February 8, 2024 • 37 mins
Geopolitics are a potential menace to public debt markets that could present opportunities for private lenders, according to Mike Dennis, co-head of European credit at Ares Management. “The capital markets in general are still pretty fragile,” Dennis tells Bloomberg News’ Lisa Lee and James Crombie in the latest Credit Edge podcast. “It wouldn’t take much for that liquidity to reverse out of the system,” he said. Volatility may open the door for private credit firms to participate more in larger corporate loan deals, Dennis says, adding that there’s more demand for European transactions than supply. Also in this episode, Bloomberg Intelligence’s Stephane Kovatchev analyzes the shipping sector after a 300% increase in freight rates. Greater supply of ships coupled with fading demand are expected to relieve some of the price pressure, Kovatchev says.
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Episode Transcript
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Speaker 1 (00:18):
Hello, and welcome to The Credit Edge, a weekly markets podcast.
My name is James Crombie. I'm a senior editor at Bloomberg.
This week, we're very pleased to welcome Mike Dennis, co
head of emia Credit at Aries Management in London. How
are you, Mike, Yeah, very well, James, thank you, Thank
you so much for joining us today. We're very excited
to dig into your credit market views. Also delighted to
welcome back Bloomberg's very own Lisa Lee covering markets from London.
(00:40):
Great see you and Lisa.
Speaker 2 (00:41):
Great to see you and thanks for having me again.
Speaker 1 (00:44):
And from Bloomberg Intelligence. Excellent to see Stefan cob Chef,
also in London. Welcome back to Stefan.
Speaker 3 (00:49):
Hi James, thanks for having me.
Speaker 1 (00:51):
So let's start with you, Mike. Great to see you
on the Credit Edge. We're going to get to the
specifics of your portfolio and your positioning, but let's start
with a macroview. The economy is chugging away, inflation is moderating.
It's all about rates now. Last year turned out to
be a good one for credit, mostly because of a
huge rally in November and December, which really did seem
to come from very aggressive policy easing priced in early
(01:13):
and probably too much, it would seem. Now those duvish
bets are being unwhelmed. The Fed's pushing back on any
imminent rate cuts. Markets are selling off just as we're
seeing corporate supply really ramping up. So where do we
go from here?
Speaker 2 (01:26):
Mike?
Speaker 1 (01:27):
Everyone keeps telling us this is a great credit market,
tons of opportunity out there. But when does the FED
start cutting? How much will they reduce rates? Do they
even need to do anything given how well the economy's
performing right now? What's your view? Yeah?
Speaker 4 (01:39):
I think rates are due to come down this year,
but let's not forget you know, it wasn't too long ago.
We're in a zero rate environment, So even if they
come down, I think they're only going to moderately reduce
during twenty twenty four, and that creates a good environment
for credit. I think people have more confidence as to
where rates are going. That, combined with what you've just
(02:02):
said there, James, combined with the benign macro environment is
driving activity levels, and we definitely saw more activity in
Q four and I think that's translated into more activity
in Q one. So actually, in terms of the deal environment,
from an activity point of view, I think, actually, this
is a pretty good time to be in credit. And
(02:22):
as I say, even if rates come down a little bit,
you know, we're talking about rates at three four four
percent plus. You know that combined with the spreads you're
finding in credit today, still generate relatively good risk adjusted return.
Speaker 1 (02:36):
So I just wanted to take advantage of that. You're
in Europe and you cover Europe to sort of dig
a little bit into that region. When we talk to
global portfolio managers about Europe, they'd certainly like the sound
of it for potential diversification, or too because it looks
relatively cheap. Of course they skew to the bigger US market,
and maybe Europe's cheap for a reason because of those economies.
You know, they seem a bit more challenged in the US,
(02:59):
A lot of issue with inflation, which is tying policy makers' hands.
Also seems to be you know, the headlines we're seeing
this week on property issues with the banks. What's the
macro outlook in terms of emia From where you sit, Mike.
Speaker 4 (03:14):
Yeah, Look, I think this is a challenge that sitting
in London I get. I get a lot from global
investors and commentators. Look, the reality is most commentators would
have had the UK and the European markets in recession
at this point, and the fact is that's just not happened. Actually,
what we're seeing is is low but growth, positive growth.
(03:35):
And again let's let's let's you know, talk about what
we're trying to do, what credit investors are trying to do,
they're for the most part taking firstly in seeny secured
risk through thirty forty percent loan to value and therefore,
as long as you're in a stable economic environment, actually
the GDP growth doesn't need to be that positive to
(03:56):
make these senior investments attractive. So actually, as a senior
secured lender for the most part, seeing growth at zero
point five percent up to maybe one percent across most
of the markets in Europe, that's not a bad place
to be. It might not work for the equity, but
actually it works for credit investors. And so you know,
(04:17):
there's an overlay to that as well, James, which is
to say, you know, credit investors aren't buying GDP, right,
they're not buying the macro, We're not buying to a benchmark, right.
Private credit direct lending is a very selective asset class
where we're specifically choosing to invest in companies and sectors
that are actually in growth and don't exhibit some of
(04:40):
the cyclical characteristics maybe that you've just alluded to. So
when you look across direct lending or private credit portfolios,
generally you're not going to see a lot of consumer
B two C. You're not going to see a lot
of energy, construction, manufacturing. What you will find is actually
a lot of B to B type businesses. These are
the service based businesses, software, technology, healthcare, education, etc. And
(05:05):
so those sectors tend to exhibit more defensive characteristics, and
therefore whether the economy is growing at zero one two
percent actually doesn't really matter for senior secured credit investors.
Speaker 2 (05:17):
You've been one of the areas is one of the
biggest and leading private credit lenders, and you also have
a sizeable liquid business. Let me bring up the example
ar Dona, which even a few months ago we were
expecting to go to the private credit lenders and perhaps
even be the biggest private credit loan ever, and instead
now it's going almost half two billion into the public
(05:40):
debt markets high yr bonds, and then three for direct lending.
Tell me, what does that tell you about the health
of the market and opportunities for private credit.
Speaker 4 (05:49):
Yeah, and let's not forget Our Donna was financed in
the private credit markets for some time. But as I
said before, you know, given the confidence in the macro,
given the ability of the macro and the I think
most investors now have some kind of view as to
where rates are going, and probably down, not up. That
(06:09):
has given the confidence for this the public credit markets
to become more active. So I think it was inevitable
as we entered into twenty twenty four that the banks
and public credit investors would be more involved in assets
like Our Donna, And I think that's what's going to
happen in twenty twenty four. You're going to see this
continued convergence and coexistence between public and private credit. I
(06:34):
think that's especially true in the European markets, and even
more so in the Sterling markets, where liquidity I think
will continue to be constrained.
Speaker 1 (06:43):
There's a sense of that the private credit came in
when times were rookie, and now that times aren't so rookie,
and you know, the public markets say gaining confidence that
the sort of the value proposition of private credit is
somewhat diminished, and public markets end up sort of naturally
taking those deals back in the you know, the whole
hype about the golden age of private credit that all
(07:03):
sort of fades now at this point, do do you
think that that's that's a possibility.
Speaker 4 (07:08):
Well, James, I really don't like the term the golden
age of private credit because frankly, I think it's been
a good time for private credit for some time. So
now let me just address the public private credit coexistence
a little bit a little bit more. And the reality is, yes,
are done at tapped the private markets when the overall
(07:29):
market was a little bit bit trickier. But don't forget
private credit players or direct lending players in general, look
at that large end of the market Opportunistically, they're businesses.
Our businesses are not founded on those larger bit those
larger deals basically sustaining our business model. For the most part,
(07:50):
direct lenders heritage and foundation was really in the mid market,
and that's where most of that deal activity, most of
the deployment of direct lenders and private credit providers, that's
where it sits. And so, yes, our Donna was slightly
different in that it was a very large deal. Private
credit took that down in a difficult credit market, but
(08:11):
that doesn't take away the proposition or the value add
that direct lenders and private credit providers can provide to
middle market lenders. I think that's absolutely still true, and
the tailwinds in that market are as good as ever
the banks continue to retrench, the commercial banks, those middle
market banks are still risk off for the most part.
