Hello, and welcome to The Credit Edge, a weekly markets podcast. My name is James Crombie. I'm a senior editor at Bloomberg. This week, we're very pleased to welcome TJ Durkin, head of structured credit and Specialty Finance at TPG. Angelo Gordon, How are you, Tj?
Very well, Thank you for having me.
Thank you so much for joining us, say, very excited to have you on the show. Also delighted to welcome back co host David Havens from Bloomberg Intelligence.
Hello, David, Hey, great to be with you all.
Also joining us with the questions from Bloomberg News, Carmen Arroyo. Great to see you, Carmen. How's it going?
Thank you for having me, James.
So, just to set the scene a little bit here, structure credit markets are booming as rates for the economy grows and asset backed securities look relatively cheap compared to other parts of fixed income. We've seen huge volumes of asset back deal including clos this year, and there's more to come in twenty twenty five. Private debt has also
experienced a meteoric rise. It's now a one point six trillion market, but it could well be worth tens of trillions of dollars more when you wrap in asset based finance, very tight credit spreads, tons of issuance, and rising fund inflows. That doesn't mean that there's no risk out there. The FED started to cut rates, but yields remain high, and the stated aims of the next government all sound quite inflationary,
signaling a period of higher for longer debt costs. That's going to hurt borrowers across the board, especially the weak ones. We're also seeing signs of private credit stress in the form of amendments, extensions and increasing number of loans being repaid with more debt, plus a rise into faults. In the background, we have a lot of geopolitical risk, which will only get worse as the Trump trade wars continue. Plus the threat of recession hasn't gone away entirely. A
major downturn would cause more distress in credit markets. So TJ, let's start with you. I'm interested in your views on structured finance. To start with you, you've been doing that for a long time. Why the boom this year?
Yeah, Well, listen, I think the main street economy, if you will, is still doing quite well. Public market spreads have certainly recovered from the wides of twenty twenty two, and you know that's usually a healthy environment for issue and so you've got a healthy economy, cooperative spreads, and capital looking for other places to go other than corporate credit.
So record issuance volumes this year, does it continue next year? And what sustains it?
Well, again, I think it's that same theme. So can it be sustained? I think absolutely. I think when you have healthy capital markets, you see the emergence of either newer issuers or newer products that maybe haven't been funded via the abs markets, and that's really the time to come to market. And so, you know, provided sort of the rest of the financial markets macroeconomic things stay in tune with where we are, I would expect heavy issuance to continue.
You mentioned something that was interesting, which was like newer issuers, newer type of products. We've seen also a rice on esoterics this year. Is that new or are we going to continue to see that? And by that I mean like music royalties, like art bonds, like really weird stuff.
Well, listen, I think some of the more niche products are probably still living in the private markets, whereas some of the more mainstream, if you will, products of today that weren't of yesterday. At things like data centers right or fiber to home. Those are probably more scalable assets that it makes sense to do the work to get
public market funding because it's repeatable. And so I think there's a bifurcation between the very esoteric versus what might have been esoteric five years ago versus maybe becoming more mainstream today.
And data centers are part of it, and I think that's AI related chips, all that world.
Yeah, I mean that's clearly the probably most talked about theme in the market.
You mentioned also like how a lot of this is going to the private markets. Can you talk us through a little bit of what you're seeing in private credit where that asset class is kind of growing or where is it going to?
Yeah, So I think most people know private credit as direct lending right sponsoring sponsor backed private equity companies funding those purchases. I think that's where most investors got their toe hold in private credit. What's been happening under the surface is really the private assetbect finance space where I live, and that's been really slowly happening under the surface for a decade plus, right, there's been this natural evolution of
what I'll call that the main street economy. So I think auto loans, real estate finance that were primarily traditionally funded by banks, depositories, the specialty finance universe has slowly been gaining market share, right, And that's just been how happening very organically, and that's where we have traditionally deployed private credit in the asset based space. We're either lending to those specially financed companies or we're buying their production.
And then you had twenty twenty three happen, right, And I think that was the big wake up call of investors primarily saying, like, what's happening over there? Is there an opportunity for me to deploy capital and make good returns.
And that's what got everyone's attention, right, And so this is something that's been happening, but certainly the events of March twenty twenty three created a lot more interest that we've seen, you know, going on eighteen months now, and we think that this is structural and we're in the early ennings of it.
