December 21, 2023 • 51 mins
New entrants to the rapidly-growing private credit market, scrambling to deploy capital as demand exceeds supply, risk making loans that don’t perform well, according to Alan Schrager, senior partner and portfolio manager at Oak Hill Advisors. “You sort of love private credit tourists who potentially do bad deals, because bad deals that ultimately you don’t own make you look good on a relative basis,” Schrager says. “Even though we do think private credit is really cheap, we are trying to stay high quality,” Schrager tells Bloomberg News senior reporter Lisa Lee senior editor James Crombie in the latest episode of the Credit Edge podcast. Also in this episode, Bloomberg Intelligence senior credit analyst Arnold Kakuda weighs the outlook for banks heading into a tougher macro environment next year. Large financial institutions are well prepared for credit risk after withdrawing from some markets that private lenders stepped into fill, and they will be big bond issuers in January, according to Kakuda. Regional banks are more exposed to commercial real estate stress, he adds.
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Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:18):
Hello, and welcome to The Credit Edge, a weekly markets podcast.
My name is James Crumbie. I'm a senior editor at Bloomberg.
This week, we're very pleased to welcome Alan Schreeger, senior
partner and portfolio manager at Oak Hill Advisors, a global
alternative investment firm.
Speaker 2 (00:32):
How are you, Alan, I'm doing great, James, how are
you doing very well?
Speaker 1 (00:36):
Thanks so much for joining us today. Really looking forward
to getting your take on the credit markets. And we're
also delighted to see Lisa Lee. He Lisa covers credit
markets from London and it's great to see you again.
Also on this show we have Arnold Kakuda, who covers
banks for Bloomberg Intelligence in New York. There's a lot
going on in that sector and Arnold always has some
great calls, so please do stay with us. But first,
(00:59):
Alan Schreeger Kill Advisors. Great to have you on the
Credit Edge. It's been a big year for credit, not
quite the Year of the bond that some people have
been predicting, but definitely a good run for risk assets,
at least when you look at total return. Also a
very big year for private credit, which everyone says is
going through a golden age. But before we get to that,
aland I just want to get your macro view, in
(01:20):
particular on rates. We've flipped around quite a bit from
fear about inflation hard landing to some pretty aggressive bets
on FED rate cuts happening fairly early next year, plus
a view that the economy can avoid a recession. What
do you make about the make of that? Alan? Are
we getting ahead of ourselves? What's your macroview?
Speaker 2 (01:38):
So our review is that the market desperately, desperately wants
rates to go down, and that every opportunity they get
to grab hold of anything that gives the inclination that
the Fed is going to cut either sooner than they
think or earlier enough that it will have positive impact
(02:01):
on returns and the resulting benefits to the markets, everyone
grabs hold of them. And you know, we've been looking
We look at thousands of companies, We've been looking at
the inflation numbers that we see across businesses, We've been
looking at the macro. We have a strong view that
the FED clearly doesn't want to make the mistakes of
the seventies and eighties, and that they are going to
(02:21):
be prudent in how they do that. Now, I will
say sort of last week's commentary that sounded more dubbish
than we thought they were going to be surprised us
a little bit and led us to believe, Okay, maybe
they are already starting to think about where they're going
to cut I think people thinking, and now there's been
(02:43):
some pullbacks recently in terms of commentary that they're going
to start cutting as soon as the first half of
the year seems really aggressive to us and is not
our base case. Our base case was that they were
going to keep rates at this level for a while.
It's hard to see stand firm on that commentary, given
(03:03):
the commentary we've heard from the Fed over the last
couple of weeks. But we still think that there's an
inflation problem, and when you look at where labor is
and you look at where housing is, the fact is
it's hard to convince yourself that the Fed's going to
be able to get to where they say they're going
to need to be to be able to cut rates.
(03:25):
So we're still a little bit bearish on that. We
are still a little bit more hawkish, although I will
say we're also a little bit concerned of that view
given some of the commentary we've heard from the FED
over the last couple of weeks, notwithstanding some clean up
comments over the last week.
Speaker 1 (03:43):
So let's talk private credit, which is the hot topic
at the moment. You have been beating some of the
large Wall Street banks out their own game, most recently
by leading a deal for Greenway Health they're refinancing alone
that was originally made by a more traditional lender Oakhill
ended up getting in on the reef. How are you
managing to do that sort of deal and what's your
(04:03):
edge over the Wall Street banks?
Speaker 2 (04:05):
So, if you think about private credit, you know there
are so many advantages to using private credit if you're
an issuer. And this is really from the issuer standpoint,
because to your question, the fact is is that why
does an issuer choose to go private credit, especially if
there's a premium to that. And what I would say
(04:27):
is that you have a lot of advantages as an
issuer for private credit, the speed, the confidence level, the certainty,
the structuring of it. The fact is is that a
lot of people don't like their paper trading. They don't
like to not know who their holders are. And an
example like a Greenway where you're coming closer to maturity,
(04:49):
the ability to extend it with people who are maybe
people the issuer doesn't have a relationship with, making an
A and E less likely. There are so many different
reasons that people want to use private credit that it
can come down to simplistically that they choose that as
just an easier way to do it. One of the
(05:09):
things that I think is underappreciated is that in a
private deal a company like Greenway or a Finastra or
any of the other deals we've done or that you
might mention, over the term of this conversation, we get
a lot more diligence. We get to talk to and
look at information that gets you much more comfortable with
(05:31):
the business, gets you able to diligence the company both
from a downside protection, which we like. But this is
a conversation about why issuers choose it. But you're able
to actually explain to the buyers what the company is
going to do, why is it in an okay shape
versus a public markets where they get much less of
that because of disclosure rules. And the fact is we're
(05:54):
able to structure around a lot of those issues because
of the flexibility of private credit. So you know, My
view is that private credit has just this huge multiple
tier advantage over the syndicated markets. What the syndicated markets
do really well is priced tight, right, they get lower
(06:16):
cost financing, They're able to price things that are tighter.
And when you have a B one credit that's an
issue a seasoned issuer with a lower leverage profile. The
fact is is that syndicated markets are a great provider
of that capital. The same way the high yield market
has evolved over decades from what used to be an
(06:37):
LBO market when I started in the late eighties and
nineties to in essence a double V, you know, private
public market. And so I think that the private credit
market is just going to continue to do what it
does most efficiently, which is some of those more difficult deals.
Speaker 3 (06:55):
Alan you've said that you think private credit could take
almost forty possibly of the bobby syndicated market going forward.
It seems now banks are finally starting to get a
little bit of their mojo back. The levish loan market
has gone back, the single double b's are training in
the high nineties. Now, how in terms will the competition
(07:16):
be in next year, and also how much do you
think next year banks will be get back the traditional
left in.
Speaker 2 (07:25):
Business, people talk about it as if the banks matter,
and to a certain extent, obviously, the banks don't want
to give up fee business, and I'm sympathetic to that
and understand that. And obviously we have a large syndicated business,
and we think that the banks are incredibly important and
good partners in that. Regard on the private credit side
(07:47):
or the portion of the syndicated market that is unlikely
to grow or be as big on a going forward basis,
the fact is is that the banks need somebody to
sell these owns to. You know, the banks are just
a conduit. They're they're not a holder of these assets.
So what they want is a little less relevant than
(08:08):
what do their clients want, what do the end buyers want.
And the reason why I think there that the private
credit market is going to continue to take share from
the syndicated market is first of all, to the to
the point I made to James's question, which is it's
so much easier, it's so much faster, it's so much
more uh, it's so much more consistent through a variety
(08:31):
of markets. But just as a regular bank construct, to
the to the point you're making you have to have
people who are willing to buy what you're selling, and
for the most part, until the COLO market changes enough
that it's a good buyer of B three credit or
more levered business. And you think about what the syndicated
(08:52):
loan market has become. To my same point about high
yield moving towards a double B public company market, the
loan market and the loan and the first and second
lean market have become more of the LBO financing market.
And what I just believe and the reason why I
think that transition happens is there's just less availability of
(09:14):
second leans, meaning that there's less availability of an amount
of leverage that the private credit market can provide. And
two is that all of those are rated B three,
which means that the colos have to be willing to
continue to finance the B three market. Now, as COLO
market picks back up and COLO liabilities tightened and there's
(09:36):
more of that spread and you can see more colos done,
there's going to be a portion of them that buy
B threes and they are going to be B three's
in the syndicated market. But when you think about what
the COLO market needs to be, which is a B
two basically average rated entity or securitized asset class. When
(09:57):
we think about it, and we run a large colo businusiness,
it's really attractive to buy a B two B one
mix of assets, lever them attractively in the syndicate in
the CLO securitization market, create double digit returns and not
have to reach into the B three take weighted average
(10:18):
rating risk or downgrade risk, and just means that they
might not be the ideal buyer, which ultimately means that
the banks are going to be pitching B one and
B two credits and most likely will win some B
three deals, but less and less as time goes on.
Speaker 3 (10:33):
Do you think that SALO market will come back next
year because there's been a sort of a laggered Triple
A buyers have not disappeared, but they pulled back. Right.
There's just not as many triple A buyers as they
used to be. There might be more of them, but
there's not the depth that there used to be, and
the ARBs become incredibly tough, and that's something that they've
struggled with all year long, and also with interest rates
(10:56):
the way they are, resets and refines aren't really happening
what's your take on the COLO market going forward, because
you're right it has to return if leverage loans and
the bank arranger business is going to be turning the
way they did.
Speaker 2 (11:10):
I do think it's going to come back. I do
think that you're seeing more and more triple A buyers
who are realizing than in the mid one hundreds, triple
a COLO risk, especially on a floating basis, is a
pretty attractive asset class to own. I think as the
banks actually think about that, their direct lending part of
(11:32):
their business will probably decline a combination of regulatory issues
as well as obviously private credit moving up and down
the spectrum of large to small. I think that the
banks are going to look for asset classes that meet
in essence, what their their needs are, and I think
you're going to see more and more triple A buyers
(11:53):
across the bank platform.
Speaker 1 (11:54):
I want to ask you about the funding costs from
an issuer's perspective. Obviously this form of funding private credit
is faster, it's easier in many ways, it seems more efficient,
but you've noted that it's more expensive than the syndicated
markets we are hearing you know, you mentioned double digit returns.
We're hearing high teens on some of the loans that
are going through. How is that sustainable for companies that
(12:17):
are facing a potential downturn in the economy and slower earnings.
Speaker 2 (12:22):
So obviously that's one hundred percent right, which is they
are borrowing. If you think about private credit, and this
is whether it matters whether it's syndicated or non syndicated,
because the spread differential, if it's one hundred and fifty
or two hundred basis points, doesn't free up or suddenly
make the company incredibly free cashual or positive versus not.
