Hello, and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway.
And I'm Joe.
Why isn't thal Joe.
It's a new year, Happy New Year, Happy New Year. This is our first podcast recording of the year, and I think it's fair to say that we are going into a different environment in terms of sentiment than we were going into twenty twenty three. So this time last year, everything was very pessimistic. Lots of people were expecting recession. The hills were alive with the sounds of inverted yield curves and things like that. This year feels a little bit better. Stalks are up, lots of talk about a
soft landing. Of course, the irony is that if there is going to be a recession, and you know one hundred percent chance there will be a recession in the future, it's closer than ever, and yet we feel a lot better about it.
Yeah, it is.
It's funny the optimism that we really felt in December about soft landings and bull markets and raids coming down in normalization. Interestingly enough, we're recording this January third so far, I guess this is we're looking at. We've had a few down days but you know whatever, a few days here there, it doesn't make a big difference.
I call it profit taking Joe profit But anyway, you know, New Year, New Themes to discuss.
Taking profits, I wish.
But one of the things that's still with us is this concern about whether or not the economy can escape the full force of these very dramatic interest rate hikes that we've seen over the past couple of years, whether or not there's still a shoe to drop.
Basically, yeah, you know, it gets to the lags debate. We talked about it with Anna Wong at the end of twenty twenty three. The market expects rate cuts, obviously, some people think as soon as March. Unclear when or if that will be. That theoretically is taking off some of the pressure from markets, particularly credit markets. But yeah,
we had this really big rise in raids. Some people think that the lagged effect still has yet to come, and so sort of trying to understand what's changed from when we were etserped to when we're at five percent, I think is still an important conversation to.
Have, absolutely, and in my mind one of the big areas of concerns, And it also goes to the idea of what's changed over the past few years has to be private credit. Ye. Right, We've seen this absolute swelling of this particular asset class at a time when interest rates have been going up, and there's still lots of concern over whether or not this new source of funding basically knows what it's doing right, Like are these managers,
are these investors like getting it right? But then the other thing I keep thinking about, and we've sort of talked a little bit about this, but this idea of the macro impact of private credit. If you have a body of money that is now one point three trillion or one point six trillion outstanding, depending on which estimate you're looking at, that is more or equivalent to the
size of the entire junk created corporate bond market. So there's basically this like new pool of money in the economic system at a time when interest rates are going up and we're not really sure what impact it's having.
And I'll just add on to that. Part of the interest obviously is Okay, what does it mean for this cycle a higher rates, et cetera. But this acid class that's exploded, it's not going to go away regardless. And the expectation is that it's going to overtime continue to grow. So I think there was just a lot of need and interest, but I would say need to sort of understand, as you say, the macro impacts from this space. I'm
also curious about the source of excess returns. We talked about it a little bit, but it's always sort of important when thinking about an asset classes, like, Okay, what is it specifically that's being exploited here for above average returns? How correlated uncorrelated is I think it's still worth trying to untangle the impact and the role of this asset class.
Absolutely so. We've done one episode on this topic. Previously, we spoke with Laura Holsen from New Mountain and she basically gave us the elevator pitch for why this asset class has been growing so dramatically in recent years. But in this particular episode, we're going to dig a little bit more into the macro impact of private credit, how it competes with other types of funding, and per Joe's point, where the source of those excess returns is actually coming from.
And I'm very pleased to say we have the perfect guest. We're going to be speaking with Ben Emmons. He's a senior portfolio manager at New Edge twelf. Some of you might remember that we spoke to him last year about the contraction in bank lending after the collapse of Silicon Valley Bank and a few others. He's had a very wide ranging career. He was at PIMCO for a long time. A great person to give us an overview of how private credit is interacting with the rest of the financial
system and the economy. So Ben, thank you so much for coming back on all thoughts.
Tracy Joe, it's great to be back. Happy New Year, Thank you for having.
Me, Happy New Year, Thank you for coming back.
Yeah, So maybe to begin with tell us, what's your particular interest in private credit? You know, sitting at New Edge, you're a portfolio manager. What is the offering posed by private credit?
