Webinar Replay – The Domino Effect: How Private Credit Changed Fixed Income

Shawn Eubanks: Good morning everyone. My name is Shawn Eubanks and I'm the Director of Business Development at Osterweis Capital Management. We'd like to welcome you all to the webinar today, The Domino Effect: How Private Credit Has Changed Fixed Income. Today's session will feature Carl Kaufman and John Sheehan, portfolio managers for the Osterweis Strategic Income Fund. As you all likely know, private credit has been in the news quite a bit lately, mostly for the wrong reasons. Today, Carl and John will look back at the history of private credit, and they'll discuss not only how we got to where we are today, but also how the exponential growth in private credit has been a long-term positive for the overall quality of the high yield bond market.

I'd like to thank you all for attending, and I hope you find the webinar useful. Carl, over to you.

Carl Kaufman: Thank you, and thank you everybody for joining us today. I guess we're going to start with our first polling question. Why did you register for today's webinar? Curious minds, want to know. . Learn more about private credit. It's a good answer. Fair see what the others are. But anyway, thank you all for sharing that with us. Okay, so let's go to the next slide. We're going to talk today, clearly, as Shawn mentioned, the growth of private credit has been pretty quick and it has had an impact on fixed income. We'll discuss what those impacts are and what they aren't. And also maybe hopefully give you a framework for assessing that risk. Next slide, please.

Let's talk about the market evolution for a moment. Back when I started in the Civil War era, there were basically two choices you had to make when you were investing in fixed income. You either invested in investment grade or you invested in non-investment grade, also known as high yield. As you can see here, investment grade was the dominant part of the market, and it still is in terms of size, seeing as government debt seems to grow every year. If we can go to the next slide, you can see some headlines. High yield started out in the early 80s with Drexel Burnham being the progenitor of the modern era of what they call junk bonds. We certainly have had a few ups and downs and growing pains with that culminating in the S.&L. crisis in the 1990s when a lot of bonds that were issued were in fact junk.

There wasn't much credit work done by buyers. As you remember, Mike Milken got a little vacation courtesy of the federal government for his machinations and fixing and moving things around. And it was a wake-up call for the market and it did get better as time went on. Let's go to the next slide.

After the high yield market found its footing, there was a parallel move in securitization of debt. Started with mortgages, but what happened was banks used to do most of the direct lending in this country. The C&I loans were popularly followed by many people to gauge the health of the industry. But what happened was there were a lot of smaller, lower quality borrowers, and there were also sponsor-backed leverage buyouts that needed to finance with debt. And banks, seeing that these were a little risky, decided to start arranging and syndicating new issues rather than putting them on their books. So that reduced their balance sheet exposure. They also became a fee-collecting machine rather than an interest-collecting machine with the associated credit risk. And they would basically accept lower returns, but from their point of view, it was nearly risk-free. The leverage loan pipeline clearly spun the CLO market as insurance companies and institutional investors became large buyers, it's much easier to buy a big package of loans than doing research on each loan to create your own package.

So that was an easy move for them. And that started in the 1990s.

Next slide, please. So the 2000s pre the Great Financial Crisis, a lot of banks struggled to compete, because these big banks were basically hogging up all the loans and the smaller regional banks were stuck with either weaker, smaller credits. And so there was a big consolidation that went with that. And that accelerated the de-risking trend that began in the 1990s as borrowers increased their reliance on leveraged loans and CLOs. And as you can see from 2004 on, C&I loans as a proportion of central bank, well, up until 2004, they really went down from 18% down to 12%. They've risen a little bit since then, up until 2008. If you can go to the next slide, you can see that the Great Financial Crisis was clearly a signpost or an era-changer, if you will. Subprime loans were plentiful. House flipping was commonplace. People had multiple homes.

