October 23, 2025 • 45 mins
Corporate collapse and allegations of fraud hog the headlines, but a slumping US economy is much more troubling for debt markets, according to Monarch Alternative Capital. “There are large portions of the economy that are hurting,” Adam Sklar, the firm’s co-chief investment officer, tells Bloomberg News’ Irene Garcia Perez and Bloomberg Intelligence’s Negisa Balluku in the latest Credit Edge podcast. “That is a more notable element to the corporate-credit story right now than super-loose underwriting or fraud,” Sklar says. They also discuss private credit stress, opportunity in auto, chemicals and packaging debt and risks to software companies.
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Irene Garcia Perez (00:18):
Hello, and welcome to The Credit Edge, a weekly market podcast.
My name is Irene Garcia Perez. I'm a team leader at Bloomberg and.
Negisa Balluku (00:25):
I'm Negisa Ballaku, senior bankruptcy litigation analyst at Bloomberg Intelligence.
This week, we're very pleased to welcome Adam Sklar Co,
Chief Investment Officer of Monarch Alternative Capital.
Adam Sklar (00:37):
How are you, Adam good, Thank you, Thank you for
having me.
Negisa Balluku (00:40):
Thank you for being here with us today. Adam leads
the investment team, portfolio strategy, and strategic direction across Monarch's corporate,
credit and real estate platforms. Monarch is a global investment
firm founded in two thousand and two with approximately sixty
billion dollars in assets under management. It focuses primarily on
opportunistic credit and real estate across various market segments and
(01:03):
instrument types. In his capacity as co head of real
Estate for Monarch, Adam is focused on directing Monarch's investment activities.
In leading the firm's real estate platform, he sits on
the investment committees on each Monarch strategy, in addition to
being a member of the firm's Partnership Committee and Operational
Executive Committee. Prior to joining Monarch In two thousand and seven,
(01:23):
Adam was an analyst at JP Morgan in Financial Institutions.
Irene Garcia Perez (01:26):
Group, So Adam, thank you very much for joining us.
Last week we had JP Morgan CEO Jamie Diamond talking
about cockroaches in relation to Tricolor and First Brand's blow ups,
that when you see one of those, you should expect
to see more. He also made some remarks about undergrading
standards by some that are not particularly good quote unquote,
(01:48):
and that internship triggered a few private credit executives, including
Blue Ovel Capital co CEO Mark Libshals, who say the
issue was in loans at bangalad as opposed to private
credit loan. Two questions that come to mind on the
back of these situations, do you expect to see indeed
more frauds emerge and the other one has a hunt
(02:09):
for you? And the amount of capital race in the
past few years, be it in direct lending strategies, be
it in clo strategies, move view diligence to a secondary role.
Adam Sklar (02:20):
Very good questions, very topical for this discussion. I'm given
to your point Jamie Diamond and Mark Lipschultz's comments last
week and all of the attention that is now coming,
you know, to the corporate credit space. To answer your
questions directly before I make a broader statement, I would
say it's very hard to anticipate fraud generally, and I
(02:41):
think it's very logical for people to look at, you know,
tricolor first brands where there may be some form of
fraudulent activity and view that as idiosyncratic. That being said,
when I look across our portfolios and as someone participating
in the levered loan and high yield bond markets very actively,
(03:01):
what I do see as an environment where away from
AI and AI cap X spending, there are large portions
of the economy that are hurting, and we can talk
about that further. But through that, what I see and
feel every day is it feels like a moment, you know,
picking up on a quote from Warren Buffett, you know,
when the tide goes out, you see who's been swimming naked?
(03:23):
And so we have gone through a period where there's
been you know, both tremendous monetary and fiscal stimulus coming
out of all the monetary stimulus we had in twenty
twenty three and twenty twenty four, you know that began
to put stress on levered capital structures with higher interest rates,
and through the balance of those few years we've been
in a period we're on a real basis, big parts
(03:46):
of the US consumer base of getting squeezed. Nominal wages
are coming down, job growth is slowing, and inflation has
been quite persistent. And so there are big parts of
the economy, as I referenced earlier, where we're seeing, you know,
fundamental weaknesses and cracks emerging on a daily basis. And
so I don't, you know, I'm not focused on frauds necessarily,
(04:08):
but I do think, you know, there are issues, you know,
in the corporate credit space, fundamental issues that are popping up,
and so I think the markets are right to be
focused on that. Second, on corporate credit as a potential
risk moving forward.
Irene Garcia Perez (04:23):
We have seen also a couple other situations and a
fee in sex where without fraud being involved in those cases,
but where from the time the company should the dead
until it offered at the stress exchange, it was just
a matter of months, not even a year. Do you
think that investors, because of this handful year hunt for
(04:46):
yield or this need to employ capital, sometimes feel rush
to just you know, sign to those deals.
Adam Sklar (04:54):
Yeah, I feel like it's less a function of those
elements which may have been press over the past few years.
It's hard for me to comment, but I think it
is notable kind of to part of your point that
you know, twenty twenty three too through twenty twenty four
were really a great time to be a credit investor.
(05:14):
You had, you know, arise in the base rate, which
had been incredibly low in the United States for the
previous decade, and that afforded, on an absolute yield basis,
a higher rate of return to credit investors. And part
of the reason why we've seen such an explosion just
so much growth in private credit in the US as
a function of the fact that the base rate was
(05:36):
at five percent or higher, you know, spreads coming out
of the volatility that we saw in twenty twenty three,
the regional banking crisis, geopolitical events, et cetera. It was
a really special time to deploy capital into the credit space,
and so as a as a result of all of
that capital coming in and needing to be deployed. To
(05:57):
your point, do I think there could have been in
underwriting mistakes made, of course, but I don't think that's
the big story today. As I said earlier, I think
the bigger issue is just we're in a very uneven
macroeconomic moment. It's why the FED, you know, partially part
of the reason why. There may be other political reasons,
but part of the reason why you see the FED
(06:19):
moving to cut interest rates. And I think that is
a more notable kind of element to the credit the
corporate credit story right now than you know, super loose
underwriting or fraud. And frankly, if you think about something
like a SAX. You know, so in brick and mortar, retail,
in the restaurant space, we're seeing it in chemicals, paper
(06:42):
and packaging, certain parts of commercial construction housing. I mean,
what I just listed is probably fifty percent of US GDP,
and so you know they're there are We're seeing real
issues on the revenue side there in terms of softness
and that as you you know, if you're in a
levered capital structure that's sensitive to revenue and EBITDAH and
(07:03):
debt service coverage metrics. You know, I think that's the
bigger issue right now facing the corporate credit space.
Negisa Balluku (07:09):
Adam, So in this back and forth between those that
say that private credit sector or non bank lending sector
are subject to these bad landing centers or untrustworthy borrowers.
More bad news is about to come. On one hand,
and on the other hand, we have this argument that
most of the exposure was actually being held by banks
(07:30):
and that this is fear mongering. Are we basically in
a wait and see approach? Are there things you think
that we need to see to prove or disprove this
thesis that this is in fact the systemic failure of
the private credit sector. At what point I'm curious you
think that the examples could turn into data.
Adam Sklar (07:48):
That is a really challenging question. I don't just to
reiterate what I was just saying, I don't see that
in terms of a systemic failure. And underwriting that being said,
I think there's two notable elements to answer your question
in terms of what we're going to see over the
next three, six, nine, twelve months and how that may
inform you know, people's views. One obviously cyclicality. You know,
(08:12):
I'm commenting on what I see on the ground today,
and so I'm seeing, you know, it feels very late
cycle to me in certain sectors, and we're seeing you know,
certain weaknesses that you know I mentioned before, especially those
sectors that are very levered to the US consumer. The
second area which is getting more focus in our world,
(08:33):
and you know in certain parts of the credit markets,
is the exposure to legacy SaaS so software businesses in
that we're that were sold at very high multiples of
what was perceived to be recurring cash flow, thus levered
at very high multiples as well, if AI poses a
risk to those cash flows moving forward, you know, could
(08:56):
that be an issue? And what was notable to me
over the past year or so, you know, we've come
to see that software credit lending to these software businesses
makes up thirty to forty percent of the private credit space.
And so if you look at public BDCs, which are
you know, a good window into the private credit world
where you get a lot of public disclosure, you know,
(09:18):
you'll see software as always the top category in those
portfolios and could be upwards of thirty to forty percent,
And so I think that's very notable. You know, in
the history of the credit markets, if you look at
where people get into trouble, oftentimes it's when they have
a certain concentration. So when private credit emerged and took
(09:38):
all of this market share from from the BSL market
and other balance sheets. You have to ask yourself, well,
why are they winning all this business? Why? You know,
are some of these huge firms, you know, winning all
of these loans? Are they the best lender to a
certain industry, to a certain type of borrower? And I
think software really stands out, which seems like a great
(09:59):
place to be until you have a potential for technological
disintermediation and disruption in the form of AI that could
be really significant risk to your question, I think it's
too early right now to know, but that is, you know,
it's a notable element that I think bears Mentioning.
