Finance Leaders on Systemic Risks in Private Credit

Thank you, Danny. Um,

welcome everyone. Good morning. Um, I'm

u happy to be on this stage with um Milwood Hobbs of Oakry, Mark Pinto of Moody's, and Ammy Villain of um Voya.

We're here to talk about systemic risk and um liquidity in private credit. Um

very topical at the moment. Um Mark,

maybe I'll I'll start with you. like it

feels like uh you know a few years ago it would have been really hard to find someone even discussing systemic risk around private credit and the idea was like you were putting you know loans

that banks used to do into steadier hands matching long-term assets with long-term liabilities. Um what do you

long-term liabilities. Um what do you make of the discussion around sort of these semi-liquid funds and how uh are you thinking about systemic risk? Yeah,

I would say uh for sure private credit has become more systemically important, right? I think that's you know a decade

right? I think that's you know a decade or two ago it was really on the periphery. We used to call it shadow

periphery. We used to call it shadow banking. It's all grown up. It's called

banking. It's all grown up. It's called

private credit now. Um so it is more systemically important and it's uh it's it's changing a lot as well. I mean it's something that you really have to stay

on top of. It started out being middle market um uh lending and it's really become more global in nature. It's moved

to assetbased finance is something we talk about a lot today. Uh and to the point that Brad made at the very end there the credit spectrum uh has also widened. Whereas it was largely

widened. Whereas it was largely speculative grade type lending you also see investment grade type lending. So um

there's a lot happening. it is more systemically important and uh that makes it important for us to focus on. I want

to come back to the asset back finance piece um as well, but um Milwood maybe just to get your perspective as someone who's actually putting uh money to work.

>> Um how does >> how does liquidity u and and and you know having to create some liquidity for retail investors affect your process because that as we were just hearing in

the the prior panel can create issues when the money is coming in too fast or when it's going out too fast.

>> Right. Well, look um thanks for having me. Um I think it's important to

me. Um I think it's important to recognize and I think the last panel said this that the funds are are structurally set up to invest in private

illquid assets right and the the footnotes say we can redeem up to 5% of NAV on a quarterly basis and so the way we manage through that is we have we

have liquidity facilities we have public um securities that we can sell um to manage that but really you know if you think about beyond ond the 5%.

I'm either going to sell assets, right, or take liquidity for the other folks who stay in the fund. So, I think it's I think what everyone's trying to sort of figure out is what's the sort of when

the noise sort of stops, >> what's sort of baseline redemptions could be. And if you go back to 16 or

could be. And if you go back to 16 or 2020 or even Q1 to 23, 40 days in COVID, the best sort of returns in the space

was during the the volatility and dislocation. So I think I think if

dislocation. So I think I think if you're actually trying to sort of generate returns for investors, you know, someplace like oak, that's when we sort of invest more, right? We kind of

underinvest in benign markets and we invest more in volatile markets. And Amy

Voya has a partnership with Blue Owl and and the point of that effort is to bring private markets um to the to the retirement community.

>> That's right.

>> Um how are you thinking about that? And

particularly with all the concerns that we've seen and the pressure we've seen on on BDC's for example in in recent months, has sort of your thinking about

that shifted in any way? No, I mean it it continues to be important to us and important to our clients, the adviserss that we work with uh to be able to have

diversification um for for plan participants um and for the employers that that manage those plans. And so that continues to be very

plans. And so that continues to be very very important. I think one of the

very important. I think one of the things that we're learning and working through together um with our partners

and and other partners in this space is is really to be able to understand you know we we we um guide ourselves on two things one is

education heard that a lot in the last panel uh I don't think it can be said enough and the second is really around professional management so when we think

about these inside of a retirement plan.

We really think of them really only right now in the context of professional management. So think of an advisor

management. So think of an advisor managed account or a target date fund not and one of the things we had talked about a little bit earlier was was not

having that investment option available to that individual participant directly to make some of those decisions. so that

the advisor the advisor uh the investment manager are are actually professionally managing that and then considering the size of the allocation

as well as the liquidity.

