August 28, 2025 • 41 mins
Leveraged buyouts are poised for a revival, albeit less aggressively structured than in the last wave, according to Moody’s Ratings. “Ultimately everyone will need to adjust to the new environment and you will see deal flow come back,” Christina Padgett, the firm’s head of leveraged finance and private credit research, tells Bloomberg News’ James Crombie and Bloomberg Intelligence’s Jean-Yves Coupin in the latest episode of the Credit Edge podcast. “There’s too much capital that needs to be put to work,” says Padgett, noting potential for LBOs in the technology, health care and services sectors. We also discuss the rise of distressed debt exchanges, leveraged loan risk, the impact of tariffs on weak borrowers and why default rates should fall next year.
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Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:17):
Hello, and welcome to the Credit Edge Weekly Markets Podcast.
My name is James Crumbie. I'm a senior editor at Bloomberg.
Speaker 2 (00:23):
And I'm John if Cooper, a senior credit analyst at
Bloomberg Intelligence. This week, we are very pleased to welcome
Christina Patchett, Associate Managing Director at Moody's.
Speaker 3 (00:31):
How are you, Chris Good pleased to be here.
Speaker 2 (00:35):
Christina, with whom I had the privilege to work a
few years ago, as a unique perspective on the credit markets.
Form of her many credit cycles at Moody's and previously
as an investment banker at JP Morgan, she regularly meets
with investors, regulators, bankers, and she also chairs many high
yel rating committees across a broad range of industries. In
(00:55):
her research, she covers the trends in the credit market,
including corporate defaults, liquidity, and more recently, the growing private
credit markets.
Speaker 1 (01:05):
Credit markets are hot, with bond spreads at the titles
in almost twenty seven years. As demand's sows and net
new supply remains thin, the buying hasn't been entirely indiscriminate, though,
with spreads on the riskiest part of the market triple
C rated bonds staying quite wide. That highlights concerns about
missed debt payments as rates stay high and the economy
comes under pressure from tariffs and immigration reform. But it's
a quite small part of the market and investors don't
(01:26):
really expect blow ups there to have much of a
ripple effect. Moody's had a recent report showing that the
number of companies rated B three and lower hit the
highest level in almost a year. For our listeners, not
aware that B three rating is equivalent to B minus
from other rating agencies, So it's just one notch higher
than triple C, which is the grade given to companies
that probably won't pay you back. So Chris break it
(01:49):
down for us, Why are there more of these very
risky companies right now?
Speaker 3 (01:53):
Well, there's a number of dynamics at work here, some
from the past and some from the more recent past.
So over time, the B three negative list has become
longer as a consequence of higher rates, really weighing on
some of the most highly leveraged companies that we follow
in the specuative grade universe. After April, we had another
(02:15):
set of challenges around the tariffs and what has happened
since then is companies that are either cyclical or vulnerables
to specific tariffs have experienced volatility, uncertainty, and rising costs.
So there's been a combination of factors, and going forward
they may also feel pressure on the revenue side as
(02:38):
consumers become more selective.
Speaker 2 (02:41):
So I guess in terms of sectors, I mean, which
one are the more exposed and why?
Speaker 3 (02:46):
Well, I think what we see is on the industry side.
You might think of consumer durables, automotive, We've had some
pressure in a chemical sector, retail and apparel, and I
could go on. But there's another way to think about
this population, and that is LBO versus non a LBO,
(03:07):
because the majority, the vast majority of the population on
our distress list are actually LBOs and they've made themselves
to some degree more vulnerable by virtue of being concentrated
in floating rate debt, which has put a bigger burden
on those companies as rates have stayed high.
Speaker 2 (03:26):
But I suppose with you know, tariffs and potential, you
know margin squeeze effects from those, you know, some subset
some industries will will probably be more exposed. Is a
market differentiating that at the moment or are you seeing
you know, significant difference in terms of you know, default
rate by by industry or is it pretty homogeneous.
Speaker 3 (03:47):
Well, I think it is very easy to discern where
there is more skepticism on the part of investors, and
so you do see weakness in those industries that are
exposed to as more specifically, and conversely you see demand
for for example, software companies, and the reason being is
(04:08):
that they tend to not be cyclical. They don't have
a lot of a capital expenditure requirements, they're embedded in
many companies, so the revenue source is a little bit
more secure. They tend not to be so cyclical. So yes,
you know, there's winners and losers here for sure.
Speaker 1 (04:27):
Beyond fundamentals, there's also liquidity to consider. I mean, the
idea generally is that liquidity is very ample for all
borrowers and they've got many different options, including private credit.
Is that the case all the way down to B three?
Speaker 3 (04:38):
I would say more than it used to be, because
that is one of the things that's been notable about
this market is even with all the uncertainty, there is
still a fair amount of liquidity. We have seen though
some different kinds of discrimination. For example, we see that
the COLO investor has actually decided to more orient towards
(04:59):
B two A higher ratings, So these be quite comfortable
with the B three B three structure. Now maybe appeals
more to private credit B three negative and below distress.
Everybody kind of hesitates there, although we have seen direct
lenders at times step in on these weaker credits, whether
they ask the private equity sponsor to kick in more equity.
(05:22):
You know, that may be the case. We see that
much less frequently on the public side. There, we see
we're more likely to see a distressed exchange.
Speaker 2 (05:32):
Could you maybe be more specific in terms of maybe
for our listeners what moodies define as a distressed exchange
as opposed to default of missing an interest payment for instance.
Speaker 3 (05:42):
Sure, because I would say that one person's distressed exchange
is another person's pick right. For example, in our world,
if a company has committed to at inception of the transaction,
committed to servicing their debt and then, due to cash
flow pressure, converts to picking payment in kind. In other words,
(06:04):
you build up your debts as opposed to actually providing
cash interest. For us, that is a default. Secondarily, if
you amend and extend your credit agreement. That can also
be considered a default. Not everybody would across Wall Street
assume that, but for us, it means that you're not
(06:24):
meeting your original commitment. I think we would all agree
in regard to distressed exchanges that when somebody gives you
less than one hundred cents on the dollar to exchange
your debt, that that's a distressed exchange.
Speaker 1 (06:37):
But that's become so widespread. You know, these what the
bank is like to called liability management, you know, which
ultimately is I think a default in disguise, But it
has become such a common practice, and even I don't know,
six months ago on this show, one of the investors
involved was calling it capitalism at work. You know that
you're just going to see this continue, and it's going
to get more aggressive. It's going to, you know, ultimately
(06:59):
impact invests even more. Where do you see this going?
Is it something that you think is going to spiral
from here or is it under control?
Speaker 3 (07:08):
Well, I guess the way I would describe it. First
of all, it is the majority of our defaults. Maybe
in the last round we looked at it was about
sixty five percent of total defaults. Were what we would
call a distressed exchange. Liability management transactions can emerge in
a variety of factions, some much more punitive to certain
(07:29):
investors and others, and some of that's been addressed with
more recent credit agreements trying to prevent these challenges in
terms of getting primed getting ahead of other lenders for example.
Whether this will continue, I think absolutely. Law firms are
very anxious to make as flexible a credit agreement as
(07:52):
possible for their sponsor clients, and I think there's nothing
that suggests to me, especially in an environment like this
where demand is high for paper, that that's going to change.
One point that we would like to make is there
is a little bit more movement on the debt investors
side to maybe cooperate with each other so that it's
(08:13):
there's less tension between investors, that they aren't feeling vulnerable
to one pitting one against the other.
Speaker 2 (08:20):
Another theme is is covenants, and I guess maybe they're
both related. We've seen you know, looser covenants, I guess
o our time, and that is also on the one
hand encouraging or creating maybe this kind of face liquidity
like liquidity. At the same time, those loose covenants may
also create down the line a much bigger problem for investors.
(08:43):
What's your opinion or what's your view on the current
state of the covenant pretiction.
Speaker 3 (08:50):
I think I would say, you know, broadly speaking, they're
week and they're going to stay weak. That is, if
you think that the majority of credits that default are
private equity back to LBOs, they are the borrowers most
committed to building flexibility into their credit agreements, and they
(09:11):
frequently succeed, especially in a market where there is demand.