(08:32):
You know, we've talked about interest rates, but interest rates
are still going to be north of zero, and therefore
cash coupons on these loans are still going to be
relatively attractive in twenty twenty four and beyond, and so
again I don't think we should get hung up looking
at the one or two deals at the large end
of the market that the private credit providers did maybe
in twenty two to twenty twenty three. That does not
(08:54):
change the value proposition of private credit or direct lending
to investors.
Speaker 3 (08:59):
Great and maybe a question on the potential risks ahead
from me. I'm coming from a cyclical industrial background, so
obviously in the US we have elections and around Europe
as well, and a lot of geopolitical risk as well,
especially here in Europe. So wondering how are you thinking
about allocation of risk in the year ahead. It will
(09:23):
there be some potential traps or land minds to avoid.
Speaker 4 (09:27):
Yeah, well, it's interesting you've picked up on the geopolitical
point because I actually do think whilst there has been
more activity from the public, credit markets and banks have
come back pretty strongly, I guess in early twenty twenty four.
I think the capital markets in general are still pretty fragile. Right,
It wouldn't take much for that liquidity to reverse out
of the system. Some of those geopolitical risks you've just
(09:50):
talked about may welcome to the forum. We've got elections
later in the year. I do think that creates quite
a bit of fragility, and therefore actually maybe private market
it will play a larger role in these larger deals
this year if that comes to fruition in terms of
the way we think about risk, and go back to
something I said earlier, you know, look, we are cash
(10:11):
flow lenders. For the most part. We are looking at
or trying to find companies in sectors which demonstrate real
resilience at the revenue line with really good margin structure.
Right on top of that, these businesses have to generate
really good levels of cash conversion. So when you ask
me about industrial cyclicals, those types of businesses are never
(10:34):
going to be or find their way into kind of
the direct lending portfolios in any big way, right. I mean,
there's always exceptions to the rule, but there's never going
to be big allocations to those kind of cyclicals for
the reason the reason I mentioned.
Speaker 1 (10:48):
We've talked a lot about all the money being raised
for this strategy. Private credit, you know, is the big
thing when there is too much money tasing too few goods.
I mean, there aren't that many deals to go around.
Sometimes there's a there's a risk of you know, bad
deals happening. Do you fear that some you know, there
may be some lemons out there, there may be a
(11:09):
bigger default risk appearing. I mean, it's it's also very
hard to see the defaults because these things get amended.
But do you feel that, you know, we are going
to get a lot more defaults in private credit?
Speaker 4 (11:20):
Well let me let me come on to the default
question in a minute, James. But just to you know,
think about you know, too much capital chasing too few
deals or that that's your I guess perception potentially, But
let's look at Europe. Europe is a market for direct
lenders and private credit providers where they are continuing to
take share from banks. So this is not necessarily just
(11:42):
about the size of the market. It's about the relative
shares within it. And actually, as I said before, there's
a lot of tailwinds for direct lenders as they take
market share away from the commercial banks. So I would argue, actually,
there isn't sufficient dry powder in the private lending community,
the direct lending community, to actually meet the demand. I mean,
you think about the amount of dry powder in the
(12:04):
private equity markets in Europe today. You know, we're talking
about two hundred and fifty billion plus. The dry powder
in the direct lending market in Europe we would estimate
closer to sixty seventy billion. So I would argue, actually,
there's a mismatch the other way, James. And if the
commercial banks aren't going to fill that void, right, who is?
And in Europe, clearly it's going to be the direct lenders.
(12:24):
You know, in Europe, we don't have BDC structures, we
don't really have mid market clos we don't have those
other sources of credit and capital creation that you do
in the US, it's really just the commercial banks and
the direct lenders, and so I think we're in a
market actually where the supply demand imbalance is in favor
of the direct lenders potentially rather than the other way around.
Speaker 2 (12:48):
Well, since you did mentioned dry powder areas is one
of the most active fundraiser what is the fundraising environment
right like right now? And how often are you on
a plane? And when's the first destination go to in
the least is it Japan less?
Speaker 4 (13:03):
Well, so you know, I'm not going to talk about
specific fundraisers, but look, I would say that generally speaking,
investors are still looking to allocate to direct lending and
private credit generally for all the reasons we've talked about
over the last ten to fifteen minutes, because effectively they
can access high cash yielding investments with relatively low risk
(13:27):
right as I say, these are senior secured investments thirty
forty percent loan to value and with good governance and
structures around them. So I think from an allocation point
of view, we're certainly hearing from LPs that they want
to allocate more to the space. That said, there are
also global investor challenges, and those challenges come in the
(13:51):
form of liquidity. You know, let's not forget there's been
an awful lot of capital or allocations been made to
alternative asset class is over the last three, four, five,
six years. Question the amount of distributable proceeds that have
been given back to investors. So there is this the
liquidity or cash profiling challenge that some investors will face.
(14:14):
But I think they're doing all they can to allocate
to this vintage. I'm not going to use the word
Golden age, James, but you know they are doing all
they can to allocate to a vintage where you know,
interest rates will remain elevated, spreads are pretty stable, and
therefore the risk adjusted return of the asset class still
remains pretty attractive.
Speaker 2 (14:35):
So fundraising is still going on and you're making your finding.
LPs are interested. One of the reasons why LPs like
private credit is the fact that you don't have as
much volatility. But as private credit and public markets sort
of converge and like take ARDNA once again, where you
(14:57):
are going to have a higher bond and a private
credit option, does the volatility starts to bleed in, it
will still be sort of a sort of immune from
volatility and more more commer more marks will be stable
or will it will there be more volatilely going forward?
Speaker 4 (15:17):
Potentially a little bit. But again, think about the portfolio
formation of these direct lenders and private credit providers. For
the most part, you know, a lot of the allocation
is going to be into a liquid middle market debt,
which obviously doesn't exhibit the same levels of volatility. So
I think you might be right, but for a small
proportion of these portfolios. So I actually don't think it's
(15:38):
a too big a challenge for LPs to to get
their head around.
Speaker 1 (15:42):
Going back to defaults. Like I know you want to
talk about them. The idea is that you're getting very
high yields, which is great for the investor, but possibly
not so much for the issuer in going into a
downturn where the earnings are going to be suffering at
the same time. You know, when we talk to private
credit investors, they'll say, well, we only do the good deals.
(16:03):
Surely that can't be always the case. What do you
think about the fault rates in this market?
Speaker 4 (16:09):
Yeah, Look, I think the first thing to say is, actually,
when you look at private credit portfolios generally, what you
are seeing is actually pretty robust earnings growth. Right, Revenues
and earnings are growing. I would accept James, that in
most portfolios that we see, you're seeing some kind of
margin pressure. We all know twenty twenty three we saw
(16:32):
wage inflation, energy inflation, etc. That has a margin impact
at the underlying issuer level. That said, absolute earnings are
still continuing to grow in these niche segments, these sectors
that I've already talked to where we're focusing our time.
So I don't think today's issues one of operating performance
(16:53):
or profitability. Liquidity is more of a challenge because you've
gone from a zero to a four five base percent
base rate environment, so liquidity is more more challenged. But again,
you know, when you have well structured firstly in deals
through thirty forty percent LTV, you're very very well covered
(17:14):
from a valuation perspective. And even if you get a
tick up in defaults, which you could be right, James,
I think that's a possibility than in twenty twenty four
we see an increase in defaults, we actually should be
looking at loss given default you know, I think that's
much more of an important metric. And I think where
I think what you're going to find is in these
(17:35):
senior secured portfolio is the lost given default actually doesn't
doesn't go up. Actually, the recovery rates are very very
high on these senior secured loans. So I don't worry
too much about defaults because let's not forget, if you
have a default and you're a senior secured lender, that
actually gives you quite a lot of control. You can
reprice risk, you can take control of the asset in
(17:56):
extra miss So actually defaults in and of themselves are
not the issue. I think what we should be looking
at is loss given default.
Speaker 1 (18:03):
And as Lisa has written a lot about, you know,
the recoveries have gone substantially down. You know, there used
to be about eighty percent. Now they're in the twenties
or thirties, So you're going to take a much bigger
hit potentially. Do you do you have a kind of
number in terms of your when you think about default rate,
because on the syndicated loans, I think Moody's is saying
around six percent or something, which doesn't seem presced into
the to the loan market. But is the default rate
(18:24):
much higher or is it lower? In direct lending?
