April 24, 2025 • 49 mins
Risky corporate debt markets have room to fall further to reflect the damage of ongoing trade wars, according to BlackRock, the $11.6 trillion money manager. “We’re likely to see spreads widen from here as we see further deterioration in risk assets,” Mitch Garfin, the firm’s co-head of leveraged finance, tells Bloomberg News’ James Crombie and Bloomberg Intelligence’s Robert Schiffman in the latest Credit Edge podcast. “If this uncertainty continues for another quarter, two quarters, three quarters — that could lead to a more significant downturn.” Garfin and Schiffman also discuss private credit relative value, distressed exchanges, technology sector opportunities, portfolio trading and auto sector risk.
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Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:18):
Hello, and welcome to the Credit Edge, a weekly markets podcast.
My name is James Crumbie. I'm a senior editor at Bloomberg, and.
Speaker 2 (00:24):
I'm Rob Schiffman, a senior analyst covering tech at Bloomberg Intelligence.
This week, we're very pleased to welcome Mitch Garfin, Co,
head of US Leverage Finance at Blackrock.
Speaker 3 (00:33):
How are you doing, Mitch, I'm doing great? Thank you?
How are you guys?
Speaker 2 (00:36):
Awesome? Mitch works on black Rock's Fundamental fixed income platform.
He's responsible for managing the US high yield and global
high yield strategies, and also has oversight of US leverage
loan strategies.
Speaker 1 (00:48):
So just to set the scene here before we start,
global markets are getting slammed by trade wars and growing
concerns about the US government's attack on federal reserve independence.
US equity markets and the dollar have both dropped. Yields
are also up. There's no safe haven bid for treasuries
as in other periods of elevated volatility, and global investors
are trying to find alternatives to US assets as the
(01:08):
storm rages on. Analysts meanwhile slashing earnings estimates, fearing that
a severe economic slowdown is coming, and the risk of stagflation,
which would be bad for corporate borrowers, is up. We
are staring at a lot of red on the screen today.
Despite all of this, the credit market reaction has been
relatively muted. Spreads have moved higher, but only really back
(01:28):
to something that more closely resembles fair value after years
of trading way too tight. We're starting to see some
big fund outflows, leverage loan deals for buyouts are getting
hung and primary market issuance has all but stopped in
some parts of the credit markets. And there are definitely
some signs of stress out there given the very troubling
macro and geopolitical outlook. Though, we're probably going to see
(01:49):
some more repricing wider and credit, especially in high yield
bonds and loans. But what do you think, Mitch am
I being too negative? How would you characterize the longer
term impact on credit markets of all this turmoil, especially
at the lower quality end.
Speaker 3 (02:02):
Thanks James.
Speaker 4 (02:02):
I think there are some elements of what you are
suggesting that are fairly accurate. I think there are other
parts of that that are maybe a little bit more
on the aggressive side. And I have some thoughts and
some views that I'd love to share. To take the
other side of that, I'm not necessarily suggesting that it's
all rosy and we have an optimistic view and spreads
(02:25):
are going tighter tomorrow. But I don't think it's as
draconian as maybe the backdrop that you're suggesting.
Speaker 1 (02:31):
So in more specific terms, though, do you think that
spreads will not blow out from it? Do you think
that fundamentals won't suffer as much as some people feel
poetically we go into recession?
Speaker 3 (02:41):
Yeah?
Speaker 4 (02:41):
No, I do think you know we're going to see
some deterioration in fundamentals. I think it's also important to
understand the starting point for where fundamentals are, which I'll
get into in more detail.
Speaker 3 (02:55):
On a second.
Speaker 4 (02:55):
But I also think it's important to understand the big
pick sure of what the high yield market is today
versus what it isn't, It's important to understand the compositional
differences over time, which I think will lead us to
the better outcome that I'm suggesting. And so let's put
(03:17):
that in some number terms. There's been a significant upgrading
of credit quality within the high yield market over the
last fifteen or twenty years.
Speaker 3 (03:28):
Put some numbers behind it.
Speaker 4 (03:30):
WB risk was about thirty five percent of the market
back then. Today it's fifty to fifty plus percent. Triple
c's were about twenty percent of the market. Today it's
about twelve percent. So we've seen this, this high grading
of the high yield market, and yes, some of that
has come at the expense of the leverage low market.
It's also come at the expense of the private credit markets.
(03:53):
But the point here is that with a higher quality market,
with larger, more global, more diverse buid businesses that we're
underwriting within high yields, the fundamental starting point is definitely
much better, but it should provide more cushion, more ability
to withstand the economic volatility that we're likely going to
(04:13):
see in the coming months, in the coming quarters.
Speaker 2 (04:16):
So, Mitch, you know, in December, high yield bonds for
trading in the low to mid seven percent range, and
we're only in the low eight percent range now, but
spreads are one hundred and fifty basis points wider. You know,
the real question about high yields is that you know,
what are high yields? You know they're higher than investment
grade yields, but you know what really is a high
(04:37):
yield And I'm just wondering, like, you know, with this
sort of eight percent sort of range, how much do
you think overall risk is being priced into the market
right now.
Speaker 4 (04:48):
I think there's a significant amount of risk being priced
into the market. But it's also very much a bifurcated market, right,
so just looking at the headline level doesn't necessarily tell
the full story. Right there's you know, more than ten
percent of the market trading at yields greater than twelve, thirteen,
fourteen percent somewhere. In that context, it's not just about
(05:10):
yields obviously, it's you know, it's about spreads. And we've
we've gone back and forth debating the yield environment the
spread environment, you know what, what is it?
Speaker 3 (05:19):
And I think you have to consider both spreads.
Speaker 4 (05:23):
You're right, spreads have widened I guess one hundred and
fifty basis points from the tights as of today. The
move that we're seeing today is probably another twenty maybe
twenty five basis points wider, So maybe it's more like
one seventy five.
Speaker 1 (05:34):
Uh.
Speaker 4 (05:35):
The you know, the move that we saw a week
or two ago was out two hundred basis points to.
Speaker 3 (05:39):
Spreads of four fifty. I'm not suggesting, you.
Speaker 4 (05:43):
Know, these are you know, the widest levels we're going
to see, because they are not right. We're likely to
see spreads widen from here as we see further deterioration
in in risk assets, in overall credit quality. That said,
you know, what is the what is the right level?
Speaker 3 (06:01):
Over time?
Speaker 4 (06:02):
You know, as we've seen slowdowns or recessions or defaults
pick up, you know, we've seen you know, spreads anywhere
from six to eight hundred. Certainly there are points in
time that you'll point to that we've seen spreads materially
higher than that. I'm taking out the global financial crisis.
I think this is very different than what we saw
in the Global financial crisis. And so if I look
(06:24):
at relative valuations, we're probably thirty percent of the way
if we're including today's move of the way to where we.
Speaker 3 (06:33):
Were in sort of the average period during those those slowdowns.
Speaker 4 (06:37):
What that means for us, and what I've been recommending
to clients is that it makes sense to focus on
the higher quality part of the market. If you have
one hundred dollars to spend, you don't spend it all today,
you probably look to the higher quality part of the
market by twenty five thirty percent of what you're thinking
about allocating to the acid class. You're never going to
(07:00):
all the wides in high yield spreads, and when it
feels the worst, most investors are unlikely to allocate capital
to the asset class. That is precisely you know when
we think the right time to be allocating capital to
the asset class is. And so we've had a couple
of conversations with clients overtime in the last few weeks,
(07:20):
when spreads are out to four fifty, suggested buying the
the higher quality part of the market, and that trade
you would have worked out reasonably well. I'm not suggesting
it will work out well over the next you know,
two months, three months, four months, there will be volatility,
there will be wire spreads. But I think you use
that volatility wider spread environment to further add add capital
(07:41):
to your position.
Speaker 1 (07:42):
In terms of the spread widening thoughment you mentioned that
it could go wider. I mean it seems like it
probably will. I just wondered if you had any kind
of sense of how to quantify that. You say, obviously
that the market is better quality now, so maybe there's
less widening than in previous events. But some people are
saying that this, you know, potentially is worse than than
what we've seen before just because there is no FED backstop.
(08:03):
There is kind of a self inflicted damage on the
US economy. There are lots of unknowns. There is, you know,
huge uncertainty about how the tariff's thing in the trade
war shakes out. So so how how wide does it go?
Speaker 4 (08:15):
Yeah, I think you're right there. There is uncertainty out there.
You know, from an earnings perspective, right, first quarter will
likely be very good, but earnings guidance for the second
quarter and the rest of the year will remain uncertain.
I don't think a lot of companies will give a
very clear guidance just given the economic backdrop.
Speaker 3 (08:37):
But some part of that is already priced in.
Speaker 4 (08:39):
Right, We've seen a significant downtrade inequity markets. The high
old market obviously is decently wider in terms of spread,
But is there room for further further spread widening? You absolutely,
you know, it's tough to put a number on it.
But I would say is that the fundamental backdrop, the
starting point is very strong.
Speaker 3 (09:00):
So if I look at leverage.
Speaker 4 (09:03):
Metrics, debt tbada at you know, roughly four times pretty
good for a starting point heading into a potential slowdown.
The lower market a little bit weaker than that. I
look at interest coverage levels, you know, very strong, north
of five times off of the peaks of call it
six times ibadata interest, right, So some deterioration there, and
(09:26):
you might expect with an economics slowdown or a shallow recession,
that you would see further deterioration and therefore spread widening.
So I can see the environment getting us from you know,
call it four four twenty five today out to you know,
five hundred or six hundred. In that context, it's it's
tough for me to speculate to suggest that spreads are
(09:47):
going to seven hundred eight hundred without knowing what that
backdrop looks like. But I feel really comfortable about the
types of issuers that we're underwriting. Uh, the the stronger
cash flow stability, less of an impact from a tariff
standpoint of direct impact, I should say, And so I
think companies within our market will hold up better than
(10:10):
they have historically when there's you know, it's been a
much lower quality type compositional risk within the acid class
so yeah, I'm expecting volatility. I'm expecting some spread windening,
but we're going to use that opportunistically and add to positions,
add to sectors that we like that have strong, stable
(10:31):
cash flow. Right, So the sectors that we're focused on
within technology, really like software given the recurring revenue stream,
Really like the insurance brokers for a number of reasons,
but you know, the non discretionary aspect to it, very
strong pricing power, less economically sensitive, and that you know,
(10:54):
strong stability of cash flow that the acid class offers.