Irene Garcia Perez (10:17):
You were on this point of BDC's exposure to legacy
SaaS businesses, there was another trend in that space that
some people were pointing as potentially problematic in the future,
which is the amount of peak loans that are in
those vehicles. Have you seen any opportunities emerge for monarch
or funds like Monarch that are more focused on opportunistic
(10:39):
credit emerge from these issues emerging in private credit.
Adam Sklar (10:44):
So, just to clarify, I think you're absolutely correct. We
have noticed and the public markets I think have taken
notice that the percentage of picking debt within some of
the public BDC portfolios has gone up, and in some
instances is fifteen twenty twenty five percent of these portfolios.
It's hard for me to tell, based on the public
(11:04):
disclosure whether or not those were originated as picking loans
or they went through some type of amend and extend process.
The businesses were weakened from when they were underwritten, and
thus they needed that pick because they couldn't afford the
cash interest, which would obviously send a very negative signal.
So I just want to mention that. But factually, there
(11:25):
is a lot of picking debt in these portfolios, and
I do think it's a cause for some concern in
terms of opportunity. You know, we at Monarch are really
trying to be a first lean lender, so we want
to stay at the top of the capital structure, and
really what part of what's core to our strategy is,
(11:49):
you know, we're looking for situations where it may be
unclear what's going to happen to the equity of the business.
You know, is the sponsor or owner of the business
in the money, are they going to have a success
for exit, or there could be some junior debt instrument
that may have to equitize, and we seek to get
paid a premium, you know, premium rate of interest or
(12:10):
premium spread by buying debt at a discount a dollar
price for the volatility that's below us in the capital structure.
That leads itself to we are seeing opportunities in these
types of situations, but oftentimes it's where we're coming in
as a new lender, not buying their debt at a discount.
(12:31):
And so the answer is yes, but it's not you know,
we haven't seen that many instances where a BDC or
a private credit institution is coming to sell us their
debt on the secondary market. It's been more so that
we're part of a new capital structure that would either
take them out in part or in full or otherwise.
(12:52):
And but yes, I mean there's as they've taken more
and more market share from the BSL market, we're going
to be interact with them more and more.
Irene Garcia Perez (13:01):
Right and in terms of industries and geographies, where are
you looking for opportunities?
Adam Sklar (13:09):
Is this yep? So we came through a period, as
I said, it was just a tremendous environment to be
a credit investor in twenty twenty three and twenty twenty
four for our strategy for other strategies, and so with
the end of MMT and QE forever or whatever, you know,
everyone has their own name. For the period of extraordinary
(13:30):
monetary policy we came through, you know, with interest rates
rising at unprecedented rate. Defensives were really center stage for
US and went through sector level cycles in things like telecom, healthcare,
real estate, and so those were huge areas of focus
in twenty twenty three and twenty twenty four. Coming into
(13:50):
this year, spreads at the index level were fairly tight.
But as I mentioned earlier, what we've started to see
the sectors we're seeing increasing our opportunities are really in cyclicals,
so autos, cams, packaging, we're seeing a significant pickup in
the opportunity set there. And then also as I mentioned,
(14:13):
in software less so in we're not seeing volatility or
cyclicality and real time results, but the cost of capital
to those businesses and capital formation surrounding the software sector
has become much tighter, and that's leading to both a
rerating in the secondary market, you know, in levered loans
(14:35):
and high bonds and also, you know, companies that may
need to refinance debt coming to us more actively because
their prospects to find new capital are are much more
limited today.
Irene Garcia Perez (14:48):
If we had recorded this podcast, say six months ago,
we would have spent a good amount of time talking
about tariffs. Now, the goal post has changed a fair
bit since they were first announced, but a number of
the industries that you mentioned, as you know, opportunities or
offer opportunities because of this weaker micro environment. Also in
(15:08):
this ven diagram of tariffs, in particular chemicals and the
auto space, have you seen any other industries or any
other opportunities emerging from these tariffs, and if not yet,
like do you expect to see them at this stage?
Adam Sklar (15:25):
It's a great question. Through my lens, I think the
issue that tariffs have created and are creating really goes
to the point on you know, real spending power being constrained.
And so if you looked at a chart of wage growth,
(15:46):
nominal or real wage growth, it peaked in twenty twenty one,
early twenty twenty two, and it's just been dropping since.
When you change trade policy and increased tariffs, you know,
there's been both through the general inflation environment, we've been
in in the US, combined now with this change in
trade policy, there's this huge impetus amongst consumer facing businesses
(16:08):
to take price and so I think the tariff story
really dovetails into the fact that, you know, the consumers
getting squeezed. Nominal wage growth is decelerating. We're really not
adding net jobs on a monthly basis, which is in
disha of a labor market that's gone from being incredibly
tight to now softening. And you know, when you look
(16:29):
through CPI, which has been sticky at the headline level,
you know, I think partially due to the tariff point
partially due to other factors, it's worse, you know, than
the headline data would indicate. I was looking at you know,
healthcare costs. Healthcare costs and CPI are up three point
four percent year of year. But I was reading a
report the PwC put out stating that on a commercial basis,
(16:51):
for commercial payers, healthcare costs are up eight percent year
of year. Healthcare is one of the biggest you know,
inputs into you know, the consumer space ending basket. Then
you look at food, well, in home, you know, grocery
store food prices have been you know, that has been
decelerating and that's growing at around three percent. But if
you look at out of home food, so when people
(17:12):
go and eat in restaurants, you know that's closer to
four and a half to five percent up year of year.
And so when you really start looking at what the
consumer is exposed to, you know there there's a lot
of real spending power pressure, and you know, tariffs are
a part of that story. It's hard for me to disaggregate,
you know, where and when they're most impactful. You know,
(17:34):
one sector where I know they are very impactful is
in brick and mortar retail, but there because of everything
that's gone on in that space over the past ten years,
it's really not a big part of our market anymore
and not a sector that we focus on.
Negisa Balluku (17:46):
Adam, I wanted to move on to a pretty big
topic for the past five years or so, there's no
secret that obviously because of costs, primarily perhaps bankruptcies have
gotten more and more truncated. And this is sort of
the past ten fifteen years. And then because of those
loose documents of again past ten fifteen years, we've arrived
(18:06):
in the past five your series of this explosion of
the lemes. I guess first I want to I want
to ask as to how custom investors are at this
out of court fix now, because it almost seems like
it's an expected stepping stone to a Chapter eleven filing.
And then on that I want to also ask as
(18:27):
to how this shift from in court solution to in
boardroom solutions so to speak, has, as far as restructuring goes,
has impacted your investment decisions.
Adam Sklar (18:39):
So you are absolutely correct. LME has become, you know,
a huge part of what it means to be an
opportunistic credit investor and has been a tool that sponsors
and businesses have used to deal with their capital structures.
You know, just to frame it a little bit, I
would say, it's a very logical step in the evolution
(19:03):
of a business that, as I mentioned earlier, may have
you know, some is experiencing some type of issue that
was unforeseen at underwrite. You know, sponsor's equity is not
accreting at twenty percent a year and we're moving towards
a sale. Something else has happened and maybe the sponsor
needs more time where the business needs more liquidity, And
(19:25):
so you know, in the broadest strokes, what's what's what's
happening is the sponsor is taking very open restricted payments
and investment capacity, which is you know, in the documents
you referenced, and is trading that for term in some
instances liquidity and in some instances discount capture to delever
(19:47):
a bit. And so that is a very very notable
part of being an opportunistic player in in the levered
loan market in terms of you know, how that's impacted us,
I think in our process. I think from our perspective,
it's incredibly important to be a student of all of
the precedent transactions to understand, you know, how sponsors will
(20:12):
look to handle, you know, whether it's a pending maturity
or the need for some of the elements I mentioned,
and to try to look at a potential investment in
the secondary market and some of these in some of
these capital structures through the appropriate lens, baking in the
fact that there may be an extension of the maturity.
(20:34):
So maybe the yield to maturity isn't what you thought
because the debt will be extended. Discount capture is obvious,
we need to bake that in, you know, to have
a margin of safety and the price we're willing to
pay for something. If creditors are going to agree to
take a haircut to the face amount of their debt
and liquidity, frankly, can be a huge opportunity for us.
We can deploy incremental capital at a very low LTV
(20:58):
generally at really attractive spreads. So there's a number of
things to consider, but it's been it's been a positive
for us in two ways. One, I think the price
of a loan in deals in businesses that are going
through some type of you know, transitory issue, the loan
(21:19):
not only has to reflect the fundamental value the market's
willing to ascribe to the business, but also the prospect
for the lme. And what that does is that generally
creates another ten twenty points of trading price discount to
account for the fact that the future of the capital
structure is somewhat uncertain. And you know, for us, you know,
(21:40):
who are constantly playing in that market, you know, we
think there's we think there's alpha there and capturing some
of that discount.
Negisa Balluku (21:47):
How do you define all this curious as is, how
do you define success in that space? Because it could
mean different things to all the parties involved in that
big ecosystem. Obviously, one simple way to view it is
whether the company ends up by in a year, two years,
three years, and we see that that happens all the time, right,
But also you're also often times are looking with an
I who was positioning yourself better or while for that
(22:11):
eventual bankruptcy. How do you view success in that space
when you're evaluating your choices.
