Private Credit “Doom” Narrative On Shaky Foundation? | Michael Haynes On Why Retail Outflows Are Real But Credit Foundations Are Solid

Today's episode is brought to you by Kaya NXT. Later in the show, you'll hear more about how you can take the next step for your clients with Kaya NXT's alternatives education courses. But for now, let's get into today's interview. I am joined today by Michael Haines, head of private credit at Beach Point Capital Management, a credit firm that manages over $20 billion in assets under management. Michael, welcome to monetary matters. >> Thank you for having me. Pleasure to be here. So, Michael, many of our viewers probably have seen the phrase private credit in headlines over the past two to three months. That is a term that encompasses like 11 different things. And perhaps it would be a little bit more of a dramatic episode if you were in the eye, your firm was in the eye of the hurricane, the eye of the storm of a firm that had a high amount of retail capital, so not institutional capital, and a high amount of software loans. And that kind of is the area of concern. There's a little bit of a liquidity crunch and perhaps maybe it's a little bit more than a little bit of a crunch in those sectors. But I want to say for audience that, yeah, that is not your firm. >> Thank you for pointing out. I was going to point it out if you didn't, but appreciate that. >> Definitely, tell us about what, how do you define what you're doing? What you do as private credit. How much of it is direct lending? How much of it is asset-backed lending, as well as the differences in investor at LP composition between a firm like yours and the firms that we're reading about in the headlines? >> Sure, let's see. I'm going to take those in slightly reverse order. First, about each point, as you mentioned, we manage over $20 billion. We manage money for institutions. We do not manage retail capital. Our investors are generally large plans about public and corporate. Together with some foundations and downwinds, some sort of high network in the offices and so forth. But largely, it's institutional capital. It's very patient capital. And our clientele are pretty targeted in what they're trying to achieve, whether in public or private markets. We'll get to why I think that's particularly relevant when we get there. As relates to private credit, each point is involved. We're a subinvesting great credit manager, and we're involved sort of across the spectrum in public and private markets. So I'll just speak to private since that's the topic of today. Starting on one end of the spectrum, we manage money in a pretty traditional middle market direct lending strategy. This is lending, firstly, in top of the capital structure, money to companies, most of which are owned by private equity sponsors, though not all, some are family owned or found their own, so forth. And that's a pretty straightforward strategy. And a lot of the headlines you're seeing are about that. So we'll come back to that topic. On the more opportunistic side, we have a series of funds referred to as the opportunities funds, our capital solution strategy. This is a higher returning more concentrated strategy where we're looking to get paid premiums for accepting additional credit risk and complexity and noise, and sometimes for being willing to invest in industries or jurisdictions or market environments that are dislocated for one reason or other. That could be companies specific, traditional example. That would be good company, bad balance sheet. That could be an industry that's going through trouble. That could be an interest rate environment, could be the pandemic, could be, anyway, lots of reasons why markets have fallen off the cliff at various times in my career, and that impacts private markets as well. Then there are adjacencies. We have a commercial real estate-related private credit fund that we call B-Pred, each point real estate debt fund. And we have an asset-batic strategy, which all define as anything that isn't commercial real estate or corporate credit. And I think asset-backed finance encompasses a very, very wide universe of potential opportunities. Then we have what we refer to as our hybrid strategy that's also corporate generally. But that is a strategy that invests exclusively in private middle market opportunities, where we are stepping into the area that exists in between credit strategies and private equity strategies. It's otherwise known as a hybrid strategy. Some of our competitors have similar ones. And here, some of our returns come from contractual returns and more credit-like characteristics. Some of them come from equity upside and profit sharing and so forth. And then we're involved quite a bit in governance of the underlying companies and so forth. So like I said, that's probably a strategy that is best thought of as somewhere in between an opportunistic credit strategy and privately strategy. So that covers a really wide range of the universe. And for me, being sort of sitting on top of that, I guess what I'd say the privilege of that is getting to see so many different opportunities and getting to constantly compare risk reward, having the benefit of being able to interact with clients to understand where their appetite is now and where it is going. And I think of that as like kind of a beach point wanting to be where the puck is going to, rather than where it might happen to exist today. And like public markets, that is constantly changing. One, I would say misunderstanding of private markets is as thought of as less liquid which it is. But that doesn't mean it doesn't change like public markets. It always does. Investors' appetite's change. Relative value changes. We like to be kind of on the forefront of where we think the best value exists in the market at any one time. So that's our business. It's about a third of beach points overall capital under management has a big portion of our investment team as well. And is certainly one of the areas where we have seen over the last couple of years and continue to see, notwithstanding the headlines, substantial institutional client interest in finding premium returns and exchange from being willing to accept some ill-equity. And I don't see any reason that that's likely to change over the next couple of years. So you named like I don't know five or six different markets and you said that advantages, you can see where the best risk reward is right now. Where would you say the best risk reward is across those markets you see or some of the most compelling? Let's see. If you're my client, my first question would be please explain to me what your objectives are and your appetite is for volatility, ill-equity, drawdowns and so forth. And so I think that's best probably explained by talking about for each individual market where I think we kind of are in that cycle. And as I mentioned, the markets always moving like are we at the most attractive end of the range of opportunities or the least and it's different for each one. Speaking of starting with direct lending. Direct lending is lending to companies. Lending to companies. Yeah. Top of the capital structure generally thought of as the biggest food group within quote unquote private credit, largely the private equity owned companies. We actually just recently had our annual meeting on a panel that I was moderating asked where my colleagues involved in that