Aerospace and defense another one, uh, primarily US supply chains
backlogs are very strong, should lead to good earnings expansion
over time. And on the flip side, avoiding sectors that
are more directly exposed to tariffs like autos and retail, consumer,
(11:17):
consumer products and the like should provide us with a
good portfolio construction to benefit some near term volatility.
Speaker 2 (11:26):
Yeah. The problem that I've been running into and everyone's
asking me as a tech sector analyst is how I'm
modeling out this year, and I'm finding it really difficult
when there's so many big picture questions and when we're
in this sort of self first ask questions later market,
having a real gauge of what risk premium should be
(11:47):
or difficult. I know you started out, you talked a
lot about your research team. You started out as an
IG research analyst. How do you utilize that bottoms up
analysis to really get a good gauge of bigger pictures
credit risk in an uncertain macro environment like it's how
do you get comfortable framing out that we're not going
to spreads of a thousand when we have no idea
(12:10):
what's going to be coming out of Washington tomorrow.
Speaker 4 (12:13):
Yeah, it's not about having the certainty. It's about thinking
about the different sort of alternatives or the probabilities associated
with different outcomes and looking to to to price that
into some of the assumptions that you're making to give
you greater greater clarity on what that but what that
(12:36):
outcome may look like. Right, So I would not sit
here and tell you with one hundred percent certainty that
anything is happening.
Speaker 3 (12:42):
Right, There's a lot of uncertainty out there.
Speaker 4 (12:45):
But if we can take a step back, think about
the key drivers that are driving credit risk. Understand you
know what underpins credit quality? Focused on where a company
is generating their rev you their EBITDA, their cash flow,
assigned probabilities to different economic environments and outcomes, and and
(13:07):
look at what that conclusion is. That gives us greater
clarity on what the potential range of outcomes are. And
then obviously you know that there there's risks that you're
taking by by choosing to you know, get long risk
or be underweight you know, credit risk at different you know,
in different sectors, at different valuation levels. But I think
(13:29):
doing that hard work from the bottoms up, which is
what we've always done and how we've built our business
over time, I think is really rewarded throughout a cycle.
It's not just about the next one month or three
months or six months for us, It's it's about how
we underwriting credit over the next twelve to eighteen months
(13:49):
and in fact, maybe even longer than that. Yes, you
need to withstand the volatility in the near term, but
you need to think through some of these environments and understand.
Speaker 3 (13:58):
What things may look like on the other side as well.
Speaker 2 (14:01):
Yeah, and I you know, you started to mention some sectors.
I do want to talk about that more. But before
we get into that, what are just that bigger this
bigger picture of sort of liquidity in the market, rising
default risks like are the markets functioning right now? Are
you able to trade in size what you want? Are
you getting are you getting bids on things that you
(14:23):
don't love? Or is it sell what you have to
not what you want to.
Speaker 4 (14:27):
Yeah, liquidity in general is fine. We're able to do
what we want to do when we want to do it.
I'm not suggesting that every minute of.
Speaker 3 (14:37):
Every day is that way.
Speaker 4 (14:39):
When there's uncertainty, when there's volatility, as you know, trading activity,
you know, can can dry up for you know, a
short period of time. But that hasn't you think about
what we've seen over the last month or so with
that volatility, with that uncertainty, that hasn't got in the
(15:00):
way of our ability to manage portfolios and move risk around. So,
for example, as I'm sure you're aware, the acid class
has seen eleven twelve plus billion dollars of outflows over
the last two weeks. We manage a large pool of capital,
(15:21):
large portfolios, and we've not been immune to some of
the outflows that the acid class has witnessed.
Speaker 3 (15:28):
We have done plenty of things in managing our portfolios
to make sure that we deal with.
Speaker 4 (15:35):
The outflows that we have, the same risk that we
had yesterday and the day before, and the risk that
we want to have tomorrow.
Speaker 3 (15:41):
Right, So what have we done? There have been a
few notable trades in the portfolio.
Speaker 4 (15:47):
We've taken our loan exposure from call it eleven percent
down two or three percent to eight or eight and
a half percent. I think, you know, some of the
sales that we made there were pretty timely. The high
yield market was experiencing some weakness. The loan market was
holding up better, uh, you know for the first few days,
and we used that opportunity to reduce some of our.
Speaker 3 (16:09):
Exposure in loans.
Speaker 4 (16:11):
You know, when most loan prices were still ninety nine
ninety nine and a half to the plus. We've seen
some deterioration there by two or three points in the
loan asset class. So that was a reasonably thoughtful trade.
We've also, you know, high graded the portfolio to an extent.
We've sold lower quality risks, more more single bee, more
(16:33):
triple C exposure, and you have been focusing more on
higher quality credit and higher quality credits doesn't just mean
double b's, double b's and single bees issuers and sectors
that have greater stability of cash flow that I alluded
to to earlier. So there's you know a lot of
things that we've been doing in the portfolio.
Speaker 3 (16:55):
At a sector level.
Speaker 4 (16:56):
We've reduced and maintained underweights in auto in detail, and
energy some of the sectors that have been more exposed.
But to you to your specific point on liquidity, as
you know, there's been a significant uptakeing the amount of
portfolio trading that has gotten done, both in the investment
grade market and the high yield markets, and we've been
(17:16):
at the forefront of some of that activity. In recent weeks,
we were very involved in some of that trading activity.
Speaker 3 (17:24):
Uh. You know, dealers.
Speaker 4 (17:28):
Have positioned themselves in such a way to be able
to be buyers of credit risks during periods of stress
or volatility given some of the trades that they've done
on the other side, and we've really been the beneficiary
of many of.
Speaker 3 (17:39):
Those trades, right. So some you know, over the last
couple of weeks when.
Speaker 4 (17:42):
We were trading, we were getting done at levels that
were fairly close to mid market. When bidass breads head
widened from half to three cores of a point to
a full point.
Speaker 3 (17:52):
So I think.
Speaker 4 (17:54):
Utilizing all the tools that are at our fingertips, including
using liquid products, et aps, CD acts, et cetera, has
been has been part of our toolkit to manage riskool.
Speaker 1 (18:06):
On a related note, Mitch and the kind of borrower
that you'd like to buy the debt of, you know,
the high quality stable have scale, low leverage. You know,
these sort of defensive names. That's that's you know, essentially
everyone wants that and everyone comes on that show, on
the show and talks about that stuff. They want to
(18:27):
get hold of this stuff, but there isn't a lot
of net new supply of it. So you know, for
someone running a huge portfolio, you know, black Rock biggest
in the market, how do you scale it?
Speaker 4 (18:38):
Yeah, I guess I would, you know the the original
comment there. I just want to make a clarifying point.
Speaker 3 (18:46):
While we have high.
Speaker 4 (18:47):
Graded to to an extent, if you look at two
of our biggest overweights, you know, one technology on the
software side and two insurance brokers more focused on the
property casualty side. These are credits that we've underwritten, sectors
that we've underwritten at a time where leverage is higher,
(19:09):
not necessarily lower, on the back of M and A
that has been primarily debt financed. But what we feel
good about, what we feel comfortable about is the strong
stability of cash flow that underpins those sectors.
Speaker 3 (19:23):
Right. It's less dependent.
Speaker 4 (19:25):
On the the you know, the the economy, uh and
more dependent on the strong stable cashow that recurring revenue
stream that we're getting out.
Speaker 3 (19:35):
Of those issuers, out of those sectors.
Speaker 4 (19:37):
So while I would agree with you that at the
present time most people are focused on the higher quality
part of the market, it doesn't mean that's the only
thing that we're doing.
Speaker 3 (19:47):
Right.
Speaker 4 (19:47):
We have built a h you, we've built portfolios, we've
built a business underwriting credit across the quality spectrum, and
we're not shy about going down in quality.
Speaker 2 (19:58):
Right.
Speaker 4 (19:58):
If you look at our overall composition, we are underweight
double B risk, we are overweight single BE risk, and
we are flat to slightly overweight triple c's even in
the current environment, and I would specify within triple c's
we own the higher quality part of the triple C
market and have a fairly significant underweight to the right tail,
the higher beta, more stress or distressed part of the market.
Speaker 3 (20:21):
So I think that that's the first point.
Speaker 4 (20:23):
The second point is we have really strong relationships with issuers,
with banks, with private equity sponsors, and when deals come
to the market, we are at the forefront of engaging
with all of those constituents to help define or at
least attempt to define the types of deals that are
coming to market such that if and when we decide
(20:45):
to participate, you know, we are hopefully getting more significant
allocations within that process. And that has worked out really
well for us over a long period of time. We
have a dedicated team on the capital markets front that
works very closely with the banks, with issuers, with private responsors,
and my partner Dave Delbos, you know, he has done
a tremendous job leading the effort, working with a lot
(21:07):
of our private responsors, thus making sure that we're getting
good quality, you know, well underwritten deals into the portfolio.
Speaker 2 (21:15):
You know, what you're saying makes complete sense. I'm trying
to understand physically how able you are to execute on it.
Like you've rattled off a lot more sectors that you
don't like than you do like, So how easy is
it to get lighter in those spaces? And maybe you
could talk a little bit more in depth about some
(21:36):
of those places that you don't like, like retail, and
you know what the real concerns like, do you do
you see defaults going up meaningfully in the in the
spaces that you don't like or is it just a
matter of spread widening?
Speaker 4 (21:51):
Yeah, you know, to the first point there. I think
it's also important to understand the magnitude. Right, in some
cases they are small underweights, but there are any of them,
and then some of the overweights that we're talking about,
they're more substantial in size and its scale.
Speaker 3 (22:06):
So I think that's that's important to note.
Speaker 4 (22:08):
I don't think defaults are going to increase very substantially.
We're coming from a very low starting point. To my
point earlier, I think fundamentals are generally in a reasonably
good spot. In fact, if you look at some of
the leverage metrics predimetrics that I was citing earlier, we
saw some improvement in the.
Speaker 3 (22:28):
Fourth quarter versus the prior quarter.
Speaker 4 (22:31):
Right, Yes we expect deterioration, Yes we expect a slowdown,
but I don't think you'll see a massive uptick in
default So maybe very low single digits, you know, one percent,
you know, sub one percent in some cases, a little
bit north.
Speaker 3 (22:45):
Of that, maybe that becomes two three four percent.
Speaker 4 (22:49):
I don't see the scenario at the present moment where
that becomes eight to ten percent similar to what we
saw in you know it well, I guess COVID was
less than that, and the global financial crisis was was
more than that. I don't see that being the path
forward over the next six two to twelve months. You know,
our views around some of the sectors that I was highlighting, retail, autos,
(23:14):
consumer products. You know, I think those are are generally
fairly straightforward and probably very well articulated.
