0:02

Welcome to Macquhive Conversations with Balaf Hafiz.

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more details. Now, onto this

1:01

episode's guest, Randy Shrimmer. Randy is

1:03

vice chairman of Churchill, where he

1:05

oversees the Investor Solutions Group. Previously,

1:08

he served as co-head of senior

1:10

lending, responsible for senior lending origination

1:12

and capital markets. Randy also serves

1:14

on the firm's executive committee and

1:16

senior lending investment committee. Randy is

1:19

also the founder and publisher of

1:21

the lead left, Churchill's weekly newsletter,

1:23

reviewing deals and trends in the

1:25

capital markets. He also produces private

1:27

capital call, a monthly podcast. And

1:30

prior to Churchill, Randy held senior

1:32

roles at B&P Parab and JP Morgan.

1:34

Now on to our conversation. Greetings

1:36

and welcome back. Randy is fantastic to

1:38

have you back on the podcast show.

1:40

Balal, it's so great to be back with

1:42

you. It seems like it's been a while

1:44

and so much has happened. So I look forward

1:46

to finding out, you know, where we've been and

1:48

where we're going. Absolutely. Yeah, there is a lot

1:51

going on. And so perhaps we

1:53

can start with that. You know,

1:55

obviously you're focused much more on

1:58

the private side, private credit and

2:00

so on, but it's hard to

2:02

ignore. macro background to everything in

2:05

the background. So first, I mean,

2:07

do you have a macro view

2:10

to start with and then how

2:12

do you then map that onto

2:14

private markets? Yeah, well, first of

2:17

all, thanks again for having me

2:19

on. You have an amazing enterprise

2:21

and to look at the scope

2:24

and depth of your podcast guest

2:26

that you have on and the

2:28

work that you're doing is really

2:31

incredible and top-not. So, congrats on

2:33

that. You know, just by way

2:36

of introduction or reintroductions. So, Randy

2:38

Schwamer, vice chairman of Churchill, asset

2:40

and management. Myself and my co-founders

2:43

Ken Kinsell and Chris Cox, started

2:45

the business where the remaining co-founders

2:47

of the business or other founders

2:50

have retired over the years, but

2:52

you know, we started the business

2:55

back in 2006 as a private

2:57

capital credit solutions provider for both

2:59

investors and issuers. And we've really

3:02

stuck to our guns over the

3:04

last 20 years and we're now

3:06

owned. by TIA as our ultimate

3:09

parent company which is a multi

3:11

trillion dollar asset manager the actual

3:14

money manager if you will is

3:16

Newvene which is wholly owned by

3:18

TIA and we are an affiliate

3:21

of Newvene dedicated to private capital

3:23

solutions with our European sister company

3:25

Arkmon we represent about an 80

3:28

billion dollar business focused primarily on

3:30

financing for our borrowers and investing

3:33

and managing investments for investors a

3:35

wide range of private capital products

3:37

and solutions mostly for middle market

3:40

businesses backed by private equity firms

3:42

and the macro to some extent

3:44

is also something that we talk

3:47

a lot about with our parent

3:49

company because they as a one

3:52

and a half trillion dollar business

3:54

are involved in a number of

3:56

different strategies. both public and private

3:59

liquid and ill liquid, they have

4:01

about a $350 billion alt's business.

4:03

And so getting a lot. of

4:06

their signals about the impact on

4:08

their various businesses, real estate, timberland,

4:11

infrastructure, and so forth, has been

4:13

very helpful for us. And what

4:15

we look for is in the

4:18

economy, kind of what are the

4:20

headwinds and tailwinds on businesses, particularly

4:22

in the service oriented sectors. We've

4:25

noted over time below that to

4:27

prevent some of the cyclical winds

4:30

that occur when you have up

4:32

and down drafts with interest rates

4:34

and the economy and so forth.

4:37

That the service businesses, more free

4:39

cash flow oriented, less cap X,

4:41

have been more successful, particularly in

4:44

the credit business when it's all

4:46

about minimizing losses. So we look

4:49

at the macro. climate. And ready,

4:51

just as an example, I mean,

4:53

what are some examples of sectors

4:56

within services that have this free

4:58

cash flow? So business services in

5:00

general, and these can be logistics

5:03

businesses, you know, anything that involves

5:05

moving boxes, for example, anything that

5:07

involves commercialization of services, so, you

5:10

know, at a very micro level,

5:12

commercial landscaping is a is a

5:15

business in the middle market, which

5:17

is a very robust business and

5:19

survives a lot of cycles. We

5:22

discovered that during COVID when everybody

5:24

went home and the offices were

5:26

empty, but the owners of the

5:29

office buildings had to keep the

5:31

lights on the lawns mode, the

5:34

sidewalks cloud, and so we discovered

5:36

that companies that manage those buildings

5:38

actually are very stable from a

5:41

revenue and cash flow perspective. And

5:43

then, you know, health care technology.

5:45

software, you know, anything that tends

5:48

to be less manufacturing focused, although

5:50

we do do some specialty manufacturing,

5:53

but businesses that over time, private

5:55

equity firms, you know, can invest

5:57

in and not really worry about.

5:59

when they're going to exit. Basically,

6:02

you know, these companies do well

6:04

through multiple cycles. And so the

6:06

macro trends that everyone was worried

6:08

about last year, so what was

6:10

particularly in the beginning of 2024

6:13

when the Fed was sort of

6:15

realized that, okay, I think at

6:17

five and a half percent, the

6:19

benchmark is probably going to be,

6:21

you know, having some sort of

6:23

impact eventually on the inflation, which

6:26

was correct. They were right about

6:28

that. and began to think about,

6:30

in fact, having rates coming down.

6:32

So here we are a year

6:34

later, and in the beginning, certainly

6:36

in January, the sense was the

6:39

lot of the headwind, such as

6:41

interest rates, the economy, inflation and

6:43

so forth, had become pretty much

6:45

tailwinds. The economy was still doing

6:47

well. Inflation had come down, if

6:50

not to their target of 2%,

6:52

at least to a 2-ish percent

6:54

range. labor markets continue to be

6:56

pretty strong. The unemployment rate was

6:58

still kind of a pretty much

7:00

a low. And the worry before

7:03

the new administration took office even

7:05

was, you know, tariffs and the

7:07

geopolitical climate. And that was even

7:09

for middle market companies, those types

7:11

of things do have an impact.

