00:00Let's talk a little bit about what's actually going on in private credit, because I guess it depends on who you ask.
00:05I mean, some people will say that, you know, it's basically just, you know, some ticking time bomb.
00:09And then, you know, you had this full throated defense the other day on Bloomberg by Mark Rowan over at Apollo,
00:14basically saying that people aren't really valuing what private credit is, what the industry is, what the structure of it is properly.
00:20What do you see? I think there are a couple of things there. One, at the end of the day, credit is just credit.
00:26So there are a lot of consistencies, actually, across public and private credit in terms of focus on fundamentals, focus on structuring.
00:33I think private credit does a few things that are attractive for borrowers.
00:36One, it gives them certainty of execution in periods of episodic market volatility, which is very valuable.
00:41And I think the other kind of game-changing dynamic, even post-pandemic, so not that long ago,
00:46is that private credit can now fund larger borrowers, many of which have demonstrated access to the public markets.
00:52The reason is that private credit has grown to be scalable enough that it can write those larger checks and fund those larger transactions.
00:59Said differently, it's no longer reserved for these niche financing solutions.
01:02So for investors that can actually take some illiquid risk, they can earn an additional spread premia on that attractive asset class, in our view.
01:12But at the end of the day, a lot of the same elements of dispersion, fundamental credit quality that we watch in the public markets,
01:18are also consistent in the private markets.
01:21And so really, you know, underwriting expertise, manager experience, having been through a cycle, that's all very important.
01:26And I know that it doesn't matter what corner of the market you're in, there's always going to be outliers.
01:30The idea that some people aren't doing it right here.
01:32But when you see the fears publicly articulated, what do you think about that?
01:38Is it misplaced?
01:39Well, actually, we've done deep dives on U.S. and European private credit over the past couple of weeks.
01:44And I would say at a high level, what we see is an environment of dispersion, but not widespread market disruption.
01:49When you look at aggregate metrics like interest coverage, covenant defaults, they've actually been improving in both regions.
01:55But under the surface, there's a fair amount of dispersion.
01:57Take EBITDA growth, for example.
01:59If you isolate by dimension of company size, company sector, there are very different outcomes.
02:03I think you said it well.
02:04There are tens of thousands of issuers in these markets across liquid and private credit.
02:09As we kind of go through a choppy market environment with that episodic volatility, there's bound to be defaults.
02:15That's not a surprise.
02:16But really, for private credit, what matters is how do you maximize recovery on the other side?
02:20How do you work with the borrower to actually protect your position?
02:23And that's what's really key.
02:24And based on what we know, those potential recovery rates are relatively high.
02:27You can see that in the realized loss rates, that actually the realized losses in private credit are actually below the historical average right now.
02:35And certainly that can vary by strategy or focus.
02:37But really, that's ultimately what we focus on, not so much the headline default level, but actually what is the realized performance.
02:43And I think what's even more attractive in our view is that the yield backdrop is still pretty compelling versus the realized losses.
02:51And that's true both on an absolute basis and relative to liquid credit.
02:54Pushing ahead, what does that yield backdrop look like for 2026?
02:58Our view on monetary policy for the Fed is that maybe they have one or two more rate cuts left.
03:02But we think it's one or two.
03:03Yes, we think it's actually going to be more of a nuanced decision for the Fed, given that we're now approaching the high end of some estimates of neutral, given their dual mandate on how much they cut from here.
03:14So we've all along for 2025 been forecasting a normalization of monetary policy.
03:20So removing that degree of restriction as opposed to a sharp easing.
03:23And what could change that view?
03:25Does that take into account the potential change in leadership at the Fed in May?
03:28I mean, I think in general, the Fed, the committee will still need to navigate this dual mandate.
03:32They have a tough job ahead of them, for sure.
03:34But I think in general, it's difficult for us to see an easing below neutral absent a sharp downturn in growth.
03:40And that's not our base case.
03:41Actually, we see scope for a reacceleration in growth in 2026.
03:44So, yes, to answer your question, in both liquid and private credit, that yield backdrop should remain robust.
03:49Have there been any reservations amongst you and your team about the potential changing of the guard at the Fed?
03:55I mean, I think what we're watching is that how is the committee navigating what is an increasingly complex environment with the dual mandate?
04:00So, really, it's about, in our view, how are they maintaining an eye on the labor market deterioration versus inflation that's been above target for a couple of years?
04:09And I think that's a challenging backdrop for them.
04:11I am curious what new issuance looks like next year with the assumption that at least we know the Fed funds will likely be lower than where it is as we sit today and presumably Treasury yields.
04:20I think there's a case for actually new issuance supply to be slightly above the kind of call it $1.8, $1.9 trillion that we've seen in USIG this year, coupled by a few things.
04:29One, companies getting ahead of upcoming refinancing and actually pre-funding years in advance, which we've seen historically.
04:37And then, two, the case for M&A.
04:38We've already seen an acceleration in strategic M&A volumes.
04:41We think actually sponsor volumes have some room to catch up.
04:44There will be financing associated with that.
04:46And then, of course, the CapEx spending across the AI universe, both in liquid and private markets, we see a lot of activity there, I think.
04:53And that's really a multi-year trend.
04:54With regards to the AI CapEx activity and the borrowing we've seen in that space, does that almost become a little bit of a distraction for the rest of the market?
05:02Does that basically suck the air out of the room for anyone who isn't in AI?
05:06No, I think there's a significant amount of demand for high-quality spread duration product across the board.
05:11It actually reminds me of some sectors, like health care, for example.
05:14Back in 2009, 2010, some of these companies were very highly rated.
05:19They methodically added debt to their capital structure to fund strategic initiatives.
05:22Seems very similar in our view, although what's happening in artificial intelligence is a much larger scale.
05:28But, no, I don't view it as a crowding out.
05:29And I would say even some of these sectors, they're still small relative to some of the larger sectors like financials and USIG.
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