I think it is probably worth noting that if you
do a distressed exchange once fix your balance sheet and
move forward, you actually have a pretty decent recovery, better
than the long term average if I'm speaking in broad averages.
(09:32):
But what we sometimes see with companies is they incrementally
have subsequent distressed exchanges and potentially ending up in a
chapter eleven that kind of destroys value unequivocally, and those
recoveries are often the worst.
Speaker 1 (09:48):
Seen one study that suggests it's fifty to fifty. You
know that half of these things don't actually work out,
in which case you know the lawyers are getting paid,
but the problem is not being solved. Is that sort
of a fair amount, fair assessment of what's going on.
Speaker 3 (10:00):
It's pretty close to true. About half the time you
do it as stressed exchange, you fix your balance sheet.
You know, maybe it was a production problem, maybe it
was a swift change in the rate environment. But half
the time, yeah, you can. You'll fix your balance sheet,
move on, and investors actually, relatively speaking.
Speaker 2 (10:21):
Do better.
Speaker 3 (10:22):
If, on the other hand, that the other half of
the time, yeah, you're just in for a deteriorating credit.
With valuation dissipating over time.
Speaker 1 (10:32):
There's a bit of a coin toss. I'm glad you
mentioned recoveries though, because that's also something that has really
diminished over time. I mean, I remember some years ago
it must be that you'd expect to get seventy eighty
cents back on a loan, for example, but now it's
more like thirty forty. Is that kind of roughly where
we are and why is that and where does it
go from here?
Speaker 3 (10:50):
I would say that's a little bit dramatic. So historically
senior secured loans did recover probably close to eighty cents
on the dollar, and that's a long term average. We
have plenty of history to suggests as much. What really
changed was the balance sheet. And if your entire balance
sheet is a first lean loan and average recoveries around
(11:13):
fifty cents, you're going to get fifty cents if that
particular issuer decides to default. So it's the change in
the structure. In the old days, which I was present for,
you had a senior secured loan and you had high
yield bonds. Highield bonds were unsecured and below the loans
(11:33):
and absorbed the majority of the risk. After the financial crisis,
rates went down and the market decided that they liked
the loan market, they liked the security, and that market exploded,
and to the extent that now we have plenty of
credits in the portfolio that are maybe first lean, second lean,
(11:54):
but both secured loans or first lean only, and those
in distress do the worst.
Speaker 2 (12:02):
As you said, this market exploded, and I want to say,
and to some extent so default rates. I think we're
close to six percent right now. What's your antlouch for
default rates and why?
Speaker 3 (12:15):
Well, that's an interesting question because while defaults were relatively
high over the past year, and certainly well above the
long term average, our forecast by this time next year
is quite the opposite. So if you think about the
default rate today at being close to six percent, it's
probably going to be down around three percent according to
(12:36):
our forecast by this time next year. The challenge to
that assumption are many though. There's so much volatility in
the market now, there's greater than average volatility. When we
do our forecast, we usually have an optimistic case and
a pessimistic case. The optimistic case and the base case
they're right on top of each other. There isn't any
(12:58):
more to give there the pessimistic case, things could get
a lot worse.
Speaker 1 (13:05):
What does that rely on? I mean, what is pessimistic?
I mean there's so many different views of the economy
and markets right now. What's pessimistic?
Speaker 3 (13:13):
Well, I will say that just to be clear, our
forecast isn't bottoms up. We're not looking at every credit
that we rate and saying what does this look like
when we aggregate this information. It's called a credit transition model,
and it's driven by the change in ratings, the change
in outlooks, the change in the momentum of downgrades, then
(13:35):
the high old spread, the change in the high old spread,
and the change in unemployment. So with spreads as narrow
as they are, with the expectation that we might get
a couple of rate cuts by the end of this year,
you actually can imagine that the market will strengthen somewhat
at the low end and default would go down. But
(13:57):
there's been so much volatility that you can imagine the
investors would take a different view over the next twelve months,
and spreads good widen That would be a big driver
of a change in our forecast, and unemployment, which is
pretty has remained relatively at modest levels today, could worsen.
Speaker 1 (14:19):
Those are drivers, right, But now we're in a situation where,
you know, all those things make sort of rational sense
in sort of macroeconomic terms, textbook style, that we're in
a world where, you know, can we trust the numbers
on the unemployment side, can we you know, do we
know what's going on at the BLS. There's all this
immigration reform that's muddying the waters a bit. And then
(14:40):
the other one is spreads, which you mentioned, which I'm
fascinated by at the moment because for so long now
people have been asking me why they're so tight when
you know the macro isn't isn't amazing, It's not brilliant,
but they just keep getting tight. And I think it's
just because there's more demand than supply, as simple as that.
Speaker 3 (14:56):
Yeah, No, I agree with you, and I think the
issue around the supplied demand dynamic works in the favor
of the market for existing issuers, and it might be
a technical that allows for them to be that allows
for more liquidity, but that can prop up the market
for a while. So with spreads this narrow, you can refinance,
(15:18):
you can reprice, and that will support a lot of
the market. It will take much longer, I think for
a negative momentum to appear when you have this kind
of demand. It's interesting. You know, economic fundamentals are very important,
but so it's just you know, having someone who wants
(15:38):
to invest in your company, and you know, the clos
in twenty twenty four and twenty twenty five, I think
that's been incredibly strong new issuance and so that supports
this market.
Speaker 2 (15:50):
And to your point, there's also fairly new entrant in
this market is private demand. Private credit. There seems to
be occurring up tight from you know, private credits, potentially
opening this to retail investors. At some point. How do
you see this playing up in the finance and the
companies that you rate well.
Speaker 3 (16:11):
I think the part of the market that's public will
continue to potentially actually move to slightly higher credit quality
because there will be opportunity to go to the private side.
So if you think, for example, of the leverage loan index,
it actually weakened pretty dramatically with the demand from clos
(16:34):
for low rated paper when rates went down. As rates
went back up, you know, there was this migration as
I mentioned earlier, from a B three to a B two,
and actually loan size in the index got larger. So
if you think of a larger deal and a higher
(16:55):
rated deal as probably improving credit quality, that's what you'll
see within the leverage loan market. And those transactions are
migrating to the private side. So I don't think they're
going to get smaller. I think there's still a lot
of liquidity that needs to be put to work, but
you could actually see better quality on the public side.
Speaker 1 (17:19):
Does that mean that the private markets are essentially paraphrasing
and probably being crude but taking all the rubbish that
the public markets don't want, you know, those weaker companies
are basically paying up for that access. And how sustainable
is that for their bounds sheets.
Speaker 3 (17:33):
Well, I'm not going to call it rubbish. I would
call it higher risk. They and they have a different
relationship with the issuers. For example. What I did say
earlier is that when you have a public issuer and
they're in distress, they tend to do a distressed exchange.
If you have a bilateral relationship with a direct lender,
(17:54):
you might actually have to put in more equity in
order to get that revolver extension or the loan extension
or you know, the ability to pick. So I think
I think the answer is more complex and more nuanced.
In that. That being said, I am certainly concerned that
(18:16):
there is more liquidity than assets to satisfy investors and
that that is an issue. And the mystery evaluation is
much higher with all these private companies. You know, if
you have a publicly traded entity, you have some sense
of the value not always right right. Market has psychology
(18:38):
in it as well, but it is much more complicated
to value non traded assets, for example.
Speaker 2 (18:46):
And that's sim also to create higher risk because on
the private credit side, especially private credit with more open
to retail investors, you may have also different you know,
liquidity needs or demands that and be created, and maybe
potentially a mismatch between what people are planning to lend
and for how long and the need to sell some
(19:09):
of the assets. So it could it be like a
bit of fatiguing bomb going forward where you may see
or may see significantly higher assets being financed when they
could maybe not be before.
