YouSaid · the spoken record

Mikhail Z. Kovalchuk

lines on the record: 27
first: 2022-07-12
most recent: 2022-07-12
sittings or episodes: 1
sources: podcast

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“Would say maybe to add to this look, if you looked at the asset allocators, large pension funds, retirement plans, insurance companies, if they were not themselves. Right, so we're still at the early phase of the growth, I think, of this asset class. It's really taken off 15 years ago, as we've said. But that would be another risk that maybe the regulator may have some concerns. It's how diversified are those pension funds across asset class, public and private, and asset class equity infrastructure, real estate, credit, and so on. But certainly when we speak to CIOs, we're not concerned about how diversified or not diversified they are. They're very diversified. Even if private credit is typically a very small fraction of their own portfolio.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“Small, even if you have large losses in the system to the risk of leverage losses, which is eventually what fuels a systemic crisis. And that was the key ingredient in 2008. It's not so much the size of subprime mortgages. It's really the leverage that was deployed behind them. Leverage is very low this time around. It's nothing remotely close to the 15, 20 or sometimes 30x leveraged structures that we had back in 2006 and 2007. But as far as the narrative goes, it's usually the risk of large losses in direct lending portfolios leading to contraction of credit and therefore exacerbating the severity of an economic downturn.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“Other concern that you hear all the time is that large losses on direct lending portfolios would eventually lead to a contraction of credit available to borrowers. And then you enter some kind of a vicious circle where credit contracts and then the pressure on growth gets exacerbated. I think there are two big offsets to that, in my view. One, you have to put the numbers in context a little bit. But direct lending, if you can dry powder, is worth probably around half a trillion dollars. That is still very small relative to the broader credit complex. I mean, keep in mind that the investment grade bond market, for example, is worth around 6.5 trillion. A high yield bond market is worth another trillion and a half, 1.6 trillion almost. And then the broadly syndicated leverage loan market is worth 1.4 trillion. And so in the grand scheme of things, the size of direct lending is still reasonably.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“Think there are a couple things in my mind. One is will this asset class produce the same returns in this cycle as it has in previous cycles? So that's one concern. And again, I don't think this is a systemic risk concern. I think as private credit is being increasingly sold to retail investors, there's no doubt there's going to be more disclosure required, more transparency around the portfolio construction around how much due diligence is coming into these investments, around kind of the GP, their teams and so on. No doubt there's going to be more disclosure here and hence the regulator is probably going to take a closer look at direct lending.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“Over the same period, and so there's little mismatch between the assets and the liabilities, that mismatch was one of the primary drivers of the large deleveraging shock that followed the global financial crisis. And so we disagree with the view that from a systemic risk standpoint, private debt markets and direct lending in particular would exacerbate the severity of any macro shock.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“Actually, the protections are stronger, if anything, than public markets, but whether it's governance structures, due diligence, the standards are typically higher on the private side than they are on the public side. So that shouldn't be a concern in my view. The concern that you hear all the time is a sort of parallel between private debt markets and shadow banking or shadow lending. We disagree with that characterization. One, if you think about the two primary ingredients that led to the global financial crisis leverage and then mismatches and balance sheets to mismatches between assets and liabilities, those are not here today. Direct lending involves very little leverage. There is a little bit of leverage, but nothing that comes remotely close to the levels that we had in pre-global financial crisis, the way a direct lending fund works is quite straightforward. Capital is locked in for a period of time and it's basically lent to borrowers.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“Another differentiating factor that hasn't come up in our conversation yet is just the fact that private lending is relatively lightly regulated relative to public markets. So are there protections in place to protect borrowers and investors in this space or is there risk there?”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“Instead of financing, one of the fascinating developments of the last couple of months has been these large LDO transactions that have been entirely funded on the private side. That's a paradigm shift. We used to think of private markets as sort of niche markets for small issuers, but I think private markets have also demonstrated their ability to commit and allow investors to deploy capital in these multi-billion type of transactions. And so definitely more depth, which is good, I think, for the reputation of the market and I think it will continue to stimulate demand over time.