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Hello and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.
And I'm Joe Wisenthal.
Joe, I keep thinking about that Sam Altman hype cycle kind of phrase, the whole it's over and then we're so back back thing. And obviously he was talking about AI and how people you know, feel about AI, but I think you could apply it to a bunch of different markets at the moment. So AI obviously, but also
private credit totally. Think back to the end of last year, right, we had all the JP Morgan Jamie Diamond's proverbial cockroaches emerging from private credit, and people started to get really worried. Fast forward to January twenty twenty six, and a lot of those concerns seem to have faded into the background.
Right, you wrote the thing, right, spreads everywhere are super tight, and already we know that the stock market is up for the year, but credit market is off to a very strong start of all flavors.
From what I understand, right, stock markets stealing all the spotlight. But if you look at the corporate bond market, now this is the public bond market not private, but spreads are at basically historic tights. I think the high Yield Index is starting at its tightest level ever in the history of the index for the year. This is crazy, but it also highlights an important point, which is that
spreads and returns are all relative. Yeah, right, And so if the public market is absolutely booming, that could be a good thing for private credit. But also private credit competes with the public market, right, so if you're getting pretty good returns in public credit, leverage loans, something like that, maybe you're not going into private credit as much as you used to.
What if you found a house that just had one cockroach that could you imagine.
There's never one cockroach? That's the point.
There had to have been a first cockroach that enters the house. You get it really quickly in your and then you don't have a cockroach problem.
Did I ever tell you I hate cockroaches so much? The first of all, the first Japanese word I ever relearned when I moved back to Japan as like a fourteen year old was go ki bori hoihoi because I had to go down to the local compini, the convenience store and buy cockroach hotels because the entire apartment was infested. And secondly, I hate cockroach is so much. I once read an entire book about cockroaches just to know my enemy. Wow, it was like three hundred pages on cockroache.
Do we get the author on the podcast?
It was actually a really good book. It was a sort of like cultural and scientific study of the history of cockroaches. But anyway, we are getting massively off topic. Shall I introduce our guest. We do, in fact have the perfect guest. All right, So we're going to be talking all things private credit, including how private credit is relating to the AI space. At the moment, we're speaking with Michael Zowatsky, also known as Ze. He is the
global Chief Investment Officer for Blackstone Credit and Insurance. So Z, thank you so much for coming on the podcast.
Wonderful to be here, Thanks for having me.
So I am told by your lovely Blackstone representatives that over the last twenty years you have grown Blackstone's credit franchise into the largest business by assets at Blackstone. How hard was that? Were you just sort of like riding a wave of corporate issuance.
Well, let's talk about a few things that have happened here. You know, I often get asked about this growth of private credit, and I think there's a misconception that that growth was driven by excess risk taking. But when you actually step back and think about what's happened in the market, you basically had a innovative breakthrough that changed the way business was done that was better for all market participants. The way I like to analogize it to is what
happened with Amazon in the retail space. Right before Amazon, if you want to go buy something, you had to go to the store. But Amazon kind of took out that middleman and brought you the consumer directly in the manufacture and in the process created something that was simpler, more efficient, better for the economy, more transparent. What's private credit done. It's done the same thing. It's brought the borrower right up directly to our investor's capital least. Sometimes
call it this farm to table model. Right, what have you done in that process? You've cut out all the middlemen, all the syndication, all the trading desks, all the stuff that led to leakage along the way, and in the process you built something that was better for all market participants. If you're a borrower, you get to speak directly to your lender. You get a customized solution, you get speed,
certainty of execution. If you're an investor, you capture all of that excess leakage in the form of higher returns. And that's been the case for the last twenty years. And by the way, if you're the financial markets, you have an ecosystem that is less levered. More asset liability management brings more financial stability to the overall ecosystem. When you have something that's really good for all market participants, it tends to grow a lot. And that's what's happened in private credit.
What is the equivalent of like in this analogy, which I really like, what is the equivalent of the web?
Right?
So, the reason Amazon could cut out the physical bookstore or the various other retailers, et cetera, is because the Internet exists and that creates solves some information problems, et cetera. How would you described the sort of like the thing that exists now such that so many different middleman and so forth can be cut out? Scale okay, scale?
Right. The reason we couldn't do what we do today twenty years ago, Yeah, is because we didn't have the capital base, We couldn't write a billion dollar plus deal. Here's an interesting fact. Before twenty twenty one, there were only five billion dollar plus private credit deals done. Ever since twenty twenty one, one hundred plus, and we have Blackstone have done most of them. So what does that mean. We have the scale of capital to actually solve the
problems for our clients. We have the breadth of team to go out and cover the market and bring these solutions direct to our bart worst. And then the other thing that's happened is the expansion of private credit beyond what a lot of people think of it as, which is middle market sponsored back back lending, into what we
call the real economy. Right, taking what is a two trillion dollar market today and thinking about a thirty plus trillion dollar addressable market when you think about areas like private investment, grade real assets, asset back finans, and so the other big piece of this is just the massive expansion in the addressable market that's come about.
