June 18, 2025 • 50 mins
When the credit cycle turns, “the game will be over” for some private debt funds that are overly exposed to weak companies, according to Silver Point Capital. “We see every deal that’s getting done — there’s some good deals and there’s some bad deals,” Michael Gatto, the firm’s head of private side businesses, tells Bloomberg News’ Irene Garcia Perez and Bloomberg Intelligence’s David Havens in the latest Credit Edge podcast. “If someone is doing too many bad deals, they won’t exist,” says Gatto, referring to what generally happens when debt market liquidity dries up. Gatto and Havens also discuss Silver Point’s approach to private credit, the growth of liability management exercises and disqualified lender lists.
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Episode Transcript
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Speaker 1 (00:17):
Hello, and welcome to the Credit Edge, a weekly market podcast.
My name is Ida Agathia Perez, and I'm a team
leader at Bloomberg.
Speaker 2 (00:25):
And I'm David Haven's, a senior credit analyst a Bloomberg Intelligence.
This week, we're delighted to welcome Michael Gatto, a partner
and head of private side businesses at Silverpoint Capital. Michael,
how are you?
Speaker 3 (00:36):
I'm great, Thanks for having me excellent.
Speaker 2 (00:38):
We're delighted to have you here, as if being head
of privates at Silverpoint weren't enough. Michael is also an
adjunct professor at Columbia Business School in Fordham's Gibelli School
of Business, where he teaches credit analysis and distressed special
Situation investing. Now let me toss it back.
Speaker 1 (00:53):
To your Silverpoint has its origins in distress debt, founded
by Edmulay and Boboshi, who came from GOLDMANSAC Special Situations Group.
You work with them at Goldman then joined them shortly after,
so you you're not a founding partner, but as close
as it gets. Pretty much of silver Point in recent years,
(01:15):
though it has expanded. I guess expanded is more accurate
than pivoted to private credit because of the stress strategy
is still a relevant one. But I wanted to ask
you you're under the private credit strategy, tell me more
about this expansion. What is the cell point or what's
the edge that your private credit strategy has, and how
(01:38):
have you convinced How difficult was it the conversation with
borrowers that yes, you have a loan to own strategy,
but you do more things on that.
Speaker 3 (01:47):
Yeah, it's a great question, and I think it's a
little misunderstood in the maocket. And you know, as the
three of us was discussing earlier at silver Point, we
never really talked about ourselves a lot to the press
or other than our investors and our barwers. But we
started we were Amulet and Barboa Change said they started
(02:11):
all of the credit functions investing at Goldman Sachs and
they left two thousand and two and started silver Point,
and in that we are a credit fund. The press
has called us a distress debt fund, But in two
thousand and three we were doing private credit along with
(02:34):
investing in the secondary markets. So how we view ourselves
are we are investors in credit and that could be
performing credit, that could be originating new loans in private
credit and buying in the secondary market of credits that
are having problems. So what I want to make a
(02:57):
clear We've been in that private credit business since two
thousand and three, and in fact, coming into the Great
Financial Crisis, we had five billion dollars of our originated lots.
We had gone through the life into the financial crisis
about nine billion, and we had five billion that we
(03:18):
worked through successfully and in fact got very good returns
on our that they came in and out of the crisis.
But you're right, you have a perception of your distressed
that fund, so people will say on occasion, why would
I borrow from you? And if it's okay, I'd like
(03:38):
to break it up into two components. One is right now,
our fund has thirty eight billion of a vestible capital.
North of half of it is for performing credits four
billion dollars colos, sixteen billion dollars private credit. That's twenty
(04:01):
and the remainder is our special opportunities. When we're going
to the market in the private credit, we're trying to
fill a gap that's greatly appreciated. And as you know, David,
you follow private credit, a lot of lenders have a
(04:22):
very distinct box they lend it to. They want to
lend to a new LBO. They have a loan to
value they want, and they have industries that they like
and industries they don't like, and the minute something fits
in that box, they're gonna win. They're gonna go after it.
(04:44):
And they basically are saying, hey, tell me where I
need to be to win. And that's an overbank market.
Today won't be through cycles, but today it is. We
have a different conversation. One we're going to try to
target thirty forty percent of our loans will be two nonsponsors,
(05:07):
which is very underbanked because it's harder. You have to
be comfortable doing full due diligence. You can't rely on, Hey,
an equity sponsor's buying this company for a billion, they
want a five hundred billion dollar loan. I could go
to cent committee with a straight face, fifty percent loan
(05:29):
to value plus they're going to give me go all
their work, and then I could cut in paste that summarizon.
We we will do our own credit work, and we're
comfortable doing full level private and wey like due diligence
for a loan, and that allows you to attack that
(05:49):
our non sponsor space. Then that's not to say we're ignoring.
If that's thirty forty percent, well if I do the
math one hundred minus forty, that'd be sixty percent will
be sponsors. But we break sponsor's need for financing into
three buckets. Bug. The number one is that core LBO
(06:12):
it's fairly vanilla, and that we will look at all
of those we want to see it, but we're only
going to do very few. Now you say, well, why
would you even look at it if it's overbanked, Because
when the cycle turns, we want the relationships and we
want to be in that. And I'll give you an example.
(06:34):
A lot of people say, well, there aren't a lot
of cycles. You had nineteen ninety eight, two thousand and two,
two thousand and eight and COVID, but you've got a
lot of mini cycles. So we were maybe doing ten
to fifteen percent in LBOs and then two thousand and
three hat men and the market shut down short period
(06:55):
of time. But you had our real fear of inflation.
You had interest rates going off for the first time
in a long time. You had banks with hung deals,
Twitter was stole hung, and you had all of a sudden,
Silicon Valley bank blows up. So you had this short
period of time where the market shut and we went
(07:20):
in and aggressively filled that cap. The golden moment, Yeah,
it's the golden moment, but you gotta have the capital,
the confidence, and the relationship. So that's one part of
how we're attacking the sponsor market. The second component is
what we call specialty LBOs, and that's where the sponsor
(07:45):
does not want to go to the broadly syndicated low
market or go to ten and fifteen lenders and play
one off the other. It could be a take private.
I'll give you just an example. Company has four billion
market cap goes down to a billion because it was
(08:07):
growing at high rates, their core business matured and the
throwing a lot of cash into potential growth businesses, none
of which are working. A sponsor comes in sees where
the prices knows, the industry knows, the management team knows,
(08:27):
the board and says, you shouldn't be a public, you
should be private. Wi'll pay a thirty percent premium and
cuts the deal. They got to go announce it, get
shareholder votes to close. They are not looking to fight
(08:49):
about every basis point. What they're fearful of. What if
this leaks before the shareholder meeting. What if the stock
price goes above our thirty percent premium. What if some
investment banks start calling the board and saying, I have
a buyer who could do better. They might be fishing,
(09:11):
but the board gets nervous, Oh, maybe I need They
want to go to one lender who they trust.
Speaker 2 (09:18):
They want to have the assurance of getting the deal.
Speaker 3 (09:19):
Done, deal done quietly. It's both exactly David is and
someone who the confident could step up and write a
check for three four hundred million. And if they're paying
a little more upfront, a little more call, a little
more coupon stronger docs. It's small in the overall thing
(09:45):
of private equity funds auctions. They know they paid more
than everyone else a proprietary deal that they might have
spent a year, two years developing the relationship. Everything falls
in line. They want to come to someone like us,
(10:05):
So we have core LBOs. We're going to attack that
in market dislocations, MIDI and major specialty finance. That's what
we're marketing and things that don't fit everyone's box.
Speaker 2 (10:21):
Is that specialty finance component that the sort of the
private element that you just described is that pretty much
a niche.
Speaker 3 (10:28):
Are there only a few places in that for sure? Okay,
it's a big niche. Yeah, you have to have you
have to have the capital, you have to have the relationships.
And when you go through it and you have to
drop everything and get it done quietly in a short
period of time, there are ready that many players that
(10:48):
could do that. That the sponsors are confident and when
I look at our core relationships they repeat. And then
finally there's a lot of deals in the sponsor world
that are not for new LBO add on acquisition refinancing.
(11:09):
The incumbent lender always has a massive advantage if everything
was going well, if there were a lot of hiccups
and all of a sudden it's three or four years later,
and the original incumbent lenders were reliant on the sponsor's
(11:30):
loan to value from three years ago. It's sort of
irrelevant now because things did not go as plan and
we market ourselves, come to us, we'll re underwrite it.
