00:00Mark Pinto, the global head of private credit at Moody's Ratings, says the sector is entering a more complex and
00:05more volatile phrase.
00:06He joins us now. Mark, I feel like this point, I mean, you made this point in the commercial break,
00:11and it also was driven home to me at Super Return, where I feel like usually this conference in Berlin
00:14has this, like, big consensus coming out of it.
00:17And we kind of felt absent of one. Is there just no consensus? Because there is just so much dispersion
00:22happening right now.
00:23Well, it really is a tale of two cities, right? It's the best of times. It's the worst of times.
00:27So to your first point about infrastructure, asset-based lending is becoming bigger and bigger.
00:32And private credit, the OG Mag 7, are meeting up with the private credit Mag 7.
00:39They're doing a dance, and they're financing and helping each other finance this big build-out of data centers.
00:45But private credit is also doing other types of infrastructure as well, whether it be energy or types of things
00:51like that.
00:53So AI is the sword that cuts both ways, basically, in private credit.
00:58I mean, it's how they're making their money now, but also on the software side, a lot of them are
01:03taking a hit because they, I guess, over-invested in software, right?
01:07Yeah. So that's the worst of times in the tale of two cities.
01:10So if you look at the BDCs, on average, they have, it's well-documented, about 25% exposure to software
01:16companies.
01:17And, you know, since Claude Cowork walked into the room, people are scratching their heads and wondering, is this going
01:23to be a growth enabler or will this be an existential threat?
01:26And we probably won't know that until 2028 when we see the first refinancing wall.
01:32A lot of these companies were underwritten or debt was provided to them, loans were provided to them in 2021
01:38when you had zero interest rates, great growth.
01:41And there was a lot of tight credit spreads because there was a huge amount of demand for this stuff.
01:46By the way, we saw that happening.
01:48I mean, I was interviewing people on private credit at the time and saying, like, what are you going to
01:52do when rates go up?
01:53And nobody was worried.
01:54Why didn't anyone sound the bells?
01:58Yes.
01:59You know, they were telling the story that, yes, we're underwriting, assuming a more normalized interest rate environment, more normalized
02:06interest rate environment.
02:07But I think what we're seeing now, if you look at the BDCs, we're tracking troubled borrowers.
02:11We're tracking non-accrualed loans.
02:13And what we're finding is a lot of the non-accruals are in that 2020, 2021 and early 22 vintage
02:21when the world was in, you know, it was a Goldilocks type market.
02:25And so when we're looking at non-accruals, we're looking at concentration risks, we're looking at vintage and we're looking
02:32at granularity because if you have a portfolio that has a lot of little loans in it, it takes a
02:37lot of problems for them to sort of boil up and become an issue for you.
02:41If you have a more concentrated portfolio, then one or two issues amongst your borrowers can really damage or, let's
02:50say, shoot up, see your non-accrual loan ratio shoot up.
02:54Well, and a large criticism has just been since interest rates started to go higher that there's just been so
02:59much can kicking in this industry, sort of exemplified by PIC, by Payment and Kind.
03:03Yeah.
03:03How do levels look at this moment?
03:05You know, Payment and Kind has risen, but it hasn't risen dramatically.
03:09I think as we approach 2028, this will be a sorting mechanism.
03:15We'll be separating the wheat from the chaff.
03:18You'll see some extend and pretend or extend and amend, however they call it.
03:22And you'll see some distressed exchanges, which we at Moody's view as a default.
03:27The key is not only looking at non-accrual loans, though.
03:30It's really looking at what are the ultimate losses.
03:32In the business development companies, a lot of their positions are first lien.
03:36What does that mean?
03:37It means you're first in line for any payouts, even if the can, excuse me, even if the keys have
03:44been handed to you.
03:45All of the BDCs have a little drop box outside of their offices to drop the keys in when the
03:50private equity sponsors decide they don't want to be playing anymore.
03:53By the way, I've heard that argument.
03:54I mean, it's something that, like, Mark Lipschultz talked to me before Blue Owl kind of went underground, but used
03:59to talk to me about and basically say, look.
04:01When they used to talk.
04:02When they used to talk, and hopefully they do again soon.
04:04Used to say, look, we're in a better position than equity because we're higher up the capital stack.
04:09But doesn't also private credit have a problem that returns were already pretty compressed?
04:15So if you have one stinker in the portfolio, it's pretty bad for them versus equity.
04:20Like, you can have a company underperform because you have massive outperformers.
04:23So in that way, isn't credit a little bit more at risk if some of their software bets go under?
04:28Yeah, the calculus, you've got the calculus right here, but you have to remember these loans are generating a fair
04:33amount of income for these guys.
04:35These are non-investment grade loans for the most part.
04:39You know, you can see the dividend yields were double-digit.
04:41They're now starting to move a little bit below that double-digit.
04:44So it does hurt when you have a concentrated position that goes bad.
04:48And we haven't seen a lot of write-offs as yet.
04:50We've seen here and there, but non-accruals are ticking up, but they can be very lumpy.
04:56So, for example, one of the Blackstone BDCs, the smaller one, BXSL, we saw the non-accrual loan rate go
05:04from under 1% to over 5% in one quarter.
05:07But if private equity comes in and says, all right, we're going to sort out the capital structure, they can
05:11easily fall below 1% again.
05:13So it's really, we're looking, you know, if you really want to focus on this as an investor, you need
05:19to watch, is there a sustained deterioration in non-accrual loans?
05:23And then the second-order effect are, what are the write-offs that you're going to see as a result
05:27of that?
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