So I take the point about you know, customized financing solutions and bringing investors closer to capital and all of that, but at the same time, like the concern is that as the space grows, competition for deals increases, and that's when you start to see not just potentially lower spreads, but also more leverage. And we have seen, you know, some first leans that are now UNI tranches and things that would normally spark a little bit of worry. Is that something that you're seeing in the market.
It's funny. Look, I've been doing private credit for two decades. I think to the deals that we were first doing in private credit twenty years ago, and I would tell you I don't know that a single one of them would pass our investment committee today. They were small, they were cyclical, they were basically the stuff the banks wouldn't do. Fast forward to today. Think about the average direct lending deal we do. It's a two hundred million dollar EBITDAV business.
It's forty percent loan to value. Pre GFC loan to values on deals were sixty five percent plus. And so when I think about the risk posture of a senior secured loan today, it feels pretty good relative to history. And then that needs to be combined with the fact that this opportunity in investment grade private credit, I would say, is the fastest growing opportunity we see in credit at Blackstone.
Right, So this is the other new thing that's happening is ig private credit. So you know, private credit extended to companies with very good balance sheets, not junk graded, has become more of a thing. It's going mainstream, and a lot of that is driven by AI is ands and tech related issuance. Talk more about what you're seeing in that space.
Well, I think that's a big part of it. Right. Anytime you see a significant need for capital, which we obviously see in the data center build out, and then connected to that all the energy, power and infrastructure that needs to accompany that, you see huge capital needs and markets that need that much capital need to access all available options, and that includes public credit, but that also
includes private credit. Morgan Stanley put out a piece late last year that estimated that eight hundred billion dollars of private credit alone is needed to finance the digital infrastructure build out over the next five years. Okay, so that's
a massive number. I think what gets missed when people think about the financing element of financing a data center, for example, is we're financing fifteen to twenty year take er pay contracts with some take pay contract meaning think about a triple net lease contract, matter what your usage is, no matter what your operating costs are, you're getting a fixed sum every single month from your tenement. And they
can't get out of that contract. Okay, okay. And you're getting that from some of the highest quality credit counter parties in the world, right, Hyperscalers are the tenants in most of the data centers today. And so as I sit with my credit hat on, if I can lend against some of the best counter parties in the world against a known, defined stream of cash flows, and I can do that with one hundred and fifty to two hundred basis points of excess spread versus like rated public credit.
Yeah, well, so explain that. So we the most credit worthy companies in the world are these cash flow gushers, the big tech companies, et cetera. What is the I still don't quite get what is the advantage for them of the private credit market spreads as you mentioned, are wider. They can access the bond market. They do it all
the time, or they certainly can. So what is what is private credit solve for the metas of the world and the apples of the world, such that they can't borrow versus the public credit market.
Customization, speed, certainty, flexibility, bringing that solution direct to the borrower. Sometimes there's certain elements in terms of the timing or whatever the case may be that requires a private solution.
Confidentially, you just explain that a little further, Like what is it about these projects specifically when you say like customization.
If people say customization all the time, give us a specific.
Exam Yeah, okay, Well, sometimes there's a construction element. Okay, So you need to fund over time as opposed to funding all of your capital day one. That's a good example, right. Sometimes you need to structure in a certain way in terms of the timing of the cash flows. That's another example. So there are things that are needed that don't necessarily increase credit risk, but they don't fit the cookie cutter mold of a straight away investment grade public on.
So this might be a difficult question to answer. But when you look at your own portfolio, your own very large portfolio, can you give like a rough estimate of how much AI exposure has increased over the years.
Well, that's a fascinating question, right, because I tend to think about AI exposure pretty broadly, Right, because I think AI will impact not just data centers and the direct right, you know, first derivative impact, but the second derivative impact, the third derivative impact.
So you're looking at companies that could be disrupted as.
We're looking at it all and we have been looking at all and this is this is part of working at Blackstone right, Like, we have unbelievable insights into what's going on all around the globe in all of these markets, not just within our credit business that has five thousand plus barwords, but our private equity business, our infrastructure business, our real estate business. We happen to own a couple
of the largest data center developers in the world. We have a huge operating team that helps companies implement AI capabilities, help them play offense and defense when needed. And so we leverage all of these resources. And I think about AI impact across almost every business in our portfolio, the varying degrees, But I think you have to be front footed in thinking about that as an investor.
What about direct exposures, I forget about I take the point, but like, the reason I'm asking is because there are some concerns around concentration limits at places like insurers.