So those events in March twenty twenty three were the failure of some of the US regional banks. Credit Swiss imploded at that time as well. So it was an interesting time and it created a lot of opportunity. That vacuum seemed to have been filled pretty quickly in the in the market, just in in terms of the lack
of volatility that we're seeing this year. But I'm curious where you're seeing the greatest opportunity right now, Like, what is when you throw your remit out into this sort of giant asset backed area, what's most interesting and how is that evolving?
Well, I think what people thought was going to happen and coming out of March twenty twenty three was there, It's going to be a lot of asset sales, forced asset sales out of the regional banks. And to your point, there was some government intervention, the balance sheets were sort of short up, if you will, pretty quickly, and the
volatility dissipated. And so if you fast forward today, we've seen maybe less than two handfuls of what I would call big forced asset sales coming out of the banks, and those have been I would say, very well attended. I think where we're seeing opportunity is lending to those on bank originators as they're scaling their business and taking
market share. We think the risk adjusted returns there are just much better because there's less competition than fighting over assets coming out of the bank balance sheets.
Yeah, what why aren't the banks chasing this market?
Well, I mean I think of I buyfrecate the banks into two groups. You've got like the top fifteen that control pretty much the same amount of assets as the next four thousand, Right, So you've got the g SIPs if you will, that I think are optimizing capital, and then you've got the regional banks that are not deploying capital. So you know that's where there's opportunity in filling that gap again in the main street economy. So if you look at the regional bank balance sheets, you know eighty
percent of that balance sheet is non corporate credit. It's these asset classes that my team and I focus on, and so with the healthy economy, there's a need for non bank capital to help bolster that origination.
What kind of assets we're talking about here? Is it consumer loans? Is it car loans? Is it credit cards? What sort of deals?
Yeah, I think it's everything from from the consumer oriented products to real estate related products, whether it's you know, commercial or residential, down to more hard assets like equipment finance.
And that's all in good shape. I mean, the consumer at the lower end is not doing well. There's this perception in you know, direct lending as you call it, that you know, the weaker credits need to go private because you know that they don't really have the public option. Is it the same in the asset based markets, that you know, the weaker borrowers need to go to the asset based private markets.
I don't know that to be the case. I think I think there's there's different things to sort of unpack there.
I think, you know, the the weaker consumer demographic is certainly feeling the pain of inflation more a large part of that segment is actually not really even in the financial market, so sort of live paycheck to paycheck, you're not seeing that necessarily in terms of delinquencies and the like that you would see in auto finance as an example, we're definitely seeing i would say deviation in performance between different sponsors or different origination companies, and so that's where
you really need to do the work. It's not a sort of beta trade, if you will, of auto finance is interesting, let's go all in. You have to really be discerning and who you're partnering with because as the economy starts to season more and you're seeing deviation between channels, that's really where you need somebody that's been in the space long enough to be able to tease that out during the underwriting and underwriting phase.
So the growth of facet based finance is directly linked to what banks are doing, as you were saying, and as you mentioned, like last year we saw a lot of like asset sales, and this year we've seen a lot of like forward flow agreements and thanks kind of like pursuing more like synthetic risk transfers or bonds that help them kind of like strengthen their balance sheet. What do you expect to see next year?
Yeah, no, I think things are are moving in concert. And so like if you if you break those two
themes up right, there's there's CRT and SRT. I think what's being miscategorized is that that's an asset class that's really just a risk mechanism, no different than selling the loans or doing a securitization, right, So it's a different it's a different transaction mechanism, and so what we're focused on is staying very disciplined on making sure the CRT or SRT opportunities that we're looking at are core to
our expertise. My team, for example, is not going to wander into looking at a CRT transaction off corporate revolvers. That's that's not our DNA, that's not where we have an edge. And so I think what you've seen this year has been a lot of leverage finance type opportunities and CRT. I think as the big banks move through that pipeline, as we cross into twenty twenty five, we're hopeful that we will get to our asset classes of consumer finance or real estate related and so I think
that's more on the come. With regards to forward flows, that's really a technology or a concept that especially finance companies have used for a long time that now the regional banks are starting to utilize. And if you think about a regional bank, it's really just a consortium of origination platforms, right.
And so the.
Sophisticated ones, the sophisticated banks are saying, we keep reading about all this private credit capital formation, We've got the clients we've got the plumbing. We might not have the right type of capital anymore or the right quantum of capital anymore, but it seems like there's a marriage to be made. And so you're seeing it again and maybe start maybe with corporate credit, and I think it will continue to move into asset based I.