Speaker 4 (18:26):
Do you think it's I think it's a lot lower
into direct lending today, and I wouldn't recognize loss as
a loss given default at twenty percent because again, most
of the assets in the middle market where direct lenders
spend most of their time. You know you have one lender.
You're structuring these deals at very low loan to value.
(18:48):
Just think about all the equity value that sits across
these loans. You know that the equity value from these
private equity firms. They've invested a huge amount of capital
in thesesets and therefore there's a significant amount of value
to burn before actually the lenders start to lose money.
So I wouldn't recognize a loss given to fault anywhere
(19:09):
close to eighty.
Speaker 3 (19:10):
Percent on your sector allocation preferences. You mentioned a very
benign macro environment, and a lot of people are also
talking about AI or the big tech So just wondering
if you have any specific picks in terms of big sectors.
Speaker 4 (19:26):
No, Look, we're trying to create sector diversification for our investors.
That's something that's you know, that's important to them, it's
important to us as portfolio managers. And as I said before,
we're focusing on a number of sectors that show defensive characteristics,
so that would include a number We're not thematic investors
in that sense, right. It is very much bottom up
(19:48):
asset by assets specific. So I'm not trying as a
portfolio manager to invest to a theme in twenty twenty four.
I'm trying to originate as much as we can from
the market that we operate in and then be very
selective on an a set biast basis.
Speaker 2 (20:04):
So ting to go back mic onto recoveries. And you're
saying they expect higher recoveries from little market loans. Now,
I was at ge Capital, but very short time, not
like you, not a senior level person like you, but
I do remember how long it took and how much
work it took to work out a troubled loan. Do
you think the industry as a general is aware of that.
There's a lot of new entrants, they have never seen
(20:26):
a real true default cycle or recession, and you can't
trade out of these things, and there's not I don't
see that many restructuring people in many of these shops.
So what is your forecast maybe for the industry wide?
Speaker 4 (20:41):
I think that's a really interesting question. I mean It's
something that the areas we put a lot of resource
and focus on is the whole portfolio management, the restricturing capability,
the human talent, you know, human capsule we have in
that area. I think as an industry, yes, I think
people have built out origination teams, but the portfolio management
(21:01):
functionality has probably lagged. We've seen that change a little
bit in the last twelve, eighteen, twenty four months, but
I think you're right. I think there's still a little
bit of a gap in that area. And we all
know that restructurings do take a lot of time. And
I think we saw this a little bit in covidly, so,
which is to say, you know, a number of peers
(21:22):
really were inwardly looking during covid Ie. They were focused
on the portfolio. And it's really interesting because when you
go through periods of dislocation like that, actually what you
want to be doing is focusing on the new deal
market because frankly, the risk of just in return for
new deals when you go through periods of dislocation tend
to be attractive. So for me, you need to be
(21:44):
able to and have the resources to play both. I
use the American term offense and defense, right, you need
to be able to defend the portfolio, but at the
same time have the resources to go out into the
market and find that risk ad just a return which
potentially could be better because of the dislocation that's going
on in the wider market.
Speaker 2 (22:03):
Since you mentioned discal location, it does seem like right
now the dislocation that we've experienced for the past year
and a half is sort of dissipating. But I wonder
how truly is that when you look at the levish
loan market and the higher bomb market across US and Europe.
For instance, in Europe, I mean in the US, cultivity
is going seems to be going to towards the bank route,
(22:25):
but in Ardna, like as you said, there's only five
hundred million that's coming to the European market. So how
strong is the bid in Europe and in the US?
And are base getting a little ahead of themselves given
that COLO issuance is better but not like rebounding in
a massive way.
Speaker 4 (22:43):
Yeah, Look, I think the bank bid in the in
the US is absolutely stronger than it is in Europe,
and is stronger than the sterling markets. And that's probably
always been the case, COLO issuance actually look at is
still muted. Actually with we saw twenty six twenty seven
billion I think euros of new COLO issuance last year.
(23:04):
I think commentators would say that that should increase slightly
in twenty twenty four. But actually in terms of the
forecast for new lev loan activity, that's not going to
fill the gap. So it's really interesting. We've seen, you know,
the activity levels for refinancings, repricings, etc. When the new
M and A markets come back, then has is there
(23:27):
sufficient capital being raised within the COLO market and the
public credit markets to actually satisfy that. I think that's
a really big question, and I think it's a really
big question in the euro markets, but actually in the
Sterly markets more particularly. So we will see on that one.
Speaker 2 (23:43):
I think since you mentioned M and A is it
coming back, because we have a lot of processes and
a lot of deals that don't seem to actually close.
When will we get a healthy M and A market?
Bag you talked to a lot of the PEA guys.
Speaker 4 (23:57):
Sure, what is their thinking? Yeah, Look, it's the million
dollar question. There is no doubt there is pent up
demand and there's a lot of new deal activity, let's
say in the pipe, right, So we know that M
and A advisors due diligence advisors have published reports. There
is a lot of processes ready to go. And yeah,
(24:18):
the question is who's going to have the confidence to
press the button? Now? Given the benign macro, Given as
I say, people have got more visibility on where interest
rates are going, I suspect people will have the confidence
to push the button. And again I think I touched
on it earlier. LPs really want to see distributions. So
there's certainly a little bit of pressure coming from the
(24:39):
LP community to these managers saying, you know, we really
need you to go and realize some assets. You know,
go and sell, Go and sell some assets, Go and
create some distabultable proceeds that in itself will drive activity.
So you know, I am relatively optimistic that the M
and A markets will come back this year and come
back pretty pretty strong.
Speaker 1 (25:00):
In terms of the global opportunity. When you look at
all of the stuff you're looking at all day long,
what's the best opportunity in terms of relative value?
Speaker 4 (25:09):
Yeah, of course, I mean I could easily just talk
to my book in Europe, couldn't I James, that would
be the easiest thing to do. But I think when
we look at private credit globally, we're seeing obviously elevated
yields because of base rates. We're seeing risk come down mathematically,
that has to be the case because of serviceability and
where interest rates are. So you know, we see in
(25:30):
most regions of the world attractive risk of just a
return for direct lending, and the liquidity premium relative to
the liquid markets is continuing to be consistent. So you know,
I'm not going to pick one region in the world, James,
I think, or else i'd be accused of talking my
own book in Europe.
Speaker 1 (25:48):
So you're not then worried. I mean, we've talked a
little bit around this, but you're not worried about the
comeback of the public markets sort of taking away returns
or taking away the advantage from direct lending.
Speaker 4 (26:00):
Look, as I think i'd touched on a few minutes ago.
You know, direct lending is really founded on and the
heritage of that business is in the middle market where
banks you know, are not underwriting, right, I mean, as
I say, I think the underwriting market is still relatively fragile. Today,
we're seeing flex in those in those banking deals, you know,
and that that flex can be punitive, which is why
(26:21):
some of these deals are not getting done. To Lisa's point,
so look, even if the public credit markets came back
strongly this year, that does not impact on the bread
and butter, if you like, of direct lenders, which is
that core middle market we've we are seeing that convergence though.
I mean, you know, I think now borrowers have have
tasted what it's like to have direct lending or private
(26:43):
credit providers in their capital structures. I think we are
going to coexist. I think we're pretty well entrenched in
some of these larger cap type financings. So I don't
think I don't think, you know, we kind of totally
disappear from that end of the market. But as I said,
you know, we've treated that market as opportunistic. It doesn't
really dictate our value proposition, which is more, you know,
(27:04):
more in that middle market space.
Speaker 1 (27:06):
And just to give you a chance to talk your
ine book in terms of Europe. When you meet someone,
you know, let's say in Abudabi or Toronto or wherever,
a talk about private credit and they say, why Europe,
what's the response, Why Europe? At this point.
Speaker 4 (27:21):
Yeah, look to your point James earlier, I think it's
a really good diversifier to people's global global portfolios. Europe
is in a different stage of its life cycle relative
to the US. Right. The US, we all acknowledge, is
a pretty mature private credit market. Europe really, you know,
only got going in twenty eleven twelve. I know we
(27:42):
set our business up in two thousand and seven, but
it was really only twenty eleven twelve where direct lending
really became in and of itself an asset class in Europe.