Yeah, it's driven much by clients interest in demand for this asset class, you know, in part maybe because the type of clients at New Edge in this case services are working in the private credit industry themselves ironically, so
they're interested in investing out of private credit strategies. But it's also i think born out of clients who have connection with the companies that these private credit lenders are lending to or have some sort of involvement in that, and are interested and allocating the effort to this as a class as opposed to you know, let's say the retail approach of like, well, okay, I heard about private credit.
There may be an ETF on it, like you know, and so let's buy this ETF and and now I go to a wealth man's perform like new Egine and they will help me with that. That's far less. So the investors that we talk to are very involved in private credit themselves, So it gives you an interesting angle on it because once you are starting to talk to these clients, you know, you have to really learn about
what this aesca class truly is about. You know, it's far less an asked class about the way we're trading public markets. You know, if you look at treasury bonds, that's not what private credit is really, how it is
traded or how it is functioning. So I find it a really interesting different alternative way of investing as something I had not looked at in my career previously, you know, until I really started to get into the Vegisa's investment advisory business and so interesting the watches to see this unfold.
So what is it for an investor? You know, you think about overall portfolio. People have some equity, and they have some maybe risk free government debt, et cetera, and whatever it is. What is it about private credit? What does it deliver for a portfolio?
So the one it is truly diversification, and it is an asset class that's traditionally non correlated to equity or fixed income, even though you know all of the loans that are in the devocredit funds are off based off the secured overnight funding rate, that's the self rate, right, So there's there is obviously a connection with interest rates, but it has been long term uncorrelated based upon how the returns have behaved relative to returns and equities and
fixed income. I think what the tracks people is that the loans that are being issued by those private lenders, you know, they have been at extreme low default rates for a really long period of time. Now, I always talk to the private credit managers with a bit of a caution here because coming from a world of total return and fixed income training, you take immediately set back well, okay, load the faults. Really, I mean so.
I yesh, it's sort of true of every new asset class, right, like, oh, the history is limited, so there aren't many defaults exactly.
So that's exactly a very good point. That's one reason. On the other hand, it's about you know, okay, the individual companies that they lend to have had a good credit history so far, at least in many of the funds. If we looked at that's been the case. Very little impairments that have happened. Second, the private lenders are in control, so they set the covenance. It's not like a bank involved or another intermediary that is controlling the contract. It's
really Blue Out Blackstone KKR. Those companies. They set the terms and they also are very good at enforcing those terms. And think it gives clients a confidence that these loans are staying current and we're not get any major impairments of anything. Now, what I think otherwise is I think of attraction to clients is that you know, it is an astraclass that is not out on the screen. It
is privately managed and traded. Private credit funds are nothing like a mutual fund of etfor or hedgephone manager they are very selective in how they pick their different companies to lend to. I think all of those things play a role in why investors are interested in this aska class.
So a lot of this reminds me of the debate around cove Light in sort of like the middle twenty tens, when there was an explosion in cove Light bonds or a dramatic deterioration in the amount of protections that investors were demanding in order to lend to companies. And I remember that time. There was an argument sort of for and against. So you know, some people were arguing, this is terrible. This is the result of the search for yield.
It basically means people will lend to anywhere they can get a return, and they're not going to ask for any protections because they're just desperate to get any sort of yield. But then the offsetting argument was that, well, actually it sounds bad. Cove Light sounds bad. The idea of investors giving up protections sounds bad. But if something were to happen, if there were a recession, then it could end up being a good thing because it means
companies have more flexibility to refinance. They don't have as many restrictions around what they can do. So I always remember there were sort of pros and cons to the cove light argument, and it feels similar in private credit, maybe to.
An extent ration. But I would say the managers that we've spoken with, and you know, we talked to over one hundred managers in that space, what we've read from most of those governance they're not lights. They're actually stricter, and I think it is because of the personal relationships that these private lenders have of the company that they're
lending to. And they told us that we've actually got an examples they've shown also, you know, uh, a presentation of the different companies that are actually we are in the fund right who are basically let's say, long term standing relationship between say a Blackstone and that company itself. So I'm trying to get us that the covenants are sort of maybe like customized governance. They certainly don't do
to us as light. You know, there's a very strict control on payments of interest and it's about trying to you know, really help the company move ahead. So there's much of a i think also a private equity aspect to this, and that's typical in private credit anyway, where you have a sponsor that it's involved in the structure of private credit fund. But having that private equity approach gives these companies that sort of, let's say, empower those companies to do the right thing with that money and
invest in the right way. And therefore the governance, although they look really strict, are not necessarily going to be at some moment like, Okay, you can't pay off those loans, We're going to, you know, really put the screws on this company if we're going to take the keys right at lily and and therefore the company becomes totally impaired
and dysfunctional. That doesn't seem to be the case so far, even though from what I read, those governants there are strict compared to say, clos where that governant light showed up in the mid to twenty.