And while we're known to do much more due diligence
than most and structure more than most, we fit this
(11:54):
need so we're embraced by the sponsor community in it.
Speaker 2 (12:00):
So you obviously have tremendous perspective on the market. I
mean you fledged from Goldman in two thousand and two
and got going in two thousand and three. Really at
silver Point, Techrek was winding down. Enron just happened. Financial
crisis was a few years away. Europe languished right after that.
COVID nineteen happened. Private credit is sort of described or
thought of as a new thing. It's not really a
(12:21):
new thing. I went through a chemical bank training program
back in nineteen eighty seven to do leverage loans to
middle market companies. But how have you seen this market evolve?
You've been here since the very beginning of what sort
of is referred to as private credit. So two decades
in two decades plus in how has it changed.
Speaker 3 (12:40):
Oh, it's changed tremendously in the amount of capital. So
I agree. I was in I taught those training programs,
and we had, like I said, at Goldman Sachs, we
did private credit. I think what's changed the most is
how many players have come in since the Great Financial Crisis.
(13:05):
It was viewed the Great Financial Crisis opened this window
as banks had to worry about their own liquidity solvencies.
Regulators clos were not getting the same type of leverage
they needed to make their business model worked, and people
(13:26):
jumped in, which is great, And I actually think, you
know all this the private credit is somehow bad for
the economy. I don't get that in that it's phenomenal there.
When you think of economic crisises, they're driven and magnified
by a lack of capital to refinance loans to fund growth.
(13:50):
Private credit will fill has filled that vacancy. The real
question that people ask is it has gotten overheated, especially
in that core LB oh, and is it a bubble
that's gonna blow up? And the answer is, you know,
(14:11):
it's the warring buffet quote that everyone loves. When the
tide goes out, we're gonna see who's when we get
into the next cycle. There will be people who do fine.
There will be people who don't do well, and they
will work down their portfolio and go out of business,
(14:34):
and there will be a third category that not only
does fine, but has the dry powder and the expertise
to lean into that. What I love, what silver Point
loves is when the market is driven by fear of
(14:54):
missing out risk on to just constantly be saying, when
it changes, how is our portfolio going to do? Do
we know every potential problem and have a plan of attack,
and do we have the dry powder and the expertise
(15:14):
that when we go from fear of missing out to
fear that's where you want to be. And if you
have capital, don't you're not playing triage and you have
the confidence to step up when most people are not.
That's how you really win, and that's how you build
(15:37):
the long term relationships. When the market's heated, it's odd
everyone will do that deal. This monster in a core
LBO is not saying thank you, thank you, thank you.
They're saying you say thank you, thank you, thank you
to me because I have twenty term sheets. It's when
you're attacking the markets, in the segments that aren't as competitive,
(16:03):
or when everything shuts down, then you build the long
term relationships.
Speaker 1 (16:08):
Right, speaking of dry powder, that combined with added pressure
to deploy, I'm not speaking about silver point sell, but
about like funding private credit in general that seems to
add to the risk to the bottom to just sign
any type of deal to some extent in terms that
are very favorable for favorable for borrowers, but not necessarily
(16:32):
the best terms for creditors with the best protections for creditors.
Are you seeing any opportunities from this type of loans
that for private credit loans that you know, offer very
few protections for creditors. And now I don't know if
you're seeing opportunities in perhaps private credit secondaries or other
sorts of like ways in for re.
Speaker 3 (16:54):
No, I mean, I think that there's a lot and
you guys have written a lot, you guys meaning bloomberk
and trading of private credit, you know, And we're gonna
have a discussion around that because that's sort of interesting
because the whole idea and the whole part of the
benefit of private credit is I'm dealing with self appoint
(17:14):
you're my lendo. When we need to amend the doc,
I'm calling you. I know who universe is it? I
don't know who's the person I need to talk to.
But no, we're not seeing a lot of opportunities in
buying private credit, whether over time that trades or not.
What I would say is the race to the bontom
(17:37):
phenomenal is there. You got to avoid it. And it
goes back to We're not gonna know the winners and
the losers until things get bad. What you know? And
or investors will ask me, well, what questions should I ask? Well, One,
I look at it and say, what scares me the
(17:58):
most is a couple of things. One, small companies ten million,
fifty million EBDA doesn't have significant market share when there's
a problem. You might not have the senior secure downside protection.
You might be taking equity risk getting debt like returns.
(18:21):
So small business is scamming two documents. I'm like almost
shocked at how loans sometimes and this is also the
worldly syndicated loan market. The focus on the loan to
value day one the company, But then there's the docs.
(18:44):
Are the docks right? But if I'm landing five hundred
million dollars to a company that's worth a billion today,
But the docs say there's a carve out and they
could move two hundred and fifty million dollars of value
out of the companies that you're lending to to an
unrestricted sub that I cannot put a covenant on. I
(19:08):
can't go after the value. It's misleading to say I'm
fifty percent loans of value taking five hundred over the billion,
I would take five hundred divided by seven fifty because
the sponsor, of course, they should move assets out when
there's a problem. And unlike being a venture capitalist and
(19:31):
equity value growth equity, where you worry about good things
and bad things happening, as a lender, all you care
about is bad things.
Speaker 2 (19:44):
Yeah, your best outcome is getting repaid what you lent.
Speaker 3 (19:48):
Par plus my coupons. Yeah, that's the game of our men.
And therefore I have to say, what could go wrong,
what's the probability of it going how much can value
deteriorate if that happens, and what does the document allow
(20:09):
that company to do. You know, I have a lot
of friends in VC and growth equity, and they'll say, Michael,
your job so easy, senior secured, And I'm like, no, No,
your job is so easy because you could do ten deals,
get a zero on three or four of them, mediocre
(20:31):
returns on three or four. As long as you have
of the deals being the next uber the next day,
are your hero. We can't lose money. We have to
be paranoid about everything that could go wrong and say,
if it goes wrong, do I think I'm gonna lose money.
(20:52):
We will, and that's a tough way to live a life.
Speaker 1 (20:56):
We will go into more detail about liability management exercise.
Speaker 3 (20:59):
Letter liability management as in you love to participate, Oh no,
I love talking, I love well, I will talk about
I love talking about it. It's interesting.
Speaker 1 (21:09):
Okay, But before that, do you think investors are adequately
compensated for the risk of fill liquidity?
Speaker 3 (21:16):
Yes and no. You know, it's gonna be the simple answer.
Certain segments of the market, I think you're getting fairly
to overcompensated for it. Again, these parts of the segments
where they're just less efficient, less capital. Yes, I think
in certain of the deals you're getting no ill liquidity premium.
(21:40):
But then again, you have some investors that are fine.
You know, it's also who are the investors of the fund.
If the investors of the fund have a very very
long term their capital, very long term, they don't want
market vowel of things going up and down just based
(22:01):
on something the president says. They actually value not having
all that liquidity. So it depends on a lot of things.
I think right now the core LBO market is what
I would call a beta trade. It's not there's no
(22:21):
excess return in it, and you're probably being adequate for
those who do it. Well, I think you're getting adequately
compensated for the risk and the liquidity. And my only
point before not everyone has the same illiquidity premium. So
the people who go into these assets aren't aren't going
(22:44):
to be someone who knew needs day to day liquidity
and therefore they don't need the same liquidity premium as others.
Does that make sense?
Speaker 2 (22:54):
Yeah, So just sort of sticking with this liquidity issue
and pivoting a little bit. Private credit has been a
hot sector for a while. Is it suitable for retail
investors via ETFs with a private credit component? Don't we
have the risk of fundamentally illiquid assets being backed by
daily liquidity funding sort of?
Speaker 3 (23:15):
Well, it's unambiguously a legitimate concern, right, So if you're
raising money to the retail market, you need to explain
what is the liquidity of this. Now you could have
liquidity backstabs, so allowing you could draw on to pay
(23:39):
out x percent of the investors, so you know there
is some liquidity. We're just early on in thinking about
whether we should or shouldn't raise money from the retail investors.
So there's a big learning curve of a fund saying
is that appropriate or not?
Speaker 2 (24:00):
It seems to be a little bit of baby steps too,
because the private credit component is relatively low in these
funds so far.
Speaker 3 (24:08):
Yeah, I agree with that. So to answer your question,
it's going to be I think, yes, it is appropriate
if it structured correctly and it's disclosed that marketed correctly.