Housing prices were only going to go up. And banks didn't really care because they didn't hold these on their books. They securitized them, sold them off to Wall Street who had an insatiable appetite for this stuff. And the rating agencies were kind of asleep as well. They had, I think, as many as 60,000 triple A ratings on some of the higher-rated tranches of these things. And in fact, by the end of '08, they were acting more like triple Cs. So that clearly caused a pretty bad recession and took a couple of old line players down with them, Lehman Brothers, Bear Stearns, not to mention Fannie, Freddie, and AIG. So that was basically due to lax lending practices. You'll hear more about this as we progress. Next slide.

Post the Great Financial Crisis, there was aggressive de-risking. Part of it was regulatory. Since the taxpayers had to bail out the banks, there was some regulatory overhaul, Dodd-Frank, Basel III. Lending standards were tightened. Capital reserves were increased. Weaker loans carried additional capital charges. And in fact, they prevented banks from lending to the type of credits that were the biggest borrowers, which are the big LBO financings, and those were basically companies with over six times leverage. So corporations needed to find new sources of funding. And where there's a need, Wall Street will fill it. Next slide, please. I'm going to let John talk about the current market structure at this point.

John Sheehan: Thank you, Carl. So the net result of what Carl just talked about has been substantial growth in both private credit and leveraged loan markets. Much of the lending that used to take place within the banking system has now gone into the markets where leveraged loans have been driven by the evolution of securitization and the CLO market. So what that has really done is it allowed investors who are mandated or constrained by ratings, take an insurance company, for example, would allow them to buy non-investment grade loans or bonds, but through the miracles of securitization, they were able to buy them in triple A and double A form. And then direct lending, which is also another term used for private credit, really exploded in growth as a result of the constraint that were put on the banks through some of the regulations. Carl mentioned the six times leverage cap.

So those borrowers that were more than six times levered didn't go away. They just found new sources for borrowing. Also, during that same time period, there's a substantial growth in private equity, the amount of assets that private equity managers managed, and they no longer could rely on the banks to fund their deals. So that gave both a great supply and demand dynamic to the private credit markets. Private credit markets now exceed the high yield market, and on a relative basis, high yield market has stayed relatively unchanged over the time period where leveraged loans and direct lending saw explosive growth. We don't have investment grade in here, but the investment grade market has seen similar growth. The investment grade credit market now is over $9 trillion in total debt outstanding. Next slide, please. So this is showing the evolution over close to the last 40 years.

So what was once a two-tiered market created by the line from the rating agencies between investment grade and non-investment grade has evolved into a four-tier market. Investment grade is still at the top, followed by high yield, leveraged loans, and private credit. There is some overlap from one to the next, but for the most part, this is in the order of credit quality as well. The net effect of lower credit quality borrowers financing in leveraged loans and private credit has given them more opportunities to finance, but it's also shifted the quality in the other markets as a result as well. So we'll get into that in the next slide.

So what is private credit? I think it's, as Carl mentioned at the top of the call, very commonly talked about, it feels like it's reaching a fever pitch right now in the media, but basically private credit is lending that used to take place in the banks but has now been pushed out of the banking system. So it's an agreement or a loan between two non-bank parties. We talk about the non-investment grade or the lower quality private credit, but there is also a segment of the private credit market among investment grade companies. Best example of this would be the hyperscalers and their insatiable need for funding to build out data centers, and they've turned to the private credit markets for this. Meta is probably the best example, and they like the fact that they can get quick liquidity. Oftentimes it's one counterparty writing the check as opposed to a big syndication process.

And then the other dynamic is that many of these private equity managers became private credit managers, and they also went out and bought insurance companies. So these captive insurance companies need investment grade assets as well. So there's been a new source of demand for investment grade private credit.

And within leveraged private credit, it looks very similar to what we've always seen in leveraged loans. So it's a $1.7 trillion market. These tend to be smaller sub-investment grade companies, very heavy PE-backed (Private Equity-backed) companies, both in terms of startups, but also companies that are wholly owned by the private equity managers. And there's various sources or examples, but BDCs have been around for a very long time. They traditionally provided funding to these companies, but we're seeing a proliferation of the type of vehicles and the people that are being targeted to invest in these vehicles. There's also been a good amount of attention to the fact that there's an executive order allowing private credit to be marketed to our retirement accounts and 401ks.