TENHS for now, So what what cause a company to decide to go the private route versus you know, either issue a bond or take out a loan from a bank in the public market.
So I did announcers on the b credit fund, for example, from Blackstone, and all those are in there are non listed. All of those companies have what we from our conversations with them, have no interest in going public at all. And Thirdly, what I did find, and I did say that to Blackstone, about ten percent or so of that pool, there's very little information I can find on these companies, and I go online, I don't see much of any
kind of information. So some of our really really private, private type companies we talk about literally like services companies a car wash or some technology services company like that you've never heard of before. And so these companies I think are no also not in the position to just go to the public markets unless there's a bank that is really that easy in terms of his lending standards, that is willing to give these companies money or allow
them to come to market. On the other hand, I mean, some of these companies may be in a position where they get better and better revenues, they get more traction, get more attention to their business model, and at some point some big investor compans like, hey, look, you know, we can help you go public and raise equity. We've not found those examples in these pools so far.
How much of the rise of this acid class, in your view, is simply about scale and capacity within the banks, or maybe lack thereof, because if the story is right, the companies are not listed, they're not particularly well known, so, like you know, you're sort of starting from scratch on due diligence or familiarity. Perhaps the covenants are bespoke. In many cases, as you've described, they're tailored, so that obviously takes legwork on the part of whoever is making lending decisions.
So is this like a story of like essentially going to post Dodd Frank world where like banks are constrained, et cetera, that essentially it just makes more sense for in many cases for a third parties who have the capacity and scale to specialize and find in creating that relationship.
That's spot on, Joe. I think the outer part of that story is that as banks have skilled back ye dedicated market, that created a void, and I think that was part of the story too, of these companies automatically getting towards a private lender as supposed to going to it let's say mid size or smaller bank trying to get a loan or business loan. But as I mentioned, the personal aspect that found really fascinating of how personal
relationships they've had. Now, any private banker has this right if you go to I don't think of any of the major banks there's a personal relationship. But I think in this case it's very driven by personal long term relationships. So that void of the banks, not you know, lendings as much in that syndicated loan channel, is one reason why there is a lot of demand for private lending. On the other hand, it's really the personal relationships. I think that's driving it.
Tracy, it still strikes me as perverse that the banks that failed in twenty twenty three were like the banks where they actually took like private relationships seriously. Like it sort of bothered me. It's like, oh, this is like what I think like bankers should be, like really getting to know the clients, bespoke offerings that isn't just like some generic website.
There's a difference between getting to know the clients and doing whatever they want you to do.
I guess that's it, but it still feels like man like, I think that's what bankers should be doing, but I guess apparently not, that's not what the market said.
Well, I mean, just going back to the regulation, I mean a lot of this was by design. I remember when the leverage lending guidelines came out again in the mid twenty tens. That was back when the market was going absolutely haywire, and the regulators came out and said, hold on, you guys have to like take a breath here and stop doing so many things that are risky, basically forcing that activity into what we used to refer
to as the shadow banking system. I don't see that term as much as I used to, but that is exactly what private credit is, of course. But just on this note, I remember there was a really interesting chart. I think I put it in one of the All Thoughts newsletters maybe a couple months back, but it showed commercial and industrial bank lending in the US versus USGDP, and for most of the history of that time series,
they pretty much moved together. So if there are more commercial and industrial loans, then GDP tends to be growing. But over the past couple of years they've kind of decoupled, and in my mind, it really raises the question of, like, what is driving GDP growth. If it isn't bank lending, you know, maybe it's government funding. We've seen a lot of infrastructure spending and things like that, but maybe it is also the more than one trillion dollars of private credit that now exists.