business. On a scale of one to ten where we opportunity set wise, his answer was five or six. And spreads in that business are kind of historically where they have been on average. So from a profit per dollar of risk, I would say we're kind of in the middle of the range of outcomes. Credit risk itself in so far as managers have avoided software is also kind of I would argue in the middle of the range. And for this product, that is a totally acceptable environment bearing in mind to my point, Jack about what we're talking, you know, what would your objectives be? Clients who are allocating to the strategy are looking for a stable core income stream without the volatility of public markets where they're minimizing loss and minimizing draw down risk. And we're still in an environment where they can achieve that within direct lending would be my view. And so notwithstanding the noise that's out there, I still think of the investment climate as one that's likely to achieve the underlying institutional investors objectives when they make allocations to the space. Now we can pause there and say there is a ton of noise largely related to software exposure, but that's kind of a look back noise, not a go for noise. From our point of view, we don't have any software exposure and material amounts in our direct planning strategy. And we don't need to add any unless we saw something incredibly compelling. And so, you know, we have a pretty clean business and I think benefit from not having our clientele need to be asking, taking half of our time asking about software exposure. My view on software exposure is I think the challenge is not in the performance of the underlying companies, the vast majority of that universe, I think will perform just fine. The challenge is for technology that's advancing so fast, how would anyone possibly be begin to predict what enterprise values are going to be five years from now. And as a result of that, if you don't have a good prediction of value, you don't know how reasonable your current loan is. If you think in five years you're going to be some 50% LTV, that's refinanceable. If multiples contract and you might be covered, but you're 70% LTV, that's a problem. And so from my point of view, we're looking at sort of a longer term challenge, more than we are likely to see the underlying credits that have software exposure, seeing real performance drags, and therefore creating more near-term losses amongst those loan portfolios. So interesting thing about that, that's what makes a market. People have different views. Mine would be lots of noise, a little less near-term stress and terms of credit performance. A more interesting question would be, on a go-forward basis, what would someone have to pay someone like us to step in to software or to technology adjacent risk? I don't have a great answer for you other than to say substantially more than it would have a month ago or two months ago or six months ago. And I do think that will restrict the private equity industry, engaging a lot of large software transactions from here, only because the financing environment will be very uncertain. So that's direct lending. Now let's go to the sort of more corporate opportunistic strategy. All of the headwinds that we can all read about, those headwinds could be software. They could be the M&A environment being slow within private equity. They could be higher for longer interest rates. All those things are huge tailwinds for an opportunistic capital solutions provider like each point, because we're stepping into those situations, being willing to help private equity firms and founders and entrepreneurs through those challenges. And sometimes those are transactions where we're lending at the top of the capital structure, sometimes on a junior basis. But all of that I'll call it sort of kink in the hose is an opportunity for us to be a liquidity provider into those same challenges and to get paid extraordinarily well for doing so. That's a lot of what we're doing in our sort of signature capital solution strategy. That strategy, I would regard as a 7, 8, maybe moving towards 9 out of 10 in terms of attracting this. We've been extraordinarily busy in that strategy with a lot of opportunity and we continue to pursue it. The second area that's relevant to that is oftentimes, even for a private credit strategy, we look to the public markets and dislocations in the public markets as an opportunity set. If you look at the, in our subinvesting grade universe, if you look at public markets, the high yield indices, when bank loan indices, they're wider than they were a month ago, but marginally wider, I'd say. And on the other hand, there's huge dispersion. My dispersion, what we mean is if you look at the lower credit quality end of that market, there's some that are really tight, not interesting. But there's a lot that have traded off wildly, some, you know, baby out with the bathwater, tech adjacent names, others that are in cyclical industries. You're talking about public aid, the broadly syndicated loan market. Yeah, and high yield market could be either. But there's a big part of the universe that is trading at stress credit levels. And many of those we find really, really interesting today. That is, that is being driven by a different dynamic. We have seen some shedding of risk in tech adjacent names. We have seen building products and other cyclical names, where there is fear of sort of the economic backdrop and so-called case shape economy. There's fear about the impact of that on more discretionary consumer expenditures and so forth, construction environment, home building and so forth. And while all those risk factors may be legitimate, that still tends to produce mispriced opportunities, then one thing for sure that will come out of the war in the Middle East is almost certainly a higher for longer interest rate environment. And that debt service challenge also continues to create opportunities for us to step in and challenges in refinancing and the charty issues and so forth. And so that too is creating an awful lot of opportunity where we can hope, where we hope we can use our so-it-short flexible private capital to get involved in situations that are difficult to solve purely in public markets. So really busy time. Probably have a lot more gray hair on my head than I did a couple months ago, but that's what we're here for. And we've had an extraordinary run. Talking about the adjacencies real estate debt or real estate, commercial real estate, finance business, has been the beneficiary of a slowdown in middle market bank lending to commercial real estate. That's been a process over the last three years that's created a real technical tailwind for that business. The loans we're making are on the margin a little higher in LTV, but still to the major food groups of real estate, industrial hospitality. We just did our first office deal in a few years. That was interesting. And how many of those deals-- You see, in the direct lending market, a majority of the firms you lend to are owned by private equity sponsors in the real estate world. Yeah, completely different. So real estate is dominated by the sort of universe of local market players. Even very experienced, well-capitalized local market players tend to be a much more significant portion of that market. It's a lot more fragmented in ownership than the larger corporate environment. And