Speaker 3 (19:23):
Well, I think on the retail side, the pickup is
going to be slower than might otherwise happen as a
consequence of the financial advisors being cautious about introducing these
kind of assets to you know, within four on one
(19:44):
case for example, So the pickup may not be as
aggressive as on the private side, where you have sophisticated
investors looking for long term returns. You know, the advantage
of private credit has been that, for example, you have
large insurance investors that can tolerate volatility because they can
(20:06):
ride out weakness in a cycle. They have very long
horizons that they need to invest. Theoretically, so do four
on one K investors, but they don't always operate that
way right. Sometimes you actually need to take that cash
out and they tend to be less sophisticated. There is
a potential for that part of the market to grow
(20:26):
more slowly and for more rulemaking to change before that
becomes a really dominant part of private credit.
Speaker 2 (20:33):
What about disclosure are we are we looking at with
a more important role played by private credits? Could we
go towards a model where we are seeing less disclosure
transaction that being done away from the public eye. Pricing
reference might actually disappear in the market or when you
know it's sort of price discovery mode. Do you think
(20:55):
that that could translate into less disclosure you're in more
opescity or more omplix transaction.
Speaker 3 (21:03):
Yes, absolutely, and I think that is something that we
particularly at Moodies, are sensitive to. We rate most of
the BDC sector, So BDCs are companies that are direct
lenders acquiring a lot of these leverage loans to LBOs.
(21:24):
They do have more reporting requirements than other parts of
private credit. For example, they are publicly traded, they are
subject to Securities forty Act, and yet it's still a
challenge to see the underlying performance. But they do have
to report where the loans are trading every quarter. It's
(21:45):
still a relatively illiquid market, but it does provide some insight.
I think the greater concern is potentially other parts of
private credit which are still evolving and which have less requirements.
And what we really see now is an immigration to
what we would call asset based finance and greater incursions
(22:06):
into securitizations. Those add not just opacity, but also complexity.
At the same time, I think there's a real demand
for capital.
Speaker 1 (22:17):
Right.
Speaker 3 (22:17):
Some of the things that they are intending to finance
is this momentum towards deglobalization, is the need for data centers.
You know, there are certainly reasons why there's this opportunity
for private credit. It just it lacks a certain kind
of transparency and a.
Speaker 1 (22:36):
Lot of that stuff's actually being rated investment rate, isn't.
Speaker 3 (22:38):
It by some body. That's a tough question for me
to answer.
Speaker 1 (22:45):
Just changing the topic though, back to private equity. You know,
you mentioned at the top that that has been a
source of defaults. You know, the LBOs have done at
very low rates and now they're having to pay that
money back. Where do we stand with that and what's
the outlook from here in terms of you know, does
private actually come back, do LBOs come back? Do you
expect that to revive it at any point.
Speaker 3 (23:07):
You know, it's an interesting question. We ask ourselves the
same question. A couple of things are certainly true, which
has been there's been a really a much slower turnover
of these LBOs. And we've looked at private equity investors
holding on to issuers much longer than they would have
(23:27):
in a different environment. But they bought in a zero
right environment at a very high multiple, and it's been
tough as growth has slowed to grow into that balance
sheet in a satisfactorily in a satisfactory way. So we
have seen the slow down in exits, and we've seen
(23:48):
a slow down also in new LBA formation for similar reasons.
You know, valuations are tough for sellers as well. I
think though ultimately everyone will need to adjust to the
new environment and you will see deal flow come back.
There's too much capital that needs to be put to work.
(24:09):
It's not going to stay you sort of immobilized forever.
When we look at the fall now and the relative
stability we've seen in the economy, I think you could
imagine this fall being busier than it has been thus far.
But as I pointed out earlier, there's just much more
unpredictability within this economy than maybe many of us are
(24:33):
accustomed to do, and that has been among the valuation
issues itself. It's not just where rates are, it's not
just that growth has slowed, But if you don't know
what's happening next on the tariffs, it's much harder to forecast.
Speaker 2 (24:49):
Maybe take a step back and look at the credit cycle.
I mean, you have very extensive experience and monitoring and
filling with credits. Where do you think we are in
the creative cycle? Are we kind of have we passed
a peak or or not? Or is it very difficult
to say because of all those uncertainties you just.
Speaker 3 (25:09):
Mentioned, I think it's harder to call, so thank you
for putting me on the spot. But I we do
feel like we've just gone through a pretty notable default cycle.
We've we've watched some companies get flushed out, you know,
where where they the multiples were too high, the forecast
(25:31):
was too optimistic. And I think we've been in this
environment potentially long enough that there's just going to have
to be a more conservative take going forward. I think
it's possible we'll see more equity in some of these
LBOs as they try and access the market. I say
(25:53):
that while I would also observe that, I feel like
we're still going to see documentation being very much on
the borrowers to the borrowers advantage, and that's how they'll balance,
you know, the expectation that potentially they create a more
conservative balance sheet.
Speaker 1 (26:13):
So the default wave is over.
Speaker 3 (26:15):
Oh, you're not going to the default wave is over.
We are forecasting lower defaults from what we can see today.
There will always be defaults. You know, we have a
seventeen zero point five percent of the population is be
three negative and below. Will continue to see defaults, will
(26:39):
they be lower than they have been over the past
twelve months. I think that's what we expect right now.
Speaker 1 (26:45):
And that is essentially speaking to better macroeconomic conditions, better liquidity,
and the fact that the bad companies have already been
taken out. Is that yes, fair enough? Sounds quite bullish. Therefore,
I mean, we debate the what looks like a mismatch
between economic fundamentals, you know, balance sheets, leverage and the price.
(27:09):
But it sounds like if we if we're through the
worst of the defaults and we're coming out and it's
going to get down to three percent next year, that
that actually these levels are justified in the market.
Speaker 3 (27:17):
I don't. I don't actually spend most of my day
thinking about the the right spread for a certain level
of economic risk. What I would say is that this
is a heart this is probably and that you can
speak to CEOs, you can speak to people in the
in the financial community. This is a hard market to forecast.
(27:41):
So while I think that we have evidence that you know,
there's enough stability for for this market, I think that
it's much harder to say what the longer term impact
of a materially higher tear for will be on the
(28:01):
US economy.
Speaker 2 (28:03):
Maybe moving onto the covenants, and you mentioned a couple
of occasions, but some of the lenders or the investors
are trying to get together and maybe alter a little
bit the balance of power between between them. The companies
or the banks that are bringing deals to the market,
PE firms and UH and the investors in the end
(28:26):
support the risk. I also noticed that some companies actually
have already been pretty aggressive in terms of some examples,
I think American Greeding Corporation being sold sponsor to sponsor
without triggering any change of control. Close What are you
what do you see on your end in terms of
(28:47):
investors trying to afflict their muscles and and try to
be maybe a little bit like in the UK, sometimes
you see maybe more coordination between between investors to try
to tell the scale to where they're in their favor.
Speaker 3 (29:02):
There's some of that. There's occasions where they decide, you know,
to you know, coordinate more so that there isn't the
dispersion in terms of who gets what and who gets primed.
There's still plenty of opportunities to do that. I think
also on the sponsor side, they're a little more sensitive
perhaps and they had been in terms of not alienating investors.
(29:26):
That being said, I think, to use a cliche, investors
are often fighting the last war, so you know, some
part of the covenant gets exploited, they fix that in
the credit agreement, and then they find a new opportunity.
That being said, you know, there's also is some discrimination.
There weren't very many high healed bonds in the market
(29:48):
in terms of LBOs, but two recent ones I think
it's called Sizzling Platter that was a B three. They
tightened up that bond agreement pretty tightly. At the same time,
there was probably the Sketchers deal. I think they got
everything they wanted, So now that was a B two.
(30:10):
I believe actually it might have been a bee too positive.
So you can see that there is some pressure when
it comes to better credit quality if there's positive momentum.
And probably there were a lot of investors interested in
holding Sketchers, and so they got all the flexibility that
they asked for pretty much, and Sizzling Platter did not.