Mean, just in the sort of interplay between the so called asset back securities market and the asset based finance market. Some people think of these as you know, almost interchangeable, that one is private and illiquid and the other is public, you know, and traded. Is that the correct way of looking at it? Does and does one shift to the other as we get all this private deck growth.
Well, I think they're linked right in the sense of there is not public ABS creation without some form of private capital being ahead of that in terms of a warehouse financing or other types of aggregation vehicles to get to that critical mass where you can issue an ABS securitation. No one does twenty million dollar ABS steals. They do five hundred million dollar ABS steals, And so private capital is on that sort of value chain or conveyor belt
before you get to the public ABS markets. And I think what you're seeing too is especialty finance companies are looking to diversify their their funding sources, and so when you have public markets really fall out of bed like they did in twenty twenty two, maybe solely relying on that for one hundred percent of your financing is not
a good business strategy. And so you know, two years later, we're seeing more openness of saying we should have thirty percent of our origination funded privately or via forward flow, and the other seventy can go to the public abs markets or whatever. That right ratio is that necessarily wasn't in the mindset of CFOs or CEOs, especially finance companies prior to twenty twenty two.
But when we talk about the esset based finance market coming into the tens of trillions, I mean Apoul's talking about forty trillion, Blacksman is talking about thirty trillion. Is that basically just taking all of the public abs market and putting it into the private market.
Well, it's a combination of the public markets and then how much leaves the bank balance sheets, right, So it's a combination of those two.
Okay, but you're outbeating the bushes with these sort of smaller well, a wide array of producers, but you're not solely focused and some of the large producers, like the public market is. You're looking at at sort of small producers, finance companies, specialty finance companies, captive finance companies, that sort of thing.
Yeah, but again, even routine repeat abs or shares need that bridge capital, that warehouse capital in our in our vocabulary to scale to get to those critical masses. And so what we offer them is effectively revolver. So they'll originate those auto loans, get to that critical mass, the issue of the abs, they pay us down.
And they start all over again.
And so more mature scale companies may do four issuances a year, and so we'll according up and down four times. A less scale company may do that once a year, right, And so we're providing that capital to get them to what their end state desire is, which is public abs, which should be a cheaper cost of funding.
So you're looking at a wide array of the economy, a wide array of asset classes, you know, sort of in that asset backed area. Commercial real estate is an area that's been a hot button, particularly the office segment, maybe not other areas to the same extent. So I think a lot if you look at the public markets, you look at where spreads are, it seems to be all rainbows and unicorns. Are you seeing rainbows and unicorns or are there a few black clouds out there as well?
Well?
I would say one observation that we have is that in general, risk seems to be priced in a pretty tight cluster. That's one thing that the team and I are very wary of, right in terms of what we like to say, in the public markets, their credit curve is very flat, and you're seeing that in terms of sort of private market pricing.
As well, spread compression, spread.
Compression, and quality isn't necessarily being rewarded, or certainly dangerous situations aren't being priced appropriately with regards to office and SIRI. I mean, ironically, I would tell you in the public markets, I think CNBS is probably the most interesting asset class
because there's a lot of price disparity and discrepancy. I think there's a lot of historic holders who are sort of risk off at any level, just maybe based on what else is in their portfolio and legacy asset management issues, and so coming in with fresh capital and opportunistic lens. I think that's the most interesting space that we're seeing in the public market.
Yeah, I mean that CIRA space seems to be, or the office areas is an interesting area because it really is a situation where location, location, location matters, and you really need to know the specifics of the asset itself, because you know, you can have one building next to one another, you know, across the street on Park Avenue or something or Broadway, and one is underwater and one is going gangbusters just because they've got the right rent
roles and the right you know, amenities, facilities and things like that.
No, we agree.
I mean that's why you know, granular analysis is necessary. I mean, and there's a huge focus on what we call the saasby space, a single acset, single borrower where you can do that kind of private equity type underwrite even though it's a debt instrument. And I think that's where we've spent a lot of time over the last couple of years as it's been again a fertile hunting
ground for I would say performing but discounted securities. I think the CMBs space where we see opportunity is not in terms of credit risk, where we can stay at the top of the capital structure. We've been seeing. The risk is the duration risk, meaning the loan may have a legal maturity of three years including all its extensions, but in reality, if the sponsor's paying that special service,
is probably going to grant another extension. And so the market is trying to guess what's the duration of the cash flow, not necessarily the credit worthiness of it at the triple A level or the double A level.