Adam Sklar (22:17):
Yeah, Look, it goes to a point. I mean, we
need to be for investors in the credit markets, we
need to be experts. We need to be great at
process and understanding obviously the credit documents that we're investing in,
but we also have to be good investors, you know,
and pick businesses that you know perform to our underwriting
and so, you know, we generally view ourselves as transitional capital.
(22:42):
We're coming to a situation because there's some type of complexity,
and we attempt to find great businesses or great assets
and underwrite through that. In terms of success in an
LME setting, I do think there's an element of trying
to find a win win, you know, where it's a
success for us as stakeholders and the credit part of
the capital structure, but it also should be a success
(23:04):
for the sponsor. And so I define that as creating,
to your point earlier, an efficient process where the alternative
of going through a formal restructuring the feebur and would
be materially higher. So you're saving what can be hundreds
of millions of dollars in fees and expenses that otherwise
could go into the business, and you know, providing a
(23:26):
capital structure that's more sustainable and has more runway for
the business to turn around or continue to perform. And
you know, and that's how we define success. It's not
you know, we don't know what's going to happen two, three,
four years forward, and so I think it's unfair at
the time of the LME to you know, fully burden
(23:47):
yourself with what may occur three years down the road. Now,
if there's things that are apparent to you at the time,
you know, some impending issue, you know, that would be
a bit silly to go through an LME process to
then only end up in bankruptcy six months later. I
can't think of one instance we've been involved in where that,
you know, that was our perspective at the time.
Negisa Balluku (24:06):
Yeah, I mean I always wonder because how you incorporate
restructuring costs long term because you could potentially have this
multiple rounds of restructuring that also layer costs when you
have LME, but then you could have a bridge loan
and then you have the dip and then the exit loans,
so that that kind of ends up over time when
the company eventually fails. But one quick question that you
(24:28):
mentioned earlier that you are typically on the top or
try to be, in the tablo cavalty structure. And we're
the point when we hear so much about this new
environment we're on and this new weather you call it
two point h or three point zero. Where is this
idea that lenders are going towards the sponsor sort of
joining arms and then there's power in numbers, and that
(24:48):
co ops are kind of the main topic and we
hear about so much. But I also wonder, being on
the oftentime, being on the tabolo cavialty structure, how you
think of flexibility. Is there are always best to insert
yourself on the early in the process. Are there times
when signing a co op may not make sense? How
proactive you are, and when it makes sense to engage
(25:09):
with a sponsor whatnot? How do you think of that
in those at least in those early stages when anelemie
is potentially being considered.
Adam Sklar (25:17):
Great question, very tough to answer generically. I mean, co
ops really shouldn't be a one size fits all exercise.
They're appropriate in certain instances where there may be certain
dynamics at play. One thing that comes to mind is
sometimes we you know, we're buying debt of a business
in the secondary market, We you know, show up to
(25:38):
an ad hoc group that's already been formed, and maybe
there are two groups, and so rather than going down
a path of having two groups quote unquote bidding against
themselves to come together, you know, and sign a co op,
you know, maybe logical, they're also you know, we haven't
spoken about this yet, but oftentimes we get involved in
capital structures where there may be multiple tranches of debt.
(26:00):
So there could be think about a capital structure where
there's a senior secured loan, unsecured bonds, and then equity.
You know, maybe some of the creditors own the unsecured bonds,
others don't. That could be another impetus for having a
co op where you know, it could be viewed as
mutually beneficial, but it's really hard to speak about them generally. Also,
(26:20):
the terms of co ops can be very different, so
it's hard for me to speak at a high level.
But it really goes to say, it's another example of,
you know, an element of why it's very hard to
be a tourist in this space. This is part of
our core business. It's what we do every day, and
so it's it's it's become harder and harder, I think
to step into some of these, you know, more opportunistic
(26:44):
loans or bonds to trade in the secondary market without
understanding these dynamics.
Irene Garcia Perez (26:49):
Are you seeing an increased staff or by the sponsors
and or their advisors to try to blog early on
this type of arrangements or again say from predators. Mostly
I'm asking if you're seeing more deals because I would
imagine typically that happens more in primary issue that you
have to like just included in the new language early on.
(27:12):
But I was wondering maybe in some amends and extent,
since you're there, you can also like take the language
and include something just in case in the future.
Adam Sklar (27:22):
Yeah, I will say, never underestimate the creativity of the
bankruptcy bar and the sponsor community. So without getting into specifics,
things like DQ lists or even NDAs you know that
can certainly, you know there's an attempt to weaponize those
things at times, but overall, I wouldn't say there's been
(27:46):
a material change from what we've experienced over the past five, ten,
fifteen years.
Negisa Balluku (27:52):
Any thoughts to get specific maybe on the anti boycotting
language in order of brothers and whether that could be
viewed as a way of precursors to the anti co
op language that we keep hearing about that, I don't
think it's actually made it into any of the documents,
any kind of any thoughts there. It's really mainly prohibiting
(28:12):
the ability of current lenders to prohibit third party financing.
But there's some thoughts that could be potentially a precursor
to anti co op language that it hasn't It hasn't
gotten to that point yet.
Adam Sklar (28:22):
Yeah, I've heard, we've we've seen a few instances of
anti co op language or things that I would say,
or maybe a cousin to what you're describing, where you
know someone in the advisor group or sponsor group or
the owner of the business wants to kind of pre
wire or restrict what may occur in the future. Those
(28:47):
things that my experience are tough and frankly it may
be diletarious. They may think that is a positive for
them for their interests, but these things can be so
unpredictable the way they go that for closing, optionality you know,
may actually be a negative. So it's not something that
I've seen become like a major market theme.
Negisa Balluku (29:08):
Well, I think for closing, optionality goes both ways sometimes, right.
I think that's probably the reason from the lenders perspective,
what we haven't seen omni blockers being deployed. They haven't
gotten much traction with some one in spirit and that's
kind of made sense there. We know that now, but
typically speaking, we're not seeing the much of an effort
to insert those in even Postell and me, maybe.
Irene Garcia Perez (29:30):
I wanted to go back to AI for a moment
you were mentioning earlier in the case of legacy SaaS
businesses that you look into, if AI poses a risk
to those cash flows, how does your team approach the
AI impact? Because in some even in some distress situations,
(29:51):
I can imagine businesses where AI could be a positive
and in others where it's actually a threat to the business.
But even with the its. In some cases is technology
that is already there or it's being developed. In other
cases is like what you think it, Yeah, you may
be able to do in five to seven years. So
how does your team approach this element?
Adam Sklar (30:14):
It is a huge area of focus for us internally,
to the point where it's pretty abnormal for us to do.
You know, we'll have a credit review and then have
four or five internal meetings subsequently just to dig into
the topic, almost like a special research project of how
AI could or may or is impacting some of these credits.
(30:39):
It's hard to talk about it monolithically because within software
there's so many sub segments of that market, and but
the pace at which we're looking at new opportunities is
so robust that we're effectively going through whether it's cyber workflows,
data management, you know, we're going through each sub segment
and doing our best to come up with views, you know,
(31:03):
as you'd expect. It's it's almost like a quadrant analysis
where we're looking at you know, we're making certain assessments
about disintermediation risk based on the customer type. You know,
is it on prem or off prem? Is who does
(31:23):
the business compete with you know, are they what is
their ability to utilize AI? What is the customer's ability
or willingness or desire to utilize AI? And we're making
assessments based on you know, a huge checklist of considerations.
Is that going to be perfect, No, but it's starting
to give us a framework, you know, as to where
(31:46):
we you know, where we see more susceptibility than not.
And again, because we're generally playing at the top of
the capital structure, we believe that we're going into these
situations if we decide to invest with a very significant
margin of safety beneath us. And so we're trying to
set up a framework where we want to feel as
comfortable making those investment decisions on the future of these
(32:07):
businesses in the same way we would a chemicals company,
a packaging business, et cetera. That the issue is is
that we've been investing in keems or packaging or housing,
et cetera for decades. You know, software has just not
been an area where we have as much you know, experience,
and so we're we're dedicating a huge amount of resources
(32:28):
to try to get up the curve. And again, as
I mentioned earlier, we have to get the capital structure
and the process right. But we also, to your point,
have to you know, there's a risk and there's capital
flight from the sector for a reason, and we have
to get that right. And it's certainly it's certainly not easy.
So it's a huge topic. It kind of goes to
a broader point which you know, we haven't talked about yet.
(32:52):
But it's pretty remarkable that, you know, high yield spreads
are at their ninety fifth percentile. And I think a
lot of people would listen to this and say smps
at or near all time highs every day. You know,
credit spreads are so tight. What is this guy talking about?