Speaker 1 (23:22):
Uh.
Speaker 4 (23:23):
You know to your audience, you know, over the last
you know month or so, as you've talked about tariffs,
you know, the retail in particular, uh you're you're sourcing
from from China in particular, but not limited to China, Vietnam, Cambodia, Taiwan.
Uh So those those sector, that sector I think is
going to be uh somewhat challenged in the in the
(23:46):
current environment. Autos that that is, you know, going to
be a near term concern. There may be some or
there may have been some pre buy activities that is
going to you know, prop up some sales figures and
some of the financial metrics over the last month or so.
(24:06):
But as we know that that likely won't be sustained
and that will likely lead to a slowdown in demand.
That will also lead to UH, you know, some pressure
as margins get squeezed for for these oe ms On
the consumer products. Obviously, a lot of hard goods are
still imported from from Asia uh and that is going
(24:30):
to be challenged with the tarot environment you also have.
It's not just about tariffs, right, It's also about consumer
confidence and business confidence waning.
Speaker 3 (24:41):
Right.
Speaker 4 (24:41):
As you know, as the consumer pulls back the demand
for many of the goods that I'm highlighting, many of
the sectors that I'm highlighting are going to be challenged.
I'm not suggesting that's that's game over or overly problematic
form these sectors. They'll be challenged. It'll be interesting to
see how management teams deal with this challenging operating environment.
Speaker 3 (25:03):
It's also a question of how long lived will it be? Right?
Speaker 4 (25:07):
Are we looking at something that's going to be three
to six months is going to be materially lower than that.
Speaker 3 (25:11):
Are there going to be trade deals that are negotiated.
Speaker 4 (25:14):
One thing that I do know is that if you
are a CEO or a CFO making important management decisions
as to how you're going to operate your business. Given
the economic backdrop right now, you are you're pulling back,
you're slowing down. You're not moving forward without CAPEX program
without knowing what the backdrop is going to look like.
So that has led us to be underweight many of
(25:35):
those sectors. Additionally, the energy sector that you know that
is you know going to be We've seen signs of it.
It's going to be a bit more challenge than we've
seen in the recent past. We've seen commodity prices come down,
which is going to be a challenge for independent exploration
(25:56):
and production companies. But the knock on effects are are
significant for oil field servicers and drillers. Right as CAPEX programs,
as development programs are pulled back, that's going to have
a significant impact on services and drillers. We also have
a slight underweight to midstream companies, so think pipeline and
(26:18):
storage here it's greater stability of cash flow, but they
will not be immune to some of the challenges that
I'm highlighting within the the oil sector.
Speaker 2 (26:28):
What would change your mind on just market direction what
would make the market get meaningfully worse or what could
all of a sudden solve all these problems. And we
go back to the day after the election, and that
you know, everyone thinks IG spreads are going to zero
and highyield spreads are only going to be you know
(26:49):
nothing behind.
Speaker 4 (26:50):
Well, I don't think anything today or tomorrow is going
to meaningfully change what.
Speaker 3 (26:56):
That what that outlook looks like, right because to some extent,
the seeds are in place for this slowdown. Right, think
about what I was just highlighting with the consumer.
Speaker 4 (27:08):
With CEO CFOs, they've been making decisions that are consequential
over the next month, quarter, and maybe even longer than that.
So yes, they can change as the backdrop changes, but
these are decisions that have consequences out a quarter or
two in all likelihood. But if we had greater clarity
(27:32):
around the tariff environment, if management teams understood specifically what
that looked like and there was certainty around it. Right,
The certainty part is really important here because you may
get a decision, but how do we know that decision
is not going to change tomorrow or the next day
(27:53):
or a month or a quarter out right, So we
need greater clarity around that, and I think you know
that the big point here is clarity and stability around
the economic backdrop is critically important. I think the FED,
you know, I think it was alluded to earlier that
there's there's no backstop, whether that's monetarily or fiscally, I'm
(28:18):
not sure I necessarily agree with that. I think there
are levers that can be pulled, both monetary policy and
friscal policy that can alleviate some of the concerns that
that we're talking about today. I think from the FED standpoint,
they are there. You know, they're in a difficult spot, right.
(28:41):
You have inflation that has not come back down to
the targeted level from the COVID spike. You have a
backdrop that is, you know there's likely going to lead
to greater inflation over the coming quarters. You have a
likely environment where growth slows, right, so that you know that,
(29:04):
you know, in theory, should provide a an opportunity for
the FED to ease, but they need to be really
focused on the inflation dynamic as well. So it's it's
it's a really tough.
Speaker 3 (29:16):
Spot to be in.
Speaker 4 (29:16):
I think they'll be really focused on the employment picture,
what the job's environment looks like and to the extent
you see that starting to come off right, some some
weakness coming through where not only do you see a
lack of hiring, but you start to see more job cuts.
(29:37):
I think the FED UH may may think a little
bit more aggressively about an easy backdrop UH, to the
extent they have weakness in the in the in the
employment dynamic.
Speaker 2 (29:50):
But so it's it's pretty clear like you moved up
in quality sectors, high, better cash flows, the risk profiles
for a lot of these names or somewhat limited. But
what like what gets us to we wake up tomorrow
morning and it's like a uh oh, I couldn't see
that one coming. What is that next? Like? Where where
(30:12):
does this market all of a sudden get crushed? And
are you just saying that you just can't the probability
that is so low or just so uncertain, you just
can't see that for all the data that you've got
in front of you.
Speaker 4 (30:24):
Now, No, there is some probability of that existing, of course,
so I can't say that I can't see that. I
think at the moment the probability is low. But you
know there's to what has been highlighted here a few times,
both myself you James, like, there's uncertainty out there, and
(30:45):
if this uncertainty continues for another quarter two cores, three cores,
that could lead to a more significant downturn than what
we're expecting. So there is some probability of that. I
would say the probability of that is fairly low at
the moment. I think you will see monetary and fiscal
(31:09):
stimulus to offset that to the extent we get to
those more draconian economic environments, but there is a non
zero probability of that playing out.
Speaker 1 (31:20):
Going back to what you said about bonds and loans, Mitch,
you reduced leverage loans more than you did high yield bonds,
suggests that relative value lies in the bonds direction. I'm
interested in hearing more on that. Definitely, the leverage loan
markets under more stress, but as an investor, you're getting
some pretty good floating rate debt must look appealing. So
what's the rationale there, Well.
Speaker 3 (31:41):
There's a few things.
Speaker 4 (31:43):
When we executed that trade over a few days, the
low market was holding up much better than the high
yelled market. So from a relative value standpoint, as we
saw more weakness being priced into high yield bonds relative
to loans. We use that as an opportunity to reduce
our exposure on.
Speaker 3 (32:02):
The loan side.
Speaker 4 (32:03):
That wasn't in isolation, right, So what else is important?
The loan market is carrying at very attractive levels, or
was carrying and still is to an extent at very
attractive levels as compared to the high yield market. Now,
part of that was with a view towards what the
rate dynamic and the forward looking rate dynamic looks like.
(32:26):
To the extent the market is pricing in and or
the FED begins a more aggressive easing regime, that's going
to have greater implications for the floating rate acid class
loans like you just mentioned. So you know, there's a
few thoughts there that led us on the margin to
(32:47):
reduce the loan exposure a little bit more aggressively relative
to high yield bonds. Now, the other point is, and
I alluded to this in my first few comments, is
that the overall construction of the leverage loan market is
a little bit weaker in terms of credit quality than
the overall high yield market. Right, So, if you think
(33:07):
about the evolution over time small and medium sized leverage
buyouts you know, we're generally getting financed in the leverage
loan market as compared to the high yield market.
Speaker 3 (33:18):
There's there's one, fairly and probably multiple reasons why that's
the case.
Speaker 4 (33:22):
But as a private equity sponsor, I want to have
flexibility in my capital structure. If I issue a high
yield bond that was typical structure eight non call three,
seven non call three. The important point here at least
three years of call protection, and the loan market, you know,
a sponsor has the ability to reprice that loan, you
know after the first you know called six months of
(33:44):
soft call protection. So if that issuer went out and
sold an asset for a billion dollars and wanted to
either reprice or pay down debt, they have the ability
to do so in the loan market. They do not
have the ability to do so in the high yield market.
So that's a real advantage for an issue or sponsor
taxes one market relative to another. But the point there
is that has led to a deterioration and credit quality
(34:07):
of the low market relative to the high yield market.
And so as I think about you know, the looming
credit risks that are ahead or the potential slowdown. Which
market may be more impacted. It's likely to be the
leveraged loan market for the aforementioned reasons as compared to
high yield.
Speaker 1 (34:25):
So you expect to high default rates in loans competitive bonds.
Speaker 4 (34:28):
Yeah, that's a reasonable expectation, right, lower quality, credit risk
and leverage loans versus high yield bonds likely to see
more defaults or maybe i'll say more distressed exchanges, more
liability management exercises that are getting done in the leverage
loan market as compared to the high yield market, which
also counts as a default or restructure.
Speaker 1 (34:49):
Yeah, I'm glad you brought that up because it's a
huge theme for listeners and guests on this show. It
just seems to get worse. It just seems to get
more coercive and more violent in terms of the structures
and what the issuers and the lawyers are trying to do.
How do you protect yourself as an investor? How do
you think about that? Do you have to expand your
team of legal support.
Speaker 4 (35:10):
We have plenty of resources, both on the research side
of things as well as on the legal side of things,
so that's generally not an issue. But we as you mentioned,
we're a large player within the space on the active side.
We're large in and of itself, but we also benefit
from Blackrock having tremendous au M assets under management across
(35:33):
a range of different products within high yield bonds or
leverage loans, and so that generally gets us a seat
at the table, very involved in conversations that are happening
that will lead to potential outcomes on the distressed exchange
or liability management side of the things.
Speaker 3 (35:49):
So we are.
Speaker 4 (35:50):
Active participants and very engaged with sponsors with issuers to
try to achieve the best.
Speaker 3 (35:56):
Outcomes for our clients.
Speaker 4 (35:58):
Now, one thing I would say here is well, in
the short term, some of these distressed exchanges, you know,
can work out well depending on what part of the
capital structure you're in. You know, I believe we believe
that's a near term fix. It doesn't necessarily solve the.