Yeah, Look, we have over five hundred billion dollars of assets and credit at Blackstone, and I would tell you, like the amount of direct data center exposure is a small minority that it would not rise to the level of something where any of our clients would feel like they have concentration.
What about in terms of I guess said like formal concentration limits. Just in terms of like on a day to day business right now or over the last year, how much of new new activity would you say is related to either sort of data centers or maybe some of the power the power financing that is also needed for data centers.
Look, I would tell you it's a material portion of what we're doing because it is such a capital intensive, credit intensive part of the market. But when I think about everything we're doing across our business and credit, it doesn't it doesn't screen as something that's you know, significantly overweight.
Like if I think about what we're doing in our private investment grade business, that's a real asset strategy broadly defined right that includes obviously digital infrastructure and includes energy and power, but it includes residential mortgages, which is a
massive asset class. It includes equipment, finance. We just announced a deal recently to do an aircraft engine partnership, and frankly, I'd say the single biggest thing that it includes is what we call corporate solutions, and these are large scale, customized private credit partnerships with public investment grade companies. And so recently we did a deal with Rogers up in Canada where we did a five billion dollar financing for
them against their network infrastructure back haul. We then did a deal late last year with Cempra Infrastructure to help them build out an LENNG project. And we're seeing that not just in the US, we're seeing that globally. We announced the deal yesterday in fact, with Ahold, the European supermarket company, to help expand their logistics footprint. And so I would tell you the biggest theme I see across our private investment grade business is this notion of what we call corporate solutions.
What's it like sourcing deals at the moment? So Blackstone obviously very big, So I imagine people are coming to you constantly. But at the same time, I'm one of the things we heard when the private credit market was very, very hot, was there's a lot of competition for deals, right, and everyone wants in on certain financing transactions. So what's it like?
You got to ticket market by market, right, we were just talking about private investment, great corporate solutions, some of these big infrastructure credit areas. I would tell you in that market there is more demand for capital. Then there are players like Black Zone with the scale to actually meet those needs. And so that is a market where I would tell you we have robust deal activity, and that is a market where I see a lot of excess spread. I know you mentioned earlier that spreads are tight.
That's an area where I would say spreads are actually quite attractive. Right. If you think about public IG spreads today are eighty basis points, if you can make two hundred and fifty basis points it like for like credit rated risk like, that's a lot of relative excess spread. And that's happening because the demand for capital relative to the supply of capital is quite attractive, and that's showing
up for us as lenders. I'd say in the direct line market, that's a market where spreads have tighten in sympathy with the liquid subinvestment grade markets, but the excess spread remains. Right, that excess spread of a couple hundred basis points persists. I think what is helping is you are seeing this increase in deal activity. We saw very strong M and A activity in the back half of
last year. If I look at our Q four pipeline, it's actually up twenty five percent versus what it was at this time last year, and so I think we are optimistic about a strong recovery and deal activity that will help on your point in terms of sourcing deals in that market specifically, I think the other thing that's really important, and you asked this question around how do we scale a business. Part of it is not just
waiting and sitting for the phone touring. A huge part of what we do is think about the thematic areas within all of Blackstone, not just credit that we want to deploy capital in and digital, infra, energy and power. Those are good examples in the investment grade space, but there are also examples in the subinvestment grade space life sciences, utility services. And what our team does is we proactively
identify these companies and pitch them customized solutions. And because we have the scale of capital to actually solve that problem, we can do that. We did a deal late last year with a company called Signant Health in a life sciences space. The billion dollar plus transaction that we led. How did we do that? Well, we had financed their number one competitor. We had followed this loan because we had held it in our liquid book, and so we had the idea, Hey, let's call this company and say
you should do a private loan. And that's where the idea, aation comes, and that's where the differentiation in the market comes. A lot of people can pick up the phone, not a lot of people can create their own ideas and actually effectuate them. And I think that's something we're uniquely good at.
Everything is just sort of like scale empower laws and compounding return from having grown and having that network the big get bigger. It's really such an extraordinary thing and we see in tech, but we also clearly see it in finance. I think with like you know, the percentage of market share, that a cruise to the biggest players
clearly an advantage. Obviously, want to talk more about the industry overall, going back to you know, Tracy mentioned, we're so it's so over we're so back, we're so so cycleed. So at the end of last year, there were two things there were like two like kind of blow ups in but both were both related to auto. So tree clore, I don't know if I'm pronouncing it.
Try That's one of those words where I feel like very stupid pronouncing it the right way.
Yeah, I M yeah, And I'm like, should I just say try color?
Yeah?
So there was a pre color and then first brands, which I'm pretty sure pronouncing correctly, and then there was like so that was like in the auto space, and then there was all this stuff that went viral for about five minutes, something about the chips and maybe they're going to depreciate faster than people expected. Bunch of people are going to be holding the bag and I want to back get that out aside, you get those blow ups in the auto area. Jamie Diamond comes out with
the cockroaches. What was your read on that moment? Was there reason to think that there are more Creek colors? I just want to say that, I like saying you do well, thank you, more three colors out there.
