't make sense. And if you go back to the point you made to begin the podcast, how private credit and the proliferation of the loan market has impacted the high-yield investment-grade market.
What was once a two-tiered market of investment-grade, non-investment-grade, has really become a four-tier market, investment-grade, high-yield, leveraged loans, private credit, in that order of credit quality, most of the credits that do not meet our underwriting standards have fallen into leveraged loan and private credit.
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