IQ-EQ Virtual Debate: ‘Debt is dead. Long live debt!’

0:14

Hello and welcome from the IQ-EQ studio. I am Justin Partington,  Group Head of Funds at IQ-EQ, and it is my pleasure to introduce this unique debate on debt in 2021, between Richard Vague, author of A Brief History of Doom and The Next Economic Disaster and Gabriel De Alba, an international investor.

0:48

The rules require me to disclose that this debate is sponsored by IQ-EQ, in case you hadn't noticed.

0:54

In terms of format, we will have six segments with two-minute answers from each speaker.

1:00

As the moderator, I may prompt a follow up discussion or rebuttal on any of the questions or statements and the speakers will be allowed that brief rebuttal.

1:09

Both debaters have agreed to these rules.

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For the record, IQ-EQ has chosen the questions for this debate.

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I would like to emphasize that this debate is being conducted under strict health and safety protocols. As a precaution, both debaters have agreed not to shake hands at the beginning of the debate, which would be tricky anyway as coronavirus has meant this is now a virtual event. The audience in the webinar is to remain silent. No cheers, no boos, no interruptions so that we and most importantly you can focus on what the debaters have to say.

1:43

And when we saw the audience list, we thought it best to put you all on mute anyway, just as a precaution.

1:49

Now, I am very honoured to welcome such impressive speakers in today's debate.

1:57

Richard Vague, is the Secretary of Banking and Securities for the Commonwealth of Pennsylvania.

2:03

He is the author of A Brief History of Doom, A Chronicle of the Major World Financial Crises, The Next Economic Disaster, a book with a new approach for predicting and preventing financial crises, and the upcoming illustrated business history of the United States to be released in early 2021.

2:22

Mr Vague is the founder of the Economic Data Service, Tycho's, at Tychosgroup.org, which specializes in analyzing private debt trends.

2:31

Previously he was Managing Director of Gabriel Investments, an early stage venture capital company.

2:37

Mr Vague was also co-founder, Chairman and CEO of Energy Plus, and also co-founder and CEO of two banks; First USA, and Juniper.

2:50

Gabriel De Alba is an international investor who has recapitalized, restructured and built businesses in the US, Europe, and Canada, as well as the emerging markets.

3:00

Mr De Alba has spent 19 years as Managing Director and Partner of the Catalyst Group, which raised over $4.5 billion, across seven investment funds.

3:11

He has acted as Chairman, board director, and CEO of multiple Catalyst portfolio companies.

3:17

Mr De Alba also led stakeholder groups in distressed and special situations in both credit and equity.

3:25

In 2018, he was named Global Private Equity Growth Dealmaker of the Year, by the Global M&A Network.

3:32

His experience includes investing in seven economic crises dating all the way back to the 1994 Tequila Crisis.

3:45

Gentlemen. A lot of people have been waiting for this debate. So let's get going.

3:53

3:59

Our first subject is the state of the global debt market.

4:04

The 2021 Preqin Global Private Debt Report highlighted that private debt emerged as a core alternative asset class after the global financial crisis and has again proved its worth in this current economic slowdown caused by the Covid-19 pandemic.

4:22
 
 

Statement one: Private Debt seems to thrive in crisis only, agree or disagree, and why?

4:30

Gabriel, in this first segment, you go first, two minutes. 

Thank you Justin and thank you to IQ-EQ for this great invitation.

4:39

Richard, it is an honour to be in this discussion with you.

4:42

To your first question, I absolutely disagree that private debt is only viable in challenging crises. Private debt has actually proven to be sustainable, not only during crises, but also beyond moments in which the international markets and the local markets have been suffering for challenging economical environments.

5:09

It seems at the moment that we're suffering from the Covid crisis. We are experiencing the most exciting and a broader set of debt markets that have existed in basically the history of modern financial theory. The markets have benefited not only from great appetite on the pursuit of yield, but actually great support from monetary authorities across the globe.

5:36

Private debt has been proven to not only be a good risk return opportunity but actually to also support companies during this period of crisis.

5:46

Thank you, Gabriel.

5:48

Richard.

5:51

Thank you to IQ-EQ. It's an honour to be here and it's a great privilege to be on stage with Gabriel, given all that he has achieved.

