00:00You have the perfect view on the ground of what's actually happening in private credit.
00:05You heard there Christian Strack saying that the things coming up for sale are pretty bad.
00:09John Zito warning earlier in the year saying that everything looks mispriced and then kind of clarify that to say
00:15it was just software.
00:16What are you seeing? Is this a mispriced market right now?
00:21So maybe back up a second and you alluded to this.
00:24At Lincoln, in our valuation opinions group, we do 25,000 valuations a year.
00:29We value nearly a third of every LBO in the U.S.
00:34So it is a very statistically significant database.
00:36And we have the number one share in valuing private credit.
00:42And part of private credit is this private direct lending, which I think is what everybody's been talking about.
00:47And our view, and again, we have access to all the fundamental data.
00:50We get down to the financial performance of the business.
00:53We know what the credit agreements say.
00:54We know what the loans to value are.
00:56And when we look at the underlying health of the private credit market, we don't have major concerns.
01:02There are some idiosyncratic headlines where fraud was involved.
01:06There's been this AI chill of what's this going to mean for long term for some of these loans into
01:11the software world.
01:13But if you cut through it all, one of the things we look at is payment in kind interest.
01:19And when you see that tend to spike, that means that's businesses that can't service their loans and they're starting
01:24to pay in kind.
01:25And there's good pick and there's bad pick.
01:27Good pick is the pick that's done at the time of the loan.
01:31Bad payment in kind is that comes in later because you can't cash flow the loans.
01:35Bad pick is up.
01:36It's up a little bit.
01:37I mean, picks call it's 11% of our total database, which means 90% of the loans are servicing
01:43the debt.
01:44And, you know, if you look at default rates or this kind of shadow pick rate, shadow default rate, as
01:50we like to call it, back several years, it was probably 2%, 3%.
01:54That's probably 5%, 6%.
01:56So it is up.
01:56But every private credit lender also models in a certain level of defaults and they model in a certain level
02:03of recovery.
02:03So there is uncertainty, but as we look at the underlying health of the businesses that are underpinning these loans,
02:12we think the headlines are materially worse than the financial health.
02:15Are the headlines worse than the financial health even when it comes to things like software loans?
02:22Software is an interesting one because I don't think people are necessarily worried.
02:25But first of all, if you look at the software companies' loans to the value of that company, it's like
02:3030%.
02:31So there's a lot of cushion.
02:32There's a lot of equity cushion before you get into these loans being with zero.
02:36I mean, a lot of these businesses would have to go to zero and they'd have to go to zero
02:39quickly because these loans are actually being serviced.
02:43And if we look at the growth in our underlying database, about half the companies we value had positive EBITDA
02:50growth last year.
02:51The software were 70%.
02:53So I think the fear over the AI chill is, are these companies here five years from now?
03:00There's not a huge maturity wall coming up for these businesses in the next several years.
03:04And so these businesses are throwing off a lot of cash.
03:07They can service their debt in the short term.
03:09I think the concern, and again, some of the horizontal software companies are at much greater risk.
03:15When you look at the vertical software companies, and we're seeing this in the investment banking side of our business,
03:19we have lots of software companies we have for sale that are moving forward.
03:23There's new software businesses we're taking to market.
03:25So I think the risk, the existential risk, is longer term for some of these businesses.
03:29And yes, there's going to be some bad businesses that default on their loans and software in other areas.
03:35But that's not new.
03:36That happens.
03:37So I think there is a longer term concern in that.
03:41In the short term, we don't see it being the credit crisis that others are making it out to be.
03:47There have been certainly some wobbles in public credit markets and even leveraged loans, kind of the lifeblood for a
03:54lot of the LBOs, which Lincoln, of course, takes a very close look at.
03:58And you know intimately well.
03:59You have this ground level sort of knowledge of it.
04:01Like J.P. Morgan, for example, not being able to sell Qualtrics debt in the way that they would, rethinking
04:07the package of EA loans, too.
04:10Is there any way in some of these wobbles are actually a saving grace for private credit?
04:14How does it change the contouring of how financing is getting done for dealmaking?
04:19You know what's interesting?
04:20When you had SOFR, when you had much higher interest rates and much higher spreads, these private credit funds were
04:28getting 12%, 13% returns.
04:30Well, all this capital flooded into them.
04:33When private equity is getting 16% or 17% and private credit is getting 12% or 13%, guess
04:37what?
04:37Private credit is going to raise a lot of money because the risk return is much better.
04:42We've had multiple rate cuts.
04:43The spreads are down.
04:44Now private credit is under 10%.
04:46And so, but when it was up that high, there's so much capital that is flooded into private credit and
04:53to private lending.
04:54That capital is still there.
04:55That capital is committed.
04:56That capital wants to be spent on funding private equity and leveraged biotransactions.
05:01So I don't see this being a credit crunch issue because there's an incredible amount of liquidity sitting in private
05:08equity and private credit that wants to be put to work.
05:11And so I think some of what we're seeing is going to affect pockets of this.
05:15But do I see a credit crunch getting in the way of funding the right private equity deals?
05:21We just don't see that because spreads are still relatively low, which means that this capital wants to be put
05:26to work and there's not enough opportunity to put it to work.
05:29Just taking a step back, Rob, these overall M&A markets, they've faced a lot of headwinds.
05:35Last year, you get tariffs.
05:36This year, still trade concerns.
05:39These AI wobbles.
05:40And then at the same time, now we have to contemplate the geopolitical volatility of war.
05:44How do you see 2026 evolving?
05:46Will volumes be robust or will it be more of a slow and steady year?
05:52Maybe set the context of the back half of last year.
05:55So I think you have to look at that to determine kind of what we're expecting this year.
05:58There was a material pickup in M&A in the back half of last year.
06:04It was clear it was an improving market, not yet a good market or a great market, but an improving
06:08market.
06:09And generally what you see in the M&A market is volume of M&A follows value.
06:14Last year was the year of the mega deal.
06:16You had a real spike in the ultra-large deals.
06:19What we've seen in every kind of recovery of the M&A market is volume follows.
06:23And we started to see that a bit in the back half of the year.
06:27Our investment banking business, which is largely driven by M&A, was up almost 30% last year.
06:31And a lot of that was in the back half of the year because, as you noted, we had Liberation
06:35Day in April.
06:36And everybody thought last year was going to be a really bad year for M&A.
06:40It didn't play out that way.
06:41It shook that off and picked up in the back half of the year.
06:44And why is that?
06:45That is because the fundamentals are still good, right?
06:48Inflation has gotten under control.
06:50There's an expectation of lower interest rates.
06:52The underlying economic performance of our economy is good.
06:55So with those fundamentals good, with private equity having a backup of deals they'd like to sell,
07:01we expected and continue to expect this to be a good or an improving M&A market in 2026.
07:08There is no doubt, though, that in the last several months or the last several weeks, we've talked about the
07:15private credit.
07:15Injecting some volatility.
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