so most of our bars are very experienced, very sophisticated, but they tend to be specialists in their asset class or in their local market. And so in those circumstances, they are accustomed to borrowing from their local or regional bank. And when those lenders are less willing to satisfy their needs, that's been an opportunity for us to step in. And so we're financing great projects and income-producing properties, transitional properties, at hundreds of basis points more spread than historically speaking, those risks would have priced at. So it's like I said, a really interesting opportunity today. We think it will endure for quite some time, but is kind of a unique environment today. Lastly, I'll touch on ABS. So ABS, we can define this sort of-- Yeah, asset-based securities. And then there's ABL of asset-backed. Let's call it all the same, like asset-back meaning it is not backed by a company. And it is not backed by commercial real estate. So let's keep those in a different universe. Welcome that encapsulate. Consumer credit, residential mortgage financing, it could be financing aviation. It could be-- we've been involved in the financing motorcycles, Harley Davidson's. We've been-- we've been-- we've been a esoteric commercial real estate property, referred to as paced loans. We've-- I'm sure I'm missing some things. In a non-performing residential loans. So these are all areas where Beachquence is been active over time. And there are things that are even more esoteric than that that exist in the ABS market. What these all have in common are streams of cash flows underpinned by hard assets or financial assets that give you a pretty predictable stream of earnings against which you should be willing to lend money, or you should be willing to price those underlying assets. And it's become popular because it's an alternative that's regarded as perhaps lower yielding but higher in quality and lower in credit risk than comparable corporate strategies. History will tell us whether or not that indeed is the way it plays out because asset back lending also tends to be more highly leveraged than corporate credit. But that's thesis. It's been very popular for institutional clients. Our business today has a number of different components. But one of the important ones is a non-agency residential mortgage strategy. We have our own originator that's a platform called Visio that we think is kind of a leading invest in class originator. And we've executed dozens of securitizations directly. Some of those securitizations we retain junior portions of those, other in other cases. We will monetize our holdings. And in all cases, what's critical about that business is the differentiated origination of the underlying assets. We do buy on the secondary market. But in most cases in that business, you'd much rather be thinking of it as a manufacturer of the product than a buyer of the product. And that gives you a yield premium, gives you an ability to control risk, to manage underlying assets, to work through issues. issues to the extent that you have any on a more direct basis. And so that's kind of the foundation for us. Work and strategies very attractive right now. When we talk about higher for longer interest rates, a data point visible to the markets, there are a lot of people focus on our mortgage rates, which are approaching historic highs. 30-year mortgage tipping on towards kind of 7% would be, I think, a huge level to achieve. In our non-agency mortgage market, we see we're seeing very attractive underlying returns on those loans. And we don't see a lot of sort of incremental credit risk that we're obligated to take to originate those portfolios. So I would call it a, you know, easily a 7, 8, 9, 9, 10 environment as relates to our non-agency mortgage strategy as well. So a bunch of different flavors there. And many of the cases I'm describing to you, challenges for the market and Beach Point as a firm that loves running into that building on fire rather than being scared off by it. That is certainly our approach to the world. And a lot of headlines and noise out there that are giving us some of those opportunities. - Right, and it's a poor distinction that you said, which is, you know, I say most bond funds and the public bond funds are certainly most equity funds. They buy it, they buy their securities from someone who bought it from someone who originated at like the bank that did the IPO or the bank that did the underwriting for the bond. Private credit is different in that a lot of the times the people who are the investors, the manager, in this case Beach Point, is the actual originator. So that's just an important distinction to draw for our audience. - Absolutely. And for headline reasons, you know, I can make it draw the metaphor of being the sort of manufacturer versus the sort of consumer of loans. But there are less obvious benefits and let's just take a specific case of a loan that we have that is to, I would call it to one of the country's leading sort of luxury brands and hospitality. And it's not just that we were able to price and structure that loan, it's that to the extent that there are issues, I am talking directly to the principal of that company who has, whose family has owned this business for a hundred years. And we're solving problems together to the extent there are any and those personal relationships give you a level of transparency and interaction and early warning that I think are critical or risk management. And so it's not just kind of the headlines or the structure or the pricing, it has a lot to do with how close we are to the underlying assets. Bearing in mind, we're not a private equity fund. So in some cases, yes, but in most cases, we don't control these companies. We're not hiring the management team in our credit strategies and so forth. So being close to those assets and feeling like a real partner in those businesses and behaving like one is a critical part of making sure we're able to manage risk. Would that company be Chippewaani? No, come. I gotcha. So I think that's a really good overview of all of the different asset classes that go under the umbrella private credit. Perhaps there are one or two that you didn't mention that are in the world, but I think you got most of them. I want to ask about the liquidity of the asset class and the consequences in the following way. If there is a stock or a bond or a public business development corporation that owns these private credits, when there's panic in the market, it sells off. You immediately see it. The yield can go from 8% to 11%. It's immediate. When there's panic in the private market, so not publicly traded, are you able to capture the extreme panic in the market to the upside? One of those I'm saying is sometimes in the market, I mean, when there's a giant panic, you can buy companies that have PEs of four or something. Is the private capital market too rational? Where actually, OK, yeah, you can buy a loan at $0.70, but you're not going to buy a loan at $0.30. Do you know what I mean? Yeah, so let's talk about liquidity in the private markets. First off, I believe at some point in the future, private markets and public markets will start to more closely resemble each other. It's referred to as convergence. And we see that often. We see loans that might quote unquote be private credit loans. Have 10 or 15 participants might be billions of dollars. And they're