I would tell you when all of that was going down, we were scratching our heads. And the biggest reason we were scratching our heads were all of those examples were bank led BEG syndicated bag underwritten deals that somehow got
confused with private credit. And this is the biggest frustration for us, because we looked at those deals and we said, hey, one of the advantages of private credit is you can actually do private level due diligence, you can get access to management team, you can do weeks of work, you
can get private access to information. And so one of our observations there was there was this misconception, and that's why we think it's so important to continue to educate on the distinctions between public credit and private credit, and those situations were public credit. I think the other thing that I think people maybe don't appreciate is while private credit has gotten a lot of attention recently, private credit
has been around for a long time. You can look at twenty year returns in private credit and you can see that they've outperformed liquid credit by several hundred basis points over twenty years through cycles. Also, you can look at the fact that realize losses over that twenty year period for the industry have been one percent. And so I think we look to the data, we look to the clarification, But then I think the last thing That's also important to highlight here is defaults happen in some
the best bit great credit. And I think this is the other thing that I think gets missed. People see a headline about a credit issue. We have thousands of credit in our portfolios. Some of them are going to have issues. That is normal. If you look at the long term default rate in the leverage loan market, in the public high yield market, it's three percent. These things happen. We account for them in our underwriting, we account for them in how we mark our portfolio, and most importantly,
we have the resources to deal with those situations. We have operating people, We've got a big workout team, and if we do have challenges in our book, I think to your point on scale, Joe, having the strength of Blackstone, the resource and intellectual capital of Blackstone to actually support those companies and drive good outcomes for our investors overturn, that's what matters.
I take your point about the twenty year returns, but you know, twenty years ago the private credit industry barely existed, right, and then we've basically had a seventeen year bullmarket except for five minutes and twenty twenty eight a seventeen year bull market in risk assets. So I don't think it's crazy to say, like, yes, the returns the real they deliver,
the faults are low. Defaults happen, but I don't think it's totally crazy to wonder if you're at turning points, because there's to some extent you can only take a twenty year track record so far if seventeen years of them were in more or less a NonStop bull market.
So here's what I see. First off, what I think will happen in the market is that you will continue to see private credit grow, and you will continue to see strong private credit performance. That said, you're right, if I look forward versus looking back, I think it's reasonable to believe that you will see more dispersion in the asset class. You will see some players underperform, you will
see some players have higher losses. I don't think that means the entire asset class will face challenges because the model, like we started with that Amazon analogy that still persists, the excess spread versus liquid markets, that is durable, the way our clients access private credit, and all of these new areas beyond direct lending. We're at the very very beginning of that very, very long road, and so I think the long term thesis for private credit is intact.
By the way, you don't see massive ways of defaults outside of recessions, and it doesn't feel like to me we're headed into a recession. When I look at corporate earnings growth, when I look at where consumers are, when I look at fiscal and monetary stimulus, none of that points to recession to me. And so when I look forward, I don't see I don't see this big turning point for the industry. I see continued growth in the industry. But what I do see is more dispersion, which is
a good thing. If you think about all established asset classes, you have top growd tile managers and you have bottom quartile managers, And so I think the asset class will be a lot more about who is better at originating deals, who is better at managing challenges in their portfolio, Who has the broadest aperture to identify areas within credit broadly defined where clients can deploy, where there is excess spread,
where there is better risk adjusted returns. I think that's the era we're heading into, and I would say we strongly embrace that era.
Okay, so you don't see lots of defaults coming up, But what about liability management exercises or just restructuring debt, because this is something that comes up occasionally. If you look at default rate for private credit, I think officially it's below two percent something like that, But if you add back in the liability management exercises that we've seen at places like First Brands, it goes higher. I think it goes to like five percent or something like that.
Would you expect more companies to be restructuring debt as this dispersion effect maybe feeds through well.
I think there's two pieces I want to unpack there. One, this whole notion of liability management. It really is a public market phenomenon, and it exists in the public markets because public credit documents are really weak, right. They don't have the same covenant protections that you have in private credit, and so you can have debt layered in front of you, you can have collateral strip That's what's happened in a
lot of these situations in the public markets. Fortunately, in private credit, the documents are more protective, and so I think you will see less of that aggressive behavior in the private credit markets certainly versus the public credit markets. The second thing I would say, Tracy, is the default is just the beginning. What really matters to clients are losses, right because the strength of a private credit document allows you to get to a table and negotiate with the
owner for maybe more equity. Sometimes we have to take control of the company and we can use all of the resources of Blackstone to improve that company and actually deliver a strong outcome for our clients. And so I think those are the two points I would focus on. Yes, you will see defaults, but the question is over time, what is the loss experience for investors? And that's something I think we have a lot of conviction in.
