Hello, Welcome to The Credit Edge, a weekly markets podcast. My name is James Crumbie. I'm a senior editor at Bloomberg. This week, we're very pleased to welcome Jim Fellows, co president and CIO of First Eagle Alternative Credit.
How are you, Jim, Good, Happy New Year.
Happy new year to you. Thanks so much for joining us today. We're very excited to have you on the show, and also delighted to welcome back our co host David Havens from Bloomberg Intelligence.
Hello, David, Hey, great to be with you on Go Eagles.
So, just to set the scene here, credit markets are hot and borrowers globally are taking advantage. We're expecting a record amount of debt issuance from the US companies this month. Most of it is for refinancing. There's a lot of debt coming due. That means even more cash returning to invest who have already received a ton of inflows over
the last year and are very keen to buy. Given how high all in yields are, you can get a yield of almost five point four percent right now on high grade debt with a very low chance of default. That's the highest in about six months the demands supply and balance, though, is keeping spreads raisor thin, and also pushing investors to other parts of credit like structured finance
and private debt, where returns are even higher. Some fear it's also leading to complacency and mispricing of risk throughout credit markets, which is only expected to get worse in twenty twenty five. So, Jim, I want to bring you in here. What's your view? Are you very bullish for this year like everyone else, or do you see reasons to be cautious right now?
I'm typically always cautious. That's that's a fault that I have. Yees, spreads are close to pre crisis tights across a lot of acid classes, loans, high yield, private credit, you know, areas that we focus on and you know, as you hit it on your opening statement, a lot of it
is dependent on just lack of activity. We do have a fairly significant maturity wall that is being worked through, the cost of capital finally going up for some of these borrowers because of you know, a lot of the debt was put in place, you know, during crisis, during posts the Great Financial Crisis, when rates were hugging zero. So you're you're going to see an increase in the cost of capital going forward. And you know, I think everyone is expecting more net new issuance from M and
A activity. I think that's a lot of that is wishful thinking. I think that there's still uncertainties globally that may subdued M and A activities, especially you know, with tariffs. I think a lot of companies may be less willing to commit to M and A give and the uncertainty of policy overall, so that that could constrain supply here
for you know, the next three to six months. Hopefully things start to loosen up as we go, you know, you know, as we move into the second half of twenty twenty five.
Does that mean even tied to credit spreads from here?
Jim, It's possible. It is entirely possible. Uh. You know, we're seeing spreads tightening, tightening across the board. As I said, our three areas of focus, probably syndicated private credit and high you bonds spreads spreads have certainly tightened considerably. Yeah.
I mean, Jim, we seem to be in a period, in a tale period in the markets. I mean, we've got the IG index down around seventy five eighty basis points, which that's territory that is probably occupied about one percent of its history. We actually have Invesco speak at a Bloomberg Intelligence Credit conference in December and New York, and their view is that that IG credit spreads could head towards fifty five basis points during the course of twenty
twenty five. Is is that of you that you might share? You know, obviously there are reasons for caution out there that you that you explained as well, but there's so many technical factors that seem to be pushing towards towards tighter markets, you know, sort of modern GDP growth, relatively contained inflation, strong employment, and just a wall of cash out there.
Yeah, I think that's entirely possible, you know, and you know, again on my our focus in the loan the non investment grade space, I think that's that's definitely going to be the case because I believe that, as I mentioned earlier, m and A activity could be subdued. I think the most M and A activity that's first going to occur will be strategy ex buying leverage finance companies and taking
net supply out of the market. Going forward, so that certainly will support spreads tightening over you know, the next six to nine months.
That's an interesting and interesting take on things.
Uh.
I haven't heard that all that much about the about the you know, sort of leverage finance companies or leverage leveraged companies being being taken out, but there's the consensus seems to be pointing towards much increased M and A just because you know, the the the the private equity firms have been sitting on a lot of cash. They need to put that money to work. They're under pressure
to put that money to uh, to work. Rates still have I don't know, one or two you know, sort of cuts in them at least that's what consensus is pointing towards this year. So so what are you going to do if if these if spreads keep on moving tighter.
