KKR's Sheldon Not Seeing Signs of Gundlach's 'Garbage Lending' Concerns

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00:00Double Line Capital founder Jeff Gunlock has a warning. The next big crisis in financial markets

00:05will come from private credit. He spoke with OddLot's anchor Joe Weisenthal and Tracy Alloway.

00:10The most ridiculous argument of all for private credit has been private credit belongs in every

00:16portfolio because it lets you sleep at night because it helps you ride out the volatility

00:21of your public credit. Again, that's just the repackaging of the volatility. If you don't

00:27market to market, there's no volatility. But if the price goes from 100 to zero in a matter of a few

00:32weeks, there's something untoward is going on. And so I'm very, very negative on those types of

00:41non-transparent markets. It reminds me, I've been saying this for probably two years now,

00:46that the next big crisis in the financial markets is going to be private credit. It has the same

00:54trappings as subprime mortgage repackaging had back in 2006. Now, it took a couple of years for

01:03it to totally unravel. So this stuff doesn't happen in a week or a year even. But I'm very negative on

01:09that. Double Line Capital founder Jeffrey Gunlock speaking with OddLot's hosts Joe Weisenthal and

01:16Tracy Alloway. For more on the state of private credit, we're joined by Christopher Sheldon, KKR

01:21Co-Head of Credit and Markets, who joins us now. Chris, there's a lot we want to talk with you

01:25about. But we have to just start with Gunlock's comments, given how much interest that they're

01:30starting to take. And we want to talk to you not just because, of course, you oversee KKR's credit

01:34portfolio, but you do a lot of research on the state of the industry as a whole. In the words of

01:40Gunlock, is there a concern that there's, quote, garbage lending going on out there?

01:45We just don't see it. I mean, if you look across our corporate credit, private credit

01:50portfolio, our revenues are up 9%. Our EBITDA is up 8%. Our interest coverages are healthy

01:57over two times. Our average LTVs are sort of sub 60%. So we're just not seeing that elevated

02:05concern. However, we are seeing slowing in the economy and we are seeing more dispersion

02:11in results. We see that in the public markets. We see it in the private credit markets. But

02:17we're not seeing that level of concern that Jeffrey mentioned.

02:20It seems like we haven't really seen a million cockroaches, right? You've seen a couple of

02:27really idiosyncratic issues. It's hard to argue otherwise. The problem isn't that there are

02:34occasional bankruptcies here and there. It's that BlackRock marked this debt at 100% and then two

02:44weeks later at zero, even though they knew from months beforehand that there had been negotiations

02:51about, you know, a revamp here. It's the marks that are the real problem in these issues. And do you

03:00think that the industry needs to look inward and figure out a better way of doing that?

03:07Look, I mean, I think we use a third-party valuation to evaluate all our illiquid assets.

03:13And I think where you're seeing dispersion in the valuations are when assets underperform.

03:20And so I think it's really just about a policy to make sure that you're working closely with those

03:26independent valuation providers to make sure you're giving the real up-to-date information of what's

03:32going on in that individual credit. How others are doing it and the velocity of the moves is

03:39depending on each situation. And you are seeing, to your point, very idiosyncratic situations that

03:45sometimes move extremely quickly in terms of if they're hitting a liquidity wall to where maybe

03:52there is a little bit more aggressive in quickness of moving that mark. Chris, it's interesting you talk

03:57about the divergence because maybe the kind of dirty little not-so-secret of this industry is that

04:03private credit returns don't look that different from player to player unless you do something that

04:08really gets messed up. So in a world where you also have more money coming into the asset class, where you

04:15have rates coming down, how difficult is it to find alpha right now in private credit?

04:21Yeah, and private credit is defined, depending who you talk to, it's defined in many different ways. And you're

04:27right, there hasn't been a lot of dispersion in corporate direct lending returns, manager to manager, although I

04:33expect more and more dispersion to happen. And so what we're really doing across our corporate direct lending book is

04:40running very diversified portfolios, keeping it very high quality at the upper end of the middle

04:45market. And I think that's where you, and you should be playing, is not reaching for that incremental

04:50yield, incremental few basis points, which often leads to risk. I think where dispersion and returns will

04:57happen is when you make more concentrated bets or you're reaching for incremental risk. Where we see alpha

05:05is actually trying to be as flexible as you can be, find those pockets where there isn't as much supply

05:13and demand imbalance. And those areas could be things like capital solutions or asset-based finance, where

05:20that supply and demand imbalance is not as pronounced, or in regions like Asia. And then where there's areas

05:27where there's a little bit more exuberance, where there's been a lot of capital coming in, like the liquid

05:32markets like corporate direct lending, keep it high quality and diversified. And it's hard to lose

05:38money if you do that, keep to your knitting and from a credit underwriting. If you're earning high

05:43single digits in income, you have to make a lot of mistakes with very severe recoveries to actually not

05:52ink out positive returns, which goes to my point where we're just not seeing the concern that maybe others

05:57are. One of the, I think, really cool ways that you can differentiate yourselves is through your

06:03experience as a private equity company for so many decades with portfolio companies and leading

06:10strategies that are successful. So I've noticed you have worked with companies like Harley-Davidson,

06:17which could obviously tap the plain vanilla syndicated loans market. But do they choose to work

06:23with you because they also want your advice and your guidance on how to improve their businesses?

06:28Yeah. There's a couple of trends going on where corporates are tapping into private markets and then

06:35large public companies are tapping into private markets. And I think historically that was perceived

06:39as a weakness. They didn't have access to other capital. Now they're actually looking for partnership

06:44capital. Either they want us in the boardroom and want some help with something that maybe they don't have

06:50the skill set for. Or there's this big trend where if you've been a capital light model, your stock has

06:57been up and to the right. And if you've been capital intensive, your stock's been relatively flat.

07:02And so there's a big push to finance stuff off balance sheet, which is similar to what we did with Harley-Davidson,

07:09what we announced with Sally May, what we've done with PayPal, where we're taking a bunch of assets,

07:14taking off balance sheet, finance those. That gives them capital to future their growth

07:20initiatives and turbo that a little bit quicker. You could probably add Keurig, Dr. Pepper to that

07:24list too, which of course you were also part of that deal, Chris. And to the point that both you

07:29and Matt are making, I mean, these are deals that it wouldn't be unusual to usually see them in the

07:34broadly syndicate market. And maybe that's why someone like Jamie Dimon hasn't loved you and your

07:40peers because it's taking away market share. How do you see that balance continuing to evolve? Is this an

07:45industry that you think will continue to chip away at the market share that banks usually hold in

07:51lending? Look, we need banks. Banks need us. It's a cohesive relationship. And a bank is usually

07:58involved in many of these large transactions from an advising standpoint. And look, the banks are some

08:05of the biggest financing providers for our diversified portfolios against private credit. So I don't see it

08:12as an either or. I see it as a, you know, a partnership that's getting stronger. And I do think

08:17that the larger you are, the more scaled business you can do, the more diversified the type of businesses

08:23you can do. That's where you're going to have bigger, better and stronger partnerships with the banks.

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