(12:46):
So I actually think this is a leverage finance question
more so than a private credit question, because if you
look at where the syndicated market is and you say
that that's a SOFA plus three fifty to four hundred market,
and you're saying that that's ten or eleven versus an
eleven to thirteen on the private credit market, all of
(13:07):
those at certain leverage levels clearly can mean that these
are levered capital structures that have sustainability issues. Obviously, different
companies are very different in terms of how they're going
to be able to handle this. You have businesses with
lower capital expenditures and lower fixed costs that are obviously
able to sustain interest levels at a higher level. They're
(13:29):
also levering a little bit more, so they're not necessarily
giving that as cushion, they are utilizing that for slightly
more leverage. You have businesses that have some some inherent
growth because of either improvements that a new owner might
make or investments that they've already made through capital expenditures.
(13:50):
But you're right, a big portion of the market has
free cash flow levels that are sort of break even
or slightly higher break eve, slightly above breaking even. And
one of the reasons why you're seeing a little bit
more of it of an insertion into a pick into
some of these capital structures. To allow these capital structures
(14:11):
to have that flexibility, they are reliant on ultimately growing
to create real free cash flows in that market. My
perspective in my argument on this is that the reason
why private credit is so attractive is exactly what you
just said. I actually don't think it's bad for private
(14:32):
credit when you think about that, it's able to structure
with full understanding of where rates are and where the
expectations of the business are. For the most part, it
is first dollar of debt through a certain leverage level
at fifty percent loan to value, and the equity is
who's in essence bearing the risk that there is ultimately
(14:53):
an increase in either valuations which they obviously rode for
ten years over the last ten years, or from in
their perspective improvement and performance and company EBATA, even in
the face of some dislocation. The reason why private credit works, though,
is because it's able to sort of work in all
of those environments. In the positive case, it obviously is
(15:15):
the receiver of all of this excess interest, so it
obviously is a great returning asset class on a relative
basis to almost anything that we see. On the downside,
its first dollar of debt, it's fifty percent loan to value,
which means the equity has to come up with a
way of making sure they do pay that. There's a
lot of things you can do in private credit to
(15:35):
make sure these capital structures work. In exchange for compensation,
you can pick in exchange for compensation, you can allow
them to raise incremental debt.
Speaker 3 (15:46):
Since you mentioned pitt, I'd love to follow on that tray,
especially not so much like a medicine pick, which subordinated debt,
which I think we're used to, but we're starting to
see pick in first lean and unit chant, and there's
a deal in the market with a sponsor is asking
for one hundred percent pick right off the bat for
the unit tranch, and some people are saying this can
(16:07):
points to the fact that maybe there's a bubble going
on in private credit. So what is your answer to that.
Why are you guys allowing this kind of pick? Does
one hundred percent pick make sense? And what is a
bridge too far? And what is your answer to the
idea that maybe this points to a bubble.
Speaker 2 (16:23):
So let's start with just the general pick question, which
is where the market is evolving, and it's evolving it
started with the evolution of private credit. In essence, when
you eliminate the banks, you had to figure out how
to replace what the banks were providing, which was revolvers
(16:44):
and delayed draws to a certain extent, so everyone started questioning, Okay,
well why are you doing the revolvers? And part of
that was is that if you're replacing the capital structures
that existed before, you obviously have to provide everything that
was provided before. Revolving were part of that The second transition,
which came with partial pick or small amounts of pick,
(17:06):
especially with rates where they are, is that the market
is evolving to a place where it's replacing not only
the syndicated first lean market or the syndicated it first
and second lean market, but it's taking a little piece
of the junior capital market and taking few different components
(17:27):
of each of those. And part of the component of
junior capital is that there is a pick component that
doesn't make it bad. It obviously means you have to
incorporate the right pricing and the right security. But if
you think about an efficient way to finance a business,
if you financed it with five turns of debt and
then one turn of pick preferred to get to six
(17:49):
turns of leverage, you have two constituencies. That five to
six turn piece is a much harder piece of paper
to structure because it has real downside risk because it
has five turns of debt in front of it. By
combining the two of them and taking a little bit
of both, which is a little bit of the cash,
a little bit of the pick, and then ultimately levering
(18:12):
more so you're zero to six instead of zero to five,
and then five to six, you're still talking about you're
sitting at a fifty percent loans of value. We use
fifty percent sort of broadly. Everyone sort of talks about that.
Some of it's forty or thirty, and some of it's
fifty five or even sixty. We don't see a lot
of sixties today, but you see fifties for sure, which
is why I use it. And when you think about
(18:35):
what you're doing, you're, in essence, providing capital at a
piece at a piece of a capital structure well within value,
and you're, hopefully, if you're doing it right, pricing it
appropriately for the amount of capital that exists. The mes
markets exists for decades, and this is just combining a
little bit of those markets and making sure you're getting
(18:57):
paid for it. So if I gave you a scenario
where you had to business that was worth fifteen times
and you were levering at six and a half times,
and you were picking and that pick, let's just say
that that pick is at a place where the six
and a half times becomes with no growth at the business,
the six and a half times becomes seven or seven
(19:18):
and a half times, you're still sitting there at a
very low loan to value where you are, assuming you're
getting properly paid, sitting at getting compensated for providing that
first dollar of debt. So I think when we think
about pick as a general matter, it doesn't scare us
as long as we're lending to a good company where
(19:39):
we think the coverages are great. I think the question
of why is this evolving is that as the preferred
market is less efficient and there's enough people in the
unitronch market who are willing to provide a little bit
more leverage and take some of that PICK in a
(20:00):
exchange for in essence doing that, I actually think it's healthy.
We clearly want companies that are willing and able to
pay the interest that they have, so you want to
make sure they have the flexibility. It's one of the
things that private credit does provide. It is definitely an
indication that the market has gotten stronger than it was
(20:21):
a year ago when we were looking at five turns
leverage and not six or six and a half and
very little pick because you didn't need pick when you
only had five turns. But private equity and buyers we're
still paying fifteen turns and what they're in essence saying
is will you share some of the value purchase price
(20:42):
in terms of getting paid for that? And I do
think that that's not an irrational thing to do. Obviously,
as issuers get some of that, they look to get
more and more. And obviously you're referring to the Ctivity
deal that's out there that people are talking about, where
they're being asked to do full pick because there's a
(21:04):
reasonable amount of leverage, and that's a great, great company,
but there's obviously some things they need to do on
a free cashulow basis that might require them, combined with
the leverage level, to have less cash availability upfront, requiring
the lenders to provide some of that pick capacity. And
(21:25):
I don't think that the market strengthening and certainly being
willing to do things that didn't do six months ago
or a year ago, means that it's a bubble. I
think it means that the market continues to get efficient
and certainly a little bit more aggressive in terms of
what it's willing to do. But I do take a
little bit of offense to the bubble comment, not from you, obviously,
(21:47):
but as a general matter, because what I think a
bubble implies is that the market gets irrational to a
place for valuations. And it works much better in an
equity scenario where you obviously buy something for twenty times
that's only worth ten and then when the realization comes
(22:08):
you lose half your money. In private credit, where you're
still fifty percent loan to value covered, and let's assume
that pick means that you're getting to a little higher,
you get to sixty percent, you still have this cushion,
you still have a maturity that you're getting your money back,
and the likelihood is that as long as you're not
doing bad companies, you're going to get repaid. Obviously, private
(22:33):
credit has shown historically a very low default rate in
an ever lower default loss rate, And so I think
that the level of where does a bubble exist and
what is that constitute valuations, especially in private credit, where
you don't in essence, you don't have to buy and
sell things every day. So if you have something that's
(22:53):
mispriced by a small amount twenty five or fifty basis points,
which is what you're in essence talking about here, those
don't create valuation degradations that lead to real losses. And
so it's so far away from a bubble perspective that
I think it's a it's it's not the right thing.
Speaker 1 (23:11):
Now.
Speaker 2 (23:11):
Has the market gotten more aggressive? Yes, we were seeing
in twenty two and early twenty three five to six
turns of leverage at higher coupons, and obviously that has changed.
But the market has changed. I mean, look at the
where the equity markets are, look at you know, enterprise
values to ebata's, look at where the syndicated markets are gone,
(23:33):
and we're obviously even treasuries. You think about where that
is and what you're going to do there. The fact
is is private credit on a relative basis, which is
how the world invests, still looks because of the component
of coupon and risk free, still looks incredibly cheap relative
to those things, even if that attractiveness has created some
(23:57):
tightening of the of the coupons and some loosening of
the terms.
Speaker 1 (24:02):
You know, and we get a lot of people on
the show talking about private credit. They all want to
do the good deals. No one's doing the bad deals.
No one's lending to the bad companies. But there is
so much competition right now, there's so much driypowd of
so many new entrants. Do you worry that this is
going to lead to bad outcomes. You know, the what
some people are calling the private debt tourists coming in.
Speaker 2 (24:22):
You know, you sort of love private credit tourists who
potentially do bad deals because bad deals that ultimately you
don't own make you look good on a relative basis,
So you sort of have a mixture, right. The fact
is is private credit and an asset class. I don't
think gets permanently tinted by people individual firms because they're
(24:47):
either not capable of getting sourcing the good deals or
making good decisions on which ones are the good deals.
I actually think that's a good thing for those of
us who are actually more established players and obviously doing
a lot have a lot of choices. If you don't
have a lot of choices, you're a tourist in private credit.
I love that phrase, and I've used it before too,
so I appreciate the phrasing. But if you're a tourist,
(25:11):
you don't get to see that many deals, so you
sort of have to choose the ones that you get.
So the selection process, right, if you think about the
adverse selection problem that they have is that they might
end up with things that we or others have turned
down already and they don't have much of a choice.
(25:33):
That's not terrible for us, because ultimately, differentiation is happening
in the credit markets, and the more differentiation that happens
in the private credit markets is positive to the people
who obviously ultimately make good decisions, and we hope that
that's us. Obviously we work really hard to do that.
But I think would be a little egotistical to sit
there and say, hey, you know, we're really good at
this and nobody else is good. I don't think that's true,
(25:56):
and obviously future is going to tell you. But I
do know, having run all of our performing businesses during
the crisis, there are a lot of people who blew
out of existence in nine and ten, and it did
allow those of us who did well in eighth nine
to actually differentiate yourselves and grow, And so I'm not
(26:20):
as fearful of that. Candidly, I would love I love
when a deal that I think is sort of silly
that other people do it, because if it turns out
to truly be silly, that will be a differentiating factor.
But I don't think that taints private credit. I think
ultimately every asset class has whether it's investment grade all
the way through to high yield deliverage loan syndicated markets mes,
(26:42):
and certainly private credit generically has people who really do
this well and do it poorly. And the more people
who do it poorly means that the people who do
it well succeed.
Speaker 1 (26:53):
Does it mean a high default rate next year?