Stay conservative, stay conservative. I think that's that's the mantra that we're operating under. It's uh, you know, you don't see a lot of screaming value. I think in the lower part of the direct lending space or private credit space, you're not seeing as much compression and spreads. You're seeing some of it, but not as not as dramatic as you're seeing in the more liquid parts of the market.
You know that that's an area where you know, investors can find value in an environment of tightening tightening spreads. I do feel like rates the short end of the curves are not going to move down as much. Obviously the said probably is not going to tighten as much as what people are expecting going into twenty twenty four. So I think that's that's the you know, that's kind of the curse as well. It's going to keep you know,
short rates relatively high. Therefore, more money is going to flow into the credit markets and keep spread stight, vicious circle.
But by lower and Jim, do you mean lower quality like you know triple cy or do you mean lower as in smaller size like mid market.
Lower in size of company it? So, what kind of sidement market?
When when you talk about middle market, I mean it's a term that we often hear, but it seems to be applied to all sorts of different things in different ways. What does it mean to you?
Yeah, companies that have ebit on average of twenty to fifty million dollars, so truly you know, true private privately created credit to companies that are undergoing an acquisition by a sponsor. That's typically Uh. When I say that, I mean and right now that market is either side of six percent. Uh, you know, it can't. In some cases, it's tighter for credits that are substantially less levered. So you know, you see a lot more dispersion in that
part of the marketplace. You've just given the nuances of these type of companies.
Maybe you can walk us through the process of how you go about accessing these these assets. It seems as though different different shops have different ways of approaching the market of sourcing the assets. And then who are you seeing the most competition from in that twenty five to fifty billion dollar segment.
Yeah, there's there's a number. You know, I think some of the well we'll start with some of the larger alternative credit managers. Some of them may start to come down market as as Spreads Titan up market, so you know, we may start seeing competition from the likes of you know,
the Apollos, Blackstones, et cetera. But you know, we typically are focusing on companies that are sponsored by middle market private equity companies that oftentimes it's a founder entrepreneurs selling their company to you know, monetize their life's work, and you know, they're looking to do sponsors to help effectuate
those types of transactions. We have we have a we have a we have a number of originators that are calling on sponsors looking to transact on on on on deals and we're there to help finance these type of transactions. And you know, typically, as I said, they typically have twenty five million to fifty million dollars of viva DA on average.
And is it only would you say it's mainly other direct lenders that you're coming across, or are you seeing banks beginning to get a little bit more active in that market or are they still simply discentivized by regulations from from you know, sort of lending into that single bee sort of high triple C space.
Yeah, banks have been relatively quiet over the past couple of years. We are now beginning to start seeing some
banks moving into that market and becoming more competitive. We had a situation just recently where we ended up winning because the private equity sponsor was worried about the banks being able to you know, the private equity sponsor's initial premise on buying that particular company was you It was a buy and build strategy, and they were a little concerned that the bank would not be as flexible or as dynamic and growing that capital structure along with their
strategy of buying other other tack on acquisitions for that particular company. So you know that that that is that net positive for direct lenders still that are not banks. So but you we are starting to see banks show up more often in bidding processes and.
The kind of companies you're dealing with. Jim, what size deal are we talking about here? Generally?
You know, you could you know, facility size, that quantum you know, anywhere from sixty million up to two hundred million. That's typically you know what we're seeing what we're looking at. Sometimes they're smaller if if it's really you know, you have another We see a number of situations where it's could be smaller, but the sponsor has a very direct line of sight of additional acquisitions that they're looking to make. So you know that that facility, you know, maybe thirty
million dollars, but it could grow very quickly. So you know, you do see that type of dynamic from time to time.
And when you say six percent is that the margin or is that the all in?
Yeah? That so the margin we're seeing sofur plus anywhere from sofur plus five to six percent. That's that's the range of we're seeing in the marketplace today. There's a few situations that may be slightly tighter than that. The market probably ends up going tighter to sub five, but you know, right now we're seeing solidly in the five to six percent over so range.