So you know, we're a kind of decade in James.
So you know, we're still really growing quite quickly as
the asset class matures, and with that growth becomes obviously
depoylant deployment opportunity, et cetera. And as I said before,
(28:03):
from a competitive dynamic perspective, you know, it is just
less complex, it's more simple in Europe. You know, we've
got the banks and the derel ending funds. We really
don't have a lot of the other forms of capital,
the BDC's extracta, the et cetera that you have in
the US. So I would, you know, if I had
to talk my boy, You've just forced me to do it.
I would still argue that Europe is a is a
(28:23):
good place to invest.
Speaker 1 (28:24):
So we're going to dig in to the shipping side
with Stefan Kovichev over at Bloomberg Intelligence in a little bit.
But before we do, Mike, I just wanted to ask
you about the risk because I keep banging on about it.
But what is the thing that keeps you up worrying
at night. What is the most concerning thing on your
radar right now?
Speaker 4 (28:42):
Yeah, Look, of course we have to keep up our
underwriting standards. You know that selectivity. I think the big
the big issue for everybody is human capital, actually more
than financial capital, i e. You know, having the talent
to execute on the strategy. Talent is pretty scarce in
most of the markets we operate in. Good talent is
(29:04):
it's hard to come by. So it's really keeping the
talent in the team that we've got. That's what I
spend a bit of time, you know, kind of worried about.
Speaker 1 (29:13):
Great stuff. Mike Dennis, Co, head of Emia Credit at
Aries Management. Many thanks for coming on the Credit Edge. Cheers.
Speaker 4 (29:18):
Thanks, James.
Speaker 1 (29:19):
Also want to say a big thanks to Lisa Leeve
with Bloomberg News in London. Brilliant to see you again.
Thank you read all of Lisa's great scoops on the
Bloomberg terminal and of course at Bloomberg dot Com. So
Stephankovichev at Bloomberg Intelligence, thank you so much for coming
on the Credit edge. Looks like supply chains are being
disrupted again. A couple of years ago it was due
to COVID. Now it's due to the situation in the
(29:39):
Red Sea. What's the latest in that sector.
Speaker 3 (29:42):
Indeed, supply chains are being disrupted again, this time due
to the Hooty rebel attacks on ships in the Gulf
of Ymen and also in the Red Sea. So if
we just zoom out for a second and look at
the shipping companies moving goods. If you are to move
a container from Asia to Europe, the quickest route is
(30:04):
via the Red Sea and the Suez Canal. Yet now
traveling in the region is not safe anymore as Hooti
rebels are firing rockets and trying to board on ships.
So containing container shipping companies are choosing to avoid the
Red Sea altogether and saale around Africa. So this adds
about ten days to the voyage and has a negative
(30:25):
knock on effect on a lot of things, such as
the delivery schedules, the availability of the actual shipping capacity,
and ultimately on the prices and freight rates have risen
about three hundred percent on some routes in the last
six weeks. So yes, a very interesting and volatile industry.
Speaker 1 (30:44):
Indeed, three increase in freight rates sounds like a hard
load to lift for those shipping companies, but also quite
inflationary at a time we're worried about inflation. Can you
elaborate a bit on you know, why it's gone up
so much and where do we go from here?
Speaker 4 (30:59):
Sure?
Speaker 3 (31:00):
So we're talking about the price of shipping a forty
foot container from Asia to Europe or from Asia to
the US. And the forty foot container is pretty big, actually,
you can fit about four cars or ten thousand jackets
in it. So that the price of transporting this container
has gone up from about one thousand, five hundred dollars
(31:23):
in December to triple that amount and at four thousand,
five hundred or thereabouts today, And this is largely due
to the situation in the Red Sea. So why has
this happened? Well, we estimate that about twenty five percent
of global containers have been rerooted or delayed because of
the situation in the Red Sea, and as container ships
(31:46):
are delayed, there is less available capacity in the market.
We estimate that there may be a reduction of about
eight percent of global capacity pretty much overnight due to
the situation in the Red Sea. Companies such as Nike
and Ike fight for this reduced space on container ships.
(32:07):
This has resulted in a pretty steep increase in prices.
Speaker 1 (32:10):
Indeed, do they keep going up from here?
Speaker 3 (32:11):
Do you think we are more on the costs Depending
on how you look at it, James, So from a
container shipping company point of view, you want prices to
be high. From a you know, a regular consumer side,
you want them to be low. But we expect the
you know, freight rate to to move lower from here,
(32:34):
to normalize, so to speak. And we have you know,
about three maybe three key reasons for that. So number
one is that if you look at the charts of
the freight rates, you can see that, you know, there
is some room for them to increase. If you look
at pandemic peaks, which were at about fourteen thousand dollars
to ship a container from Asia to Europe, but the
(32:55):
situation now is very different. So back then factories were
closed due to co without breaks and ships were stuck
outside of boardswo weeks. But currently, you know, ships are
still sailing. They just go around Africa. It takes them
an extra ten days, So the supply chain disruption is
nowhere near the levels of the pandemic. So that's one
(33:18):
kind of angle that makes us a bit more and
more positive on the trajectory of freight rates. And the
second reason is demand. You know, although everyone is talking
about the soft landing, you know, the high inflation and
lower disposable incomes are still very much problems for end consumers,
so that the demand side of the equation is quite uncertain. Also,
(33:40):
recession odds, maybe they've reduced in the US, but they've
actually increased in Europe in the last six months. And
the last point is the actual supply of new ships.
So if you look at them, what companies did container
shipping companies did with all the profits during the pandemic,
They went and ordered new, bigger and more efficient container
(34:01):
ships and those take two to three years to be built.
So now actually a lot of container ships are coming online.
We estimate of about nine percent nine percent increase in
net capacity in the sector this year, So more supply
of ships and an uncertain demand outlook should in theory,
(34:23):
I mean, keeping all else equal, uh, you know, lead
to lower freight rates in the coming quarters, which I
think is very good news for US and consumers hopefully,
and maybe not so good news for container shipping companies.
Speaker 1 (34:35):
So on the inflation side, I particularly, this is a
central easing of inflation, which is good for rates, which
is good for credit markets generally. But in terms of
the actual issue, as you look at the companies, you
look at how does it affect them? Who are we
talking about here? And you know who's who are the
winners and loses?
Speaker 3 (34:51):
Well, I look at the sector from a credit viewpoint,
and you know, looking at the bonds of companies such
as Mersk and hapack Lloyd, I think that what the
credit markets are telling us is that, you know, the
investors don't seem too worried about about the trends here.
You know, MRSK and Hpack Lloyd bonds trade in line
(35:14):
or even tighter than similarly rated piers, and to be fair,
companies in the sector do have very strong balance sheets,
so you know, record profits and record cash generation during
the pandemic have you know, left these companies in a
much better place compared to historical averages. That said, what
we highlight in our research are the risks ahead, be
(35:37):
it in terms of supply or demand that we just discussed,
or even in a scenario where the situation in the
Middle East were to normalize and freight rates could you know,
crash back lower quite quite quickly potentially. So I think
the bottom line is that this is a very low margin,
competitive and very cyclical shipping industry, and you know, the
(36:01):
weak fundamentals that resulted in quite low profitability for the
industry two months ago, so before the Red Sea situation,
the industry was in a pretty bad space and a
lot of oversupply, low demand, et cetera. So I think,
you know, there may be quite volatile times ahead because
(36:21):
those negatives have not really gone away if we move
aside the situation in the Middle East. So I think,
you know, the potential negative catalysts ahead may not be
fully reflected in bond prices at this stage, at least
from what you know the credit markets are telling us.
Speaker 1 (36:39):
Stephan Kochev, Bloomberg Intelligence, thank you so much for joining us.
Speaker 3 (36:42):
Thank you, James.
Speaker 1 (36:42):
Really fascinating topic. Check out all the Stepfan's research on
the Bloomberg Terminal or contact him directly if you need
more information. I'm actually gonna spell your name Stefan so
people can find you Stephan with an E on the end,
and it's COVID chef ko V A T C H
e V. Do check it out. It's wonderful stuff. Thanks
again to Mike Dennis at Aries and Lisa Lee from
Bloomberg News. Read all of Lisa's great scoops on the
(37:04):
Terminal and at Bloomberg dot com. Please do subscribe wherever
you get your podcasts. We're on Apple, Google and Spotify.