Speaker 2 (26:56):
There's a lot of businesses that have hit the fault,
had losses for different parts of the capital structure that
still exists today. And the syndicated markets are or in
the regular markets, and I think the private credit market
is just built so much better to sustain us. So
will defaults go up, No doubt they'll go up, partially
(27:16):
because there's going to be if the economic cycle goes down,
there will be companies that, you know, when the ocean
pulls back, they realize that they're not wearing any bathing suits.
There will definitely be some of that. There'll be capital
structures that are just non sustainable and they're going to
need to do some restructuring and maybe to deal with
(27:38):
preferreds or junior capital, they might have to do a
restructuring or a default. But I think the difference in
a bad market between private credit and the rest of
the markets will be very obvious, whereas there's a lot
of solutions that are actually good for private credit investors
where they get incremental economics, they get potentially pieces of
(27:58):
equity and a troubled situation, or ultimately they just are
able to realize that if the business goes from fifty
percent loan to value to eighty percent loan to value
and the company defaults and they in essence accelerate, they're
still going to get their money back because they still
have a twenty percent cushion on value. So I do
think defaults will go up, but I don't think it's
(28:20):
as scary and I don't think it's as prevalent as
it will be another market.
Speaker 1 (28:24):
What do you think the biggest opportunity is for next year?
Speaker 2 (28:26):
Ellen?
Speaker 1 (28:26):
When you look at everything you cover in terms of
the credit opportunity, what are you most excited about?
Speaker 2 (28:33):
You know, I think this, I think there's and you
guys ask this question in the context of the bubble,
which I strongly disagree with. But it's hard to argue
that the market opportunity has tightened in private credit over
the last few months, as there's been a reasonable amount
(28:54):
of growth and demand and supply is just starting. And
I think the story we're telling investors is that as
companies approach the maturity wall, they're going to need to refinance.
And I think that the market opportunity is twofold with
regards to that. From a credit investor, one is if
(29:15):
you truly believe there's a business that has equity value
that's going to get either refinance or recapitalized in some way,
and it's trading at a discount, and there's a number
of those names in the market. Buying those at discounts
and then capturing that in essence, repayment at par is
clearly a way to create some total return, and we're
doing that in sort of our opportunistic business across our platform.
(29:39):
And then the second is obviously being that take out,
because if you're willing to buy that risk, you probably
are willing to do that refinancing. And I do think
that all markets are about supply demand, and right now
you have growing supply in the leverage finance market with
increasing demand probably outpacing it a little bit. I think
(30:00):
that changes as companies realize that their maturity is at
twenty five and in twenty four, it's a year away.
And yeah, it's really nice to capture the coupons of
the historical three twenty fives or three fifties, but you're
now going to have to realize we need to recapitalize
the business and refinance the business. It's going to cost
this more, but ultimately it will extend our equity optionality.
(30:23):
And I think there's going to be a lot of
that in twenty four as people realize twenty five and
twenty six are very close and they're going to need
to do that. So I think that discount capture is
a really interesting it's a really interesting way to play
the refinancing market that's going to happen over the next
couple of years. I think providing that refinancing capital is
(30:44):
a really interesting thing to do. And then ultimately, you know,
on the distress side, you are going to have decent
businesses that are just overlevered or have hiccups in their performance.
We haven't seen a lot of that. Most of the
businesses that are in distress are bad businesses, and at
least from our perspective, or bad businesses, and we have
(31:06):
been very very much on the sidelines and now just
stressed business where we've been doing distress since the late
eighties early nineties and have a phenomenal track record there,
and we're doing very little right now because we think
that the businesses are not a problem of capital structures
or time. They are a problem of secular risks or
you know, you look at a telecom business or healthcare
(31:27):
businesses that just have issues that are very hard to solve.
I think that's going to be different if there's a
market dislocation in twenty four and so we'll be ready
for that as well. But one of the reasons why
we like private credit is because it sort of protects
you from that is that if even if the market
does struggle and go down, you are first dollar of debt,
you control your capital structure, You're able to provide for
(31:50):
incremental coupon, you know, pick or or liquidity.
Speaker 1 (31:55):
Are there sectors that you love and or hate.
Speaker 2 (31:58):
We've never been a set so so do this sector
we love. We've been doing software and technology since two
thousand and four. I actually started that practice here at
OKILL and we've invested over thirty billion dollars in technology
and software and have done very very well in that
sector and we've always been heavily weighted to software, healthcare
(32:20):
and services. That's where we've been.
Speaker 1 (32:23):
So before we talk to Animald Caacuta over Bloomberg Intelligence,
what's your most contrarian trade right now?
Speaker 2 (32:31):
You know, right now, with where the world is in
what almost feels like this benign environment, our contrarian trade
is actually trying not to buy everything. You know. It's
when you look at a lot of the things that
you're done, it seems like deals right now are can
clear at pricing or at leverage levels that we say
(32:55):
to ourselves, we don't want to get caught up in
the momentum trade or the desperation trade of a BBC
that has to deploy their capital. We sort of have
a different structure because most of our capital is an
essence either where we can call it in private equity style,
so we have an ability to stay a little patient.
So our contrarian as being even though we do think
(33:16):
private credit is really cheap, we are trying to stay
high quality. We would rather say no to something that
we don't like. I don't know that there's an obvious
thing out there in a sector basis where you say, okay,
well everyone's got this wrong. You know, healthcare is not
going to have the issues in telecom. Telecom's a perfect example, right,
(33:39):
Telecom's going through this huge technology shift that's really really
hard to evaluate. They've all got that wrong. It's all
going to be fine. Like I don't think we have
any of that, and we don't really have a perspective
on that. I think what we're trying to do is
be more selective as the market stay strong, rather than
just deploy for the sake of deploying.
Speaker 1 (34:00):
Great stuff. Adam Schreeger Held Advisors, thank you so much
for being on the show.
Speaker 2 (34:04):
I really appreciate it. It was great to have both of
you today.
Speaker 1 (34:07):
Also want to say a big thanks to Lisa Lee
with Bloomberg News in London. Brilliant to see you again. Cheers,
thank you so much for.
Speaker 3 (34:12):
Having me, and happy holidays and.
Speaker 1 (34:14):
All the best to both of you for twenty twenty four.
I hope it's a good one. So I'm delighted to
welcome back on the Credit Edge Arnold Kakuda, who covers
banks for Bloomberg Intelligence based in New York. How's it going, Arnold?
Speaker 4 (34:25):
Awesome? Awesome.
Speaker 1 (34:26):
So we've talked a lot about financial institutions. This year,
our March edition on the banking crisis was very popular.
Thank you very much for being there, Arnold, to explain
to us what was happening break it all down for us.
At that time, a very large global, systemically important institution,
credit SUEEE, went bust and we lost a handful of
regional banks in the US. Since then, we seem to
(34:48):
have bounce back. Credit markets have performed well. The eighty
one market almost fully recovered. But what's the situation now, Arnold?
How robust really is the banking sector? There are a
lot of Macro's storm on the horizon. Traditional banks are
losing out to other types of financial institutions that so
called non bank lenders in the world of direct lending.
(35:08):
Regulations are exerting some pressure on the belge bracket. And
the latest news I'm looking at is that banks are
cutting bonuses for traders, which is never a good sign.
So what's the outlook, Arnold? Will twenty twenty four be
a tough year for banks? What do you think?
Speaker 4 (35:21):
Well? I think you know, there's definitely still concerns with banks,
and I think you can see that and how the
bonds are still trading wider right there, They're now about
like thirteen basis points. Financial bonds are about thirteen basic
points wider than the overall index. So you know, if
we rewind back to February, before any sort of you know,
crisis was on the horizon, financials and non financials traded flat.
(35:46):
So you know, yes, things are getting better, but you
know they're still concerned out there, and you know, the
spreads head wide into about you know, over twenty basis
points wider right the financial bonds. So things have gotten
better kind of retraced almost half of it, but still
have more to go. And then in terms of the
you know, the key concern I think is is these
unrealized losses on these bank balance sheets, and with the
(36:08):
recent you know, less concern on inflation, looking at FED
rate cuts, you know, the long duration you know, long
bonds rallying, you know, yields coming down, that is really
going to help that situation with these banks. So I think,
you know, the fundamentals are improving, but but you know
there's still some more to go there.
Speaker 1 (36:27):
That's assuming you actually believe in this big aggressive rate
cut scenario that load of people betting on. But but
let me ask you about the spread, so that it's
interesting you point out thirteen basis points above the index.
What does that relate to in terms of like history,
how how does it generally trade flat over the last
like five five or so years.
Speaker 4 (36:44):
Yeah, typically, you know the banks have traded uh, you
know about ten bases points tighter actually when when times
are good or times are normal, right, But I was
just kind of mentioning that data point of like, you know,
went back to kind of flat February when when things
seem to be okay. So I think I think, you know,
in a time of crisis, you know, spreads do widen
(37:05):
out a lot. You know, let's say in a traditional
recession and whatnot, that's when you see these kind of
things peak out. But but yeah, because these spreads are
still wider, and it's really the the regional banks, right,
which makes sense, right, They're the ones that faced a
lot of you know pressure, but you know, the big
six banks, they were seen as a rock, they were
seen as as a stabilizing force, and they're definitely tighter.
(37:28):
But you know, it's still these regional banks that that
still carry a lot of spread.
Speaker 1 (37:32):
So we may see some more trouble that you think.
Speaker 4 (37:35):
Uh so, I think you know, things will steadily improve, right,
they need time to kind of fix the hole on
their well, the the artificial hole on the balance sheets.
You know, lower yields definitely help. But then they're also
being a lot, you know, very conservative on capital returns.
Uh So, basically no little to no share buybacks right
for the next few quarters until they can build up
(37:57):
their adjusted capital levels back to where the market is comfortable.
Speaker 1 (38:01):
We seem to be heading though, into more difficult year
in terms of the economy, and you know, the consumer
is going to be under more pressure. Do we do
we expect banks therefore to suffer to have a much
tougher just operating year next year?
Speaker 4 (38:14):
Well, I think that that, you know what the banks
are better prepared for. You know, we learned what this
crisis the banks uh or some of the regional banks
weren't as well prepared for UH interest rate risk, right ironically,
But then what they've really been good at is preparing
for credit risk, right, And I think that's the more
traditional you know, asequality and you know you kind of
(38:35):
mentioned the private credit, but you know banks have been
kind of reducing you know, their their their risk appetite
and kind of getting out of some space where or
the private you know, lending has has stepped in, right,
So I think that'll help from that perspective. In terms
of the next crisis, you know, the regionals are more
a little bit more exposed to you know, the the
(38:56):
office real estate market overall. Right, Well, the bigger banks
are more exposed from a dollar perspective, but in terms
of percent of loans on the balance sheet, the region
is a little bit more exposed to office. But but
we think, you know, that that will play out over time, right,
and it's specific to certain regions and whatnot, so that
the banks will have time to combat that. But yeah,
(39:17):
so I think, you know, there will be some you know,
increasing concern, but I think it'll be contained for the
most part.