Um Mark, how far do you think we are from a point where liquidity pressures on and and redemptions even if they are

u investors acting out of fear and maybe the fundamentals don't justify that but do snowball into u any credit issues?

>> It's an important thing to look at. You

know, we've been emphasizing as well that this is a liquidity issue today, but a prolonged liquidity issue can turn into uh a credit issue and I think you

heard from some of the panelists u just before us that um they're thinking very carefully about liquidity and in fact the more liquidity you hold in the fund

could very easily impact the overall return that you provide to investors. So

this is about confidence, trust, education. Um we have been saying uh for

education. Um we have been saying uh for some time and in our our private credit outlook that we put out last month that as you bring more uh private individuals

into the private credit uh ecosystem, it potentially raises risk. And if the private investor is not receiving what

it believes it was promised, then you end up with a confidence issue. And

while you know there was a lot of very logical uh uh discussions uh just previously and and about what's going on

in this market um the uh investor base has been spooked and billions of dollars in market cap have been lost and it's important to to to focus on that. Uh

again it's it's it's um educating the market about what's going on here uh and emphasizing the structural features of this market and the fact that the market

is operating um um uh rationally at this point in time >> and Milwood um talking about um sort of

credit issues we've definitely have had some accidents along the way uh banks have had them private credit funds have had them I think no one is immune to that, >> right?

>> Um but when you see, you know, there's been a lot of concern around valuations for example in private credit and you see loans that drop from 100 to zero in a very short period of time.

>> Yeah.

>> What does that tell you about the underwriting environment and could you help us size that?

>> So, so look, I think I think it's important for everyone to appreciate that private credit is a subset of leverage credit in totality. And what

you see is in the public markets, what you see is generally speaking, it's a liquidity issue and not a credit issue.

So when you think about the AI and software and loans went from roughly par to on average 92 in software, it's it's not that the software names are now

worth 92. It goes to a level where

worth 92. It goes to a level where there's someone willing to buy the risk, which is not necessarily driven by the credit. Um and I think it's important

credit. Um and I think it's important for everyone to appreciate that um markets move based on capital, right? So

we've been in a market the last few years where capital was more than the opportunity set. And so when capital is

opportunity set. And so when capital is more than opportunity set, you tend to price capital versus the underlying risk. And so that's that's the challenge

risk. And so that's that's the challenge that we've had in the markets generally speaking. Now you have psychology,

speaking. Now you have psychology, right? And so at some level what drives

right? And so at some level what drives movement in that credit is the psychology aspect of it. And I think that that's what we're dealing with. And

that's going to take some time. Um but

what I think happens over time is that if you're sort of like patient, right? If you're patient, I

patient, right? If you're patient, I think you will see most of the credit issues will be solved. Uh we will have higher defaults. That's clear. Like

higher defaults. That's clear. Like

everyone in our market's been a genius since 2010. and there's been no one

since 2010. and there's been no one that's dumb. So, uh, we will have some

that's dumb. So, uh, we will have some issues. Um, and I think the other thing

issues. Um, and I think the other thing you will find is that we'll have some opportunities, right? Because now with

opportunities, right? Because now with the outflows, we have to repric our capital because we're not getting the inflows. So, we have to be more

inflows. So, we have to be more selective. So, asset selection becomes

selective. So, asset selection becomes more critical and we're going to repric capital based on the fact that there's less capital now relative to the opportunity set. So, I think that's some

opportunity set. So, I think that's some discipline. bring discipline. That's

discipline. bring discipline. That's

good. The the underlying all of this is we've had interest rates at, you know, 5% or elevated levels for some period of time. And interest rates are kind of

time. And interest rates are kind of like I think of it like rainfall. If it

rains every day all day, but you can kind of get in out of your car, get in and out of the office, after two or three years, sink holes develop, trees fall down, mudslides. And so I think

what you're seeing overall in the market is that the interest rate being high is sort of impacting what I think could be the macro. Um and if you were a capital

the macro. Um and if you were a capital structure that was done in 21 and 22 ahead of rate increases at some level you're you're overlever on cash flow basis because no one predicted rates

would go from zero to 5%. So it's not like the diligence process has changed.