So there's some very notable differences between private credit and high yield, both in terms of the assets themselves, but the fund vehicles that are used to offer those products. So a daily liquidity high yield fund, we mark our positions every single day. There's daily liquidity at NAV, where these leveraged private credit funds, many of which are an interval structure, which means they set specific intervals where you can get liquidity. Most of them are quarterly. Some of the bigger ones are offered monthly, but they do not mark their positions as frequently, and they restrict the amount that can go out at those intervals. So typical structures, they'll limit monthly or quarterly liquidity to 5% of the total fund. I think some of the concerns that have flared up in the market recently is that some of these funds have received requests in excess of 5% of the total fund size, and they prevented or gated withdrawals from those funds.

Most of private credit is not rated. That comes from the fact that it's an agreement between two counterparties, so they don't feel the need to bring in a third party rating agency, pay the fees to the rating agencies. There are some rating agencies who've started to look at them and put ratings on them on their own, but it does not rely on the public rating agencies the way the high yield market does. Dramatically, less disclosure from the investor's perspective in terms of financial statements in the private credit market relative to high yield. We have not seen the private credit in its current form, given the magnitude of all the different vehicles go through a credit crisis, a liquidity crisis or a recession. So that's yet to be seen. Typically, the fees are greater in a private credit fund than they would be in a public mutual fund.

And again, because mutual funds are dealing liquidity, low investments, they're much more easily accessible than some of these private credit funds are. I think we have our second polling question now. Do we want to jump into that? So before we jump back into a little bit of the difference between high yield and investment grade, we wanted to ask the second polling question, which is, which fixed income securities do you typically invest in? This pretty much covers the gamut of all the credit products, even some of the Treasuries.

Carl Kaufman: Okay, good answers.

John Sheehan: Yeah, pretty good split here. Blended investment grade, I'd say that's a good proxy for the Agg or core funds. Lots of investment grade corporates, Treasuries, and high yield is very high up there as well. So good response there and good to know. In terms of what the impact has been to the high yield market around the proliferation of leveraged loans and private credit is that we've seen a significant improvement in the credit quality of the high yield market. So in 2009, basically right after the financial crisis, about 42% of the market was the highest ratings category of double B, 35% with single B and 23% was the lowest category of triple C. Roll the clock forward now to the end of last year, 58% of the market in high yield is now the highest category, so a significant improvement in that category and equally as important is that the triple C category, the lowest quality, has gone from 23% to 10%.

That is because many of those triple C issuers who once upon a time would've come into the high yield market, they've now gravitated towards leveraged loans and private credit. So the high yield market as a whole is much higher quality than it was at the conclusion of the financial crisis.

Interestingly, we've also seen the degradation of the credit quality of the investment grade market. So if you were to look right now at the composition of the investment grade market, just under half of the investment grade market is rated triple B. I believe around the same time at the end of the financial crisis, this number was 25%. So almost a doubling of the triple B ratings within the investment grade market. And when you put the two together, the triple B in investment grade and the double B in high yield, there's a very heavy concentration around the line created by the rating agencies. This is an intentional decision by corporate management teams where they feel that there's not getting paid enough to be a single A or double A credit quality. So they'll happily add additional leverage to the balance sheet, which allows them to do share buybacks or dividends because the credit curve right now is very flat between triple B and double B.

So Corporate America is responding by taking advantage of that pricing in the market.

This is the similar ratings composition of the leveraged loan market. You can see that 63% is single B, so a good bit lower quality than the high yield market. Only 25% is double B, and then 9%, which is similar to the high yield market is rated triple C. This is somewhat dictated by the CLO structures. So the leveraged loan issuers oftentimes are issuing directly into CLOs and they have specific rating buckets that they're looking to fill. So they manage the balance sheet enabled to access that CLO bid, but a good bit lower credit quality and leveraged loans than in high yield.

