00:00We can talk about some of the liquidity issues. I know we talked about it a bit on our panel,
00:03but I first want to start with these comments from Mark Rowan, this idea that there's going
00:07to be a shakeout in the industry. And he says, I don't think it's going to be short term.
00:12He's pointing to hyperconcentration in software. Do you agree with him? Is there going to be a
00:16shakeout in private capital? So look, I think when you think about private credit, I think there's
00:21two issues you have to think about. There's a technical issue and a fundamental issue.
00:25I think on the technical issue, obviously we started to see in the fourth quarter
00:29where some retail investors who had gotten involved with these vehicles start to redeem
00:33and some of those inflows kind of start to slow down. And so that creates kind of a technical
00:39dynamic. And then there's the fundamental. And with the fundamentals, I would say a couple of
00:43things. On the one hand, if you look at where default rates are in public loan markets right
00:48now, they're about 1.3%. If you look at where the non-acruel rate is in private credit, it's also
00:55kind of in and around 1.3%. Now in the public market, if you add back, you know, sort of
01:01LME
01:01transactions, that probably takes you to something like a 4% type number. But the state of kind of
01:07credit markets right now, public and private, the actual sort of performance of the companies and
01:12defaults and so on are actually at a healthy level. That said, we are late in the credit cycle.
01:18Uh, we've had a benign credit environment, uh, going back to almost the end of the global
01:23financial crisis. Uh, and that is by historical standards, a long period of time. Uh, and so with
01:28every, you know, month and year that goes by, you're sort of later, uh, in that cycle. Um, as
01:33relates to software, there was a period of time where software was 30% of, you know, kind of private
01:38equity deal flow. Uh, and so that worked its way, um, into the, uh, into the loan markets, both
01:43private credit. By the way, Vivek, why, why is that? Because if I look at the S and P or,
01:49uh, you know, the Russell or even high yield, we're talking about 7% or 4%, you know, of these
01:58indexes, uh, are our software. And if I look at direct lending, if I look at private credit,
02:03it's like 25% or as you say, 30% at one point, why, why so much more allocation to
02:08software?
02:09Well, look, I'm, I'm giving you industry volumes. Not every manager, um, has that type of
02:13exposure. Our exposure is much, much less than that. Um, but part of it is that, um, you know,
02:18some of these businesses are actually really good businesses. And I think one of the things we have
02:22to be careful not to do is to paint all of software with a broad brush. Uh, there are different
02:27types
02:28of software companies with different models, different of those companies will have different
02:32levels of exposure to AI disruption. But I think the broader point is, um, it is a good reminder that
02:37it's important to have a diversified portfolio. Uh, and one of the things that we've been very careful
02:42about in portfolio construction, uh, is making sure that we do maintain a diversified portfolio.
02:46Uh, and that's why our software percentage is, you know, sort of much lower than some of these
02:49numbers that you're seeing from others. By the way, it goes beyond software. You put out an
02:53excellent letter, uh, last week talking about some of the concerns around private credit.
02:58And we have seen a lot of outflows. I realize that there's been a lot of noise,
03:02that there's a lot of headlines to contend with, but do you think that this industry has made
03:06mistakes along the way as it's seen this rapid growth? Uh, so I think it's important. Um, and
03:11we've been very deliberate, uh, as we've sort of thought about, uh, the retail community. Um, so I
03:15think it's very important, uh, that as this market grows, that it grows in a measured way, uh, and
03:20thinks about, uh, the way in which it's growing and communicates, uh, the risk around that. Uh, so for
03:25example, we do not use the word semi-liquid. We understand what people mean when they use that
03:30phrase. Um, but for us, when you're investing in private credit, it is a private asset class.
03:35The loans are illiquid. And part of the premium that investors are getting for, uh, uh, you know,
03:40relative to public markets is for that illiquidity. Uh, relative to a drawdown fund, there is, uh,
03:46a best efforts ability to have some interim liquidity. That, uh, liquidity can be subject
03:50to gates, but those gates are a feature, not a bug. Uh, and they're actually designed to protect
03:55the investor from a technical dislocation because in a technical dislocation, you can have,
04:00you know, sort of value degradation from sort of fire prices.