Give us a review, tell your friends, or email me
directly at jcrombeight at Bloomberg dot net. I'm James Crombie.
It's been a pleasure having you. See you next time
on the Credit Edge.
Hello, and welcome to The Credit Edge, a weekly markets podcast.
My name is James Crombie. I'm a senior editor at Bloomberg.
This week, we're very pleased to welcome Mike Dennis, co
head of emia Credit at Aries Management in London. How
are you, Mike, Yeah, very well, James, thank you, Thank
you so much for joining us today. We're very excited
to dig into your credit market views. Also delighted to
welcome back Bloomberg's very own Lisa Lee covering markets from London.
(00:40):
Great see you and Lisa.
Speaker 2 (00:41):
Great to see you and thanks for having me again.
Speaker 1 (00:44):
And from Bloomberg Intelligence. Excellent to see Stefan cob Chef,
also in London. Welcome back to Stefan.
Speaker 3 (00:49):
Hi James, thanks for having me.
Speaker 1 (00:51):
So let's start with you, Mike. Great to see you
on the Credit Edge. We're going to get to the
specifics of your portfolio and your positioning, but let's start
with a macroview. The economy is chugging away, inflation is moderating.
It's all about rates now. Last year turned out to
be a good one for credit, mostly because of a
huge rally in November and December, which really did seem
to come from very aggressive policy easing priced in early
(01:13):
and probably too much, it would seem. Now those duvish
bets are being unwhelmed. The Fed's pushing back on any
imminent rate cuts. Markets are selling off just as we're
seeing corporate supply really ramping up. So where do we
go from here?
Speaker 2 (01:26):
Mike?
Speaker 1 (01:27):
Everyone keeps telling us this is a great credit market,
tons of opportunity out there. But when does the FED
start cutting? How much will they reduce rates? Do they
even need to do anything given how well the economy's
performing right now? What's your view? Yeah?
Speaker 4 (01:39):
I think rates are due to come down this year,
but let's not forget you know, it wasn't too long ago.
We're in a zero rate environment, So even if they
come down, I think they're only going to moderately reduce
during twenty twenty four, and that creates a good environment
for credit. I think people have more confidence as to
where rates are going. That, combined with what you've just
(02:02):
said there, James, combined with the benign macro environment is
driving activity levels, and we definitely saw more activity in
Q four and I think that's translated into more activity
in Q one. So actually, in terms of the deal environment,
from an activity point of view, I think, actually, this
is a pretty good time to be in credit. And
(02:22):
as I say, even if rates come down a little bit,
you know, we're talking about rates at three four four
percent plus. You know that combined with the spreads you're
finding in credit today, still generate relatively good risk adjusted return.
Speaker 1 (02:36):
So I just wanted to take advantage of that. You're
in Europe and you cover Europe to sort of dig
a little bit into that region. When we talk to
global portfolio managers about Europe, they'd certainly like the sound
of it for potential diversification, or too because it looks
relatively cheap. Of course they skew to the bigger US market,
and maybe Europe's cheap for a reason because of those economies.
You know, they seem a bit more challenged in the US,
(02:59):
A lot of issue with inflation, which is tying policy makers' hands.
Also seems to be you know, the headlines we're seeing
this week on property issues with the banks. What's the
macro outlook in terms of emia From where you sit, Mike.
Speaker 4 (03:14):
Yeah, Look, I think this is a challenge that sitting
in London I get. I get a lot from global
investors and commentators. Look, the reality is most commentators would
have had the UK and the European markets in recession
at this point, and the fact is that's just not happened. Actually,
what we're seeing is is low but growth, positive growth.
(03:35):
And again let's let's let's you know, talk about what
we're trying to do, what credit investors are trying to do,
they're for the most part taking firstly in seeny secured
risk through thirty forty percent loan to value and therefore,
as long as you're in a stable economic environment, actually
the GDP growth doesn't need to be that positive to
(03:56):
make these senior investments attractive. So actually, as a senior
secured lender for the most part, seeing growth at zero
point five percent up to maybe one percent across most
of the markets in Europe, that's not a bad place
to be. It might not work for the equity, but
actually it works for credit investors. And so you know,
(04:17):
there's an overlay to that as well, James, which is
to say, you know, credit investors aren't buying GDP, right,
they're not buying the macro, We're not buying to a benchmark, right.
Private credit direct lending is a very selective asset class
where we're specifically choosing to invest in companies and sectors
that are actually in growth and don't exhibit some of
(04:40):
the cyclical characteristics maybe that you've just alluded to. So
when you look across direct lending or private credit portfolios,
generally you're not going to see a lot of consumer
B two C. You're not going to see a lot
of energy, construction, manufacturing. What you will find is actually
a lot of B to B type businesses. These are
the service based businesses, software, technology, healthcare, education, etc. And
(05:05):
so those sectors tend to exhibit more defensive characteristics, and
therefore whether the economy is growing at zero one two
percent actually doesn't really matter for senior secured credit investors.
Speaker 2 (05:17):
You've been one of the areas is one of the
biggest and leading private credit lenders, and you also have
a sizeable liquid business. Let me bring up the example
ar Dona, which even a few months ago we were
expecting to go to the private credit lenders and perhaps
even be the biggest private credit loan ever, and instead
now it's going almost half two billion into the public
(05:40):
debt markets high yr bonds, and then three for direct lending.
Tell me, what does that tell you about the health
of the market and opportunities for private credit.
Speaker 4 (05:49):
Yeah, and let's not forget Our Donna was financed in
the private credit markets for some time. But as I
said before, you know, given the confidence in the macro,
given the ability of the macro and the I think
most investors now have some kind of view as to
where rates are going, and probably down, not up. That
(06:09):
has given the confidence for this the public credit markets
to become more active. So I think it was inevitable
as we entered into twenty twenty four that the banks
and public credit investors would be more involved in assets
like Our Donna, And I think that's what's going to
happen in twenty twenty four. You're going to see this
continued convergence and coexistence between public and private credit. I
(06:34):
think that's especially true in the European markets, and even
more so in the Sterling markets, where liquidity I think
will continue to be constrained.
Speaker 1 (06:43):
There's a sense of that the private credit came in
when times were rookie, and now that times aren't so rookie,
and you know, the public markets say gaining confidence that
the sort of the value proposition of private credit is
somewhat diminished, and public markets end up sort of naturally
taking those deals back in the you know, the whole
hype about the golden age of private credit that all
(07:03):
sort of fades now at this point, do do you
think that that's that's a possibility.
Speaker 4 (07:08):
Well, James, I really don't like the term the golden
age of private credit because frankly, I think it's been
a good time for private credit for some time. So
now let me just address the public private credit coexistence
a little bit a little bit more. And the reality is, yes,
are done at tapped the private markets when the overall
(07:29):
market was a little bit bit trickier. But don't forget
private credit players or direct lending players in general, look
at that large end of the market Opportunistically, they're businesses.
Our businesses are not founded on those larger bit those
larger deals basically sustaining our business model. For the most part,
(07:50):
direct lenders heritage and foundation was really in the mid market,
and that's where most of that deal activity, most of
the deployment of direct lenders and private credit providers, that's
where it sits. And so, yes, our Donna was slightly
different in that it was a very large deal. Private
credit took that down in a difficult credit market, but
(08:11):
that doesn't take away the proposition or the value add
that direct lenders and private credit providers can provide to
middle market lenders. I think that's absolutely still true, and
the tailwinds in that market are as good as ever
the banks continue to retrench, the commercial banks, those middle
market banks are still risk off for the most part.
(08:32):
You know, we've talked about interest rates, but interest rates
are still going to be north of zero, and therefore
cash coupons on these loans are still going to be
relatively attractive in twenty twenty four and beyond, and so
again I don't think we should get hung up looking
at the one or two deals at the large end
of the market that the private credit providers did maybe
in twenty two to twenty twenty three. That does not
(08:54):
change the value proposition of private credit or direct lending
to investors.