So another concern in the commercial real estate market was at least last year, was how many of these loans are in banks balance sheets? And we haven't really seen any stressed asset sales on CRE especially in office. When is that going to happen? Is it going to take years?
Or I mean, if you go back to twenty twenty three, right, you've seen, I say, a very accommodative regulatory regime when it comes to the banks and their balance sheets and the capital ratios.
Right.
I remember we used to come in every morning and we get a new research reports, you know, sorted by percent office, percent non performing percent of their Tier one capital, and like that's obviously not been the case for late So it feels to me like there's this long play going on that there's an organic way for them to sort of de risk out of it versus a rip the band aid approach that people honestly may have been
hoping for in terms of distressed asset sales. Sitting in our seat, maybe we can just switch gears a little bit. As you may know, there was an election in this country just to few weeks ago. When when you all came in on Wednesday or later that week after the election, what sort of conversations did you have? How does it change your strategy?
What?
What?
How do you see the market changing, the opportunities, the risks changing as the new administration comes in with some of the some of the policies that they're talking about, and some of the people coming into that might be coming into the cabinet.
Well, I think, just from a regime perspective, I think the FTC loosening of M and A is good for what we're looking at, which is the banks. Right, there's clearly too many banks in this country. You get a more relaxed M and A environment that should help both solve the problems of their their balance sheets and their capital ratios. But probably more exciting for US is and
I've seen this throughout my career. As good markets are bad, bank M and A almost always creates asset sales, and so that to us might be the catalyst versus stressed markets of twenty twenty three sort of you know, productive mergers but still creating asset sales.
So that's what's exciting to us. I think.
The rest of it is not. I think a lot of the other policies you ran on not necessarily to affect this market, right right.
Interested in what you said earlier bills about some dangers of potentially you know, risk isn't being priced. We're seeing that a lot in the public markets across the bulge and triple c's to you know, double B bonds. What are you saying in structed markets? That stands out.
Again, I think as you get into certain spaces, the auto space as an example, or the consumer finance space, there's a lot of different origination platforms and that performance tiering is becoming more and more prevalent, but the pricing on those assets or those securities does not reflect it, right, And we've been very surprised that they're sort of has not been a rerating, if you will, some of the lower tier originators versus the upper tier.
So you're talking about the maybe some of the subprime and non prime borrowers used car markets things exactly.
And you know, even if you look at the non prime auto space, there's some originators that are performing as they normally have, right they've had they had good control on their credit. Maybe some of the smaller, newer or faster growing company has lost a little control on that. But yet the asset pricing, if you were to look in the public markets, the triple B bonds, they don't really price that differently, and we don't see the rationale
behind that. So we're being patient, and that's not a space where we're overly active on price compression.
It's interesting what you were saying is especially and I'm going to use this example but feel free to change. But in this as our team market, we've seen some of those bonds kind of priced really really really tight, and still we are seeing a lot of buyers coming in and you know, willing to take on that risk for maybe like not that much like you know, payment or like you know, pricing. How tight does it have to get for buyside to stop deploying so much?
Well, I think I think that space, the the SRT and the CRT space is interesting because you're in the early innings of of what I think will be a continued wave of issuance, and it doesn't fit the natural
buyer base of credit risk. Meaning if you think about rated abs bonds or corporate credit securities that are going into daily liquidity bond funds or ETFs, they these instruments are a bit more liquid, they might not have a rating despite the fact that on an underwriting perspective it's really good risk, right, it just doesn't It doesn't take the box of traditional issuance.
And so.
I think that's why buyers are still interested in the space despite it tightening from you know, twelve months ago, because on a relative value, it's off and compelling returns. So I think there's probably still room to run.
Actually, what about other parts of structure though, TJ. You know, you've heard the whole year people saying structure products are great, we have to start buying more of them because you know, investment grade bonds just got so tight and everything's so expensive in the other markets. Does that continue? Is there's still that kind of gap between the two in terms of prising and you've got all this new money piling in. You know, there's just a ton of bid for fixing
come across the board. Everyone wants yield at this point. Does that gap between the two markets get.