04:03Are we heading towards that right now with what we're seeing that you might see some
04:07of that technical degradation turn into a fundamental problem?
04:11Um, look, I think that just because you see an uptick in redemptions doesn't necessarily
04:14mean that you see, uh, a kind of a, uh, that type of degradation. I think for three reasons.
04:19One is, um, you know, all of these vehicles have, uh, pretty healthy liquidity sleeves.
04:24Uh, and so, you know, a lot of these vehicles, 20% or more of the vehicle is in liquid
04:28assets.
04:28Uh, so that's point number one point number two is remember this is credit. You have fixed
04:32maturities, you have cashflow. And so these loans mature and for a lot of these portfolios,
04:37a lot of these managers, 20% or so of their portfolio, the capitals returned every year
04:42from sort of maturing loans. And so that creates a lot of liquidity. Uh, and then third, you know,
04:46you still have, uh, inflows from some various channels. And so when you add all of that up,
04:51um, it's not clear you will have that technical dislocation, but that's the point of the vehicle,
04:55which is the, the vehicles are structured so that you don't have to have a kind of a technical
05:00dislocation and you don't have to have a fire sale. What, what do you see? I mean,
05:05the canary in the coal mine is if you, um, start to see these software companies go bankrupt and
05:12we've heard, uh, forecasts like from UBS, for example, that you could see up to 15% default rates.
05:19Um, how do you see that playing out? If we get to numbers like that, how serious is 15%?
05:25Well, look, I think that, um, again, there's a spectrum of software and I think it's important
05:29to understand, you know, what type of software and what are the characteristics of that software
05:33portfolio? Are these companies that are, uh, you know, kind of creating revenue, but not free cash
05:38flow? And are you lending off of revenue? Are you lending off of free cash flow? We, for example,
05:42have been very careful about having a very, very small, small, small single digit percent of our
05:47portfolio, uh, in these so-called sort of ARR loans. Um, you know, again, if you think about
05:52the broader industry, um, if you think about, uh, default rates kind of picking up, um, you know,
05:57the next question is what's the recovery rate. And so if you were to have a elevated default rate,
06:02uh, what's the recovery rate on that and how would that play through portfolios? If you have a 10 or
06:0715% default rate and you have a 50% recovery rate and that plays out for a couple of
06:11years,
06:11what that means is you have a five to seven and a half percent value degradation on an asset class
06:16that's kind of been earning 10% net. So if you're earning 5% net instead of 10% net
06:21in that sort of
06:22scenario, you know, that sort of frames, you know, one potential outcome, obviously there's better
06:26outcomes and worse outcomes than that, but that's how I would think about sort of the risk of defaults
06:31rising. Vivek, I realize in a lot of the ways you're talking about this, you're talking about
06:35averages. So I'm assuming there is a place that there's a concentration in pain. Maybe it's managers
06:40who are overly exposed to software. Maybe it's smaller ones who can't get the same type of terms.
06:45Where exactly is that pain? And what does it look like on the ground? Are there just a bunch of
06:50zombie private credit managers wandering around who are facing bankruptcies that are taking back
06:55keys and are struggling to fundraise? Look, I, you know, we're obviously focused on our own
06:59portfolio and our own clients. And so, um, you know, we don't track sort of the entire industry.
07:04You must hear a little bit out there though. What I would say is two things. One is that, um,
07:09I do think that, um, you know, we've always set ourselves up with the assumption that the credit
07:13cycle will change. We don't know when it will change. We're not in the prediction business,
07:17but we're in the preparation business. And so we underwrite every credit, assuming that there
07:21could be a recession, um, platform and track record matters. We've been in the private credit
07:25business for 30 years. We've been in the senior direct lending business for 18 years. Um, and we
07:30have a very diversified source of funding. And so, you know, for us, the vast majority of our capital
07:34comes from institutional clients. And so we're less exposed to, you know, some of these kind of
07:39technical issues in and around retail. Uh, and so we think that, you know, there will be dispersion
07:43among managers, just as there is in public credit. And we think that, um, you know, being a platform
07:48where you're diversified, both on the types of investments and the sources of funding is how
07:52you kind of weather through cycles.
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