Speaker 3 (36:15):
Longer term problem.
Speaker 4 (36:16):
The real problem is what are the reasons why we
have gotten to this point in the first place. What
fundamentally is going on within that issue or within that
sector that has led to these challenges, that has led
to leverage metrics that are six seven, eight plus times,
if not more that has led to bond or loan
(36:37):
prices trading in the fifties, sixties, seventies. You know what
is bringing that sponsor or, that issuer to the table
to engage in these conversations.
Speaker 3 (36:46):
You may have a near term.
Speaker 4 (36:48):
Uh, you know, positive credit development by cutting twenty to
thirty percent of the debt in a particular trunch, But
longer term, have you really fixed anything within that business?
If you haven't changed anything on the fundamental side of things.
Speaker 1 (37:01):
Is there any chance so that it might lead to
better covenants though for investors, and you must be sort
of demanding more protections because this is becoming such a
big risk.
Speaker 4 (37:09):
Of course it does, especially in those in those transactions.
Speaker 3 (37:12):
Of course it does. The dynamic that exists in.
Speaker 4 (37:15):
The in the high market, in the low market continues
to be challenging from an investors standpoint in terms of
our ability to get sort of our wish list in
terms of covenant packages across many of these issuers.
Speaker 3 (37:29):
Well, I would say it's.
Speaker 4 (37:30):
Very relevant for the mid to lower quality issuers that
are coming to market, especially in the current environment. It's
a little bit different for the very high quality issuers.
Think that will be high sing will be where we
think there's a very low probability of significant challenges in
the near to intermediate term.
Speaker 3 (37:47):
The demand for.
Speaker 4 (37:50):
Allocations in many of those deals leads to a very
strong investor appetite and significant over.
Speaker 3 (37:58):
Subscription levels and deal dot com.
Speaker 4 (38:00):
And as a result, you know, sponsors and issuers have
the ability to push back and sort of the wish
list of asks. But for more challenging deals for sure,
the deals that are struggling to get done, we are
very vocal with the counterparties that I mentioned to get
the types of covenant, types of structures in place to
protect us in our clients over time.
Speaker 1 (38:23):
And how important does private credit become in all of this.
Does it step in to do some of these deals?
Speaker 3 (38:28):
Very important?
Speaker 4 (38:29):
As you know, over time there has been convergence between
public markets and private markets. There there has been a
liquidity premium or an ill liquidity premium i should say,
in private markets, and obviously the types of issuers that
go to one market versus another over the last you know,
(38:50):
three five, seven years has been quite a bit different.
What's notable in the current environment with high yield bonds
and leverage loans and spreads widening the relative value, in
our opinion, is a bit more attractive in high bonds
or leverage loans relative to private markets, as private markets
(39:10):
take a little bit longer to reprice to some of
the volatility and market weakness that we're seeing. And so
if you think about what that that that spread pickup was,
if you assume private markets are largely unchanged or somewhere
in that five fifty five seventy five context, and you've
seen highal bonds and leverage loans back up, that that
(39:33):
premium has decreased, thus making public market transactions a little
bit more attractive. But to your to your point, to
the extent capital market activity has dried up on the
private side of things, you can and will and potentially
have seen more issuers going to private markets getting deals
done now when they need to or have to. For me,
(39:57):
it's it's not just about today, right, It's a about
the forward environment, right. So you're going to see issuers
that access the private markets over time that are different
points in their life cycle that may be interested in
going public over the next year. And so maybe it
makes more sense to come back to the public markets,
(40:18):
start thinking about, you know, more, being more engaged with
public market participants providing quarterly earnings right, readying yourself for
that public market. I po that that many of these
issuers may be focused on down the road.
Speaker 3 (40:35):
So I think it just depends.
Speaker 1 (40:36):
So, as you mentioned, Mitch, the fundamentals of the market seem,
you know, certainly strong a bit, but we are seeing
some technical weakness among those foreign demand for US credit.
When you've got high Japanese government bond yields, for example,
that's going to affect the interest from from Asia for example.
And another thing seem to be weakening. We've seen outflows.
(40:59):
What do you make the technical pressures right now?
Speaker 4 (41:01):
Yeah, I think the technical backdrop is waning. To your point,
it has been maybe somewhat negative. We've seen fairly significant
outflows from the asset class.
Speaker 3 (41:15):
You know, over the last week we saw two billion
come out.
Speaker 4 (41:19):
Prior to that, we saw the largest outflow on record
at nearly ten billion, uh, sort of wiping out all
the inflows that we had.
Speaker 3 (41:27):
Here to date.
Speaker 4 (41:28):
Now at slight outflows for for the asset class, a
lot of model based or momentum type investors have largely
exited the asset class. What we're seeing at Blackrock both
internally and externally as more and more investors looking to
allocate capital to too high yield. So if you think
(41:49):
about some of the internal pools of capital that you
know that we manage on the multi asset credit side
of things, you know, or broad fixed income side of things,
We've seen a few different types of investors, both on
the short duration side of things and more core fixed
income allocate more capital to too high yield, particularly in the.
Speaker 3 (42:11):
Higher quality part of the market.
Speaker 4 (42:13):
We've also seen insurance companies allocate a substantial amount of capital.
Really almost every day for the last week or two,
they've been buying significant chunks of high quality credit just
given the relative weakness that we had seen, and I
think that makes a tremendous amount of sense. One of
the points I should make is the relative value between
(42:35):
double B risk and truty risk has cheapened fairly significantly.
Alebi's look quite attractive. They probably looked more attractive a
week or two ago. We've seen some outperformance there to
capture some of that back, but I still think there's
good value in the higher quality part of the double
B market relative to trivial BE risk.
Speaker 1 (42:55):
But are you noticing that there is a less of
a foreign demand for US assets. Generally, that's a big
thing that everyone seems to be picking up on. Obviously,
there are constraints to that because the scale of the
US versus everything else. But but is that something that
you think is happening as a kind of secular shift.
Speaker 4 (43:08):
I think it it will happen. I haven't seen a
tremendous amount of that, but you're certainly right. You know,
we've seen and heard a lot of people talking about that.
But in terms of our desk, we managed US high
yeld as well as global high yield. I haven't seen
very significant flows out of the US into Europe.
Speaker 3 (43:29):
Or or for that matter.
Speaker 4 (43:31):
I have not seen some of our investors out of Asia,
you know, pull back and avoid the US. So you
haven't seen that dynamic, but you know, I recognize that
they are. For that to play out, I would say
dealer inventories seem to be pretty light, you know. I
would say dealers last weeks sold six and a half
(43:54):
seven billion dollars of risk seemingly on their balance sheet.
And so if I think about inventory level over the
last three or four months, they're among the lowest.
Speaker 3 (44:02):
Levels that we've seen over time.
Speaker 4 (44:05):
So I think that, combined with what I was suggesting earlier,
significant OUTFLOWDS that seemingly has subsided more demand from insurance companies,
more demand from broad fixed income investors or multi asset
type investors, and some of our external clients, whether it
be large on balance sheet, corporate cash clients, private banks,
(44:28):
insurance companies, all of those investors have not allocated capital
to high yield, but they're all engaged in the conversation
and very much looking to do that.
Speaker 3 (44:37):
We've seen.
Speaker 4 (44:39):
On the private bank side of things a few small
to medium size flows come into our funds. Away from
that hasn't been very substantial, but as a trend that
I think.
Speaker 3 (44:52):
We'll see as we see further spread widening.
Speaker 1 (44:55):
So you see a lot of stuff all around the world.
You get to see great detail, and I'm going to
ask you a tough question, best relative value? Where do
you think it is right now, let's say for the
next twelve to eighteen months. I know it's very hard
to project because things are uncertain, but best relative value?
Speaker 4 (45:12):
Yeah, So what I would say here is that the
relationship of US, you know, high yield versus European high
yield Europe has held up significantly better. They've had some challenges.
They've seen certainly spreads widening, but not nearly to the
extent we've seen in the US market, and early on
(45:37):
that has led us to reduce our exposure to European
credit risk in favor of US credit risk. Now, it's
not necessarily a super obvious trade, because there are there
are very important themes in Europe that I think are
worth noting. Monetary policy is clearly much further ahead of
(45:59):
where the is. ECB easing fairly aggressively, and that is
obviously supportive for risk assets. And then the other major
point is what we've seen out of Germany in terms
of the substantial increase in infrastructure spending as well as
defense spending. That's going to be to the benefit of
many of the issuers within those markets. That said, when
(46:22):
I look at European valuations relative to high yield not
just over the last twelve months, but over a three year,
five year period of time, that relationship continues to be
in the very low percentile rankings relative to where it's
been historically, and maybe rightfully so for the reasons that
I just mentioned, But it doesn't necessarily get me to
(46:42):
want to invest a lot.
Speaker 3 (46:44):
More capital in the European market today.
Speaker 4 (46:47):
That may be the case if we see a little
bit of a cheapening relative to the US, but I
think in the current environment, I still think it makes
sense to be invested in high quality.
Speaker 3 (46:57):
Double by single B US domiciled issuers.
Speaker 4 (47:01):
And one point on that is, when you think about
US domiciled issuers, about eighty percent of the revenues for
companies within the high yield space is coming from the US.
Only twenty percent is coming over the revenues is coming
from international. And so the point here is that the
tariff impact, the direct tariff impact, while maybe substantial for
(47:23):
certain sectors or for certain issuers, is not necessarily going
to be pervasive across the entire space. Certainly, the secondary effects,
the knock on effects to the ones that we highlighted
throughout this conversation, that kind of will be more substantial.
Speaker 1 (47:38):
So to be clear, it's a sell high yield in
Europe and by US high yield instead.
Speaker 4 (47:43):
I'm not sure it's just sell one versus by the other.
But I would say for US in our global fund,
the marginal dollar is getting invested in US high yield.
We still remain constructive on the European market. Just valuations
have held up better there than in the US.
Speaker 1 (48:01):
Okay, god's it. Great stuff. Mitch Garffin, co head of
US Leverage Finance at black Rock, it's been a pleasure
having you on the Credit Edge.
Speaker 3 (48:06):
Many thanks thanks for having me.
Speaker 1 (48:08):
And to Robert Schiffman with Bloomberg Intelligence, thank you very
much for joining us today or even more analysis. Read
all of Rob's great work on the Bloomberg Terminal. Tech
is his life. Call him. Bloomberg Intelligence is part of
our research department, with five hundred analysts and strategists working
across all markets. Coverage includes over two thousand equities and
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(48:32):
to the Credit Edge wherever you get your podcasts. We're
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tell your friends, or email me directly at Jcrombeight at
Bloomberg dot net. I'm James Crombie. It's been a pleasure
having you join us again next week on the Credit Edge.