Speaker 1 (30:34):
So the covenant outlook is mixed, and it's not really
like it's getting worse. It's kind of hit a sort
of stable level. But but I do wonder, you know,
whether when we see all this, as you said earlier,
I think excess liquidity not enough to buy, does that
not just keep the pressure on weaker covenants? Is that
not going to push it? You know? I mean that
the lawyer is a key to be as creative as
(30:54):
they possibly can. So why wouldn't the borrowers jump on it?
Speaker 3 (30:57):
One hundred percent? Yes, I mean I think if you
have been in this market for as long as I
have said, you know, twenty five years, covenants are very
different than they used to be. And I would certainly
argue that if you want to do something aggressive to
(31:18):
protect the LBO versus the creditors. You can there are ways.
Speaker 1 (31:27):
Are there any particular areas where we think LBOs might
make you come back? In terms of sectors, Do you
think that we're going to see more consolidation in any
particular and you mentioned software earlier, is that potential an
area for that.
Speaker 3 (31:39):
I think that that we are going to continue to
see tech deals for sure. You know, healthcare, we always
see a lot of service deals. Those are probably the
three largest exposures, CLOS and BBC's right, both sides of
the of the LBO market. I think that that will continue.
(32:00):
I think the tougher deals will be anything that has
a foreign component. You know, until that gets resolved, that's
going to put a lot of that will create a
lot of challenges for businesses.
Speaker 1 (32:15):
So kind of given the impact that trade has had
on tariffs I've had on the market generally on borrowers
and the weaker borrowers. You know, we are at a
point where there is one of our guests called stroke
of the pen risk and that anything could be signed
or announced on truth social at any time that could
fundamentally also the landscape for lots of different companies and
(32:36):
their balance sheetes do you you know that there are
more vulnerabilities potentially out there, and that there is more
political risk now in the US market that the will
affect leverage finance.
Speaker 3 (32:47):
I think that anything that brings greater volatility to the
market makes a leverage finance issuer more vulnerable. These are
highly leveraged companies. You know, it can be geo political,
it can be oil crisis, right, it can be COVID.
You know, these are vulnerable companies. You know, when we
(33:09):
rate a company investment grade, it usually means that it
can muddle through a variety of cyclical downturns. Low single
big companies, they're vulnerable to it all. So, yes, none
of that has changed.
Speaker 2 (33:25):
Very much. Back to the basics of cash flo predictability
and some companies lending themselves to more suited for an
LBO than others. I mean you mentioned healthcare. Seen a
record level of transactions in healthcare, but also very high
to fools a couple of years ago that I've come
down quite a bit. But there's also reading uncertainty in
(33:47):
healthcare right now, so we could see a bit of
a pee cup.
Speaker 3 (33:49):
I would think that's been a tough one because in
theory it's appealing for an LBO because you know, it
tends not to be cyclical, right it take out COVID,
which obviously riag TABOC in that area, but in general
it should be a relatively stable on the demand side.
What has troubled a lot of healthcare companies generally speaking
(34:12):
is change in the regulatory environment on anticipated changes in
the regulatory environment, and that those are hard to predict,
but they can be pretty dramatic when they happen.
Speaker 1 (34:23):
But the risk is more on the foreign ownership side
given the administration. Is that correct? I mean, if you
see a company that's got a foreign ownship or it's
got a foreign angle to it, maybe they impose a
lot of romative. Is that something that is particularly like
a red flag for ratings?
Speaker 3 (34:42):
Well, so I would say not foreign ownership, but foreign input, right,
And so will it take them longer to restructure their
supply chain things like that? You know, as in everything
in this market, it kind of depends on the price.
I can't I could certainly see a private equity firm
(35:02):
looking at a company and saying, you know, if there
weren't terriff pressure, it would be a twelve times company
now it's a nine times company, and I see an
opportunity here, you know, I don't. I don't think you
will see no manufacturing deals for example. It's just it
(35:23):
does create a much difficult forecasting environment.
Speaker 1 (35:27):
And it's across the board. It's not just a couple
of sectism and that there's more of a like a
widespread impact on leverage, bonds and loans.
Speaker 2 (35:36):
Yes.
Speaker 1 (35:38):
Yeah.
Speaker 2 (35:38):
As a writer, when you look at a transaction, would you,
given the uncertainty and the difficulty to forecast earnings, would
you say that you're inclined to take an even more
conservative or a more conservative approach to the kind of
forecast that a company can produce.
Speaker 3 (36:00):
I think analysts are looking at their companies and speaking
with the CFO and the CEO and trying to come
up with a realistic scenario. You know, every analyst, probably
every investor figures out a downside case. You know, determines
whether the downside case is close to realistic or is
(36:22):
too dramatic. But I think it's pretty hard not to
build in a certain amount of conservatism on the on
the P and L side. But alternatively, you know, there
is the potential for rates to go down, and that
(36:42):
means that you might see some increased ability to service
the debt. So I think everything is being taken into consideration,
but I think it's fair to say we're pretty conservative
most of the time. You may remember that, John Eve.
Speaker 1 (36:59):
The reasons, as John you've stated at the top we're
so delighted to have you on the show, Christina, is
that you have such a long track record and you've
seen a lot of things in the market. And I'm
interested in putting this market into perspective because I've also
been doing this a fair amount of time. But I
also find it very confusing in terms of you know,
what's going on and what the market does in response
to that, And some of the things that we've seen
(37:20):
over the last six months would have been enough, I think,
to cause a major panic, but the market just keeps
going up. So I'm interested in, you know, if you
could put it in some kind of historical terms, you know,
how would you compare this market.
Speaker 3 (37:33):
So a challenging question without having time to think a
lot about the history. But I would say is most
pronounced about being involved in leverage finance is it is
always changing. And I could tell you that you know,
the first thing that happened when I was following leverage
finance was Russia defaulted on a response and that impacted
(37:57):
the US leverage finance market, which was fascinating because you know,
they seem quite unrelated. So that was in the late nineties,
and then we went to the dot com bust, and
there were a couple of other challenges along the way,
but obviously the big challenge was two thousand and eight,
and it was very interesting to watch how the change
(38:20):
in rates really grew this market from what was almost
exclusively a high yield bond market with a very small
loan market. The loan market was probably three hundred billion
prior to the financial crisis to where we are today,
where if you where the loan market and the bond market,
they're about the same size, over three trillion dollars together,
(38:43):
and a real concentration in private equity private companies really
you know, about half the market or private companies. So
a lot has changed over time. Not I can't compare
today to something that we've seen in the past. Almost
each time it's been quite different.
Speaker 2 (39:04):
Right.
Speaker 3 (39:05):
The last dramatic moment we would probably leave share would
be COVID that was definitely not foreseen, but the market
comes back each time.
Speaker 1 (39:16):
And in terms of you know, moodies, we look to
you to identify risk and I'm keen to know if
you know, we've we've talked about a lot today, But
is there anything else else out there that you should
think we should be more focused on, we should be
worried about in terms of, you know, potential canaries in
the coal mine for leverage finance.
Speaker 3 (39:34):
I think what I pay attention to when I think
broadly about the space as opposed to you know, individual
ratings or our default forecast, is just given how much
liquidity there is in the market today, is there a
concern around valuation broadly? As more of the market is private,
(39:55):
whether it's in the leverage loan market on the rated
side or within the direct lenders, it's just tougher to
get that kind of information, So that I think that's
something that is probably one of the big differences as
we've evolved over time in this market that I think
(40:15):
I keep an eye.
Speaker 1 (40:16):
On that ultimately leads to investors overpaying and then suffering
losses down the road.
Speaker 3 (40:23):
Could but doesn't have to you know, the problems you
don't know and when it starts to become a parent
is later than you're accustomed to.
Speaker 1 (40:33):
Great stuff. Christina Paget, Associate Managing Director with Moodies. It's
been a pleasure having you on the Credit Edge. Thanks,
and of course I'm very grateful to Johnny Coupan from
Bloomberg Intelligence. Thank you very much for joining us today.