called private, but they kind of feel like a syndicated deal. Equally, we've had quote unquote syndicated deals that have four or five holders. If you want to buy it, you call one of the other four holders. And if you want to sell it, you call one of the other four holders. And so even though it's syndicated, you'd ask yourself, is that really a sort of capital markets transaction? In many cases, that feels a lot more like a private credit transaction. And there are transactions that are in the middle of those where I'm going with this is, I do think we're going to see less sort of label based differentiation in the market, three, four years from now. I think you'll have lenders willing to accept transactions with less liquidity and lenders who require the liquidity. I think this distinction between what is capital markets and what is private is kind of going away. Having said that, I'll address your question. Today, and as a result of some other redemption or requests you see in from the market participants who have retail money, we have started to see, I'll think of them as like bid lists, meaning lists of private credit transactions that are in theory available for sale. And that has the makings of an opportunity set for us. But market-wide, the plumbing isn't quite there yet to facilitate real liquidity. And the reason is confidentiality restrictions in many of those transactions restrict information on the borrower to the people who are already involved. And so I could look at a list and decide, I'm willing to do the work on it. But if I can't get a data room giving me financials, indulgence materials, and quality of earnings, and so forth, how am I going to really come up with an appropriate price for that asset? And so right now, most loans, most opportunities are trading from one existing holder to another. And in our case, our opportunity set today is looking at the existing loans we are on phone, looking at who the other participants in those loans might be, and talking to those people directly, hey, we don't know what's going on, but, you know, word has it that there's some redemptions out there. It was interesting for you to offer you a bid for any of those assets. Let us know. On a few modest number of occasions, we have been met with, yes, that would be interesting. But I would not call it today a particularly liquid opportunity set. And I'm going to say yet, because I absolutely think that is come. I just think the plumbing has to get a little more developed market-wide to facilitate that. And a lot of that's on borrowers. Barters are going to have to get comfortable that when they do a private credit deal and they have three relationship lenders, they have some stake in giving those lenders the flexibility to share information with people. On private companies, which they'll be instinctively reticent to do. And I think we can all understand why they should be reticent to do it. What I would say is enabling some liquidity would allow private equity owners to achieve more efficient costs of funds. And so that's the judgment they'll have to make. And that's what would be required to produce real liquidity in today's iteration of private credit assets. So in the syndicated loan market, there's five banks or 40 banks. However many they are, they all make the same loan-- that gets called a syndicate-- private credit, as it emerged, a lot of the time it was one firm making the loan that has the relationship with the bar. Oh, and now it's two firms. And I think once it goes to two or three or a certain number of lenders in the private credit, it becomes called a club deal. I think that's the-- True. And by the way, it is typically not one lender choosing to bring in friends. It is typically the borrower wishing to have several of that borrower's friends participate. So it's borrower driven more often than not as opposed to lender driven, the dynamic you're describing. And does having multiple lenders does that often lead to slightly more favorable terms for the borrower, so lower spread or no? No, it just gives them an opportunity to maintain more than one relationship. And I think sophisticated borrowers understand the virtue of that. Give them some risk mitigation. You have one lender, and that lender runs into issues and you need an extension or you need more capital. Might be tricky. If you have three lenders in a club, and one of them decides not to participate, probably the other two will be happy to. So I think there's a number of benefits to borrowers from that. And earlier you said that-- you're talking to other people in some loans who have the same loans to the same companies that you do, and you're calling them saying, "Hey, I've been seeing the headlines perhaps, and I've seen some redemptions, "is there a chance where you might want to sell the loan to us? "We have the conversation." So you're saying those conversations are happening, and you're saying the opportunity to buy those loans from potentially not to stress sellers, but motivated sellers, let's call them. That opportunity said is emerging, and you said it's not here yet, but you think it will be here. That's what you're saying. - That's accurate, and I think a way to think of that is, it can happen today episodically to create a market with real sustained liquidity. There will need to be a slightly different infrastructure and information sharing available more regularly in the market. So that will happen. I just think it'll take a little while to get there. - And how wide are I guess the discounts if you are looking to buy something, if it's marked at $100,000, presumably 97 cents. Okay, three cents, it's not great. - Now you're asking for the secret formula, I think. I'll say look, we price risk. In some cases, there's loans we like, and we're happy to buy them at bar. They have good spreads, and we might be under exposed to those names, and are glad to own more of something that we think just as a great trajectory. In other cases, they might be circumstances with, let's say a little bit of hair on them, and in those circumstances, if they're business plans that have performed less well, then yeah, then you want to price that risk as well. But I have not seen, I'm not sure this is a question you're asking, but I've seen no evidence of there being sort of distress selling of otherwise good assets. That does not exist today. Nor in all the cases where you've seen news about private loans trading, am I aware of any that have been it particularly heavily discounted prices? I don't think that's what's happening in the market. - I hope you're enjoying today's episode. As many of you know, the asset management game is changing. Increasingly, alternatives are eating into both stocks and bonds and becoming staples for all types of portfolios. 