Speaker 1 (39:25):
Another thing that came up this year after the bank
crisis is the suggestion that there are just still too
many banks in America. So will we get consolidation.
Speaker 4 (39:35):
Well, I think you have a couple of you right now, right,
But in terms of consolidation, I think, you know, I
think over the mid to long term. Yes, In the
short term, as long as these unrealized losses continue to
live on, these balance sheets. I'd say that's a no,
because when you do M and A, everything needs to
(39:56):
be marked to market, to balot to So basically all
these unrealized losses would become real and so that'll create
another capital hole. And so you know, until this situation
gets better or there's like a creative solution, then I think.
You know, these large scale M and A I think
is on pause for a little bit. But then you know,
like I said, these banks are really being conservative with
(40:18):
capital turns. They're increasing their capital levels. Plus with lower
yields and a lot of these things running off, that'll
help with these unrealized losses. So you know, once that
situation gets more concerned, I think, yes, I think what
you're saying makes sense.
Speaker 1 (40:32):
So I'm glad you mentioned bonds earlier. Let's talk about
the bonds. You read a great piece this week on
the Bloomberg Terminal about issuance by banks. You expect a
big January for bank bonds. Why is that? What's driving that?
Speaker 4 (40:46):
Well, basically, I think it's a return more to like
the normal pattern that we had pre pandemic. Last year's
January was actually abnormally low, only about eight billion of issuance,
and you know, this year we're calling for about twenty
five billion, and that that's on like one hundred and
thirty five billion annual number. So we're kind of going
(41:09):
with the kind of historical seasonality where January, out of
all the months, is typically the biggest month of issuance
about eighteen percent, right, about almost twenty percent, So that
that's kind of how we derived the twenty five billion.
And last year was just we started off the year
really slowly, and that's really coming on the back of
a really at extremely active pandemic years of twenty twenty one,
(41:34):
twenty twenty two.
Speaker 1 (41:36):
So why do they need all this cash? Why did
they need twenty five billion dollars in January? What's it
all for?
Speaker 4 (41:41):
Well, I think you know the ones that we think
that will be more active, JPM Wells and maybe Goldman
JPM and Wells we think are more impacted by new
upcoming regulation called Basil Endgame, and so we think they're
they're balance sheets. We'll create a bit of a hole
in terms of how much excess bail and eligible debt
(42:03):
they'll have. I mean, they look totally fine now under
the current regulation, but a lot of these banks like
to or investors kind of point ahead to hey, what's
this upcoming regulation. What would it be on a perform
a basis. Oh, some banks look later than others, and
you know, you always want to quash any concerns early.
So so I think that's why JPM and Wells they're
(42:24):
a bit more affected by this new regulation. Bottle endgame,
you know, they want to get ahead of that. And
then for Goldman, it's more they were, you know, very light.
They along with City were very late this year, and
so we think it's more of a return to normal
for those two.
Speaker 1 (42:37):
That's a endgame that sets off my jargon alarm. I
should get a gong for that whenever you mentioned it.
But what do you what do you mean by that?
Break it down?
Speaker 4 (42:43):
For us, it's basle endgame. It's this is the regulation
that a lot of these bank CEOs are complaining about, saying, hey,
why why is there increased regulation? Why do why do
banks need to hold more and more capital, more equity?
Even though the biggest banks, even though they came out
of this stress in March to May like they were
(43:04):
the fine they were the bedrocks, right, why do they
need to do that?
Speaker 2 (43:06):
Well?
Speaker 4 (43:07):
It's actually the regulators playing catchup from you know, an
overall regulator. The global regulators suggestion ten years ago saying,
let's implement a standardized approach to riskuided assets. Basically right now,
what we have across the world is each region, each
(43:29):
country has their own risk weights for let's say a
mortgage loan. Right and but but because there's a lot
of latitude in that, the global regulators like, hey, we
need to have certain floors for that. And then when
they when they put in you know, that calculation for
the US banks, plus we call goal plating that the
US regulator put in additional stuff. That's where all these
(43:52):
big banks, you know, they say, would need to hold
twenty percent more risk wuided assets, which is the denominator
of equi in capital requirements. So they need to hold
more equity in capital as well, and also need to
hold more debt as well on top of that.
Speaker 1 (44:07):
Also the big comeback I mean this you say it's
a return to what it was you know, a few
years ago, maybe, but it is a big increase. It
is a lot of debt that's coming. Is there a
certain amount of market timing there? I mean, you know
these guys. They advise debt capital markets, they tell issuers
when to go, they look at rates, they look ahead.
The banks. Are they the smartest issues in the room, Well,
(44:28):
I think they.
Speaker 4 (44:29):
You know, they are always in the market. They're always
looking at the market, right, and then sometimes they just
have to do it right. And you know, the big
difference between bank and financial debt compared to non financial
is the banks typically issue shorter, right, So if you
look at the financials index, it's a lot shorter duration
(44:50):
than the overall And so from just that standpoint of
you're just looking at maturities, right, the banks need to
be continued, you know, big issuers from that standpoint, so
I think there's some aspect of timing, but I think
you know, you're looking ahead to some of the regulation
and whatnot. You know, these banks always need to be
(45:11):
the market anyway, and you know, if you if you
have let's say we're calling for most of the banks
to do twenty to twenty five billion of debt this year,
you don't want to do that whole twenty in a
one day, right, you know, you want to do it
over you know, a few quarters, you know, use all
the quarters, right, and then typically they like to come
a day or two within the week after they report earnings,
(45:33):
right in January, April, you know, July, and October. So
those are kind of the peak periods that typically happen,
and we think, you know, that that'll come back this year,
you know, unless, of course, you know, the things that
kind of mess that up a little bit have been
like kind of the Ukraine War or like you know,
some you know, we thought there might be an issue
with you know, haw Maas and Israel and stuff like that.
(45:54):
But you know, unless we see things like that on
the horizon, which is kind of hard to say, you know,
we think it'll become more of a historical pattern.
Speaker 1 (46:03):
So for the investors in this stuff, where are the
best opportunities right now? Where's the relative value?
Speaker 4 (46:09):
It's the things are getting tighter and tighter, but you know,
some I think there's still some spread in some of
the regionals. You know. The US Bank Corp. Is a
name that felt really hard. This was used to be
the tightest training bank, you know, of of all banks.
You know, they've been hit with some several downgrades and
they they closed an acquisition unfortunately at at at kind
(46:33):
of the worst time they at the marke to market. Uh,
union banks unrealized losses and so their equity levels went
down a lot, and then we hit we got hit
with the regional bank. Uh so you know SVB fall,
you know First Republic you know issue, So you know
that that was front and center when when their capital
levels were were kind of very low, right, So we
(46:54):
think that's coming back a lot. So you know, even
though it's not higher rated than P and C, you know,
the bond still trade trade wider, so we think kind
of there might be an opportunity there, Uh within the
Big six space. We think you know, b of A
trades wider than than JPM by about like ten fifteen
basis points. B A Bay you know, continues to be
(47:17):
an active issuer. You know, this week we've had Brian moynihan,
the CEO, saying will continue to invest in trading, which
kind of is a double edged sword for for bondholders
because the trading business is financed with bonds. So again,
you know, be a A will be an active issuer, but
we think JPM will be as well. And but b
of A actually they do better. You know, they're one
(47:38):
of the best stressed test banks in terms of their
loan losses are lower. So in a software landing or
any kind of landing, right, we think that they're fundamentally
they might you know, outperform you know, their peers.
Speaker 1 (47:50):
So anyone you stay away from.
Speaker 4 (47:54):
Uh, stay aways is a tough word, but we think
you know, City Group, you know, get the pairing between
City Group and Wells Fargo. Wells Fargo we think is
going to be an active issuer, but their bonds already
trade the widest and yet you know lower rated City
Group we think, you know, trades a little bit tighter.
And then we think that they'll return to the markets
(48:15):
this year, you know, back to a normal level. So
you have some issuance kind of negative technicals that we
think will happen this year. And plus they're more kind
of internationally exposed. They're trying to, i know, improve on that,
but but they're still they still have a more international footprint.
So if there's any more geopolitical risk that comes about, right,
like the Middle East is always something to look at,
and then you know, will that be a contangent around
(48:36):
other em countries so that that might you know, if
that flares up that then City is a name that
people might look at and say, hey, there might be
a little more increased risk.
Speaker 1 (48:48):
So to wrap things up here on what are your
what are you most excited about when you look at
twenty twenty four and what gives you the most sleepless nights?
Speaker 4 (48:57):
I don't know if there would be more sleepless nights
like they were in March, but I think what's exciting is,
you know, it's it'll, it'll you know, normal compared to
this year. I think, you know, normal typically is a
boring word. But after the year that, you know, the
rock and roll ride that we had with with with
the regional bank crisis this year, I think, you know,
(49:18):
for banks, not normal, I think is a nice thing.
And then what keeps me up at night? I think
you know, there's always you know, as a quality pressure.
You know, we we look at you know, the office
space is often mentioned as you know, so what's what's
the fallout? Right? And how quickly will this office uh
fallout hit hit the banks? And we continue here It's
(49:42):
it's going to take some time, but you know, is
that going to be you know, this year, next year,
the year after that, right? But but at least it's
it's it's kind of like typically when we see these
big things on the horizon and everybody's talking about it,
those aren't the things that usually kind of you know,
are the big issues. And so I feel like we're
(50:03):
already talking about it. You know, banks are preparing for it,
they're provisioning more for it in terms of potential you know,
long losses and that that'll I think, you know, definitely
pick up, but I think it might take a little
bit more time and be reasonable. So but if anything,
you know, yes, the the office space, you know, that's
a sector to.
Speaker 1 (50:21):
Look out for, but as of now, you think it
affects mostly the regional banks.
Speaker 4 (50:25):
There are more you know, as a percentage of loans. Yes,
they're more exposed from that standpoint.
Speaker 1 (50:29):
Okay, And I like the way you characterize twenty twenty
four as a normal year, given we're heading into a
very unusual election cycle.
Speaker 4 (50:36):
Yeah, that too.
Speaker 1 (50:37):
Yeah, So let's hope you're right. Thanks very much, And
Kakuda of Blueberg Intelligence you can read all of his
great analysis on the Bloomberg terminal. Do check it out.
And I hope see you back on the show soon. Donald, great,
thanks for having me again, and I hope we'll not
be discussing another banking crisis at that time, and have
a great holiday in great New Ya. Thanks a lot,
you too, Cheers, Thanks a lot, and thanks again to
(50:59):
Alan Shred of voke Kel Advisors and Lisa Lee from
Bloomberg News. Read all of Lisa's great credit scoops on
the terminal and at Bloomberg dot com. Please do subscribe
wherever you get your podcasts. We're on Apple, Google and Spotify.