As we said at the top of the call, most of private credit is not rated certainly by the public rating agencies of Moody's and S&P. You do have a rating agency, Egan Jones, who's attempted to start to rate some of these loans, but the magnitude of the number of loans, I think they've rated something like 3,000 private credit investments. This is done with a team of 20 analysts. So you can see that they're stretched very thin, nowhere near the level of transparency as we see in publicly rated instruments in high yield. And this quote right here is something from the Fed, but they're talking about the combination of many of these borrowers in the private credit world being highly levered and then very few collateralizable assets. So one of the big selling features of private credit has been that it's a senior secured loan, but when you combine the fact that they're highly levered, this has most recently come to a head in the software space.

People are concerned about AI potentially disrupting the software space. So many of these software companies were bought by private equity managers with eight to 10 times leverage, and you have to question how much being senior security is going to help you in a business like software. Historically in the high yield market, when a company were to go to default, the creditors own the factory, they may own some real estate, they own inventory, et cetera, which is very quickly saleable and helps recover some of their investment. A software company where their primary asset is their intellectual capital that is now potentially able to be replicated by AI for a fraction of the cost. How much are you really being protected when you have so few collateralizable assets?

This is the topic that we spend a good amount of time on is the difference between high yield spreads and high yield yields. So on a spread basis, on the surface, it looks like spreads are tight on an historical basis, but when you adjust for the fact that the composition of the index is much higher quality now, so if we were to take today's spreads and convert them to the weightings of the previous categories, it's a translation of close to 100 basis points, meaning spreads right now appear to be 100 basis points tighter than they would be, but if you give credit to the fact that it's a higher quality index, it makes sense that that spread should be tighter here.

And on a yield basis, right now the high yield index is yielding just a little over 7%. If you look at that on an historical basis, that's a pretty good time to invest in high yield. The forward returns starting at 7% historically have been very good. You're getting compensated for some of the credit risk in there. So we like to focus more on yields than spreads. And right now when you look at high yield on a yield basis, it's much more attractive than what you might be misled looking at just spreads in isolation. We are starting to, or the market is starting to give credit to the better credit quality of high yield, especially relative to leveraged loans. So you can see spreads in high yield have started to open up a gap versus leveraged loans. You do see that when loans are refinancing, that they are sometimes forced to pay a wider spread than companies that are refinancing in the high yield market.

And then if we move to the next slide, this will tell part of the story of why there's been a decoupling in spreads because we've seen a noticeable gap opening up in defaults. So you've seen an uptick, which is the light blue line there of defaults in the leveraged loan market, whereas defaults in high yield has been relatively low, certainly on a historical basis. So you should demand a wider spread given the higher default rate in leveraged loans relative to high yield.

And this is a topic that comes up a lot in private credit is the transparency within the market, because you don't have a publicly traded market, because you don't have companies releasing anywhere near the amount of information, it's much more difficult to sense or see some of the stress that's coming around the corner. So we think if you just look back at that stacking of the four different markets, if we're starting to see defaults pick up in leveraged loans, it makes sense that the even lower quality private credit is starting to see some signs of stress, and we may see an uptick in defaults.

These are some of the ways that we look to see some of the distress. You've seen a noticeable uptick in loans converting to PIK interest. So PIK is pay in kind. So oftentimes when a company is having trouble meeting their interest liability, they convert it to a pay in kind where they just promise you more principal over time at the end of the loan. This number has close to doubled the amount of loans that are in PIK interest. Also, there is a story on the Wall Street Journal that Fitch has estimated that the default rate within private credit could be as high as nine and a half percent. Keep in mind, that's probably double, if not triple, any typical default rate that you see in high yield. And then if you look at the number of issuers or borrowers in the private credit market that are at the lowest possible triple C minus, this is right before you're about to default, that has seen a significant uptick as well to the tune of 14 billion of total debt.

And I would suspect that the number is even significantly larger if we had transparency to dig deeper.

Carl, I'll turn it back to you here.