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So you have these private BDCs, business development companies that are marked at $100 marked at par, and then you have public BDCs, some instances from the same company. In many instances, I've heard 70 to 80% overlap of the same assets. I don't know that's just what I've heard. That the trading well below net asset value, 10% discount, 20% discount, in some extreme cases, it can be a 50% discount, of course, that's not representative of what's going on here. But when you see that what opportunities do you think and what are some of the thoughts that Poppinder had when you see that dislocation, which is a, it is a pretty remarkable. - Yeah, it's a good question. Like all things, it's really critical to get into the nuance of BDCs, particularly public BDCs, 'cause they are not each one like each other. There are some that are only call it 60% ish first lean portfolios, they own second lean, they own unsecured, they own equity. So that is a far different risk profile and should have capital values that have wider variation in terms of pricing. That's one difference. A second difference we talked about earlier would be the amount of software, tech, adjacent exposure, those firms have, which also probably should be somewhat discounted and will give you broader variations and outcomes and broader senses of risk amongst the investor universe. So on the one hand, there are definitely portfolio level differences that allow, make it difficult to kind of generalize, hey, they trade here and there, and what do I think of that? For example, compared to what I do, 'cause they're not necessarily very similar. And then the last feature is leverage profiles. Some of them are running more leverage that would suggest larger discounts from NAV. Others of them are very modestly leveraged and so you'd expect the volatility in their underlying equity to be not as much. When we look at public market situations and across each points business in some of our public strategies, we will look at public BDCs as a potential source of opportunity. We think of that pricing as implying a discount at the asset level. We care less about kind of quote unquote discount to NAV. We wanna know how cheaply we're buying the underlying portfolio, not necessarily how cheaply we're buying the stock. So that's kind of a view on how to think about that. The last thing I'd say is, I agree. I think there are some BDCs that are harshly discounted in the market and probably are great opportunities. If you're an investor and you're making that relative to value determination between public BDCs and let's say making an allocation to a private credit portfolio. If you're making a new allocation, then you're not sort of buying yesterday's mess. You're buying in theory a clean portfolio from your sense, one difference. And the other is in a public BDC, you have a volatile stock and you have to be willing to wear that volatility even if you have a view that that's a better relative value opportunity. Mr. Market can speak up loudly at times in ways that might create marks to market that not every investor is probably equipped to handle. And so I think investors ought to make sure they're mindful of how much volatility they're prepared to own while they get to what might end up being long-term just as good or even a better outcome. So like where we started, what's your objective as an investor and make sure what you're doing is kind of consistent with that? - Tell me about business development companies. I think my tourist understanding of them is they are companies that borrow money to buy things in some instances, debt in some instances, equity and everything we're talking about is mostly credit. But I know you and I had spoken earlier, you said that business development companies, there's at least on the institutional level, but there's some structural reason why they can be favorable. - I'll tell you my general understanding of BDCs and Beach Point has evaluated getting into that business at different times. BDCs accomplish a couple things. One of them is they are a good structure for offshore investors to participate in private credit in the US. There would otherwise be substantial tax issues associated with that and BDCs as registered investment companies get the benefit of some safe arborist for offshore investors. So that is not really the fundamental business purpose behind them, but that is a mechanism that has attracted capital offshore to invest in the direct lending market in the states. Beyond that, structurally speaking BDCs allow, they're open ended in the sense that they allow a continued inflow of capital over time. So from a capital raising process, you can kind of continue to scale in those structures in many cases. And that's of some benefit too. As a restriction, there are some restrictions on how leverage BDCs can be, but that restriction is generally above the tolerance, most direct lending market participants would feel comfortable with anyway. While that's a technical restriction, I don't think it serves as much about sort of business restriction in the real world. So yeah, how common is it for private credit funds to be levered and can private credit funds be levered without there being a BDC? Sure. I mean, you can have typical limited partner and Delaware partnerships and, you know, Cayman's partnerships and so forth that are participants in track lending marketplace. A BDC is just one structure that gives you some benefits, but then has a disadvantage of now you're a registered investment company, so you have different level of SEC compliance and so forth. And so there's traditional private fund structures available for direct lending, And there are different than exist for private equity and another asset class. as well. I don't think that's particularly novel technology. And same thing, you're trying to adopt the structure to the clientele and the investor base that you have. They all have different tax needs and liquidity needs and so forth. So that's really more of a matching of requirements to the product. And for our institutional client, they tend to favor more sort of straightforward fund structures and that's mostly what we do at the future. And just to leverage within the funds? Oh, sorry. Thank you, leverage. All over the board, there are some particularly insurance companies and offshore investors that are happy to own these assets unleverged, no debt on them whatsoever. A BDC's, public BDC's tend to be levered, give or take one to one, some as much as one and a half to one. Private fund managers like Beach Point, some would be more modest leverage, some would be more aggressive, maybe up to two to one leverage. And so there's really no commonality. There's more just again, matching sort of underlying client risk appetite to how you're approaching it. Some clients want the juice, they want to run leverage. They're happy to accept additional drive on risk and so forth. Others are looking for a more modest but stable streamed income and would rather not have the volatility that leverage kind of introduces to the asset class. I know I spoke with several regulators and regulatory adjacent people around three years ago. Honestly, early in my journey of understanding private credit and stuff. And they said, oh, they referred to private credit as an unlevered asset class. And of course, there are the insurance companies that are unlevered. Were they just wrong three years ago? Or is there comment illustrative of a trend that leverage has been, the use of leverage has been moderately increasing over the past few years as well as, you know, the 10 years you've been in the business. Yeah, tough, tough for me to know what specific comment they were making. But if someone were to say, hey, direct lending is an unlevered asset class, I would say that is not right. Sorry, not that you're not lending to extremely leveraged companies, but that and you know, high risk higher order, of course, but that's on level that you're borrowing, the fund is bar. Saying