6:02

To the point, I also disagree, private debt does not thrive only in crisis. In fact, private debt is often a contributor to crisis, as with commercial real estate debt in the 2008 global crisis or energy debt growth, and the 2015/16 energy crisis.

6:20

As an investment opportunity, private debt sector is hard to ignore, since taken as a whole it is a much larger part of the economy than government debt in the US and most other markets. Globally in countries that together total 90% of all GDP, public debt totals roughly $70 trillion, while private sector debt totals a total $123 trillion.

6:43

Private debt can be a solid safe contributor when national or sector debt growth trends are benign, because over the long run, as has been mentioned, it can provide better yields than other types of debt instruments.

6:56

And yes, private debt becomes a great opportunity in a crisis because fear takes over lenders and debt buyers overreact, and withdraw from markets in debt and equity, frankly, get oversold that creates opportunities for brave and savvy investors.

7:12

However, success investing in debt within a particular depends on genuine and deep familiarity with credit in that sector.

7:20

Our view is that an important predictor of risk is the sheer volume of loans in a sector.

7:27

For example, the energy sector, we measure that, but by dividing total credit, including bank loans in a sector by GDP and watching the trends, from quarter to quarter and year to year in that sector, we include all credit, as mentioned.

7:43

There's a pattern. If debt growth is low or benign, it's probably a good sign that credit risk is benign. If it's growing rapidly, especially over a period of 2 or 3 years, it is likely a sign that overcapacity is being created. Too many buildings, too many drilling rigs and credit problems will emerge, there's usually a second space.

8:03

This usually brings a contraction in that sector. At the point, the industry is struggling with credit problems in a given sector and lenders are pulling in their horns. Something that's usually accompanied by a plateauing or contracting of debt, it is probably a good opportunity for buying distressed debt.

8:20

Thank you, Richard. Thank you.

8:22

Mr De Alba, Any comments, too much volume? Handling the crisis? Any rebuttal?

8:29

I actually agree with Richard, that debt in itself cannot be seen as a single standalone asset class. I absolutely agree why there are some sectors, especially the investment grade sectors, that have proven reliant.

8:43

I actually believe that the lower rated sectors, they well, that is alive.

8:50

There is also overextending, I think, that the life of debt, is also one that goes into a cycle of overexpansion, and then distress and opportunities.

9:03

I understand that at this moment, while the markets are extraordinarily strong, they are risks that are being taken that are likely to result in large opportunities for investors that can capitalize on the overextended risk appetite for the lower risk credits.

9:24

Especially the ones that will be challenged to get back to a normalization of their performance, following the vaccination and re-opening period post Covid.

9:35

In other words, thank you.

9:37

If it does, it is difficult to sustain it.

9:41

Thank you, Gabriel. Let's explore that further in a second statement, which is around the changing environment, which you've alluded to, in terms of times of change.

9:48

So, second statement is, private debt is a safe haven investment in that changing environment, agree or disagree?

9:57

Gabriel, please pick up where you were.

9:59

Again, on the private debt side, lower rated credits of companies who have replaced their revenue with debt for the past 12 months which are also expected to continue to suffer from a slowdown in the revenue recovery, slowdown on EBITDA and the cashflow recovery in the coming 6 to 12 months that part of the market, which in 2020 requested covenant waivers and amendments, I believe it's overextended. I believe lenders and governments have been patient.

But it's likely that with the re-opening, a lot of the economic reality of the challenges that these companies who have over levered themselves are experiencing are likely to result in a large amount of restructuring. It seems that, at the moment, governments have banned and stopped several recapitalizations under restructurings by basically providing free debt or actually negative rate debt. I actually think that, well that trend is not sustainable.

11:06

Thank you, Gabriel. Richard, you care to comment?

11:09

Yeah. The question is, Is private debt safe haven investment haven and a changing environment? And I tend to disagree, because that is far too much of a blanket statement.

The answer, as to whether it is a safe investment in a changing environment, is very sector specific, take 2004 to 2007. There were some sectors that managed to resist the siren song of debt growth and fared fairly well. Others obviously partake of that and brought the crisis. Change presents both opportunity and risk.