Carl Kaufman: Back to me. Thank you. So let's try to make sense of all this and figure out where the best place to go is. So high yield clearly has delivered strong returns for a long period of time. Clearly versus IG, I think investors have been well compensated for taking additional credit risk. High yield was less sensitive to rising rates given the higher coupons and more sensitivity to economic growth. And active management clearly can eliminate some of the problem areas. So avoiding some of the really tightly priced benchmark issues that everybody needs to own or the LBO deals that get into trouble certainly can help with some of that performance. You can see the performance numbers here, high yield versus the Bloomberg Aggregate. It's 450 basis points over 10 years. That's a reasonable return advantage, I think. Next slide.

So this just visually shows that since 2000, you can look at the dark blue line is above the black line, which is the S&P, for close to 20 years. So meaning that high yield outperformed equities for 20 years following the peak in 2000. Most betters, I think, would get that wrong, but that's pretty impressive. Of course, equities should have higher returns since they are the most volatile and most sensitive. They are a residual claim asset and they're lower on the cap stack. And in fact, the last four or five years, they have done extremely well, as they should have. Next slide, please. This is sort of a slide that we've presented in the past, but it shows visually. If you look at the columns, rolling five, rolling 10-year returns, you look at the S&P 500, High Yield Index, Corporate Investment Grade Index, and Treasuries. So you start in 1999, which was sort of the end of the Internet bubble.

Some people feel we're getting close to that with AI, but remains to be seen. But look at the rolling five-year periods and rolling 10-year periods. The green highlighted areas are where high yield did best. So you can see that it kind of dominates the five- and 10-year rolling periods for returns. And down below, reiterating once again that for the 19 years, 1999 to 2018, high yield did the best of all the asset classes. So just food for thought that a high yield allocation might be a different way of looking at risk in a portfolio in terms of de-risking a portfolio versus equities, rather than increasing risk versus, and possibly returns versus investment grade. I've always felt that high yield is more analogous to equity than it is to investment grade since the causation factors that cause them to outperform or underperform are very similar in equities in high yield, whereas they're very different in investment grade versus high yield.

Next slide please. So the three takeaways that I have here are private credit clearly emerged as a necessary solution to a genuine problem. The banks couldn't lend. So where are corporations going to get loans? Where there's demand, supply will find a way, and regulators made it difficult for the banks to continue doing what they did. So private lenders stepped in. 15 years later, clearly the impact has been profound in a number of ways. One is that the lower end of high yield has been sucked into the private credit market. As weaker borrowers have exited or not been able to raise money in that market, we've gotten a little spoiled in high yield, I guess, with better credit quality. And private credit has become, for lack of a better term, the new junk market. And high yield has become what we refer to as IG light.

And although high yield quality has increased, returns are still attractive. We think it's suitable for most investors. It's an excellent complement to IG, but even maybe a better sort of swing factor for equities. When you're feeling a little risk averse, maybe you don't want to give up your equity returns entirely, maybe switch over to a little high yield instead of equity as a complement, particularly near market peaks, as we have shown. Next slide.

I guess we have a third poll. In 2026 this year, which asset class do you think will perform the best? And we've given you the year-to-date numbers so you can have something to key off. Okay. Someone's been paying attention. Well, it looks like the S&P 500 expected to be the worst return and high yield bonds the best with investment grade bonds slightly better than the S&P. I guess now we can move to Q&A. We have some questions from the field, so why don't I start with those?

Slide 14. Despite weaker protections for the investor, aren't the protections better for the lender relative to the high yield market, e.g., better covenants, restrictions on debt, dividends, restrictions on ability to transfer assets? It's a really good question. One would think that that would be the case. However, it being so opaque, I don't really have a factual answer to give you, but I will say that nothing beats a good underlying credit. You can play with assets, but if those assets are not worth much, you're more likely to not get full repayment of principal and interest from that, whereas we do have visibility in the high yield market as to what those restrictions are. And it really depends on what type of issuer you are lending to. So for example, LBO transactions, which are generally large, have the leakiest buckets when it comes to covenants. And public companies or family-owned businesses that are private tend to want to protect their assets, but the market generally demands better protection from them.