But there's a lot beneath the surface to look at
and talk about, and there's a huge amount of dispersion
(33:13):
within the credit markets, and so I just wanted I
didn't really mention that upfront, but I think it's a
really notable element to this discussion. And yes, software is
a huge part of the market. Frankly, even as someone
who has grown up in credit, you know, I've lived
in these markets for the last nineteen years. If you
had asked me two years ago what percentage of private
(33:35):
credit was lending to software, I just would have had
no idea it's as large as it is, and so
these are really big spaces, and you know, the impact
that AI is going to have not only on software,
by the way, on other businesses were involved in as well,
whether it be positive or negative to your point, is nascent,
but the rate of change is really fast, and so
(33:57):
in something that in previous cycles may have taken five
years for us to fully know what the impact, my
concern is now you know, maybe six months or twelve
months or eighteen months, and so the duration of those
revenues or that cash flow that we're banking on, you know,
maybe more volatile than even we perceive. And it's something
(34:17):
you know that we're pressure testing every day.
Irene Garcia Perez (34:20):
Right. Does that mean that you will have at some
point maybe to ask the companies to send you financials
monthly as opposed to qually to check for that.
Adam Sklar (34:29):
I don't think we're quite at that point, but yet,
I mean we're we're certainly monitoring these things incredibly closely
and again in a regular way kind of if you
think about the Russell versus the mag seven, you know,
we're often investing in value businesses, companies that would be
if they were public in the Russell and there again
(34:50):
based on our own experience and those sectors and generally
how those sectors perform. You know, we don't to your point,
have to be monitoring things monthly, you know, generally, but
with this, you know, we are acutely focused on the
topic and we're trying to leverage our resources to get
as smart as possible, as quickly as possible.
Irene Garcia Perez (35:11):
You were mentioning earlier in real estate, commercial real estate,
which has gone through a lot in the past five
to ten years, is not that appealing these days. Brick
and mortar in particular, Where do you see in real estate?
Where do you see attractive pockets these days?
Adam Sklar (35:27):
Yeah? Sorry, just to clarify, I was talking about brick
and mortar retail. So the retailers is just not most
of them have no debt because of the retail apocalypse
in twenty seventeen, and what's happened to that sector since
there's not a lot of actionable opportunities for us in
that space. In real estate to your point, you know,
real estate went through a very very violent adjustment in
(35:52):
twenty twenty three and twenty twenty four as a function
of interest rates moving up and thus cap rates moving wider,
so valueuation multiples coming down. And then within certain pockets
of the commercial real estate space, you know, there's been
there's been some some idiot more idiosyncratic issues fundamentally, and
so that sector really re rated over the past two
(36:14):
year A few years now, you know, I'm seeing much
more volatility in the corporate credit space, and real estate
I think should be on stronger footing. One really positive
thing for commercial real estate in the US is where
we are in the capital cycle. So what happened, you know,
interest rates rose, obviously, as I mentioned, you know, valuation
multiples came down, a lot of capital destruction in that space.
(36:37):
But partially what that's led to is very little new
supply in most sub sectors of the commercial real estate space.
And traditionally, outside of these extreme movements and monetary policy,
the biggest driver of winners and losers in commercial real
estate is new supply. And so we're not going to
have a significant amount of supply twenty twenty six, twenty
(36:58):
twenty seven, even into twenty twenty eight, I think in
most real estate categories, supply is going to be well
below new supply, be well below historical levels, which sets
up quite nicely for fundamentals, putting the economic cycle aside
for a second, and so real estate has been in
the eye of the storm, so to say, values you know,
(37:19):
based on the cap rate expansion I was mentioning or
down anywhere between twenty and forty percent, you know when
you look, when you look nationally, and so you know,
I'm I think it's a more stable area to actually
investigainst now moving forward prospectively, especially if you believe that
the FED is going to continue cutting and so we're
(37:39):
still seeing significant opportunities there to lend, you know, originate
loans by loans, invest in CMBs, and it's a little
bit I think the analysis prospectively is a little bit
more straightforward than cyclicals or something like software that we've
been we've been talking about how.
Negisa Balluku (37:58):
Do if you the supply finishes and consumer weakness generally
as far as the impact that they have in a
wider scope of industries than what with typicul sye and
kind of discrete these stress cycles, whether you we expect
to see more Chapter twenty twos, for example, we've seen
those a little bit lately.
Adam Sklar (38:17):
Yeah, look it goes to the I hate to you know,
quoting Buffett as an investor. It's a little bit cliche,
but I do think we're in one of these moments
where you know, the tide is going out, and it's
it's hard to always predict, you know, where we're going
to see issues, but it's there is some circularity to
(38:38):
the argument in the sense that now right now, over
the past two weeks, really there is a big spotlight
on corporate credit. I think you know, where the BDC's
and some of the relevant gps are trading in the
public market is certainly you know, getting a lot of attention,
and then you know, having large kind of these you know,
(38:59):
large losses in situations like First Brand and Tricolor have
brought now a huge amount of focus and scrutiny to
situations that you and I may be talking about in
the next thirty sixty ninety days, whereas at other moments
of time, you know, it just may not be as notable,
and so it's hard. I mean, we've talked about a
number of cyclical sectors that you know are really significant
(39:23):
in the lever loan and highal bond markets and in
the private credit space as well. There's nothing else that
comes to mind that may be lesser talked about, but
I do think now you know, whether it's a credit
committee at banks, the regulatory complex that oversees the banking sector,
credit committees at large private credit institutions. You're just going
(39:45):
to have an acute focus on potential issues and tbd
will have to see how those are dealt with.
Negisa Balluku (39:52):
One of the responses has been from the ones most effected,
say first Brand, for example, that there is an ability
to absorb the loss. How much the thing that matters
I mean, does size matter in this environment or is
I mean could matter more in the short term or
rather more in the long term. What do you think
of that as a response.
Adam Sklar (40:10):
I'm glad you brought that up. There's one other notable
element that's happening right now that we haven't talked about,
being with FED funds at five and a quarter, and
let's say spreads were one hundred wider in twenty twenty four.
What that does when you look at if you look
at the BDCs and private credit vehicles, the asset side
of the balance sheet is yielding twelve or thirteen percent,
(40:32):
And what that does is it gives you more buffer
to absorb losses. If you're targeting a ten percent rate
of return and the asset side of your book yields
thirteen percent, you can take some quantum of loss. What's
happening right now, and part of the reason why I
believe the BDCs are trading where they are is because
the FED is cutting rates. And so remember the vast
(40:56):
majority of the levered loan market, for sure and private
credit are in floating rate instruments, and so as the
FED cuts, what's happening the yield on their book is
actually declining. And so the confluence of having an environment
where the yield on your portfolio's declining and you may
have increased credit issues is obviously not ideal, and it's
(41:21):
hard to disaggregate these various issues. But I think for
sure part of the reason why the BDCs are trading
at such a notable discount to NAV is because their
yields are coming down and that impacts their ability to
cover their dividend payment. And so what you may start
seeing are BDCs that have to start cutting their dividends,
private credit vehicles that just have less yield, and you know,
(41:43):
tbd on where we go in terms of credit issues.
Although you know, I think there's that enhanced focus on
amending and extending debt, picking debt. I noticed in analyzing
the BDCs about a third twenty five to per sent
to a third of their portfolio are from our loans
issued prior to twenty twenty three. And so these loans
(42:07):
were issued in a different point in time. Cap multiples
were higher, interest rates were far lower, and so you know,
seeing kind of a zombification of those portfolios where there's
huge amounts of extension, significant amounts of pick at a
time when when on their good loans they're earning less interest,
(42:28):
you know, can be tough. And so I think that
is a part of the story that we hadn't covered yet,
but is important to note.
Negisa Balluku (42:34):
My only final question is any particular cases called cases
you're keeping an eye on what's interesting to you right now?
We've seen a few in the I guess sort of
space in September. I was just curious what you're keeping
an eye on.
Adam Sklar (42:47):
Yeah, so Converge one is a very notable case that
you know, may impact how deals in in court or
out of court are offered to creditor constituencies. You know,
they're constantly my career, there have been a number of
landmark cases. And it kind of goes to the earlier
(43:09):
point of it's tough to be a tourist in the sector.
You know, we need to constantly be up and be
current on legal precedent in addition to what i'll call
market precedent. You know, what are market norms, but also
you know what in various jurisdictions, what are the legal
precedents permitting and how do we do deals that you
know and find transactions that fit within you know, the
(43:32):
four corners of the law, so to say, and and
that and that landscape even over the course of the
last ten to fifteen years has changed from time to
time pretty notably, so we're always, you know, focused on
on making sure we're up to date there. And to
your earlier question, it may influence how we view certain
situations and how capital structures can evolve, whether in court
(43:56):
or out of court.
Negisa Balluku (43:57):
Yeah, and converted oneas particularly interesting to me, at least
because we had a court decide this majority of our
minority issue based on the bankruptcy Code as opposed to
the document language which we're most typically used to saying.
Irene Garcia Perez (44:09):
Read stuff. Adams Clark from Monarch Alternative Capital, Thanks so
much for joining us on the Credit Edge, and of
course we're grateful to Nigisavoluku from Bloomberg Intelligence. Thank you
for joining us. Thank you for more credit market analysis
and insight. Read all of Nigisa's great work on the Terminal.
Bloomberg Intelligence is part of our research department, with five
hundred analysts and strategies working across all markets. Coverage includes
(44:33):
over two thousand equities and credits and outlooks on more
than nineteen industries and one hundred market indices, currencies and commodities.
