- The turmoil in bank stocks has soured the mood at this year’s Milken Conference.
- Private credit was seen as increasing as banks contracted.
- Still, “more will break,” fund executives say.
About 3,500 investors, bankers and pension fund managers gathered at the Beverly Hilton in Beverly Hills, California this week for the 2023 edition of the annual Milken Institute Global Conference.
Named after Michael Milken, widely credited as the founder of the modern junk bond industry, the conference was attended by some politicians and non-profit leaders and was the premier event for financial industry executives. I got to one of the conferences.
Hundreds of others chose not to attend the meeting, but holed up in nearby Waldorf Astoria and Peninsula Beverly Hills hotels to hold marathon meetings with private market managers and the pension funds that fund them. Several attendees likened the event to an episode of speed dating.
The list of big hitters included Citigroup and Wells Fargo CEOs Jane Fraser and Charlie Scharf, respectively. Carlyle’s new CEO, Harvey Schwartz. CEO of organizations as diverse as Wynn Resorts, Amgen and Mayo Clinic. His CEO at Goldman Sachs, David Solomon, held court in Waldorf next door.
Virginia Governor Glenn Youngkin, who is being discussed as a potential presidential candidate, and Los Angeles Mayor Karen Bass were there. West, Virginia Senator Joe Manchin, and ExxonMobil CEO Darren He were scheduled to appear on stage with Woods.
Here are the top five takeaways from this year’s conference:
The regional banking crisis is not over yet
Conference attendees were awakened Monday morning by the news that JP Morgan had acquired First Republic in a deal brokered by the Federal Deposit Insurance Corporation.
Opinion is divided on whether this marks the end of the region’s banking crisis, with Citigroup’s Fraser suggesting that the last point of ambiguity has been removed from the market.
“It’s good to see that today the last remaining major source of uncertainty has been resolved,” Fraser said. “We should all be happy about that.”
The chief executive of one of the country’s largest banks says regional banks may weather unless another shoe falls, such as interest rates rising more than expected or the commercial real estate market bottoming out. suggested. .
After all, information about the losses facing banks should be known and the market should have already digested it, the person said.
But others were much more pessimistic. A senior executive at a bad-debt hedge fund said the problems were just beginning. The person, who requested anonymity to speak freely, and others who spoke on the sidelines of the event believe industry losses may require banks to raise hundreds of billions of dollars in equity. increase.
Banking executives described the situation as a “precarious equilibrium” and suggested that regulators would be watching closely and trying to determine how to recapitalize the industry without upsetting the market.
Once they can stick the needle and the industry has the freedom to raise that money in the next few years, the disruption to the system is likely to become manageable, executives told Insider.
If short sellers and others in the market continue to mark unrealized loan losses on the market and seek out the weakest institutions, the crisis could continue until government officials find a more permanent solution.
Now is the time for private credit
Regardless, many expect the loans to hit the market as banks take steps to build a stronger foundation.
Bank pullbacks have raised expectations for those in the private credit industry. This segment of investors, also known as direct lenders, has filled the hole left by banks in corporate and property lending. An industry that gained popularity after banks emerged from the financial crisis and became reluctant to lend to riskier mid-market companies, PrivateHis credit industry is now one of the brightest areas in alternative asset management. floating as one.
David Hunt, CEO of PGIM, the investment management arm of US Prudential Insurance Company, made this point during a panel discussion.
“Nonbank lenders have been taking a cut from the banks, but with these failures and the real tightening of regulation on many of these regional banks, it will accelerate,” Hunt said. “So when you look at private credit as an asset class and a lot of institutional investors here, I think we’re going to see non-bank financial institutions take even more share out of the banking industry going forward.”
More broadly, as interest rates are expected to remain elevated for the foreseeable future, direct lenders are beginning to realize that they can increase their loan repayments to generate higher returns.
David Blake, Global Head of Public Markets at Principal Asset Management, said on a panel that Vivek Mathieu, Head of Asset Management at Antares Capital, said private credit loans were made at this point in the cycle. will be the best one yet.
“The vintage we’re currently producing in that market will, in hindsight, be the best private credit vintage in years,” Blake said.