Give us a review, tell your friends, or email me
directly at Jcrombeight at Bloomberg dot net. That's J C
R O M B I E. That's in my surname
(51:21):
and the number eight at Bloomberg dot net. This is
the last show of the year. We're taking a short break,
but we'll be right back with you on January fourth
to ring in the new year. Don't miss it. I'm
James Crombie. It's been a pleasure having you join us again.
Next time on the Credit Edge.
Hello, and welcome to The Credit Edge, a weekly markets podcast.
My name is James Crumbie. I'm a senior editor at Bloomberg.
This week, we're very pleased to welcome Alan Schreeger, senior
partner and portfolio manager at Oak Hill Advisors, a global
alternative investment firm.
Speaker 2 (00:32):
How are you, Alan, I'm doing great, James, how are
you doing very well?
Speaker 1 (00:36):
Thanks so much for joining us today. Really looking forward
to getting your take on the credit markets. And we're
also delighted to see Lisa Lee. He Lisa covers credit
markets from London and it's great to see you again.
Also on this show we have Arnold Kakuda, who covers
banks for Bloomberg Intelligence in New York. There's a lot
going on in that sector and Arnold always has some
great calls, so please do stay with us. But first,
(00:59):
Alan Schreeger Kill Advisors. Great to have you on the
Credit Edge. It's been a big year for credit, not
quite the Year of the bond that some people have
been predicting, but definitely a good run for risk assets,
at least when you look at total return. Also a
very big year for private credit, which everyone says is
going through a golden age. But before we get to that,
aland I just want to get your macro view, in
(01:20):
particular on rates. We've flipped around quite a bit from
fear about inflation hard landing to some pretty aggressive bets
on FED rate cuts happening fairly early next year, plus
a view that the economy can avoid a recession. What
do you make about the make of that? Alan? Are
we getting ahead of ourselves? What's your macroview?
Speaker 2 (01:38):
So our review is that the market desperately, desperately wants
rates to go down, and that every opportunity they get
to grab hold of anything that gives the inclination that
the Fed is going to cut either sooner than they
think or earlier enough that it will have positive impact
(02:01):
on returns and the resulting benefits to the markets, everyone
grabs hold of them. And you know, we've been looking
We look at thousands of companies, We've been looking at
the inflation numbers that we see across businesses, We've been
looking at the macro. We have a strong view that
the FED clearly doesn't want to make the mistakes of
the seventies and eighties, and that they are going to
(02:21):
be prudent in how they do that. Now, I will
say sort of last week's commentary that sounded more dubbish
than we thought they were going to be surprised us
a little bit and led us to believe, Okay, maybe
they are already starting to think about where they're going
to cut I think people thinking, and now there's been
(02:43):
some pullbacks recently in terms of commentary that they're going
to start cutting as soon as the first half of
the year seems really aggressive to us and is not
our base case. Our base case was that they were
going to keep rates at this level for a while.
It's hard to see stand firm on that commentary, given
(03:03):
the commentary we've heard from the Fed over the last
couple of weeks. But we still think that there's an
inflation problem, and when you look at where labor is
and you look at where housing is, the fact is
it's hard to convince yourself that the Fed's going to
be able to get to where they say they're going
to need to be to be able to cut rates.
(03:25):
So we're still a little bit bearish on that. We
are still a little bit more hawkish, although I will
say we're also a little bit concerned of that view
given some of the commentary we've heard from the FED
over the last couple of weeks, notwithstanding some clean up
comments over the last week.
Speaker 1 (03:43):
So let's talk private credit, which is the hot topic
at the moment. You have been beating some of the
large Wall Street banks out their own game, most recently
by leading a deal for Greenway Health they're refinancing alone
that was originally made by a more traditional lender Oakhill
ended up getting in on the reef. How are you
managing to do that sort of deal and what's your
(04:03):
edge over the Wall Street banks?
Speaker 2 (04:05):
So, if you think about private credit, you know there
are so many advantages to using private credit if you're
an issuer. And this is really from the issuer standpoint,
because to your question, the fact is is that why
does an issuer choose to go private credit, especially if
there's a premium to that. And what I would say
(04:27):
is that you have a lot of advantages as an
issuer for private credit, the speed, the confidence level, the certainty,
the structuring of it. The fact is is that a
lot of people don't like their paper trading. They don't
like to not know who their holders are. And an
example like a Greenway where you're coming closer to maturity,
(04:49):
the ability to extend it with people who are maybe
people the issuer doesn't have a relationship with, making an
A and E less likely. There are so many different
reasons that people want to use private credit that it
can come down to simplistically that they choose that as
just an easier way to do it. One of the
(05:09):
things that I think is underappreciated is that in a
private deal a company like Greenway or a Finastra or
any of the other deals we've done or that you
might mention, over the term of this conversation, we get
a lot more diligence. We get to talk to and
look at information that gets you much more comfortable with
(05:31):
the business, gets you able to diligence the company both
from a downside protection, which we like. But this is
a conversation about why issuers choose it. But you're able
to actually explain to the buyers what the company is
going to do, why is it in an okay shape
versus a public markets where they get much less of
that because of disclosure rules. And the fact is we're
(05:54):
able to structure around a lot of those issues because
of the flexibility of private credit. So you know, My
view is that private credit has just this huge multiple
tier advantage over the syndicated markets. What the syndicated markets
do really well is priced tight, right, they get lower
(06:16):
cost financing, They're able to price things that are tighter.
And when you have a B one credit that's an
issue a seasoned issuer with a lower leverage profile. The
fact is is that syndicated markets are a great provider
of that capital. The same way the high yield market
has evolved over decades from what used to be an
(06:37):
LBO market when I started in the late eighties and
nineties to in essence a double V, you know, private
public market. And so I think that the private credit
market is just going to continue to do what it
does most efficiently, which is some of those more difficult deals.
Speaker 3 (06:55):
Alan you've said that you think private credit could take
almost forty possibly of the bobby syndicated market going forward.
It seems now banks are finally starting to get a
little bit of their mojo back. The levish loan market
has gone back, the single double b's are training in
the high nineties. Now, how in terms will the competition
(07:16):
be in next year, and also how much do you
think next year banks will be get back the traditional
left in.
Speaker 2 (07:25):
Business, people talk about it as if the banks matter,
and to a certain extent, obviously, the banks don't want
to give up fee business, and I'm sympathetic to that
and understand that. And obviously we have a large syndicated business,
and we think that the banks are incredibly important and
good partners in that. Regard on the private credit side
(07:47):
or the portion of the syndicated market that is unlikely
to grow or be as big on a going forward basis,
the fact is is that the banks need somebody to
sell these owns to. You know, the banks are just
a conduit. They're they're not a holder of these assets.
So what they want is a little less relevant than
(08:08):
what do their clients want, what do the end buyers want.
And the reason why I think there that the private
credit market is going to continue to take share from
the syndicated market is first of all, to the to
the point I made to James's question, which is it's
so much easier, it's so much faster, it's so much
more uh, it's so much more consistent through a variety
(08:31):
of markets. But just as a regular bank construct, to
the to the point you're making you have to have
people who are willing to buy what you're selling, and
for the most part, until the COLO market changes enough
that it's a good buyer of B three credit or
more levered business. And you think about what the syndicated
(08:52):
loan market has become. To my same point about high
yield moving towards a double B public company market, the
loan market and the loan and the first and second
lean market have become more of the LBO financing market.
And what I just believe and the reason why I
think that transition happens is there's just less availability of
(09:14):
second leans, meaning that there's less availability of an amount
of leverage that the private credit market can provide. And
two is that all of those are rated B three,
which means that the colos have to be willing to
continue to finance the B three market. Now, as COLO
market picks back up and COLO liabilities tightened and there's
(09:36):
more of that spread and you can see more colos done,
there's going to be a portion of them that buy
B threes and they are going to be B three's
in the syndicated market. But when you think about what
the COLO market needs to be, which is a B
two basically average rated entity or securitized asset class. When
(09:57):
we think about it, and we run a large colo businusiness,
it's really attractive to buy a B two B one
mix of assets, lever them attractively in the syndicate in
the CLO securitization market, create double digit returns and not
have to reach into the B three take weighted average
(10:18):
rating risk or downgrade risk, and just means that they
might not be the ideal buyer, which ultimately means that
the banks are going to be pitching B one and
B two credits and most likely will win some B
three deals, but less and less as time goes on.
Speaker 3 (10:33):
Do you think that SALO market will come back next
year because there's been a sort of a laggered Triple
A buyers have not disappeared, but they pulled back. Right.
There's just not as many triple A buyers as they
used to be. There might be more of them, but
there's not the depth that there used to be, and
the ARBs become incredibly tough, and that's something that they've
struggled with all year long, and also with interest rates
(10:56):
the way they are, resets and refines aren't really happening
what's your take on the COLO market going forward, because
you're right it has to return if leverage loans and
the bank arranger business is going to be turning the
way they did.
Speaker 2 (11:10):
I do think it's going to come back. I do
think that you're seeing more and more triple A buyers
who are realizing than in the mid one hundreds, triple
a COLO risk, especially on a floating basis, is a
pretty attractive asset class to own. I think as the
banks actually think about that, their direct lending part of
(11:32):
their business will probably decline a combination of regulatory issues
as well as obviously private credit moving up and down
the spectrum of large to small. I think that the
banks are going to look for asset classes that meet
in essence, what their their needs are, and I think
you're going to see more and more triple A buyers
(11:53):
across the bank platform.
Speaker 1 (11:54):
I want to ask you about the funding costs from
an issuer's perspective. Obviously this form of funding private credit
is faster, it's easier in many ways, it seems more efficient,
but you've noted that it's more expensive than the syndicated
markets we are hearing you know, you mentioned double digit returns.
We're hearing high teens on some of the loans that
are going through. How is that sustainable for companies that
(12:17):
are facing a potential downturn in the economy and slower earnings.
Speaker 2 (12:22):
So obviously that's one hundred percent right, which is they
are borrowing. If you think about private credit, and this
is whether it matters whether it's syndicated or non syndicated,
because the spread differential, if it's one hundred and fifty
or two hundred basis points, doesn't free up or suddenly
make the company incredibly free cashual or positive versus not.
(12:46):
So I actually think this is a leverage finance question
more so than a private credit question, because if you
look at where the syndicated market is and you say
that that's a SOFA plus three fifty to four hundred market,
and you're saying that that's ten or eleven versus an
eleven to thirteen on the private credit market, all of
(13:07):
those at certain leverage levels clearly can mean that these
are levered capital structures that have sustainability issues. Obviously, different
companies are very different in terms of how they're going
to be able to handle this. You have businesses with
lower capital expenditures and lower fixed costs that are obviously
able to sustain interest levels at a higher level. They're
(13:29):
also levering a little bit more, so they're not necessarily
giving that as cushion, they are utilizing that for slightly
more leverage. You have businesses that have some some inherent
growth because of either improvements that a new owner might
make or investments that they've already made through capital expenditures.
