00:00You know, credit in general, but actually we've seen a little bit of a difference.
00:03The spreads have been widening, right, for both corporates and fixed income.
00:06Is that a good thing? Is that healthier?
00:07Yeah, I think in general, first of all, spreads haven't widened that much yet in credit.
00:12We're hoping more, and the news flow today will probably drive that.
00:16Overall at TCW, we're actually underweight credit, both in public and private markets.
00:21We came into the year that way, and we're hoping some of this news flow will give us the opportunity
00:25to deploy capital in both markets.
00:27I mean, how do you see the news flow actually impacting your world, given all of the uncertainties?
00:32But also investors are behaving in different ways, depending on which part of the market you're in.
00:36That's right. I was actually thinking about you on the way here, because the last time we saw each other,
00:41you might remember this, was at a Billy Idol concert in January.
00:45We feel so cool right now.
00:47Yes, exactly. That was fun.
00:50And I was thinking on the way over here, it reminded me of a rock star that's more popular in
00:54my house,
00:55which is Taylor Swift, and two messages from that is, A, there's a lot going on right now,
01:00and B, we all need to calm down a little bit as it relates to private credit.
01:04So let me just tell you a little bit of context on us, because I think that will build credibility
01:09in what our view is.
01:11And then I want to just talk about kind of what is it, what's changed, and where the opportunity is.
01:15So in terms of context on us, we've been doing private credit at TCW for 26 years.
01:20Actually, 98% of managers started post-global financial crisis, which is a relevant data point we'll come back to.
01:29We also don't own any software exposure in our private credit portfolios.
01:34We also don't have wealth BDCs in our private credit portfolios.
01:39And I'm saying that not to take a victory lap, just to, again, build confidence and credibility that actually we're
01:45the beneficiary of things dislocating.
01:48Is that because you saw something in software that you didn't want to touch?
01:52Yeah, it's such a good question.
01:53And no, it's not because we were massive visionaries around what was going to happen in software.
01:58It's actually because we maintain a lot of discipline.
02:01So we had leverage of three to four times when the market was at five to six because we have
02:07strong covenants and documentation.
02:09So you can either say that we didn't lend to software companies or you could say they didn't want our
02:13expensive capital that was strongly documented.
02:16But either way, it led us to not having that exposure.
02:19And so I just want to remind people, because I think we're getting a little bit confused in this asset
02:22class, kind of what it is, what's changed, and then, again, where the opportunity is.
02:27So this is just bank lending, and bank lending as an asset class is as old as the Notre Dame
02:32Cathedral, which we all toured last night.
02:34Older, actually.
02:35It goes back to Mesopotamia.
02:37This is just the way we finance companies forever.
02:39And if you make loans and you approach it as the negative art it is, which is trying to avoid
02:43mistakes so you have contained leverage and good documentation and covenants, you will get your clients' money back.
02:50So we think this asset class will persist.
02:53It's been around forever, and it will continue.
02:55Okay, so what's changed, and where are the problems that people are focused on now?
03:00What's changed is actually who's lending the money.
03:03And post-global financial crisis, as you know well and as you've reported a lot, the lendings move from banks
03:08to the asset managers.
03:10Now, have some of these asset managers lacked discipline?
03:12Have they made mistakes that we're now looking at?
03:15Yes.
03:15And what are some of those things that we should reflect on?
03:18Number one, do we allow these funds to become too big?
03:22It's a question we should ask ourselves.
03:23Number two, when the industry made these funds so big, did it give up discipline?
03:28Were covenants eroded?
03:29Did documentation get weaker?
03:31I do think some of that behavior did happen.
03:34So you would answer yes to the first two questions.
03:36Yes, definitely.
03:37We think there is some misbehavior and some lack of discipline on that part, broadly.
03:42And then I would say the portfolio construction point is important, which is that I think the industry started to
03:49approach this more as a capital markets exercise of putting loans out versus portfolio construction.
03:56So the problem with software is that it became 20% to 30% of some of these portfolios.
04:01And this is leveraged finance.
04:02Things go wrong.
04:04Most of it, a lot of time.
04:05And so you just don't want all those things to go wrong in one sector.
04:09And then you need the documentation to be able to work out of it.
04:11And so there's going to be some, you know, there's going to be some reflection on what people could do
04:15better.
04:16But I want to end by saying this is a massive opportunity.
04:19We just published a paper on this, which is available on the TCW website, which essentially says as the crowds
04:25go for the exit, this is actually the moment where people should be buying.
04:29And so we're really excited about new loans and also about rescue opportunities and private credit.
04:34Where do you see those?