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“Continued maturation of the asset glass, I would say. So, first of all, keep in mind that of the 1.2 trillion of AUM, there's a little less than that that is just dry powder, so capital available for future investment. In the near term, I do think that public markets have reset from evaluation standpoint to levels that are starting to look attractive, particularly from an all-eneal standpoint. If I take the high yield bond market as an example, the average yield was around three and three quarter percent in June of 2021. Today it's at eight and a half percent. And so there are some competing alternatives out there on the public side that will likely slow things down a little bit in the near term, but structurally in the medium to long term, the case is quite strong in my view on the investor side. I think you'll see continued growth of the asset class and more importantly, more breadth too and more depth.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“Also taking a very conservative view in this environment. And that's on the senior side, also on the junior side. And on the structure credit side, I think we're also starting to see companies who've raised capital in the past, financing in the past, and are in the need of kind of restructuring their balance sheets. And here, an ability for us to step in and provide a solution to give maybe those companies a bit more breathing room, maybe longer maturities so that they can go through this current cycle. And so whether it's on a senior on the junior side, on the more tallistic side, private credit as a whole, I think is seeing probably an increased level of opportunity. And it is certainly validated by our pipeline.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“Seeing a lot of investment opportunities, and I think it's several reasons for that. Number one is if you look at In private equity, it's about three times what it was about 15 years ago. And so there's a lot of money here waiting to be invested by privately firms and they themselves are buying larger companies. So that's one factor that is underlying some of the tailwinds around private credit. Number two is we're seeing the banks retranch in this environment of high volatility. And why is that? Because they're less confident about their ability to go and syndicate The markets given the volatility and given the fact that market participants”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“Is really a deep moat around their business model, very low churn, ability to pass through pricing, but also to grow volume through maybe new product launches. We like investing in essential services, business services, and we have quite a few of these companies in our portfolio globally that have the ability, frankly, to grow with their customers, but also pass through any inflationary pressure they're seeing. We tend to shy away from companies that are exposed to commodity prices and that will be probably more on the manufacturing side and we don't have a lot of exposure to these sectors. And no question that we'll start seeing also rising defaults here from bowers that are unable to grow out of their capital structure, bearing in mind in particular the rising rates. And I think you're going to start seeing really differentiated performance as we go through a more challenging cycle.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“Difficult question to answer because it's not that one size fits all, right? And that's where really credit selection applies. Finding those borrowers who can support slowing growth, who can support rising rates. One of the fundamental questions that we ask ourselves as we diligent assets is really around the pricing power of these assets and their ability to pass it through to their customers linked to this is also their cash flow generation power given rising rates with pivot towards those sectors and those companies that have those attributes. And so if you look at the sectors in which we tend to gravitate, a lot of healthcare, a lot of healthcare services, a lot of software in Europe in particular, we have a lot of exposure to ERP software companies that would sell their products to SMEs.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“During the global financial crisis. And the reason for that is the market's perception that the ability to have access to funding backstop provided by private equity firm was viewed as an asset as opposed to a liability. And so that does provide an offset to the prospect of higher rates here.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“If you look at the bond market, however, when number one bonds are fixed rate, and then number two, there's the average maturity has extended quite materially over the last two to three years. And so there's definitely some differential between the two markets in terms of the ability to withstand an aggressive hiking cycle with larger and more front-loaded hikes. Beyond that, I do think that there are a number of offsets on the private side that are important to keep in mind, but obviously oftentimes private equity sponsors are solo lenders. And so they do have the ability to provide more liquidity at times of financial distress for the borrowers. We saw that playing out very vividly during the COVID shock, but in the two to three months that followed the COVID crisis, actually a higher bonds issued by sponsored companies sharply outperformed their peers issued by non-sponsored companies, which is the exact opposite of what happened.”