I think that's right, because you know the fact that it is one point three trillion dollars going to lily companies that making twenty five to fifty one hundred million dollars of gross revenues a year. That's part of the really the small mid size backbone of America that's driving GDP and again doing reach own these companies. From the information that I've found on it is, you can really tell like their business models have expanded very rapidly of
last several years. In part I think is the infusion of private credit and the availability of private credit. Again to that question of Joe like that if the availability is from private lenders not from banks, it does eventually do show up in GDP, maybe not because of the commercial and industrial loan contractions you're see in there, but
through the other channel of private credit extension. I think also that the impact in itself of leveraging gearing in the financial markets is actually none by from private credit. There has been one colo now issues of Blackstone's bi credit fund that was very very recently. It was about
a five hundred million dollar deal. They took the most I think that the best loans that they had in their fund and bundled them together and sold them to investors at a very i think, very tight spread compared to where high yielders and anything else, so very conservative. But as not much more of that is happening yet.
So if you think of impact from private credit on the economy, we go through leverage and securitization as an example, so that maybe the next stage in the future, as Blackstone sort of tipped the waters there and figured out, hey, there is investor demand instead of direct into our fund, we can securitize. If that were to pick up that securitization, I would think you're going to get an even more compounded effect from this, and then maybe the fears about
the risk of private credit will become more justified. Right because I'm maybe jumping ahead of another question, but you know the risk if you think of macro impact on the economy and you think of risk, I would think the real risk of private credit is that the leverage, yeah that's in these funds, which tends to be about one and a half two times is sort of most of the funds that have that sort of leverage that that gets compounded by securitization the loans in the funds,
and we haven't gotten to that stage yet. So the actual leverage itself, I think relatively low. If you compare it to the public markets take investment grade leverage is still three four times. Yeah, earnings is supposed to one or two times.
I've brought this up in a few different conversations, but always blows my mind. So I keep asking the same question. But people like the fact that it's not on a screen. You mentioned that, And so there's this attraction to prices that I guess you don't have to look at every day. And if the market's read one day and the stock market's down two percent, but you look at your privacy easy.
To be diversified if you're not traded.
Yeah, there's like, oh, hey, my credit exposure was totally fat, even though like implicitly like that's a lie. I mean, we all know, but like, here's what I don't get about that. So A, like, is that real like that premium that people pay for the appearance of non diversification, And b it seems to me that the people who should really like pay up for the privilege of not
having to look at their quotes. Are like individual retail investors who are like prone to panic and selling it the worst time and buying at the top, et cetera. But for the sophisticated investor, which I imagine most people who are like allocating to private credit, you know, they're not mom and pop. They're you know, they're people with moving serious money and sophisticated, like they're pros at this. Shouldn't they like be able to bear to look at
their portfolio on a day to day basis? Why do they need to not have the screen?
Yeah? I know, And that actually has happened because if it takes step back, yeah and go to the four quote of twenty twenty two, they are suddenly this news out that institutional investors in Asia were taking their money out of Beat Credit, and that was the first news of sort of this redemption starting, and that did spill over to the US and cause a little bit of a nerve, including with some of our clients that we
got redemption requests. And because it's a gated fund, but they only pay out up to five percent of the total bull per cord order and it's an an auction type basis right, so you don't get your the five percent is a pro rade idea, you know, I did think made people wary of that. To your point, it's not on the screen, it's not mark the market, but there are marks clearly, and if you follow the ten Q ten K filing every quarter, you can see that
the change of the value. This is what I do obviously because I have to do this for my job. And yeah, there's some stresses have built in over the last year, and you could tell us from the spreads on those loans they were when I started a new edge somewhere in the three the five hundred base points over sofa more than the fifty percent of the pools right now i'm looking at are more like five hundred to seven hundred base points over sofa, So that has
a change has happened. So I think the sophisticated investor looks at this similarly, saying I'm getting wider spreads than in high almost double now Kearney, and the marks are indeed somewhat deteriorating now that the fault rates stay low. That's you know, of the total pool, that's how they
present it. But if you break it out by different sectors, and a lot of these, by the way, these private credit pools are allocated significantly to software and healthcare, and that's where the weaknesses have been in the economy, so you can tell that those president only wider than they were a year ago. There's also I think from the marks on the loans from when I looked at different ten K filings, Yeah, there's some default breaters picked up
there and there's some impairments have been reported. That is also showing up again to the covenant and the control that seems to be quite tight, and that I think why it hasn't been a floodgates of redemptions coming out of these funds, but that is ongoing is I think it's a sign of that people are looking at the ASKA saying we want more transparency and not so much ovagueness. I like to better understand what the liquidity truly is.