Please do subscribe to the Credit Edge wherever you get
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Give us a review and tell your friends I, Meeta,
(44:53):
Negarthia Beteth it's been a pleasure having you join us
again next week on the Credit Edge
Hello, and welcome to The Credit Edge, a weekly market podcast.
My name is Irene Garcia Perez. I'm a team leader at Bloomberg and.
Negisa Balluku (00:25):
I'm Negisa Ballaku, senior bankruptcy litigation analyst at Bloomberg Intelligence.
This week, we're very pleased to welcome Adam Sklar Co,
Chief Investment Officer of Monarch Alternative Capital.
Adam Sklar (00:37):
How are you, Adam good, Thank you, Thank you for
having me.
Negisa Balluku (00:40):
Thank you for being here with us today. Adam leads
the investment team, portfolio strategy, and strategic direction across Monarch's corporate,
credit and real estate platforms. Monarch is a global investment
firm founded in two thousand and two with approximately sixty
billion dollars in assets under management. It focuses primarily on
opportunistic credit and real estate across various market segments and
(01:03):
instrument types. In his capacity as co head of real
Estate for Monarch, Adam is focused on directing Monarch's investment activities.
In leading the firm's real estate platform, he sits on
the investment committees on each Monarch strategy, in addition to
being a member of the firm's Partnership Committee and Operational
Executive Committee. Prior to joining Monarch In two thousand and seven,
(01:23):
Adam was an analyst at JP Morgan in Financial Institutions.
Irene Garcia Perez (01:26):
Group, So Adam, thank you very much for joining us.
Last week we had JP Morgan CEO Jamie Diamond talking
about cockroaches in relation to Tricolor and First Brand's blow ups,
that when you see one of those, you should expect
to see more. He also made some remarks about undergrading
standards by some that are not particularly good quote unquote,
(01:48):
and that internship triggered a few private credit executives, including
Blue Ovel Capital co CEO Mark Libshals, who say the
issue was in loans at bangalad as opposed to private
credit loan. Two questions that come to mind on the
back of these situations, do you expect to see indeed
more frauds emerge and the other one has a hunt
(02:09):
for you? And the amount of capital race in the
past few years, be it in direct lending strategies, be
it in clo strategies, move view diligence to a secondary role.
Adam Sklar (02:20):
Very good questions, very topical for this discussion. I'm given
to your point Jamie Diamond and Mark Lipschultz's comments last
week and all of the attention that is now coming,
you know, to the corporate credit space. To answer your
questions directly before I make a broader statement, I would
say it's very hard to anticipate fraud generally, and I
(02:41):
think it's very logical for people to look at, you know,
tricolor first brands where there may be some form of
fraudulent activity and view that as idiosyncratic. That being said,
when I look across our portfolios and as someone participating
in the levered loan and high yield bond markets very actively,
(03:01):
what I do see as an environment where away from
AI and AI cap X spending, there are large portions
of the economy that are hurting, and we can talk
about that further. But through that, what I see and
feel every day is it feels like a moment, you know,
picking up on a quote from Warren Buffett, you know,
when the tide goes out, you see who's been swimming naked?
(03:23):
And so we have gone through a period where there's
been you know, both tremendous monetary and fiscal stimulus coming
out of all the monetary stimulus we had in twenty
twenty three and twenty twenty four, you know that began
to put stress on levered capital structures with higher interest rates,
and through the balance of those few years we've been
in a period we're on a real basis, big parts
(03:46):
of the US consumer base of getting squeezed. Nominal wages
are coming down, job growth is slowing, and inflation has
been quite persistent. And so there are big parts of
the economy, as I referenced earlier, where we're seeing, you know,
fundamental weaknesses and cracks emerging on a daily basis. And
so I don't, you know, I'm not focused on frauds necessarily,
(04:08):
but I do think, you know, there are issues, you know,
in the corporate credit space, fundamental issues that are popping up,
and so I think the markets are right to be
focused on that. Second, on corporate credit as a potential
risk moving forward.
Irene Garcia Perez (04:23):
We have seen also a couple other situations and a
fee in sex where without fraud being involved in those cases,
but where from the time the company should the dead
until it offered at the stress exchange, it was just
a matter of months, not even a year. Do you
think that investors, because of this handful year hunt for
(04:46):
yield or this need to employ capital, sometimes feel rush
to just you know, sign to those deals.
Adam Sklar (04:54):
Yeah, I feel like it's less a function of those
elements which may have been press over the past few years.
It's hard for me to comment, but I think it
is notable kind of to part of your point that
you know, twenty twenty three too through twenty twenty four
were really a great time to be a credit investor.
(05:14):
You had, you know, arise in the base rate, which
had been incredibly low in the United States for the
previous decade, and that afforded, on an absolute yield basis,
a higher rate of return to credit investors. And part
of the reason why we've seen such an explosion just
so much growth in private credit in the US as
a function of the fact that the base rate was
(05:36):
at five percent or higher, you know, spreads coming out
of the volatility that we saw in twenty twenty three,
the regional banking crisis, geopolitical events, et cetera. It was
a really special time to deploy capital into the credit space,
and so as a as a result of all of
that capital coming in and needing to be deployed. To
(05:57):
your point, do I think there could have been in
underwriting mistakes made, of course, but I don't think that's
the big story today. As I said earlier, I think
the bigger issue is just we're in a very uneven
macroeconomic moment. It's why the FED, you know, partially part
of the reason why. There may be other political reasons,
but part of the reason why you see the FED
(06:19):
moving to cut interest rates. And I think that is
a more notable kind of element to the credit the
corporate credit story right now than you know, super loose
underwriting or fraud. And frankly, if you think about something
like a SAX. You know, so in brick and mortar, retail,
in the restaurant space, we're seeing it in chemicals, paper
(06:42):
and packaging, certain parts of commercial construction housing. I mean,
what I just listed is probably fifty percent of US GDP,
and so you know they're there are We're seeing real
issues on the revenue side there in terms of softness
and that as you you know, if you're in a
levered capital structure that's sensitive to revenue and EBITDAH and
(07:03):
debt service coverage metrics. You know, I think that's the
bigger issue right now facing the corporate credit space.
Negisa Balluku (07:09):
Adam, So in this back and forth between those that
say that private credit sector or non bank lending sector
are subject to these bad landing centers or untrustworthy borrowers.
More bad news is about to come. On one hand,
and on the other hand, we have this argument that
most of the exposure was actually being held by banks
(07:30):
and that this is fear mongering. Are we basically in
a wait and see approach? Are there things you think
that we need to see to prove or disprove this
thesis that this is in fact the systemic failure of
the private credit sector. At what point I'm curious you
think that the examples could turn into data.
Adam Sklar (07:48):
That is a really challenging question. I don't just to
reiterate what I was just saying, I don't see that
in terms of a systemic failure. And underwriting that being said,
I think there's two notable elements to answer your question
in terms of what we're going to see over the
next three, six, nine, twelve months and how that may
inform you know, people's views. One obviously cyclicality. You know,
(08:12):
I'm commenting on what I see on the ground today,
and so I'm seeing, you know, it feels very late
cycle to me in certain sectors, and we're seeing you know,
certain weaknesses that you know I mentioned before, especially those
sectors that are very levered to the US consumer. The
second area which is getting more focus in our world,
(08:33):
and you know in certain parts of the credit markets,
is the exposure to legacy SaaS so software businesses in
that we're that were sold at very high multiples of
what was perceived to be recurring cash flow, thus levered
at very high multiples as well, if AI poses a
risk to those cash flows moving forward, you know, could
(08:56):
that be an issue? And what was notable to me
over the past year or so, you know, we've come
to see that software credit lending to these software businesses
makes up thirty to forty percent of the private credit space.
And so if you look at public BDCs, which are
you know, a good window into the private credit world
where you get a lot of public disclosure, you know,
(09:18):
you'll see software as always the top category in those
portfolios and could be upwards of thirty to forty percent,
And so I think that's very notable. You know, in
the history of the credit markets, if you look at
where people get into trouble, oftentimes it's when they have
a certain concentration. So when private credit emerged and took
(09:38):
all of this market share from from the BSL market
and other balance sheets. You have to ask yourself, well,
why are they winning all this business? Why? You know,
are some of these huge firms, you know, winning all
of these loans? Are they the best lender to a
certain industry, to a certain type of borrower? And I
think software really stands out, which seems like a great
(09:59):
place to be until you have a potential for technological
disintermediation and disruption in the form of AI that could
be really significant risk to your question, I think it's
too early right now to know, but that is, you know,
it's a notable element that I think bears Mentioning.
Irene Garcia Perez (10:17):
You were on this point of BDC's exposure to legacy
SaaS businesses, there was another trend in that space that
some people were pointing as potentially problematic in the future,
which is the amount of peak loans that are in
those vehicles. Have you seen any opportunities emerge for monarch
or funds like Monarch that are more focused on opportunistic
(10:39):
credit emerge from these issues emerging in private credit.