Squashed Historically No, Historically the asset based space always has a little bit of a spread premium to the corporate space. I don't see that, you know, inverting anytime soon. But with that being said, I think there's plenty of issuance
to sort of sort through. I think again, we actually probably think the top of the capital structure is more compelling than the bottom, kind of going back to that comment on the credit card being flat and so, you know, a flexible capital we're able to kind of dial up or down the credit risk and wait for better opportunities maybe at the bottom of the capital structure.
I have a question on the lpiece. We've kind of like heard all year how limited partners were asking money managers to go a little bit more into esoterics or into asset based finance because they were already like kind of like very like very present or write and direct lending. What are the LPs asking now where do they want to go? Like do they want to buy more infraud. Do they what are they interested in?
Well, I think they're looking for diversification, right, They're looking for diversification because they might feel over exposed to corporate credit. They're looking for diversification because there's sort of tearing going on with pick or LME and when you think about the premise of asset base, some of that just can't happen, right, My SPV can't be stripped of the assets, and so
I think there's appealing aspects of private abs. The duration profiles generally are different, right, we're generally looking at two to three year duration profiles. There's a lot of amorization, there's a lot of cash flow, it's d risking in nature versus five year bullet maturities. So I think you
add all that up, it's compelling. I think there's still a huge education process going on, and so there's certainly been some first movers, but we're spending a lot of time with LPs are really across the globe and sort of helping them understand how the US asset based finance sector is emerging. And then it kind of trickles out across the globe in different ways.
Are there various classes of buyers that are sort of emerging. Is it family offices, is it insurance companies who've been involved for years. You know, banks have obviously been involved, sovereign wealth funds.
Yeah, I think everyone's got a different need, right, So going to insurance as an example, we spend a lot of time with large insurance companies that have a public market presence, right, So they're interacting with the cell side every day on ig parts of the capital structure, but they maybe haven't built out the team in a way that can source the private side, so source underwrite asset matters the private side, and so those have been great
partnerships to develop. I think the you know, the sovereigns or the pensions are looking for more absolute return and just really kind of a brute force comparison to what they're seeing in direct lending, just as sort of the natural comp And then I think it's probably an even more complicated story to explain to retail, So they're probably
last on the journey of maybe getting exposure holistically. But I think everyone generally, after a few meetings, feels under exposed to the asset class when you think about it in comparison to the size of the economy, people are generally under allocated.
So if we're talking you know, sort of top of the stack, like a triple A security, like what sort of a risk dreamium. You know, does the private ABS deliver versus a public ABS?
Just generically yeah, So I mean I think the private ABS market doesn't get tranched as much as the public So I would think of it as sort of IG and non IG risk. We on both sides of that coin generally see double the spread of the public market equivalent.
And that's derived from really three things. One is the liquidity, right, so it can't go into some of the homes that public securities go, the ETFs, the bond funds, I would say, the human complexity of sourcing underwriting it right, you have to put the docks together versus by the syndicated bond, so you've got to build that infrastructure on the sourcing side. And then third is the operational complexity. It's very different than direct lending and the fund and it's a horrible
at maturity in five years. Generally, what we're doing is revolving facilities. We're funding our borrow or twice weekly, we're checking the covenants, ability criteria, the borrowing base, and so you need to build up that operational capability, and so for all that put together, you get roughly double the public market equivalent across the cycle.
So in the past couple of years, we've been talking a lot about the rise of insurance, which is what you were mentioning earlier, and most people kind of mentioned always Apollo and the Theme and other like insurance tie ups that we've been seeing with asset managers, like Blackstone has its own, and like all the large asset managers do.
What should we expect for like the next twelve months, Are we going to continue to see like asset managers chase those tie ups or is that kind of like played out already.
No, I don't.
I don't think anyone's chasing. I think insurance companies would probably say they're overweight to corporate credit as well. I think they see the risk adjusted returns are compelling in the asset base base. I think they're trying to figure out how to access it, and so I don't think we're near the end of that journey. I think they'll continue to be partnerships, whether they're exclusive or not be formed.
I mean, we I spend a lot of time personally with insurance companies and helping them understand our platform and how we can compliment what they're maybe doing internally, and that's where they're looking to, I would say, expand the balance sheet on the private side of the ABS side.
Also, like I have another question on this. Basically, it's very We've seen a lot of asset managers when they want to grow in acid based finance, they go out and kind of like buy a shop instead of building one out, and we've seen a few of this in
many transactions this year. Do you have any shops in mind that do you think like now we're going to have to they're going to have to go out and buy another asset manager, or we're gonna they're going to be hiring, or how competitive is it getting in that space?
