Tell me what's happened here. How could the credit markets stare down?
They say that 500 basis points they seem to have just absorbed and go.
How about the equity markets? Up 15% also true.
So, look, the markets are up because the economy is doing better than people
expected. And the big adjustment has been that
inflation hasn't gone away and that reversed the market's expectations of
six Fed cuts down to one one or two this year.
And so when you have a resilient economy, it's good for equities and it's
very good for credit, too. And when we talked last time, you were
talking about something like $1,000,000,000,000 in debt that was
going to have to be refinanced at a different interest rate than we'd seen
before. What happened to that?
It doesn't seem to have happened yet. They're just extending the time.
Are they fixing it? What's going on?
So I'd say the biggest development in the markets has been the reopening of
the syndicated markets. Again, we as a firm do syndicated
markets, private credit stressed in distressed and structured credit.
And what happened is the cost of financing for what's called close these
collateralized loan obligations, which are the biggest buyers of leveraged
loans. It's not the banks who buy leveraged
loans. It's the sellers that by lenders own 70
plus percent. The cost of financing has come down 50
basis points in the last six months. And with that cost coming down and with
a positive economic backdrop, there's been and with very limited M&A, private
equity activity, you've had demand pick up because the close have low cost of
capital, you've had limited supply of new deals.
And guess what happens? Pricing goes up.
Spreads come down and you have this very buoyant refinancing market.
So there's been a lot of refinancings in this syndicated market, principally
because of close. So we've taken a dent out of that wall,
but there's still a trillion plus of debt coming due.
And that's something we're going to have to deal with and some that we're quite
excited about. So more creativity is going on as well.
I hear things about things like liability management exercises or
transactions. I hear about payments in kind.
Are these ways that creditors are finding to really restructure their
capital stack so they don't have to pay the debt?
So let's separate the pieces because pay in kind pick features is something that
is 30 plus years old, is now making a resurgence.
I come back to that in a minute. Liability management exercises are
essentially when companies have debt coming due in 2025, 26, 27 and because
of some challenges in the business, because of higher interest cost, there's
a sense that maybe they can't refinance at par in a couple of years and the debt
is trading at discounts. Now, again, the distress ratio, which is
a percentage of the high yield market that trades a thousand basis points over
the ten year Treasury, over the relevant Treasury, five year Treasury is only 6%.
So there's not a lot of stressed and distressed debt out there.
But where there is, what companies are doing is these so-called lien liability
management exercises, where they're going to the debt holders and say, Hey,
we'll swap you into something that's coming due, something that was coming
due in 26. And we'll ask you to extend your
maturity. If the debt might be trading at 60,
we'll offer you an 80 cent offer you $0.80 of recovery in something that
people perceive to be money good so they can take their existing paper from 60 to
80. Now they are leaving $0.20 on the table
because they have a poor claim. And so the liability management business
is a very complex business. It's super exciting.
We're incredibly active in it and I do believe that is the next wave of
stressed and distressed credit on the payment and kind or pick
features. What you're seeing is that you hadn't
seen that much PIK issuance where you're now starting to see and it's emerging in
private credit is companies are looking at their businesses and they may buy a
business for $2 billion and it may be a very high growth
business and they want to do $1,000,000,000 of debt issuance and
rather than then pay out cash interest, they'd rather have the debt accrue in
kind. That's not necessarily a bad thing, nor
is it necessarily a good thing if you can if you invest in that company and
you believe that company is absolutely worth $2 billion and you're investing,
that's make it 800 million, not a billion.
And you pick on a small portion, you're compounding at that rate, which they
would be in the neighborhood of ten, 11%.
And it gives the company extra cash flow.
Where pick is a little bit more concerning is where it comes.
These are more challenge and they don't have the cash at all.
I think picks in new deals are really about financing growth as opposed to
remedying more challenge situation and tell you what the risks being faced by
the people putting money into private credit.
We had Jamie Dimon this week sort of come out and say there may be hell to be
paid if in fact, private credit goes out.
He seems to think there's a lot of risk he may be talking his book.
I don't know. But what are you talking about?
Look, Jay, Jamie always has incredibly interesting things to say.
At the same time, Jamie is talking about adding more money in private credit and
potentially buying a private credit manager.
I think where he's focusing on is that in a market where there's lots of
demand, there is sometimes a tendency for people to be too aggressive in
underwriting. And there's certainly a number of
players out there that are new to private credit and may be willing to be
a bit more aggressive. That said, when I think about the
underwriting that we and many of our large peers do, and medium size peers
too, if you have 50 plus percent equity cushion in a deal and you do a
reasonable job of underwriting the credit, even if you make some mistakes,
you have a lot of cushion and only a couple of points.
One is that we did this study and we looked at what does it mean to have a
50% equity cushion? So I did a study of the Russell MidCap,
which basically has median EBITDA of 150 or so million kind of right down the
fairway of what we do. And I did the analysis asking how how
often did a company that more than 50% of its equity value in 23 years in 2000.
And the answer 5% of the time and that happened in 2001 after 911 and the
Internet bubble bursting. It happened in 208 from the GFC and
happened in 2022 when growth stocks got hit.
And so if you do careful underwriting and you pick good companies, you really
should have sufficient cushion. The last thing I'd say in terms of where
I think Jamie was going is there's a legitimate question on the accumulation
of alternative assets by the retail investor and by the high net worth
individual. And there's certainly some concern that
Jamie expressed that maybe some of these investors, when and if they go to take
their money out and they can't get out or they have losses that their
congressmen will get concerned. Again, I think because the amount of
cushion is so significant, I think that outcome is less.
But for sure, and we have wealth distribution with our products.
We want to make sure that the people who are buying our products, just like the
institutional investors, understand what they're buying.