11:45

In fact, if the changing environment you're referring to results in a rapid acceleration of sector debt, then I strongly disagree because that particular change, in and of itself, creates risk. The acceleration of debt levels usually is the agent that brings change that impacts markets. Commercial real estate lending can bring a rise in valuations. But if it continues, the over lending eventually brings over capacity and collapse. A rapid increase in home lending can bring a rise in home prices. But when that debt trend brings over saturation and homes, it does the opposite. Too much lending in the energy sector can bring to many regs and the very drop in prices that lenders fear I call it the paradox of debt that is necessary and can be good, but a rapid rise or levels that are too high bring problems.

12:40

Thank you, Richard, a brief rebuttal, Gabriel?

Not a rebuttal, but a further expansion on the topic. I actually believe that the over expansion of debt that we're currently experiencing has to do with the fundamental change of who the participants are in the market providing debt with the entry of CLOs, (collateral loan obligation) funds, which look to accumulate and repackage layers of debt

13:11

a lot of the credit analysis is left as a second priority versus the structuring aggregation and packaging of debt.

13:22

So, it's not only over expansion, it is the fact that we are now packaging a lot of private debt into structural problems, which lacked governance. In some cases actually lack the required credit analysis and in sectors that are overextended that we are unable to perform.

These structured products are also slow to react because of their own limitations as to how they need and can deal with situations where they're distressed or there are covenants required to be waived, or there are defaults and bankruptcies. The CLOs are not necessarily adjusted to deal with these.

14:01

Thank you, Gabriel. Thank you.

14:03

Let's move on to our third question. Dominique Mielle, a Forbes contributor, said in an article published on the 12th of January 2021, that distressed investing is one of those trends, like shoulder pads, which, one must be exacting, not only with timing, but also interpretation.

Incidentally, I'm reliably informed that shoulder pads do feature in the Louis Vuitton 2021/2022 fall/winter collection.

14:28

But now, is this the right time for debt, and how best to execute a debt strategy? Richard?

14:38

Thank you. And I know I've already acquired my shoulder pads for the new season, but again, the answer is sector specific.

14:46

And getting in at the wrong time is easy to do, because the worst time to get in is usually when everybody is excited about a particular type of security.

14:57

Timing is critical in private debt, because different sectors show markedly different trends, and getting in at the wrong time can be disastrous, while getting in at the right time can bring a bonanza.

15:08

Our view is that the underlying trends that provide insight into risk don't happen in a day or a week or a month, but instead develop over a year or 2 or 3, and so are very possible to detect.

15:22

It is important to know a given sector space well and have your own sense of true underlying value well in advance of the sector’s distress.

15:31

What we've seen in the Covid crisis is that in the US, private sector debt has gone from somewhere in the order of $16.9 trillion to well over $17.5 trillion, So you've seen a lot of growth in that category.

15:49

In the high yield debt in particular area we've seen that grow from $1.4 trillion in 2018, to the current level of $1.75 trillion which is a percent of GDP is now above the level reached in 2007. So it is clearly an area for a heightened scrutiny overall.

16:13

Thank you, Richard.

16:14

Gabriel, two minutes.

16:17

I'm not into the shoulder pads theory, neither fashion. I actually think that distressed investment is actually an ongoing part, which at times indeed grows. I actually believe that the opportunity set for distressed investing, as we will see, post the re-opening and vaccination period of Covid, in which there are going to be situations across the globe in which companies or economies will have to re-adjust and can no longer continue to experience the beneficial overextension of monetary and fiscal policies, as well as negative rates. And the back to reality period is going to happen is providing for an extraordinary opportunity to sit on the distressed side. Now the distressed side is also not the same as it was before.

17:04

Distressed requires now leadership and co-operation and the ability to gather groups of stakeholders that are prepared to work with management to recapitalise, restructure and transform business. So, actually, distressed investing is a great combination for investors that are looking to have the opportunity to have disproportionate and asymmetric returns by investing in senior debt, but at the same time, participate with parties that can lead the restructuring on the legal side, the restructuring, and turn it run on the operational side, the recapitalization of the balance sheet, the reset of the strategy, and a transformation that now also includes ESG policies at the governance level and also digital transformation of businesses so that they can be set up to better perform post the crisis.

17:56

Thank you, Gabriel.

17:57

Richard, a brief comment. Yes, I think Gabriel has said it very very well in both of his recent comments.

18:06

There's going to be a rare opportunity for distressed debt investing.