7:13

One of the reasons we like

7:16

these smaller companies is that they

7:18

tend not to be whipsawed by

7:20

you know issues with global trade

7:22

you know and so forth or

7:24

even you know the geopolitical issues

7:27

going on with Ukraine or even

7:29

the Middle East but I think

7:31

what you have seen now and

7:33

you know we're at the beginning

7:35

of March when we tape this

7:37

that the public markets are reacting

7:40

okay there's the starting to realize

7:42

that this tariff thing could could

7:44

potentially be real that it's a

7:46

significant potential inhibitor to growth which

7:48

is why you saw of like

7:51

equities, you know, do what they

7:53

did in the last few days.

7:55

It's... now I think clear that

7:57

you know unless these tariffs get

7:59

pulled back and there's always that

8:01

chance right that there is going

8:04

to be some negative impact on

8:06

the economy that's the reason the

8:08

markets are reacting the way they

8:10

are and so from a deal

8:12

activity perspective talking now about private

8:14

capital in our business particularly in

8:17

the LBO business so private equity

8:19

companies being bought and sold You've

8:21

seen and I think you probably

8:23

have commented in your broadcast about

8:25

the global M&A trends since 2021

8:28

as interest rates have moved up.

8:30

You've seen climate global M&A going

8:32

down. We began to see a

8:34

bit of a restoration of that

8:36

in the third quarter of last

8:38

year if you look at the

8:41

global. pipeline of deals, but it'll

8:43

be interesting because while we experienced

8:45

a record in our experiencing a

8:47

record first quarter in terms of

8:49

our deal flow, the pipeline for

8:51

the second quarter is much lighter

8:54

than we would have expected. And

8:56

it seems as if in the

8:58

conversations with our peers in private

9:00

capital that they're experiencing that same

9:02

slowdown. And is this related to

9:05

the M&A private equity deals or

9:07

is this direct lending or is

9:09

it all of the above? We

9:11

are experiencing it in the direct

9:13

lending LBO business. Okay. Okay. And

9:15

my guess is that the global

9:18

M&A business will probably experience similar

9:20

impact. It's hard to tell the

9:22

moment. And the reason is it

9:24

comes down to simple, you know,

9:26

exit and entry prices, right? When

9:28

you buy a company who had

9:31

a certain multiple, when interest rates

9:33

were low, the ability to finance.

9:35

that same company when interest rates

9:37

are high becomes more problematic and

9:39

so the multiples just as you

9:42

would you know when you if

9:44

you buy a house when mortgage

9:46

rates are 2% you know now

9:48

you're looking to sell it when

9:50

mortgage rates are 7% whoever the

9:52

buyer has to bear the burden

9:55

of that unless there are cash

9:57

buyer. And so we're seeing that

9:59

kind of hesitation. It was really

10:01

interesting because what the impact of

10:03

that slow down, of course, is

10:06

that the LPs of the sponsors

10:08

who have been financing through their

10:10

fundraising these buyouts, since the M&A

10:12

market has slowed the realizations that

10:14

these investors would have hoped to

10:16

find as a result of the

10:19

exits of these businesses. has slowed

10:21

as well. And I was reading

10:23

today, I think it was in

10:25

financial times, Hugh MacArthur at Bain

10:27

put it well, he said, you

10:29

know, the, there's more money going

10:32

into the cigar box than coming

10:34

out of the cigar box. So,

10:36

you know, and from a fundraising

10:38

perspective, everybody's trying to get money

10:40

from the elpies and the elpies

10:43

are saying, hey, I haven't got

10:45

my money back from the deals

10:47

that, you know, that you did

10:49

a year or two or two

10:51

or three ago. So I think

10:53

that. that cycle of realizations and

10:56

fundraising and deployment has definitely slowed.

10:58

And in this sort of environment,

11:00

or more generally, I mean, how

11:02

do you go about sourcing deals?

11:04

And, you know, coming to like

11:06

Churchill, obviously you're very well established.

11:09

What's your edge in terms of

11:11

sourcing deals? Yeah, we're very fortunate

11:13

being an organization that has a

11:15

significant amount of capital that we

11:17

deploy directly as an investor as

11:20

an LP into the GPs themselves.

11:22

of almost $20 billion that's allocated,

11:24

committed to 300 different private equity

11:26

firms and their funds. And we've

11:28

been doing this for 15, almost

11:30

20 years now. And the advantage

11:33

of that is that as an

11:35

LP, as an investor, we're treated

11:37

differently than you would be treated

11:39

if you were just a credit

11:41

provider because credit is probably the

11:43

ultimate commodity. You're out there saying,

11:46

hey, we'll finance this company and

11:48

we'll give you a deeper cheaper

11:50

pricing and even weaker terms. That's

11:52

great for the borrower, not so

11:54

great for the investor. So one

11:57

of the beauties of our model

11:59

is that as an LP, we're

12:01

seeing all the deal flow from

12:03

these sponsors. They want us, you

12:05

know, we're in fund four and

12:07

we're fund eight and they want

12:10

us to be in fund five

12:12

or fund nine. So they continue

12:14

to show us transactions and we

12:16

can be picky, you know, without

12:18

the sponsor being upset with us

12:21

because, you know, they said, you

12:23

don't do the deal, that's great,

12:25

we'll show us someone else. And

12:27

we do tend to be picky.

12:29

the deals you do that comprise

12:31

your trackers, the deals you don't

12:34

do. It's the more risky ones

12:36

that you avoid that tend to

12:38

be a better reflection of your

12:40

track record. And so we take

12:42

that to heart. We probably turned

12:44

down about 95% of the stuff

12:47

that's coming in. And since the

12:49

stuff that's coming in is coming

12:51

from sponsors where we are already

12:53

investor in their funds, that's a

12:55

pretty high quality pipeline that we're

12:58

seeing. And theoretically, we see about

13:00

a thousand deals a year. We

13:02

could probably do all of them.