So as one of my partners likes to say, when we invest and we lend to a company, we're always rooting for the pilot. We want them to succeed.

John Sheehan: And within the private credit market, because these are direct loans, the lender needs to go out and find the company. There's not a standardized market like there is in the public high yield market. So oftentimes it becomes a race to the bottom or a competition for which lender will give the most favorable covenants is the ones that's ultimately going to get the loan. So that's a big contributor to why covenants have been weakened within the private credit world. And then in the leveraged loan market, because so many are going to the CLO market, people are relying on financial engineering or securitization much more so than the covenants within the loans themselves.

Carl Kaufman: Those are good points. And we've had that corroborated by a couple of issuers who have gone to the private credit market saying, "I just toss the meat out there and they all jump for it. And I pick the best terms for me." The next question, can you talk about the evolution of seniority and collateral in the high yield market generally, and also the attributes of OSTIX's portfolio with respect to those attributes specifically? Clearly, with the advent of more and more deals being LBO-sponsored, seniority is that they want to push you as junior as possible because it gives them the most flexibility. We tend to avoid those deals because their interests are not aligned with ours. They are, a matter of fact, they are exact opposite sides of the table to us. They're trying to extract as much cash out of that company and asset as possible, and they will do whatever they can to do that because they want to pay their LPs with big dividends and things like that.

So we tend to avoid those. We have virtually no LBO-backed loans or bonds in our portfolio. I hope that answers the question. The third question is, is there a contagion risk from the fallout in private credit markets to the broader economy? I don't think so.

I don't think there's contagion risk to high yield. Clearly, these companies would have defaulted whether they borrowed from a bank or borrowed from a private credit fund or anybody else. I mean, when you have a company that is either borrowing based on fraud, as we had a couple of examples earlier this year, late last year, in the case of First Brands and Tricolor, I mean, you're always going to have that in the market, and those are not big contributors to the economy when you're based on fraud. So I'll say I don't think you're going to see a contagion there.

The other one, next question is, do you find double B to be a sweet spot with less efficiency and better risk-adjusted returns because of a lack of natural buyers IG can't buy? High yield often looking for even weaker credits for yield pickup. The answer to that is really no, because most investment grade funds when they own a fallen angel, in other words, a company that gets downgraded from triple B to double B, they can continue owning that because in their charter it's typically worded "must buy investment grade at time of purchase." So they can continue to hold that credit. So you don't see a wholesale selling of those names. We would like that to be the case to create value for us. You will find some more value there than in double Bs clearly, but they generally trade pretty well. Single B I would say is probably where you're going to find the most variation and the most divergence and the most value if you hunt for it.

So I'm going to go with that. Next question. Has the high yield market become much less cyclical now relative to its history, given more in tech and discretionary and less in energy and cyclicals? Hence, its higher overall quality is high yield most correlated to tech stocks NASDAQ. I would say that private credit has more exposure to tech than does the high yield market.

It's got a decent weighting, but it's not a huge weighting. It has become a little less cyclical only because as you say, the quality has improved. We try to be defensive most times and wait for big corrections, but those have been less frequent over the last four or five years. We've had a couple, but they tend to be shorter lived because the companies are pretty good and people will buy at lower yields than they used to in a panic. So yes, I think high yield is a much more solid footing cyclically than it has been in the past. Next question. Out of curiosity, what is the average yield on leverage loans and private credit?

In private credit, I say you want to add maybe 50 to 150 basis points above that. But remember, those are loans and they float. So if rates come down, those rates come down as well.

John Sheehan: Exactly. Yeah, they're all pegged versus SOFR. So if the Fed were to cut or SOFR were to come down, your yield would come down.