Adam Sklar (10:44):
So, just to clarify, I think you're absolutely correct. We
have noticed and the public markets I think have taken
notice that the percentage of picking debt within some of
the public BDC portfolios has gone up, and in some
instances is fifteen twenty twenty five percent of these portfolios.
It's hard for me to tell, based on the public
(11:04):
disclosure whether or not those were originated as picking loans
or they went through some type of amend and extend process.
The businesses were weakened from when they were underwritten, and
thus they needed that pick because they couldn't afford the
cash interest, which would obviously send a very negative signal.
So I just want to mention that. But factually, there
(11:25):
is a lot of picking debt in these portfolios, and
I do think it's a cause for some concern in
terms of opportunity. You know, we at Monarch are really
trying to be a first lean lender, so we want
to stay at the top of the capital structure, and
really what part of what's core to our strategy is,
(11:49):
you know, we're looking for situations where it may be
unclear what's going to happen to the equity of the business.
You know, is the sponsor or owner of the business
in the money, are they going to have a success
for exit, or there could be some junior debt instrument
that may have to equitize, and we seek to get
paid a premium, you know, premium rate of interest or
(12:10):
premium spread by buying debt at a discount a dollar
price for the volatility that's below us in the capital structure.
That leads itself to we are seeing opportunities in these
types of situations, but oftentimes it's where we're coming in
as a new lender, not buying their debt at a discount.
(12:31):
And so the answer is yes, but it's not you know,
we haven't seen that many instances where a BDC or
a private credit institution is coming to sell us their
debt on the secondary market. It's been more so that
we're part of a new capital structure that would either
take them out in part or in full or otherwise.
(12:52):
And but yes, I mean there's as they've taken more
and more market share from the BSL market, we're going
to be interact with them more and more.
Irene Garcia Perez (13:01):
Right and in terms of industries and geographies, where are
you looking for opportunities?
Adam Sklar (13:09):
Is this yep? So we came through a period, as
I said, it was just a tremendous environment to be
a credit investor in twenty twenty three and twenty twenty
four for our strategy for other strategies, and so with
the end of MMT and QE forever or whatever, you know,
everyone has their own name. For the period of extraordinary
(13:30):
monetary policy we came through, you know, with interest rates
rising at unprecedented rate. Defensives were really center stage for
US and went through sector level cycles in things like telecom, healthcare,
real estate, and so those were huge areas of focus
in twenty twenty three and twenty twenty four. Coming into
(13:50):
this year, spreads at the index level were fairly tight.
But as I mentioned earlier, what we've started to see
the sectors we're seeing increasing our opportunities are really in cyclicals,
so autos, cams, packaging, we're seeing a significant pickup in
the opportunity set there. And then also as I mentioned,
(14:13):
in software less so in we're not seeing volatility or
cyclicality and real time results, but the cost of capital
to those businesses and capital formation surrounding the software sector
has become much tighter, and that's leading to both a
rerating in the secondary market, you know, in levered loans
(14:35):
and high bonds and also, you know, companies that may
need to refinance debt coming to us more actively because
their prospects to find new capital are are much more
limited today.
Irene Garcia Perez (14:48):
If we had recorded this podcast, say six months ago,
we would have spent a good amount of time talking
about tariffs. Now, the goal post has changed a fair
bit since they were first announced, but a number of
the industries that you mentioned, as you know, opportunities or
offer opportunities because of this weaker micro environment. Also in
(15:08):
this ven diagram of tariffs, in particular chemicals and the
auto space, have you seen any other industries or any
other opportunities emerging from these tariffs, and if not yet,
like do you expect to see them at this stage?
Adam Sklar (15:25):
It's a great question. Through my lens, I think the
issue that tariffs have created and are creating really goes
to the point on you know, real spending power being constrained.
And so if you looked at a chart of wage growth,
(15:46):
nominal or real wage growth, it peaked in twenty twenty one,
early twenty twenty two, and it's just been dropping since.
When you change trade policy and increased tariffs, you know,
there's been both through the general inflation environment, we've been
in in the US, combined now with this change in
trade policy, there's this huge impetus amongst consumer facing businesses
(16:08):
to take price and so I think the tariff story
really dovetails into the fact that, you know, the consumers
getting squeezed. Nominal wage growth is decelerating. We're really not
adding net jobs on a monthly basis, which is in
disha of a labor market that's gone from being incredibly
tight to now softening. And you know, when you look
(16:29):
through CPI, which has been sticky at the headline level,
you know, I think partially due to the tariff point
partially due to other factors, it's worse, you know, than
the headline data would indicate. I was looking at you know,
healthcare costs. Healthcare costs and CPI are up three point
four percent year of year. But I was reading a
report the PwC put out stating that on a commercial basis,
(16:51):
for commercial payers, healthcare costs are up eight percent year
of year. Healthcare is one of the biggest you know,
inputs into you know, the consumer space ending basket. Then
you look at food, well, in home, you know, grocery
store food prices have been you know, that has been
decelerating and that's growing at around three percent. But if
you look at out of home food, so when people
(17:12):
go and eat in restaurants, you know that's closer to
four and a half to five percent up year of year.
And so when you really start looking at what the
consumer is exposed to, you know there there's a lot
of real spending power pressure, and you know, tariffs are
a part of that story. It's hard for me to disaggregate,
you know, where and when they're most impactful. You know,
(17:34):
one sector where I know they are very impactful is
in brick and mortar retail, but there because of everything
that's gone on in that space over the past ten years,
it's really not a big part of our market anymore
and not a sector that we focus on.
Negisa Balluku (17:46):
Adam, I wanted to move on to a pretty big
topic for the past five years or so, there's no
secret that obviously because of costs, primarily perhaps bankruptcies have
gotten more and more truncated. And this is sort of
the past ten fifteen years. And then because of those
loose documents of again past ten fifteen years, we've arrived
(18:06):
in the past five your series of this explosion of
the lemes. I guess first I want to I want
to ask as to how custom investors are at this
out of court fix now, because it almost seems like
it's an expected stepping stone to a Chapter eleven filing.
And then on that I want to also ask as
(18:27):
to how this shift from in court solution to in
boardroom solutions so to speak, has, as far as restructuring goes,
has impacted your investment decisions.
Adam Sklar (18:39):
So you are absolutely correct. LME has become, you know,
a huge part of what it means to be an
opportunistic credit investor and has been a tool that sponsors
and businesses have used to deal with their capital structures.
You know, just to frame it a little bit, I
would say, it's a very logical step in the evolution
(19:03):
of a business that, as I mentioned earlier, may have
you know, some is experiencing some type of issue that
was unforeseen at underwrite. You know, sponsor's equity is not
accreting at twenty percent a year and we're moving towards
a sale. Something else has happened and maybe the sponsor
needs more time where the business needs more liquidity, And
(19:25):
so you know, in the broadest strokes, what's what's what's
happening is the sponsor is taking very open restricted payments
and investment capacity, which is you know, in the documents
you referenced, and is trading that for term in some
instances liquidity and in some instances discount capture to delever
(19:47):
a bit. And so that is a very very notable
part of being an opportunistic player in in the levered
loan market in terms of you know, how that's impacted us,
I think in our process. I think from our perspective,
it's incredibly important to be a student of all of
the precedent transactions to understand, you know, how sponsors will
(20:12):
look to handle, you know, whether it's a pending maturity
or the need for some of the elements I mentioned,
and to try to look at a potential investment in
the secondary market and some of these in some of
these capital structures through the appropriate lens, baking in the
fact that there may be an extension of the maturity.
(20:34):
So maybe the yield to maturity isn't what you thought
because the debt will be extended. Discount capture is obvious,
we need to bake that in, you know, to have
a margin of safety and the price we're willing to
pay for something. If creditors are going to agree to
take a haircut to the face amount of their debt
and liquidity, frankly, can be a huge opportunity for us.
We can deploy incremental capital at a very low LTV
(20:58):
generally at really attractive spreads. So there's a number of
things to consider, but it's been it's been a positive
for us in two ways. One, I think the price
of a loan in deals in businesses that are going
through some type of you know, transitory issue, the loan
(21:19):
not only has to reflect the fundamental value the market's
willing to ascribe to the business, but also the prospect
for the lme. And what that does is that generally
creates another ten twenty points of trading price discount to
account for the fact that the future of the capital
structure is somewhat uncertain. And you know, for us, you know,
(21:40):
who are constantly playing in that market, you know, we
think there's we think there's alpha there and capturing some
of that discount.
Negisa Balluku (21:47):
How do you define all this curious as is, how
do you define success in that space? Because it could
mean different things to all the parties involved in that
big ecosystem. Obviously, one simple way to view it is
whether the company ends up by in a year, two years,
three years, and we see that that happens all the time, right,
But also you're also often times are looking with an
I who was positioning yourself better or while for that
(22:11):
eventual bankruptcy. How do you view success in that space
when you're evaluating your choices.
Adam Sklar (22:17):
Yeah, Look, it goes to a point. I mean, we
need to be for investors in the credit markets, we
need to be experts. We need to be great at
process and understanding obviously the credit documents that we're investing in,
but we also have to be good investors, you know,
and pick businesses that you know perform to our underwriting
and so, you know, we generally view ourselves as transitional capital.