Okay, So the other thing, besides the first brand and first brands and three color blow ups you just want to keep saying more times, was this anxiety about you know, the quality of some of these data sunderfining, like, oh, the chip's going to be as valuable as people think, and you know, actually it was just looking up, like from the credit default swabs on Oracle actually basically continuing
to hit new highs. Core Weave, which is another one that people are watching a lot that's actually come in a bit, So maybe I don't know, people are chilled out a little bit. But from the capital provider the lenders, what is the appetite right now for AI or related infrastructure financing in the wave of some of these hiccups, and what we see in the CDs market for what might be some proxies for this kind of stuff.
Look, I think the nature of the risk matters, right. I don't want to paint it with a broad brush, because you hit it. The type of collateral matters, who your counterparty matters. For us, whether we're financing chips, we're financing a data center, we don't want to take residual value risk, right, I don't view that as credit risk.
So if I can invest in chips, if I can invest in a data center that has investment grade counterparty risk, and my debt will fully be repaid inside of that contractual agreement, whether it's triple net or whatever, and I don't have to take residual value risk. I don't care what that data center's worth in year twenty five. I don't care with those chips are worth in year seven. That's really good risk. I think when you confine it to that which is what we are doing. I think
that's quite attractive. Will folks take that next layer of risk? They might, but you need to make it.
See any pullback like some of the you know, the less triple net whatever they like, could say okay January twenty twenty six versut January twenty twenty five, any anxiety because we know that there is still incredible demand for the buildout. Right it's this multi year, multi trillion dollar thing. From your perspective right now, how strong is the capital base for that buildout? Has it changed at all?
I think when you have the contractual protections that I'm highlighting, I think the demand is there now.
Might there been some change to twenty twenty five?
I would tell you that because the demand for capital is so significant, okay, and bigger than the supply of available capital. When you see that happen, you see spread sent to widen. That's a healthy thing. That's a good thing for the markets. And I think some of those deals that don't have the protections that I highlight, they have a harder time getting done in the credit markets, and you see them get funded in the equity markets. I think both of those things are healthy. I think
when I take a big step back. There is a lot of chatter about this market, but we are firm believers in the impact of AI SURE, and I think the bigger risk is underestimating the impact of it on your broader portfolio. Like I was alluding to before, what.
Was the fourth quarter actually like for you? And what sort of questions were you getting from investors? Because we know some other private credit players like Blue Oul got a bunch of redemptions, did you see similar pressures?
Look, anytime you tend to see some of the press that you highlighted, it's natural to get questions, and we embrace those questions and we address them with the facts that I just highlighted. I think for us, we continue
to see very strong demand for credit. I was around the world I think twice in the fourth quarter, meeting with our clients around the world, and I would tell you, in aggregate, they want more private credit right our institutional clients, I think year to day through nine thirty, inflows were up over fifty percent versus where they were a year prior.
We held a forum with many of our big clients late last year to discuss relative value and risks in the credit market, and Actually it was great for me because it was a way I could actually survey our clients on their views, and I would tell you they continue to be very bullish on private credit. If anything, they feel under allocated to private credits and asset class and so I think the momentum will continue.
This sort of touches on one of my favorite things to talk about, like sort of portfolio construction. But for these mega clients, yeah, they say, okay, we're under allocated more of this. What is it that in their broad portfolio allocation, the characteristics of private credit are solving for them right now?
Yeah, well, look yield.
Okay, especially everyone loves yield.
Right, everybody loves yield. And I think even with spreads tighter and with rates coming off a little bit, even with that, the yield and credit relative to the earnings yield of the S and P is as attractive has been over a very long period of time. So credit
remains attractive. I think when valuations are expensive like they are across the world today in most asset classes, being defensive at the top of the capital structure really matters diversification, right, most of our clients have a lot of credit risk. Corporate credit risk. Excuse me, corporate risk in their portfolio, whether it's private equity or on the credit side. What
about real assets. That's why asset back finance, That's why investment grade have been so convincing for you know, so high conviction for our clients, because it offers that diversification, It offers that access to real hard assets that are downside protected versus corporate risk. And then I would say, the other big theme for our clients around the world is something we call multi asset credit. It is this notion that credit as a whole is a place I
want to be deployed into. However, I'm also recognizing the fact that markets EBB and flow. Where one market within credit is attractive, one might be less attractive. How do I partner with someone like Blackstone across everything we do over a dozen different asset classes within credit to build a diversified, resilient, higher yielding portfolio that allows me to pivot to the best opportunities in the market wherever they may be.