Carl Kaufman: Keep in mind that a lot of private credit funds do use leverage to goose their returns. So those returns are not solely from the assets that they own. And as you've seen recently, JP Morgan is cutting credit to private credit funds. So it's going to be as they've lowered their marks or their estimated marks on the portfolios. So that could be interesting. Next question. What is the typical recovery rate on high yield defaults and does the reduced duration help keep defaults at bay over time? I think that recoveries have come down a little bit as you see a greater percentage of private credit, I mean LBO-type deals in the marketplace. Those tend to not leave you with as many assets as the old-fashioned public company, but we have had such a low default rate, but I'd say overall we're in pretty good shape. And lower duration certainly does help keep defaults at bay.

You know pretty much whether you have a better sense of whether a company's going to default if it's a two-year piece of paper than if it's an eight-year piece of paper. Next question. What types of firms are really going to end up wearing these private credit leveraged loan funds? Well, I think a lot of these private credit sponsors are public companies now. Their stocks have taken a pretty big beating this year. I think the private credit fund sponsors in response to large redemption requests are going to have to find ways to raise capital. There are firms that will buy private credit portfolios, but at a haircut, so they are probably going to be wearing it, but hopefully at a good price. John, I don't know if you have anything to add to that?

John Sheehan: I would just add the captive insurance companies. So all these managers have bought life and annuity companies, and they've put a lot of the private credit that they've originated into those insurance companies. I'm sure they're all honorable people, but that does seem like a little too close for comfort where the same firm originating the loan is putting it into its insurance company. So that's an area that is worth keeping an eye on where these are regulated insurance companies that own a substantial amount of these assets in their general accounts.

Carl Kaufman: Historically, high yield acted more like equity in the down stock market and did not provide portfolio ballast as a hedge against equity declines. Do you still agree with that? To a lesser degree, yes. But if you remember '08, while they do trade down with equities, they trade down less, but they bounce back a lot stronger. So '08, '09 as a two-year period, you had high yield down about a thousand basis points less than equities in '08, but in '09, high yield was up 53%. Equities were up, I think 25, 30, 35. So over two years, you do provide a much better return characteristic than equities. But given the higher quality of the portfolio, probably acts like better ballast going forward.

Do you think private credit overhang will clear quickly or will the redemption request persist for a couple of quarters since the people who want out will not be able to get out quickly? It's not going to clear up quickly. There's going to be ... I think when people get tired of an asset class and there's no clarity on where value is being created, it's not like you can go into a public market and say, "Hey, it's trading at a 20% lower than it was last week. I think it's time to buy." You don't have that mechanism yet in private credit. As it matures, you may. Apollo announced that they're going to start looking into pricing more frequently. They're going to start monthly and maybe go weekly at some point. Hopefully they get to daily. So there's no real gauge to know. There's no ability to buy at a discount.

So I think people are going to still demand their money out as their clients call them, and I'm sure you'll probably be getting some calls. Those of you who are invested in private credit, how are we doing in private credit? And there are some good private credit sponsors and there are some bad ones, just like anything else. So I think it may take a while though.

John Sheehan: And just to add to that, some of these funds that have exceeded the gates, that's just the backlog for next quarter. So there's lots of headlines about 7% where they had a 5% gate. So you already have 2% of people waiting for next quarter redemptions. And human nature, when you tell people they can't get their money, they tend to increase the amount of redemption requests as opposed to cut them back. And then also, because a lot of these funds use leverage, they need to sell one and a half loans for every dollar of redemption requests. That also puts pressure. So I agree with Carl that the redemption requests are not likely to slow. And then lastly, if you're hoping to meet redemptions with maturities, that means that you're refinancing the loans. When loans mature or bonds mature, they're most often repaid by new borrowing. So if there's a constriction in the capital markets or in the ability to refinance these loans, they're not going to be able to rely on loans maturing to meet redemptions.