And obviously, you know, spread is is you know, the cost of funding. Spread is one way that you can that you can compete. There are other ways to compete also, as you as you well know, terms and conditions and things like that. So what sort of trends are you what sort of compression or pressure you know, trends are you seeing on the terms and conditions side of the equation.
Yeah, I mean there's there's you know a lot of times there's significant or an aggressive ask for a large d d t L to help fund future acquisitions. You know for some people that are TL is delayed draw term loan. So it's a term loan structured to be drawn at a later date where you have, as you know, define use of proceeds. Typically an acquisition you know, there's covenant terms tied to the ability to access that d D T L. So I mean we're we're seeing terms
hold fairly, fairly solidly. Maybe they're slipping a little bit, but nothing like you're seeing further up the market, like in the probably syndicated market or even the upper end of the middle market, where there's very little structural sport in terms included in the credit agreements.
Given little of this pressure we're talking about, you know, money coming in competition from the big guys moving down into the smaller deals and just this way of cash, do you expect some titus spreads in the middle market this year and also looser conditions was covenants, all of that stuff.
I think that's that's a safe assumption in the environment that we're currently operating.
Yes, yeah, And I guess one of the things that you know, a lot of the investors that we talked to and the folks that read our research here, I think are they're not confounded by it, But I would say that they're prized by the lack of of of credit loss, the lack of credit problems that have that have come to the forefront in private credit portfolios. I mean you had a five hundred and twenty five basis
point rate increase. You know, at the FED in twenty two to twenty three you had somewhat slower economic growth and there were hardly any significant bankruptcies or credit losses. Is that the same sort of thing that you're seeing in your portfolio? And why aren't we seeing more of that?
Well? I mean you can look at the broadly syndicated market as a guidepost, where you know, the fault rate in the broly syndicated market is approaching five percent if you include LM transactions and such, and you know, in good old fashioned defaults and bankruptcies, So you know that that you know that number is like five in the broadly syndicated market, you go down market, it's so pike, No one really knows, be perfectly honest. I you know,
I track a couple different indices. Fitch has a couple data points that they publish on in terms of some of the companies that they rate from a private standpoint. Krauscour has a database where they're monitoring default rates. So and it varies considerably. I mean, I've seen a delta as high as seven and as low as two point seven or a pool of private credit assets, depending on who's providing that data, so it varies quite a bit.
There there could be situations where you know, assets are picking and they're not quote unquote default because with lender agreed to waive the default in lieu of a pick. You know, my mind, that's technically a default. But there there there's definitely definitional challenges as you look deeper into the credit private credit market. Whereasn't it probably syndicated market, it's pretty straightforward. You know, you have a market that's
telling you what it's worth. So it's it's a little different.
Definitional challenges, I think is a pretty good way of putting it. I tracked the BDC data here at Bloomberg and that non accrule rate has remained quite low, but pick has definitely come up, and you know, below the surface, you know that there have also been a fair amount of you know, sort of extensions and amendments and things like that along the way.
Yep, yep, today's picks become tomorrow's non accruals.
Can you expand a bit on the sexes that you'd like and the sex as.
You avoid, So you know today some of the positive. Financials have some pretty good dynamics taking place. I think deregulation with the new administration should be all very positive for financial segment. You know, and in the broadly syndicated and private credit markets, we see a lot of asset managers, see a lot of you know, servicing companies that are
servicing a variety of financial institutions. We see insurance brokers, and so there's there's a breath of you know, breath of type, you know, various types of financial services companies that come to market, you know, within financial services. Right now, we're a little cautious on any financial services company that relies on float to to generate incremental ebit duh, because you know, rates are expected to come down. Maybe that's probably not as much of the challenge going forward if
rates don't come down as much as people think. So financials were positive on business services. There's a lot of activity there. It tends to be countersick cool, and you know, the one thing to watch in that sub segment today is you know a lot of outsourcing and offshoring of labor, and so you have to we have to be mindful of that. And with some of the new administrative administration's
policy as it relates to labor. So we're but we still are generally positive on business services utilities that that's a segment that we were very cautious on five five, seven years ago. Given the advent of renewables. Now abilities are starting to turn around. You're seeing power prices increase, you have demand for power as it relates to AI,
data centers, et cetera. So the wind is at their backs from a from a sector standpoint, uh and then some of the negatives, the automoti of bly chain that's under a lot of pressure. We expect that to continue be under a lot of pressure. Retail. I feel like retail has always been a no go area for a decade.