Setting aside some of the cockroach phenomenon of late twenty twenty five, there was another thing that happened that was pretty big for the credit market, and that was the withdrawal of the leverage lending guidelines for banks, basically making it easier for them to do broadly syndicated loans. Would you expect that to increase competition between the banks and the you know, BDCs so to speak.
Look, that one's gotten a lot of attention. I've spoken to a lot of my friends at the banks recently. I think the reality is on new direct lending deals the market, and by the market I mean the private equity sponsors. They've largely spoken right like speed, certainty, flexibility, customization, all the stuff I hit on. That's a really good thing for them, especially when they're buying a company and
they're in a competitive auction process. Even deals that met the leverage loan lending guidelines that were in place over the last two years, eighty five percent of them were financed privately, right, So even when you had complying deals, they were borrowers were still choosing private credit. I'd say today, our partnership opportunities with the banks, particularly on the investment grade side of what we do, it is more. It is bigger than anything I would say that we've seen
over the last several years. The banks desire to partner with us where they keep the client arrangement, they keep the servicing, we keep the asset. We are seeing that as a global dynamic, especially around some of these longer duration asset classes, these hard asset asset classes, and those are the exact things that our investors want, and so I think that partnership opportunity will continue to grow.
This is the front of me dynamic that we've spoken about before, right, So private lenders are in competition with the public lenders, the banks, but at the same time we're seeing more partnerships.
No, and there's a lot of into something intuitive there about you know, wanting to keep that relationship, but also this element of like okay, the speed and customization and the financing. I have a question actually about management, internal management and the art of growing a business. You mentioned being proactive, so you're gonna have people on the phone and they're like, we did this thing, would you be
interested in this solution and so forth? If this big company you're building it over time, I'm curious, like, how do you design a system such that you have lots of people working the phones but wanted to grow their own books but not lower standards and led garbage into it, and how do you think, like, how do you build those systems into it so that the person on the phone isn't, you know, yeah, bringing in a bunch of garbage just to grow volume.
I love this question. So as I think back at the history of our business at Blaspheming Credit, obviously we've seen tremendous growth. We've seen tremendous success. A big turning point for me personally was COVID, because up until that point in time, we ran each of our businesses almost as verticals, right we whether it was direct lending or
asset back finance or liquid credit. We had pms and each of those businesses and they ran each of their businesses from raising the capital to investing the capital, to manage the team almost as a vertical entity. We had no horizontal layer. But what COVID taught us when we were all at home and our pajamas and the markets were going walky, that we needed that connectivity. It would be really valuable if one piece of our business was
really connected with the other piece of our business. And so we started building out our CIO office, which I lead, as a horizontal layer to connect all of the dots and bring tremendous consistency across our teams. And five years on, that team is now one hundred and twenty plus people. And what that team does day in, day out is unifying the fabric of every single one of our investment businesses.
And so we have a single investment committee that whether you are a direct lending deal or an asset back dealer or a liquid deal, you go to that same investment committee, same underwriting standards, same memo, but most probably the same people hearing the deals from all the different parts of the Blackstone credit ecosystem to know where are the best opportunities. By the way, that investment committee also includes Senior represented as a Blackstone outside of credit. What
are we learning in private equity? What are we learning an infrastructure that might influence this decision? The way we aggregate and monitor data. We now have one centralized portfolio company reporting system, and so at any time we see weaknesses in an area, instantly the entire team knows them and say, okay, let's pull back origination in this sector
and let's lean into origination in this other sector. And so systemaizing our data, centralizing our processes, being even more plugged into the themes we see more broadly at Blackstone. That has been a critical part of our journey and I think a huge competitive advantage for us going forward.
I just want to go back to where we started the conversation, and I mean really the beginning of the conversation. Your job title so CIO for Blackstone Credit and Insurance. I think this is really important and underappreciated in many ways. But the partnership between insurers and private credit has been phenomenal. Like a lot of the private credit growth that we
are seeing is coming directly from insurers. How important is too, I guess be an insurance company if you're in the private credit space or have access to that pool of capital.
Sure. Well, a couple points I want to really hit here. One is our business model an insurance because it is different than some others. Right, we don't have a captive insurance balance sheet. We don't originate insurance liabilities directly at Blackstone. All we do is act as a third party asset manager on behalf of insurance clients. That's what we do best, That's all we want to do. Brick bry Brick. We built our client base. It's a fully open architecture model.
All of our clients sit shoulder to shoulder, and so I think that business model is critical. Right. We don't want to compete with our clients, and we want to make sure that every single one of them gets a great experience with us. I think that's a business model question, and I think that's an important part of how we set up that franchise. The second piece is of the why why are insurance companies seeking private credit capital. Well, in the case of a life insured, you're writing a
forty life insurance policy. In case of writing an annuity, you're writing a set contract. The best way to manage assets against those liabilities are safe, cash paying contractual assets.