For more credit market analysis and insight, read all of
Johnny Coupan's great work on the Bloomberg Terminal. Bloomberg Intelligence
is part of our research department, with five hundred analysts
and strategists working across all markets. Coverage includes over two
(40:56):
thousand equities and credits and outlooks on more than ninety
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 at bpod Go. Give us a review,
tell your friends, or email me directly at Jcrombier at
(41:16):
Bloomberg dot net. I'm James Crombie. It's been a pleasure
having you join us again next week on the Credit Edge.
Hello, and welcome to the Credit Edge Weekly Markets Podcast.
My name is James Crumbie. I'm a senior editor at Bloomberg.
Speaker 2 (00:23):
And I'm John if Cooper, a senior credit analyst at
Bloomberg Intelligence. This week, we are very pleased to welcome
Christina Patchett, Associate Managing Director at Moody's.
Speaker 3 (00:31):
How are you, Chris Good pleased to be here.
Speaker 2 (00:35):
Christina, with whom I had the privilege to work a
few years ago, as a unique perspective on the credit markets.
Form of her many credit cycles at Moody's and previously
as an investment banker at JP Morgan, she regularly meets
with investors, regulators, bankers, and she also chairs many high
yel rating committees across a broad range of industries. In
(00:55):
her research, she covers the trends in the credit market,
including corporate defaults, liquidity, and more recently, the growing private
credit markets.
Speaker 1 (01:05):
Credit markets are hot, with bond spreads at the titles
in almost twenty seven years. As demand's sows and net
new supply remains thin, the buying hasn't been entirely indiscriminate, though,
with spreads on the riskiest part of the market triple
C rated bonds staying quite wide. That highlights concerns about
missed debt payments as rates stay high and the economy
comes under pressure from tariffs and immigration reform. But it's
a quite small part of the market and investors don't
(01:26):
really expect blow ups there to have much of a
ripple effect. Moody's had a recent report showing that the
number of companies rated B three and lower hit the
highest level in almost a year. For our listeners, not
aware that B three rating is equivalent to B minus
from other rating agencies, So it's just one notch higher
than triple C, which is the grade given to companies
that probably won't pay you back. So Chris break it
(01:49):
down for us, Why are there more of these very
risky companies right now?
Speaker 3 (01:53):
Well, there's a number of dynamics at work here, some
from the past and some from the more recent past.
So over time, the B three negative list has become
longer as a consequence of higher rates, really weighing on
some of the most highly leveraged companies that we follow
in the specuative grade universe. After April, we had another
(02:15):
set of challenges around the tariffs and what has happened
since then is companies that are either cyclical or vulnerables
to specific tariffs have experienced volatility, uncertainty, and rising costs.
So there's been a combination of factors, and going forward
they may also feel pressure on the revenue side as
(02:38):
consumers become more selective.
Speaker 2 (02:41):
So I guess in terms of sectors, I mean, which
one are the more exposed and why?
Speaker 3 (02:46):
Well, I think what we see is on the industry side.
You might think of consumer durables, automotive, We've had some
pressure in a chemical sector, retail and apparel, and I
could go on. But there's another way to think about
this population, and that is LBO versus non a LBO,
(03:07):
because the majority, the vast majority of the population on
our distress list are actually LBOs and they've made themselves
to some degree more vulnerable by virtue of being concentrated
in floating rate debt, which has put a bigger burden
on those companies as rates have stayed high.
Speaker 2 (03:26):
But I suppose with you know, tariffs and potential, you
know margin squeeze effects from those, you know, some subset
some industries will will probably be more exposed. Is a
market differentiating that at the moment or are you seeing
you know, significant difference in terms of you know, default
rate by by industry or is it pretty homogeneous.
Speaker 3 (03:47):
Well, I think it is very easy to discern where
there is more skepticism on the part of investors, and
so you do see weakness in those industries that are
exposed to as more specifically, and conversely you see demand
for for example, software companies, and the reason being is
(04:08):
that they tend to not be cyclical. They don't have
a lot of a capital expenditure requirements, they're embedded in
many companies, so the revenue source is a little bit
more secure. They tend not to be so cyclical. So yes,
you know, there's winners and losers here for sure.
Speaker 1 (04:27):
Beyond fundamentals, there's also liquidity to consider. I mean, the
idea generally is that liquidity is very ample for all
borrowers and they've got many different options, including private credit.
Is that the case all the way down to B three?
Speaker 3 (04:38):
I would say more than it used to be, because
that is one of the things that's been notable about
this market is even with all the uncertainty, there is
still a fair amount of liquidity. We have seen though
some different kinds of discrimination. For example, we see that
the COLO investor has actually decided to more orient towards
(04:59):
B two A higher ratings, So these be quite comfortable
with the B three B three structure. Now maybe appeals
more to private credit B three negative and below distress.
Everybody kind of hesitates there, although we have seen direct
lenders at times step in on these weaker credits, whether
they ask the private equity sponsor to kick in more equity.
(05:22):
You know, that may be the case. We see that
much less frequently on the public side. There, we see
we're more likely to see a distressed exchange.
Speaker 2 (05:32):
Could you maybe be more specific in terms of maybe
for our listeners what moodies define as a distressed exchange
as opposed to default of missing an interest payment for instance.
Speaker 3 (05:42):
Sure, because I would say that one person's distressed exchange
is another person's pick right. For example, in our world,
if a company has committed to at inception of the transaction,
committed to servicing their debt and then, due to cash
flow pressure, converts to picking payment in kind. In other words,
(06:04):
you build up your debts as opposed to actually providing
cash interest. For us, that is a default. Secondarily, if
you amend and extend your credit agreement. That can also
be considered a default. Not everybody would across Wall Street
assume that, but for us, it means that you're not
(06:24):
meeting your original commitment. I think we would all agree
in regard to distressed exchanges that when somebody gives you
less than one hundred cents on the dollar to exchange
your debt, that that's a distressed exchange.
Speaker 1 (06:37):
But that's become so widespread. You know, these what the
bank is like to called liability management, you know, which
ultimately is I think a default in disguise, But it
has become such a common practice, and even I don't know,
six months ago on this show, one of the investors
involved was calling it capitalism at work. You know that
you're just going to see this continue, and it's going
to get more aggressive. It's going to, you know, ultimately
(06:59):
impact invests even more. Where do you see this going?
Is it something that you think is going to spiral
from here or is it under control?
Speaker 3 (07:08):
Well, I guess the way I would describe it. First
of all, it is the majority of our defaults. Maybe
in the last round we looked at it was about
sixty five percent of total defaults. Were what we would
call a distressed exchange. Liability management transactions can emerge in
a variety of factions, some much more punitive to certain
(07:29):
investors and others, and some of that's been addressed with
more recent credit agreements trying to prevent these challenges in
terms of getting primed getting ahead of other lenders for example.
Whether this will continue, I think absolutely. Law firms are
very anxious to make as flexible a credit agreement as
(07:52):
possible for their sponsor clients, and I think there's nothing
that suggests to me, especially in an environment like this
where demand is high for paper, that that's going to change.
One point that we would like to make is there
is a little bit more movement on the debt investors
side to maybe cooperate with each other so that it's
(08:13):
there's less tension between investors, that they aren't feeling vulnerable
to one pitting one against the other.
Speaker 2 (08:20):
Another theme is is covenants, and I guess maybe they're
both related. We've seen you know, looser covenants, I guess
o our time, and that is also on the one
hand encouraging or creating maybe this kind of face liquidity
like liquidity. At the same time, those loose covenants may
also create down the line a much bigger problem for investors.
(08:43):
What's your opinion or what's your view on the current
state of the covenant pretiction.
Speaker 3 (08:50):
I think I would say, you know, broadly speaking, they're
week and they're going to stay weak. That is, if
you think that the majority of credits that default are
private equity back to LBOs, they are the borrowers most
committed to building flexibility into their credit agreements, and they
(09:11):
frequently succeed, especially in a market where there is demand.
I think it is probably worth noting that if you
do a distressed exchange once fix your balance sheet and
move forward, you actually have a pretty decent recovery, better
than the long term average if I'm speaking in broad averages.