Hello, and welcome to the Credit Edge, a weekly markets podcast.
My name is James Crumbie. I'm a senior editor at Bloomberg, and.
Speaker 2 (00:24):
I'm Rob Schiffman, a senior analyst covering tech at Bloomberg Intelligence.
This week, we're very pleased to welcome Mitch Garfin, Co,
head of US Leverage Finance at Blackrock.
Speaker 3 (00:33):
How are you doing, Mitch, I'm doing great? Thank you?
How are you guys?
Speaker 2 (00:36):
Awesome? Mitch works on black Rock's Fundamental fixed income platform.
He's responsible for managing the US high yield and global
high yield strategies, and also has oversight of US leverage
loan strategies.
Speaker 1 (00:48):
So just to set the scene here before we start,
global markets are getting slammed by trade wars and growing
concerns about the US government's attack on federal reserve independence.
US equity markets and the dollar have both dropped. Yields
are also up. There's no safe haven bid for treasuries
as in other periods of elevated volatility, and global investors
are trying to find alternatives to US assets as the
(01:08):
storm rages on. Analysts meanwhile slashing earnings estimates, fearing that
a severe economic slowdown is coming, and the risk of stagflation,
which would be bad for corporate borrowers, is up. We
are staring at a lot of red on the screen today.
Despite all of this, the credit market reaction has been
relatively muted. Spreads have moved higher, but only really back
(01:28):
to something that more closely resembles fair value after years
of trading way too tight. We're starting to see some
big fund outflows, leverage loan deals for buyouts are getting
hung and primary market issuance has all but stopped in
some parts of the credit markets. And there are definitely
some signs of stress out there given the very troubling
macro and geopolitical outlook. Though, we're probably going to see
(01:49):
some more repricing wider and credit, especially in high yield
bonds and loans. But what do you think, Mitch am
I being too negative? How would you characterize the longer
term impact on credit markets of all this turmoil, especially
at the lower quality end.
Speaker 3 (02:02):
Thanks James.
Speaker 4 (02:02):
I think there are some elements of what you are
suggesting that are fairly accurate. I think there are other
parts of that that are maybe a little bit more
on the aggressive side. And I have some thoughts and
some views that I'd love to share. To take the
other side of that, I'm not necessarily suggesting that it's
all rosy and we have an optimistic view and spreads
(02:25):
are going tighter tomorrow. But I don't think it's as
draconian as maybe the backdrop that you're suggesting.
Speaker 1 (02:31):
So in more specific terms, though, do you think that
spreads will not blow out from it? Do you think
that fundamentals won't suffer as much as some people feel
poetically we go into recession?
Speaker 3 (02:41):
Yeah?
Speaker 4 (02:41):
No, I do think you know we're going to see
some deterioration in fundamentals. I think it's also important to
understand the starting point for where fundamentals are, which I'll
get into in more detail.
Speaker 3 (02:55):
On a second.
Speaker 4 (02:55):
But I also think it's important to understand the big
pick sure of what the high yield market is today
versus what it isn't, It's important to understand the compositional
differences over time, which I think will lead us to
the better outcome that I'm suggesting. And so let's put
(03:17):
that in some number terms. There's been a significant upgrading
of credit quality within the high yield market over the
last fifteen or twenty years.
Speaker 3 (03:28):
Put some numbers behind it.
Speaker 4 (03:30):
WB risk was about thirty five percent of the market
back then. Today it's fifty to fifty plus percent. Triple
c's were about twenty percent of the market. Today it's
about twelve percent. So we've seen this, this high grading
of the high yield market, and yes, some of that
has come at the expense of the leverage low market.
It's also come at the expense of the private credit markets.
(03:53):
But the point here is that with a higher quality market,
with larger, more global, more diverse buid businesses that we're
underwriting within high yields, the fundamental starting point is definitely
much better, but it should provide more cushion, more ability
to withstand the economic volatility that we're likely going to
(04:13):
see in the coming months, in the coming quarters.
Speaker 2 (04:16):
So, Mitch, you know, in December, high yield bonds for
trading in the low to mid seven percent range, and
we're only in the low eight percent range now, but
spreads are one hundred and fifty basis points wider. You know,
the real question about high yields is that you know,
what are high yields? You know they're higher than investment
grade yields, but you know what really is a high
(04:37):
yield And I'm just wondering, like, you know, with this
sort of eight percent sort of range, how much do
you think overall risk is being priced into the market
right now.
Speaker 4 (04:48):
I think there's a significant amount of risk being priced
into the market. But it's also very much a bifurcated market, right,
so just looking at the headline level doesn't necessarily tell
the full story. Right there's you know, more than ten
percent of the market trading at yields greater than twelve, thirteen,
fourteen percent somewhere. In that context, it's not just about
(05:10):
yields obviously, it's you know, it's about spreads. And we've
we've gone back and forth debating the yield environment the
spread environment, you know what, what is it?
Speaker 3 (05:19):
And I think you have to consider both spreads.
Speaker 4 (05:23):
You're right, spreads have widened I guess one hundred and
fifty basis points from the tights as of today. The
move that we're seeing today is probably another twenty maybe
twenty five basis points wider, So maybe it's more like
one seventy five.
Speaker 1 (05:34):
Uh.
Speaker 4 (05:35):
The you know, the move that we saw a week
or two ago was out two hundred basis points to.
Speaker 3 (05:39):
Spreads of four fifty. I'm not suggesting, you.
Speaker 4 (05:43):
Know, these are you know, the widest levels we're going
to see, because they are not right. We're likely to
see spreads widen from here as we see further deterioration
in in risk assets, in overall credit quality. That said,
you know, what is the what is the right level?
Speaker 3 (06:01):
Over time?
Speaker 4 (06:02):
You know, as we've seen slowdowns or recessions or defaults
pick up, you know, we've seen you know, spreads anywhere
from six to eight hundred. Certainly there are points in
time that you'll point to that we've seen spreads materially
higher than that. I'm taking out the global financial crisis.
I think this is very different than what we saw
in the Global financial crisis. And so if I look
(06:24):
at relative valuations, we're probably thirty percent of the way
if we're including today's move of the way to where we.
Speaker 3 (06:33):
Were in sort of the average period during those those slowdowns.
Speaker 4 (06:37):
What that means for us, and what I've been recommending
to clients is that it makes sense to focus on
the higher quality part of the market. If you have
one hundred dollars to spend, you don't spend it all today,
you probably look to the higher quality part of the
market by twenty five thirty percent of what you're thinking
about allocating to the acid class. You're never going to
(07:00):
all the wides in high yield spreads, and when it
feels the worst, most investors are unlikely to allocate capital
to the asset class. That is precisely you know when
we think the right time to be allocating capital to
the asset class is. And so we've had a couple
of conversations with clients overtime in the last few weeks,
(07:20):
when spreads are out to four fifty, suggested buying the
the higher quality part of the market, and that trade
you would have worked out reasonably well. I'm not suggesting
it will work out well over the next you know,
two months, three months, four months, there will be volatility,
there will be wire spreads. But I think you use
that volatility wider spread environment to further add add capital
(07:41):
to your position.
Speaker 1 (07:42):
In terms of the spread widening thoughment you mentioned that
it could go wider. I mean it seems like it
probably will. I just wondered if you had any kind
of sense of how to quantify that. You say, obviously
that the market is better quality now, so maybe there's
less widening than in previous events. But some people are
saying that this, you know, potentially is worse than than
what we've seen before just because there is no FED backstop.
(08:03):
There is kind of a self inflicted damage on the
US economy. There are lots of unknowns. There is, you know,
huge uncertainty about how the tariff's thing in the trade
war shakes out. So so how how wide does it go?
Speaker 4 (08:15):
Yeah, I think you're right there. There is uncertainty out there.
You know, from an earnings perspective, right, first quarter will
likely be very good, but earnings guidance for the second
quarter and the rest of the year will remain uncertain.
I don't think a lot of companies will give a
very clear guidance just given the economic backdrop.
Speaker 3 (08:37):
But some part of that is already priced in.
Speaker 4 (08:39):
Right, We've seen a significant downtrade inequity markets. The high
old market obviously is decently wider in terms of spread,
But is there room for further further spread widening? You absolutely,
you know, it's tough to put a number on it.
But I would say is that the fundamental backdrop, the
starting point is very strong.
Speaker 3 (09:00):
So if I look at leverage.
Speaker 4 (09:03):
Metrics, debt tbada at you know, roughly four times pretty
good for a starting point heading into a potential slowdown.
The lower market a little bit weaker than that. I
look at interest coverage levels, you know, very strong, north
of five times off of the peaks of call it
six times ibadata interest, right, So some deterioration there, and
(09:26):
you might expect with an economics slowdown or a shallow recession,
that you would see further deterioration and therefore spread widening.
So I can see the environment getting us from you know,
call it four four twenty five today out to you know,
five hundred or six hundred. In that context, it's it's
tough for me to speculate to suggest that spreads are
(09:47):
going to seven hundred eight hundred without knowing what that
backdrop looks like. But I feel really comfortable about the
types of issuers that we're underwriting. Uh, the the stronger
cash flow stability, less of an impact from a tariff
standpoint of direct impact, I should say, And so I
think companies within our market will hold up better than
(10:10):
they have historically when there's you know, it's been a
much lower quality type compositional risk within the acid class
so yeah, I'm expecting volatility. I'm expecting some spread windening,
but we're going to use that opportunistically and add to positions,
add to sectors that we like that have strong, stable
(10:31):
cash flow. Right, So the sectors that we're focused on
within technology, really like software given the recurring revenue stream,
Really like the insurance brokers for a number of reasons,
but you know, the non discretionary aspect to it, very
strong pricing power, less economically sensitive, and that you know,
(10:54):
strong stability of cash flow that the acid class offers.
Aerospace and defense another one, uh, primarily US supply chains
backlogs are very strong, should lead to good earnings expansion
over time. And on the flip side, avoiding sectors that
are more directly exposed to tariffs like autos and retail, consumer,
(11:17):
consumer products and the like should provide us with a
good portfolio construction to benefit some near term volatility.