13:04

and probably have a pretty good

13:06

track record, but some of these

13:08

deals are more equity like their

13:11

higher growth. They may be in

13:13

businesses that would be good for

13:15

an equity investor, you know, a

13:17

startup or quasi startup, which would

13:19

have a high equity delta in

13:21

terms of the buy-sell differential for

13:24

the sponsor, but for a credit

13:26

provider, all we're getting really is

13:28

the interest in principle and a

13:30

little bit of fee income. So,

13:32

At the end of the day,

13:35

it's not so much being the

13:37

first, second, or third horse that

13:39

finishes the race as one of

13:41

my friends says. It's actually finishing

13:43

the race at all. And we

13:45

want to make sure that we

13:48

finish the race and get our

13:50

money back. So I think that's

13:52

our differentiating feature. And then from

13:54

an A perspective, and this is

13:56

actually true across the board and

13:58

the middle market and private credit,

14:01

these sponsors work with smaller companies

14:03

that they have identified through their

14:05

partners. or their operating partner. and

14:07

the operating partners often are former

14:09

CEOs or CFOs or entrepreneurs in

14:12

the industry, so I mentioned commercial

14:14

landscaping. So, you know, the entrepreneur

14:16

who has started a number of

14:18

commercial landscaping companies gets his money,

14:20

retires, and then gets hired by

14:22

the private equity sponsor to identify

14:25

in a geographic region similar companies

14:27

that the one that the entrepreneur

14:29

started, and he or she may

14:31

have in fact relationships with those.

14:33

companies that they've built over the

14:36

years and has a credibility that

14:38

the sponsor may not have in

14:40

the industry where they can reach

14:42

out to those companies and, hey,

14:44

we've got a sponsor that's looking

14:46

at consolidating the region of commercial

14:49

landscapers, let's say in the southeast

14:51

and can approach those companies. And

14:53

if you think about all the

14:55

hundreds of different types of niche

14:57

industries in the middle market and

14:59

look at all these hundreds of

15:02

companies, private equity sponsors who are

15:04

looking in those niches for opportunities,

15:06

what you have is an ecosystem

15:08

that is a little bit detached

15:10

from global M&A because it's been

15:13

created in a way by these

15:15

sponsors to develop opportunities in underserved

15:17

markets. And so what we've discovered

15:19

over time is even if the

15:21

global M&A market seems, you know,

15:23

a bit off because of interest

15:26

rates or the economy or whatever,

15:28

that There is some insulation in

15:30

these smaller businesses to the overall

15:32

macros because of these specialized opportunities

15:34

that these sponsors and each sponsor

15:36

has a little different niche where

15:39

they tier to I think the

15:41

word is used the edge. They

15:43

have an edge. So when you

15:45

talk to the managing part and

15:47

say, you know, we really like

15:50

this industry because we have knowledge

15:52

that nobody else has and therefore

15:54

we can extract value. that someone

15:56

else might not. And that we

15:58

think in this direct lending middle

16:00

market has provided. some insulation over

16:03

time and so our pipeline continues

16:05

overall to be pretty full

16:07

with the exception as I said

16:09

of this pause that I

16:11

think everyone is probably

16:14

partaking in in order

16:16

to see what's going to happen

16:18

next. One thing I have noticed is

16:21

that there has been much more focus on

16:23

private credit as an asset class in recent

16:25

years. Not a week goes by where I

16:27

don't hear of some new boutique being set

16:29

up or something as people try to enter

16:31

this market. So I'm just trying to think

16:33

of the pressures on the sector. One

16:35

pressure would be, why don't banks enter

16:37

this space? I mean, more generally, obviously,

16:39

there's a reason why private happened in

16:41

the first place. Perhaps it was to

16:43

regulation of banks. And so as bank

16:45

capital withdrew private stepped in. But is

16:47

there a chance banks come back into

16:49

this space and just say, look, why

16:51

leave it to the private credit guys?

16:53

And then another question is, if there

16:55

is more competition now, can you move

16:57

up the chain? I mean, not middle

17:00

market, but the larger market, you know,

17:02

just move up, you know, further. So

17:04

how do you think about those two

17:06

factors? So I'm not surprised that you

17:08

have, you know, within five minutes, ten

17:11

minutes have identified the critical issue about

17:13

our industry. My history before Churchill was

17:15

in banking. I was at JP

17:17

Wharton for 15 years. I was

17:20

responsible for what was then the

17:22

middle market and the trading, the

17:24

syndicated loan business in that sector.

17:26

Now it's all private credit. And

17:29

in those days, back in our

17:31

early 80s and early 90s, particularly

17:33

the banks owned the leverage loan

17:36

market. There was really no such

17:38

thing as private credit. Yes, there

17:40

were some middle market practitioners. There

17:43

were some finance companies,

17:45

you know, Heller Financial,

17:47

GE Capital, others that did

17:49

practice in the smaller space.

17:51

But over time what happened

17:53

was as the banks consolidated

17:55

because they were in chase

17:57

now is a, you know,

18:00

composition of many banks, you know,

18:02

Chaseman Add and Chemical Bank manufactures

18:04

Hanover, Bank One. I mean, there's

18:06

a lot of banks that, you

18:08

know, were gobbled up to create

18:10

JP. And they became less interested

18:12

in these smaller companies. They actually,

18:14

the Fed and the OCC was

18:16

saying, you know what, we don't

18:18

really like you holding these leverage

18:21

loans because they're risky and therefore

18:23

we're going to charge you more

18:25

capital for this. And so the banks

18:27

realize, you know, you know, I'm much

18:29

better off. instead of holding these loans,

18:31

just selling these loans. And so

18:33

they created these trading businesses that

18:35

were designed to just, you know,

18:37

get fee income and not hold the

18:39

loans at all. So from a capital

18:42

perspective, it made a lot of sense.

18:44

But what happened over time, and, you

18:46

know, and 2008-09 was a perfect

18:48

example below, where the markets became disruptive

18:51

and then there were no buyers.

