A (3:29)

So we have a market for issuing corporate debt that's pretty wide open, as you mentioned, very high levels of issuance and supply going through despite would have been a lot of concerns. And one of those concerns is the conflict in Iran. But another concern that's been cropping up is a concern around this market often known as private credit, where you've seen a lot of focus, a lot of headlines, volatility in some of the managers of private credit. But also I think this is an area where less is known and where there's still a lot of confusion about what it is and how it's performing. So for the second set of questions, Vishwas, maybe we could just start with when you think about private credit, what is it to you and how do you break up the market?

B (4:12)

Yeah, so I think at a very high level you can think about private credit as capital that is provided by non bank lenders and in some ways that is not broadly syndicated. So it's different from investment grade bonds or high yield bonds or leveraged loans in that respect. The second factor I laid out, you know, private credit overarchingly is a big umbrella term. It includes direct lending to businesses, it includes infrastructure finance, project finance, the private placement market, asset based finance. So there are a lot of subcomponents. Now to your point where the market's a little worried and there is growing anxiety is around the direct lending portion of private credit. That segment of the market has grown substantially over the last decade. It was about 500 billion or so 10 years ago. It's about 1.3 trillion right now.

A (5:02)

And this is lending directly to companies?

B (5:04)

Yeah, this is lending directly to companies. Leverage typically tends to be higher than what you see in the public market. So one of the challenges around navigating the risks are when you get a bunch of negative headlines that isn't necessarily the readily available information to either disprove or validate it. So I think that's some of the anxiety which is building among the investor base. Our view is these risks are significant and investors should be cognizant of what's happening.

A (5:32)

Maybe just to take a step back a little bit there. Why have investors been more worried about the private credit space? Have we seen particular events or is it more other factors that you think have driven this increased focus?

B (5:45)

Yeah, I think it's been a rolling set of factors this year. The whole story has really been about software and concerns about AI disruption. But before I get into that, I think it was a process that really began, I would say, second half of last year. So private credit really had its moment in the, in the sun a few years ago where inflows were massive, the public market was choppy while the Fed was hiking rates and a lot of stressed issuers were choosing to raise capital via direct lenders. And at that time, spreads in the private credit market were also very attractive. What you've seen last year is private credit AUM was effectively flat. The fee income being generated on the loans has come down as the Fed has eased policy, and the spread on private credit versus the public market has also narrowed. So what started off, I think was more macro. It was driven more by what was happening on the policy front.

A (6:38)

More yield, compression, less yield for investors, which caused them to be just a little bit less attracted to the space.

B (6:44)

Absolutely, yeah. And I think that was largely the driver of the correction in some of these asset manager stocks to begin with. Then you had some of the headlines around, specific single name headlines, double pledging of collateral, some accounting malpractices, which I think we can say with the benefit of hindsight, those were idiosyncratic, those were one off. But again, you know, doesn't make for a positive headline when you get news flow to that effect. And then this year, as I said, it's really been about concerns around the

A (7:15)

software sector, which is a very big part of the private credit market.

B (7:18)

It is a very big part of the private credit market. It made up for almost a third of all LBOs that were originated between 2018 through 2022. And in fact, really, if you look at 2021, when interest rates were very low, a lot of the outstanding software loans were originated in those really weak market. And so I think AI disruption has maybe been the catalyst to drive some of this price action. But that's on top of software, where a lot of loans were originated with high leverage. But now that you have a very disruptive force around margins potentially looming, the concern has now shifted towards what do balance sheets look like? And the software sector is very levered. In the bank loan market, for example, more than 50% of software loans outstanding are rated B minus or lower. And one extension of that is that you have a non trivial amount of debt that is maturing in the next few years. So through 2028 we see about 65 billion of software loans maturing largely in that lower quality cohort. So even before we get clarity around how AI will diffuse and disrupt or not disrupt these names, the issue is really refinancing in this period of uncertainty, will all these software loans over the next 12 to 18 months, will they have the capital to term out their maturities?

A (8:39)

So, Vishwas, maybe just in closing, as you're going around and talking to credit investors at the moment, what do you think are the two or three biggest high level takeaways and views that you're trying to get across?

B (8:51)

A few things, I would say. So specifically on private credit, we are saying that I think we are in for a period where returns might be subpar. It is possible that private credit sees AUM growth that is sluggish, maybe even down year over year this year. But we would not conflate that with something that's systemic. And I think it's very important to lay that out. But importantly, some of the linkages to the banking system are through leverage that is significantly lower in this cycle than what we've seen in the past, say prior to the gfc. So that's one second. I continue to think that the aspect of issuance being very high and somewhat agnostic to macro conditions that's been validated so far. And when I look at what credit markets are priced for in aggregate, we think valuations are still too tight and that's notwithstanding everything that's going on in the Middle East. We clearly have a commodity price shock to navigate and that can have a feedback loop via what central banks will do and the US consumer. But I would say just the convexity of credit is very weak if, let's

A (9:55)

say we get limited upside relative to

B (9:58)

more downside very limited upside and downside if we get both a technical and a fundamental and why it is significant. And the third thing I would say is it makes sense to own hedges here. Again, hedges can be expensive, can lead to loss of carry, but they can also be a very efficient way to protect yourself. And if you look at this time last year in the lead up to Liberation Day, credit had held up really well for the first, say five or six weeks of that sell off. But then when it moved, it moved very quickly. And in some ways, if investors were able to protect themselves through that last leg of volatility, that effectively provided a very good entry point to capture the rally that played out thereafter.

A (10:38)

Vishwas, I think that's a great thing to keep in mind. Thanks for taking the time to talk.

B (10:42)

All right, thank you for having me,

A (10:43)

Andrew, and thank you as always for your time. If you find thoughts of the market useful, let us know by leaving a review wherever you listen and also tell a friend or colleague about us today.

C (10:54)

The proceeding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for you.