Speaker 3 (08:59):
Great and maybe a question on the potential risks ahead
from me. I'm coming from a cyclical industrial background, so
obviously in the US we have elections and around Europe
as well, and a lot of geopolitical risk as well,
especially here in Europe. So wondering how are you thinking
about allocation of risk in the year ahead. It will
(09:23):
there be some potential traps or land minds to avoid.
Speaker 4 (09:27):
Yeah, well, it's interesting you've picked up on the geopolitical
point because I actually do think whilst there has been
more activity from the public, credit markets and banks have
come back pretty strongly, I guess in early twenty twenty four.
I think the capital markets in general are still pretty fragile. Right,
It wouldn't take much for that liquidity to reverse out
of the system. Some of those geopolitical risks you've just
(09:50):
talked about may welcome to the forum. We've got elections
later in the year. I do think that creates quite
a bit of fragility, and therefore actually maybe private market
it will play a larger role in these larger deals
this year if that comes to fruition in terms of
the way we think about risk, and go back to
something I said earlier, you know, look, we are cash
(10:11):
flow lenders. For the most part. We are looking at
or trying to find companies in sectors which demonstrate real
resilience at the revenue line with really good margin structure.
Right on top of that, these businesses have to generate
really good levels of cash conversion. So when you ask
me about industrial cyclicals, those types of businesses are never
(10:34):
going to be or find their way into kind of
the direct lending portfolios in any big way, right. I mean,
there's always exceptions to the rule, but there's never going
to be big allocations to those kind of cyclicals for
the reason the reason I mentioned.
Speaker 1 (10:48):
We've talked a lot about all the money being raised
for this strategy. Private credit, you know, is the big
thing when there is too much money tasing too few goods.
I mean, there aren't that many deals to go around.
Sometimes there's a there's a risk of you know, bad
deals happening. Do you fear that some you know, there
may be some lemons out there, there may be a
(11:09):
bigger default risk appearing. I mean, it's it's also very
hard to see the defaults because these things get amended.
But do you feel that, you know, we are going
to get a lot more defaults in private credit?
Speaker 4 (11:20):
Well let me let me come on to the default
question in a minute, James. But just to you know,
think about you know, too much capital chasing too few
deals or that that's your I guess perception potentially, But
let's look at Europe. Europe is a market for direct
lenders and private credit providers where they are continuing to
take share from banks. So this is not necessarily just
(11:42):
about the size of the market. It's about the relative
shares within it. And actually, as I said before, there's
a lot of tailwinds for direct lenders as they take
market share away from the commercial banks. So I would argue, actually,
there isn't sufficient dry powder in the private lending community,
the direct lending community, to actually meet the demand. I mean,
you think about the amount of dry powder in the
(12:04):
private equity markets in Europe today. You know, we're talking
about two hundred and fifty billion plus. The dry powder
in the direct lending market in Europe we would estimate
closer to sixty seventy billion. So I would argue, actually,
there's a mismatch the other way, James. And if the
commercial banks aren't going to fill that void, right, who is?
And in Europe, clearly it's going to be the direct lenders.
(12:24):
You know, in Europe, we don't have BDC structures, we
don't really have mid market clos we don't have those
other sources of credit and capital creation that you do
in the US, it's really just the commercial banks and
the direct lenders, and so I think we're in a
market actually where the supply demand imbalance is in favor
of the direct lenders potentially rather than the other way around.
Speaker 2 (12:48):
Well, since you did mentioned dry powder areas is one
of the most active fundraiser what is the fundraising environment
right like right now? And how often are you on
a plane? And when's the first destination go to in
the least is it Japan less?
Speaker 4 (13:03):
Well, so you know, I'm not going to talk about
specific fundraisers, but look, I would say that generally speaking,
investors are still looking to allocate to direct lending and
private credit generally for all the reasons we've talked about
over the last ten to fifteen minutes, because effectively they
can access high cash yielding investments with relatively low risk
(13:27):
right as I say, these are senior secured investments thirty
forty percent loan to value and with good governance and
structures around them. So I think from an allocation point
of view, we're certainly hearing from LPs that they want
to allocate more to the space. That said, there are
also global investor challenges, and those challenges come in the
(13:51):
form of liquidity. You know, let's not forget there's been
an awful lot of capital or allocations been made to
alternative asset class is over the last three, four, five,
six years. Question the amount of distributable proceeds that have
been given back to investors. So there is this the
liquidity or cash profiling challenge that some investors will face.
(14:14):
But I think they're doing all they can to allocate
to this vintage. I'm not going to use the word
Golden age, James, but you know they are doing all
they can to allocate to a vintage where you know,
interest rates will remain elevated, spreads are pretty stable, and
therefore the risk adjusted return of the asset class still
remains pretty attractive.
Speaker 2 (14:35):
So fundraising is still going on and you're making your finding.
LPs are interested. One of the reasons why LPs like
private credit is the fact that you don't have as
much volatility. But as private credit and public markets sort
of converge and like take ARDNA once again, where you
(14:57):
are going to have a higher bond and a private
credit option, does the volatility starts to bleed in, it
will still be sort of a sort of immune from
volatility and more more commer more marks will be stable
or will it will there be more volatilely going forward?
Speaker 4 (15:17):
Potentially a little bit. But again, think about the portfolio
formation of these direct lenders and private credit providers. For
the most part, you know, a lot of the allocation
is going to be into a liquid middle market debt,
which obviously doesn't exhibit the same levels of volatility. So
I think you might be right, but for a small
proportion of these portfolios. So I actually don't think it's
(15:38):
a too big a challenge for LPs to to get
their head around.
Speaker 1 (15:42):
Going back to defaults. Like I know you want to
talk about them. The idea is that you're getting very
high yields, which is great for the investor, but possibly
not so much for the issuer in going into a
downturn where the earnings are going to be suffering at
the same time. You know, when we talk to private
credit investors, they'll say, well, we only do the good deals.
(16:03):
Surely that can't be always the case. What do you
think about the fault rates in this market?
Speaker 4 (16:09):
Yeah, Look, I think the first thing to say is, actually,
when you look at private credit portfolios generally, what you
are seeing is actually pretty robust earnings growth. Right, Revenues
and earnings are growing. I would accept James, that in
most portfolios that we see, you're seeing some kind of
margin pressure. We all know twenty twenty three we saw
(16:32):
wage inflation, energy inflation, etc. That has a margin impact
at the underlying issuer level. That said, absolute earnings are
still continuing to grow in these niche segments, these sectors
that I've already talked to where we're focusing our time.
So I don't think today's issues one of operating performance
(16:53):
or profitability. Liquidity is more of a challenge because you've
gone from a zero to a four five base percent
base rate environment, so liquidity is more more challenged. But again,
you know, when you have well structured firstly in deals
through thirty forty percent LTV, you're very very well covered
(17:14):
from a valuation perspective. And even if you get a
tick up in defaults, which you could be right, James,
I think that's a possibility than in twenty twenty four
we see an increase in defaults, we actually should be
looking at loss given default you know, I think that's
much more of an important metric. And I think where
I think what you're going to find is in these
(17:35):
senior secured portfolio is the lost given default actually doesn't
doesn't go up. Actually, the recovery rates are very very
high on these senior secured loans. So I don't worry
too much about defaults because let's not forget, if you
have a default and you're a senior secured lender, that
actually gives you quite a lot of control. You can
reprice risk, you can take control of the asset in
(17:56):
extra miss So actually defaults in and of themselves are
not the issue. I think what we should be looking
at is loss given default.
Speaker 1 (18:03):
And as Lisa has written a lot about, you know,
the recoveries have gone substantially down. You know, there used
to be about eighty percent. Now they're in the twenties
or thirties, So you're going to take a much bigger
hit potentially. Do you do you have a kind of
number in terms of your when you think about default rate,
because on the syndicated loans, I think Moody's is saying
around six percent or something, which doesn't seem presced into
the to the loan market. But is the default rate
(18:24):
much higher or is it lower? In direct lending?
Speaker 4 (18:26):
Do you think it's I think it's a lot lower
into direct lending today, and I wouldn't recognize loss as
a loss given default at twenty percent because again, most
of the assets in the middle market where direct lenders
spend most of their time. You know you have one lender.
You're structuring these deals at very low loan to value.