Speaker 2 (11:26):
Yeah. The problem that I've been running into and everyone's
asking me as a tech sector analyst is how I'm
modeling out this year, and I'm finding it really difficult
when there's so many big picture questions and when we're
in this sort of self first ask questions later market,
having a real gauge of what risk premium should be
(11:47):
or difficult. I know you started out, you talked a
lot about your research team. You started out as an
IG research analyst. How do you utilize that bottoms up
analysis to really get a good gauge of bigger pictures
credit risk in an uncertain macro environment like it's how
do you get comfortable framing out that we're not going
to spreads of a thousand when we have no idea
(12:10):
what's going to be coming out of Washington tomorrow.
Speaker 4 (12:13):
Yeah, it's not about having the certainty. It's about thinking
about the different sort of alternatives or the probabilities associated
with different outcomes and looking to to to price that
into some of the assumptions that you're making to give
you greater greater clarity on what that but what that
(12:36):
outcome may look like. Right, So I would not sit
here and tell you with one hundred percent certainty that
anything is happening.
Speaker 3 (12:42):
Right, There's a lot of uncertainty out there.
Speaker 4 (12:45):
But if we can take a step back, think about
the key drivers that are driving credit risk. Understand you
know what underpins credit quality? Focused on where a company
is generating their rev you their EBITDA, their cash flow,
assigned probabilities to different economic environments and outcomes, and and
(13:07):
look at what that conclusion is. That gives us greater
clarity on what the potential range of outcomes are. And
then obviously you know that there there's risks that you're
taking by by choosing to you know, get long risk
or be underweight you know, credit risk at different you know,
in different sectors, at different valuation levels. But I think
(13:29):
doing that hard work from the bottoms up, which is
what we've always done and how we've built our business
over time, I think is really rewarded throughout a cycle.
It's not just about the next one month or three
months or six months for us, It's it's about how
we underwriting credit over the next twelve to eighteen months
(13:49):
and in fact, maybe even longer than that. Yes, you
need to withstand the volatility in the near term, but
you need to think through some of these environments and understand.
Speaker 3 (13:58):
What things may look like on the other side as well.
Speaker 2 (14:01):
Yeah, and I you know, you started to mention some sectors.
I do want to talk about that more. But before
we get into that, what are just that bigger this
bigger picture of sort of liquidity in the market, rising
default risks like are the markets functioning right now? Are
you able to trade in size what you want? Are
you getting are you getting bids on things that you
(14:23):
don't love? Or is it sell what you have to
not what you want to.
Speaker 4 (14:27):
Yeah, liquidity in general is fine. We're able to do
what we want to do when we want to do it.
I'm not suggesting that every minute of.
Speaker 3 (14:37):
Every day is that way.
Speaker 4 (14:39):
When there's uncertainty, when there's volatility, as you know, trading activity,
you know, can can dry up for you know, a
short period of time. But that hasn't you think about
what we've seen over the last month or so with
that volatility, with that uncertainty, that hasn't got in the
(15:00):
way of our ability to manage portfolios and move risk around. So,
for example, as I'm sure you're aware, the acid class
has seen eleven twelve plus billion dollars of outflows over
the last two weeks. We manage a large pool of capital,
(15:21):
large portfolios, and we've not been immune to some of
the outflows that the acid class has witnessed.
Speaker 3 (15:28):
We have done plenty of things in managing our portfolios
to make sure that we deal with.
Speaker 4 (15:35):
The outflows that we have, the same risk that we
had yesterday and the day before, and the risk that
we want to have tomorrow.
Speaker 3 (15:41):
Right, So what have we done? There have been a
few notable trades in the portfolio.
Speaker 4 (15:47):
We've taken our loan exposure from call it eleven percent
down two or three percent to eight or eight and
a half percent. I think, you know, some of the
sales that we made there were pretty timely. The high
yield market was experiencing some weakness. The loan market was
holding up better, uh, you know for the first few days,
and we used that opportunity to reduce some of our.
Speaker 3 (16:09):
Exposure in loans.
Speaker 4 (16:11):
You know, when most loan prices were still ninety nine
ninety nine and a half to the plus. We've seen
some deterioration there by two or three points in the
loan asset class. So that was a reasonably thoughtful trade.
We've also, you know, high graded the portfolio to an extent.
We've sold lower quality risks, more more single bee, more
(16:33):
triple C exposure, and you have been focusing more on
higher quality credit and higher quality credits doesn't just mean
double b's, double b's and single bees issuers and sectors
that have greater stability of cash flow that I alluded
to to earlier. So there's you know a lot of
things that we've been doing in the portfolio.
Speaker 3 (16:55):
At a sector level.
Speaker 4 (16:56):
We've reduced and maintained underweights in auto in detail, and
energy some of the sectors that have been more exposed.
But to you to your specific point on liquidity, as
you know, there's been a significant uptakeing the amount of
portfolio trading that has gotten done, both in the investment
grade market and the high yield markets, and we've been
(17:16):
at the forefront of some of that activity. In recent weeks,
we were very involved in some of that trading activity.
Speaker 3 (17:24):
Uh. You know, dealers.
Speaker 4 (17:28):
Have positioned themselves in such a way to be able
to be buyers of credit risks during periods of stress
or volatility given some of the trades that they've done
on the other side, and we've really been the beneficiary
of many of.
Speaker 3 (17:39):
Those trades, right. So some you know, over the last
couple of weeks when.
Speaker 4 (17:42):
We were trading, we were getting done at levels that
were fairly close to mid market. When bidass breads head
widened from half to three cores of a point to
a full point.
Speaker 3 (17:52):
So I think.
Speaker 4 (17:54):
Utilizing all the tools that are at our fingertips, including
using liquid products, et aps, CD acts, et cetera, has
been has been part of our toolkit to manage riskool.
Speaker 1 (18:06):
On a related note, Mitch and the kind of borrower
that you'd like to buy the debt of, you know,
the high quality stable have scale, low leverage. You know,
these sort of defensive names. That's that's you know, essentially
everyone wants that and everyone comes on that show, on
the show and talks about that stuff. They want to
(18:27):
get hold of this stuff, but there isn't a lot
of net new supply of it. So you know, for
someone running a huge portfolio, you know, black Rock biggest
in the market, how do you scale it?
Speaker 4 (18:38):
Yeah, I guess I would, you know the the original
comment there. I just want to make a clarifying point.
Speaker 3 (18:46):
While we have high.
Speaker 4 (18:47):
Graded to to an extent, if you look at two
of our biggest overweights, you know, one technology on the
software side and two insurance brokers more focused on the
property casualty side. These are credits that we've underwritten, sectors
that we've underwritten at a time where leverage is higher,
(19:09):
not necessarily lower, on the back of M and A
that has been primarily debt financed. But what we feel
good about, what we feel comfortable about is the strong
stability of cash flow that underpins those sectors.
Speaker 3 (19:23):
Right. It's less dependent.
Speaker 4 (19:25):
On the the you know, the the economy, uh and
more dependent on the strong stable cashow that recurring revenue
stream that we're getting out.
Speaker 3 (19:35):
Of those issuers, out of those sectors.
Speaker 4 (19:37):
So while I would agree with you that at the
present time most people are focused on the higher quality
part of the market, it doesn't mean that's the only
thing that we're doing.
Speaker 3 (19:47):
Right.
Speaker 4 (19:47):
We have built a h you, we've built portfolios, we've
built a business underwriting credit across the quality spectrum, and
we're not shy about going down in quality.
Speaker 2 (19:58):
Right.
Speaker 4 (19:58):
If you look at our overall composition, we are underweight
double B risk, we are overweight single BE risk, and
we are flat to slightly overweight triple c's even in
the current environment, and I would specify within triple c's
we own the higher quality part of the triple C
market and have a fairly significant underweight to the right tail,
the higher beta, more stress or distressed part of the market.
Speaker 3 (20:21):
So I think that that's the first point.
Speaker 4 (20:23):
The second point is we have really strong relationships with issuers,
with banks, with private equity sponsors, and when deals come
to the market, we are at the forefront of engaging
with all of those constituents to help define or at
least attempt to define the types of deals that are
coming to market such that if and when we decide
(20:45):
to participate, you know, we are hopefully getting more significant
allocations within that process. And that has worked out really
well for us over a long period of time. We
have a dedicated team on the capital markets front that
works very closely with the banks, with issuers, with private responsors,
and my partner Dave Delbos, you know, he has done
a tremendous job leading the effort, working with a lot
(21:07):
of our private responsors, thus making sure that we're getting
good quality, you know, well underwritten deals into the portfolio.
Speaker 2 (21:15):
You know, what you're saying makes complete sense. I'm trying
to understand physically how able you are to execute on it.
Like you've rattled off a lot more sectors that you
don't like than you do like, So how easy is
it to get lighter in those spaces? And maybe you
could talk a little bit more in depth about some
(21:36):
of those places that you don't like, like retail, and
you know what the real concerns like, do you do
you see defaults going up meaningfully in the in the
spaces that you don't like or is it just a
matter of spread widening?
Speaker 4 (21:51):
Yeah, you know, to the first point there. I think
it's also important to understand the magnitude. Right, in some
cases they are small underweights, but there are any of them,
and then some of the overweights that we're talking about,
they're more substantial in size and its scale.
Speaker 3 (22:06):
So I think that's that's important to note.
Speaker 4 (22:08):
I don't think defaults are going to increase very substantially.
We're coming from a very low starting point. To my
point earlier, I think fundamentals are generally in a reasonably
good spot. In fact, if you look at some of
the leverage metrics predimetrics that I was citing earlier, we
saw some improvement in the.
Speaker 3 (22:28):
Fourth quarter versus the prior quarter.
Speaker 4 (22:31):
Right, Yes we expect deterioration, Yes we expect a slowdown,
but I don't think you'll see a massive uptick in
default So maybe very low single digits, you know, one percent,
you know, sub one percent in some cases, a little
bit north.
Speaker 3 (22:45):
Of that, maybe that becomes two three four percent.
Speaker 4 (22:49):
I don't see the scenario at the present moment where
that becomes eight to ten percent similar to what we
saw in you know it well, I guess COVID was
less than that, and the global financial crisis was was
more than that. I don't see that being the path
forward over the next six two to twelve months. You know,
our views around some of the sectors that I was highlighting, retail, autos,
(23:14):
consumer products. You know, I think those are are generally
fairly straightforward and probably very well articulated.
Speaker 1 (23:22):
Uh.
Speaker 4 (23:23):
You know to your audience, you know, over the last
you know month or so, as you've talked about tariffs,
you know, the retail in particular, uh you're you're sourcing
from from China in particular, but not limited to China, Vietnam, Cambodia, Taiwan.