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“Until basically, the two sort of reconnects structurally, however, I do think that the case is still very strong, partly because that ability to generate better sharps relative to public markets is still there. It hasn't gone away. From the perspective that the borrower, you're absolutely right. I think we're entering a period that is unprecedented, at least by the standards of the great moderation, i.e. the last three decades. But if you take one immediate headwind, which is the prospect of larger and more front-loaded hikes, we do see more vulnerabilities potentially on the private side relative to the public side, particularly if you look at the high yield bond market. The reason is direct lenders lend in floating rate terms. And so if you think about it, what's going to happen over the next two to three quarters is an immediate shift in the cost of funding for these borrowers. And not all of them will have the ability to withstand that. On the public side,”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“There's the investor's view, and then there's the borrower's view. On the investor side, I think the biggest challenge right now is that public portfolios have experienced such a sharp decline year to date that it's going to be a little bit difficult to allocate more into a liquid private markets. What I mean here is that if you simply took a traditional 60-40 portfolio, 60% equities, 40% bonds, that portfolio is actually off to its worst start since the mid-70s, which is the inception of the Bloomberg Ag index. And so you can sort of look at a global portfolio in terms of two slices. One is very liquid, tilted to the public side, and the other one is a liquid tilted to the private side. Right now, the public slice of that portfolio looks a lot cheaper relative to the private one. And so two things could happen. One, a little bit of catch down on the private side in terms of valuation, or two, a little bit of a slowdown in terms of inflows.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“Now, of course, that ability to generate higher risk adjusted returns as a price, not price is illiquidity, unlike public bonds or broadly syndicated leverage loans, private debt is illiquid almost by design. But as James alluded to earlier, that illiquidity is hardly an issue given the investor base in private debt markets. In fact, if you look at the ownership structure of private debt markets, what you see is two-thirds of it is dominated by investors that are traditionally net liquidity providers as opposed to net liquidity consumers. And so that includes insurance companies, pension plans, sovereign wealth funds, foundations, family offices. For this type of investors, liquidity is not really a need, if anything, like said, they tend to be liquidity providers on the public side. And so it's well suited for an investor base that doesn't need liquidity on a daily basis and it has the ability.”
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“Yeah, I mean, the popular narrative has been investors go to private debt markets because they're looking for some kind of a yield pickup. We've always had a more nuanced view. I think the yield pickup is something that you can perfectly achieve by deploying leverage, for example, in some macro products and credit like CDX, high yield, for example. What you can do, however, by deploying leverage into macro indices is get the risk adjusted returns that private credit gives you. And I think that's really the value proposition of the asset class for multi-asset investors. If you look at the risk adjusted performance of direct lending, for example, and compare that to high yield bonds and broadly syndicated leverage loans, what you see is that direct lending outperformed pretty much since 2010. And so the ability to generate higher sharp ratios is, in my view, the number one appeal for multi-asset investors.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“In terms of size, we're talking about 1.2 trillion dollars globally. So that includes a variety of segments. Direct lending is about 40% of it. And then you have other segments like infrastructure, distress, special situations, et cetera. Now, 1.2 trillion essentially makes private credit a scalable and investable asset class that is comparable in size to other well-established markets like the high yield bond market, for example, which is worth around 1.6 trillion, or the broadly syndicated leverage loan market, which is also worth around $1.4 trillion. So over the years, there's no question that asset allocators, particularly on the fixed income side, now have come to the conclusion that.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“Absolutely. I think private credit has been demystified. And again, if you look at one or two decades ago, very few players typically sophisticated LPs, pension phones, sovereign wealth funds, insurance companies started getting into the private credit. By the way, some of these LPs also direct setting up their own direct team. And I would say with now 10 to 15 years of track record for the asset class having gone through in particular some of the cycles that we've seen, including COVID recently and the outperformance and the lower volatility of this asset class, somewhat the superior returns given the origination that is attached to direct lending. You're now seeing different type of vehicles targeting retail investors around the world to get them access to private credits. And that is fueling the growth of this particular asset class, which in turn is allowing those investing platforms.”