18:53

And yet the private equity sponsors had

18:55

deals to be done. And so

18:57

they were coming to. Churchill, the

18:59

Churchill's of the world saying, you

19:01

know, my bank has basically stopped

19:04

lending, I need your help. And

19:06

so over time, it's certainly

19:08

energized and motivated by the

19:10

great recession, it became obvious

19:13

that having a long-term balance

19:15

sheet, long-term liabilities to match

19:17

the long-term assets of these

19:20

loans without having depositors at

19:22

risk, all right, that, you know,

19:24

to take it out of that regulatory

19:27

framework. into a more asset management

19:29

framework made a lot of sense

19:31

and in that from 2009 to

19:34

10 really up through the present this

19:36

development of a new

19:38

asset class which really isn't middle

19:40

market lending's been going on for

19:43

a thousand years but in its

19:45

new guys as an asset class that

19:47

it turned out to be more resilient

19:49

than anyone had thought. When I was

19:51

growing up in the business everybody thought

19:54

that smaller deals were more risky that

19:56

the middle market defaults and losses were

19:58

going to be way than liquid companies,

20:01

which on the surface made sense.

20:03

These are big companies, they have

20:05

scale, they can go public, they

20:07

can issue bonds. But when you

20:10

started to dig into the details,

20:12

what I discovered pretty early on

20:14

was that actually, when it came

20:16

to defaults and losses, the

20:18

dynamics of what was going on

20:21

in the liquid loan market were

20:23

actually worse for investors. Because what

20:25

would happen in a troubled situation

20:28

is this. you know if you

20:30

didn't trade out of that soon

20:32

sooner than the visibility of the

20:34

problems became evident you were kind

20:36

of stuck with a loan that

20:38

traded well below par which was

20:40

your entry point and then you

20:42

would attract funds who if they

20:45

bought in at 60 cents on

20:47

the dollar were happy to get

20:49

out at 70 but if you

20:51

would come in at par you

20:53

weren't happy to get it in

20:55

70 and so the dynamics of

20:57

those lender relationships actually created more

20:59

problems on average for the BSL

21:01

market and if you look historically

21:03

over time the default rates and

21:06

loss rates for large cap loans

21:08

in general were worse than for

21:10

the middle market and as people

21:13

started to realize that the fact that

21:15

the illiquidity of private credit which historically

21:17

was thought to be a negative if

21:19

you are holding the assets for as

21:22

long as you need to. to see

21:24

that that value get back to bar.

21:26

And if the other lenders in the

21:29

lender group that you're with are of

21:31

a like mine, you can actually get

21:33

your money out for the most part

21:36

at the end of that period. And

21:38

so that discovery, you know, is like

21:40

Newton watching the apple drop on his

21:43

head. The law that illiquidity does

21:45

not mean bad credit, but

21:47

actually means more stable valuations.

21:49

created this wave that

21:51

started almost 20 years ago

21:54

and is, you know, showing no

21:56

signs of, you know, reversing. And

21:58

so what we're seeing to to

22:00

your question is that the banks,

22:02

while they came back in the

22:04

market last year because of the

22:06

Fed's change of direction and

22:09

the realization by CLO

22:11

investors and CLOs, these

22:13

are collateralized loan obligations, structured

22:15

vehicles that are designed to

22:18

hold these loans, that those

22:20

that the the equity arbitrage

22:22

now with lower interest rates

22:25

worked and so CLO value

22:27

picked up. the broadly syndicated

22:30

market literally January 1st of

22:32

last year turned on and had

22:34

a record year but the secret

22:37

is that 95% of the deals

22:39

they did were refinancing and repricing

22:41

so they kind of were unable

22:44

to get back into the LBO

22:46

market for the most part and

22:48

that as private credit market has

22:51

expanded has that that field has

22:53

been really been left to us. And

22:55

I think then it has your

22:57

question about the large cap. What

22:59

we've discovered in our business is

23:01

that the middle market is probably

23:03

the best place to be from

23:05

an investor perspective because as you

23:07

go up, as the larger asset

23:09

managers go up market, they realize

23:11

in order to keep the private

23:14

equity sponsor from actually going to

23:16

a bank, they have to be

23:18

competitive in terms of pricing, which

23:21

means narrower spreads and also

23:23

covenants which in the case of

23:25

large cap deals means for the most

23:27

part covenant light transactions which is

23:29

a fancy way of saying you

23:31

know bond like covenants these are

23:34

covenants financial tests that as opposed to

23:36

being measured at any time are only

23:38

measured if you occur more debt well

23:40

if you don't occur any debt then

23:42

they never get measured so you

23:45

could theoretically have infinite leverage

23:47

As long as you're still

23:49

paying your interest payments, nothing

23:51

happens. Those kinds of structures

23:54

for us anyway are not as all

23:56

weather and therefore we tend to like

23:58

the more concerned. of the market

24:00

which has financial tests, lower leverage and

24:02

so forth. So we're fine where we

24:05

are and we expect that even though,

24:07

you know, I'm not saying well, all

24:09

that if the bank market goes away,

24:11

if we have a recession, bank market

24:13

goes away, we will get the calls

24:16

on the larger deals and we'll say,

24:18

look, here's how we'd like to structure

24:20

it if you'd like our money. That's

24:22

okay. So there is something different about

24:24

the larger market. It's not just middle

24:26

market, but bigger, but there's something fundamentally

24:29

different. It's the covenant structure is different,

24:31

the banks, the spreads, everything just changes. It's

24:33

the deep end of the pool. Yeah. And

24:35

we find the swimming just fine in the

24:37

regular lanes. Now you mentioned default rates and

24:40

such and you know at least

24:42

on the macro level you are

24:44

seeing increasing default rates, delinquency rates

24:46

in certain sectors if not generally

24:48

you know picking up. Are you

24:50

seeing that at the sort of

24:52

the micro level as well? No

24:54

and I'll give you that's you

24:56

know I mentioned the macro historically

24:58

on default rates where because of

25:00

this dynamic in the liquid versus

25:03

liquid markets that the middle market

25:05

has proven to be, you know,

25:07

easier to deal with in order to

25:09

get your money back. The current environment

25:11

is such that there are expectations a

25:14

year ago and a lot of media

25:16

print and some investment bank and

25:18

research teams who frankly were not

25:20

necessarily involved in private credit,

25:23

you know, particularly some of the

25:25

big banks who came out with

25:27

reports saying that there is all

25:29

this, you know, default is going

25:31

to happen waiting to happen. You've

25:33

read this, I'm sure. And usually when you

25:35

read the article, it's somebody who

25:37

doesn't have experience in the space.

25:39

And you know, like I said,

25:41

on the face of it, one would

25:44

understand, oh, small companies, they're

25:46

going to be more vulnerable.