The point is to acknowledge that credit has become tighter as the world has changed, allowing lenders like the private credit sector to charge higher interest rates for loans with better protection.
and a changing environment characterized by three decades of declining interest rates and cheap borrowing that spurred the rise of the private equity industry. Some panelists and others speaking in the halls of the event suggested there had been a massive handoff from private equity to private credit.
Many private equity firms are rushing to raise private credit to take advantage of this.
Carlyle’s Schwartz told another panel: “The opportunity to capture 8% or 10% on a different risk-adjusted basis would be huge for market participants.
Schwartz, the leader of one of the world’s largest private equity firms, has warned against writing off private equity deals in his business, as did Tawfiq Hammoud, a senior partner at consulting firm Boston Consulting Group. Hammoud said it’s too early to underestimate the private equity industry or suggest it’s going backwards.
“I don’t think this is the end of private equity, but the environment certainly favors private credit,” he said.
Time to date could be a problem for private credit
Right now, the environment may favor private credit, but Katie Koch, new CEO of fixed income fund manager TCW, said money raised in the past few years has seen lower interest rates and less protection. He warned that borrowed loans could struggle to succeed as they experience losses.
Koch, a rare manager at a conference suggesting there are troubled assets in the private credit industry, said the pace of the Federal Reserve’s rate hikes will lead to further challenges as it is already causing trouble for the banking system. Stated. Private credit could suffer a lot of losses, she said.
“The price of capital has been revalued very aggressively in a short period of time,” Koch said. “Every time it happens, something breaks. There will be more.”
Koch cited commercial real estate, including loans and private credit held by local and community banks.
According to Koch, many deals have been made in the past five years with weaker protections for lenders, known as covenants. These will be tested over the next few years, she said. And that will show up in lower returns for private credit funds, she said.
“The next five years won’t be fun,” Koch said, adding that TCW is on pace to raise more money than ever with its newest private credit fund. started after the global financial crisis, so there are a lot of managers in this space who are only investing in a zero or low interest rate environment. You can be a genius in your environment.”
Retail investors prepare to feed mid-tier portfolio companies
As investors try to adapt to the new environment and save cash, they are looking at the companies many people own and making difficult decisions about which companies are worth investing in on an ongoing basis, some say. investors and bankers working with them said.
Private equity funds, for example, are using this time to cut costs, refinance debt and do what they can to make the companies they own run more efficiently, said one banker. . In some cases, we may choose to sell a company that we have determined is no longer worthy of our attention.
Venture capitalists are making similar arguments, according to another banker who works in the tech industry and who frequently talks to venture capitalists. explained. Companies that still have the potential to deliver 10x returns are getting the most attention, the banker said. Perhaps it’s from his 25% to his 33% of the portfolio.
For another 33% to 40% of the portfolio, we may decide to fix any issues they may have, but we do so carefully and aim to keep costs down. And for the bottom 25% of the portfolio, the venture fund should relinquish the position, or at least refuse further investment, and sell the company to a large publicly traded tech company or another private his equity investor. may choose. deplete capital.
The pressure has also been added by private equity and venture capital fund limited partners pressuring investors to return some of their funds to the LP, bankers said.
M&A and funding markets have new shoots
A tough decision like this may not be welcome news for companies at the bottom of their portfolios, but for bankers Insider spoke to, it suggests an upside for M&A later this year. .
Several insiders who spoke to said the pace and number of rate hikes slowed and the second half of the year will pick up as investors get a better sense of which companies can and cannot continue to thrive under clearly higher rates. said that he expects. t.
For example, in technology banking, bankers see the potential for a flood of deals as venture capital firms adjust their portfolios and large technology companies tap into the large amounts of cash on hand.
Other industries that saw increased activity include biotechnology, national security, and restructuring practices, bankers said.
Mergers are gaining momentum as the gap between the price sellers are willing to accept and the price buyers are willing to pay is starting to close. Boards often consider trading at his 52-week high for the stock, and the market is now above his late-2021 market high, making the comparison more favorable.
“Seller expectations are changing rapidly,” said one banker. “We all know the world has changed, and there is no going back.”