But I'm not an expert on it.
Speaker 1 (24:26):
In the book, one of the things and you were
discussing now, you mentioned the and you emphasized a lot
of importance of due diligence, and you were talking about
it just now. And in the book you mentioned the
anecdote of Mark Dreyer, the lawyer that was sentenced to
I think twenty years of prison for fraud. Yes, that
was you know, I was trying to sell loans that
(24:47):
were actually non existent. It was a fraud basically, and
was getting annoyed by the level of due diligence questions
that Silverpoint was asking. Was meant to have dinner with
you guys, but was actually the rest in Canada the
day before? I think is due diligence even more important
in private credit, equally importantness in public markets? Is there
(25:09):
something additional that investors would need to take into account.
Speaker 3 (25:14):
Our firm believes due diligence is the core of who
we are. In fact, we have certain core principles, and
one is we dig deeper we enjoy due diligence. You know,
we think it's really important. Now. The less liquid your
investment is, the more due diligence you need, because if
(25:37):
you make a mistake, you can't get out. So if
it's a public investment, you might have done eighty percent
of your work and say, I am going to start
to buy because I think I have a unique investment thesis.
I think I'm ahead of the curve, and even though
(25:58):
I still have work to do, the price is trading
at today compensates me for buying without all of my
due diligence done, because if I wait until I'm done
and the price moves up ten twenty points, well I
didn't do my job. So when there's liquidity, you could
(26:20):
start to buy and then change your mind and get out,
and you might take a loss. If you're doing on
the other extreme, your private equity fund, you have to
finish your due diligence before you invest. So I would
say if you're lending to private deals, you're going to
(26:42):
have to do more due diligence because you can't decide
to make a mistake and move out, or if you're
doing nonsponsor loans, that even magnifies that because you can't
piggyback on the work sponsor has done. So I think
(27:02):
due diligence is really really critical, and it will go
back to one of the themes when the cycle changes.
Those who were deep in due diligence have confidence in
their investment, will not only do better on how their
existing investments performed, but I also think they'll do better
(27:28):
in building the relationships with their barers because if you
did all your work and then there's a downturn in
the economy, but you have ultimate confidence in the value
cushion to your loone that this is very temporary, that
this company is going to have some problems and then
(27:52):
come out of this recession as good, if not better,
because some of their competitors might disappear, you are going
to be more accommodating to that ball. Versus if you
didn't do a lot of due diligence, you were not deep,
and then you're worried, which one of your credits are
(28:15):
high likelihood of impairment versus one you should be leading
in and support it well.
Speaker 2 (28:21):
Due diligence has to be the name of the game,
right I believe so, sort of leveraged lending, which sort
of brings up a question about the way again, the
way that the market has evolved over time. When you
were early on getting involved in private credit, it was
it wasn't terror incognita, but it was not far off
from that. There seemed to be cruise line liners coming
(28:43):
in now, you know, bringing tourists to the space. And
I'm just wondering what sort of an impact you're seeing
at your business in terms of, you know, sort of
the underwriting expectations, the documentation, the rationality of pricing, the
rationality of extending credit in the market today, Like, are
we overheated? There's certainly a lot of concern we are.
Speaker 3 (29:05):
Yeah, I yes, we are overheated in certain segments, I
think incerting segments. No, they expect you to come in
do due diligence. I find, you know, in the non
sponsored deals, I find you know, we did a deal
to a family owned business big close to a billion
dollars of sales or EBDA ranging from eighty million to
(29:29):
one hundred and twenty million, then a massive pop up
due to COVID, a massive pop down as a COVID correction.
But I found like those businesses, they actually embrace due diligence.
They know every detail of their company, and they actually
enjoy you coming in and asking. So I think there's
(29:51):
segments where they understand you're a lender, You're gonna come in,
you're gonna ask a ton of questions, and that that's
part of the process, and you're going to have a
normal document. You know, you're gonna have a loan document
that says what you can and can't do. So I
find there's those segments that everything is a good risk
(30:14):
adjusted return, including the documents. And then but if you
go back to just pure a very vanilla LBO, the
sponsors are doing what they should do is saying a
lot of capital wants to lend to a new LBO,
(30:35):
and if you want to do it, I need the
best terms, including the best documents for there. And you
know it goes back. You know, it's almost I don't
want to be the repeat. There'll be three sets of
funds who are in this business, ones that do fine
continue to exist, ones that are prepared for the downturn
(30:57):
and wants to fill those void and then they are
all going to be players who are done. And I'm
not going to say who zoo. Well, we'll all find out.
But there's plenty of LBO deals where they tell the
lenders zero access to management, can't even have a conversation.
Speaker 2 (31:17):
Yikes. So so you've got this specialty area, you've had
it for a while that I would say probably gives
you an edge over people that are sort of a
little bit less established or haven't been doing it as long.
Does that business come to you through long term relationships
that you guys have with sort of succession planners and
(31:38):
sort of firms like that, or where does it come from?
Speaker 3 (31:41):
I would wreak it up. It comes from a lot.
We we want to see everything and that's why we're
doing the core LBOs. We're doing but very few of them, right,
but we want to see them. We're doing what we
call this specialty LBO. One lene that come to us
the RIVA and the nons sponsor. So it'd say on
(32:01):
the sponsor side we have seventy five core relationships. You know,
a third of those were doing that repeat deal. It
always is where we're coming to us and they understand.
And then when you go outside of that, it is
(32:22):
a lot of advisory firms, It is a lot of
legal firms. You know, we are You have all these
banks that are dealing with these large family owned non
sponsor companies and when they come in like the one
(32:43):
I described to you, they are needed alone. They were
only using an ABL revolver from a bank. That advisor
called us and said would you be interested? And we
got into a dialogue and I don't think they called
anyone else, And if they did, it wasn't we were.
(33:05):
It was not a situation where there were ten term sheets.
It was more normal. Again, if we didn't price it appropriately,
we would be opening the door for ten term sheets.
So you're pricing it at a level you feel you're
getting a premium because it's under banked, but not such
(33:31):
that it's where the their their advisor and the family says, well,
this is selling.
Speaker 1 (33:39):
For the funds that won't make it. What do you
think could be the triggers in the medium term.
Speaker 3 (33:45):
I don't see. I think in the medium term you
will have it will be hot you're going to need
the event, right. I think if you look at funds
and say, how much of your loans were originated with
pick interest paid in kind? How much of your loans
today is paid in kind? The first, the first red
(34:07):
flag of problems is for funds that are dealing with
problems but not directly, is pick interest the barrow. And
it's different if you originated a loan, they're integrating an acquisition,
you're giving them a holiday on a covenant. You're saying
(34:28):
you could pay x percent and Pick you came in
making that decision. It's different when it's all of a
sudden it wasn't pick and today it's Pick. It's come
to maturity and you're refinancing it, not because you want
to extend the maturity, but because you have no choice.
(34:51):
They can't pay you and the market is in there.
So I think you will see red flags out there.
And the vests that a vest in these funds have
a checklist and they should be asking how much pick
how much is not on performing? But then when the
(35:11):
cycle changes, I think that the game will be over
for those funds. And I want to be clear, I
don't think it's everyone. I don't think it's close to everyone.
But we see every deal that's getting done. There's some
good deals and there's some bad deals. And if someone
is doing too many bad deals, they won't exist. And
(35:33):
that's every cycle. That's nothing like I'm not saying anything
that is controversial. Of course, money comes in, then you'll
see who does well with it, and then money will
come out.
Speaker 2 (35:46):
Yeah, it's actually you know, I follow the BDC is
and it's actually quite interesting to look at the data
that I've been able to compile on unpick and non accruals.
Non acrules have remained I would say surprisingly low, particularly
after five hundred and twenty five basis points at base
rate hikes in twenty two and twenty three. I think
that probably has something to do with base rates coming
(36:06):
off a zero boundary. Yes, but pick rates have also
remained pretty steady in the six to seven percent range.
Are you seeing sort of similar trends in your own portfolio?
Speaker 3 (36:17):
Yeah, we're not. We our portfolio is holding it in
very well, are so. Yeah. I don't follow like you
do all the BDCs. So my point was, really that's
where you start to see the potential red flags. But
when there is markets where there's a lot of capital,
(36:40):
the mistakes are less easy to spot because more money
constantly comes in. It is when that tide goes out
that you figure out who's doing a good job and
who is it.