18:11

But it's going to take a lot of savvy and a lot of work.

18:15

I'll repeat something. I said a moment ago from December of 1919, when private sector debt in total in the US was $16.2 trillion, it's grown to $17.7 trillion. So you can see businesses and individuals have levered up in spite of what the headlines we read recently about, you know, will we have demand for credit? There has been an enormous demand for credit. Folks, sectors that have had too much going on have increased their debt even more, so opportunity should have bound for the savvy.

18:50

Thank you, Richard.

18:52

Let's turn to ESG, which was mentioned just a moment ago.

18:55

So on the fourth question/statement, the rising tide of regulation on ESG, for example, will ensure transparency and private debt as in other asset classes. For or against. Richard?

19:11

You know this, we love this subject. We are strongly in favor of increased disclosure and transparency. New regulation and legislation will require disclosure by certain managers in some detail of the risk of ESG impacts on the value of an investment, and about whether and how they take account of longer term ESG impacts.

19:33

In my view, there's a solid benefit to having relatively uniform disclosure requirements for ESG, which can support investor choices. It can also help avoid what's been termed greenwashing situations where investors are being misled by claims about the environmental benefits of an investment.

Increased disclosures will help everybody. It seems that increased ESG investing is being driven to a certain extent by the increased availability of this data. For accredited analysts, transparency is always good, especially in the long term. As someone who is constantly confronting the lack of sufficiently detailed data for even relatively recent timeframes, I applaud the trend.

20:16

By the way, there are lots of other areas that need more disclosure too beyond ESG. Derivative information in some countries is very hard to get. As one example, R K Goes has shown us that we could have used more disclosure requirements for those derivative contracts called total return swaps, which allowed it to match a huge stakes and publicly traded corporations without disclosure. We would hope the spirit of a disclosure would go beyond ESG.

20:44

Thank you. Richard.

20:45

Gabriel: Yeah, totally embrace it that ESG is indeed a value added approach to investing.

20:54

Just to describe some of the things that we have done on our own portfolio companies, We position them in the terms of governance to be certainly socially responsible, environmentally driven, and governance that indeed can see there's multiple stakeholders while indeed pursuing these policies to motivate management teams and employees to deliver great risk adjusted returns.

21:21

This starts with the environmental front, it is the dedication of resources to companies that can prove themselves as sustainable.

21:30

On the social side, it is making sure that the policies and adjustments, even on a turnaround, consider how to reposition companies and employees so that the companies can thrive and be better aligned and can grow not only in revenue and EBITDA would even grow their employee base in the coming future, also turnaround other restructuring. And on the governance side is putting and tying together the business plan that in addition to looking to generate cash flow, generate margins, also looks to regenerate the sustainable business in which indeed the governance relates to transparency, accountability not only in terms of accounting and reporting, but also to all stakeholders, certainly including shareholders and employees.

22:20

Thank you. Thank you, Gabriel.

22:21

Let's move on to the fifth question/statement.

22:24

A controversial area at times: covenant light loans are often referred to as the scourge of corporate lending, Agree or disagree.

22:33

Gabriel.

22:35

I think, you know, covenant light loans are dangerous. As we were just discussing, debt lenders and debt market participants have the opportunity to better frame not only ESG, but the direction and the risks that companies should take in order, indeed, to have a sustainable business going forward.

22:57

Covenant light loans forget about this framework of performance in a way, take disproportionately equity risk when that is going away from just lending.

23:09

I can tell you that, again, not only this is dangerous, but usually these loans end up in the hands of investors which were only chasing yield without having done the right risk return analysis.

23:22

I also understand that several private equity sponsors push credit investors, debt investors, toward covenant light loans in order to allocate capital. I think this capital is then getting allocated on a risk adjusted basis that is not appropriate to the underlying investors of the credit funds that are providing the capital.

23:48

Thank you. Gabriel. Richard, can you comment, please.

23:52

Gabriel, as a practitioner, I think, has hit the nail on the head, and in our view all credit crises, all credit crises, whether they rise to the level of a national banking crises, as they did in 08, are contained within a sector are preceded by compromised credit standards. It is one of the clearest signs that lending totals within that sector will rise. First, bringing a boom, then bringing over capacity that brings credit problems and a bust.

