Hi, can you hear me? So thank you for bearing with us. We will now move to the second part of the panel discussing the impact of rising private debt markets. It is our pleasure to have with us on stage Mathieu Chabran, the co-founder of Tikehau Capital, Joshua Friedman, co-founder, co-chairman, and co-CEO of Canyon Partners, and Roberto Hoerck, co-head corporate and investment banking at Standard Chartered. Gentlemen, thank you very much for taking the time to be here with us. So we already had a conversation. I'm not sure if you were with us in the room in the previous 20 minutes. We discussed the potential growth for the private credit space and the associated risk. Mr. Chabran, why don't I start with you to give us your point of view on that before we move on to more specific topics?
Sure, well thanks for having us. And you know, since there was a part one of this discussion, I will maybe pick it up on the credit secondaries, because I think our colleagues covered the emergence and the very strong and solid growth of the primary private debt market over the past 10, 15 years. And effectively, it seems that we've come to a time now where there is a huge opportunity to provide the liquidity that Glenn and Dan were talking about, and his comment about the leverage loan market, the perceived liquidity, the actual liquidity, and what's happening on the real private market. I can tell you at Tikehau we launched a secondary private credit practice a couple of years ago, and the couple of billion we've deployed was acquired at 96 cents a dollar, so a 14% discount, which effectively illustrates what is the illiquidity premium you need to get to provide the liquidity to this primary debt market. So after such solid growth of the market, I'm expecting, similar to what we saw in the private equity space by the way and the venture space that other colleagues discussed earlier, I'm expecting this to grow to provide liquidity to any illiquid asset class. This is what our clients, the investors, want to see, and from an allocation standpoint, you know, the risk reward in my view doesn't get better than that.
Mr. Friedman, I want to go back to the risk associated, especially that we were through a period of very high interest rates which increased the rates of default. So are investors underestimating the risks in the system?
There are a lot of companies that can't survive the current interest rate environment, and if they refinance into it, they're going to have issues. I saw a BofA piece that said 80% of the companies rated below double B had this issue. I don't think it's quite that high, but I think that private credit is a little different from looking at secondary markets and refinancings. Mostly first lien with a stretch, that's made it larger generally speaking. Where you have systematic risks that take place, it's when there are institutions that are doing the lending that are highly highly leveraged and have a mismatch between their assets and their liabilities. That was what happened to Lehman Brothers, that's what happened to Long-Term Capital Management, that's what happened in the GFC to all of the commercial banks, and it's also what you saw earlier this year with SVB. The small sized banks had long duration assets, they had short duration liabilities, and it wasn't well matched on top of a lot of leverage. The leverage implicit in the private credit market is tiny. It's maybe one turn of leverage in general, as opposed to multiples of that in the banking community. On top of it, bank deposits can leave, whereas the liabilities, if there are any at all, in private credit funds are generally well matched. You look at something like CLOs, which are basically the predecessor to private credit but with syndicated loans, and the default rate for the CLO entities themselves that buy bank debt are tiny, it's measured in basis points. And that's in spite of 10x leverage, but that's because the assets and the liabilities are extremely well matched, but it's also a pretty careful curation of assets. But in private credit generally, it tends to be a little riskier debt than what we might traditionally think of as first liens, but so much lower leverage that the excess spread has offset it. The only other point I would add to that is in the initial stages of the private credit market, when there was this very rapid accumulation of assets, there was so much cash that flowed that the spreads were much higher than they are now. So we have to be candid about that. The large cap unitranche lending was being done at 675 over, 650 over, and those same loans are being done today maybe with fewer covenants and they're being done at 450. So I think not to think that you're being as well compensated as you were maybe three years ago in that part of the private credit market, I think would be inaccurate. I think it is riskier, but nothing close to the level of the type of systematic risk that you're inquiring about.
Mr. Hoerck, from an investor's perspective, are there any specific risks that investors should be looking at when they approach this market?