(13:50):
But you're right, a big portion of the market has
free cash flow levels that are sort of break even
or slightly higher break eve, slightly above breaking even. And
one of the reasons why you're seeing a little bit
more of it of an insertion into a pick into
some of these capital structures. To allow these capital structures
(14:11):
to have that flexibility, they are reliant on ultimately growing
to create real free cash flows in that market. My
perspective in my argument on this is that the reason
why private credit is so attractive is exactly what you
just said. I actually don't think it's bad for private
(14:32):
credit when you think about that, it's able to structure
with full understanding of where rates are and where the
expectations of the business are. For the most part, it
is first dollar of debt through a certain leverage level
at fifty percent loan to value, and the equity is
who's in essence bearing the risk that there is ultimately
(14:53):
an increase in either valuations which they obviously rode for
ten years over the last ten years, or from in
their perspective improvement and performance and company EBATA, even in
the face of some dislocation. The reason why private credit works, though,
is because it's able to sort of work in all
of those environments. In the positive case, it obviously is
(15:15):
the receiver of all of this excess interest, so it
obviously is a great returning asset class on a relative
basis to almost anything that we see. On the downside,
its first dollar of debt, it's fifty percent loan to value,
which means the equity has to come up with a
way of making sure they do pay that. There's a
lot of things you can do in private credit to
(15:35):
make sure these capital structures work. In exchange for compensation,
you can pick in exchange for compensation, you can allow
them to raise incremental debt.
Speaker 3 (15:46):
Since you mentioned pitt, I'd love to follow on that tray,
especially not so much like a medicine pick, which subordinated debt,
which I think we're used to, but we're starting to
see pick in first lean and unit chant, and there's
a deal in the market with a sponsor is asking
for one hundred percent pick right off the bat for
the unit tranch, and some people are saying this can
(16:07):
points to the fact that maybe there's a bubble going
on in private credit. So what is your answer to that.
Why are you guys allowing this kind of pick? Does
one hundred percent pick make sense? And what is a
bridge too far? And what is your answer to the
idea that maybe this points to a bubble.
Speaker 2 (16:23):
So let's start with just the general pick question, which
is where the market is evolving, and it's evolving it
started with the evolution of private credit. In essence, when
you eliminate the banks, you had to figure out how
to replace what the banks were providing, which was revolvers
(16:44):
and delayed draws to a certain extent, so everyone started questioning, Okay,
well why are you doing the revolvers? And part of
that was is that if you're replacing the capital structures
that existed before, you obviously have to provide everything that
was provided before. Revolving were part of that The second transition,
which came with partial pick or small amounts of pick,
(17:06):
especially with rates where they are, is that the market
is evolving to a place where it's replacing not only
the syndicated first lean market or the syndicated it first
and second lean market, but it's taking a little piece
of the junior capital market and taking few different components
(17:27):
of each of those. And part of the component of
junior capital is that there is a pick component that
doesn't make it bad. It obviously means you have to
incorporate the right pricing and the right security. But if
you think about an efficient way to finance a business,
if you financed it with five turns of debt and
then one turn of pick preferred to get to six
(17:49):
turns of leverage, you have two constituencies. That five to
six turn piece is a much harder piece of paper
to structure because it has real downside risk because it
has five turns of debt in front of it. By
combining the two of them and taking a little bit
of both, which is a little bit of the cash,
a little bit of the pick, and then ultimately levering
(18:12):
more so you're zero to six instead of zero to five,
and then five to six, you're still talking about you're
sitting at a fifty percent loans of value. We use
fifty percent sort of broadly. Everyone sort of talks about that.
Some of it's forty or thirty, and some of it's
fifty five or even sixty. We don't see a lot
of sixties today, but you see fifties for sure, which
is why I use it. And when you think about
(18:35):
what you're doing, you're, in essence, providing capital at a
piece at a piece of a capital structure well within value,
and you're, hopefully, if you're doing it right, pricing it
appropriately for the amount of capital that exists. The mes
markets exists for decades, and this is just combining a
little bit of those markets and making sure you're getting
(18:57):
paid for it. So if I gave you a scenario
where you had to business that was worth fifteen times
and you were levering at six and a half times,
and you were picking and that pick, let's just say
that that pick is at a place where the six
and a half times becomes with no growth at the business,
the six and a half times becomes seven or seven
(19:18):
and a half times, you're still sitting there at a
very low loan to value where you are, assuming you're
getting properly paid, sitting at getting compensated for providing that
first dollar of debt. So I think when we think
about pick as a general matter, it doesn't scare us
as long as we're lending to a good company where
(19:39):
we think the coverages are great. I think the question
of why is this evolving is that as the preferred
market is less efficient and there's enough people in the
unitronch market who are willing to provide a little bit
more leverage and take some of that PICK in a
(20:00):
exchange for in essence doing that, I actually think it's healthy.
We clearly want companies that are willing and able to
pay the interest that they have, so you want to
make sure they have the flexibility. It's one of the
things that private credit does provide. It is definitely an
indication that the market has gotten stronger than it was
(20:21):
a year ago when we were looking at five turns
leverage and not six or six and a half and
very little pick because you didn't need pick when you
only had five turns. But private equity and buyers we're
still paying fifteen turns and what they're in essence saying
is will you share some of the value purchase price
(20:42):
in terms of getting paid for that? And I do
think that that's not an irrational thing to do. Obviously,
as issuers get some of that, they look to get
more and more. And obviously you're referring to the Ctivity
deal that's out there that people are talking about, where
they're being asked to do full pick because there's a
(21:04):
reasonable amount of leverage, and that's a great, great company,
but there's obviously some things they need to do on
a free cashulow basis that might require them, combined with
the leverage level, to have less cash availability upfront, requiring
the lenders to provide some of that pick capacity. And
(21:25):
I don't think that the market strengthening and certainly being
willing to do things that didn't do six months ago
or a year ago, means that it's a bubble. I
think it means that the market continues to get efficient
and certainly a little bit more aggressive in terms of
what it's willing to do. But I do take a
little bit of offense to the bubble comment, not from you, obviously,
(21:47):
but as a general matter, because what I think a
bubble implies is that the market gets irrational to a
place for valuations. And it works much better in an
equity scenario where you obviously buy something for twenty times
that's only worth ten and then when the realization comes
(22:08):
you lose half your money. In private credit, where you're
still fifty percent loan to value covered, and let's assume
that pick means that you're getting to a little higher,
you get to sixty percent, you still have this cushion,
you still have a maturity that you're getting your money back,
and the likelihood is that as long as you're not
doing bad companies, you're going to get repaid. Obviously, private
(22:33):
credit has shown historically a very low default rate in
an ever lower default loss rate, And so I think
that the level of where does a bubble exist and
what is that constitute valuations, especially in private credit, where
you don't in essence, you don't have to buy and
sell things every day. So if you have something that's
(22:53):
mispriced by a small amount twenty five or fifty basis points,
which is what you're in essence talking about here, those
don't create valuation degradations that lead to real losses. And
so it's so far away from a bubble perspective that
I think it's a it's it's not the right thing.
Speaker 1 (23:11):
Now.
Speaker 2 (23:11):
Has the market gotten more aggressive? Yes, we were seeing
in twenty two and early twenty three five to six
turns of leverage at higher coupons, and obviously that has changed.
But the market has changed. I mean, look at the
where the equity markets are, look at you know, enterprise
values to ebata's, look at where the syndicated markets are gone,
(23:33):
and we're obviously even treasuries. You think about where that
is and what you're going to do there. The fact
is is private credit on a relative basis, which is
how the world invests, still looks because of the component
of coupon and risk free, still looks incredibly cheap relative
to those things, even if that attractiveness has created some
(23:57):
tightening of the of the coupons and some loosening of
the terms.
Speaker 1 (24:02):
You know, and we get a lot of people on
the show talking about private credit. They all want to
do the good deals. No one's doing the bad deals.
No one's lending to the bad companies. But there is
so much competition right now, there's so much driypowd of
so many new entrants. Do you worry that this is
going to lead to bad outcomes. You know, the what
some people are calling the private debt tourists coming in.
Speaker 2 (24:22):
You know, you sort of love private credit tourists who
potentially do bad deals because bad deals that ultimately you
don't own make you look good on a relative basis,
So you sort of have a mixture, right. The fact
is is private credit and an asset class. I don't
think gets permanently tinted by people individual firms because they're
(24:47):
either not capable of getting sourcing the good deals or
making good decisions on which ones are the good deals.
I actually think that's a good thing for those of
us who are actually more established players and obviously doing
a lot have a lot of choices. If you don't
have a lot of choices, you're a tourist in private credit.
I love that phrase, and I've used it before too,
so I appreciate the phrasing. But if you're a tourist,
(25:11):
you don't get to see that many deals, so you
sort of have to choose the ones that you get.
So the selection process, right, if you think about the
adverse selection problem that they have is that they might
end up with things that we or others have turned
down already and they don't have much of a choice.
(25:33):
That's not terrible for us, because ultimately, differentiation is happening
in the credit markets, and the more differentiation that happens
in the private credit markets is positive to the people
who obviously ultimately make good decisions, and we hope that
that's us. Obviously we work really hard to do that.
But I think would be a little egotistical to sit
there and say, hey, you know, we're really good at
this and nobody else is good. I don't think that's true,
(25:56):
and obviously future is going to tell you. But I
do know, having run all of our performing businesses during
the crisis, there are a lot of people who blew
out of existence in nine and ten, and it did
allow those of us who did well in eighth nine
to actually differentiate yourselves and grow, And so I'm not
(26:20):
as fearful of that. Candidly, I would love I love
when a deal that I think is sort of silly
that other people do it, because if it turns out
to truly be silly, that will be a differentiating factor.
But I don't think that taints private credit. I think
ultimately every asset class has whether it's investment grade all
the way through to high yield deliverage loan syndicated markets mes,
(26:42):
and certainly private credit generically has people who really do
this well and do it poorly. And the more people
who do it poorly means that the people who do
it well succeed.
Speaker 1 (26:53):
Does it mean a high default rate next year?
Speaker 2 (26:56):
There's a lot of businesses that have hit the fault,
had losses for different parts of the capital structure that
still exists today. And the syndicated markets are or in
the regular markets, and I think the private credit market
is just built so much better to sustain us. So
will defaults go up, No doubt they'll go up, partially
(27:16):
because there's going to be if the economic cycle goes down,
there will be companies that, you know, when the ocean
pulls back, they realize that they're not wearing any bathing suits.