24:22

They are a very important signal to the careful analysts. The cycle is always the same. In an otherwise placid sector one lender, or issuer, with relaxed credit standards, and that loan, or bond will be a great success, encouraging others to follow suit.

24:38

Then given time, another lender or issue will loosen them still further, and those loans or bonds will also be a great success. So, again, others will pile in. Sophisticated rationale for the appropriateness, this loosening or proffered, anyone who is not willing to loosen standards in keeping with others is left behind. The trend continues bringing rapid growth in debt within that sector: a boom. It brings too many buildings, too much drilling too much of something else, that then brings an earnings decline, and an impairment of credit. We studied major lending crises over the last 200 years, and the six largest economies in the world, and we can't find an exception.

25:19

The only differences are the extent of the misbehavior and the actions of regulators and governments in response. Covenant light loans stand in this tradition.

25:31

Thank you, Richard.

25:32

Gabriel, any final comment?

25:35

Again, we have said disproportionate risk practice that leads to loosening behavior, mostly by asset aggregators that tend to follow, as Richard has properly said, a trend and forget about the underlying credit analysis. I don't think that those loans end up working out well.

26:00

Let's conclude this extremely interesting debate by asking a question. A final question to our speakers.

26:08

Debt is dead. Long live debt! Agree or disagree?

26:12

Richard?

Debt is definitely not dead, so long live debt!  Private credit will always be with us because it is the agent and catalyst of economic growth. It takes debt to build factories, build office buildings, buy houses and cars. Private debt permeates the economy and economic life, as we know it would not be possible without copious amounts of private sector credit.

26:40

As mentioned, private sector debt taken as a whole is much larger total than government debt in the US and most other markets. If you add in US household debt, the total in the US is roughly $34 trillion, of which $17 trillion is business debt.

26:55

So you can't ignore it.

26:57

Private debt normally carries a yield premium, and therefore, it can be an important component of a balanced portfolio.

27:05

Notably, private debt has almost always been a larger and more consequential factor than government debt and economic outcomes.

27:12

I think I mentioned this, but globally, public debt is $70 trillion in private sector is $123 trillion, so, private debt, long live, private debt.

27:25

Thank you.

27:26

Gabriel. Agree or disagree?

27:29

Agree.

27:30

There is a life that is actually transforming itself.

27:36

At the moment, we have probably the most successive risk-taking market that we have experienced in the recent modern times, in the form of the willingness to take risk in proportion to the return that has been allocated.

27:51

We went through this during the 2008/2009 crisis, and now, all of these efforts, as Richard has mentioned, have resulted in more than tripling the amount of leverage that existed in the system just 12 years ago.

28:06

At the same time, markets are more competitive.

28:10

Companies have to be more aggressive in order to perform as they're getting more and more levered, their ability to become sustainable becomes more challenging.

28:20

There is a life, that is transforming.

28:23

Well, there most of the companies wouldn't be able to thrive with finance and grow.

28:28

We believe the disproportionate amount of credits will also have to go through a process of rebirth, in which those companies will have to re-adjust their balance sheets, look for recapitalizations, look for turnarounds, and restructurings.

28:42

But what makes me very positive about this is that, in this moment, ESG transformations and the digital inclusion into business plans by the practitioners that it can also work on turnarounds are going to bring back companies that will be stronger than what they were before.

29:02

This is better than the alternative, which is to keep so many companies that can barely afford their debt,

29:07

management teams that cannot thrive, and employees which are not able also to develop their careers, because they are trapped on capital structures in which that basically absorbs all of the profits.

29:20

So this opportunity to revive companies to revive the debt markets, and to transform balance sheets, I think, it's not only the best in history, but one in which, the practitioners are capable to, not only reduce the debt, but have the companies thrive through digital and operational transformations.

29:40

Gabriel, Thank you.

29:43

We have a number of questions from the audience.

29:49

Our first subject is the state of the global debt market.

29:58

The first question we have from our audience today is: Will private debt funds continue to increase their market share of total debt at the expense of banks? Richard?

30:11

No, I think it's reasonable to believe that that's true, and that has really come as regulators, particularly out of the great recession, became concerned about certain types of debt and really clamped down hard on banks that has caused really what I might even characterise as an explosion of alternative sources, business development companies, private equity lenders, and on and on and on. So, I think it's a reasonable thing to think that that will continue to grow outside of the walls of traditional banking.