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“And you've also seen the type of investor then evolving, correct? So this used to be just the realm of sophisticated institutional investors, but you've now seen other types of investors getting involved.”
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“By the way, if you look at 20 years ago, the banks were very much on a tech and a whole basis. And then they started moving from taken holds to underwriting and placing the debt with market participants. And as the syndication becomes more tricky and volatile times, then suddenly it leaves the way for others like direct lenders to step in. And so now you've got the confluence of both sides. On the LP sides, i.e. the investors, on the borrower side, and things are accelerating actually, to the point where you can say that private credit has become a very large asset class today. And to some extent, it's become a lender of first choice as opposed to a lender of last resort. That's been one of the most meaningful challenges that certainly I've witnessed in the last 15 years.”
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“Absolutely. So the borrowers are larger, they're very high quality. We've seen Unitranche or privately placed financing up to 3, 4 billion dollar. And that's becoming a recurring theme, both in the US, but also now increasingly in Europe. And so we've seen companies that would have no problem raising debts in the public market, deciding and choosing on purpose a direct lending solution for all the benefits that I mentioned earlier. This is further accelerating, by the way, at times of dislocation. When the main competitor, the banks, also retrenching. And really, we saw that, I would say, at the GFC time 15 years ago, when the bank started retrenching back in 08, 090, it really opened the gate for direct lenders to go and step into the shoes of the banks. And we're seeing it a little bit right now with the volatility that is hitting the market. And that has been a fundamental change.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“It's very flexible in nature, it can really suit the needs of the borrower when it comes to its cash flows, when it comes to its effects. A lot of these companies may need an acquisition facility to grow, something that you can negotiate up front. There's no rating required. If you go to the markets, the management teams will have to go and seek a rating with a rating agencies. Here, there's no rating required. And so the management team can spend their time elsewhere. The process is very confidential and can be also very conducive to speedy execution and very nimble. And then what I would say is for a borrower, for its management team, for its owner, knowing and trusting who owns your debt is very important. And we've really experienced it in particular during the midst of the lockdown and during COVID, where we had to sit down with some management teams to figure out a way to give them a bit of breathing room.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“Multiple benefits to these. First of all, the banks are not the eventual holders of the debt. They need themselves to syndicate it in the market. And so there's a big question mark around what will be the stape of the market at the time of syndication. And it typically happens two to three months after the banks have underwritten the financing. And so for the borrower, whilst they have their financing underwritten by the banks, they don't know the price of the debt. That's a big risk that they're taking, in particular when there is volatility and the markets can be shaky. The price of your debt might be a lot higher than what you had expected. So that's point number one. If you're dealing directly with the eventual holder of the debt, then you can negotiate what the price of that debt is going to be. There's no uncertainty linked to the market volatility. Second is when you're dealing directly with the eventual holder of that debt, your financing can be very bespoke.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT
“Let's start with direct landing, which is basically the fact that you originate a loan or an investment, a debt investment without the need for an intermediary. I would say if you go back 20, 30 years ago, typically when a corporate borrower wanted to raise financing, they would go to their banks. And then the banks at that time would club a number of banks together and then offer the financing. This eventually evolved towards underwriting and syndicating to the markets. And what direct lending has done in the last 10 to 15 years is really putting the borrower directly in discussion with the eventual holder of the debt, right? And so it's this ability to originate directly to negotiate the terms of that financing directly with the borrower, the terms, the documentation, and the way that basically the debt is going to function for the duration, which is typically seven or eight years. So it's that ability.”
2022-07-12 · Goldman Sachs Exchanges · The Boom in Private Credit · IDENTIFIED FROM THE TRANSCRIPT