It's not like we're sort of like oh my god we have to do this deal. the higher

interest rates are are constraining cash flows, right? Tariffs are constraining

flows, right? Tariffs are constraining companies ability to to actually earn profits. So there they're real things

profits. So there they're real things out there that are driving this versus, you know, some of the things we're talking about here.

>> Yeah. And um Mark, maybe briefly to come back to you, are there specific credit concerns that you have at the moment um in terms of the underwriting environment?

Um, I'm a rating agents analyst, so I'm concerned about everything all the time.

>> Glass half empty got classic.

>> Exactly. Exactly. No, I mean, we actually are pretty constructive on the market overall. We see rates potentially

market overall. We see rates potentially moving down a little bit to solve some of the issues that Milwood just brought up. Um, we see the economy ticking

up. Um, we see the economy ticking along. You know, not super strong

along. You know, not super strong growth, but decent. I would say the economy is pretty resilient. have been

plenty of conferences like this and the word resiliency has has really stood out to me. Um, currently if we look at our

to me. Um, currently if we look at our global uh high yield default rate, it's about 5% today and we expect that to go to about 3% by the end of the year. So

that's a pretty constructive uh view for the market. You know, we do look at

the market. You know, we do look at concentration risks certainly. Um the

greater focus on software and technology companies is something that we're looking at very carefully, but we also look at you know what does a software company what are they providing? Are

they an embedded and an important aspect to a company's operation or is it just maybe some sort of an interface? So

there are um and then also how the loan is underwritten, right? What kind of collateral you have, what kind of contracts do you have? So there's a lot of uh complexity to looking at that

market today. Um but I would say overall

market today. Um but I would say overall we're pretty constructed.

>> Yeah. On the marks by the way. So you

know I think that's a good we should we should talk briefly about it. So the

marks in private credit are twofold.

Number one is just movement and spreads.

>> Sure.

>> Which is the science of a mark. Right.

Then the other aspect of mark is the valuation of the business. And so what we don't mark to in private credit is a fire cell of an asset when you need to raise liquod. No, no one marks. We don't

raise liquod. No, no one marks. We don't

mark to that. And so I think we are all conscious around marks. You know these are these are vehicles where the retail investor has a lot of oversight from the government. I think none of us want to

government. I think none of us want to be perceived as mismarking uh names. So

I think we spend a lot of time on marks, but we don't mark for selling it on a Monday when the market's closed and we have to have the money by Tuesday. We

don't mark for that.

>> And actually, I wanted to bring Amy into this this conversation because obviously when you think about retirement plans, you know, um we all have them, you know, the instinct of a retail investor when

market is down is go check where, you know, where the retirement pot is um is marked at. How do you solve for that in

marked at. How do you solve for that in with private markets? Right. these are

assets that can be hard to value. Um,

how do you give investors comfort that the number that they're seeing on the screen is is kind of the the true value of the underlying assets?

>> Yeah. So, um, it's not unfamiliar in retirement plans to have uh certain assets that have different valuations.

And so, as uh retirement providers, we have the capabilities of of doing that.

I I often quote that people have pieces of art in their 401ks sometimes. And so

um the the valuation piece is just something that we work with will continue to work with the the private asset managers to make sure that we have

that. And then that'll be the the the

that. And then that'll be the the the beauty of the retirement provider is that we really are that window to that plan participant to see the information.