Well, I think we were just on the other side of a transaction, right, So you know, I'm happy to say we're a year into the TPG transaction, and so I recall some of their line of questioning when we were we were going through through diligence. So it's a space that it takes a long time to penetrate, and so I can understand why people are buying it versus building it. If you want access to that exposure, organic is going to take you a while. So I see
the the rationale. I can't comment really on what other people are thinking, but but I mean we we obviously saw a firsthand in terms of our transaction with TPG.
Yeah, you you you invoke the the TPG transaction. It it did happen a year ago. TPG has you know, been a pretty significant force across the market, as as is Angela Gordon over the years, and it definitely seems like a complementary fit between the two. I'm sort of interested in what uh what new tools uh TPG may bring to your toolkit that you didn't have prior to the transaction.
Yeah.
I mean they have subject matter expert teas in very deeply in certain spaces, and so the one that probably is most relevant to my business is in the climate space, right, and so they've got a tremendous franchise and their private equity business called Rise Climate, and so a lot of that infrastructure or even consumer type products actually gets funded
in the debt market, and you know, tangentially with ABS. So, I mean the easiest example is RESI Solar, right, Like that's kind of the most generic one I can point to. But as things continue to emerge, the fact that our investment team on my side can now tap into that really subject matter expertise on the technology, on the competitive landscape, that's where that's where we've been spending time.
Now.
It's interesting bringing up residential solar because and this sort of gets back to the change in administrations. The incoming administration, I don't know, it just seems like it might be a little less interested in supporting climate change and understand it. There's a there's you know, fairly significant amount of government financial backing that goes into that into that segment. Is that the sort of thing where you might see change over the next four years.
Yeah, I mean, listen, there can definitely be change with anything that has tax credits or sort of other you know, softer, harder regulatory aspects. I mean, I think if people still want, you know, solar power, a lot of that is quite honestly made in the Red States, right in terms of where the jobs are, and so I'd be surprised if it's as blunt force as as maybe the rhetoric is. So I don't think we're particularly worried about that, but we'll see how this plays out.
I think that's what you were saying TJ about talking to the insurance companies and other new types of investors about this asset class. How do you talk to them about valuing the assets over time and monitoring for stress and you know, any particular words on liquidity. I mean, do you just tell them you can't try it, you go to stuck with it for the next seven years and just hold on to it and be happy.
Well, no, I think people are looking to take advantage of the illiquidity premiums, right So. I think most investors are going into that eyes wide open. It's not being misallocated, if you will, into a liquid vehicle, right so, especially
the insurance companies, as you mentioned. So, I mean, the fact of the matter is is most of these asset classes have been around for decades and decades, and there's a tremendous amount of performance history to effectively when you're underwriting the initial transaction as well as sort of doing your asset management work, understanding where.
The trajectory of the performance is going.
It's not a surprise if you will like where things are today, whether you think they're trending twelve months from now.
We shouldn't be.
That far off based on all the tools we have available to us. And that's really where sort of the infrastructure, the asset management, the analytics come in. And that goes back to why we have not seen a tremendous amount of competition because you need to build us and it costs a lot of money, it takes a lot of time, and there's a little bit of an incumbency bias to this business versus maybe some other products that are more easily accessible.
So is it safer than in relative terms than direct lending?
I think the risks are different, right, I think the risks are different. We talked about duration, we talked about the cash flow profile, we talked about having the assets secured. The downside, maybe there's probably more direct lenders than there are sypacks finance providers, So in terms of thinking about their refinancing risk, you might say that it's better opportunity in the direct lending space. But from our seat, when we look at our borrowers or counterparts, we have a
very high recapture rate on those financings. Right, there's less competition if both sides are happy there's a high switching costs versus direct lending. Meaning we've got the SPV setup, we've got the trustees in place, we've got the borrowing base, we've got the legal docs. If it's working for both counterparties, we generally see pretty hybrid nual rates.
We should also be able to cut stamize things for the buyers as well, right, more so than you know, sort of just direct lending would.
Yeah, correct, I mean it's it's still highly covenanted, right, Like it's different than direct lending, where I think it's a multiple and a and a spread function largely driving. And I think it's about eligibility criteria, it's about flexibility. Those are things that are important to these specialty finance companies much more so than just what's the raw spread?