25:48

There's also a perception of

25:51

a lot of that because

25:53

these are private businesses, private companies,

25:55

and that loans don't trade, that if

25:57

you can't see the business on a

25:59

ticker. on a Bloomberg that, oh, it

26:01

must be bad. The value must be

26:04

questionable. But in fact, the value

26:06

is not only something that

26:08

we as investors are focusing on

26:10

every day and looking at

26:12

the performance of these business and

26:15

rating them depending on how

26:17

they're performing relative to budget on

26:19

a monthly basis, but they're

26:21

also being tracked by third-party

26:23

valuation firms that we hire

26:25

in order to give our

26:28

investors comfort. that it's not just

26:30

Churchill saying this, but we've got

26:32

some major valuation firms in there,

26:34

you know, going through our portfolio

26:36

name by name. The sector issues I

26:39

think that we have seen just in

26:41

our own portfolio under pressure, just

26:43

to name a couple examples, I

26:45

think technology, not so much

26:47

in terms of operating performance, but

26:49

in terms of competitive pressures. And

26:52

we've seen this in the large

26:54

cap public markets, right? So even... for

26:56

like the video, which is like the

26:58

darling of the of the magnificent seven,

27:00

there's issues when a new entrant comes

27:03

in. It's like, whoa, how are they

27:05

going to compete with the video? Now it

27:07

looks like, you know, the video's going to

27:09

be fine. Thank you very much. But if

27:11

you go down the food chain in

27:13

technology, the speed of evolution of

27:16

advancement is such that with certain

27:18

businesses, you really don't know. Will

27:20

someone come in and invent a

27:22

better mous trap? And so what

27:25

we have done a Churchill is

27:27

just focus on more more enterprise

27:29

focused, business service oriented technology that

27:32

is ingrained and built into, for

27:34

example, you know, part of the

27:36

production of the business that

27:39

focuses on improvement and efficiencies

27:41

and technology is employed there

27:44

to reduce costs. And those

27:46

types of tech, quote, tech

27:48

businesses tend to be in the

27:50

lower tech end and with

27:52

businesses, smaller businesses. where that

27:55

particular company that that service

27:57

provider has been doing business

27:59

for me. many years as

28:01

ingrained and embedded in the

28:03

infrastructure of those companies or

28:06

service companies that, for example, one

28:08

of the sub sectors we like right

28:10

now is measuring efficiency. So

28:12

if you have a business

28:15

that is providing production line

28:17

calculations and analysis to make

28:19

sure that the product is

28:21

being, you know, going through the

28:23

pipeline process in a way that

28:25

reduces. costs and creates better profitability,

28:27

those kinds of companies right now

28:29

in the face of potential softening

28:32

in the economy are getting a

28:34

lot of attention. So in some

28:36

senses you're staying away from the

28:38

glamorous, you know, high tech, you

28:40

know, fast moving side, which takes

28:42

all the headlines and instead moving

28:44

in the areas where it's tech,

28:46

but it's entrenched in processes, longer

28:48

procurement processes, they've got good relationships.

28:50

So it's inherently more stable. Correct.

28:52

And so, but it is something

28:54

that we're now alert to and

28:56

I would say, obviously, government contracting

28:58

businesses gives given the new administration's

29:00

focus, because that's something that is,

29:03

and we've not been necessarily big

29:05

lenders in that space anyway, but

29:07

it's further evidence of why that's

29:09

that's always a bit of a

29:12

challenged space because you never know

29:14

with a change of administration what's

29:16

going to happen. And then the

29:18

last area which is of interest

29:20

is health care. It's been one

29:22

of our historic largest sectors over

29:24

the last 20 years, basically because

29:26

it's such a big part of

29:28

the economy, but also because when

29:31

you just say health care per

29:33

se, there's no such thing. And

29:35

there's really like, you know, dozens

29:37

of sub sectors within health care.

29:39

We tend to not focus on

29:41

the, you know, for example, hospitals

29:44

and, you know, the more direct

29:46

service providers as opposed to areas,

29:48

you know, that are related to

29:50

that. So for example, historically, we've

29:52

done a lot of physician specialty

29:54

practices that spin off from hospitals

29:57

and, you know, going back several

29:59

that. decades, the growth of dental

30:01

practices that are set up or the

30:03

growth of surgical practices. That has become

30:06

a little more problematic as that space

30:08

becomes more crowded, and particularly as, you

30:10

know, the doctors are owning these businesses

30:12

in large part along with the private

30:15

equity sponsors. You know, you want to

30:17

make sure that the physicians feel like,

30:19

okay, the value of the businesses. They

30:21

are otherwise, why am I doing this?

30:24

I could be just work for hospital

30:26

and making good living. And so some

30:28

of the risks, particularly in businesses where

30:30

reimbursement, cost reimbursement, we're seeing

30:32

coming down, is an issue. Those are

30:35

parts of health care that were

30:37

being cautious on. But in general,

30:39

the expectation of widespread defaults as

30:41

a result of high interest rates

30:43

was that was the call from

30:45

a lot of these research firms,

30:47

again, who were not necessarily as

30:49

plugged in as others. never

30:51

really materialized. And in fact,

30:54

default rates in amongst the

30:56

direct lending deals

30:58

actually significantly below

31:01

where people thought they were going

31:03

to end up. I think KBRA

31:05

is now saying something like I

31:07

think it's less than 2% default

31:09

rate ending up for 2020 or

31:12

compared to an over a 5%

31:14

default rate for the BSL market.

31:16

I mean, why do you think that

31:18

is? I mean, interest rates went up

31:20

dramatically. And as you said, certain banks

31:22

were sort of like going out and

31:25

newspapers were saying credit going to

31:27

blow up and it just didn't happen.

31:29

Why do you think that is?

31:31

So the direct lending managers now,

31:33

including us obviously, have been around long

31:36

enough and seen so much variability in

31:38

the macro environment since

31:40

2008 and even before the recession,

31:43

that they have a playbook. We have a

31:45

playbook, they have a playbook, a lot of

31:47

the experienced lenders. I'm not saying that some

31:49

of the inexperienced new lenders aren't going to

31:51

have issues. But for those that have been around

31:54

a while, when we look at a deal, we look

31:56

at it and we say, all right, it's great now.