Speaker 2 (36:53):
So it's it's impossible, Michael, impossible to have a podcast
without bringing up AI. Since we're talking about objects, do
sure not telling about the seventy six ers Great Alan
iverson artificial intelligence. We can go lots of ways with AI,
but maybe you could walk us through the benefits of
it to the private lending space and the drawbacks. Specifically,
(37:17):
there's concern that software attack and some services, big components
of many private lending portfolios may be disrupted by AI,
but maybe it has benefits too.
Speaker 3 (37:26):
Yeah. Yeah, I mean when we when silver Point discuss risks,
that's one of the risks of every company. So you
have all this tariffs, inflation, interest rates, you'll have the
geopolitical risks of what's going on in the world, but
you also have the AI risk. And AI risk is
(37:49):
tough because it is so new, so that every in
every loan that you make, you have to say how
vulnerable is this to AI? And you've got to really
have that discussion and you don't have the seeing the
(38:12):
story over. Like there's a lot of things between people
at have Fund that have twenty thirty years, multiple cycles,
they say, I know how this is going to play out.
This is very different, this is new. So what I
would say about it is we're scared of it, but
(38:33):
in a good way. That's what we do. We get paranoid,
we talk, We ask a lot of questions, we talk
to people outside and that's on the investing side. On
the productivity per hour of work, it's amazing and we're
embracing it as everyone should. It is another tool so
(38:55):
that you could quickly go through a doc, find the area,
issue spot patterns. So it's helpful, but it's scaring.
Speaker 2 (39:05):
Yep.
Speaker 1 (39:06):
Moving on to Lemes. It sounds like reading the docks.
It's necessary but not sufficient, and you need to to
take into account like all the game theory that goes
into the flexibility of the dogs. How have lemies changed
the way you approach distress investing And in the cases
where you see that that company will need a second round,
(39:28):
how do you factor that in?
Speaker 3 (39:29):
Yeah? And as I said before, and I was joking
but only slightly jumping, I love talking about les because
they were interesting and they are new and everyone's figuring
them out are and the press loves them because they
are new and interesting, right. Creditor on creditor violence, distress
(39:50):
dead exchanges. I even had someone try to call them
position enhancing transaction pats. Never caught on because that's a
part positive tone and I think we all know positivity
doesn't sell as well. But when you break lmemes, this
is documents, every loan, every bond, there is a legal
(40:14):
document between the borrower and the lender of what can
and can't be done. And an LMA transaction is when
a company is in search of liquidity to avoid a
crisis and potentially a bankruptcy. They're going to look at
every aspect of that doc and says what can I
(40:35):
do now? There was big two pictures. One is moving
assets away. That was the J crew walk up and
the intellectual property was no longer your collateral. The other
type is the SURTA where half the lenders say we're
going to change the documents. Whereas prior no debt could
(40:58):
come ahead of the senior secured, we're going to amend
the docs as we are allowed a majority to allow
debt come ahead, and then we're gonna lend money to
the company senior to the originally broadly syndicated loan, which
doesn't adversely affect anyone disportionately because it hurts everyone by
(41:23):
pushing them down. Except the second part of the transaction
is we're gonna lend you money. Part of it you
could use to turn around the company, and part of
it you're gonna use to buy back my debt. That
effectively primes. So now when you look at that and
all variations, you have to understand it and you have
(41:47):
to incorporate that in your investing, and let me go through,
you have clos. For the most part, this is really
bad for clos, especially colos that are not linked to
a special situations, to those that are real experts and
(42:09):
those that are not large, because in all of this
it only hurts them. And in an overheated market, if
the docs allow it, what are you gonna do? Not invest?
So you got the clos, then you have the special
situation players like us, And for us it's only positive
(42:33):
in that we understand it, we can make bets and
that's what we are paid for it. So in certain
situations we might think the secure debt is trading at
an inappropriate discount because we don't think an LME is
gonna happen, but the market does, and we could buy
(42:56):
This is like about Shalam an other situation. We could
be part of the majority and help create a solution
of liquidity. And then it's less impactful in the private
credit because there upcheering. Well, that's not an issue if
(43:16):
you own everything, because you're not gonna change the docs
to hurt yourself. But it is a big issue in
the moving the assets the j crew. Some people call
it trapdoor drop down, and again you have to know
what you're agreeing to.
Speaker 1 (43:36):
It's a documents game, but it's also a size game
because clearly bigger funds that can.
Speaker 3 (43:42):
Write the big checks have an advantage.
Speaker 1 (43:44):
Have an advantage. Do you think small funds can actually
like successfully play this game.
Speaker 3 (43:49):
I think they're at a massive disadvantage.
Speaker 2 (43:52):
And then just final thing for me, because we're just
talking about banks. Are banks friends? Are they friendly foes
or they the frenemies or they both? We're going to
see them re engage in direct lending. You know that's
what banks always did.
Speaker 3 (44:09):
I thought correct, no, with their friends. In fact, we
really embrace banks because our view is and a lot
of times we want to partner with them, and we have.
We have so many of where because we have a
clo business, we see a struggling deal, we could come
in and say you make these tweaks, will be the anchor.
(44:33):
If you want to take it to private, we'll do it.
We'll do the whole thing. But if you want to
be involved, you want certain clients. We want banks to
view us as a creative lender that thinks about solutions
but isn't looking to box them out, is looking to
(44:54):
do things where they leave and the happy they made
a call to us. So virtually every bank we have
done deals with, some of the time they're leading it
and we're an anchor, but we help structure it. Some
cases we said we're fine. Underrated will be a backstop
(45:18):
that's inside the flex so you could go with confidence.
We want to be extremely helpful to banks because some
of the private credit lenders they're going to be really
fearful of that is saying this is an existential risk.
So we want to be very commercial and figure out
(45:39):
ways to work together to do good deals that we
both are happy with.
Speaker 1 (45:45):
Michael's final question from me because Sally, we have to
wrap up.
Speaker 3 (45:49):
Yes.
Speaker 1 (45:50):
Another hot topic industress investing is this qualified lenders list.
In the US it's called the blacklist, and in the
US they have the white list equivalent. What is your
view on those and should there be limitations on the
US for sponsors of those lists?
Speaker 3 (46:09):
Yeah, the disqualified lenders list, they used to be for competitors. Right,
A company would say, look, if my loan's trading around,
a competitor or someone who owns a competitor can buy it.
They've expanded over time or we're not on many of
those lists because, as I said, we're providing value to
(46:31):
the sponsor. And even on the side that people call distress,
which we don't, we call special situation. US buying into
someone's loan is usually helpful because then we're pitching ideas
to get in more capital and I know we're running
out of time. I go through examples, so we don't
(46:52):
find it a big deal. For silver Point, we end
up on them every once in a while. More for
the I think you google us, And that said, we're
on in most cases. If we talk to the sponsors,
say reach out to these other sponsors, we get off
then you go to So that's me answering it from
(47:14):
my perspective at silver point. The me answering it from
the market perspective is I think sponsors are really smart
and they do things that make economic sense. I think
if you put too much on a DQ list when
the market gets more normalized, the clos need liquidity. They
(47:40):
have caps on how much Tripless they could own, They
have caps on default things, so they need to know
if a company doesn't do as well as expected, I
can move out. If one sponsor has every single buyer
(48:01):
of Triple c's on their DQ list, the clos are
going to say that's a tougher deal for me, and
they might now do the deal, or they might demand
a higher rate. So I think what and Alon winded.
I think that it gets market regulated. I think sponsors
will put certain lenders that they think will not be
(48:26):
supportive of them on those lists. I think if it
gets too broad, their cost of capital goes up. And
from our perspective, we do not want to be on
those lists. We're not on a lot. If we're on them,
we're going to really engage in a conversation to ask
why reach stuff.
Speaker 1 (48:46):
Michael Gatto partner at silver Point. Many things for joining
us on the Credit Edge, and of course we're very
grateful to David Havens from Bloomberg Intelligence. We appreciate you
joining us today. Make sure you check Michael Spook. The
Credit Investor's Handbook has a lot of anecdotes, particularly useful
for people looking to ramp up their knowledge or get
(49:10):
into credit investing different It's very focused on elborage, loans
and how you bonds. There's a part on the stress
as well. Bloomberg Intelligence is part of our research department,
with five hundred analysts and strategies working across all markets.