And therefore I'm also reserved cautious. So it's not all in private credit and it's fantastic and you don't have to do it. I think there are just a lot of investors that have caution.
What would be the proximate cause or catalyst for this might be an unfair question, but like the doomsday scenario in private credit, because I keep thinking, like, okay, one of the strengths of the asset class is that in some respects it's very liquid and you don't have to mark to market on a daily basis, and so you can kind of withstand short lived down cycles. But at the same time, you know, I imagine if those pressures were to build up enough at some point you would have
to crystallize losses. At some point you would have investors running for the gates, per your example. So what would be the sort of trigger for that to actually happen.
That's the burning question on the mind of every client I talked to about. And there's different ways to analyze that, I think, because on the one hand, it's just as I described, there's some level of stresses building into these pulls, and in a way you would think that maybe just simply how the economy is evolving, it gets overtime software and weaker, and you get some impairments, there will be
some companies that will be behind in payments. On the other hand, it's about the liquidity aspect that yes, people have tied it up there. Liquidity in that vehicle and
wanted out. And so that big credit example is one example of people trying to maneuver the liquidity out and keep redeeming from it with the good news that there's all these funds are gated so you don't get a run on those funds, because that would be the normal financial trigger, right right, I have an edge on a ETF out there, and people, Okay, this is wrong, I'm pulling all my money out, and that effect on that they could have on broader markets. It's not the case
with private credit funds. But I think that what people will look at carefully as the realization that the loans that they've extended to these companies, if there are issues with fraud cases or other types of issues, that that will become a trigger of realization of hey, there's actually been some deterioration of lending standards have actually taken place, and as a result, invest started to react like they started to look at Okay, I'm going to start redeeming
more from these funds. Now there's little evidence of this curny, I think really because of the state of the economy where we are, or there's not been much report on this yet. I want to mention this because as this podcast gets out there, the private credit fundman as will listen to this. One of the complaints I had was that the vakeness of the funds is also expressing that
some of these companies very little information available. So as an investor would I would want to know, like if I put one dollar in that funds and you're going to lend that out to company XYZ that I cannot find any information on, I at least want to know
what that company is really about. So I've been kind of messaging this to different managers, but I think this is a concern expressly for other investors too, and probably is one of those where you say trigger ideas of like if it shows up more and more of like we're lending to companies that we can find little information on, that will be in concerned, right.
So yeah, and also there is clearly a tension in that, Like part of the investment case of this asset class is the idea of lenders building really strong relationships with private companies doing really good due diligence and very like customized deals. But then it's weird if none of that work actually shows up for the end investor, like if there's no way for you to actually check it out, and you're sort of buying into it on blind faith.
Almost yeah, you're buying into a bull of loans that is presented as this is a load of fault vehicle. It's very steady and it's yields and payout and therefore you don't need to worry about those nuances and details. And yet I think as a vestors, you should worry about that because you know, in the end, the money that you put into that fund gets to those companies,
and so that due diligence should really matter. And you know, you get a lot of assurances that that due diligence process is water tight and the covenants are very strict. And I have to say, but from what I've read, that's true. But we know from subprime lending, we know from other types of lending that it could not always work out that way, especially if you have an exuberance
that we're dealing with currenty. So the private credit market is in an exuberance face currenty, you know, because everybody's focused on a lot and a lot of money is being allocated to it, and a lot of nowadays mutual fun companies for example, jumping to the opportunity to coming very late in that race, and that would be to be interested to watch too, right, And how if they're starting to become private lenders, you know, what does their
lending stand practices compared to the experts in that space, say, you know, well established firm side Blackstone and KKR and Blue Owl, who have years of experience with been lending to private companies.
I guess on some level, this is every credit cycle, right, I mean in the sense that at some point people want to start lending money to people who can't pay it back, and then some people will make a lot of money doing that, and then someone will lose a lot of money doing that. Can you talk a little bit more about the leverage and the fund structure. So company X launches a private credit fund, how much is it like sort of like equity investors in that fund?
And then how much would they theoretically like borrow from some bank or someone else to like add leverage or sort of juice the fund. Like, how does that work?