(09:32):
But what we sometimes see with companies is they incrementally
have subsequent distressed exchanges and potentially ending up in a
chapter eleven that kind of destroys value unequivocally, and those
recoveries are often the worst.
Speaker 1 (09:48):
Seen one study that suggests it's fifty to fifty. You
know that half of these things don't actually work out,
in which case you know the lawyers are getting paid,
but the problem is not being solved. Is that sort
of a fair amount, fair assessment of what's going on.
Speaker 3 (10:00):
It's pretty close to true. About half the time you
do it as stressed exchange, you fix your balance sheet.
You know, maybe it was a production problem, maybe it
was a swift change in the rate environment. But half
the time, yeah, you can. You'll fix your balance sheet,
move on, and investors actually, relatively speaking.
Speaker 2 (10:21):
Do better.
Speaker 3 (10:22):
If, on the other hand, that the other half of
the time, yeah, you're just in for a deteriorating credit.
With valuation dissipating over time.
Speaker 1 (10:32):
There's a bit of a coin toss. I'm glad you
mentioned recoveries though, because that's also something that has really
diminished over time. I mean, I remember some years ago
it must be that you'd expect to get seventy eighty
cents back on a loan, for example, but now it's
more like thirty forty. Is that kind of roughly where
we are and why is that and where does it
go from here?
Speaker 3 (10:50):
I would say that's a little bit dramatic. So historically
senior secured loans did recover probably close to eighty cents
on the dollar, and that's a long term average. We
have plenty of history to suggests as much. What really
changed was the balance sheet. And if your entire balance
sheet is a first lean loan and average recoveries around
(11:13):
fifty cents, you're going to get fifty cents if that
particular issuer decides to default. So it's the change in
the structure. In the old days, which I was present for,
you had a senior secured loan and you had high
yield bonds. Highield bonds were unsecured and below the loans
(11:33):
and absorbed the majority of the risk. After the financial crisis,
rates went down and the market decided that they liked
the loan market, they liked the security, and that market exploded,
and to the extent that now we have plenty of
credits in the portfolio that are maybe first lean, second lean,
(11:54):
but both secured loans or first lean only, and those
in distress do the worst.
Speaker 2 (12:02):
As you said, this market exploded, and I want to say,
and to some extent so default rates. I think we're
close to six percent right now. What's your antlouch for
default rates and why?
Speaker 3 (12:15):
Well, that's an interesting question because while defaults were relatively
high over the past year, and certainly well above the
long term average, our forecast by this time next year
is quite the opposite. So if you think about the
default rate today at being close to six percent, it's
probably going to be down around three percent according to
(12:36):
our forecast by this time next year. The challenge to
that assumption are many though. There's so much volatility in
the market now, there's greater than average volatility. When we
do our forecast, we usually have an optimistic case and
a pessimistic case. The optimistic case and the base case
they're right on top of each other. There isn't any
(12:58):
more to give there the pessimistic case, things could get
a lot worse.
Speaker 1 (13:05):
What does that rely on? I mean, what is pessimistic?
I mean there's so many different views of the economy
and markets right now. What's pessimistic?
Speaker 3 (13:13):
Well, I will say that just to be clear, our
forecast isn't bottoms up. We're not looking at every credit
that we rate and saying what does this look like
when we aggregate this information. It's called a credit transition model,
and it's driven by the change in ratings, the change
in outlooks, the change in the momentum of downgrades, then
(13:35):
the high old spread, the change in the high old spread,
and the change in unemployment. So with spreads as narrow
as they are, with the expectation that we might get
a couple of rate cuts by the end of this year,
you actually can imagine that the market will strengthen somewhat
at the low end and default would go down. But
(13:57):
there's been so much volatility that you can imagine the
investors would take a different view over the next twelve months,
and spreads good widen That would be a big driver
of a change in our forecast, and unemployment, which is
pretty has remained relatively at modest levels today, could worsen.
Speaker 1 (14:19):
Those are drivers, right, But now we're in a situation where,
you know, all those things make sort of rational sense
in sort of macroeconomic terms, textbook style, that we're in
a world where, you know, can we trust the numbers
on the unemployment side, can we you know, do we
know what's going on at the BLS. There's all this
immigration reform that's muddying the waters a bit. And then
(14:40):
the other one is spreads, which you mentioned, which I'm
fascinated by at the moment because for so long now
people have been asking me why they're so tight when
you know the macro isn't isn't amazing, It's not brilliant,
but they just keep getting tight. And I think it's
just because there's more demand than supply, as simple as that.
Speaker 3 (14:56):
Yeah, No, I agree with you, and I think the
issue around the supplied demand dynamic works in the favor
of the market for existing issuers, and it might be
a technical that allows for them to be that allows
for more liquidity, but that can prop up the market
for a while. So with spreads this narrow, you can refinance,
(15:18):
you can reprice, and that will support a lot of
the market. It will take much longer, I think for
a negative momentum to appear when you have this kind
of demand. It's interesting. You know, economic fundamentals are very important,
but so it's just you know, having someone who wants
(15:38):
to invest in your company, and you know, the clos
in twenty twenty four and twenty twenty five, I think
that's been incredibly strong new issuance and so that supports
this market.
Speaker 2 (15:50):
And to your point, there's also fairly new entrant in
this market is private demand. Private credit. There seems to
be occurring up tight from you know, private credits, potentially
opening this to retail investors. At some point. How do
you see this playing up in the finance and the
companies that you rate well.
Speaker 3 (16:11):
I think the part of the market that's public will
continue to potentially actually move to slightly higher credit quality
because there will be opportunity to go to the private side.
So if you think, for example, of the leverage loan index,
it actually weakened pretty dramatically with the demand from clos
(16:34):
for low rated paper when rates went down. As rates
went back up, you know, there was this migration as
I mentioned earlier, from a B three to a B two,
and actually loan size in the index got larger. So
if you think of a larger deal and a higher
(16:55):
rated deal as probably improving credit quality, that's what you'll
see within the leverage loan market. And those transactions are
migrating to the private side. So I don't think they're
going to get smaller. I think there's still a lot
of liquidity that needs to be put to work, but
you could actually see better quality on the public side.
Speaker 1 (17:19):
Does that mean that the private markets are essentially paraphrasing
and probably being crude but taking all the rubbish that
the public markets don't want, you know, those weaker companies
are basically paying up for that access. And how sustainable
is that for their bounds sheets.
Speaker 3 (17:33):
Well, I'm not going to call it rubbish. I would
call it higher risk. They and they have a different
relationship with the issuers. For example. What I did say
earlier is that when you have a public issuer and
they're in distress, they tend to do a distressed exchange.
If you have a bilateral relationship with a direct lender,
(17:54):
you might actually have to put in more equity in
order to get that revolver extension or the loan extension
or you know, the ability to pick. So I think
I think the answer is more complex and more nuanced.
In that. That being said, I am certainly concerned that
(18:16):
there is more liquidity than assets to satisfy investors and
that that is an issue. And the mystery evaluation is
much higher with all these private companies. You know, if
you have a publicly traded entity, you have some sense
of the value not always right right. Market has psychology
(18:38):
in it as well, but it is much more complicated
to value non traded assets, for example.
Speaker 2 (18:46):
And that's sim also to create higher risk because on
the private credit side, especially private credit with more open
to retail investors, you may have also different you know,
liquidity needs or demands that and be created, and maybe
potentially a mismatch between what people are planning to lend
and for how long and the need to sell some
(19:09):
of the assets. So it could it be like a
bit of fatiguing bomb going forward where you may see
or may see significantly higher assets being financed when they
could maybe not be before.
Speaker 3 (19:23):
Well, I think on the retail side, the pickup is
going to be slower than might otherwise happen as a
consequence of the financial advisors being cautious about introducing these
kind of assets to you know, within four on one
(19:44):
case for example, So the pickup may not be as
aggressive as on the private side, where you have sophisticated
investors looking for long term returns. You know, the advantage
of private credit has been that, for example, you have
large insurance investors that can tolerate volatility because they can
(20:06):
ride out weakness in a cycle. They have very long
horizons that they need to invest. Theoretically, so do four
on one K investors, but they don't always operate that
way right. Sometimes you actually need to take that cash
out and they tend to be less sophisticated. There is
a potential for that part of the market to grow
(20:26):
more slowly and for more rulemaking to change before that
becomes a really dominant part of private credit.