(22:42):
We're coming to a situation because there's some type of complexity,
and we attempt to find great businesses or great assets
and underwrite through that. In terms of success in an
LME setting, I do think there's an element of trying
to find a win win, you know, where it's a
success for us as stakeholders and the credit part of
the capital structure, but it also should be a success
(23:04):
for the sponsor. And so I define that as creating,
to your point earlier, an efficient process where the alternative
of going through a formal restructuring the feebur and would
be materially higher. So you're saving what can be hundreds
of millions of dollars in fees and expenses that otherwise
could go into the business, and you know, providing a
(23:26):
capital structure that's more sustainable and has more runway for
the business to turn around or continue to perform. And
you know, and that's how we define success. It's not
you know, we don't know what's going to happen two, three,
four years forward, and so I think it's unfair at
the time of the LME to you know, fully burden
(23:47):
yourself with what may occur three years down the road. Now,
if there's things that are apparent to you at the time,
you know, some impending issue, you know, that would be
a bit silly to go through an LME process to
then only end up in bankruptcy six months later. I
can't think of one instance we've been involved in where that,
you know, that was our perspective at the time.
Negisa Balluku (24:06):
Yeah, I mean I always wonder because how you incorporate
restructuring costs long term because you could potentially have this
multiple rounds of restructuring that also layer costs when you
have LME, but then you could have a bridge loan
and then you have the dip and then the exit loans,
so that that kind of ends up over time when
the company eventually fails. But one quick question that you
(24:28):
mentioned earlier that you are typically on the top or
try to be, in the tablo cavalty structure. And we're
the point when we hear so much about this new
environment we're on and this new weather you call it
two point h or three point zero. Where is this
idea that lenders are going towards the sponsor sort of
joining arms and then there's power in numbers, and that
(24:48):
co ops are kind of the main topic and we
hear about so much. But I also wonder, being on
the oftentime, being on the tabolo cavialty structure, how you
think of flexibility. Is there are always best to insert
yourself on the early in the process. Are there times
when signing a co op may not make sense? How
proactive you are, and when it makes sense to engage
(25:09):
with a sponsor whatnot? How do you think of that
in those at least in those early stages when anelemie
is potentially being considered.
Adam Sklar (25:17):
Great question, very tough to answer generically. I mean, co
ops really shouldn't be a one size fits all exercise.
They're appropriate in certain instances where there may be certain
dynamics at play. One thing that comes to mind is
sometimes we you know, we're buying debt of a business
in the secondary market, We you know, show up to
(25:38):
an ad hoc group that's already been formed, and maybe
there are two groups, and so rather than going down
a path of having two groups quote unquote bidding against
themselves to come together, you know, and sign a co op,
you know, maybe logical, they're also you know, we haven't
spoken about this yet, but oftentimes we get involved in
capital structures where there may be multiple tranches of debt.
(26:00):
So there could be think about a capital structure where
there's a senior secured loan, unsecured bonds, and then equity.
You know, maybe some of the creditors own the unsecured bonds,
others don't. That could be another impetus for having a
co op where you know, it could be viewed as
mutually beneficial, but it's really hard to speak about them generally. Also,
(26:20):
the terms of co ops can be very different, so
it's hard for me to speak at a high level.
But it really goes to say, it's another example of,
you know, an element of why it's very hard to
be a tourist in this space. This is part of
our core business. It's what we do every day, and
so it's it's it's become harder and harder, I think
to step into some of these, you know, more opportunistic
(26:44):
loans or bonds to trade in the secondary market without
understanding these dynamics.
Irene Garcia Perez (26:49):
Are you seeing an increased staff or by the sponsors
and or their advisors to try to blog early on
this type of arrangements or again say from predators. Mostly
I'm asking if you're seeing more deals because I would
imagine typically that happens more in primary issue that you
have to like just included in the new language early on.
(27:12):
But I was wondering maybe in some amends and extent,
since you're there, you can also like take the language
and include something just in case in the future.
Adam Sklar (27:22):
Yeah, I will say, never underestimate the creativity of the
bankruptcy bar and the sponsor community. So without getting into specifics,
things like DQ lists or even NDAs you know that
can certainly, you know there's an attempt to weaponize those
things at times, but overall, I wouldn't say there's been
(27:46):
a material change from what we've experienced over the past five, ten,
fifteen years.
Negisa Balluku (27:52):
Any thoughts to get specific maybe on the anti boycotting
language in order of brothers and whether that could be
viewed as a way of precursors to the anti co
op language that we keep hearing about that, I don't
think it's actually made it into any of the documents,
any kind of any thoughts there. It's really mainly prohibiting
(28:12):
the ability of current lenders to prohibit third party financing.
But there's some thoughts that could be potentially a precursor
to anti co op language that it hasn't It hasn't
gotten to that point yet.
Adam Sklar (28:22):
Yeah, I've heard, we've we've seen a few instances of
anti co op language or things that I would say,
or maybe a cousin to what you're describing, where you
know someone in the advisor group or sponsor group or
the owner of the business wants to kind of pre
wire or restrict what may occur in the future. Those
(28:47):
things that my experience are tough and frankly it may
be diletarious. They may think that is a positive for
them for their interests, but these things can be so
unpredictable the way they go that for closing, optionality you know,
may actually be a negative. So it's not something that
I've seen become like a major market theme.
Negisa Balluku (29:08):
Well, I think for closing, optionality goes both ways sometimes, right.
I think that's probably the reason from the lenders perspective,
what we haven't seen omni blockers being deployed. They haven't
gotten much traction with some one in spirit and that's
kind of made sense there. We know that now, but
typically speaking, we're not seeing the much of an effort
to insert those in even Postell and me, maybe.
Irene Garcia Perez (29:30):
I wanted to go back to AI for a moment
you were mentioning earlier in the case of legacy SaaS
businesses that you look into, if AI poses a risk
to those cash flows, how does your team approach the
AI impact? Because in some even in some distress situations,
(29:51):
I can imagine businesses where AI could be a positive
and in others where it's actually a threat to the business.
But even with the its. In some cases is technology
that is already there or it's being developed. In other
cases is like what you think it, Yeah, you may
be able to do in five to seven years. So
how does your team approach this element?
Adam Sklar (30:14):
It is a huge area of focus for us internally,
to the point where it's pretty abnormal for us to do.
You know, we'll have a credit review and then have
four or five internal meetings subsequently just to dig into
the topic, almost like a special research project of how
AI could or may or is impacting some of these credits.
(30:39):
It's hard to talk about it monolithically because within software
there's so many sub segments of that market, and but
the pace at which we're looking at new opportunities is
so robust that we're effectively going through whether it's cyber workflows,
data management, you know, we're going through each sub segment
and doing our best to come up with views, you know,
(31:03):
as you'd expect. It's it's almost like a quadrant analysis
where we're looking at you know, we're making certain assessments
about disintermediation risk based on the customer type. You know,
is it on prem or off prem? Is who does
(31:23):
the business compete with you know, are they what is
their ability to utilize AI? What is the customer's ability
or willingness or desire to utilize AI? And we're making
assessments based on you know, a huge checklist of considerations.
Is that going to be perfect, No, but it's starting
to give us a framework, you know, as to where
(31:46):
we you know, where we see more susceptibility than not.
And again, because we're generally playing at the top of
the capital structure, we believe that we're going into these
situations if we decide to invest with a very significant
margin of safety beneath us. And so we're trying to
set up a framework where we want to feel as
comfortable making those investment decisions on the future of these
(32:07):
businesses in the same way we would a chemicals company,
a packaging business, et cetera. That the issue is is
that we've been investing in keems or packaging or housing,
et cetera for decades. You know, software has just not
been an area where we have as much you know, experience,
and so we're we're dedicating a huge amount of resources
(32:28):
to try to get up the curve. And again, as
I mentioned earlier, we have to get the capital structure
and the process right. But we also, to your point,
have to you know, there's a risk and there's capital
flight from the sector for a reason, and we have
to get that right. And it's certainly it's certainly not easy.
So it's a huge topic. It kind of goes to
a broader point which you know, we haven't talked about yet.
(32:52):
But it's pretty remarkable that, you know, high yield spreads
are at their ninety fifth percentile. And I think a
lot of people would listen to this and say smps
at or near all time highs every day. You know,
credit spreads are so tight. What is this guy talking about?
But there's a lot beneath the surface to look at
and talk about, and there's a huge amount of dispersion
(33:13):
within the credit markets, and so I just wanted I
didn't really mention that upfront, but I think it's a
really notable element to this discussion. And yes, software is
a huge part of the market. Frankly, even as someone
who has grown up in credit, you know, I've lived
in these markets for the last nineteen years. If you
had asked me two years ago what percentage of private
(33:35):
credit was lending to software, I just would have had
no idea it's as large as it is, and so
these are really big spaces, and you know, the impact
that AI is going to have not only on software,
by the way, on other businesses were involved in as well,
whether it be positive or negative to your point, is nascent,
but the rate of change is really fast, and so
(33:57):
in something that in previous cycles may have taken five
years for us to fully know what the impact, my
concern is now you know, maybe six months or twelve
months or eighteen months, and so the duration of those
revenues or that cash flow that we're banking on, you know,
maybe more volatile than even we perceive. And it's something
(34:17):
you know that we're pressure testing every day.