Right? How big is the investable opportunity?
Yeah, the million dollar question. Listen, I think we can we can easily kind of get to a seven potentially in a dollar market. I know there's numbers flying around multiples of that. Yeah, regardless, it's a giant, gigantic opportunity. And you know, we're very busy, right to say the least.
Because the forty trillion number that other estimates just throughout what also including infrastructure, energy like other asse of classes.
Right, Yeah, I mean we always say private credit is very loosely defined, So I mean you can you can add a whole bunch of ingredients and get to a bigger number.
You've told about more beage finance and also equipment finance offline. Can you talk about a bit more about the opportunity then, Well.
I mean, equipment finance is a space that's kind of core to again, kind of the main street economy.
Right.
It's been a space that has been dominated by the regional banks, and so even an interested investor from the private credit side has had a very hard time accessing it.
That changed in twenty twenty three, and so we've spent the last twelve months or so really you know, interviewing counterparties, whether they be banks or non bank originators, and figuring out how to plug that gap where that borrow or that finance, that that financing need was traditionally going to regional bank one two three, They can't fulfill that anymore.
The business is still good, the equipment is still the equipment, and so that's a space that we think is in the very kind of early intings of transitioning into more of a stable private credit subsector. On mortgage finance, that is a space where the interest rate move has had a profound effect on volumes and how the consumer or
the borrower utilizes it. And so you know, you sit here today and the US is unique and with this thirty year fixed rate mortgage product where borrowers have effectively locked in their lowest the lowest rate they can get on their largest obligation. And that's a good thing, right, But now you see someone that's been in their house for seven eight years with a three and a half percent mortgage saying, you know, I've got hundreds of thousand dollars of home equity.
How do I access that?
Traditionally you would refinance your firstly and take some cash out. That math doesn't make any sense today, and so we're seeing the evolution of home equity products. Again, we think the credit is pristine at this point. So that's a
space where we're looking to get deployed quickly. We know credit standers can loosen over time as more people, you know, look for that opportunity, and so that's a space that you know, we expect there could be one hundred and fifty to twohentred million of origination per year with a call it two trillion dollar really a dressable market there on the he looks helocks or secondly as yeah, yeah, okay, So.
Rates go up, rates go down. I look at the the BDCs also on the credit side, and it seems to be a double edged sword, at least for business development companies. If rates go up, it puts a little bit more stress on the borrowers, but it also creates you know, more of a I guess of a spread opportunity for the for the lender. Rates go down, less stress on the borrow but maybe maybe you know, sort of less less margin to be had there. How does
that operate in your business? So I think we're looking at probably the consensus points towards about three rate cuts over the next twelve months. It's been as high as six or seven, you know if you look back a few months. So rates go down, three rate cuts next twelve months. How does that work in your business?
I think it's it's less impactful than it is on the corporate side.
I think I think.
The duration of the product therefore leads to I would say more natural resetting. There aren't these big cliff or wall events where you're gonna have a whole bunch of low cost ig credit from twenty twenty one rollover, Right, So most of what we're doing is lending on a floating rate basis to these specially financed companies. They're adjusting their return on assets, right, So they're what they're charging to their consumer moves kind of in tandem, and it's resetting really on a daily basis.
Right.
So if you're an auto finance company and the FED cuts or it doesn't cut, you can kind of naturally think of twenty five basis points and rate being passed on. So there's not as much of this kind of built up a mismatch, if you will. I think I don't foresee rates causing a lot of stress in this market. I think that really occurred in twenty twenty two and there was a giant reset of both rates and spread, and I think companies were stress tested then.
I think things are more on balance today.
Yeah, they certainly were. Five hundred and twenty five basis point increase in base rates and then increase risk premiums on top of that was some discombobulation of the banking market made for an interesting environment. I think it's actually pretty remarkable how well credit managed through all of those changes.
I mean, listen, it didn't feel great in the second or third quarter of twenty two, but you know, most people got to the other side. Whether you know, again, it was more of a it was more of the issuers problem than it was so much the investors problem. The investors could kind of patiently wait and see how this shakes out. The issuers were the ones that had liquidity needs. They were kind of the four sellers of twenty twenty two. It wasn't the owners of the bonds.