Speaker 2 (20:33):
What about disclosure are we are we looking at with
a more important role played by private credits? Could we
go towards a model where we are seeing less disclosure
transaction that being done away from the public eye. Pricing
reference might actually disappear in the market or when you
know it's sort of price discovery mode. Do you think
(20:55):
that that could translate into less disclosure you're in more
opescity or more omplix transaction.
Speaker 3 (21:03):
Yes, absolutely, and I think that is something that we
particularly at Moodies, are sensitive to. We rate most of
the BDC sector, So BDCs are companies that are direct
lenders acquiring a lot of these leverage loans to LBOs.
(21:24):
They do have more reporting requirements than other parts of
private credit. For example, they are publicly traded, they are
subject to Securities forty Act, and yet it's still a
challenge to see the underlying performance. But they do have
to report where the loans are trading every quarter. It's
(21:45):
still a relatively illiquid market, but it does provide some insight.
I think the greater concern is potentially other parts of
private credit which are still evolving and which have less requirements.
And what we really see now is an immigration to
what we would call asset based finance and greater incursions
(22:06):
into securitizations. Those add not just opacity, but also complexity.
At the same time, I think there's a real demand
for capital.
Speaker 1 (22:17):
Right.
Speaker 3 (22:17):
Some of the things that they are intending to finance
is this momentum towards deglobalization, is the need for data centers.
You know, there are certainly reasons why there's this opportunity
for private credit. It just it lacks a certain kind
of transparency and a.
Speaker 1 (22:36):
Lot of that stuff's actually being rated investment rate, isn't.
Speaker 3 (22:38):
It by some body. That's a tough question for me
to answer.
Speaker 1 (22:45):
Just changing the topic though, back to private equity. You know,
you mentioned at the top that that has been a
source of defaults. You know, the LBOs have done at
very low rates and now they're having to pay that
money back. Where do we stand with that and what's
the outlook from here in terms of you know, does
private actually come back, do LBOs come back? Do you
expect that to revive it at any point.
Speaker 3 (23:07):
You know, it's an interesting question. We ask ourselves the
same question. A couple of things are certainly true, which
has been there's been a really a much slower turnover
of these LBOs. And we've looked at private equity investors
holding on to issuers much longer than they would have
(23:27):
in a different environment. But they bought in a zero
right environment at a very high multiple, and it's been
tough as growth has slowed to grow into that balance
sheet in a satisfactorily in a satisfactory way. So we
have seen the slow down in exits, and we've seen
(23:48):
a slow down also in new LBA formation for similar reasons.
You know, valuations are tough for sellers as well. I
think though ultimately everyone will need to adjust to the
new environment and you will see deal flow come back.
There's too much capital that needs to be put to work.
(24:09):
It's not going to stay you sort of immobilized forever.
When we look at the fall now and the relative
stability we've seen in the economy, I think you could
imagine this fall being busier than it has been thus far.
But as I pointed out earlier, there's just much more
unpredictability within this economy than maybe many of us are
(24:33):
accustomed to do, and that has been among the valuation
issues itself. It's not just where rates are, it's not
just that growth has slowed, But if you don't know
what's happening next on the tariffs, it's much harder to forecast.
Speaker 2 (24:49):
Maybe take a step back and look at the credit cycle.
I mean, you have very extensive experience and monitoring and
filling with credits. Where do you think we are in
the creative cycle? Are we kind of have we passed
a peak or or not? Or is it very difficult
to say because of all those uncertainties you just.
Speaker 3 (25:09):
Mentioned, I think it's harder to call, so thank you
for putting me on the spot. But I we do
feel like we've just gone through a pretty notable default cycle.
We've we've watched some companies get flushed out, you know,
where where they the multiples were too high, the forecast
(25:31):
was too optimistic. And I think we've been in this
environment potentially long enough that there's just going to have
to be a more conservative take going forward. I think
it's possible we'll see more equity in some of these
LBOs as they try and access the market. I say
(25:53):
that while I would also observe that, I feel like
we're still going to see documentation being very much on
the borrowers to the borrowers advantage, and that's how they'll balance,
you know, the expectation that potentially they create a more
conservative balance sheet.
Speaker 1 (26:13):
So the default wave is over.
Speaker 3 (26:15):
Oh, you're not going to the default wave is over.
We are forecasting lower defaults from what we can see today.
There will always be defaults. You know, we have a
seventeen zero point five percent of the population is be
three negative and below. Will continue to see defaults, will
(26:39):
they be lower than they have been over the past
twelve months. I think that's what we expect right now.
Speaker 1 (26:45):
And that is essentially speaking to better macroeconomic conditions, better liquidity,
and the fact that the bad companies have already been
taken out. Is that yes, fair enough? Sounds quite bullish. Therefore,
I mean, we debate the what looks like a mismatch
between economic fundamentals, you know, balance sheets, leverage and the price.
(27:09):
But it sounds like if we if we're through the
worst of the defaults and we're coming out and it's
going to get down to three percent next year, that
that actually these levels are justified in the market.
Speaker 3 (27:17):
I don't. I don't actually spend most of my day
thinking about the the right spread for a certain level
of economic risk. What I would say is that this
is a heart this is probably and that you can
speak to CEOs, you can speak to people in the
in the financial community. This is a hard market to forecast.
(27:41):
So while I think that we have evidence that you know,
there's enough stability for for this market, I think that
it's much harder to say what the longer term impact
of a materially higher tear for will be on the
(28:01):
US economy.
Speaker 2 (28:03):
Maybe moving onto the covenants, and you mentioned a couple
of occasions, but some of the lenders or the investors
are trying to get together and maybe alter a little
bit the balance of power between between them. The companies
or the banks that are bringing deals to the market,
PE firms and UH and the investors in the end
(28:26):
support the risk. I also noticed that some companies actually
have already been pretty aggressive in terms of some examples,
I think American Greeding Corporation being sold sponsor to sponsor
without triggering any change of control. Close What are you
what do you see on your end in terms of
(28:47):
investors trying to afflict their muscles and and try to
be maybe a little bit like in the UK, sometimes
you see maybe more coordination between between investors to try
to tell the scale to where they're in their favor.
Speaker 3 (29:02):
There's some of that. There's occasions where they decide, you know,
to you know, coordinate more so that there isn't the
dispersion in terms of who gets what and who gets primed.
There's still plenty of opportunities to do that. I think
also on the sponsor side, they're a little more sensitive
perhaps and they had been in terms of not alienating investors.
(29:26):
That being said, I think, to use a cliche, investors
are often fighting the last war, so you know, some
part of the covenant gets exploited, they fix that in
the credit agreement, and then they find a new opportunity.
That being said, you know, there's also is some discrimination.
There weren't very many high healed bonds in the market
(29:48):
in terms of LBOs, but two recent ones I think
it's called Sizzling Platter that was a B three. They
tightened up that bond agreement pretty tightly. At the same time,
there was probably the Sketchers deal. I think they got
everything they wanted, So now that was a B two.
(30:10):
I believe actually it might have been a bee too positive.
So you can see that there is some pressure when
it comes to better credit quality if there's positive momentum.
And probably there were a lot of investors interested in
holding Sketchers, and so they got all the flexibility that
they asked for pretty much, and Sizzling Platter did not.
Speaker 1 (30:34):
So the covenant outlook is mixed, and it's not really
like it's getting worse. It's kind of hit a sort
of stable level. But but I do wonder, you know,
whether when we see all this, as you said earlier,
I think excess liquidity not enough to buy, does that
not just keep the pressure on weaker covenants? Is that
not going to push it? You know? I mean that
the lawyer is a key to be as creative as
(30:54):
they possibly can. So why wouldn't the borrowers jump on it?