Those assets are exactly what we originate in private credit and that excess spread that we've been talking about throughout this discussion one hundred and fifty to two hundred basis points for investment grade life for light credit that is extraordinarily valuable for insurance companies versus just buying traditional liquids on the screen. And we've seen US insurance companies adopt
that in scale with a ton of success. And one of the big themes I see going forward is that same idea expanding to Europe, expanding to Asia because it is such a strong fit for insurance company balance sheets, high quality, safe contractual, LNG duration, investment grade assets.
So I've never worked in insurance private credit, but I've worked in the media industry and the digital media industry. And one of the phenomenons that you see is company starts and they buy various third party solutions off the shelf, like, Oh, I'm going to buy a piece of software to run my content management system for the website. Then you grow and then you grow and you're like, you know what, this third party solution doesn't work. I need to build
my own software for managing my content, et cetera. Does what happens, Like, do insurance companies hit a point where it's like, you know what, We've enjoyed doing business with you, but we actually want to launch our own private credit arm and we know that there are some of course, there are insurers who are joined at they do all. Is there a point where it just makes sense for them to have their own private credit shop or is it sort of case by case whether that makes sense for them?
Well, I think the direction of travel broadly is the other way, right. The reason why our business has grown so much is because insurance companies have said, hey, lack So, you're really good at this. You've got huge, dedicated team, You've got tons of expertise. We can't replicate it. But that is company by company, and some continue to do some things in house. Some have certain strategies where they have that expertise and they'll continue to do that in house.
And we're happy to complement in the areas where we can be additive. But I would say the overall direction of travel is a realization that we have built out this infrastructure, this origination team, this CIO portfolio management franchise, this asset allocation framework, and clients want to benefit from that.
You've mentioned excess spreads throughout this conversation, and I take the point that everything is relative. I think I mentioned that in the intro. But it is also true that spreads on direct lending have fallen over the past years. I think we went below ten percent for the first time in three years something like that. They used to be in the mid to low teens. What do you
see happening to spreads next year or this year? I should say, because it seems kind of concerning to me if we're getting more supply but spreads are grinding tighter.
Yeah, Well, look, I think there's a couple of things there. First, you mentioned it, right, bowers do have choice, right, and so there is going to be some connection to where the liquid markets are. And over time, that two hundred basis points spread for privates versus liquids has held, and it holds today, and so I think that's one thing to watch. And I think that relative value point you
made is the critical point. I think the second thing is, yes, you are starting to see more m and a supply, but we're still well off where we were five years ago, and so I think there's still a lot more room to run. And when I kind of step back and I look at the simple math of private equity dry powder versus private credit dry powder, private equity dry powder outstrips it five to one, Okay, And so I think there's still a lot more room to run in the
supply equation. I think spreads today are pretty stable, and I think our clients earning that excess spread versus liquids earning that absolute return, it still feels quite good, even though it's not the same as it was three years ago still feels quite good relative to where equities are valued today and other things in their portfolio.
In private assets in general, one of the popular critiques is that, you know, people call volatility laundering. It's like, oh, look, I had a rough quarter INCK in my stock portfolio and my whatever, but my credit portfolio is flat this quarter. And because there were no trades, there were no marks,
and that makes me feel sleep easier at night. And the accusation is, as an industry, you build to some extent on this notion of like, here's this asset class that just like helps me sleep better at night, it doesn't doesn't move, et cetera. You what's the response to the volatility laundering claim in private assets generally?
Yeah, A couple of things there. First, I look to a twenty year loss ratio, right, like, you can't hide that over twenty years, and I think those stats speak for themselves. Second, you're right, like this question around valuations have have been out there and private assets and blacks One's been around for forty years. We use a best
in class process with third party valuation provider. We mark our book every single quarter, and those third parties are the ones that are doing it, and we mark that to market company fundamentals, market moves. That all shows up. What's funny to me is, you know when we do see underperformance in an asset and we mark it down, which we do on our watchless assets, we get questions about that. People are paying attention to that, yet they are also asking us out of the same breath, are
you actually marking your assets? And so I think if you actually look at our portfolio, you will see a small subset of the book that isn't doing what we expected to do when we mark those accordingly. I think that's healthy. I think that's good. I think that provides some buffer for our clients, and we'll continue to use our third party, well established process to continue to do so.
You mentioned dry powder earlier, and this is a truism of markets, which is dry powder always seems to be waiting in the wings, Like no matter where we are in the credit cycle, one's talking about dry powder. I'm sort of surprised to hear that much the number you cited in the private credit space because again we have seen phenomenal growth and they're still cash lying around that needs to be deployed.
Look, we continue to see strong flows into the market. Right, the product is doing what it's supposed to do, which is generate strong, consistent outperformance for clients relative to liquids. I think as long as you see that continue, you're going to continue to see strong flows across all of our client types, whether it's insurance institutions, individuals.