Yeah, so you have to sponsor at a private equity firm. Okay, that's the main I'd say capital provider and as a fund then gets long. It literally is like, yes, they use intermediaries the fund, right, because you have ultimately, you know, the companies who borrow from that private credit fund, you
know they're facing essentially a bank. Yeah, the same idea, but the private credit fund itself has gets capital backing from a private equity firm, but still has to use intermediaries to raise the funds for in order to lend.
Right.
So now, on the other hand, it's also about I think the combination of other types of leverage. So what I've noticed was that a lot of these funds do partially invest their pull into clos I know, that's obviously where the financial leverage to an extent comes from. I found that interesting, even though it's a very small portion of it tends to be like one to two percent of the total pool. But it's it's another, i think, another source of their their leverage of funding, if you
call it. On the other hand, it's a very low leverage though I've compared to other lending vehicles that they're out there. I mean, if you talk about say the total notion of the fund is leveled one to two times max, most of them are more like one to one and.
A half, So they're not going crazy.
No, it's quite conservative. So that's I think, why are kinds of not a concern about the leverage unwind idea of what we've seen with SPVs during the financial crisis, right, some off bounce sheet vehicle fifty nine levers and it has to unwind and we get all the disaster that follows.
That I think is not so much to worry. It's more that opakness and the issue about lending to companies that although strict covenance, turned out to be issues with those companies and we didn't know about that, and therefore we're dealing with the deterioration of the pool and we have to reassess the risk. And as I mentioned, if you could tell from the change of the spreads on those loans over the past year, than there's some risk
is creeptive. So I think that's the bigger risk. But back to your original question, I think it's really the structure of having this sponsored company providing the majority of that capital, which is I think is maybe what gives a lot of clients of confidence, like you have a private equity company involved, you know, that's that's kind of like a choke hold on a particular company, right, because private equity is very keen on we want our equity.
So you're going to have to stick by these covenance that we set on these loans, and the moment that there's a change there will come in and make changes to make sure that you stay current. But there's been examples of that they actually have to take in what they call the keys of the company. They just can the company can no longer do it, and they have to take in the keys. I think that's when the online process happens and where the private equity manager then
has to just divest. And I think that's the other part of this risk of that those turning in keys becomes more problematic wider than this leverage on my So the leverage is quite low.
Is there any way to short private credit? Because well, if I think about, you know, like a corporate bond, and there are all sorts of ways, you know, primarily using derivatives, but I could short like a CDX index or something like that, or I could do you know, individual like CDs tied to that specific bond. Is there something similar for private credit?
Well, you would have to be back to the financial engineering. I think there's three ways to do it. One is to short the stock of the company itself, which is, you know, if you have shorted the stock of Blackstone, that would have not have been a good trade. It was pretty bad. There is a there's a senior loan ETF out there, that's several of them, So those are actually loans that are very similar, if not coming out of private credit funds. You could that can be short
that does. I believe even the private credit ETF in there that has invested in the different private credit funds and bundled in the ETF. So I guess that's another way of.
Shorting here VPC Right, that's the one, is you private credit?
But I believe I believe that's the one. But there's no derivatives on private credit or anything like that at this moment. But yeah, I think.
I sent an opportunity, maybe just to bring it back to the macro impact. I mean, what does it mean for the functioning of the economy and the wider financial system if we now have this pool of money that really wasn't there before, or you know, if it was there, it was in a different form, Like what does that mean for the future.
Wow. And one is positive because you know, we found an avenue to fund small mid sized companies without having banks involved in a way that you know, that could lead to more like shot prime lending and financial stresses that could ultimately end up into the negative. The detriment of those companies, those companies of the private credit markets created competition too, you know, so the regional banks are in more competition now with those funds, which lowers the
cost of funding potentially. And as I mentioned, the cost of funding, I mean currently that seems quite high if you think of you're all in yield on those loans being anywhere from eight to eleven to fifteen percent, quite high. But I think the other positive of that is, though, is that as much as that's high interest, these companies have a stable source of funding and are not dealing with any other sort of restraints other than their covenant
on that loan. So therefore they can go back to that same source and keep tapping it as long as they continue to perform and return the loans, pay off the loans, and make money as a company. So the
macro impact I think is getting more significant. I think in that sense, it would be interesting to understand better though, of the different areas where this lending is taking place, we can think of a coastal areas as usual, just like with residential mortgages, you know, because as I mentioned, the big component in these pools is technology and software. So we know that that's obviously concentrated on east and west coast bars and maybe maybe a little bit down south.
