Credit Outlook | Milken Institute Global Conference 2024

Investment Selectivity and Process

• BlackRock, Strategic Value Partners (SVP), Blue Owl Capital, and J.P. Morgan Partners (JPS) all emphasize a rigorous "funnel" approach, investing in only 2% to 5% of deals reviewed.
• Blue Owl Capital reviewed approximately 10,000 companies to originate 500 loans, deploying $100 billion with a realized loss rate of only 7 basis points.
• BlackRock's investment committee requires a broad cross-functional review, utilizing domain expertise across equity, fixed income, and regions to validate investment outcomes and risk mitigation.
• Strategic Value Partners focuses on the "higher risk, higher return" spectrum, sourcing debt directly from banks (60-80% of deal volume) rather than relying solely on intermediaries.
• JPS employs a three-pronged initial filter: determining if the business is necessary, establishing a margin of safety against downside risks, and defining the appropriate risk bucket for the asset.

Market Outlook and Risk Assessment

• Interest Rate Environment: Investors face a "higher for longer" rate regime where interest coverage ratios have declined rapidly, forcing companies to adjust to a new normal despite floating-rate protections in many credit instruments.
• Market Cycles: James Gorman (BlackRock) argues against viewing the current cycle as cyclical, instead suggesting private credit serves as a permanent portfolio diversifier due to uncorrelated liquidity and complexity premiums.
• Distressed Opportunities: Victor Kramchenko (SVP) warns of a "multi-year slog" facing the market, projecting $600 billion in maturities annually for 2025–2027, with $500 billion requiring adventurous financing and $300 billion potentially abandoned by sponsors.
• Recovery vs. Default: Panelists assert that recovery rates are more critical than default rates; liquid market recoveries have dropped to 30-40 cents on the dollar, whereas private credit covenants typically yield significantly higher recoveries.
• Spread Dispersion: Market dispersion is a key theme, with higher-quality credit spreads tightening to 10-year lows, making credit selection and alpha generation more critical in both public and private markets.

Private Credit vs. Liquid Markets

• Structural Evolution: Mark Carroll (Blue Owl) characterizes the current private credit boom not as a "golden age" but as a "renaissance" or evolution, focusing on matching long-term capital to long-term needs with superior governance.
• Covenant Superiority: Private credit loans feature significantly stronger covenants and control mechanisms than syndicated public markets, where documentation has become increasingly "covenant-light" and flexible for borrowers.
• Market Symbiosis: Liquid and private markets are viewed as symbiotic; private credit fills the gap for B-minus and lower-rated borrowers who cannot access the liquid market, which predominantly targets single-B and investment-grade issuers.
• Non-Sponsor Growth: JPS and other firms are increasingly targeting the "non-sponsor" segment, providing capital to businesses without Private Equity backing, a strategy that differentiates them from traditional direct lenders.

Operational Value and Case Studies

• Operational Turnaround: SVP's investment in Swissport illustrates deep operational involvement; the firm purchased senior debt at 70 cents on the dollar, took majority equity control, replaced 7 of the top 10 executives, and rebuilt the company from 12,000 to 60,000 employees post-pandemic.
• Sponsor Support: Strong covenants enable sponsors to inject additional equity during distress; Mark Carroll notes that 9 out of 10 times during the pandemic, sponsors provided capital to keep assets viable, ensuring high recovery rates.
• Scale Challenges: Scaling investment teams while maintaining deal quality is a primary operational concern, with BlackRock emphasizing active monitoring and the prevention of "deal fatigue" through rigorous governance.

Macro Risks and Future Outlook

• Geopolitical and Policy Risks: Geopolitical instability and rising U.S. deficits are identified as primary "sleepless" risks, with the potential for local policies to disrupt labor and goods flows, altering inflation and risk premiums.
• Banking Deleveraging: A projected $10 trillion reduction in global banking balance sheets (due to regulation like Basel III) will force a shift of capital from banks to asset managers, creating significant opportunities for private credit expansion.
• Securitization Growth: The market for structured risk transfers (CLOs, auto loans, etc.) is expected to grow as banks offload assets, allowing investors to buy tranches of risk rather than originating individual loans.
• Permanent Capital Shift: Blue Owl highlights that 92% of their business utilizes permanent capital, positioning the firm to provide stability by shifting the economy from "one-day money" (bank lending) to long-duration capital solutions.

Key Decisions and Forward-Looking Statements

• Investment Horizon: Panelists view the current environment as an opportunity for "enduring partnerships" rather than a temporary boom, predicting a long-term evolution of the credit landscape.
• Risk Management Priority: All firms prioritize covenant strength and control (e.g., controlling a tranche, limiting asset layering) over chasing incremental spread yield to protect downside recovery.
• Market Consolidation: The industry is moving toward a model where private credit acts as a stabilizing force, absorbing defaults that would otherwise be catastrophic in weakly documented public markets.
• Growth Constraints: The ability to scale is a double-edged sword; managing the transformation of investment processes and teams during rapid growth is a cited risk for all four firms.