Irene Garcia Perez (34:20):
Right. Does that mean that you will have at some
point maybe to ask the companies to send you financials
monthly as opposed to qually to check for that.
Adam Sklar (34:29):
I don't think we're quite at that point, but yet,
I mean we're we're certainly monitoring these things incredibly closely
and again in a regular way kind of if you
think about the Russell versus the mag seven, you know,
we're often investing in value businesses, companies that would be
if they were public in the Russell and there again
(34:50):
based on our own experience and those sectors and generally
how those sectors perform. You know, we don't to your point,
have to be monitoring things monthly, you know, generally, but
with this, you know, we are acutely focused on the
topic and we're trying to leverage our resources to get
as smart as possible, as quickly as possible.
Irene Garcia Perez (35:11):
You were mentioning earlier in real estate, commercial real estate,
which has gone through a lot in the past five
to ten years, is not that appealing these days. Brick
and mortar in particular, Where do you see in real estate?
Where do you see attractive pockets these days?
Adam Sklar (35:27):
Yeah? Sorry, just to clarify, I was talking about brick
and mortar retail. So the retailers is just not most
of them have no debt because of the retail apocalypse
in twenty seventeen, and what's happened to that sector since
there's not a lot of actionable opportunities for us in
that space. In real estate to your point, you know,
real estate went through a very very violent adjustment in
(35:52):
twenty twenty three and twenty twenty four as a function
of interest rates moving up and thus cap rates moving wider,
so valueuation multiples coming down. And then within certain pockets
of the commercial real estate space, you know, there's been
there's been some some idiot more idiosyncratic issues fundamentally, and
so that sector really re rated over the past two
(36:14):
year A few years now, you know, I'm seeing much
more volatility in the corporate credit space, and real estate
I think should be on stronger footing. One really positive
thing for commercial real estate in the US is where
we are in the capital cycle. So what happened, you know,
interest rates rose, obviously, as I mentioned, you know, valuation
multiples came down, a lot of capital destruction in that space.
(36:37):
But partially what that's led to is very little new
supply in most sub sectors of the commercial real estate space.
And traditionally, outside of these extreme movements and monetary policy,
the biggest driver of winners and losers in commercial real
estate is new supply. And so we're not going to
have a significant amount of supply twenty twenty six, twenty
(36:58):
twenty seven, even into twenty twenty eight, I think in
most real estate categories, supply is going to be well
below new supply, be well below historical levels, which sets
up quite nicely for fundamentals, putting the economic cycle aside
for a second, and so real estate has been in
the eye of the storm, so to say, values you know,
(37:19):
based on the cap rate expansion I was mentioning or
down anywhere between twenty and forty percent, you know when
you look, when you look nationally, and so you know,
I'm I think it's a more stable area to actually
investigainst now moving forward prospectively, especially if you believe that
the FED is going to continue cutting and so we're
(37:39):
still seeing significant opportunities there to lend, you know, originate
loans by loans, invest in CMBs, and it's a little
bit I think the analysis prospectively is a little bit
more straightforward than cyclicals or something like software that we've
been we've been talking about how.
Negisa Balluku (37:58):
Do if you the supply finishes and consumer weakness generally
as far as the impact that they have in a
wider scope of industries than what with typicul sye and
kind of discrete these stress cycles, whether you we expect
to see more Chapter twenty twos, for example, we've seen
those a little bit lately.
Adam Sklar (38:17):
Yeah, look it goes to the I hate to you know,
quoting Buffett as an investor. It's a little bit cliche,
but I do think we're in one of these moments
where you know, the tide is going out, and it's
it's hard to always predict, you know, where we're going
to see issues, but it's there is some circularity to
(38:38):
the argument in the sense that now right now, over
the past two weeks, really there is a big spotlight
on corporate credit. I think you know, where the BDC's
and some of the relevant gps are trading in the
public market is certainly you know, getting a lot of attention,
and then you know, having large kind of these you know,
(38:59):
large losses in situations like First Brand and Tricolor have
brought now a huge amount of focus and scrutiny to
situations that you and I may be talking about in
the next thirty sixty ninety days, whereas at other moments
of time, you know, it just may not be as notable,
and so it's hard. I mean, we've talked about a
number of cyclical sectors that you know are really significant
(39:23):
in the lever loan and highal bond markets and in
the private credit space as well. There's nothing else that
comes to mind that may be lesser talked about, but
I do think now you know, whether it's a credit
committee at banks, the regulatory complex that oversees the banking sector,
credit committees at large private credit institutions. You're just going
(39:45):
to have an acute focus on potential issues and tbd
will have to see how those are dealt with.
Negisa Balluku (39:52):
One of the responses has been from the ones most effected,
say first Brand, for example, that there is an ability
to absorb the loss. How much the thing that matters
I mean, does size matter in this environment or is
I mean could matter more in the short term or
rather more in the long term. What do you think
of that as a response.
Adam Sklar (40:10):
I'm glad you brought that up. There's one other notable
element that's happening right now that we haven't talked about,
being with FED funds at five and a quarter, and
let's say spreads were one hundred wider in twenty twenty four.
What that does when you look at if you look
at the BDCs and private credit vehicles, the asset side
of the balance sheet is yielding twelve or thirteen percent,
(40:32):
And what that does is it gives you more buffer
to absorb losses. If you're targeting a ten percent rate
of return and the asset side of your book yields
thirteen percent, you can take some quantum of loss. What's
happening right now, and part of the reason why I
believe the BDCs are trading where they are is because
the FED is cutting rates. And so remember the vast
(40:56):
majority of the levered loan market, for sure and private
credit are in floating rate instruments, and so as the
FED cuts, what's happening the yield on their book is
actually declining. And so the confluence of having an environment
where the yield on your portfolio's declining and you may
have increased credit issues is obviously not ideal, and it's
(41:21):
hard to disaggregate these various issues. But I think for
sure part of the reason why the BDCs are trading
at such a notable discount to NAV is because their
yields are coming down and that impacts their ability to
cover their dividend payment. And so what you may start
seeing are BDCs that have to start cutting their dividends,
private credit vehicles that just have less yield, and you know,
(41:43):
tbd on where we go in terms of credit issues.
Although you know, I think there's that enhanced focus on
amending and extending debt, picking debt. I noticed in analyzing
the BDCs about a third twenty five to per sent
to a third of their portfolio are from our loans
issued prior to twenty twenty three. And so these loans
(42:07):
were issued in a different point in time. Cap multiples
were higher, interest rates were far lower, and so you know,
seeing kind of a zombification of those portfolios where there's
huge amounts of extension, significant amounts of pick at a
time when when on their good loans they're earning less interest,
(42:28):
you know, can be tough. And so I think that
is a part of the story that we hadn't covered yet,
but is important to note.
Negisa Balluku (42:34):
My only final question is any particular cases called cases
you're keeping an eye on what's interesting to you right now?
We've seen a few in the I guess sort of
space in September. I was just curious what you're keeping
an eye on.
Adam Sklar (42:47):
Yeah, so Converge one is a very notable case that
you know, may impact how deals in in court or
out of court are offered to creditor constituencies. You know,
they're constantly my career, there have been a number of
landmark cases. And it kind of goes to the earlier
(43:09):
point of it's tough to be a tourist in the sector.
You know, we need to constantly be up and be
current on legal precedent in addition to what i'll call
market precedent. You know, what are market norms, but also
you know what in various jurisdictions, what are the legal
precedents permitting and how do we do deals that you
know and find transactions that fit within you know, the
(43:32):
four corners of the law, so to say, and and
that and that landscape even over the course of the
last ten to fifteen years has changed from time to
time pretty notably, so we're always, you know, focused on
on making sure we're up to date there. And to
your earlier question, it may influence how we view certain
situations and how capital structures can evolve, whether in court
(43:56):
or out of court.
Negisa Balluku (43:57):
Yeah, and converted oneas particularly interesting to me, at least
because we had a court decide this majority of our
minority issue based on the bankruptcy Code as opposed to
the document language which we're most typically used to saying.
Irene Garcia Perez (44:09):
Read stuff. Adams Clark from Monarch Alternative Capital, Thanks so
much for joining us on the Credit Edge, and of
course we're grateful to Nigisavoluku from Bloomberg Intelligence. Thank you
for joining us. Thank you for more credit market analysis
and insight. Read all of Nigisa's great work on the Terminal.
Bloomberg Intelligence is part of our research department, with five
hundred analysts and strategies working across all markets. Coverage includes
(44:33):
over two thousand equities and credits and outlooks on more
than nineteen industries and one hundred market indices, currencies and commodities.
Please do subscribe to the Credit Edge wherever you get
your podcasts. We're on Apple, Spotify and all other good
podcast providers, including the Bloomberg Terminal and b pod Go.
Give us a review and tell your friends I, Meeta,
(44:53):
Negarthia Beteth it's been a pleasure having you join us
again next week on the Credit Edge
Host
James Crombie
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