the direct lending manager universe is an unlevered asset class would similar be not correct. I would love to share stats if I had about how much is unlevered versus not. I would gather based on, you know, my peers and the people we interact with in the market every day that the vast majority of that universe is using some form of leverage. Even insurance companies, many of them will use what are referred to as structure notes and structure notes would be a way of trotching and rating the underlying loans. And some of those trotches will be sold to third parties, in which case, insurance companies in the sensor, absorbing the sum of the risk and reward of leverage to the extent that they're not owning the entire trot. So, you know, all different, but, but yeah, I think it's a modestly leveraged asset class and a generally responsibly leveraged asset class, but I think it's a leveraged asset class. That is good. And also perhaps those comments I heard three years ago, they may have been misinformed. I now want to ask about the limited partners of the investors in these funds. As we said at the beginning, a beach point capital, vast majority are perhaps literally 100 percent. You tell me is institutional money, not retail capital that has, you know, as my understanding that as the asset class has grown from its kind of emergence in 2005 or maybe you could say it started the 90s, whatever, that it was almost all institutional to private equity and private credits that over the past five, perhaps 10 years, there has been a growth among these alternative asset managers to diversify their investor base, not just among the institutions, the endowments, the universities, the charitable trust, but increasingly, you know, high net worth individuals as well as what's called mass affluent. So folks who are investors and can definitely afford to put money in these funds, but definitely not institutional investors. And this has come with a, I think, an increased demand for liquidity. So the rise of these so-called semi-liquid funds. So I just want to introduce this topic, get your views on it. And ultimately, I'm curious, do you think that the rise of these investors, so individual investors, mass affluent investors, whether they have a wealth advisor or not, are they suitable for the asset class? Wow. You know, you're inspiring my most capitalist inclinations in asking that question. So I'm going to answer it with that as a backdrop. I don't think we ought to be patronizing retail investors with the view that the average retail investor is incapable of making informed decisions. And so I don't fundamentally have a problem with the idea of any investor class becoming a participant in private credit or really any asset class for that matter. I do think it's critical that as a function of introducing it to that investor universe, the disclosures, but more importantly, just the good faith communication by managers as to what expectations should be are critical. And I think it's important for regulators to, you know, to keep a wary eye out for how the products are represented. And insofar as those retail investors understand, if all of you come to us for your money back at the same time, we will do our best, but you are unlikely to get it all back at the same time. You may have, you may get some of it, you may have to wait. Here's the restriction on how much we're obligated to give investors overall each quarter, each year, some of the rules that are in place, you know, for those structures. I have no sort of fundamental economic or moral or regulatory issue with that. In fact, today where what we're reading about are a lot of the retail driven managers with redemptions. You know, there's an awful lot of noises, though it implies something nefarious. I don't see it that way. Those are reputable firms. Those reputable firms, I would like to think had properly marketed those products and had provided those investors with reasonable expectations as to, you know, if we have 15% redemptions, we're only going to be able to make five this year and so on and so forth. And now I've yet to see a study that tells us whether or not those investors are unhappy. And, and, you know, maybe they are unhappy or maybe they're not. Maybe this is their expectation and this was more or less, you know, what, you know, the product that they were marketed. Moreover, there is an implication that because there are redemptions that is putting pressure on the underlying businesses of some of these managers. As we discussed just a moment ago, this is not an aggressively levered asset class. If I were those managers, I would have lines of credit available to me to make sure I could meet redemptions when it as they occur. And it is my understanding that many of them do. And at the time when they got redemptions, most of those lines of credit were not used at all. And so they had plenty of access to liquidity for the point of view of satisfying investor redemption requests, at least to part. And so, I see nothing implicitly unhealthy about what we've been reading about in the papers in some respects. I think it's healthy long term so that tomorrow's investors have an appropriate expectation of what they should expect, even if they choose to get involved. And in fact, you know, while we're seeing redemptions, what we're not seeing is what is also happening, which is these same managers are still taking inflows every day and every week. So you're seeing net outflows, but that's not to say that no new investor is interested. And so I think there's probably, you know, on the margin less noise in the industry than, you know, the front page of the Wall Street Journal would suggest. Or some other publications as well. What do you think about the so-called semi-liquid structure? Can you talk about the structure that's most institutional investors use, whether they are insurance companies, you know, the illiquid nature of that investment and how that differs from the rise of these semi-liquid funds that are distributed through the wealth and the mass affluent community where you can actually ask for a withdrawal, they're only going to tender offer a percentage of that per year or per quarter, whether it's five percent or some type of number. How it's a different structure? Yeah, institutions, the two most common forms that I've seen are one typical drawdown funds where you have an investment period, you have a harvest period, you have a static pool of investments and as they monetize, you get your money back pretty straightforward. There are somewhat more complex structures that tend to go under the monocleverine funds. So think of a fund that can raise your hands. capital continuously, so every quarter they can bring in more, and those investors, when they join in effect, are buying into the existing portfolio. What makes them suitable for institutions is that if they're looking for redemption, it is understood that what they get is a liquidating share class. So they get the proceeds from the monetizations of the loans that exist at the time of their redemption request. So they are not requiring the manager to upfront redeem them. They're just putting in notice that as the portfolio monetizes, they do not want to participate in new investments, and they would like to get paid out from existing investments. And in the case of direct lending, you know, with that's sort of a five, six, seven-year asset class, to