31:58

This is what we did from 2010 to 2022. So

32:00

it's great now, the LIBOR and

32:02

then SOFA is zero percent, Fed

32:04

funds are eight zero percent. So

32:06

yeah, we could potentially leverage the

32:08

business four or five, six times,

32:10

whatever. But what happens if interest

32:12

rates go up? And so we

32:14

model, and we've been modeling, much

32:16

higher interest rates in the projections

32:19

that we do to look at

32:21

how this company would behave. And

32:23

then we look at how the

32:25

company did during the recession. And

32:27

we take. that performance, let's just

32:29

throw out 20% revenue cut, 20%

32:31

cash flow cut. And we model

32:33

a recession within 18 months, 12

32:35

to 18 months of the time

32:37

we do the deal. So if

32:40

we do a deal today, by

32:42

the summer of 2026, we assume

32:44

that the company is going to

32:46

be in recession. And then we

32:48

look at the pro form cash

32:50

flows. and say, okay, can this

32:52

company weather that and still pay

32:54

their interest back? And if not,

32:56

then it's not a deal we

32:58

do. So what happened was when

33:00

interest rates went up, our portfolio

33:03

was already designed to withstand the

33:05

hurricane force of the winds, you

33:07

know what I'm saying? And we

33:09

were fine. And you know, the

33:11

issues that we had, yes, the

33:13

interest cushion definitely was compressed. So...

33:15

You know, blah, in 2021, we

33:17

didn't really even measure our interest

33:19

cushion on the portfolio because it

33:21

was like four, four or five

33:24

X, like, you know, because interest

33:26

rates were so low. And then

33:28

as interest rates went up, investors

33:30

were asking, well, okay, well, what's

33:32

the interest expense cushion on your

33:34

portfolio? And I'd be in a

33:36

meeting and I would text my

33:38

head of senior lending and I

33:40

would say, you know, I haven't

33:42

seen this number recently, what is

33:45

it? It went from like five

33:47

times to three or three or

33:49

two or two or two or

33:51

two or two or two or

33:53

two and two and two and

33:55

two and two and two and

33:57

two or two and two and

33:59

two and two and two and

34:01

two and two and two or

34:03

two and two and two and

34:05

two and two and two and

34:08

two and two and two and

34:10

two and two and two and

34:12

two and two and two and

34:14

two and two and two and

34:16

two and two and two and

34:18

two and two and two and

34:20

two and two and two and

34:22

two and two and two and

34:24

two and two and right? So

34:26

it definitely was compressed. But then

34:29

what happened was, you know, the

34:31

hurricane of high rates. hit us

34:33

full impact, it never got below

34:35

the 2X. We still had a

34:37

two times cushion in general on

34:39

that portfolio. And my sense is

34:41

that the other experience direct lending

34:43

community who've been through this before

34:45

had similar experience. And so, and

34:47

even frankly, if there were certain

34:49

companies that did worse than the

34:52

2X, private equity sponsors would work

34:54

with the lenders to come up

34:56

with a amended debt structure and

34:58

maybe it meant lower interest. burden

35:00

for a time, maybe it meant

35:02

less cash interest and more interest,

35:04

maybe it meant suspending it for

35:06

a couple quarters altogether until the

35:08

company got its act together, but

35:10

then over time the private equity

35:13

sponsor would work with us to

35:15

say, okay, you know, now we're

35:17

companies doing better interest rates, we

35:19

think have topped out, you know,

35:21

we're good to go. And so

35:23

when you look at the portfolios

35:25

overall in the direct lending market,

35:27

You've seen experience managers deploy this

35:29

playbook successfully and are now in

35:31

a position where, you know, we're

35:34

just, we're holding tight and seeing

35:36

what's going to happen next. That's

35:38

great. Now we touched on tech

35:40

earlier and I wanted to just

35:42

speak about AI. Are you finding

35:44

AI is being used by your

35:46

portfolio companies? Are you using AI

35:48

in some way? Because that's really

35:50

been one of the big question

35:52

marks on AI. There's a lot

35:54

of hype around at all. And

35:57

but are there any use cases

35:59

or not? Yeah. The answer is

36:01

that we comes up. frequently at

36:03

our industrial conferences. So we hold

36:05

in to a conference a year

36:07

and we have I think a

36:09

panel that's been talking about this

36:11

and we, I talk about it

36:13

whenever I'm sitting down, you know,

36:15

with the private response and asking

36:18

them because I get questioned by

36:20

people like you who are smart

36:22

in the space. And the answer

36:24

is that AI has been used

36:26

for a while by private equity

36:28

sponsors in their businesses. It's sometimes.

36:30

not cold. But, you know, to

36:32

give you an example, I think

36:34

the calculations, the rapid calculations with

36:36

complex and complicated variables that require

36:38

timely analysis, that's an area. So,

36:41

for example, I mentioned measuring and

36:43

metric oriented types of service companies,

36:45

that the sophistication of those calculations

36:47

as enhanced by AI. has really

36:49

been the driver for a lot

36:51

of the applications that private equity

36:53

sponsors are using for things like

36:55

manufacturing and even in the service

36:57

technology areas where there's need to

36:59

take an enormous amount of complicated

37:02

data and quickly synthesize and analyze

37:04

it to produce results and answers

37:06

that help not just their clients,

37:08

but frankly. the product and service

37:10

development of these businesses. And, frankly,

37:12

more quickly and more effectively. And

37:14

that part of AI has been

37:16

growing for a long period of

37:18

time. It's happening as kind of

37:20

a ongoing and integrated part of

37:22

the product and service development of

37:25

these businesses. And frankly, it's very

37:27

exciting because when you watch it

37:29

going on. You know, and we

37:31

ourselves in our own portfolio now

37:33

as an example. So think about,

37:35

you know, I mentioned we look

37:37

at a thousand deals. We do

37:39

about 50, 60, 70 new deals

37:41

a year, but we do refinancing's

37:43

add-on. So, you know, we have

37:46

a, let's say a portfolio of

37:48

300 companies, about 25, 28 billion

37:50

dollars. But I mentioned we only

37:52

do 5% of the stuff that

37:54

comes in, but we're an investor

37:56

in private equity funds that. translate

37:58

to and I'm giving a rough

38:00

number but let's say 3,000 companies.