And so you'll see that, you know, they'll be able to access that digitally on their statements and things like that. So really practical pieces that

that. So really practical pieces that that you do um wi with respect to things like valuation. And then as it as it

like valuation. And then as it as it relates to the volatility part um one I'll go back to education and I'll go back to professional management. Those

two things really guide all of our thinking with respect to to these types of investments and we share that that with employers. Adviserss are very

with employers. Adviserss are very engaged in this and through advisor managed accounts. They'll actually be

managed accounts. They'll actually be managing that, right? That's their job is to manage that is to manage that volatility. I'll just add though that

volatility. I'll just add though that uh from an industry perspective, from a media perspective, from an employer perspective,

um family member perspective, people do not react like they used to react with these peaks of of volatility.

Uh we have um you know, we call it stay the course or stick to your plan. And so

we actually in aggregate watch the behavior of the millions of participants that we have and in these spikes of

volatility 98 to 99% of them do not do hectic transfers and and asset reallocations.

And so it's a little bit of a success story for the industry and for many of you who've been involved in that um to be able to carry that message. And so we expect with a combination of

professional management, the education and the history of you know the education around stay the course that that will continue.

>> Do you think like a lot of the um volatility we've seen recently and the redemption is mostly coming from like so what people call the wealth channel, right? It's not quite as retail as

right? It's not quite as retail as retirement 401ks.

Um do you think education is obviously a big part of this but something went wrong in the communication with those type of investors >> um with the retail investors?

>> Yeah, I guess I think we all kind of have I think every single person on the stage before and now has indicated um that that the clarity of the message

disclosure and and education is is very important. I I just keep going back to

important. I I just keep going back to the same place around professional management, which puts a layer between that individual having to think about

doing that versus someone is managing that for them right now.

>> And David, I talked a little bit about how, you know, the the lending has changed, the investor base has changed.

So Brad uh talked about how they've had retail investors involved in their products for many many years, but there's been a lot more retail investors coming into this market. And they're

different. They're not all super high net worth individuals. If you were in a product years ago, you had to have a million or five million or 10 million.

Your money was locked up for 10 years or maybe two two years extensions. You'd

say goodbye to your money, a million or more for 14 years potentially. Today you

can get into a private credit fund for 2500 bucks and you're told well uh I'm there at the discretion of the board.

You need to read the fine print. 5% of

the of the assets can be called uh or can be redeemed um once a quarter. I

think some of that got lost with the new entrance. And so I think what you're

entrance. And so I think what you're seeing today is a manifestation of the challenges of bringing a wider swath of

the retail investment community into this market which again we you've heard it before. It's got certain features

it before. It's got certain features around illquidity. People understand

around illquidity. People understand the illquidity of buying a house that's that's got a certain amount of liquidity to it, right? Buying a car that's got a different amount of liquidity. buying

something on Amazon, that's got a different amount of liquidity. So, you

need to think about if I'm buying in and out on the stock market or I'm trading treasury bonds or if I'm in a private credit fund that I don't think has sunk

into the the the mentality of of the newer investors >> and I think that's right >> in the context of the retirement plan.

So if you think of the target date or if you think of um like a single strategy or multistrategy private asset CIT um the allocation so if you think about

that in the context of the target date I mean generally the products that we're starting to see come out probably have

10% or less in that in that uh sleeve and so you have that 90% wrapper of liquidity and then when you think of the

more single strategy type. We're really,

you know, each it each product or each solution has its own requirements. I

would say we're starting to see about 15% become a little bit of the norm with respect to a liquidity buffer that sits

right within that CIT.

um that that helps when someone wants to take a loan from their from their 401k or or needs to take a hardship that that access is able to be there. It still has

to be managed. It's being managed at the at the RAA level. Um but it it actually, you know, gives gives some I I would say

some help with respect to that.