get their capital back, you know, they'll need to play through the maturity of those loans. And so that's a structure that does not impose risk to other investors from any individuals, investors need for liquidity. And so I think it's appropriate for institutions. It allows institutions to be comfortable coming with funds with other institutions in a fund structure. And so that's a structure for this business that we favor. And I think it's showing increasing adoption in the sort of institutional community. So there's little to no usage of this semi-liquid structure among institutions. I have not seen-- Now you know, you know, I have not seen many examples of that. I'm sure they exist. And we have seen investors, institutional investors, participate in BDCs, for example. But if we're talking about private capital raising structures, the two I described, I think are the most common. Okay. That's a-- I mean, what do you think about the semi-liquid structure? You know, no real views. Like I said, you just have to be willing to accept the risk of the structures you step into. I think there are some, you know, the smaller end of the institutional community has less ability to drive structures that are bespoke to their needs. Large pension plans that are making material capital commitments can look for a manager that has more of a tailored structure for them. And so again, you just kind of kind of got to match the structure to the investors' appetite and the quantity needs going forward. Again, as long as everyone understands what they're signing up for, I don't implicitly think one structure is better than the next. I just think they got an understanding of it. Which is an illiquid asset class, private credit. Illiquid asset class, you know, when we make loans, they're five, six, seven-year loans. Many of them rate finance early, some don't. The underlying assets are going to, you know, take some time before we crystallize. That's the asset class. Michael, we've had a fascinating conversation. And it's amazing that we so far haven't talked about, you know, one of the probably most important thing, which is defaults. In the private credit world, you know, I know every tool doesn't have any defaults. I don't know if you're talking about that. Yeah, yeah. Every point of, you know, every little note and cranny of the credit world has like a different world, a different world for default. So in the banking system, delinquency, write-off, non-performing, I think the word of choice in the private credit world, at least in the BDCs, is not a cruel. What exact, and, you know, the journalists like me who like to get attention sometimes refer to those as shadow defaults. What do not do not accruals look like across? Let's just stick in the direct lending ecosystem. And, you know, we've seen a giant surge in the drama and, you know, negative headlines about private credit direct lending, again, focusing on the retail channel. Has there been a correspondent rise in default? We haven't seen it yet, or is there just a total mismatch? One challenge in direct lending is it's kind of a self-reporting industry. And so I can give you anecdotes, but I'm not sure there exists like a, like there doesn't public markets, a broad data set in which one can capture sort of the entire universe. All that said, I do not think we've seen a particularly large rise in the faults in that asset class. There's a bunch of reasons for that. One is because their relationship loans, lenders in direct lending tend to be more long-term flexible with their borrowers than can exist in public markets. And to the extent that it's one lender or maybe some small club, they're more likely to find an arrangement with the borrower that makes sense for everyone versus a big bondholder group that's got different interests and can it be more adversarial and so forth versus, you know, a private equity-backed fund. And so the dynamic in direct lending tends to be a lot more partnerly and cooperative. And as a result, loans that in the capital markets might have wound up being defaults in private space might might end up being extensions or other sort of non-default related amendments. And so that is one reason why they will on the surface, if we all had the data, look more modest than you might otherwise expect. The other reason is just that they tend to be pretty conservative structures in our business. We're not looking really to make loans that are more than 50% LTV. Whereas in the capital markets and high yield and bank loans, the capitalization of a transaction could be, you know, at times as much as 65 and even 75% debt to equity. And those very aggressive finance structures don't really exist in direct lending. So for all those reasons, no, I have not seen any evidence of any real pickup in defaults or things like that that would suggest any issue. By the way, you know, for my compliance group, it is unfair to say a huge point never has defaults. I will say in our direct lending business, we've seen a very, very healthy portfolio and very minimal credit issues. And that's been a function of a reasonably healthy economic environment together with the pretty conservative asset class to begin. Bearing in mind, direct lending, core, stable, less volatile income stream, that's the institutional need for that product. And so it would expect it to be relatively stable. You said LTV loan to value, I think in real estate, that's pretty clear what that means the loan is against the asset. So, you know, against a million dollar house, 500,000 dollar loan, LTV 50%, but when it comes to businesses, is the value, the enterprise value that the PE people invested in? Yeah, that's probably the right way to think about it. Like to the extent that you have an observable data point, which is the price someone actually paid, that would tend to be the value we assume. In cases where we're stepping into a refinancing, you don't have the benefit of that. So there you look to what our own judgment is of what we think a company is worth. And we'll tend to adopt a pretty conservative point of view. Together with making sure our borrowers still has some substantial capital still invested in the business. So even if we're three, four years after they bought the business, we'll still be very mindful of making sure they've got most of their original investment still in the company. How do you feel about the PE sponsors who are junior to you when you make loans? When you said loan to it, like what if they are unable to sell the company or do something like that? If you ask me what is our view of loan to own strategies and so forth, I just say fortunately, I never had to make that call so far in that business. You're not an old guy, but you've been in the business for a while. You never had to make that. When I said was in our direct lending business, we've never had to do that. So in our more opportunistic business, I would say that's somewhat of a more where we're accepting additional risk and exchange for additional return. It would be more common in that business. We tend not to be interested in high friction adversarial engagement with private equity sponsors that way. It's very expensive between lawyers, financial advisors and so forth, restructuring costs have kind of gone through the roof and as a result, make attractive recovery is more difficult to achieve. And in any case, anytime you're engaged in confrontational