It was actually the owners of the loans that needed to turn over their facilities, and so you know, it wasn't a productive P and L environment for them. But
to your point, made it to the other side. And now I think those companies have sort of reset and they've Again that goes back to why there's more demand for private credit, because if some of those companies had fifty percent of their production already determined to go to counterparty, why regardless of where triple A spreads were, they would have an easier process getting through twenty twenty two than they otherwise did.
Yeah, yep.
One thing we've seen on the public side in terms of credit spreads, you know, they're incredibly tight, you know, decades long loads in terms of you know, IG and high yield, and parts of that has been due to the fact that supply has been taken out by the private markets. To what extent does that happen in asset backed markets and how will that affect pricing?
That's a good question. I think.
I think the preferred method of funding will still be the public markets, just from a cost perspective. I think of the private markets as either the means to the end, meaning so we're giving that bridging or where house capacity to get to that public markets, and so that will always be necessary capital. But I don't see many specially finance companies completely going to private funding based on where the opportunity or where they're funding opportunities are today. So
it's much more balanced. I think, you know, where we set is we're really playing across public and private markets, and so that also provides some of our counterparties, we provide them more utility than if we were just in the public markets or just in the private markets. And that's also sort of a sourcing advantage when we think about our business.
Okay, there's probably some listeners out there thinking, you know, securitization at the highest levels since the global financial crisis and then all of it being bundled up and into private hands where you can't see what's going on, sets off a few alarm bells, particularly if you're old like me and remember the last market catastrophes. What are we doing differently this time? Why are we're not going to get into the same kind of trouble as we did last time?
Well, I mean, listen, I think the fact that it's going to I would tell you private transactions are generally pretty discerning in terms of the eligibility criteria, the traps if you will, to cut things off if they are going bad, and more so than what would be a traditional static pool securitization. So the more capital that goes into private markets actually probably means there's more control and risk.
Listen. I think.
Whether it's the rating agencies or whether it's the sophistication of the actual bond buyers versus two thousand and eight, I think the whole game has changed and evolved. But at the end of the day, I don't think there's new credit being created, it's the geography of where that credit is. So again, we've talked a lot about the auto loans used to live on the regional bank balance sheet. That person still needs the auto loan, the car still
exists as the collateral. It's not being created in thin air. So now that it's being funded in the securitization market versus the regional bank, that doesn't mean there's sort of access. It's just the geography of the funding that's the theme of I think twenty twenty three.
Seems to be a lot less leverage in the system too, and less financial weapons of mass destruction in the form of CDs.
Yeah, I was gonna say exactly, like CDs and CDOs are no longer a tool.
To put leverage on leverage, right.
A lot of that was, you know, manufactured triple a risk that I just I don't think whatever fly knowing what we know today, but.
We all still see some signs of synthetic leverage coming up, right, I mean, there are some signs out there that you know, there is a bit more froth in the muket.
Well, I mean, if you're talking about the SRT space, I mean that's actually the inverse of what happened in the GFC. The GFC, the goal was created as much triple A cheap financing as possible and export that. I think you see now the big banks sort of get capital relief throughout, but they still own the assets, they're still funding it. It's not necessarily being exported the way.
It used to be.
And if you think about everything, you're doing everything, you're looking at what's the best relative value, where's the best opportunity right now? In credit?
Well, again, from a deployment perspective, we think lending is much better than owning, generally speaking, because there's less people that are built to do it. From an asset perspective, I think we're focused on housing, we're focused on residential
real estate. We're generally undersupplied, and so these kind of emerging home equity products, if you will, seem very compelling right now because if you think about what you just asked, the amount of regulation that went into residential mortgages Posts two thousand and eight has led to really pristine credit quality even fifteen years later, and so I think that is the place, if you will, to look for high quality assets, even if the spreads are not what they
once were, you know Twelvey eighteen months ago.
Great stuff. TJ. Duck and Head of Structured Credit and Specialty Finance at TPG, Angelo Gordon, It's been a pleasure having you on the Credit Edge, Thanks guys, and of course we're very grateful to David Havenes from Bloomberg Intelligence. Thanks for much for joining us today.
Yep.
Great being with you all.
And to Carmen Arroyo with Bloomberg News milgratias.
Thank you.
Please do follow Carmen on Bloomberg dot com and the Bloomberg Terminal, and for more credit market analysis and insight read all of David Havens's great work on the 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 indices, currencies and commodities.
Please do subscribe to the Credit Edge wherever you get your podcasts. We're on Apples, Spotify and all other good podcast providers, including the Bloomberg Terminal at bpod 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.