04:35Because at the same time, if the war rages on in Iran, again, we can debate on what that means
04:41for interest rates and things like that.
04:43But you could see, you know, the investors, the famous saying of you see who swims naked when the tide
04:49goes out.
04:50That's right.
04:50I would just say, though, we can talk more about the war and the impact on liquid markets.
04:55But in general, that higher level of uncertainty is actually better for prospective returns.
05:01So we're going to get better spreads.
05:02It's going to be a more lender-friendly environment.
05:04You should be able to get better returns at better terms.
05:08You also are going to have enterprise value multiples that aren't going up and to the right.
05:12That's more healthy from a lending environment perspective.
05:15Base rates, because of oil and a lot of other reasons, are probably not going back to zero.
05:20Again, that's better for private credit as an asset class.
05:23So while people's – yes, there were some mistakes made.
05:25And while people's instincts may be to run for the door, at TCW, we think this is an incredible opportunity.
05:31And we're sitting on half of our capital base is undeployed.
05:34So actually, this dislocation should be a great opportunity for our current clients.
05:38And we're encouraging other people to step in now as well.
05:41So, Katie, so how do you see – are the next three months a kind of reckoning time where the
05:45ones that were undisciplined will face a lot of concern and scrutiny,
05:49and the ones that actually are in a better shape can find opportunities?
05:52This is such an important question because for most of this asset class's short history, there's been very little manager
05:59dispersion.
06:00Everybody gets to be a genius when rates are zero in lending money.
06:03If you've actually had discipline this entire time, we're going to get very significant manager dispersion.
06:09And for us, you know, we're excited about that.
06:12We know – we feel confident we'll get our money back for our clients because we've been doing it for
06:1626 years.
06:17In 26 years, we've had six losses.
06:19And so this should be a great opportunity for us to differentiate ourselves and for new vintages to deliver great
06:26returns.
06:26Where do you see the best opportunities?
06:28Really, you can – at this point, you can get them across all sectors.
06:32We think opportunities that will widen, particularly if the volatility increases.
06:37And at the moment, the place we're actually deploying the most capital is in rescue opportunities, where you are in
06:43the senior part of the capital structure.
06:45You can get a high current coupon.
06:47It's the only place where we'll deliberately pick and get some warrants on the equity.
06:52And we end up as equity owners in half the situations.
06:54And those rescue opportunities should not only outperform the debt market, I think it's also possible, given some of the
07:00headwinds facing private equity, that it's a very good risk-adjusted way to actually outperform potentially private equity too.
07:08But you don't see more opportunities.
07:09And I don't know whether you look through some of these oil and gas prices or whether that presents extra
07:15opportunities because of everything that's going on there.
07:18First, I would say in general, across TCW and just if I'd said what sectors that we're interested in, both
07:23in debt as well as equity markets, one is definitely power transformation in the U.S.
07:29And the other would be AI, and we can talk about the puts and takes of that.
07:33For credibility, I want to say we launched an AI equity fund a decade ago.
07:37So it wasn't like we just started using chat GPT and said, let's launch a fund.
07:40We've been doing it a long time.
07:41But those are places where you have this great intersection of high structural demand and historical underinvestment.
07:49And so we see tremendous opportunity, regardless of what happens in the macro environment, to invest in both of those
07:56spaces.
07:57What do you think will happen in the macro environment?
08:00I mean, this is – I lack the proverbial crystal ball here.
08:03But what I would say is that in these moments of dislocation, war in particular, or geopolitics just generally, it
08:13tends to create volatility, which is obviously good for active managers, but not necessarily completely change the economic regime.
08:20So the question is kind of like how did we come into this year and how has it changed?
08:24Actually, we came into this year already very late cycle, which is relevant across all asset classes.
08:30We had a cooling economy, a slowing labor market, inflation was under control, and in general, it was late cycle
08:36behavior, which led us to be positioned in liquidity, quality, and we're very underweight credit, as I said, versus peers
08:44in the benchmark for those reasons.
08:47Okay, then it was potentially offset by the fact that we were going to attack affordability, that there was going
08:52to be tax relief and all these stimulative things that the president wanted to do.
08:56I'm speaking now about the U.S., just as the world's largest economy, so a place to start.
09:00And so those risks were in balance.
09:03What I would say has happened with the war is that the risks have tilted more negative.
09:09And so there is, to us, a stronger possibility that we're going to get a – we've already obviously had
09:14underperformance in equities.
09:15It hasn't yet come to credit markets, but we do think that there could be a break in credit markets.
09:21Katie, thank you so much for doing this.
09:23Katie Koch there, Chief Executive of the TCW Group.
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