litigation, which is what bankruptcy is, a judge has an awfully large power with that gaville and that gaville can render outcomes that you might not have anticipated, so create some uncertainty. More often than not, when we are getting involved in circumstances where we expect to, or at least reasonably likely to own the company, all parties around the table understand that that is the case. And so there's, for example, a circumstance right now we're involved in where we got involved in the stress credit? We knew the company was stressed, management team knew it, the private equity owner knew it. And our arrangement with them was to give them time to sell the business to recover some of their investment. And if they did not, they would work cooperatively transfer governance and ownership to us. And that happens to be what happened in that circumstance. And so yeah, we became the owners of the company, but not in a sort of without a lot of friction. And we would far prefer in those circumstances to find a way to be as partnerly as we can. But in opportunistic credit strategies, either by plan or by outcome, there are times where you need to be ready and capable of stepping into ownership. You know, a part of our business that we don't spend a lot of time talking about is when that occurs, we have a deep and experienced team who have been involved in governance and owning and really being the sponsor for a broad variety of businesses across a number of different industries. And so while it's not always the plan, it's certainly a comfortable circumstance for us when we find ourselves being a little more of a director of those businesses. Right. And actually, earlier today, I did an interview on the shipping industry. And I found out that one of the biggest holders of a major shipping company is an alternative asset manager who, based on their famous and the stressed debt business, I imagine that that was a quite favorable situation for them. And also the fact that you and your career have never had to take over a business in the direct lending, not just to stress your opportunistic. I think that goes to show how a lot of people can say, oh my god, how can people be so into private credit? The historically, the performance has been quite favorable, especially if you compare that the higher yields relative to the high ill bond market and the leverage on the market. Just put it that out there. For sure. Look, I mean, for Beach Point's experience in direct lending and other features, there really hasn't been a severe credit cycle in that period of time. And so I think we've gotten the benefit of generally a very warm and favorable breeze at our backs. And undoubtedly, there will come a credit cycle that will put us in the position of having to make some of those judgments, a benefit of having that business exist across the broader Beach Point platform is, across our business, we have restructured a number of companies. We're comfortable being the sponsor of those companies if that comes to pass. And so not looking forward to that environment, but it will be neither for and nor uncomfortable. It'll be one that will step into being pretty confident that will maximize recoveries. And actually, I happen to think that that will be a huge differentiator in manager performance, those who are capable and comfortable working through credits when private credit sees its first real deep credit cycle. And those that have been great at originating portfolios, but don't have either the sort of culture or expertise to really understand how to maximize value out of a trouble month. And so having had to lean on that skill set, but we are certainly a ready willing and able to do so. And one day we'll have a severe credit crisis, and that will shake out the private credit industry. I think the result of that will be us in firms like ours demonstrating our hidden value. And so in a sense, I look forward to it. But so far, haven't really needed to deploy that toolkit. It's an opportunity for differentiation. And yet, we haven't had a real credit cycle in close to 20 years. And that's been a tailwind for all credit investors. You're saying, obviously, there's going to be a credit-- it's not going to be $2,200. We have all this new technology. There's never been a credit cycle to do that. To hold the thing, there's no more cycle coming. There always will be the next one. And what I'm certain of is the catalyst for that cycle is not something any of us thought of. I feel very confident that whatever it is, it's nothing any of us are circling today is a particularly prime cause of whatever that looks like. But you don't think this is it right now. You don't think this is the start of something, these redemptions from the funds that are mostly have retail investors. And you don't think that or maybe not. I do not. I do not. I think this feels like a normal circumstance for retail, a sort of illiquid asset category. I think it's in many respects a good tool for that industry so that those investors know what they're getting involved in in a sense, maybe even on the margin helps a little bit. Nor has there been any indication that investors, even if they've been gated in redemptions, are somehow going to be subject to losses they didn't anticipate. I don't think anyone's talking about that. They're just talking about needing to return capital a little more slowly than maybe investors are requested. I don't view that as a particularly long-term problematic. So you think that it's a liquidity issue but that the fundamentally the health of private credit is overall sound. Pretty intact. There will be managers who do poorly on software loans. There will be managers that have experienced poor credit selection. There will be managers in the next cycle who understand the sort of restructuring business and recovery optimization business, not as well as some of their peers. And that will create dispersion in manager performance and outcomes and any financial investment management asset class should want that. Should want there to be some shake out so that those who are good at what they do and have an easier opportunity to demonstrate that. Well, I don't look forward to the credit cycle as relates to stress and credits. I do look forward to it as relates to being able to kind of demonstrate what I think we're particularly good at. One thing for sure, Michael, is if and when that credit cycle comes when, you're going to have a lot more gray hair than you do now. Hard to do, but sure. Probably I will. And like I said, you've been in this game as long as I have. You know it's coming. You try and be dispassionated about it. You make sure you're not sort of scared overreacting seller. You make sure you're not necessarily the early buyer too because avoiding the following night is also critical in those environments. And so you walk into work with pretty resilient patients and a little bit of quiet optimism that you know what it's going to look like on the other side. And that's been our experience of each one. Those are the environments where we see the shine best. Michael, we'll leave it there. Thank you for coming on monetary matters. Thank you, everyone, for listening. Thank you for having me really enjoy it. Take care. Remember to check out Kaya NXT to level up your knowledge of alternatives today. Visit the link in the description to get a 10% discount and learn about what's next for your clients.