(18:48):
Just think about all the equity value that sits across
these loans. You know that the equity value from these
private equity firms. They've invested a huge amount of capital
in thesesets and therefore there's a significant amount of value
to burn before actually the lenders start to lose money.
So I wouldn't recognize a loss given to fault anywhere
(19:09):
close to eighty.
Speaker 3 (19:10):
Percent on your sector allocation preferences. You mentioned a very
benign macro environment, and a lot of people are also
talking about AI or the big tech So just wondering
if you have any specific picks in terms of big sectors.
Speaker 4 (19:26):
No, Look, we're trying to create sector diversification for our investors.
That's something that's you know, that's important to them, it's
important to us as portfolio managers. And as I said before,
we're focusing on a number of sectors that show defensive characteristics,
so that would include a number We're not thematic investors
in that sense, right. It is very much bottom up
(19:48):
asset by assets specific. So I'm not trying as a
portfolio manager to invest to a theme in twenty twenty four.
I'm trying to originate as much as we can from
the market that we operate in and then be very
selective on an a set biast basis.
Speaker 2 (20:04):
So ting to go back mic onto recoveries. And you're
saying they expect higher recoveries from little market loans. Now,
I was at ge Capital, but very short time, not
like you, not a senior level person like you, but
I do remember how long it took and how much
work it took to work out a troubled loan. Do
you think the industry as a general is aware of that.
There's a lot of new entrants, they have never seen
(20:26):
a real true default cycle or recession, and you can't
trade out of these things, and there's not I don't
see that many restructuring people in many of these shops.
So what is your forecast maybe for the industry wide?
Speaker 4 (20:41):
I think that's a really interesting question. I mean It's
something that the areas we put a lot of resource
and focus on is the whole portfolio management, the restricturing capability,
the human talent, you know, human capsule we have in
that area. I think as an industry, yes, I think
people have built out origination teams, but the portfolio management
(21:01):
functionality has probably lagged. We've seen that change a little
bit in the last twelve, eighteen, twenty four months, but
I think you're right. I think there's still a little
bit of a gap in that area. And we all
know that restructurings do take a lot of time. And
I think we saw this a little bit in covidly, so,
which is to say, you know, a number of peers
(21:22):
really were inwardly looking during covid Ie. They were focused
on the portfolio. And it's really interesting because when you
go through periods of dislocation like that, actually what you
want to be doing is focusing on the new deal
market because frankly, the risk of just in return for
new deals when you go through periods of dislocation tend
to be attractive. So for me, you need to be
(21:44):
able to and have the resources to play both. I
use the American term offense and defense, right, you need
to be able to defend the portfolio, but at the
same time have the resources to go out into the
market and find that risk ad just a return which
potentially could be better because of the dislocation that's going
on in the wider market.
Speaker 2 (22:03):
Since you mentioned discal location, it does seem like right
now the dislocation that we've experienced for the past year
and a half is sort of dissipating. But I wonder
how truly is that when you look at the levish
loan market and the higher bomb market across US and Europe.
For instance, in Europe, I mean in the US, cultivity
is going seems to be going to towards the bank route,
(22:25):
but in Ardna, like as you said, there's only five
hundred million that's coming to the European market. So how
strong is the bid in Europe and in the US?
And are base getting a little ahead of themselves given
that COLO issuance is better but not like rebounding in
a massive way.
Speaker 4 (22:43):
Yeah, Look, I think the bank bid in the in
the US is absolutely stronger than it is in Europe,
and is stronger than the sterling markets. And that's probably
always been the case, COLO issuance actually look at is
still muted. Actually with we saw twenty six twenty seven
billion I think euros of new COLO issuance last year.
(23:04):
I think commentators would say that that should increase slightly
in twenty twenty four. But actually in terms of the
forecast for new lev loan activity, that's not going to
fill the gap. So it's really interesting. We've seen, you know,
the activity levels for refinancings, repricings, etc. When the new
M and A markets come back, then has is there
(23:27):
sufficient capital being raised within the COLO market and the
public credit markets to actually satisfy that. I think that's
a really big question, and I think it's a really
big question in the euro markets, but actually in the
Sterly markets more particularly. So we will see on that one.
Speaker 2 (23:43):
I think since you mentioned M and A is it
coming back, because we have a lot of processes and
a lot of deals that don't seem to actually close.
When will we get a healthy M and A market?
Bag you talked to a lot of the PEA guys.
Speaker 4 (23:57):
Sure, what is their thinking? Yeah, Look, it's the million
dollar question. There is no doubt there is pent up
demand and there's a lot of new deal activity, let's
say in the pipe, right, So we know that M
and A advisors due diligence advisors have published reports. There
is a lot of processes ready to go. And yeah,
(24:18):
the question is who's going to have the confidence to
press the button? Now? Given the benign macro, Given as
I say, people have got more visibility on where interest
rates are going, I suspect people will have the confidence
to push the button. And again I think I touched
on it earlier. LPs really want to see distributions. So
there's certainly a little bit of pressure coming from the
(24:39):
LP community to these managers saying, you know, we really
need you to go and realize some assets. You know,
go and sell, Go and sell some assets, Go and
create some distabultable proceeds that in itself will drive activity.
So you know, I am relatively optimistic that the M
and A markets will come back this year and come
back pretty pretty strong.
Speaker 1 (25:00):
In terms of the global opportunity. When you look at
all of the stuff you're looking at all day long,
what's the best opportunity in terms of relative value?
Speaker 4 (25:09):
Yeah, of course, I mean I could easily just talk
to my book in Europe, couldn't I James, that would
be the easiest thing to do. But I think when
we look at private credit globally, we're seeing obviously elevated
yields because of base rates. We're seeing risk come down mathematically,
that has to be the case because of serviceability and
where interest rates are. So you know, we see in
(25:30):
most regions of the world attractive risk of just a
return for direct lending, and the liquidity premium relative to
the liquid markets is continuing to be consistent. So you know,
I'm not going to pick one region in the world, James,
I think, or else i'd be accused of talking my
own book in Europe.
Speaker 1 (25:48):
So you're not then worried. I mean, we've talked a
little bit around this, but you're not worried about the
comeback of the public markets sort of taking away returns
or taking away the advantage from direct lending.
Speaker 4 (26:00):
Look, as I think i'd touched on a few minutes ago.
You know, direct lending is really founded on and the
heritage of that business is in the middle market where
banks you know, are not underwriting, right, I mean, as
I say, I think the underwriting market is still relatively fragile. Today,
we're seeing flex in those in those banking deals, you know,
and that that flex can be punitive, which is why
(26:21):
some of these deals are not getting done. To Lisa's point,
so look, even if the public credit markets came back
strongly this year, that does not impact on the bread
and butter, if you like, of direct lenders, which is
that core middle market we've we are seeing that convergence though.
I mean, you know, I think now borrowers have have
tasted what it's like to have direct lending or private
(26:43):
credit providers in their capital structures. I think we are
going to coexist. I think we're pretty well entrenched in
some of these larger cap type financings. So I don't
think I don't think, you know, we kind of totally
disappear from that end of the market. But as I said,
you know, we've treated that market as opportunistic. It doesn't
really dictate our value proposition, which is more, you know,
(27:04):
more in that middle market space.
Speaker 1 (27:06):
And just to give you a chance to talk your
ine book in terms of Europe. When you meet someone,
you know, let's say in Abudabi or Toronto or wherever,
a talk about private credit and they say, why Europe,
what's the response, Why Europe? At this point.
Speaker 4 (27:21):
Yeah, look to your point James earlier, I think it's
a really good diversifier to people's global global portfolios. Europe
is in a different stage of its life cycle relative
to the US. Right. The US, we all acknowledge, is
a pretty mature private credit market. Europe really, you know,
only got going in twenty eleven twelve. I know we
(27:42):
set our business up in two thousand and seven, but
it was really only twenty eleven twelve where direct lending
really became in and of itself an asset class in Europe.
So you know, we're a kind of decade in James.
So you know, we're still really growing quite quickly as
the asset class matures, and with that growth becomes obviously
depoylant deployment opportunity, et cetera. And as I said before,
(28:03):
from a competitive dynamic perspective, you know, it is just
less complex, it's more simple in Europe. You know, we've
got the banks and the derel ending funds. We really
don't have a lot of the other forms of capital,
the BDC's extracta, the et cetera that you have in
the US. So I would, you know, if I had
to talk my boy, You've just forced me to do it.