38:02

10 times the number of companies

38:04

that we're getting information from, we're

38:07

starting at Churchill to think about

38:09

ways that we can analyze that

38:11

data that's coming in from all

38:13

these LP investments that we have

38:15

with funds and all of the

38:17

portfolio information from those private equity

38:19

owned businesses to tell us something

38:21

about the sectors that they're operating

38:23

in in ways that five, 10

38:25

years ago wouldn't be possible. We're

38:27

still at the beginning stages of

38:30

that. We've done some work. We're

38:32

super excited about the impact in

38:34

our own investing and thinking about

38:36

more information you get on some

38:38

of these niche businesses and how

38:40

they're doing, even if frankly you're

38:42

not a lender to one of

38:44

these companies. But getting that micro

38:46

information on how those companies are

38:48

performing is really going to I

38:51

think set the stage for some

38:53

really evolutionary. work for portfolio management.

38:55

And that I think for us

38:57

is the most exciting application of

38:59

AI right now. And I know

39:01

you predominantly focused on the US,

39:03

but do you have any views

39:05

on private markets, so private credit

39:07

elsewhere around the world, Europe, Asia?

39:09

Yeah, we have, we're, our investors

39:11

are kind of the third to

39:14

third, third, so US, we'll call

39:16

it North America, Europe, Asia. So

39:18

we're spread out pretty widely. I'm

39:20

actually headed to Australia on Friday

39:22

for a week there with our

39:24

clients. in my new role as

39:26

heading up our industrial solutions group,

39:28

the work that we do in

39:30

meeting with clients globally is really

39:32

interesting for me because being also

39:35

on our investment committee and then

39:37

also publishing our lead left podcast

39:39

and newsletter every week, the thing

39:41

that I find fascinating is when

39:43

I sit down with the European

39:45

and Asian investors, there is a

39:47

commonality to their view on private

39:49

capital and the commonality is that

39:51

They have already made the decision

39:53

below that private capital needs to

39:56

be a part of their portfolio.

39:58

Often it is part of this

40:00

alternatives category, which includes real estate,

40:02

private equity, and others, but particularly

40:04

with private credit, the stability and

40:06

durability of returns and performance through

40:08

various cycles has demonstrated now over

40:10

almost 20 years to these investors

40:12

that we need to be in

40:14

this in order to complement the

40:16

public and liquid part of our

40:19

portfolio. They saw the, you know,

40:21

damage that the interest rate change

40:23

in the ecosystem did to fixed

40:25

income and public equity equities in

40:27

2022. And they're like, you know,

40:29

I don't want to repeat that

40:31

again. I need a stabilizer. It's

40:33

that, you know, I used the

40:35

metaphor of the camera that the

40:37

steady cam, I think they call

40:40

it in movie making where the

40:42

camera. person is running on uneven

40:44

ground and yet the camera, you

40:46

know, the picture is steady. Private

40:48

credit is a steady camera of

40:50

the capital markets. It's the stabilizer

40:52

of the picture that allows investors

40:54

to maybe not get, you know,

40:56

20 plus percent returns for private

40:58

credit, but for in this environment

41:00

kind of 10 to 12 percent

41:03

returns that will be stable as

41:05

long as the, you know, benchmark

41:07

is at that level and then

41:09

if the benchmark comes down. Yes,

41:11

rates will come down, our yields

41:13

will come down, returns will come

41:15

down, but so does everything else.

41:17

And so the relative value still

41:19

remains the same. And what our

41:21

European and Asian investors now are

41:24

fully invested in is that concept

41:26

of the stability and performance from

41:28

an income perspective, whether it's high

41:30

rates or low rates, whether it's

41:32

high growth in the economy or

41:34

low growth, whether it's higher inflation

41:36

or lower inflation. stability of those

41:38

returns remains. even though Europe and

41:40

Asia are behind North America in

41:42

terms of the development of the

41:44

market, they're following of the pattern

41:47

of investing in the US is

41:49

very similar. And I find it

41:51

in fact very rewarding to be

41:53

in these markets where they may

41:55

feel like they're a little behind

41:57

the curve, but they're catching up

41:59

quickly. I mean, do you think

42:01

there'll ever be, or is this

42:03

already happening, where from a NASA

42:05

allocation perspective, private credit moves outside

42:08

of alternatives and becomes its own

42:10

individual bucket. So you have public

42:12

bonds, public equities, private credit, private

42:14

equity, and then all is kind

42:16

of. Yeah. So I was telling

42:18

the story at a conference a

42:20

couple weeks ago about, and it

42:22

was a question that was related

42:24

to that, that when private credits.

42:26

started it's almost like a teenager

42:29

that you know is trying to

42:31

move out of out of their

42:33

house and they move in with

42:35

friends and so you know in

42:37

some cases they're living with you

42:39

know a bunch of people in

42:41

their apartment so it's like private

42:43

credit didn't have when it was

42:45

starting off, they weren't able to

42:47

get their own apartments. So they

42:49

were live private credit was in

42:52

the, let's say they were in

42:54

the real estate bucket, believe it

42:56

or not, or they were in

42:58

the private equity pocket, or they

43:00

were in, believe it or not,

43:02

in one case, they were in

43:04

a hedge fund bucket. One of

43:06

our investors said, oh yeah, we

43:08

group up with hedge funds. As

43:10

the teenager has grown up being

43:13

the most popular. we ourselves think

43:15

of it that way even though

43:17

private equity is is different in

43:19

terms of you know the levers

43:21

that move that asset class again

43:23

it's it's not debt it's equity

43:25

so there's there's different things that

43:27

that affect the performance of it

43:29

and obviously different risk return variables

43:31

but I think private credit now

43:33

is firmly established in its own

43:36

category. private markets is a good

43:38

way to think of it for

43:40

the investors that we talk to.

43:42

And I think the growing sophistication

43:44

by these investors both institutionally and

43:46

I think in the next wave

43:48

of growth which will be in

43:50

the retail and wealth channels, I

43:52

think understanding that you know private

43:54

in illiquid doesn't mean anything less

43:57

valuable than public and liquid and

43:59

in some cases they have learned.