Carl Kaufman: Has indexing affected the high yield market? Yes, it has a little bit. I mean, you have a number of ETFs that are indexed to the high yield market and you have quite a number of high yield "active funds" that will have six to 800 positions or more, closet indexing, if you will. So yeah, but what it's done is those funds are price-insensitive. And by that, I mean that when they get purchases or redemptions, they just go into the marketplace and give the trading desks, and then they have evolved to handle these things, a 300-name list, make me an offer on these or make me a bid on these. And they try to match those up with other program trades. And where they can't fill those names, they come to the active market, which is us and say, "Hey, I've got this on a list. Do you care at a price?" So they're constantly paying the bid ask spread, which is a half to a point, and we're able to buy or sell near the bid or near the offer, which gives us better liquidity actually.

So it actually has not been a negative. It's actually been a positive in terms of providing liquidity.

John Sheehan: And the other way that indexing has really impacted the high yield market is the construction of the index. So the companies with the most debt outstanding have the largest weighting in the index. So if you're a fund that's trying to replicate or beat an index, you almost have to own that whether you like the credit or not, because if you happen to be wrong and it's a large weighting in your index, you're going to lag your competitors. So it's allowed some of these very heavily indebted large borrowers to just continue to keep rolling along because every time they come with a deal, it's a 2% weight in the index. I'm buying 2% if I'm completely agnostic. So it's really skewed the type of issuers that get the biggest weighting within the index and that the index followers just have to buy because they're in their index.

Carl Kaufman: Last a question online. Are floating rate funds impacted by private credit? I would say that investment grade floating rate funds, which is most of them, not really impacted at all. John, do you have any thoughts on that?

John Sheehan: Well, I think maybe the area that could be most impacted is the public BDCs. So we've seen a number of the public BDCs trading at significant discount to NAV, some 25% or greater. That's been one of the sources of angst around private credit is that these BDCs own a lot of the same assets that the private funds own. BDCs are trading at a 25% discount to NAV. Private funds are marked at par. So it's taken a while, but people are waking up to the fact that there is a transparent public proxy in the market in the form of BDCs who own floating rate loans.

Carl Kaufman: Shawn, did you have a comment on that?

Shawn Eubanks: No, but we did have a question that came in before about the situation with Blue Owl Capital. And what does that mean now that they've suspended redemptions and are liquidating the fund? Will those investors be losing money going forward?

Carl Kaufman: I can't imagine they'll be getting great returns going forward, but hard to tell. We don't have access to the portfolios and know what they own, whether they're liquidating below NAV or at NAV or what they will eventually redeem at. It's hard to tell.

John Sheehan: Yeah. Blue Owl had a public BDC and a private vehicle that they tried to merge into one. They received a lot of pushback because the people that when the private vehicle marked to par were going to take a 20% haircut. So they balked, they pulled the tender offer, but that was one of the headlines. And then in response to a different fund, that was their technology fund, exceeded their gates. They went out and sold assets to try to meet some of those redemptions. But the media has certainly sunk their teeth into private credit. It seems like there's a handful of news stories every single day.

Carl Kaufman: They did not take a huge haircut on the assets they sold because they probably sold the best assets, which is typically what happens in a big selloff. If you get big redemptions, you sell what you can, not what you have to, or what you'd like to.

Shawn Eubanks: So we did have another question come in, in the Q&A. What's the time period for settling a trade in the syndicated loan market? I heard it's 30 days. That makes us concerned about owning an open-end fund that owns a lot of syndicated loans. Do you have any comments on that?

Carl Kaufman: It's gotten a lot better. It used to be whenever you got the paperwork in, which sometimes I would hear peoples complain that they'd gotten a couple of coupons already before they'd settled the trade. They've standardized the paperwork, and I think the average is about two weeks now. John, do you hear any different?

John Sheehan: Yeah. Yeah. When the first loan ETF came into existence, that was a very common question. How could we have an intraday liquidity ETF on a product that has a 30-day settlement? But the loan market has responded to that. It's nowhere near in line with the settlement of the ETF or the open-ended fund, but it has improved. It's much shorter than 30 days, but I think it's a case-by-case example too.

Shawn Eubanks: Thank you, John and Carl. I appreciate you taking the time with us today. This has been very informative. That is the end of our Q&A, and thank you all for joining us. Please let us know if you have any follow-up questions. We look forward to talking to you soon.