I would still argue that Europe is a is a
(28:23):
good place to invest.
Speaker 1 (28:24):
So we're going to dig in to the shipping side
with Stefan Kovichev over at Bloomberg Intelligence in a little bit.
But before we do, Mike, I just wanted to ask
you about the risk because I keep banging on about it.
But what is the thing that keeps you up worrying
at night. What is the most concerning thing on your
radar right now?
Speaker 4 (28:42):
Yeah, Look, of course we have to keep up our
underwriting standards. You know that selectivity. I think the big
the big issue for everybody is human capital, actually more
than financial capital, i e. You know, having the talent
to execute on the strategy. Talent is pretty scarce in
most of the markets we operate in. Good talent is
(29:04):
it's hard to come by. So it's really keeping the
talent in the team that we've got. That's what I
spend a bit of time, you know, kind of worried about.
Speaker 1 (29:13):
Great stuff. Mike Dennis, Co, head of Emia Credit at
Aries Management. Many thanks for coming on the Credit Edge. Cheers.
Speaker 4 (29:18):
Thanks, James.
Speaker 1 (29:19):
Also want to say a big thanks to Lisa Leeve
with Bloomberg News in London. Brilliant to see you again.
Thank you read all of Lisa's great scoops on the
Bloomberg terminal and of course at Bloomberg dot Com. So
Stephankovichev at Bloomberg Intelligence, thank you so much for coming
on the Credit edge. Looks like supply chains are being
disrupted again. A couple of years ago it was due
to COVID. Now it's due to the situation in the
(29:39):
Red Sea. What's the latest in that sector.
Speaker 3 (29:42):
Indeed, supply chains are being disrupted again, this time due
to the Hooty rebel attacks on ships in the Gulf
of Ymen and also in the Red Sea. So if
we just zoom out for a second and look at
the shipping companies moving goods. If you are to move
a container from Asia to Europe, the quickest route is
(30:04):
via the Red Sea and the Suez Canal. Yet now
traveling in the region is not safe anymore as Hooti
rebels are firing rockets and trying to board on ships.
So containing container shipping companies are choosing to avoid the
Red Sea altogether and saale around Africa. So this adds
about ten days to the voyage and has a negative
(30:25):
knock on effect on a lot of things, such as
the delivery schedules, the availability of the actual shipping capacity,
and ultimately on the prices and freight rates have risen
about three hundred percent on some routes in the last
six weeks. So yes, a very interesting and volatile industry.
Speaker 1 (30:44):
Indeed, three increase in freight rates sounds like a hard
load to lift for those shipping companies, but also quite
inflationary at a time we're worried about inflation. Can you
elaborate a bit on you know, why it's gone up
so much and where do we go from here?
Speaker 4 (30:59):
Sure?
Speaker 3 (31:00):
So we're talking about the price of shipping a forty
foot container from Asia to Europe or from Asia to
the US. And the forty foot container is pretty big, actually,
you can fit about four cars or ten thousand jackets
in it. So that the price of transporting this container
has gone up from about one thousand, five hundred dollars
(31:23):
in December to triple that amount and at four thousand,
five hundred or thereabouts today, And this is largely due
to the situation in the Red Sea. So why has
this happened? Well, we estimate that about twenty five percent
of global containers have been rerooted or delayed because of
the situation in the Red Sea, and as container ships
(31:46):
are delayed, there is less available capacity in the market.
We estimate that there may be a reduction of about
eight percent of global capacity pretty much overnight due to
the situation in the Red Sea. Companies such as Nike
and Ike fight for this reduced space on container ships.
(32:07):
This has resulted in a pretty steep increase in prices.
Speaker 1 (32:10):
Indeed, do they keep going up from here?
Speaker 3 (32:11):
Do you think we are more on the costs Depending
on how you look at it, James, So from a
container shipping company point of view, you want prices to
be high. From a you know, a regular consumer side,
you want them to be low. But we expect the
you know, freight rate to to move lower from here,
(32:34):
to normalize, so to speak. And we have you know,
about three maybe three key reasons for that. So number
one is that if you look at the charts of
the freight rates, you can see that, you know, there
is some room for them to increase. If you look
at pandemic peaks, which were at about fourteen thousand dollars
to ship a container from Asia to Europe, but the
(32:55):
situation now is very different. So back then factories were
closed due to co without breaks and ships were stuck
outside of boardswo weeks. But currently, you know, ships are
still sailing. They just go around Africa. It takes them
an extra ten days, So the supply chain disruption is
nowhere near the levels of the pandemic. So that's one
(33:18):
kind of angle that makes us a bit more and
more positive on the trajectory of freight rates. And the
second reason is demand. You know, although everyone is talking
about the soft landing, you know, the high inflation and
lower disposable incomes are still very much problems for end consumers,
so that the demand side of the equation is quite uncertain. Also,
(33:40):
recession odds, maybe they've reduced in the US, but they've
actually increased in Europe in the last six months. And
the last point is the actual supply of new ships.
So if you look at them, what companies did container
shipping companies did with all the profits during the pandemic,
They went and ordered new, bigger and more efficient container
(34:01):
ships and those take two to three years to be built.
So now actually a lot of container ships are coming online.
We estimate of about nine percent nine percent increase in
net capacity in the sector this year, So more supply
of ships and an uncertain demand outlook should in theory,
(34:23):
I mean, keeping all else equal, uh, you know, lead
to lower freight rates in the coming quarters, which I
think is very good news for US and consumers hopefully,
and maybe not so good news for container shipping companies.
Speaker 1 (34:35):
So on the inflation side, I particularly, this is a
central easing of inflation, which is good for rates, which
is good for credit markets generally. But in terms of
the actual issue, as you look at the companies, you
look at how does it affect them? Who are we
talking about here? And you know who's who are the
winners and loses?
Speaker 3 (34:51):
Well, I look at the sector from a credit viewpoint,
and you know, looking at the bonds of companies such
as Mersk and hapack Lloyd, I think that what the
credit markets are telling us is that, you know, the
investors don't seem too worried about about the trends here.
You know, MRSK and Hpack Lloyd bonds trade in line
(35:14):
or even tighter than similarly rated piers, and to be fair,
companies in the sector do have very strong balance sheets,
so you know, record profits and record cash generation during
the pandemic have you know, left these companies in a
much better place compared to historical averages. That said, what
we highlight in our research are the risks ahead, be
(35:37):
it in terms of supply or demand that we just discussed,
or even in a scenario where the situation in the
Middle East were to normalize and freight rates could you know,
crash back lower quite quite quickly potentially. So I think
the bottom line is that this is a very low margin,
competitive and very cyclical shipping industry, and you know, the
(36:01):
weak fundamentals that resulted in quite low profitability for the
industry two months ago, so before the Red Sea situation,
the industry was in a pretty bad space and a
lot of oversupply, low demand, et cetera. So I think,
you know, there may be quite volatile times ahead because
(36:21):
those negatives have not really gone away if we move
aside the situation in the Middle East. So I think,
you know, the potential negative catalysts ahead may not be
fully reflected in bond prices at this stage, at least
from what you know the credit markets are telling us.
Speaker 1 (36:39):
Stephan Kochev, Bloomberg Intelligence, thank you so much for joining us.
Speaker 3 (36:42):
Thank you, James.
Speaker 1 (36:42):
Really fascinating topic. Check out all the Stepfan's research on
the Bloomberg Terminal or contact him directly if you need
more information. I'm actually gonna spell your name Stefan so
people can find you Stephan with an E on the end,
and it's COVID chef ko V A T C H
e V. Do check it out. It's wonderful stuff. Thanks
again to Mike Dennis at Aries and Lisa Lee from
Bloomberg News. Read all of Lisa's great scoops on the
(37:04):
Terminal and at Bloomberg dot com. Please do subscribe wherever
you get your podcasts. We're on Apple, Google and Spotify.
Give us a review, tell your friends, or email me
directly at jcrombeight at Bloomberg dot net. I'm James Crombie.
It's been a pleasure having you. See you next time
on the Credit Edge.
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