But what would be interesting is that if there's more expansion in the industrial area, manufacturing area through private credit, that would be I think meaningful in terms of the economy. So it is very much a stable source of funding. There have available credit to companies that may not be able to get that elsewhere. I think that's the macro impact.
All right, Ben, thank you so much for coming back on all thoughts and talking to us. Not bank lending this time, but an alternate form of lending.
Appreciate it.
Thank you, Tracy, Joe, it's great to be on.
Thanks for coming back, Joe.
That was really interesting. There was so much to pick
out there. One of the things I keep coming back to is this idea of like outsourcing the due diligence to a private equity company or a sponsor or something like that, and it's a bit of a cliche to reach for subprime, but Ben did mention it, and it sounds a lot like the rating agencies, right, Like you're kind of relying on an entity to do that due diligence for you, and maybe it'll work out, maybe it'll all be fine, but seems like there's a big question mark there.
Yeah, I mean it kind of makes sense to me,
just intuitively. The banks only have so much scale, right and like obviously there's only so much balance sheet that banks can allocate, you know, how much they can lend out, but there's also like going to just be a constraint on how much due diligence and how many relationships they can build, and the types of industries that the individual bankers at the banks like truly become familiar with enough to lend, and particular for smaller companies that may not
be like you know, megafeed generators or whatever. So I guess like intuitively it makes sense that we sort of see like the sort of like breakup of the bank and that more and more of the credit extension part would essentially be from individual specialist companies of various sorts.
Well, and also going back to the regulation I mean again by design.
Yeah, by design, by design exactly.
Regulators decided they didn't want banks to take so many risks in the aftermath of the two thousand and eight crisis, and so they put in restrictions on various types of lending, and a lot of that activity got squeezed to private credit, business development companies, that type of thing. So it makes some sense. And to Ben's point, if we have basically established a way for small to medium sized companies to
get stable funding. This was always a concern in the public markets, right that if you're a smaller medium sized company, you are probably not going to be issuing a massive leverage loan in the same way mega corporation can do it. So if there is an alternative, that seems like a good thing. However, I still kind of wonder about that, like cataclysmic trigger, because it seems like the incentives are
all really well aligned for the time being. So if you're the lender, you can keep blending money because you don't want to crystallize a loss and take a default, and you have that relationship with the company. But if that ever changes, Yeah, and we're talking about companies that don't have access to alternative forms of funding. You know, they can't go to a bank and get a loan. Often that's why they're knocking at private credit store.
I don't know.
No, maybe I shouldn't worry about the worst case scenario, but no.
I mean I guess the way I would just sort of like I said, and I would maybe like sort of go down the middle on this question, which is that like the worst case scenario will happen, in other words, at some point, because this is like, you know, there have been banking cycles and credit cycles and people wearing the rose colored goggles probably since the first loan was made. Yeah, none of us like really know the timing, but we definitely know that there will be some point in which
lenders basically lend to bad credits make loans. Maybe the terms are too nice, maybe the spreads are too narrow, Maybe the conditions that no big legs. I mean, we know this is a phenomenon, right, I mean, like maybe the terms in the conditions, the covenants are solid now, but it's only a matter of time before that deteriors the longer you go without defaults. This is how it's
going to work. We don't know the timing, But it just seems like no matter what the lending category, at some point, someone is going to come along and lend to bad borrowers at two favorable prices.
Well, I guess the thing to watch out for is the leverage question, like whether or not you start to see leverage bills, yeah, on private credit, at which point it would become a systemic.
Securitization allowing end investors, has been said, securitization allowing them to sort of lay on to their own credit. This will happen. It will happen. We don't know when it'll happen, eventually, because this is what humans do.
Very philosophical start to the new year. It is true, all right, I am just going to say that we are going to talk more about private credit, and we actually have a really interesting guest lined up, something we've never done before. So that ohtally yeah. Hopefully that will be out relatively soon after this one. But in the meantime, shall we leave it there.
Let's leave it there.
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.
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