And then healthcare. Healthcare is an area that's still I think there's a lot of uncertainty as relates to healthcare, especially with some of the ACA subsidies expiring in twenty twenty five, which will increase the number of uninsured that could pressure a bad debt expense within healthcare companies. And I think the expansion of Medicaid and some of the other federal federal programs as it relates to healthcare could be under some pressure. So We're still fairly pautious on healthcare.
Healthcare actually has been you know, it's dealing with a one two punch really to some extent. They had a lot of labor issues during COVID. Now now they've seemed to put that problem behind them in terms of contract pricing and labor. But now they're facing popline issues. So that's an area where we're fairly cautious. And actually the correlate corollary to utilities renewables, you know, renewables are still are now undergoing a lot of pressure because of over expansion,
et cetera. So those are just a few of the sectors pros and cons that we're looking at today.
So in that context, Jim, where's the best value right now for you? You know, you look at all sorts of different kinds of credit products across the globe. Where's the value? Where's the relative value?
I mean, I'm a I'm a corporate credit specialist specializing in private credit, probably syndicated high yield. So don't I don't have a broad you know, fixed income acid allocation mindset. I know we have a sister organization, Napier Park. They have more of a macro broader perspective on things. But personally, I think mortgage backs are cheap relative to everything else.
That's that's me in the cheap seats. Looking at it from like a personal investment perspective, you know, I do think that the within private credit, asset based lending is a very unique area, very esoteric, and it's it's an area that you don't see a lot of competition in.
I see. I see some of the assets and opportunities in that segment as some of the best risks return out there because it's very short in duration, very high returns, you know, but it has to be structured very carefully, and you know, we have a team that does that. It's it's some I think it's some of the best I just said some of the best risks risk adjust to return out there in my world that I look at.
When we talk about asset based lending, I think it might mean you know different things to different people. So from your perspective, when you talk about asset based lending, what are you what are you really looking at?
We're looking at companies that are undergoing a need for situational capital either either on a good perspective. They're looking to expand they have assets that they incrementally can pledge to lenders or a short period of time, and or companies that are actually experiencing specific liquidity issues and they may have some incremental assets that they can get financying on to bridge them through either a bankruptcy or to a turnaround. And you know, we underwrite to a liquidation
like an actual liquidation. So it's a it's a very specific type of underwriting process. Uh and you know, every you know, every situation could be different. We had a I can't really get into specifics, but you know, we had a uh an investment in that space recently that it was a brand that was tied into an entity that was in bankruptcy. We helped person who was behind that brand finance the acquisition of that brand out of bankruptcy. We were paid very well to do that. You know.
Unfortunately that you know, it was a nine month loan. I wish, I wish it would have stayed out for three years, five years, thirty years. But those are the type of situations we get involved in in it. And as I said, it's a very episodic type of opportunity set and there's not a lot of competition. That's another good thing about that part of the market that we find attractive is, you know, on on our our core middle market lower middle market direct lending strategy, you know,
we're peating. We're competing with ten to twenty different lenders at any given time, depending on the situation. Here, it's like five people. So it's it's it's a it's a much different universe of h of institutions that we're competing against.
It sounds like it's a very labor intensive business and quite hard to scale. But what kind of returns are you seeing, le Jim.
We're seeing so fur plus six, the so for plus nine, a lot of a lot of you know, incremental fees associated with these type of transactions. And you know it's uh, you're you're well protected because of the structure and the you know, the I mean, these are these are the most they're probably the most aggressive straight jackets out there from a structural standpoint. H It's a it's a very very specific type of deal.