There will definitely be some of that. There'll be capital
structures that are just non sustainable and they're going to
need to do some restructuring and maybe to deal with
(27:38):
preferreds or junior capital, they might have to do a
restructuring or a default. But I think the difference in
a bad market between private credit and the rest of
the markets will be very obvious, whereas there's a lot
of solutions that are actually good for private credit investors
where they get incremental economics, they get potentially pieces of
(27:58):
equity and a troubled situation, or ultimately they just are
able to realize that if the business goes from fifty
percent loan to value to eighty percent loan to value
and the company defaults and they in essence accelerate, they're
still going to get their money back because they still
have a twenty percent cushion on value. So I do
think defaults will go up, but I don't think it's
(28:20):
as scary and I don't think it's as prevalent as
it will be another market.
Speaker 1 (28:24):
What do you think the biggest opportunity is for next year?
Speaker 2 (28:26):
Ellen?
Speaker 1 (28:26):
When you look at everything you cover in terms of
the credit opportunity, what are you most excited about?
Speaker 2 (28:33):
You know, I think this, I think there's and you
guys ask this question in the context of the bubble,
which I strongly disagree with. But it's hard to argue
that the market opportunity has tightened in private credit over
the last few months, as there's been a reasonable amount
(28:54):
of growth and demand and supply is just starting. And
I think the story we're telling investors is that as
companies approach the maturity wall, they're going to need to refinance.
And I think that the market opportunity is twofold with
regards to that. From a credit investor, one is if
(29:15):
you truly believe there's a business that has equity value
that's going to get either refinance or recapitalized in some way,
and it's trading at a discount, and there's a number
of those names in the market. Buying those at discounts
and then capturing that in essence, repayment at par is
clearly a way to create some total return, and we're
doing that in sort of our opportunistic business across our platform.
(29:39):
And then the second is obviously being that take out,
because if you're willing to buy that risk, you probably
are willing to do that refinancing. And I do think
that all markets are about supply demand, and right now
you have growing supply in the leverage finance market with
increasing demand probably outpacing it a little bit. I think
(30:00):
that changes as companies realize that their maturity is at
twenty five and in twenty four, it's a year away.
And yeah, it's really nice to capture the coupons of
the historical three twenty fives or three fifties, but you're
now going to have to realize we need to recapitalize
the business and refinance the business. It's going to cost
this more, but ultimately it will extend our equity optionality.
(30:23):
And I think there's going to be a lot of
that in twenty four as people realize twenty five and
twenty six are very close and they're going to need
to do that. So I think that discount capture is
a really interesting it's a really interesting way to play
the refinancing market that's going to happen over the next
couple of years. I think providing that refinancing capital is
(30:44):
a really interesting thing to do. And then ultimately, you know,
on the distress side, you are going to have decent
businesses that are just overlevered or have hiccups in their performance.
We haven't seen a lot of that. Most of the
businesses that are in distress are bad businesses, and at
least from our perspective, or bad businesses, and we have
(31:06):
been very very much on the sidelines and now just
stressed business where we've been doing distress since the late
eighties early nineties and have a phenomenal track record there,
and we're doing very little right now because we think
that the businesses are not a problem of capital structures
or time. They are a problem of secular risks or
you know, you look at a telecom business or healthcare
(31:27):
businesses that just have issues that are very hard to solve.
I think that's going to be different if there's a
market dislocation in twenty four and so we'll be ready
for that as well. But one of the reasons why
we like private credit is because it sort of protects
you from that is that if even if the market
does struggle and go down, you are first dollar of debt,
you control your capital structure, You're able to provide for
(31:50):
incremental coupon, you know, pick or or liquidity.
Speaker 1 (31:55):
Are there sectors that you love and or hate.
Speaker 2 (31:58):
We've never been a set so so do this sector
we love. We've been doing software and technology since two
thousand and four. I actually started that practice here at
OKILL and we've invested over thirty billion dollars in technology
and software and have done very very well in that
sector and we've always been heavily weighted to software, healthcare
(32:20):
and services. That's where we've been.
Speaker 1 (32:23):
So before we talk to Animald Caacuta over Bloomberg Intelligence,
what's your most contrarian trade right now?
Speaker 2 (32:31):
You know, right now, with where the world is in
what almost feels like this benign environment, our contrarian trade
is actually trying not to buy everything. You know. It's
when you look at a lot of the things that
you're done, it seems like deals right now are can
clear at pricing or at leverage levels that we say
(32:55):
to ourselves, we don't want to get caught up in
the momentum trade or the desperation trade of a BBC
that has to deploy their capital. We sort of have
a different structure because most of our capital is an
essence either where we can call it in private equity style,
so we have an ability to stay a little patient.
So our contrarian as being even though we do think
(33:16):
private credit is really cheap, we are trying to stay
high quality. We would rather say no to something that
we don't like. I don't know that there's an obvious
thing out there in a sector basis where you say, okay,
well everyone's got this wrong. You know, healthcare is not
going to have the issues in telecom. Telecom's a perfect example, right,
(33:39):
Telecom's going through this huge technology shift that's really really
hard to evaluate. They've all got that wrong. It's all
going to be fine. Like I don't think we have
any of that, and we don't really have a perspective
on that. I think what we're trying to do is
be more selective as the market stay strong, rather than
just deploy for the sake of deploying.
Speaker 1 (34:00):
Great stuff. Adam Schreeger Held Advisors, thank you so much
for being on the show.
Speaker 2 (34:04):
I really appreciate it. It was great to have both of
you today.
Speaker 1 (34:07):
Also want to say a big thanks to Lisa Lee
with Bloomberg News in London. Brilliant to see you again. Cheers,
thank you so much for.
Speaker 3 (34:12):
Having me, and happy holidays and.
Speaker 1 (34:14):
All the best to both of you for twenty twenty four.
I hope it's a good one. So I'm delighted to
welcome back on the Credit Edge Arnold Kakuda, who covers
banks for Bloomberg Intelligence based in New York. How's it going, Arnold?
Speaker 4 (34:25):
Awesome? Awesome.
Speaker 1 (34:26):
So we've talked a lot about financial institutions. This year,
our March edition on the banking crisis was very popular.
Thank you very much for being there, Arnold, to explain
to us what was happening break it all down for us.
At that time, a very large global, systemically important institution,
credit SUEEE, went bust and we lost a handful of
regional banks in the US. Since then, we seem to
(34:48):
have bounce back. Credit markets have performed well. The eighty
one market almost fully recovered. But what's the situation now, Arnold?
How robust really is the banking sector? There are a
lot of Macro's storm on the horizon. Traditional banks are
losing out to other types of financial institutions that so
called non bank lenders in the world of direct lending.
(35:08):
Regulations are exerting some pressure on the belge bracket. And
the latest news I'm looking at is that banks are
cutting bonuses for traders, which is never a good sign.
So what's the outlook, Arnold? Will twenty twenty four be
a tough year for banks? What do you think?
Speaker 4 (35:21):
Well? I think you know, there's definitely still concerns with banks,
and I think you can see that and how the
bonds are still trading wider right there, They're now about
like thirteen basis points. Financial bonds are about thirteen basic
points wider than the overall index. So you know, if
we rewind back to February, before any sort of you know,
crisis was on the horizon, financials and non financials traded flat.
(35:46):
So you know, yes, things are getting better, but you
know they're still concerned out there, and you know, the
spreads head wide into about you know, over twenty basis
points wider right the financial bonds. So things have gotten
better kind of retraced almost half of it, but still
have more to go. And then in terms of the
you know, the key concern I think is is these
unrealized losses on these bank balance sheets, and with the
(36:08):
recent you know, less concern on inflation, looking at FED
rate cuts, you know, the long duration you know, long
bonds rallying, you know, yields coming down, that is really
going to help that situation with these banks. So I think,
you know, the fundamentals are improving, but but you know
there's still some more to go there.
Speaker 1 (36:27):
That's assuming you actually believe in this big aggressive rate
cut scenario that load of people betting on. But but
let me ask you about the spread, so that it's
interesting you point out thirteen basis points above the index.
What does that relate to in terms of like history,
how how does it generally trade flat over the last
like five five or so years.
Speaker 4 (36:44):
Yeah, typically, you know the banks have traded uh, you
know about ten bases points tighter actually when when times
are good or times are normal, right, But I was
just kind of mentioning that data point of like, you know,
went back to kind of flat February when when things
seem to be okay. So I think I think, you know,
in a time of crisis, you know, spreads do widen
(37:05):
out a lot. You know, let's say in a traditional
recession and whatnot, that's when you see these kind of
things peak out. But but yeah, because these spreads are
still wider, and it's really the the regional banks, right,
which makes sense, right, They're the ones that faced a
lot of you know pressure, but you know, the big
six banks, they were seen as a rock, they were
seen as as a stabilizing force, and they're definitely tighter.
(37:28):
But you know, it's still these regional banks that that
still carry a lot of spread.
Speaker 1 (37:32):
So we may see some more trouble that you think.
Speaker 4 (37:35):
Uh so, I think you know, things will steadily improve, right,
they need time to kind of fix the hole on
their well, the the artificial hole on the balance sheets.
You know, lower yields definitely help. But then they're also
being a lot, you know, very conservative on capital returns.
Uh So, basically no little to no share buybacks right
for the next few quarters until they can build up
(37:57):
their adjusted capital levels back to where the market is comfortable.
Speaker 1 (38:01):
We seem to be heading though, into more difficult year
in terms of the economy, and you know, the consumer
is going to be under more pressure. Do we do
we expect banks therefore to suffer to have a much
tougher just operating year next year?
Speaker 4 (38:14):
Well, I think that that, you know what the banks
are better prepared for. You know, we learned what this
crisis the banks uh or some of the regional banks
weren't as well prepared for UH interest rate risk, right ironically,
But then what they've really been good at is preparing
for credit risk, right, And I think that's the more
traditional you know, asequality and you know you kind of
(38:35):
mentioned the private credit, but you know banks have been
kind of reducing you know, their their their risk appetite
and kind of getting out of some space where or
the private you know, lending has has stepped in, right,
So I think that'll help from that perspective. In terms
of the next crisis, you know, the regionals are more
a little bit more exposed to you know, the the
(38:56):
office real estate market overall. Right, Well, the bigger banks
are more exposed from a dollar perspective, but in terms
of percent of loans on the balance sheet, the region
is a little bit more exposed to office. But but
we think, you know, that that will play out over time, right,
and it's specific to certain regions and whatnot, so that
the banks will have time to combat that. But yeah,
(39:17):
so I think, you know, there will be some you know,
increasing concern, but I think it'll be contained for the
most part.
Speaker 1 (39:25):
Another thing that came up this year after the bank
crisis is the suggestion that there are just still too
many banks in America. So will we get consolidation.