Coverage includes over two thousand equities and credits and outlooks
(49:30):
on more than nineteen industries and one hundred markets, indices, currencies,
and commodities. Please do subscribe to the Credit Edge wherever
you get your podcasts. We are on Apple, Spotify and
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deepod Go. Give us a review, Tell your friends, help
spread the word. I mean Anagathia Pereth. It's been a
(49:52):
pleasure having you join us again next week on the
Credit Edge.
Hello, and welcome to the Credit Edge, a weekly market podcast.
My name is Ida Agathia Perez, and I'm a team
leader at Bloomberg.
Speaker 2 (00:25):
And I'm David Haven's, a senior credit analyst a Bloomberg Intelligence.
This week, we're delighted to welcome Michael Gatto, a partner
and head of private side businesses at Silverpoint Capital. Michael,
how are you?
Speaker 3 (00:36):
I'm great, Thanks for having me excellent.
Speaker 2 (00:38):
We're delighted to have you here, as if being head
of privates at Silverpoint weren't enough. Michael is also an
adjunct professor at Columbia Business School in Fordham's Gibelli School
of Business, where he teaches credit analysis and distressed special
Situation investing. Now let me toss it back.
Speaker 1 (00:53):
To your Silverpoint has its origins in distress debt, founded
by Edmulay and Boboshi, who came from GOLDMANSAC Special Situations Group.
You work with them at Goldman then joined them shortly after,
so you you're not a founding partner, but as close
as it gets. Pretty much of silver Point in recent years,
(01:15):
though it has expanded. I guess expanded is more accurate
than pivoted to private credit because of the stress strategy
is still a relevant one. But I wanted to ask
you you're under the private credit strategy, tell me more
about this expansion. What is the cell point or what's
the edge that your private credit strategy has, and how
(01:38):
have you convinced How difficult was it the conversation with
borrowers that yes, you have a loan to own strategy,
but you do more things on that.
Speaker 3 (01:47):
Yeah, it's a great question, and I think it's a
little misunderstood in the maocket. And you know, as the
three of us was discussing earlier at silver Point, we
never really talked about ourselves a lot to the press
or other than our investors and our barwers. But we
started we were Amulet and Barboa Change said they started
(02:11):
all of the credit functions investing at Goldman Sachs and
they left two thousand and two and started silver Point,
and in that we are a credit fund. The press
has called us a distress debt fund, But in two
thousand and three we were doing private credit along with
(02:34):
investing in the secondary markets. So how we view ourselves
are we are investors in credit and that could be
performing credit, that could be originating new loans in private
credit and buying in the secondary market of credits that
are having problems. So what I want to make a
(02:57):
clear We've been in that private credit business since two
thousand and three, and in fact, coming into the Great
Financial Crisis, we had five billion dollars of our originated lots.
We had gone through the life into the financial crisis
about nine billion, and we had five billion that we
(03:18):
worked through successfully and in fact got very good returns
on our that they came in and out of the crisis.
But you're right, you have a perception of your distressed
that fund, so people will say on occasion, why would
I borrow from you? And if it's okay, I'd like
(03:38):
to break it up into two components. One is right now,
our fund has thirty eight billion of a vestible capital.
North of half of it is for performing credits four
billion dollars colos, sixteen billion dollars private credit. That's twenty
(04:01):
and the remainder is our special opportunities. When we're going
to the market in the private credit, we're trying to
fill a gap that's greatly appreciated. And as you know, David,
you follow private credit, a lot of lenders have a
(04:22):
very distinct box they lend it to. They want to
lend to a new LBO. They have a loan to
value they want, and they have industries that they like
and industries they don't like, and the minute something fits
in that box, they're gonna win. They're gonna go after it.
(04:44):
And they basically are saying, hey, tell me where I
need to be to win. And that's an overbank market.
Today won't be through cycles, but today it is. We
have a different conversation. One we're going to try to
target thirty forty percent of our loans will be two nonsponsors,
(05:07):
which is very underbanked because it's harder. You have to
be comfortable doing full due diligence. You can't rely on, Hey,
an equity sponsor's buying this company for a billion, they
want a five hundred billion dollar loan. I could go
to cent committee with a straight face, fifty percent loan
(05:29):
to value plus they're going to give me go all
their work, and then I could cut in paste that summarizon.
We we will do our own credit work, and we're
comfortable doing full level private and wey like due diligence
for a loan, and that allows you to attack that
(05:49):
our non sponsor space. Then that's not to say we're ignoring.
If that's thirty forty percent, well if I do the
math one hundred minus forty, that'd be sixty percent will
be sponsors. But we break sponsor's need for financing into
three buckets. Bug. The number one is that core LBO
(06:12):
it's fairly vanilla, and that we will look at all
of those we want to see it, but we're only
going to do very few. Now you say, well, why
would you even look at it if it's overbanked, Because
when the cycle turns, we want the relationships and we
want to be in that. And I'll give you an example.
(06:34):
A lot of people say, well, there aren't a lot
of cycles. You had nineteen ninety eight, two thousand and two,
two thousand and eight and COVID, but you've got a
lot of mini cycles. So we were maybe doing ten
to fifteen percent in LBOs and then two thousand and
three hat men and the market shut down short period
(06:55):
of time. But you had our real fear of inflation.
You had interest rates going off for the first time
in a long time. You had banks with hung deals,
Twitter was stole hung, and you had all of a sudden,
Silicon Valley bank blows up. So you had this short
period of time where the market shut and we went
(07:20):
in and aggressively filled that cap. The golden moment, Yeah,
it's the golden moment, but you gotta have the capital,
the confidence, and the relationship. So that's one part of
how we're attacking the sponsor market. The second component is
what we call specialty LBOs, and that's where the sponsor
(07:45):
does not want to go to the broadly syndicated low
market or go to ten and fifteen lenders and play
one off the other. It could be a take private.
I'll give you just an example. Company has four billion
market cap goes down to a billion because it was
(08:07):
growing at high rates, their core business matured and the
throwing a lot of cash into potential growth businesses, none
of which are working. A sponsor comes in sees where
the prices knows, the industry knows, the management team knows,
(08:27):
the board and says, you shouldn't be a public, you
should be private. Wi'll pay a thirty percent premium and
cuts the deal. They got to go announce it, get
shareholder votes to close. They are not looking to fight
(08:49):
about every basis point. What they're fearful of. What if
this leaks before the shareholder meeting. What if the stock
price goes above our thirty percent premium. What if some
investment banks start calling the board and saying, I have
a buyer who could do better. They might be fishing,
(09:11):
but the board gets nervous, Oh, maybe I need They
want to go to one lender who they trust.
Speaker 2 (09:18):
They want to have the assurance of getting the deal.
Speaker 3 (09:19):
Done, deal done quietly. It's both exactly David is and
someone who the confident could step up and write a
check for three four hundred million. And if they're paying
a little more upfront, a little more call, a little
more coupon stronger docs. It's small in the overall thing
(09:45):
of private equity funds auctions. They know they paid more
than everyone else a proprietary deal that they might have
spent a year, two years developing the relationship. Everything falls
in line. They want to come to someone like us,
(10:05):
So we have core LBOs. We're going to attack that
in market dislocations, MIDI and major specialty finance. That's what
we're marketing and things that don't fit everyone's box.
Speaker 2 (10:21):
Is that specialty finance component that the sort of the
private element that you just described is that pretty much
a niche.
Speaker 3 (10:28):
Are there only a few places in that for sure? Okay,
it's a big niche. Yeah, you have to have you
have to have the capital, you have to have the relationships.
And when you go through it and you have to
drop everything and get it done quietly in a short
period of time, there are ready that many players that
(10:48):
could do that. That the sponsors are confident and when
I look at our core relationships they repeat. And then
finally there's a lot of deals in the sponsor world
that are not for new LBO add on acquisition refinancing.
(11:09):
The incumbent lender always has a massive advantage if everything
was going well, if there were a lot of hiccups
and all of a sudden it's three or four years later,
and the original incumbent lenders were reliant on the sponsor's
(11:30):
loan to value from three years ago. It's sort of
irrelevant now because things did not go as plan and
we market ourselves, come to us, we'll re underwrite it.
And while we're known to do much more due diligence
than most and structure more than most, we fit this
(11:54):
need so we're embraced by the sponsor community in it.
Speaker 2 (12:00):
So you obviously have tremendous perspective on the market. I
mean you fledged from Goldman in two thousand and two
and got going in two thousand and three. Really at
silver Point, Techrek was winding down. Enron just happened. Financial
crisis was a few years away. Europe languished right after that.