Right Yeah. And this this whole asset based lending space seems to be you know, sort of exploding in a good way, exploding growth wise. Again, You've got you know, sort of the largest alternative managers, Apollo and Blackstone, talking about forty trillion dollar addressable markets. It includes the investment grade space. Now, are you looking at some of these, you know, sort of investment grade deals as well? Are you partnering up with some of these other firms on these these transactions.
That's not really our mandate from our clients. Napier Park our affiliate, they do some of that type of those type of transactions. But you know, I think I think
people when I say ABL, I'm saying asset based lending. Right, the investment grade is asset backed, So different do you have structurally it's a lot more commoditized structure is the structure, you know, whether it's aircraft or consumer receivables or what have you, whereas ours it's every the B is different, The B is bespoke, it's not commoditized as in asset backed deals. So's it varies widely?
Yeah, yeah, but yeah, but we we are seeing, you know, sort of the these larger companies getting involved in more of these base or backed transactions. Some of them are spoken, some.
Of them are telling us that they're not seeing the value in moving from public markets where there's liquidity to private markets where there's no transparency, no liquidity, no, you know, visibility, all the things we've discussed, do you do you I mean the kind of deals you're doing different. It seems like there is still a pick up between broady syndicated and private deals.
Yeah, there there is pick up. There is pick up. You know, it's just you know, it's a different process. It's a lot more labor intensive. Yeah. You think about some of the larger competitors. I mean, they've gotten large and their business models have had to adapt being larger. You know, I would love to be able to put a billion dollar private credit deal out there and get paid fees up front and put you know, that kind of capital to work very quickly. That's not what we do.
You know, the larger players, that's how they do it. And once you get to that level. As a quote unquote private credit deal, I mean, it's not any different than a broadly syndicated deal except for maybe you know, marginally, but it's much better from a business model standpoint.
The question I'd like to ask Jim is what's your edge? It sounds like your edge is just you know, flying below the radar and staying with the smaller area sort of tougher deals to do others aren't doing. Is that is that their their way of putting it.
I mean, I wouldn't say their harrier. I would just say they're more labor intensive because you have to do proper diligence on these transactions, you know. I mean, in some ways I like the risk of the lower middle market because you know, if I'm entrepreneur X who started his or her business in you know, nineteen seventy five, and it has thirty twenty million dollars eve it done, and I sold it to a private equity sponsor for four one hundred and fifty million dollars, I'm going to
finance it with eighty million dollars a debt. In some ways, having private equity involved helps professionalize the business, you know, and private equity, especially at that level, they're not looking to financially engineer that capital structure. They just want certainty of execution, the lender who understands their business and helps them through the diligence process. So I think that's kind of that is our edge from from a drugt lending perspective,
though I wouldn't say they're harrier deals. They're just newer to operating with leverage leverage capital strug.
Maybe we can now just pivot for a moment. We just have a few minutes left, but maybe we can pivot to your your own fundraising and where you're seeing, you know, sort of flows coming in from. Has there been a change in terms of of you know, sort of where you're seeing the uh, the customer flows coming to you and and maybe changes in customer allocations as well with more of an a sort of alternative bent to them.
Sure, I mean you know that that you know, five years ago we were purchased by Firstegal Investment Management with the idea of bringing private credit products to the retail distribution platform that they have. So we we have existing fund that's been up and running for over four years that's around a billion dollars. So that that that is a blended product that has private credit as well as probably syndicated assets as part of the asset base an
interval structure. We also have another product that's I can't I'm not sure what I can say or cannot say, but we'll be launched relatively soon that does it's more private oriented. So we're seeing more more demand coming out of retail side of the equation. I think that's true
for the industry. I think I was reading where there is a forty percent increase of capital allocated by retail into alternative and private credit products twenty twenty four, So you know, I think that's that's where we're seeing flows that we're seeing demand Institutionally, I think a lot of institutions are they would like to allocate more to private equity. I'm sorry, private credit, I misspoke here. They would like to allocate more to private credit. However, it's dependent on
what happens to their private equity book. They start getting realizations in the private equity side of their portfolios, they will look to allocate to private credit. So I've heard that from a number of different consultants and LPs UH and a lot of it is dependent on getting some realizations on the private equity side of their portfolios.