Question I ask a lot of people today in January twenty twenty six, within your organization, are you finding productive applications of generative AI tools that make your life easier and reduce free up working hours from people who to do other things.
Yeah. Look, this is a huge focus for us, and I think I would be lying if I say we have the golden ticket today, but we have a lot of focus on this area. How do we make our business more efficient, how do we make it easier on our teams, whether it's building models, knowing what questions to ask in their due diligence process, data aggregation and analysis. All of this stuff is in motion. It's at various stages of development, and I think you will continue to
see us lean into that significantly. It can never replace the investment decision, right, That's still going to be central to our process. But I think anytime. We can use AI to drive efficiency, and like I said, we have tools that allow that to create the start of an investment companye memo, the start of a model, aggregate data so we can help our team see trends earlier. All of these things are in process, and I think more and more you'll see higher adoption.
Could you imagine a future where valuation is done more by AI? Because I think about the third party valuation services, they're doing matrix pricing, which is basically inferring the market value from you know, other clues they can get. Inference is like you know, that's AI.
Basically, I think using AI to support that process. You know, where have market spreads moved? Okay, this company's performance was x. How does that translate into a mark? I think you will see, just like I highlighted on the investment process, I think you will see adoption of support tools, driving efficiency,
driving accuracy, driving scale. At the end of the day, you still need a human at the end of that to make the decision, but I do think you'll see it incorporating more and more into our workfloaws.
What skills are you looking for when you think about recruiting in twenty twenty six and twenty twenty seven, a lot of people anxious about what they should what they should know, what they should be studying, et cetera. What are the skills that today are still clearly valuable and will be valuable that you would want to see in a new recruit.
Well, look, first and foremost, the people we look to hire upatone, incredibly hard working, genuinely good people motivated by you know, taking on more growing Some of these like fundamental traits like yeah, that is universal and I think that will never change. I think in an environment where you're using more and more productivity tools, how do you interact with people? People want to you know, do deals with folks that they feel like they can trust, they
develop good relationships. How do you think forward around corners? These are the types of critical thinking and communication skills that I think are going to be even more valuable to layer on to all like the basic stuff we have always looked for and the people we bring into the firm.
All right, we're going to have to leave it there, But thank you so much for coming on all thoughts. Really appreciate it.
It was my absolute pleasure.
Thank you guys so much. It was a lot of fun. I learned a lot, Thank.
You, Joe.
I'm a journalist or podcast hosts. You know, there's a difference.
No, there's no no word journalists. People always make parties there, What do you do? I say, I'm a journalist, all right.
All right?
Uh.
The natural tendencies of journalists is to be a little bit more pessimist than an investor. I mean, if you're an investor, almost by definition, you have to be optimist.
I agree, I'm paranoid optimist, that's right.
But I do see some signs of worry in the private credit market. So beyond the cockroaches that we talked about, you know, we have more companies doing liability managements. The documentation point I found kind of surprising because in our previous conversations, certainly in some of the research that I see, people say that documentation is declining, so investor protections are basically going down, and there's more convergence with the public
market and things like that. So I take the point that like every private credit investor that we have on the show is going to say that they're different and they're more selective and things like that, and it may be true, but overall, if you're seeing documentation go down and leverage go up and supply increasing, that seems kind of bad.
Yeah.
No, I mean look, I think the thing that I guess, I mean, all of that sounds very intuitive to me, and the attentions. The other thing that, and it's sort of related to this, is like how do you maintain Like Okay, you think about the fundamental service, right, you think about the fundamental service of like speed and customer customizability and so forth. And then the tension that exists is like, okay, you want to like turn this around, yeah,
right away, et cetera. And the tension between that and like robust documentations and I mean again, twenty year business to some extent speaks for itself. But on the other hand, like you could see how these things over time would come in to especially come into tens such a competitive environment exactly. I want to you know what, you place a phone call to me because you need money. I want to be able to give you an answer right away.
I'm going to say yes very quickly.
I want to be able to say yes to you to maintain your business, To maintain that line and the tensions that could potentially emerge between like our relationship as the lender to the borrower versus you know, my relationship to my people who want protections, et cetera. You could see how those would emerge, for sure.
Yeah, all right, shall we leave it there.
Let's leave it there.
All right? This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway and.
I'm Jill Wisenthal. You can follow me at the Stalwart. Follow our producers Kerman Rodriguez at Kerman Arman, dash O Bennett at Dashbot and Kiale Brooks at Kilbrooks. More odd Laws content, go to Bloomberg dot com slash odd Lots. We have a daily newsletter and all of our episodes, and you can shed about all of these topics twenty four to seven in our discord Discord dot gg slash out lots.
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