COVID nineteen happened. Private credit is sort of described or
thought of as a new thing. It's not really a
(12:21):
new thing. I went through a chemical bank training program
back in nineteen eighty seven to do leverage loans to
middle market companies. But how have you seen this market evolve?
You've been here since the very beginning of what sort
of is referred to as private credit. So two decades
in two decades plus in how has it changed.
Speaker 3 (12:40):
Oh, it's changed tremendously in the amount of capital. So
I agree. I was in I taught those training programs,
and we had, like I said, at Goldman Sachs, we
did private credit. I think what's changed the most is
how many players have come in since the Great Financial Crisis.
(13:05):
It was viewed the Great Financial Crisis opened this window
as banks had to worry about their own liquidity solvencies.
Regulators clos were not getting the same type of leverage
they needed to make their business model worked, and people
(13:26):
jumped in, which is great, And I actually think, you
know all this the private credit is somehow bad for
the economy. I don't get that in that it's phenomenal there.
When you think of economic crisises, they're driven and magnified
by a lack of capital to refinance loans to fund growth.
(13:50):
Private credit will fill has filled that vacancy. The real
question that people ask is it has gotten overheated, especially
in that core LB oh, and is it a bubble
that's gonna blow up? And the answer is, you know,
(14:11):
it's the warring buffet quote that everyone loves. When the
tide goes out, we're gonna see who's when we get
into the next cycle. There will be people who do fine.
There will be people who don't do well, and they
will work down their portfolio and go out of business,
(14:34):
and there will be a third category that not only
does fine, but has the dry powder and the expertise
to lean into that. What I love, what silver Point
loves is when the market is driven by fear of
(14:54):
missing out risk on to just constantly be saying, when
it changes, how is our portfolio going to do? Do
we know every potential problem and have a plan of attack,
and do we have the dry powder and the expertise
(15:14):
that when we go from fear of missing out to
fear that's where you want to be. And if you
have capital, don't you're not playing triage and you have
the confidence to step up when most people are not.
That's how you really win, and that's how you build
(15:37):
the long term relationships. When the market's heated, it's odd
everyone will do that deal. This monster in a core
LBO is not saying thank you, thank you, thank you.
They're saying you say thank you, thank you, thank you
to me because I have twenty term sheets. It's when
you're attacking the markets, in the segments that aren't as competitive,
(16:03):
or when everything shuts down, then you build the long
term relationships.
Speaker 1 (16:08):
Right, speaking of dry powder, that combined with added pressure
to deploy, I'm not speaking about silver point sell, but
about like funding private credit in general that seems to
add to the risk to the bottom to just sign
any type of deal to some extent in terms that
are very favorable for favorable for borrowers, but not necessarily
(16:32):
the best terms for creditors with the best protections for creditors.
Are you seeing any opportunities from this type of loans
that for private credit loans that you know, offer very
few protections for creditors. And now I don't know if
you're seeing opportunities in perhaps private credit secondaries or other
sorts of like ways in for re.
Speaker 3 (16:54):
No, I mean, I think that there's a lot and
you guys have written a lot, you guys meaning bloomberk
and trading of private credit, you know, And we're gonna
have a discussion around that because that's sort of interesting
because the whole idea and the whole part of the
benefit of private credit is I'm dealing with self appoint
(17:14):
you're my lendo. When we need to amend the doc,
I'm calling you. I know who universe is it? I
don't know who's the person I need to talk to.
But no, we're not seeing a lot of opportunities in
buying private credit, whether over time that trades or not.
What I would say is the race to the bontom
(17:37):
phenomenal is there. You got to avoid it. And it
goes back to We're not gonna know the winners and
the losers until things get bad. What you know? And
or investors will ask me, well, what questions should I ask? Well, One,
I look at it and say, what scares me the
(17:58):
most is a couple of things. One, small companies ten million,
fifty million EBDA doesn't have significant market share when there's
a problem. You might not have the senior secure downside protection.
You might be taking equity risk getting debt like returns.
(18:21):
So small business is scamming two documents. I'm like almost
shocked at how loans sometimes and this is also the
worldly syndicated loan market. The focus on the loan to
value day one the company, But then there's the docs.
(18:44):
Are the docks right? But if I'm landing five hundred
million dollars to a company that's worth a billion today,
But the docs say there's a carve out and they
could move two hundred and fifty million dollars of value
out of the companies that you're lending to to an
unrestricted sub that I cannot put a covenant on. I
(19:08):
can't go after the value. It's misleading to say I'm
fifty percent loans of value taking five hundred over the billion,
I would take five hundred divided by seven fifty because
the sponsor, of course, they should move assets out when
there's a problem. And unlike being a venture capitalist and
(19:31):
equity value growth equity, where you worry about good things
and bad things happening, as a lender, all you care
about is bad things.
Speaker 2 (19:44):
Yeah, your best outcome is getting repaid what you lent.
Speaker 3 (19:48):
Par plus my coupons. Yeah, that's the game of our men.
And therefore I have to say, what could go wrong,
what's the probability of it going how much can value
deteriorate if that happens, and what does the document allow
(20:09):
that company to do. You know, I have a lot
of friends in VC and growth equity, and they'll say, Michael,
your job so easy, senior secured, And I'm like, no, No,
your job is so easy because you could do ten deals,
get a zero on three or four of them, mediocre
(20:31):
returns on three or four. As long as you have
of the deals being the next uber the next day,
are your hero. We can't lose money. We have to
be paranoid about everything that could go wrong and say,
if it goes wrong, do I think I'm gonna lose money.
(20:52):
We will, and that's a tough way to live a life.
Speaker 1 (20:56):
We will go into more detail about liability management exercise.
Speaker 3 (20:59):
Letter liability management as in you love to participate, Oh no,
I love talking, I love well, I will talk about
I love talking about it. It's interesting.
Speaker 1 (21:09):
Okay, But before that, do you think investors are adequately
compensated for the risk of fill liquidity?
Speaker 3 (21:16):
Yes and no. You know, it's gonna be the simple answer.
Certain segments of the market, I think you're getting fairly
to overcompensated for it. Again, these parts of the segments
where they're just less efficient, less capital. Yes, I think
in certain of the deals you're getting no ill liquidity premium.
(21:40):
But then again, you have some investors that are fine.
You know, it's also who are the investors of the fund.
If the investors of the fund have a very very
long term their capital, very long term, they don't want
market vowel of things going up and down just based
(22:01):
on something the president says. They actually value not having
all that liquidity. So it depends on a lot of things.
I think right now the core LBO market is what
I would call a beta trade. It's not there's no
(22:21):
excess return in it, and you're probably being adequate for
those who do it. Well, I think you're getting adequately
compensated for the risk and the liquidity. And my only
point before not everyone has the same illiquidity premium. So
the people who go into these assets aren't aren't going
(22:44):
to be someone who knew needs day to day liquidity
and therefore they don't need the same liquidity premium as others.
Does that make sense?
Speaker 2 (22:54):
Yeah, So just sort of sticking with this liquidity issue
and pivoting a little bit. Private credit has been a
hot sector for a while. Is it suitable for retail
investors via ETFs with a private credit component? Don't we
have the risk of fundamentally illiquid assets being backed by
daily liquidity funding sort of?
Speaker 3 (23:15):
Well, it's unambiguously a legitimate concern, right, So if you're
raising money to the retail market, you need to explain
what is the liquidity of this. Now you could have
liquidity backstabs, so allowing you could draw on to pay
(23:39):
out x percent of the investors, so you know there
is some liquidity. We're just early on in thinking about
whether we should or shouldn't raise money from the retail investors.
So there's a big learning curve of a fund saying
is that appropriate or not?
Speaker 2 (24:00):
It seems to be a little bit of baby steps too,
because the private credit component is relatively low in these
funds so far.
Speaker 3 (24:08):
Yeah, I agree with that. So to answer your question,
it's going to be I think, yes, it is appropriate
if it structured correctly and it's disclosed that marketed correctly.
But I'm not an expert on it.