Last question, Jim, when you look at the markets that you're directly covering, is there something you're particularly contrarian on that you think that you're doing differently the others aren't, or you think the others are missing that that you know you've you've got an edge on.
I don't really think. I think we stick to our knitting. You know, we we don't deviate from our strategy. I mean, if if anything, we would like to go maybe further up market at some point when we see value there and we have the ability to force in that part of the market. But I don't know if that's really contrariant, uh so to speak. Uh, I do believe asset based lending is contraying in itself. You're lending into very situation oriented type of deals that a lot can happen, but
structure it properly, your returns will be good. So maybe that's a little bit more contrarian, so to speak. But you know, first Eagle is a value oriented investment shop in general. Uh I wish I wish credit was more value oriented, where you can be in cash and uh have the luxury of being in cash in a portfolio. But that that doesn't work because you know, these markets do get fickle, uh during times of volatility, and again
we haven't seen volatility for some time. Yeah, maybe we'll, we'll, but we we always operate our funds with a degree of of dry powder to the extent that we can have it. Uh. Present in port fully to take advantage of opportunities. We did that in twenty twenty two in our interval fun you know, so we do our best to create those options for us in the future.
With that in mind, with the potential for volatility in twenty twenty five, let me ask you both. Do you expect private markets private credit markets specifically to be the hot thing for twenty twenty five or do you think there'll be some blow up that turns people away. I'll start with you, David.
Well, if you just look at what the consensus is saying, the the odds are that there's not going to be a blow up. So it's a you know, there are a lot of buses out there. I think that we see those buses is just the one that we can't see that we got to watch out for.
Jim. Private credit for twenty twenty five still, Hut.
You know, I don't see a blow up, but you know, I think the blow up, if it does occur, is no. I think that the there's a lot of financing that goes into the private credit markets from banks. That's how they compete. And I think I feel like if banks start to brain in their their risk appetite in terms of lending to private credit managers, private credit funds that
could really start to blow down the enthusiasm. I don't know if that creates a blow up, Uh when when acids aren't valued as frequently as they are in the probably syndicated market, you know, it's probably it's it's more of a slow death as opposed to a blow up. That's how I would look at it. Sorry to have such a morbid analogy, but you know, the the you know, liquidity is good and it's a great discipline that have a market that you have to respect and look at
on a daily basis. Private credit really doesn't have to do that, so that probably lends for less of a blow up type of scenario. I think it would be on the financing side or some of these products that have liquidity provided to investors. How what if there is a you know, we didn't even get into the ETFs for private credit, which is being spoken about right now. Yeah,
maybe that works, Maybe it doesn't. I don't know. I do know people who bandage probably syndicated loans in ETF rappers, and they'd love it because they don't they rarely have to touch their portfolio because all the liquidity happens outside of the portfolio, so maybe that happens in private credit. But I think that's that seems like that's pretty out there the ETF for private credit. That's that's good luck.
Yeah, the liquidity did is and quite match up, does it?
We shall now great stuff. Jim Fellow's co president and CEO of First Eagle Alternative Credit. It's been a pleasure having you on the Credit Edge. Many thanks, thank you, thank you very much, and of course we're very grateful to David Havens from Bloomberg AND's eligence. Thanks so much for joining us today.
A terrific being with you both and all of you.
And for more credit market analysis and insight, read all of David Havens's great work on the Bloomberg terminal. Bloomberg Intelligence is part of our research department, with five hundred analysts and strategists working across all markets. Coverage includes over two thousand equities and credits and outlooks on more than ninety industries and one hundred market industries, currencies and commodities. Please do subscribe to the Credit Edge wherever you get
your podcasts. We're on Apple, Spotify and all other good podcast providers, including the Bloomberg Terminal at b pod Go, give us a review, tell your friends, or email me directly at Jcromby eight at Bloomberg dot net. I'm James Cromby. It's been a pleasure having you join us again. Next week on the Credit Edge,