Speaker 4 (39:35):
Well, I think you have a couple of you right now, right,
But in terms of consolidation, I think, you know, I
think over the mid to long term. Yes, In the
short term, as long as these unrealized losses continue to
live on, these balance sheets. I'd say that's a no,
because when you do M and A, everything needs to
(39:56):
be marked to market, to balot to So basically all
these unrealized losses would become real and so that'll create
another capital hole. And so you know, until this situation
gets better or there's like a creative solution, then I think.
You know, these large scale M and A I think
is on pause for a little bit. But then you know,
like I said, these banks are really being conservative with
(40:18):
capital turns. They're increasing their capital levels. Plus with lower
yields and a lot of these things running off, that'll
help with these unrealized losses. So you know, once that
situation gets more concerned, I think, yes, I think what
you're saying makes sense.
Speaker 1 (40:32):
So I'm glad you mentioned bonds earlier. Let's talk about
the bonds. You read a great piece this week on
the Bloomberg Terminal about issuance by banks. You expect a
big January for bank bonds. Why is that? What's driving that?
Speaker 4 (40:46):
Well, basically, I think it's a return more to like
the normal pattern that we had pre pandemic. Last year's
January was actually abnormally low, only about eight billion of issuance,
and you know, this year we're calling for about twenty
five billion, and that that's on like one hundred and
thirty five billion annual number. So we're kind of going
(41:09):
with the kind of historical seasonality where January, out of
all the months, is typically the biggest month of issuance
about eighteen percent, right, about almost twenty percent, So that
that's kind of how we derived the twenty five billion.
And last year was just we started off the year
really slowly, and that's really coming on the back of
a really at extremely active pandemic years of twenty twenty one,
(41:34):
twenty twenty two.
Speaker 1 (41:36):
So why do they need all this cash? Why did
they need twenty five billion dollars in January? What's it
all for?
Speaker 4 (41:41):
Well, I think you know the ones that we think
that will be more active, JPM Wells and maybe Goldman
JPM and Wells we think are more impacted by new
upcoming regulation called Basil Endgame, and so we think they're
they're balance sheets. We'll create a bit of a hole
in terms of how much excess bail and eligible debt
(42:03):
they'll have. I mean, they look totally fine now under
the current regulation, but a lot of these banks like
to or investors kind of point ahead to hey, what's
this upcoming regulation. What would it be on a perform
a basis. Oh, some banks look later than others, and
you know, you always want to quash any concerns early.
So so I think that's why JPM and Wells they're
(42:24):
a bit more affected by this new regulation. Bottle endgame,
you know, they want to get ahead of that. And
then for Goldman, it's more they were, you know, very light.
They along with City were very late this year, and
so we think it's more of a return to normal
for those two.
Speaker 1 (42:37):
That's a endgame that sets off my jargon alarm. I
should get a gong for that whenever you mentioned it.
But what do you what do you mean by that?
Break it down?
Speaker 4 (42:43):
For us, it's basle endgame. It's this is the regulation
that a lot of these bank CEOs are complaining about, saying, hey,
why why is there increased regulation? Why do why do
banks need to hold more and more capital, more equity?
Even though the biggest banks, even though they came out
of this stress in March to May like they were
(43:04):
the fine they were the bedrocks, right, why do they
need to do that?
Speaker 2 (43:06):
Well?
Speaker 4 (43:07):
It's actually the regulators playing catchup from you know, an
overall regulator. The global regulators suggestion ten years ago saying,
let's implement a standardized approach to riskuided assets. Basically right now,
what we have across the world is each region, each
(43:29):
country has their own risk weights for let's say a
mortgage loan. Right and but but because there's a lot
of latitude in that, the global regulators like, hey, we
need to have certain floors for that. And then when
they when they put in you know, that calculation for
the US banks, plus we call goal plating that the
US regulator put in additional stuff. That's where all these
(43:52):
big banks, you know, they say, would need to hold
twenty percent more risk wuided assets, which is the denominator
of equi in capital requirements. So they need to hold
more equity in capital as well, and also need to
hold more debt as well on top of that.
Speaker 1 (44:07):
Also the big comeback I mean this you say it's
a return to what it was you know, a few
years ago, maybe, but it is a big increase. It
is a lot of debt that's coming. Is there a
certain amount of market timing there? I mean, you know
these guys. They advise debt capital markets, they tell issuers
when to go, they look at rates, they look ahead.
The banks. Are they the smartest issues in the room, Well,
(44:28):
I think they.
Speaker 4 (44:29):
You know, they are always in the market. They're always
looking at the market, right, and then sometimes they just
have to do it right. And you know, the big
difference between bank and financial debt compared to non financial
is the banks typically issue shorter, right, So if you
look at the financials index, it's a lot shorter duration
(44:50):
than the overall And so from just that standpoint of
you're just looking at maturities, right, the banks need to
be continued, you know, big issuers from that standpoint, so
I think there's some aspect of timing, but I think
you know, you're looking ahead to some of the regulation
and whatnot. You know, these banks always need to be
(45:11):
the market anyway, and you know, if you if you
have let's say we're calling for most of the banks
to do twenty to twenty five billion of debt this year,
you don't want to do that whole twenty in a
one day, right, you know, you want to do it
over you know, a few quarters, you know, use all
the quarters, right, and then typically they like to come
a day or two within the week after they report earnings,
(45:33):
right in January, April, you know, July, and October. So
those are kind of the peak periods that typically happen,
and we think, you know, that that'll come back this year,
you know, unless, of course, you know, the things that
kind of mess that up a little bit have been
like kind of the Ukraine War or like you know,
some you know, we thought there might be an issue
with you know, haw Maas and Israel and stuff like that.
(45:54):
But you know, unless we see things like that on
the horizon, which is kind of hard to say, you know,
we think it'll become more of a historical pattern.
Speaker 1 (46:03):
So for the investors in this stuff, where are the
best opportunities right now? Where's the relative value?
Speaker 4 (46:09):
It's the things are getting tighter and tighter, but you know,
some I think there's still some spread in some of
the regionals. You know. The US Bank Corp. Is a
name that felt really hard. This was used to be
the tightest training bank, you know, of of all banks.
You know, they've been hit with some several downgrades and
they they closed an acquisition unfortunately at at at kind
(46:33):
of the worst time they at the marke to market. Uh,
union banks unrealized losses and so their equity levels went
down a lot, and then we hit we got hit
with the regional bank. Uh so you know SVB fall,
you know First Republic you know issue, So you know
that that was front and center when when their capital
levels were were kind of very low, right, So we
(46:54):
think that's coming back a lot. So you know, even
though it's not higher rated than P and C, you know,
the bond still trade trade wider, so we think kind
of there might be an opportunity there, Uh within the
Big six space. We think you know, b of A
trades wider than than JPM by about like ten fifteen
basis points. B A Bay you know, continues to be
(47:17):
an active issuer. You know, this week we've had Brian moynihan,
the CEO, saying will continue to invest in trading, which
kind of is a double edged sword for for bondholders
because the trading business is financed with bonds. So again,
you know, be a A will be an active issuer, but
we think JPM will be as well. And but b
of A actually they do better. You know, they're one
(47:38):
of the best stressed test banks in terms of their
loan losses are lower. So in a software landing or
any kind of landing, right, we think that they're fundamentally
they might you know, outperform you know, their peers.
Speaker 1 (47:50):
So anyone you stay away from.
Speaker 4 (47:54):
Uh, stay aways is a tough word, but we think
you know, City Group, you know, get the pairing between
City Group and Wells Fargo. Wells Fargo we think is
going to be an active issuer, but their bonds already
trade the widest and yet you know lower rated City
Group we think, you know, trades a little bit tighter.
And then we think that they'll return to the markets
(48:15):
this year, you know, back to a normal level. So
you have some issuance kind of negative technicals that we
think will happen this year. And plus they're more kind
of internationally exposed. They're trying to, i know, improve on that,
but but they're still they still have a more international footprint.
So if there's any more geopolitical risk that comes about, right,
like the Middle East is always something to look at,
and then you know, will that be a contangent around
(48:36):
other em countries so that that might you know, if
that flares up that then City is a name that
people might look at and say, hey, there might be
a little more increased risk.
Speaker 1 (48:48):
So to wrap things up here on what are your
what are you most excited about when you look at
twenty twenty four and what gives you the most sleepless nights?
Speaker 4 (48:57):
I don't know if there would be more sleepless nights
like they were in March, but I think what's exciting is,
you know, it's it'll, it'll you know, normal compared to
this year. I think, you know, normal typically is a
boring word. But after the year that, you know, the
rock and roll ride that we had with with with
the regional bank crisis this year, I think, you know,
(49:18):
for banks, not normal, I think is a nice thing.
And then what keeps me up at night? I think
you know, there's always you know, as a quality pressure.
You know, we we look at you know, the office
space is often mentioned as you know, so what's what's
the fallout? Right? And how quickly will this office uh
fallout hit hit the banks? And we continue here It's
(49:42):
it's going to take some time, but you know, is
that going to be you know, this year, next year,
the year after that, right? But but at least it's
it's it's kind of like typically when we see these
big things on the horizon and everybody's talking about it,
those aren't the things that usually kind of you know,
are the big issues. And so I feel like we're
(50:03):
already talking about it. You know, banks are preparing for it,
they're provisioning more for it in terms of potential you know,
long losses and that that'll I think, you know, definitely
pick up, but I think it might take a little
bit more time and be reasonable. So but if anything,
you know, yes, the the office space, you know, that's
a sector to.
Speaker 1 (50:21):
Look out for, but as of now, you think it
affects mostly the regional banks.
Speaker 4 (50:25):
There are more you know, as a percentage of loans. Yes,
they're more exposed from that standpoint.
Speaker 1 (50:29):
Okay, And I like the way you characterize twenty twenty
four as a normal year, given we're heading into a
very unusual election cycle.
Speaker 4 (50:36):
Yeah, that too.
Speaker 1 (50:37):
Yeah, So let's hope you're right. Thanks very much, And
Kakuda of Blueberg Intelligence you can read all of his
great analysis on the Bloomberg terminal. Do check it out.
And I hope see you back on the show soon. Donald, great,
thanks for having me again, and I hope we'll not
be discussing another banking crisis at that time, and have
a great holiday in great New Ya. Thanks a lot,
you too, Cheers, Thanks a lot, and thanks again to
(50:59):
Alan Shred of voke Kel Advisors and Lisa Lee from
Bloomberg News. Read all of Lisa's great credit scoops on
the terminal and at Bloomberg dot com. Please do subscribe
wherever you get your podcasts. We're on Apple, Google and Spotify.
Give us a review, tell your friends, or email me
directly at Jcrombeight at Bloomberg dot net. That's J C
R O M B I E. That's in my surname
(51:21):
and the number eight at Bloomberg dot net. This is
the last show of the year. We're taking a short break,
but we'll be right back with you on January fourth
to ring in the new year. Don't miss it. I'm
James Crombie. It's been a pleasure having you join us again.
Next time on the Credit Edge.
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