00:00In April of this year, you downgraded your BDC sector view to negative.
00:03What, if anything, has changed since then?
00:05Well, we've assigned a few new negative outlooks to some of the names
00:09because asset quality is deteriorating to some extent
00:12and leverage is starting to rise.
00:14But to the point that Danielle made earlier and you just mentioned,
00:17there's a huge dispersion.
00:18If we look at the three dozen or so BDCs that we rate,
00:22those that show the strongest asset quality have a 0% non-accrual ratio.
00:28And those that are seeing some difficulties, the worst three, let's say,
00:32the average non-accrual rate is 8%.
00:35So that's a pretty dramatic difference.
00:38So non-accrual is at their highest in several years.
00:40Is this a warning sign or do you think is this simply a return to normal, so to speak?
00:45I think it's a little bit of a normalization.
00:48It's a little bit of seasoning that's going on in the market
00:51because overall, if you look at the non-accrual rate,
00:54it's still under 2% for the BDCs.
00:56So we expect some continued deterioration,
00:59but we're not ringing the alarm bells as yet.
01:02Maybe staying on those alarm bells,
01:04Mark, I caught your conversation at Bloomberg Invest with my colleague Millwood,
01:08which was focused on systemic risk.
01:09It feels like the conversation has shifted a bit since then.
01:13What do you think investors should be most focused on right now
01:16within the private credit asset class?
01:19Yeah, that's a great comment.
01:20You know, this market is continuing to evolve.
01:23It's a maturing asset class.
01:26It's not a shrinking one.
01:27And in the context of that growth, it's not just growing, but it's changing shape.
01:32There's a fundamental shift in the center of gravity for private credit.
01:36And that's because the borrower base is changing.
01:39There are two letters that are impacting this market in a big, big way.
01:42And there are four new risks.
01:45So, okay, now we have to ask.
01:46Please get into the four new risks.
01:47There you go.
01:48All right.
01:49Well, maybe we can take them in turn, right?
01:50So what's happening is, in terms of the borrowing base,
01:53it's moving from the equity-sponsored company who's borrowing
01:57to larger borrowers, investment-grade borrowers,
02:00and investment-grade structures.
02:01The two letters that are impacting this market, AI.
02:05No big surprise here.
02:07And really, it's interesting because it's both a tailwind and a headwind.
02:10It's been a headwind for the BDCs that have 20% exposure to that sector.
02:16And there'll be winners and losers there.
02:18But the tailwind here is all about AI compute.
02:21And private credit is massively involved in AI compute.
02:24And that tailwind is much stronger than the headwind.
02:28Four risks, you asked.
02:29So it's not just about will the borrower default.
02:34It is what happens when they do default.
02:37And so you need to think about structure.
02:39How was the investment vehicle built?
02:41That's the first risk.
02:42The second is the sponsor.
02:43There's sponsor risk.
02:44They have a lot of discretion in how they execute on their mandate.
02:49That's the second risk.
02:50The third is around valuation.
02:52What exactly is the collateral worth?
02:54And the last is liquidity.
02:56Can I get my money when I need it?
02:58I want to hone in on the private credit question because we at Bloomberg always talk about it.
03:02And honestly, every story gets a lot of interest.
03:04So it's moving up.
03:05Maybe less so now, though, by the way.
03:06Maybe less so now.
03:07It's like they're getting less clicks.
03:08Just putting it out there.
03:09Less clicks.
03:10I better start working harder.
03:11Yeah, OK.
03:12Maybe you'll answer this.
03:13So private credit, they're moving up the quality spectrum.
03:15Yes.
03:16They're financing a lot of investment-grade borrowers.
03:17So does it make the sector safer or more complex?
03:21How should we look at it?
03:22I think it's still complex, again, because you have new risks that you need to analyze.
03:27So it is investment-grade.
03:28And I think some of the structures are getting tighter because, and you were all talking about
03:32this as well, AI compute is requiring a lot of capital.
03:36We see about $800 billion this year, a trillion dollars next year, and perhaps more after that.
03:41So if you're going to go into the market and you're going to be asking investors to lend
03:47you money, you need tighter and tighter structures because they're going to become more and more
03:51disciplined.
03:52And, Danielle, I think you were talking a little bit about that.
03:55Investors need to be disciplined.
03:57And there's not this idea of, you know, can I get access to private credit?
04:01But which private credit shall I get access to?
04:04Yes.
04:05Focusing on managers who are being very disciplined and underwriting in this market.
04:10Something you said earlier, I thought that was interesting, was just the shift from private
04:13credit from more of a sponsor-backed direct lending market to a structured market.
04:18And that presents risks as well.
04:20And you've talked a lot about the difference between structured and securitized.
04:24So I thought you might want to share some of your latest work there.
04:27Yeah, private credit today is largely structured credit.
04:30But structured credit is not the same as securitizations.
04:33So some of the rated note feeders, these closed-end fund structures that will have direct lending
04:40underneath it as its collateral, looks quite similar to a CLO.
04:45But it's not the same thing as a securitization and a collateralized loan obligation.
04:50That's a very tight legal structure that is hermetically sealed, where the cash is trapped
04:55there.
04:56In a rated note feeder or these new private credit closed-end funds, there can be cash
05:01leakage.
05:02And that's why the sponsor is so important to what kind of risks I'm taking on and what
05:07my ultimate return is.
05:08So I think it's very important that the market understand the difference between structured
05:11credit and securitization.
05:13But as we're moving into this world, and you also point this out, we're having more things
05:17like joint ventures, payment in kind, especially as we move into the world of utilities.
05:20What does that mean for the transparency of these funds?
05:22Because private credit has gotten a few knocks lately about transparency issues.
05:26Yeah, it is not the most transparent market.
05:29And in many respects, it may be, never will be.
05:31In the public bond market, you get price discovery every minute, every day.
05:37You're not going to get that in private credit.
05:39There are some private credit lenders that are seeking to mark-to-market on a much more
05:42frequent basis.
05:44We'll have to see how that all plans out.
05:45But I think this market, you know, there's a trade-off.
05:48You are entering into a lot of these investments with the liquidity.
05:52The illiquidity.
05:54But I do think transparency can improve.
05:56Regulators are very much focused on trying to create more transparency as well, as we
06:01are at rating agencies, trying to provide more information to the market so they can feel
06:05more confident about how they invest.
Comments