30:48

Thank you, Gabriel, could you comment on the share of the banks? 

Certainly, I think Richard has said it well.

30:56

I will add something else.

30:59

I don't think banks in many cases in international markets have properly classed their own assets, their own balance sheets from some of their residual challenges that they have following the 2008 and 2009 debt crisis. Those banks have not been able to properly recapitalize themselves and have not been able to bring those non-performing loans out of the market.

31:27

This makes the banks not really the best suited parties to provide debt financing, especially to lower rated or smaller sized companies.

31:36

This opens the opportunity for private lenders to be able to capture market share.

31:43

We, in this case, the warning that not all private lenders are made equal.

31:49

Some of them have been very solid and have been able to bring out very sustainable risk while others are taking disproportionate risk

31:57

in portfolios that are not well diversified, not necessarily well put out on the credit side and those are likely to result in explosions.

32:05

So I believe the banks have not properly classed themselves. I believe private lenders are becoming more and more important. But that also results in some of the private lenders, having to go and restructure situations that are not going to work for them and my concern is that they do not necessarily have the capabilities, the resources or the legal fiduciary mandate to deal with the non-performing side of the portfolio.

32:30

So while the side of private lenders is growing, I believe the opportunities indeed for restructurings is going to continue growing.

32:38

Thank you Gabriel.

32:40

The second question we have from the audience is about combining LBO loans into a business development corporation. It's a trend for publicly traded debt, what are the risks with this LBO combination and these vehicles that may not be credit rated? Richard?

33:03

I mean, I would make the comment that I think there's a lot of great BDCs out there, and this has been a useful and important development, but I would mention something that we had a lot of discussion about 10 or 12 years ago, and that is in a BDC

33:21

you have separated those who get rewarded for this from those who are taking the credit risk. I mean, individual buyers in many cases aren't that sophisticated who are buying investments in BDCs.

33:36

So the possibility of a BDC offering debt, making loans, with their investors' money, where they're taking excessive risks exists, I think, to a degree that needs to be watched.

33:57

Thank you, Richard. Any comment, Gabriel?

33:58

Yeah, to follow up, regulators have put limits that usually do not allow banks to lend into into situations where debt to EBITDA is more than 2 to 2.5 times. LBO's are getting done on multiples, which are closer to 10 plus times.

34:21

The leverage that LBO's usually tried to establish their balance sheet are levels of six, plus times 6, 7, or eight times.

34:31

A private equity sponsor that is putting together an LBO is looking to maximize equity offside, by writing the smallest possible check on having the disproportionately large amount of offside to that equity investment, which in some cases is tried to be minimized to only 20 or 30% of the total enterprise value

34:50

which means that the private lenders, BDCs, and others, are the candidates to take on the LBO debt financings which are done at the highest leverage levels and are also at the lowest credit levels.

35:05

I think that this is, again, an area in which there is a disproportionately large amount of risk.

35:10

An area in which the practitioners are not necessarily following the credit profiles, but actually an area in which the restructurings happen in a disproportionately large basis.

35:20

So, for turnaround and distressed investors, it's a good area to focus on as many of these leveraged buyout loans end up in restructurings.

35:31

Thank you, Gabriel.

35:32

It ties into the next question in a way, which is quite a short one, which says: Is debt the new equity?

35:41

Richard, you can comment.

35:43

Yeah, I think there's a difference between debt and equity that is profound and will persist.

35:49

You know, that has a mandatory interest payment, and as a maturity date, I think the differences between debt and equity are important.

35:59

If what you're saying, now, if the implication of the question is, are people relying more and more on debt vis-a-vis equity, I don't think that's true at this moment, but there's definitely that possibility of just a fundamental structural increase in leverage that would represent risk.

36:21

Thank you, Gabriel.

36:22

I will actually say that debt is becoming the new equity risk, but is not having the compensation of an equity expected return.

36:35

We're seeing in the market levels of lower credit quality names that had been affected by the Covid crisis.

36:43

Many of these businesses remain fully shut down.

36:47

Many of these businesses do not expect to get back to a normal level of EBITDA until 2023, and still they have been able to raise lower quality, low covenant, low coupon debt, even though this debt is lower rated, which is basically covering the equity hole that is currently existing in the capital structure.

