00:00That is the ultimate fear here that, okay, we know that private credit has exposure to software, but there's worry
00:07out there that basically the lenders have a much bigger risk than what is actually being reported.
00:13So what are you seeing when you take a look at your data as to how big that exposure actually
00:18is?
00:19Yeah, we rate over three dozen business development corporations, and there you get probably some of the best data in
00:25terms of understanding what the exposure is to the software and IT industry.
00:30And it is large.
00:31It's the largest concentration of any sector that BDCs are exposed to.
00:35On average, it's about 20%, but that can range from anywhere from 10% to north of 50% for
00:43some of the more exposed or more specialized business development corporations.
00:49And so it's interesting.
00:51I mean, I'm taking a look at the notes you sent over to our producers that it's not a software
00:57good or bad situation here.
01:00That's not necessarily the question to ask.
01:02So with that in mind, as you see what's rippling around these different asset classes, what do you think is
01:07a better question here?
01:08Yeah, you really need to understand what the company is doing.
01:12So there are many companies within this space.
01:15We rate over 150 companies in the software space.
01:20About 60% of those are non-investment grade.
01:24Even in the lower echelon of ratings, you need to understand how central is the software that they're providing to
01:32a company.
01:33Is it mission critical?
01:34Many of these companies have specific niches that are very defendable, but they need to spend to defend.
01:43And now with the quicker pace of change, that brings more risks and it may bring more need to spend
01:51in order to continue to execute on your business model.
01:56So needing to spend more money makes it a little choppy when you look at kind of the potential underlying
02:01risks and issues.
02:03What is the first domino to follow if there is one?
02:06And what's the potential contagion effect if we do see an issue really start to percolate?
02:11Yeah, I mean, I think this is an issue that affects all companies, but investment grade and non-investment grade.
02:17Even in the investment grade side, you know, think of, for example, Microsoft, AAA rated is in this software space,
02:24right?
02:24They're going to have to, in the next two years, rethink their product, their pricing, their packaging with the vast
02:32change in technology.
02:35At the lower end of the spectrum, where you have very strong margins with many of these small companies, they
02:44have a lot of debt.
02:46And so the biggest near-term risk that we're focusing on is refinancing risk.
02:52Well, we're looking at that refinancing risk and also just looking at this chart in terms of hyperscaler spending, what
02:59area is going to be more likely to draw investor capital?
03:02Is it companies that need to refi and address some of their debt?
03:04Or is it the fact that we're seeing Oracle going out in the magnitude and size that it is and
03:09the likes of a CoreWeaver, some of those other neocloud hyperscalers?
03:13Yeah, I mean, it's really a tale of two cities.
03:15At the upper end and these companies that you've just shown on the screen, they have significant capital needs over
03:22the next couple of years.
03:24We estimate that over $3 trillion is going to be required over the next five years for data centers alone.
03:31We saw earlier this week a deal from Alphabet, which was $20 billion in size, multiple tranches, including a century
03:41bond in the sterling market.
03:44So there's a lot to come in this area of the market.
03:47What I would say is in the non-investment grade market, where we have more concerns, there's the concentration of
03:54single B-rated companies.
03:56And as I mentioned, we're worried about some of that refinancing risk.
04:00But the good news here is that there's no maturity wall.
04:04There's no refinancing tsunami that's going to be coming at that end of the market.
04:09And that's what we need to worry about right now in terms of looking for potential defaults.
04:15It's funny to hear you say that because it feels like especially that maturity wall is one of the boogeymen
04:20out there.
04:21You know, you can always point to it, but it's hard to exactly pinpoint when it might actually become a
04:27real risk here.
04:27But let's talk a little bit about data centers.
04:29We're talking about software, of course, the AI disruption.
04:32The other big part of the software trade here is the data center build out.
04:37A lot of that is being financed in the private markets.
04:40And there are some concerns out there, Mark, that maybe we could be in the midst of what will turn
04:45out to be a massive overbuild.
04:48But what are you actually seeing over there at Moody's?
04:52Yeah, I would say it's always a risk.
04:55The question is, will all of this investment pay off over the long term?
04:58And how much is being built for future needs and how much is being built for needs today?
05:05I can tell you in the next few years, the need for data centers is very tangible and very visible
05:13with respect to, for example, what we're doing with the cloud.
05:17We need the energy.
05:19We need the data centers just for that.
05:21I think when you go beyond a few years, you're building for future.
05:25You're building for future promises, future dreams, future products that maybe haven't even been thought of today.
05:31But I would say in the next few years, there is already a huge demand for the capacity that's going
05:39to come on online.
05:40Well, I feel like the big question, though, Mark, when I look at and talk to people around data centers
05:45in the build out is what happens if we're overbuilding?
05:47What happens if there's an oversupply ultimately and we're able to either be more efficient or Elon Musk ends up
05:53being successful and we have data centers in space?
05:56It's absolutely a possibility.
05:58We have data centers under the sea right now as well over in Asia.
06:02So there's lots of different iterations to what could happen.
06:05But as I said, in the first couple of years, we see strong demand for what will come online.
06:10Beyond that, the companies may need to pivot.
06:12So this $3 trillion number that we put on the needs over the next five years could be lower.
06:18It could even be higher.
06:19But again, the companies will have the ability to pivot.
06:23And, you know, we'll have to watch that very closely.
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