44:01

that being liquid isn't necessarily the

44:03

best thing when you have the

44:05

kind of headline risks that we

44:07

have been witnessing over the last

44:09

several years. And just to round

44:11

off, you know, I know you're

44:13

very focused on risk and so

44:15

on. So I mean, what are

44:18

your main worries for 2025 for

44:20

the rest of the year? Well,

44:22

I think this issue of tariffs

44:24

as we started this conversation on

44:26

geopolitical risks, you know, is definitely

44:28

top of mind for our investors.

44:30

particularly given the uncertainty law related

44:32

to that I mean with interest

44:34

rates last year and going actually

44:36

back to 2022 as an example

44:38

when the Fed was seemingly slow

44:41

to get the joke about transitional

44:43

inflation versus you know this is

44:45

permanent they did catch up and

44:47

they did actually execute a soft

44:49

landing last year you know they

44:51

slowed inflation down without slowing the

44:53

economy. Unfortunately, the Fed really doesn't

44:55

have any control over tariffs and

44:57

the geopolitical issues. And in fact,

44:59

you know, the institutional framework in

45:02

related to those two areas, it

45:04

seems to be very different than

45:06

anything certainly I've experienced in my

45:08

lifetime. And so what I think

45:10

the business community typically looks for

45:12

in the conversations I've had with

45:14

them. is, you know, bad news

45:16

is better than uncertainty. They don't

45:18

mind like, okay. Okay, if I'm

45:20

gonna sell a business in Canada,

45:22

and I know I have to

45:25

factor in a 20 or 30%

45:27

tariff, whatever it is, okay, fine,

45:29

at least I know exactly what

45:31

it is, and I can work

45:33

around that. Business people are really

45:35

good at adjusting to the realities

45:37

of the economy and the markets.

45:39

But if I'm not sure, if

45:41

I don't know what it is,

45:43

how can I plan for it?

45:46

And that's why a little bit

45:48

of this pencils down approach seems

45:50

to be the case in the

45:52

case in the market. the tariff

45:54

and geopolitical uncertainty becomes resolved, that

45:56

will have a really good second

45:58

half. I actually believe that will

46:00

be the case. I do believe

46:02

that people are telling me that,

46:04

you know, the current environment, you

46:06

know, in what's going on, you

46:09

know, in the world is probably

46:11

a result of some gamesmanship, you

46:13

know, trying to get the best

46:15

deal that's possible. And once the

46:17

deal is settled, then we can

46:19

move on. That's the hope. I

46:21

think, you know, we'll see what

46:23

happens. My guess is that the

46:25

administration probably doesn't want to see

46:27

markets, you know, tank. They prefer

46:30

good a strong economy, good markets

46:32

to be solved. They want to

46:34

get extract as much values as

46:36

they can, which is why I

46:38

think we're seeing some of this

46:40

going on. But, you know, hope

46:42

is that second half of the

46:44

year will be more productive and,

46:46

you know, the thing that is

46:48

probably our focus on our investment

46:51

committee is deal by deal right

46:53

we we live and breathe credit

46:55

our committee our investment committee has

46:57

been together for 20 years we've

46:59

approved every deal we've done we

47:01

worry okay is this deal going

47:03

to be the one that's going

47:05

to get us into trouble and

47:07

so we're super picky and super

47:09

careful about what's the impact of

47:11

macro things going on in the

47:14

world right now for this company

47:16

and then what what's going on

47:18

with the micro what's going on

47:20

with the micro what about the

47:22

world that this particular smaller company

47:24

occupies. is going to change whether

47:26

it's competitive or whether it's global

47:28

issues which tend to be more

47:30

North America focus, you know, what

47:32

about structure of the deal that

47:35

we're looking at could potentially impact

47:37

our performance and our ability to

47:39

return all our capital to our

47:41

investors with a return. Those are

47:43

probably the things that right now

47:45

we focus on more. It's sticking

47:47

to our knitting, making sure we

47:49

do good deals. don't do bad

47:51

deals and you know think about

47:53

the world from an investor perspective

47:55

we are all investors we own

47:58

equity in our business you know

48:00

we own we have in money

48:02

in our own money invested in

48:04

every fund we we do and

48:06

by the way our parent company

48:08

invests alongside us in every transaction

48:10

we do so when you have

48:12

a triple-8 parent company alongside you

48:14

it's real relief but you also

48:16

you want to keep the trust

48:19

and you want to keep the

48:21

trust and and do good deals.

48:23

So that's probably the thing that's

48:25

going to continue to keep me

48:27

up at night. Yeah, it's fantastic.

48:29

So just finally, what's the best

48:31

way for people to learn more

48:33

about? Churchill also follow your work

48:35

as well. Sure. So the lead

48:37

left is our weekly newsletter that

48:40

we send out free to investors

48:42

and Friends of Blah. I'm going

48:44

to extend that offer. Special offer

48:46

Friends of Blah. We always mentioned.

48:48

the Hive podcast with Balao and

48:50

you'll get a free subscription. It

48:52

comes out every week. I've been

48:54

doing it a lot since March

48:56

of 2008. I was out to

48:58

about 50,000 subscribers and then we

49:00

do a podcast. It's not quite

49:03

as robust and professional as yours.

49:05

We call it the private capital

49:07

call. We need to have you

49:09

on that as well. I think

49:11

that'd be a fun interview and

49:13

that's you can see that on

49:15

LinkedIn and so either either lead

49:17

left or The private capital call

49:19

and I'm all over the place,

49:21

I'm sure you can just hook

49:24

up with Randy Schwer around.

49:26

LinkedIn, we'll get

49:28

back to you. back

49:30

to great. I'll

49:32

make sure to

49:34

add those links

49:36

to the links to the

49:38

show that, So know,

49:40

thanks a lot,

49:42

really informative Really

49:44

as always and

49:47

good luck with

49:49

your upcoming with your

49:51

the way up

49:53

to Australia. all Thank

49:55

you, to It's

49:57

a Thank and a

49:59

pleasure to be

50:01

with you and

50:03

best of luck

50:05

with everything you

50:08

do. You of

50:10

a great service

50:12

for investors everywhere

50:14

and keep doing

50:16

what you're doing. what

50:18

you're thanks a

50:20

lot. Thanks a lot. Thanks

50:22

for listening to the episode. Please subscribe

50:24

to the podcast to the podcast show on Apple to podcasts.

50:26

or have you five star rating, a nice comment

50:29

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