37:09

But the pricing is not looking at returns of 20 or so percent as an equity investor could pursue.

37:16

Instead, the returns are low single digits.

37:19

So I believe that many credits are providing low returns, but actually are giving lenders equity type of exposure, without the lenders being capable to deal with that risk.

37:37

Thank you for insightful comments and thank you for that.

37:40

Next to this question was what is happening till the dry powder waiting to be deployed given that there are fewer transactions for direct lenders?

37:52

Comments, Gabriel or Richard?

37:56

I think that actually the market has been extraordinarily aggressive, desperate looking to deploy some capital, resulting in some of the excess that Richard and I have pointed out.

38:08

I think this overly aggressive competition is resulting on disproportionate risk allocation to some of these credit funds.

38:16

The biggest concern is what's going to happen next was we have to pursue a normalized level of performance as companies have been given a breather during this Covid period.

38:28

But when the re-opening happens, how are these credits going to perform? But I believe that the markets have actually been quite liquid at the moment.

38:38

38:39

Government spending, where it is accompanied by the acquisition or purchase of those securities, by the FED or by banks, dramatically increases the deposits in a marketplace, and we think there's a couple of trillion that has come into the market as a result of that. So, you know, our general sense is that there's plenty of dry powder out there to continue to invest in these kind now, that may be a good thing, and that may lead to problems, so it's something to watch.

39:13

Thank you. one last question from the audience about the variations geographically. So are the opportunities available in the private debt spectrum, credit spectrum in the US, different to what's available in Europe or Asia?

39:28

Yes.

39:29

In the US market, the market tends to be more aggressive on private direct lenders being willing to take higher levels of leverage than in European and other international markets.

39:44

The US market has the benefit of being able to transfer faster from a loan into a recapitalization and restructuring.

39:53

However, the US market, I believe, especially again, in the lower rated credits, are over extended.

40:00

In the European side, the markets tend to be more conservative.

40:06

The markets tend to be also less viable for middle sized and small companies who do not have access to banks.

40:15

And therefore the opportunity is there for the European market is greater for both direct lending and also for distressed and turnaround opportunities. In Asia, it is really market by market, same according to emerging markets.

40:28

The importance in those markets is the way we look at it is to look at opportunities in which there is a connection to the US, the UK or other markets in which the legal protocols and procedures can assure that the enforcements of debt covenants and agreements can be properly executed by the lenders and can be properly enforced in case recapitalizations and turnarounds are necessary.

40:57

Thank you, Gabriel, Richard, last comment?

Gabriel put it well earlier, too, when he said that the European banks have not really dealt as thoroughly as they should have with credits, corporate credits on their own books. And that has hampered the market somewhat as well.

41:15

So, we see Europe as being behind the US, and really as a place where there's opportunity, Asia is a different animal altogether, because of China’s unique situation of owning or controlling the borrowers or lending. So I think a lot of the growth in corporate debt, there is something to watch very, very carefully. I think it's a kind of a buyer beware situation in Asia. I want to make one other little comment before we get away from all this. We haven't talked about rates. And there's a lot of concern about inflation, and this and that, and the other. And we actually do expect that, over the short-term, maybe a year or two, rates could rise. You know, who knows? 100, 200 basis point.

42:01

But we also believe that there's a direct link, a causal link, between the amount of debt in the economy and interest rates.

42:11

The more debt you have on a secular basis, over the last 40 years, the lower rates have gone. Because there's so much debt, rising rates have a proportionately higher breaking effect on economic activity than they did 20 or 40 years ago. So I think one thing to note is, even though there's probably going to be a reversal here over the short term, we think, over the longer term, rates are going to remain low, and I think that's a positive for our discussion today, because people will be even more focused on achieving or getting yield that points straight to corporate debt and the private credit.

42:50

Thank you very much, Richard and Gabriel.

42:53

It was an extremely interesting session.

42:55

Both of our speakers agree on the fact that private debt is here to stay, but that successful debt lending is about sustainable debt, lending at the right volume, at the right time, and maintaining standards throughout, and also that debt could be better regulated.

43:16
 
 

Like the Duke d'Uzès who once proclaimed ‘long live the King’ in front of you today, I am proclaiming long live private debt.

43:25