Uh So those those sector, that sector I think is
going to be uh somewhat challenged in the in the
(23:46):
current environment. Autos that that is, you know, going to
be a near term concern. There may be some or
there may have been some pre buy activities that is
going to you know, prop up some sales figures and
some of the financial metrics over the last month or so.
(24:06):
But as we know that that likely won't be sustained
and that will likely lead to a slowdown in demand.
That will also lead to UH, you know, some pressure
as margins get squeezed for for these oe ms On
the consumer products. Obviously, a lot of hard goods are
still imported from from Asia uh and that is going
(24:30):
to be challenged with the tarot environment you also have.
It's not just about tariffs, right, It's also about consumer
confidence and business confidence waning.
Speaker 3 (24:41):
Right.
Speaker 4 (24:41):
As you know, as the consumer pulls back the demand
for many of the goods that I'm highlighting, many of
the sectors that I'm highlighting are going to be challenged.
I'm not suggesting that's that's game over or overly problematic
form these sectors. They'll be challenged. It'll be interesting to
see how management teams deal with this challenging operating environment.
Speaker 3 (25:03):
It's also a question of how long lived will it be? Right?
Speaker 4 (25:07):
Are we looking at something that's going to be three
to six months is going to be materially lower than that.
Speaker 3 (25:11):
Are there going to be trade deals that are negotiated.
Speaker 4 (25:14):
One thing that I do know is that if you
are a CEO or a CFO making important management decisions
as to how you're going to operate your business. Given
the economic backdrop right now, you are you're pulling back,
you're slowing down. You're not moving forward without CAPEX program
without knowing what the backdrop is going to look like.
So that has led us to be underweight many of
(25:35):
those sectors. Additionally, the energy sector that you know that
is you know going to be We've seen signs of it.
It's going to be a bit more challenge than we've
seen in the recent past. We've seen commodity prices come down,
which is going to be a challenge for independent exploration
(25:56):
and production companies. But the knock on effects are are
significant for oil field servicers and drillers. Right as CAPEX programs,
as development programs are pulled back, that's going to have
a significant impact on services and drillers. We also have
a slight underweight to midstream companies, so think pipeline and
(26:18):
storage here it's greater stability of cash flow, but they
will not be immune to some of the challenges that
I'm highlighting within the the oil sector.
Speaker 2 (26:28):
What would change your mind on just market direction what
would make the market get meaningfully worse or what could
all of a sudden solve all these problems. And we
go back to the day after the election, and that
you know, everyone thinks IG spreads are going to zero
and highyield spreads are only going to be you know
(26:49):
nothing behind.
Speaker 4 (26:50):
Well, I don't think anything today or tomorrow is going
to meaningfully change what.
Speaker 3 (26:56):
That what that outlook looks like, right because to some extent,
the seeds are in place for this slowdown. Right, think
about what I was just highlighting with the consumer.
Speaker 4 (27:08):
With CEO CFOs, they've been making decisions that are consequential
over the next month, quarter, and maybe even longer than that.
So yes, they can change as the backdrop changes, but
these are decisions that have consequences out a quarter or
two in all likelihood. But if we had greater clarity
(27:32):
around the tariff environment, if management teams understood specifically what
that looked like and there was certainty around it. Right,
The certainty part is really important here because you may
get a decision, but how do we know that decision
is not going to change tomorrow or the next day
(27:53):
or a month or a quarter out right, So we
need greater clarity around that, and I think you know
that the big point here is clarity and stability around
the economic backdrop is critically important. I think the FED,
you know, I think it was alluded to earlier that
there's there's no backstop, whether that's monetarily or fiscally, I'm
(28:18):
not sure I necessarily agree with that. I think there
are levers that can be pulled, both monetary policy and
friscal policy that can alleviate some of the concerns that
that we're talking about today. I think from the FED standpoint,
they are there. You know, they're in a difficult spot, right.
(28:41):
You have inflation that has not come back down to
the targeted level from the COVID spike. You have a
backdrop that is, you know there's likely going to lead
to greater inflation over the coming quarters. You have a
likely environment where growth slows, right, so that you know that,
(29:04):
you know, in theory, should provide a an opportunity for
the FED to ease, but they need to be really
focused on the inflation dynamic as well. So it's it's
it's a really tough.
Speaker 3 (29:16):
Spot to be in.
Speaker 4 (29:16):
I think they'll be really focused on the employment picture,
what the job's environment looks like and to the extent
you see that starting to come off right, some some
weakness coming through where not only do you see a
lack of hiring, but you start to see more job cuts.
(29:37):
I think the FED UH may may think a little
bit more aggressively about an easy backdrop UH, to the
extent they have weakness in the in the in the
employment dynamic.
Speaker 2 (29:50):
But so it's it's pretty clear like you moved up
in quality sectors, high, better cash flows, the risk profiles
for a lot of these names or somewhat limited. But
what like what gets us to we wake up tomorrow
morning and it's like a uh oh, I couldn't see
that one coming. What is that next? Like? Where where
(30:12):
does this market all of a sudden get crushed? And
are you just saying that you just can't the probability
that is so low or just so uncertain, you just
can't see that for all the data that you've got
in front of you.
Speaker 4 (30:24):
Now, No, there is some probability of that existing, of course,
so I can't say that I can't see that. I
think at the moment the probability is low. But you
know there's to what has been highlighted here a few times,
both myself you James, like, there's uncertainty out there, and
(30:45):
if this uncertainty continues for another quarter two cores, three cores,
that could lead to a more significant downturn than what
we're expecting. So there is some probability of that. I
would say the probability of that is fairly low at
the moment. I think you will see monetary and fiscal
(31:09):
stimulus to offset that to the extent we get to
those more draconian economic environments, but there is a non
zero probability of that playing out.
Speaker 1 (31:20):
Going back to what you said about bonds and loans, Mitch,
you reduced leverage loans more than you did high yield bonds,
suggests that relative value lies in the bonds direction. I'm
interested in hearing more on that. Definitely, the leverage loan
markets under more stress, but as an investor, you're getting
some pretty good floating rate debt must look appealing. So
what's the rationale there, Well.
Speaker 3 (31:41):
There's a few things.
Speaker 4 (31:43):
When we executed that trade over a few days, the
low market was holding up much better than the high
yelled market. So from a relative value standpoint, as we
saw more weakness being priced into high yield bonds relative
to loans. We use that as an opportunity to reduce
our exposure on.
Speaker 3 (32:02):
The loan side.
Speaker 4 (32:03):
That wasn't in isolation, right, So what else is important?
The loan market is carrying at very attractive levels, or
was carrying and still is to an extent at very
attractive levels as compared to the high yield market. Now,
part of that was with a view towards what the
rate dynamic and the forward looking rate dynamic looks like.
(32:26):
To the extent the market is pricing in and or
the FED begins a more aggressive easing regime, that's going
to have greater implications for the floating rate acid class
loans like you just mentioned. So you know, there's a
few thoughts there that led us on the margin to
(32:47):
reduce the loan exposure a little bit more aggressively relative
to high yield bonds. Now, the other point is, and
I alluded to this in my first few comments, is
that the overall construction of the leverage loan market is
a little bit weaker in terms of credit quality than
the overall high yield market. Right, So, if you think
(33:07):
about the evolution over time small and medium sized leverage
buyouts you know, we're generally getting financed in the leverage
loan market as compared to the high yield market.
Speaker 3 (33:18):
There's there's one, fairly and probably multiple reasons why that's
the case.
Speaker 4 (33:22):
But as a private equity sponsor, I want to have
flexibility in my capital structure. If I issue a high
yield bond that was typical structure eight non call three,
seven non call three. The important point here at least
three years of call protection, and the loan market, you know,
a sponsor has the ability to reprice that loan, you
know after the first you know called six months of
(33:44):
soft call protection. So if that issuer went out and
sold an asset for a billion dollars and wanted to
either reprice or pay down debt, they have the ability
to do so in the loan market. They do not
have the ability to do so in the high yield market.
So that's a real advantage for an issue or sponsor
taxes one market relative to another. But the point there
is that has led to a deterioration and credit quality
(34:07):
of the low market relative to the high yield market.
And so as I think about you know, the looming
credit risks that are ahead or the potential slowdown. Which
market may be more impacted. It's likely to be the
leveraged loan market for the aforementioned reasons as compared to
high yield.
Speaker 1 (34:25):
So you expect to high default rates in loans competitive bonds.
Speaker 4 (34:28):
Yeah, that's a reasonable expectation, right, lower quality, credit risk
and leverage loans versus high yield bonds likely to see
more defaults or maybe i'll say more distressed exchanges, more
liability management exercises that are getting done in the leverage
loan market as compared to the high yield market, which
also counts as a default or restructure.
Speaker 1 (34:49):
Yeah, I'm glad you brought that up because it's a
huge theme for listeners and guests on this show. It
just seems to get worse. It just seems to get
more coercive and more violent in terms of the structures
and what the issuers and the lawyers are trying to do.
How do you protect yourself as an investor? How do
you think about that? Do you have to expand your
team of legal support.
Speaker 4 (35:10):
We have plenty of resources, both on the research side
of things as well as on the legal side of things,
so that's generally not an issue. But we as you mentioned,
we're a large player within the space on the active side.
We're large in and of itself, but we also benefit
from Blackrock having tremendous au M assets under management across
(35:33):
a range of different products within high yield bonds or
leverage loans, and so that generally gets us a seat
at the table, very involved in conversations that are happening
that will lead to potential outcomes on the distressed exchange
or liability management side of the things.
Speaker 3 (35:49):
So we are.
Speaker 4 (35:50):
Active participants and very engaged with sponsors with issuers to
try to achieve the best.
Speaker 3 (35:56):
Outcomes for our clients.
Speaker 4 (35:58):
Now, one thing I would say here is well, in
the short term, some of these distressed exchanges, you know,
can work out well depending on what part of the
capital structure you're in. You know, I believe we believe
that's a near term fix. It doesn't necessarily solve the.
Speaker 3 (36:15):
Longer term problem.
Speaker 4 (36:16):
The real problem is what are the reasons why we
have gotten to this point in the first place. What
fundamentally is going on within that issue or within that
sector that has led to these challenges, that has led
to leverage metrics that are six seven, eight plus times,
if not more that has led to bond or loan
(36:37):
prices trading in the fifties, sixties, seventies. You know what
is bringing that sponsor or, that issuer to the table
to engage in these conversations.