Speaker 1 (24:26):
In the book, one of the things and you were
discussing now, you mentioned the and you emphasized a lot
of importance of due diligence, and you were talking about
it just now. And in the book you mentioned the
anecdote of Mark Dreyer, the lawyer that was sentenced to
I think twenty years of prison for fraud. Yes, that
was you know, I was trying to sell loans that
(24:47):
were actually non existent. It was a fraud basically, and
was getting annoyed by the level of due diligence questions
that Silverpoint was asking. Was meant to have dinner with
you guys, but was actually the rest in Canada the
day before? I think is due diligence even more important
in private credit, equally importantness in public markets? Is there
(25:09):
something additional that investors would need to take into account.
Speaker 3 (25:14):
Our firm believes due diligence is the core of who
we are. In fact, we have certain core principles, and
one is we dig deeper we enjoy due diligence. You know,
we think it's really important. Now. The less liquid your
investment is, the more due diligence you need, because if
(25:37):
you make a mistake, you can't get out. So if
it's a public investment, you might have done eighty percent
of your work and say, I am going to start
to buy because I think I have a unique investment thesis.
I think I'm ahead of the curve, and even though
(25:58):
I still have work to do, the price is trading
at today compensates me for buying without all of my
due diligence done, because if I wait until I'm done
and the price moves up ten twenty points, well I
didn't do my job. So when there's liquidity, you could
(26:20):
start to buy and then change your mind and get out,
and you might take a loss. If you're doing on
the other extreme, your private equity fund, you have to
finish your due diligence before you invest. So I would
say if you're lending to private deals, you're going to
(26:42):
have to do more due diligence because you can't decide
to make a mistake and move out, or if you're
doing nonsponsor loans, that even magnifies that because you can't
piggyback on the work sponsor has done. So I think
(27:02):
due diligence is really really critical, and it will go
back to one of the themes when the cycle changes.
Those who were deep in due diligence have confidence in
their investment, will not only do better on how their
existing investments performed, but I also think they'll do better
(27:28):
in building the relationships with their barers because if you
did all your work and then there's a downturn in
the economy, but you have ultimate confidence in the value
cushion to your loone that this is very temporary, that
this company is going to have some problems and then
(27:52):
come out of this recession as good, if not better,
because some of their competitors might disappear, you are going
to be more accommodating to that ball. Versus if you
didn't do a lot of due diligence, you were not deep,
and then you're worried, which one of your credits are
(28:15):
high likelihood of impairment versus one you should be leading
in and support it well.
Speaker 2 (28:21):
Due diligence has to be the name of the game,
right I believe so, sort of leveraged lending, which sort
of brings up a question about the way again, the
way that the market has evolved over time. When you
were early on getting involved in private credit, it was
it wasn't terror incognita, but it was not far off
from that. There seemed to be cruise line liners coming
(28:43):
in now, you know, bringing tourists to the space. And
I'm just wondering what sort of an impact you're seeing
at your business in terms of, you know, sort of
the underwriting expectations, the documentation, the rationality of pricing, the
rationality of extending credit in the market today, Like, are
we overheated? There's certainly a lot of concern we are.
Speaker 3 (29:05):
Yeah, I yes, we are overheated in certain segments, I
think incerting segments. No, they expect you to come in
do due diligence. I find, you know, in the non
sponsored deals, I find you know, we did a deal
to a family owned business big close to a billion
dollars of sales or EBDA ranging from eighty million to
(29:29):
one hundred and twenty million, then a massive pop up
due to COVID, a massive pop down as a COVID correction.
But I found like those businesses, they actually embrace due diligence.
They know every detail of their company, and they actually
enjoy you coming in and asking. So I think there's
(29:51):
segments where they understand you're a lender, You're gonna come in,
you're gonna ask a ton of questions, and that that's
part of the process, and you're going to have a
normal document. You know, you're gonna have a loan document
that says what you can and can't do. So I
find there's those segments that everything is a good risk
(30:14):
adjusted return, including the documents. And then but if you
go back to just pure a very vanilla LBO, the
sponsors are doing what they should do is saying a
lot of capital wants to lend to a new LBO,
(30:35):
and if you want to do it, I need the
best terms, including the best documents for there. And you
know it goes back. You know, it's almost I don't
want to be the repeat. There'll be three sets of
funds who are in this business, ones that do fine
continue to exist, ones that are prepared for the downturn
(30:57):
and wants to fill those void and then they are
all going to be players who are done. And I'm
not going to say who zoo. Well, we'll all find out.
But there's plenty of LBO deals where they tell the
lenders zero access to management, can't even have a conversation.
Speaker 2 (31:17):
Yikes. So so you've got this specialty area, you've had
it for a while that I would say probably gives
you an edge over people that are sort of a
little bit less established or haven't been doing it as long.
Does that business come to you through long term relationships
that you guys have with sort of succession planners and
(31:38):
sort of firms like that, or where does it come from?
Speaker 3 (31:41):
I would wreak it up. It comes from a lot.
We we want to see everything and that's why we're
doing the core LBOs. We're doing but very few of them, right,
but we want to see them. We're doing what we
call this specialty LBO. One lene that come to us
the RIVA and the nons sponsor. So it'd say on
(32:01):
the sponsor side we have seventy five core relationships. You know,
a third of those were doing that repeat deal. It
always is where we're coming to us and they understand.
And then when you go outside of that, it is
(32:22):
a lot of advisory firms, It is a lot of
legal firms. You know, we are You have all these
banks that are dealing with these large family owned non
sponsor companies and when they come in like the one
(32:43):
I described to you, they are needed alone. They were
only using an ABL revolver from a bank. That advisor
called us and said would you be interested? And we
got into a dialogue and I don't think they called
anyone else, And if they did, it wasn't we were.
(33:05):
It was not a situation where there were ten term sheets.
It was more normal. Again, if we didn't price it appropriately,
we would be opening the door for ten term sheets.
So you're pricing it at a level you feel you're
getting a premium because it's under banked, but not such
(33:31):
that it's where the their their advisor and the family says, well,
this is selling.
Speaker 1 (33:39):
For the funds that won't make it. What do you
think could be the triggers in the medium term.
Speaker 3 (33:45):
I don't see. I think in the medium term you
will have it will be hot you're going to need
the event, right. I think if you look at funds
and say, how much of your loans were originated with
pick interest paid in kind? How much of your loans
today is paid in kind? The first, the first red
(34:07):
flag of problems is for funds that are dealing with
problems but not directly, is pick interest the barrow. And
it's different if you originated a loan, they're integrating an acquisition,
you're giving them a holiday on a covenant. You're saying
(34:28):
you could pay x percent and Pick you came in
making that decision. It's different when it's all of a
sudden it wasn't pick and today it's Pick. It's come
to maturity and you're refinancing it, not because you want
to extend the maturity, but because you have no choice.
(34:51):
They can't pay you and the market is in there.
So I think you will see red flags out there.
And the vests that a vest in these funds have
a checklist and they should be asking how much pick
how much is not on performing? But then when the
(35:11):
cycle changes, I think that the game will be over
for those funds. And I want to be clear, I
don't think it's everyone. I don't think it's close to everyone.
But we see every deal that's getting done. There's some
good deals and there's some bad deals. And if someone
is doing too many bad deals, they won't exist. And
(35:33):
that's every cycle. That's nothing like I'm not saying anything
that is controversial. Of course, money comes in, then you'll
see who does well with it, and then money will
come out.
Speaker 2 (35:46):
Yeah, it's actually you know, I follow the BDC is
and it's actually quite interesting to look at the data
that I've been able to compile on unpick and non accruals.
Non acrules have remained I would say surprisingly low, particularly
after five hundred and twenty five basis points at base
rate hikes in twenty two and twenty three. I think
that probably has something to do with base rates coming
(36:06):
off a zero boundary. Yes, but pick rates have also
remained pretty steady in the six to seven percent range.
Are you seeing sort of similar trends in your own portfolio?
Speaker 3 (36:17):
Yeah, we're not. We our portfolio is holding it in
very well, are so. Yeah. I don't follow like you
do all the BDCs. So my point was, really that's
where you start to see the potential red flags. But
when there is markets where there's a lot of capital,
(36:40):
the mistakes are less easy to spot because more money
constantly comes in. It is when that tide goes out
that you figure out who's doing a good job and
who is it.
Speaker 2 (36:53):
So it's it's impossible, Michael, impossible to have a podcast
without bringing up AI. Since we're talking about objects, do
sure not telling about the seventy six ers Great Alan
iverson artificial intelligence. We can go lots of ways with AI,
but maybe you could walk us through the benefits of
it to the private lending space and the drawbacks. Specifically,
(37:17):
there's concern that software attack and some services, big components
of many private lending portfolios may be disrupted by AI,
but maybe it has benefits too.