Well, I think that when you look at what's happening in the markets, this ebullience in the equity markets and tight spreads in secondary markets, it sort of clashes with what we're seeing in the macro environment where fiscal rectitude in Europe and the US has gone out the window. And therefore, giving money to manage to these experienced private credit managers is very attractive. So investors do like the asset class. The asset class will explode. We heard this morning in the plenary, there's so much debt that needs to come out. And I think to Josh's point, the asset liability thing is the main risk mitigant from what we've seen in the past to exit systemic risk. However, we are starting to see investors want to co-invest maybe more or have much more visibility on the deals. So transparency, covenant, pricing become far more relevant. So I think in the next few years, we'll see the whole private credit class become an asset class which is about idiosyncratic risk rather than the beta of it. Large managers with expertise can just raise money and then place the money to wherever they want. So I think more scrutiny will happen, and then there's potentially regulatory risk. You know, the banks have largely been regulated out of holding debt for a long period of time due to the RWA heaviness on their balance sheets, and we'll see what happens in this sector if regulators start looking at it more tightly.
Mr. Chabran, let's talk from a policy perspective, but not only from a regulatory perspective. From a policy perspective, to what extent does the growing private credit market pose a challenge for central banks from a policy perspective, doing their job not only on the regulatory side?
Well, I don't know if I can comment about the central banks, but from an asset manager standpoint, and to the risk of being not that popular, I think that the skin in the game should remain the paramount approach for any third party asset management in credit. Maybe I could challenge what was being said earlier on the other panel when they say that banks were 10 times levered and private credit is one to two times levered, but you're levered on someone else's equity. You took third party money in your fund, it might be effectively closed end, you put some leverage on top of that, but as far as I know, it's not the manager's capital in there. So what we saw in Europe, less so in the US, after the GFC and some regulations coming in, the retention rule on CLO that lasted maybe 2 minutes and a half in the US, in Europe it stayed longer. I think that there might be, I think it's a good attitude to increase the skin in the game of any given manager side by side with the clients. Not only the clients like that you're not making money with their money, but you're making money with your kids' money. And I also think that from a performance standpoint, that should incentivize you to be more disciplined in the risk underwriting.
Mr. Friedman, you think that there are implications on how monetary policy works from the shift that is happening?
Well, it's very interesting. Obviously, inflation has a lot to do with base rates. We have a much more vertically sloped curve now, so the short rates off which loans are priced is lower, but longer rates are higher, and that can make bank loans in some fashion maybe less attractive than loans that take advantage of the upward slope of the curve. On the other hand, as rates move down or rates move up, you have different type of exposure on long-term fixed rate assets. I think people overstate the importance of monetary policy in some respects, because a lot of the problems that monetary policy is designed to address are problems that were generated in part not by monetary policy in the first place, but by fiscal policy. So wild amounts of overspending by governments and deficit spending that really has nothing to do with the Fed. So some of the seeds of the inflation that we're seeing today and a lot of the spending that's still taking place, some of those seeds, but we looked to the Fed to somehow control this problem. It really wasn't of their own creation. Now, I'm not, you have a call by the way on who's going to be in the White House soon and whether the spending will continue at that rate. Hard to outbet the betting markets on that. But I just think we overly look too hard at government policy. The one thing I would echo that we were talking about before is that when things get overregulated, and in the case of banks, you've got retail investors with bank deposits, what happens is the costs of that regulation become very high and eventually those markets shrink at the expense of other markets. For our entire careers, for all of us, we've watched the public markets shrink at the expense of private markets. We've seen it in private equity. We've seen the number of public companies shrink, and the same thing is happening today. When banks have literally tens of thousands of regulators around their superstructure of loan origination and maintenance, that's a hard cost base to overcome. So you've seen private markets take over. In the case of the private markets, the investors are very, very sophisticated. Not every single one, but generally the ones at the margin who drive the market are extremely thoughtful, extremely intelligent, and do extraordinary due diligence. So I think pressures to start to regulate the private credit market, you're going to have regulators who are a lot less sophisticated than the capital allocators who are doing their own policing of the market.