Speaker 3 (36:46):
You may have a near term.
Speaker 4 (36:48):
Uh, you know, positive credit development by cutting twenty to
thirty percent of the debt in a particular trunch, But
longer term, have you really fixed anything within that business?
If you haven't changed anything on the fundamental side of things.
Speaker 1 (37:01):
Is there any chance so that it might lead to
better covenants though for investors, and you must be sort
of demanding more protections because this is becoming such a
big risk.
Speaker 4 (37:09):
Of course it does, especially in those in those transactions.
Speaker 3 (37:12):
Of course it does. The dynamic that exists in.
Speaker 4 (37:15):
The in the high market, in the low market continues
to be challenging from an investors standpoint in terms of
our ability to get sort of our wish list in
terms of covenant packages across many of these issuers.
Speaker 3 (37:29):
Well, I would say it's.
Speaker 4 (37:30):
Very relevant for the mid to lower quality issuers that
are coming to market, especially in the current environment. It's
a little bit different for the very high quality issuers.
Think that will be high sing will be where we
think there's a very low probability of significant challenges in
the near to intermediate term.
Speaker 3 (37:47):
The demand for.
Speaker 4 (37:50):
Allocations in many of those deals leads to a very
strong investor appetite and significant over.
Speaker 3 (37:58):
Subscription levels and deal dot com.
Speaker 4 (38:00):
And as a result, you know, sponsors and issuers have
the ability to push back and sort of the wish
list of asks. But for more challenging deals for sure,
the deals that are struggling to get done, we are
very vocal with the counterparties that I mentioned to get
the types of covenant, types of structures in place to
protect us in our clients over time.
Speaker 1 (38:23):
And how important does private credit become in all of this.
Does it step in to do some of these deals?
Speaker 3 (38:28):
Very important?
Speaker 4 (38:29):
As you know, over time there has been convergence between
public markets and private markets. There there has been a
liquidity premium or an ill liquidity premium i should say,
in private markets, and obviously the types of issuers that
go to one market versus another over the last you know,
(38:50):
three five, seven years has been quite a bit different.
What's notable in the current environment with high yield bonds
and leverage loans and spreads widening the relative value, in
our opinion, is a bit more attractive in high bonds
or leverage loans relative to private markets, as private markets
(39:10):
take a little bit longer to reprice to some of
the volatility and market weakness that we're seeing. And so
if you think about what that that that spread pickup was,
if you assume private markets are largely unchanged or somewhere
in that five fifty five seventy five context, and you've
seen highal bonds and leverage loans back up, that that
(39:33):
premium has decreased, thus making public market transactions a little
bit more attractive. But to your to your point, to
the extent capital market activity has dried up on the
private side of things, you can and will and potentially
have seen more issuers going to private markets getting deals
done now when they need to or have to. For me,
(39:57):
it's it's not just about today, right, It's a about
the forward environment, right. So you're going to see issuers
that access the private markets over time that are different
points in their life cycle that may be interested in
going public over the next year. And so maybe it
makes more sense to come back to the public markets,
(40:18):
start thinking about, you know, more, being more engaged with
public market participants providing quarterly earnings right, readying yourself for
that public market. I po that that many of these
issuers may be focused on down the road.
Speaker 3 (40:35):
So I think it just depends.
Speaker 1 (40:36):
So, as you mentioned, Mitch, the fundamentals of the market seem,
you know, certainly strong a bit, but we are seeing
some technical weakness among those foreign demand for US credit.
When you've got high Japanese government bond yields, for example,
that's going to affect the interest from from Asia for example.
And another thing seem to be weakening. We've seen outflows.
(40:59):
What do you make the technical pressures right now?
Speaker 4 (41:01):
Yeah, I think the technical backdrop is waning. To your point,
it has been maybe somewhat negative. We've seen fairly significant
outflows from the asset class.
Speaker 3 (41:15):
You know, over the last week we saw two billion
come out.
Speaker 4 (41:19):
Prior to that, we saw the largest outflow on record
at nearly ten billion, uh, sort of wiping out all
the inflows that we had.
Speaker 3 (41:27):
Here to date.
Speaker 4 (41:28):
Now at slight outflows for for the asset class, a
lot of model based or momentum type investors have largely
exited the asset class. What we're seeing at Blackrock both
internally and externally as more and more investors looking to
allocate capital to too high yield. So if you think
(41:49):
about some of the internal pools of capital that you
know that we manage on the multi asset credit side
of things, you know, or broad fixed income side of things,
We've seen a few different types of investors, both on
the short duration side of things and more core fixed
income allocate more capital to too high yield, particularly in the.
Speaker 3 (42:11):
Higher quality part of the market.
Speaker 4 (42:13):
We've also seen insurance companies allocate a substantial amount of capital.
Really almost every day for the last week or two,
they've been buying significant chunks of high quality credit just
given the relative weakness that we had seen, and I
think that makes a tremendous amount of sense. One of
the points I should make is the relative value between
(42:35):
double B risk and truty risk has cheapened fairly significantly.
Alebi's look quite attractive. They probably looked more attractive a
week or two ago. We've seen some outperformance there to
capture some of that back, but I still think there's
good value in the higher quality part of the double
B market relative to trivial BE risk.
Speaker 1 (42:55):
But are you noticing that there is a less of
a foreign demand for US assets. Generally, that's a big
thing that everyone seems to be picking up on. Obviously,
there are constraints to that because the scale of the
US versus everything else. But but is that something that
you think is happening as a kind of secular shift.
Speaker 4 (43:08):
I think it it will happen. I haven't seen a
tremendous amount of that, but you're certainly right. You know,
we've seen and heard a lot of people talking about that.
But in terms of our desk, we managed US high
yeld as well as global high yield. I haven't seen
very significant flows out of the US into Europe.
Speaker 3 (43:29):
Or or for that matter.
Speaker 4 (43:31):
I have not seen some of our investors out of Asia,
you know, pull back and avoid the US. So you
haven't seen that dynamic, but you know, I recognize that
they are. For that to play out, I would say
dealer inventories seem to be pretty light, you know. I
would say dealers last weeks sold six and a half
(43:54):
seven billion dollars of risk seemingly on their balance sheet.
And so if I think about inventory level over the
last three or four months, they're among the lowest.
Speaker 3 (44:02):
Levels that we've seen over time.
Speaker 4 (44:05):
So I think that, combined with what I was suggesting earlier,
significant OUTFLOWDS that seemingly has subsided more demand from insurance companies,
more demand from broad fixed income investors or multi asset
type investors, and some of our external clients, whether it
be large on balance sheet, corporate cash clients, private banks,
(44:28):
insurance companies, all of those investors have not allocated capital
to high yield, but they're all engaged in the conversation
and very much looking to do that.
Speaker 3 (44:37):
We've seen.
Speaker 4 (44:39):
On the private bank side of things a few small
to medium size flows come into our funds. Away from
that hasn't been very substantial, but as a trend that
I think.
Speaker 3 (44:52):
We'll see as we see further spread widening.
Speaker 1 (44:55):
So you see a lot of stuff all around the world.
You get to see great detail, and I'm going to
ask you a tough question, best relative value? Where do
you think it is right now, let's say for the
next twelve to eighteen months. I know it's very hard
to project because things are uncertain, but best relative value?
Speaker 4 (45:12):
Yeah, So what I would say here is that the
relationship of US, you know, high yield versus European high
yield Europe has held up significantly better. They've had some challenges.
They've seen certainly spreads widening, but not nearly to the
extent we've seen in the US market, and early on
(45:37):
that has led us to reduce our exposure to European
credit risk in favor of US credit risk. Now, it's
not necessarily a super obvious trade, because there are there
are very important themes in Europe that I think are
worth noting. Monetary policy is clearly much further ahead of
(45:59):
where the is. ECB easing fairly aggressively, and that is
obviously supportive for risk assets. And then the other major
point is what we've seen out of Germany in terms
of the substantial increase in infrastructure spending as well as
defense spending. That's going to be to the benefit of
many of the issuers within those markets. That said, when
(46:22):
I look at European valuations relative to high yield not
just over the last twelve months, but over a three year,
five year period of time, that relationship continues to be
in the very low percentile rankings relative to where it's
been historically, and maybe rightfully so for the reasons that
I just mentioned, But it doesn't necessarily get me to
(46:42):
want to invest a lot.
Speaker 3 (46:44):
More capital in the European market today.
Speaker 4 (46:47):
That may be the case if we see a little
bit of a cheapening relative to the US, but I
think in the current environment, I still think it makes
sense to be invested in high quality.
Speaker 3 (46:57):
Double by single B US domiciled issuers.
Speaker 4 (47:01):
And one point on that is, when you think about
US domiciled issuers, about eighty percent of the revenues for
companies within the high yield space is coming from the US.
Only twenty percent is coming over the revenues is coming
from international. And so the point here is that the
tariff impact, the direct tariff impact, while maybe substantial for
(47:23):
certain sectors or for certain issuers, is not necessarily going
to be pervasive across the entire space. Certainly, the secondary effects,
the knock on effects to the ones that we highlighted
throughout this conversation, that kind of will be more substantial.
Speaker 1 (47:38):
So to be clear, it's a sell high yield in
Europe and by US high yield instead.
Speaker 4 (47:43):
I'm not sure it's just sell one versus by the other.
But I would say for US in our global fund,
the marginal dollar is getting invested in US high yield.
We still remain constructive on the European market. Just valuations
have held up better there than in the US.
Speaker 1 (48:01):
Okay, god's it. Great stuff. Mitch Garffin, co head of
US Leverage Finance at black Rock, it's been a pleasure
having you on the Credit Edge.
Speaker 3 (48:06):
Many thanks thanks for having me.
Speaker 1 (48:08):
And to Robert Schiffman with Bloomberg Intelligence, thank you very
much for joining us today or even more analysis. Read
all of Rob's great work on the Bloomberg Terminal. Tech
is his life. Call him. Bloomberg Intelligence is part of
our research department, with five hundred analysts and strategists working
across all markets. Coverage includes over two thousand equities and
credits and now looks on more than ninety industries and
one hundred market industries, currencies and commodities. Please do subscribe
(48:32):
to the Credit Edge wherever you get your podcasts. We're
on Apple, Spotify and all other good podcast providers, including
the Bloomberg Terminal at bpod Go. Give us a review,
tell your friends, or email me directly at Jcrombeight at
Bloomberg dot net. I'm James Crombie. It's been a pleasure
having you join us again next week on the Credit Edge.
Host
James Crombie
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