Speaker 3 (37:26):
Yeah. Yeah, I mean when we when silver Point discuss risks,
that's one of the risks of every company. So you
have all this tariffs, inflation, interest rates, you'll have the
geopolitical risks of what's going on in the world, but
you also have the AI risk. And AI risk is
(37:49):
tough because it is so new, so that every in
every loan that you make, you have to say how
vulnerable is this to AI? And you've got to really
have that discussion and you don't have the seeing the
(38:12):
story over. Like there's a lot of things between people
at have Fund that have twenty thirty years, multiple cycles,
they say, I know how this is going to play out.
This is very different, this is new. So what I
would say about it is we're scared of it, but
(38:33):
in a good way. That's what we do. We get paranoid,
we talk, We ask a lot of questions, we talk
to people outside and that's on the investing side. On
the productivity per hour of work, it's amazing and we're
embracing it as everyone should. It is another tool so
(38:55):
that you could quickly go through a doc, find the area,
issue spot patterns. So it's helpful, but it's scaring.
Speaker 2 (39:05):
Yep.
Speaker 1 (39:06):
Moving on to Lemes. It sounds like reading the docks.
It's necessary but not sufficient, and you need to to
take into account like all the game theory that goes
into the flexibility of the dogs. How have lemies changed
the way you approach distress investing And in the cases
where you see that that company will need a second round,
(39:28):
how do you factor that in?
Speaker 3 (39:29):
Yeah? And as I said before, and I was joking
but only slightly jumping, I love talking about les because
they were interesting and they are new and everyone's figuring
them out are and the press loves them because they
are new and interesting, right. Creditor on creditor violence, distress
(39:50):
dead exchanges. I even had someone try to call them
position enhancing transaction pats. Never caught on because that's a
part positive tone and I think we all know positivity
doesn't sell as well. But when you break lmemes, this
is documents, every loan, every bond, there is a legal
(40:14):
document between the borrower and the lender of what can
and can't be done. And an LMA transaction is when
a company is in search of liquidity to avoid a
crisis and potentially a bankruptcy. They're going to look at
every aspect of that doc and says what can I
(40:35):
do now? There was big two pictures. One is moving
assets away. That was the J crew walk up and
the intellectual property was no longer your collateral. The other
type is the SURTA where half the lenders say we're
going to change the documents. Whereas prior no debt could
(40:58):
come ahead of the senior secured, we're going to amend
the docs as we are allowed a majority to allow
debt come ahead, and then we're gonna lend money to
the company senior to the originally broadly syndicated loan, which
doesn't adversely affect anyone disportionately because it hurts everyone by
(41:23):
pushing them down. Except the second part of the transaction
is we're gonna lend you money. Part of it you
could use to turn around the company, and part of
it you're gonna use to buy back my debt. That
effectively primes. So now when you look at that and
all variations, you have to understand it and you have
(41:47):
to incorporate that in your investing, and let me go through,
you have clos. For the most part, this is really
bad for clos, especially colos that are not linked to
a special situations, to those that are real experts and
(42:09):
those that are not large, because in all of this
it only hurts them. And in an overheated market, if
the docs allow it, what are you gonna do? Not invest?
So you got the clos, then you have the special
situation players like us, And for us it's only positive
(42:33):
in that we understand it, we can make bets and
that's what we are paid for it. So in certain
situations we might think the secure debt is trading at
an inappropriate discount because we don't think an LME is
gonna happen, but the market does, and we could buy
(42:56):
This is like about Shalam an other situation. We could
be part of the majority and help create a solution
of liquidity. And then it's less impactful in the private
credit because there upcheering. Well, that's not an issue if
(43:16):
you own everything, because you're not gonna change the docs
to hurt yourself. But it is a big issue in
the moving the assets the j crew. Some people call
it trapdoor drop down, and again you have to know
what you're agreeing to.
Speaker 1 (43:36):
It's a documents game, but it's also a size game
because clearly bigger funds that can.
Speaker 3 (43:42):
Write the big checks have an advantage.
Speaker 1 (43:44):
Have an advantage. Do you think small funds can actually
like successfully play this game.
Speaker 3 (43:49):
I think they're at a massive disadvantage.
Speaker 2 (43:52):
And then just final thing for me, because we're just
talking about banks. Are banks friends? Are they friendly foes
or they the frenemies or they both? We're going to
see them re engage in direct lending. You know that's
what banks always did.
Speaker 3 (44:09):
I thought correct, no, with their friends. In fact, we
really embrace banks because our view is and a lot
of times we want to partner with them, and we have.
We have so many of where because we have a
clo business, we see a struggling deal, we could come
in and say you make these tweaks, will be the anchor.
(44:33):
If you want to take it to private, we'll do it.
We'll do the whole thing. But if you want to
be involved, you want certain clients. We want banks to
view us as a creative lender that thinks about solutions
but isn't looking to box them out, is looking to
(44:54):
do things where they leave and the happy they made
a call to us. So virtually every bank we have
done deals with, some of the time they're leading it
and we're an anchor, but we help structure it. Some
cases we said we're fine. Underrated will be a backstop
(45:18):
that's inside the flex so you could go with confidence.
We want to be extremely helpful to banks because some
of the private credit lenders they're going to be really
fearful of that is saying this is an existential risk.
So we want to be very commercial and figure out
(45:39):
ways to work together to do good deals that we
both are happy with.
Speaker 1 (45:45):
Michael's final question from me because Sally, we have to
wrap up.
Speaker 3 (45:49):
Yes.
Speaker 1 (45:50):
Another hot topic industress investing is this qualified lenders list.
In the US it's called the blacklist, and in the
US they have the white list equivalent. What is your
view on those and should there be limitations on the
US for sponsors of those lists?
Speaker 3 (46:09):
Yeah, the disqualified lenders list, they used to be for competitors. Right,
A company would say, look, if my loan's trading around,
a competitor or someone who owns a competitor can buy it.
They've expanded over time or we're not on many of
those lists because, as I said, we're providing value to
(46:31):
the sponsor. And even on the side that people call distress,
which we don't, we call special situation. US buying into
someone's loan is usually helpful because then we're pitching ideas
to get in more capital and I know we're running
out of time. I go through examples, so we don't
(46:52):
find it a big deal. For silver Point, we end
up on them every once in a while. More for
the I think you google us, And that said, we're
on in most cases. If we talk to the sponsors,
say reach out to these other sponsors, we get off
then you go to So that's me answering it from
(47:14):
my perspective at silver point. The me answering it from
the market perspective is I think sponsors are really smart
and they do things that make economic sense. I think
if you put too much on a DQ list when
the market gets more normalized, the clos need liquidity. They
(47:40):
have caps on how much Tripless they could own, They
have caps on default things, so they need to know
if a company doesn't do as well as expected, I
can move out. If one sponsor has every single buyer
(48:01):
of Triple c's on their DQ list, the clos are
going to say that's a tougher deal for me, and
they might now do the deal, or they might demand
a higher rate. So I think what and Alon winded.
I think that it gets market regulated. I think sponsors
will put certain lenders that they think will not be
(48:26):
supportive of them on those lists. I think if it
gets too broad, their cost of capital goes up. And
from our perspective, we do not want to be on
those lists. We're not on a lot. If we're on them,
we're going to really engage in a conversation to ask
why reach stuff.
Speaker 1 (48:46):
Michael Gatto partner at silver Point. Many things for joining
us on the Credit Edge, and of course we're very
grateful to David Havens from Bloomberg Intelligence. We appreciate you
joining us today. Make sure you check Michael Spook. The
Credit Investor's Handbook has a lot of anecdotes, particularly useful
for people looking to ramp up their knowledge or get
(49:10):
into credit investing different It's very focused on elborage, loans
and how you bonds. There's a part on the stress
as well. Bloomberg Intelligence is part of our research department,
with five hundred analysts and strategies working across all markets.
Coverage includes over two thousand equities and credits and outlooks
(49:30):
on more than nineteen industries and one hundred markets, indices, currencies,
and commodities. Please do subscribe to the Credit Edge wherever
you get your podcasts. We are on Apple, Spotify and
all other good podcast providers, including the Bloomberg terminal at
deepod Go. Give us a review, Tell your friends, help
spread the word. I mean Anagathia Pereth. It's been a
(49:52):
pleasure having you join us again next week on the
Credit Edge.
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