>> Sure. We only have about five minutes left, but I did want to touch on assetbacked finance. Um, Milwood, maybe

assetbacked finance. Um, Milwood, maybe I'll start with you, but obviously that is an area that a lot of people are excited about as sort of a new frontier

on private credit. A lot of it is considered u higher quality. Um,

how interested are you in in in that space? And I can't help but notice that

space? And I can't help but notice that it's also a space that has created a lot of trouble. If you think about first

of trouble. If you think about first brands and trickor >> sure sure um so I was at GE Capital in

1997. So I did ABF in 198 1997. So ABF

1997. So I did ABF in 198 1997. So ABF

is not new right what's happened is the banks have to shrink their balance sheet and one way to do that is they just do less warehousing of assets and then

securitize them. So it's it's not really

securitize them. So it's it's not really new. It's just been a shift from the

new. It's just been a shift from the banks to private credit. I think ABF is very interesting. I think it's also not

very interesting. I think it's also not that easy, right? So when you think about ABF, you've got an asset, it has contracted cash flows. Those cash flows

are driven by the revenue of that asset daily and the utilization of that asset.

So as long as the economy sort of stays steady state, that's great, right? Um if you have the economy become a little bit more choppy,

what happens is utilization goes down.

And to keep utilizations from falling off a cliff, you lower revenue, right?

And so when you do that, the asset doesn't generate the cash relative to the debt that's been put on it. So I

think it's I think it requires professional management, right? And then

I think it also requires education, but I do think um there's opportunities for private credit to grow that space because I think the banks have realized

deposits are not that sticky. And when

you have a situation where you make loans based on deposits, you've got to pick your spots where you can actually lend. And so ABF is just shrinking on

lend. And so ABF is just shrinking on the bank side. And Mark, ratings are obviously a key component of of structure finance. U insurance is a is a

structure finance. U insurance is a is a natural buyer base for a lot of that product.

>> I think there are concerns around that um idea. Colem Keller at UBS has talked

um idea. Colem Keller at UBS has talked about, you know, systemic risk coming from um US insurers uh investments and private credit. A lot of those ratings

private credit. A lot of those ratings are private. Um he's talked about the

are private. Um he's talked about the the danger of like ratings um arbitrage.

How how you're thinking about those issues?

>> Yeah. Um so there's much greater interconnectivity today than there's ever been between the insurance companies, the banks, the asset managers. We've never lived through a

managers. We've never lived through a period of time exactly like this. But I

would say with respect to the insurance companies who've been very big buyers of private credit, this is not their first time at the rodeo. They were there when railroads were being built in the

industrial revolution. The Empire State

industrial revolution. The Empire State Building down the street which was conceived in 1929 just before the crash had a bunch of banks lined up to finance it. They left. The insurance companies

it. They left. The insurance companies came in and helped to finance the building of the Empire State Building.

So they understand this. They have been increasing their asset risk. They've

been increasing their illquidity uh in their general accounts, but they've also been reducing their liability risk by selling off some uh tail business that

is a bit riskier. They're sharing some of the risk with their policy holders.

So, it's very interesting in the banking community. We're seeing asset risk come

community. We're seeing asset risk come down in the banks. We're seeing

liability risk rise because we can use our phones to move money around. We saw

that with Silicon Valley Bank. Um, and

in the insurance industry, asset risk is rising to some extent, but liability risk is is coming down. And I would say the last thing about the insurance companies who've been fueling a lot of this growth, they've been very good and

have held to their tenants of asset liability management. Um, they have

liability management. Um, they have policyh holders that are living longer.

They need duration. They need

diversification. And they need uh higher yield. and they're getting that in the

yield. and they're getting that in the private credit space because they can't get it in other places.

>> Okay, 40 seconds. Amy, like in terms of going up in quality, is investment grade private credit an area that you think could fit within uh the scope of your

effort in in private markets?

>> Um, you know, we really don't have just a limitation with respect to private credit. It's really all private asset

credit. It's really all private asset classes that that we're we're actually looking at and working with providers to be able to um to be able to offer

diversification. I mean, it comes even

diversification. I mean, it comes even within the classification of private assets. There's diversification and so

assets. There's diversification and so it it really is an intention to to explore all of that and and offer those opportunities for employers.

>> Right. Please join me in in thanking our panelists Amy, Mark, and Milwood. Thank

you very much.