00:00And I was just going through your you and the team's downgrade on BDCs and part of it is about
00:05the outflows. And we've heard from so many funds that
00:08defended or just like it's just about the headlines. It's the media scare. This will stop. It's not a big
00:13deal. Why is it a big deal to see these
00:15types of redemption. It's it's a combination of a number of different things. The market is going through a transition.
00:21It's not it's a
00:23test of the market. The market's being tested but it's not the test. It's not something like the great financial
00:27crisis. But I think
00:29investors are are feeling a little uncertain about what's happening at the private credit lenders. Private credit is being
00:37held to a higher standard. Why? Because it's been growing very significantly like we just heard. We've seen concentrations build
00:44up
00:44particularly in software. This market hasn't really been tested. It's not regulated like banks but they're becoming as big as
00:52banks. So I get the the concentration risk and the lack of regulation as a risk. Also. What about these
01:00redemptions that
01:00we're seeing because we're starting to see bigger and bigger numbers. A lot of them have a five percent cap
01:05on
01:06redemptions. Not really a hard gate. But some are enforcing that level where redemption requests go to 15 percent or
01:1420 percent
01:15or in some of the smaller funds at Blue Owl as we saw earlier 40 percent. Well I think it's
01:20a very important point that the structure of these BDCs is working the way it's supposed to. It's being a
01:27little frayed because of the somewhat inconsistent way that each one of the sponsors are dealing with this. There is
01:33a soft promise as you mentioned for them to release up to five percent of the assets of the fund
01:38on a quarterly basis. But that's decided by the board of directors.
01:42It can actually be zero. But as you've seen it can be above five percent. So we're watching very closely
01:48how managements deal with this. How they deal with liquidity leverage and the overall construction of the portfolio. But what
01:57I would say is where you can have in a situation like this a run on the bank. You have
02:02a structural feature here where you can't really have a run on the BDC because they can stop those outflows
02:09because of the way the BDC is structured.
02:12I know I know one of the way is just thinking of banks and that systemic fears come in is
02:16the fact that banks do lending themselves to some of these private credit vehicles. J.P. Morgan among the ones
02:21who have said listen we're going to reevaluate how we look at these and how we value them.
02:25Is there a risk that banks pull back in their willingness to lend to private credit. And that alters this
02:30industry too in the availability of private credit financing.
02:34I think it is a risk. It's a growing risk. But what you have to realize is that there's a
02:39lot of liquidity available to the BDCs today. Their loan portfolios mature at a fairly rapid pace that creates liquidity.
02:47They do have committed lines from many of the banks. So many of these lines are committed for a number
02:53of years. So it's not easy to turn off the spigot.
02:56They also have the ability to pledge some of their loans in a secured lending apparatus. So there is enough
03:04liquidity today. And again they can manage through this.
03:07But we're going to see a period of elevated redemptions for probably the rest of this year and possibly longer.
03:15I say because you you discuss in the note this idea that a lot of the redemption requests they look
03:19like they're being prorated.
03:20Exactly. How do you see that playing out then. Yeah. So if you didn't get your money this quarter you're
03:24going to line up for next quarter.
03:26And it may take multiple quarters for these redemptions to get through the pipes.
03:31In the past we have seen elevated redemptions but it's usually lasted for one or two quarters.
03:37This one we think it's going to be higher for longer in terms of redemptions.
03:42So what's more important then is it liquidity or funding or the underlying asset?
03:48All of the above. Liquidity I think is what we're addressing right now.
03:54When we look at asset quality we're seeing some deterioration in pockets.
03:58But overall asset quality has held up quite well.
04:02Are those pockets software as a service?
04:04I would say that it's really across the board. Software is in huge amount of focus.
04:10I mean for many years the concentration has built up in software and it was viewed as terrific and tactical.
04:17It's been an outperformer for BDCs. Today not so much.
04:20In fact we spoke to one of the third party valuation firms that look at the software exposures
04:25and they told us that 70 percent of the valuations of the software companies or software positions that they look
04:32at
04:32had fallen quarter on quarter.
04:34It didn't sound like they were falling dramatically but there is a reassessment of these particular positions.
04:40Isn't that a bad thing though because something like private equity you can have some returns that aren't great
04:45and you have other things to make up for. What happens when that occurs in a private credit portfolio
04:48where returns are usually within a range to have one that underperforms to have like a real stinker of a
04:54software business in there.
04:56So a couple of things. One returns are coming down at the BDCs and the big private credit lenders
05:02who've been on this show have been talking about it. We've had a period of very strong returns.
05:07Returns are coming down for a number of reasons. One last year towards the end of last year we saw
05:12the Fed cut three times 75 basis points.
05:15Many of these loans are floating rate so they're no longer producing the same amount of income.
05:21We're also seeing spreads that have been quite tight until recently. This is reducing profitability.
05:27What also though is a feature of this market is these are not bank loans. These are direct loans provided
05:33by the private credit lenders
05:35and they have certain tools at their disposal to manage through some borrower struggling periods. Right.
05:42So at a bank when something becomes non-performing they reserve against it and then they write it off.
05:47At a private credit lender it's more of a nuanced process. And so you know the stinker as you mentioned
05:55may not be as as a difficult situation to deal with as you might have seen in a banking construct.
06:04Mark just quickly when we go through this period that the redemptions are going to last longer than than historically.
06:09Right. When we come out on the other end of it do you think that most of all of these
06:13funds survive or will we look back and say wow actually the universe shrank a lot because of this period
06:19of stress.
06:19It's a good question whether every single one of them survive remains to be seen. But what I think we
06:25will see on the other side of this is more disclosure.
06:28We'll see more discipline and I think we'll see more direction potentially from regulators. Not that I see a lot
06:35of regulation for the private credit industry of itself but maybe through a back door through insurance regulation or banking
06:41regulation because the financial services sector is becoming much more interconnected as you mentioned earlier.
06:47And regulators and investors are asking for more disclosure in the current period of time maybe it's a little bit
06:56too little too late but I think on the other side of this you will just see a lot more
07:00disclosure.
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