Speaker 3 (30:57):
One hundred percent? Yes, I mean I think if you
have been in this market for as long as I
have said, you know, twenty five years, covenants are very
different than they used to be. And I would certainly
argue that if you want to do something aggressive to
(31:18):
protect the LBO versus the creditors. You can there are ways.
Speaker 1 (31:27):
Are there any particular areas where we think LBOs might
make you come back? In terms of sectors, Do you
think that we're going to see more consolidation in any
particular and you mentioned software earlier, is that potential an
area for that.
Speaker 3 (31:39):
I think that that we are going to continue to
see tech deals for sure. You know, healthcare, we always
see a lot of service deals. Those are probably the
three largest exposures, CLOS and BBC's right, both sides of
the of the LBO market. I think that that will continue.
(32:00):
I think the tougher deals will be anything that has
a foreign component. You know, until that gets resolved, that's
going to put a lot of that will create a
lot of challenges for businesses.
Speaker 1 (32:15):
So kind of given the impact that trade has had
on tariffs I've had on the market generally on borrowers
and the weaker borrowers. You know, we are at a
point where there is one of our guests called stroke
of the pen risk and that anything could be signed
or announced on truth social at any time that could
fundamentally also the landscape for lots of different companies and
(32:36):
their balance sheetes do you you know that there are
more vulnerabilities potentially out there, and that there is more
political risk now in the US market that the will
affect leverage finance.
Speaker 3 (32:47):
I think that anything that brings greater volatility to the
market makes a leverage finance issuer more vulnerable. These are
highly leveraged companies. You know, it can be geo political,
it can be oil crisis, right, it can be COVID.
You know, these are vulnerable companies. You know, when we
(33:09):
rate a company investment grade, it usually means that it
can muddle through a variety of cyclical downturns. Low single
big companies, they're vulnerable to it all. So, yes, none
of that has changed.
Speaker 2 (33:25):
Very much. Back to the basics of cash flo predictability
and some companies lending themselves to more suited for an
LBO than others. I mean you mentioned healthcare. Seen a
record level of transactions in healthcare, but also very high
to fools a couple of years ago that I've come
down quite a bit. But there's also reading uncertainty in
(33:47):
healthcare right now, so we could see a bit of
a pee cup.
Speaker 3 (33:49):
I would think that's been a tough one because in
theory it's appealing for an LBO because you know, it
tends not to be cyclical, right it take out COVID,
which obviously riag TABOC in that area, but in general
it should be a relatively stable on the demand side.
What has troubled a lot of healthcare companies generally speaking
(34:12):
is change in the regulatory environment on anticipated changes in
the regulatory environment, and that those are hard to predict,
but they can be pretty dramatic when they happen.
Speaker 1 (34:23):
But the risk is more on the foreign ownership side
given the administration. Is that correct? I mean, if you
see a company that's got a foreign ownship or it's
got a foreign angle to it, maybe they impose a
lot of romative. Is that something that is particularly like
a red flag for ratings?
Speaker 3 (34:42):
Well, so I would say not foreign ownership, but foreign input, right,
And so will it take them longer to restructure their
supply chain things like that? You know, as in everything
in this market, it kind of depends on the price.
I can't I could certainly see a private equity firm
(35:02):
looking at a company and saying, you know, if there
weren't terriff pressure, it would be a twelve times company
now it's a nine times company, and I see an
opportunity here, you know, I don't. I don't think you
will see no manufacturing deals for example. It's just it
(35:23):
does create a much difficult forecasting environment.
Speaker 1 (35:27):
And it's across the board. It's not just a couple
of sectism and that there's more of a like a
widespread impact on leverage, bonds and loans.
Speaker 2 (35:36):
Yes.
Speaker 1 (35:38):
Yeah.
Speaker 2 (35:38):
As a writer, when you look at a transaction, would you,
given the uncertainty and the difficulty to forecast earnings, would
you say that you're inclined to take an even more
conservative or a more conservative approach to the kind of
forecast that a company can produce.
Speaker 3 (36:00):
I think analysts are looking at their companies and speaking
with the CFO and the CEO and trying to come
up with a realistic scenario. You know, every analyst, probably
every investor figures out a downside case. You know, determines
whether the downside case is close to realistic or is
(36:22):
too dramatic. But I think it's pretty hard not to
build in a certain amount of conservatism on the on
the P and L side. But alternatively, you know, there
is the potential for rates to go down, and that
(36:42):
means that you might see some increased ability to service
the debt. So I think everything is being taken into consideration,
but I think it's fair to say we're pretty conservative
most of the time. You may remember that, John Eve.
Speaker 1 (36:59):
The reasons, as John you've stated at the top we're
so delighted to have you on the show, Christina, is
that you have such a long track record and you've
seen a lot of things in the market. And I'm
interested in putting this market into perspective because I've also
been doing this a fair amount of time. But I
also find it very confusing in terms of you know,
what's going on and what the market does in response
to that, And some of the things that we've seen
(37:20):
over the last six months would have been enough, I think,
to cause a major panic, but the market just keeps
going up. So I'm interested in, you know, if you
could put it in some kind of historical terms, you know,
how would you compare this market.
Speaker 3 (37:33):
So a challenging question without having time to think a
lot about the history. But I would say is most
pronounced about being involved in leverage finance is it is
always changing. And I could tell you that you know,
the first thing that happened when I was following leverage
finance was Russia defaulted on a response and that impacted
(37:57):
the US leverage finance market, which was fascinating because you know,
they seem quite unrelated. So that was in the late nineties,
and then we went to the dot com bust, and
there were a couple of other challenges along the way,
but obviously the big challenge was two thousand and eight,
and it was very interesting to watch how the change
(38:20):
in rates really grew this market from what was almost
exclusively a high yield bond market with a very small
loan market. The loan market was probably three hundred billion
prior to the financial crisis to where we are today,
where if you where the loan market and the bond market,
they're about the same size, over three trillion dollars together,
(38:43):
and a real concentration in private equity private companies really
you know, about half the market or private companies. So
a lot has changed over time. Not I can't compare
today to something that we've seen in the past. Almost
each time it's been quite different.
Speaker 2 (39:04):
Right.
Speaker 3 (39:05):
The last dramatic moment we would probably leave share would
be COVID that was definitely not foreseen, but the market
comes back each time.
Speaker 1 (39:16):
And in terms of you know, moodies, we look to
you to identify risk and I'm keen to know if
you know, we've we've talked about a lot today, But
is there anything else else out there that you should
think we should be more focused on, we should be
worried about in terms of, you know, potential canaries in
the coal mine for leverage finance.
Speaker 3 (39:34):
I think what I pay attention to when I think
broadly about the space as opposed to you know, individual
ratings or our default forecast, is just given how much
liquidity there is in the market today, is there a
concern around valuation broadly? As more of the market is private,
(39:55):
whether it's in the leverage loan market on the rated
side or within the direct lenders, it's just tougher to
get that kind of information, So that I think that's
something that is probably one of the big differences as
we've evolved over time in this market that I think
(40:15):
I keep an eye.
Speaker 1 (40:16):
On that ultimately leads to investors overpaying and then suffering
losses down the road.
Speaker 3 (40:23):
Could but doesn't have to you know, the problems you
don't know and when it starts to become a parent
is later than you're accustomed to.
Speaker 1 (40:33):
Great stuff. Christina Paget, Associate Managing Director with Moodies. It's
been a pleasure having you on the Credit Edge. Thanks,
and of course I'm very grateful to Johnny Coupan from
Bloomberg Intelligence. Thank you very much for joining us today.
For more credit market analysis and insight, read all of
Johnny Coupan's great work on the Bloomberg Terminal. Bloomberg Intelligence
is part of our research department, with five hundred analysts
and strategists working across all markets. Coverage includes over two
(40:56):
thousand equities and credits and outlooks on more than ninety
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 at bpod Go. Give us a review,
tell your friends, or email me directly at Jcrombier at
(41:16):
Bloomberg dot net. I'm James Crombie. It's been a pleasure
having you join us again next week on the Credit Edge.
Host
James Crombie
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