Of capital flows and borrower balance sheets

Carly Wilson:  Welcome, everyone, to our next panel where we’ll explore recent trends in global capital markets.  We are fortunate to be joined by Brent Patry, head of Global Capital Markets for BlackRock, and Peter Toal, co-head of Global Fixed Income Syndicate for Barclays Capital.  Welcome to you both.

In one of the prior panels, we heard Jimmy, Mitch, Jose, and Neeraj talk about their global market views and how this crisis has unfolded.  From the capital markets side, we’ve certainly seen an evolution as well from capital markets being closed to only open for high quality, non-COVID exposed names.  Then, fast forward to today, and capital markets are, in fact, wide open and deal competition is back, if it ever really left.

So, let’s dive into it with Peter and Brent.  Peter let’s begin with you.  Again, welcome and thank you for joining us.  From your perspective, how would you characterize ... capital markets today?  Do you agree with my opening comments that capital markets are wide open and are there ...

Peter Toal:  Yeah.  Thanks, Carly.  And first, let me begin by thanking BlackRock for having me today.  I'm absolutely delighted to be part of this conversation with you and with Brent.  I also want to recognize BlackRock for being one of the largest and most respected thought leaders, not only within the broader capital markets, but certainly within, you know, my little corner of the leveraged finance world.

I do agree completely that the debt securities markets are wide open.  Primary volumes we’re seeing across both high yield and investment grade have already surpassed volumes of last year and risk appetite is huge.  If you think about it, it’s been largely Fed and central bank induced.  If you look at the last two crises, the financial crisis and this pandemic, the pattern seems to be central banks cut rates dramatically, they open the spigots for qualitative easing.  IG spreads first, you know, rally massively and that trickles down to not only the high yield market, but equity markets as well.

The – I think it’s important to keep in mind, though, within equity and high yield and to some degree within IG, the returns are very bifurcated.  So, while it’s completely risk on or at least you would see that from reading the news, within high yield, you know, the BB segment of the market has returned massively.  The CCC segment is still negative.  And within equities, you know, NASDAQ and Dow and S&P are doing what they’re doing.  But, the S&P Mid-Cap and Small-Cap Index is still down roughly double digits.

But to – suffice it to say the technicals driving the market are massively in favor of borrowers. 

And what’s going on in the markets is to some degree disconnected from the real economy.  It’s somewhat shocking when you consider, you know, unemployment is near double digits and had been at double digits.  You know, Q2 GDP we all know was down, you know, 30%-plus.  So, the fact that the markets are doing what they’re doing is shocking, but again very much central bank induced, and which is exactly what the central banks wanted to have happen.

At the top, I talked about the securities markets being wide open.  Obviously, as a bank we do a lot of lending in the loan market and the term loan market has lagged, specifically with respect to the syndicated term loan B market.  That market, while it’s improved lately, still suffers to some degree from ratings migration downward and CLO formation, which we’re happy to talk about, but structured product formation which is getting hurt by both defaults and downgrades.  Lately though the, even the term loan B market has rallied.  There's been an awful lot of repayments and not a whole lot of primary issuance, which again creates a very positive technical environment. 

And then finally away from high yield, away from US, excuse me, Europe is seeing the same phenomenon.  It’s taken a little longer.  The European high yield market went fully two months without any real issuance.  But since that time, it’s come back largely as well and there’s an awful lot of demand over there also.

So, yeah, completely agree.  The markets are wide open at the moment.

Carly Wilson:  Yeah.  Those are some really interesting comments.  You know, it’s interesting to sit here and see, you know, a record-breaking airline raise to think about high yield pricing, you know, 3% area, sub-3% in certain cases.  You know, on the one hand I agree with your comments.  It’s sort of hard to accept on some level.  But then again, to your comments as well, you know, knowing what we know about central bank policy and how accommodative policy, you know, feels very much here to stay, you know, as was, you know, as was discussed by the Fed recently, you know, perhaps when you think about it on spread it’s actually reasonable or perhaps just food for thought.

And then kind of shifting gears a little bit, you know, we look back on March and April and, you know, how the mindset at that time and it is, you know, it’s really hard to believe that we’re sitting here today and Peter is talking about, you know, record-breaking new issuance volumes.  And just to emphasize the point, you know, a significant portion of this is net new, new/new new issue volume, you know, rather than refi volume.

So, I guess, Brent, we’ll turn to you.  You know, on the one hand, you know, thinking from a company perspective, issuing debt, you know, over the last few months, you know, sensible.  Add cash to balance sheet.  You know, responsible.  On the other hand, you know, thinking about adding gross debt to balance sheet in the face of declining earnings, you know, it’s less obvious or at least perhaps arguably it ...

You know, how you think companies should be thinking about this balance.

Brent Patry:  Yeah.  No.  Look.  As you said, Carly, it’s really we have to strike a balance here.  When raising incremental debt and increasing the leverage, it is clearly a balance between providing that liquidity and a long runway for businesses on one hand and over-leveraging those businesses on the other hand. 

At BlackRock, we have really tried to be constructive and work with most issuers and borrowers.  It’s generally in our interest as a stakeholder and creditor and a large market participant to be constructive.  Some others haven’t been as constructive.  But, it’s also important to be perceived by the Street to be a constructive partner, to be sought out by people like Peter and his colleagues when the bank’s issuers and borrowers are looking for solutions.  And long-term that is right for the platform and long-term it’s right for our clients.

And when thinking about where to be constructive and where to draw the line on leverage, it is clear that the COVID crisis impacted some companies permanently, but in many other cases just temporarily.  And we at BlackRock have been very positive towards those companies we believe are well-positioned in this impacted environment over the long run, but very cautious on those whose business models may be impaired once we get to the other side of this pandemic.

We have seen some companies raise some two to three years on liquidity to become almost bulletproof if the crisis continues for some time.  In many cases, we’ve supported these raises or even supported amendments where we allow more debt on the company than we initially permitted via covenants and in some cases to protect our capital, but in other cases, particularly early on in the crisis, as we talked about in March and April, where outsized returns and significant collateral protection were offer. 

In many situations where this extra liquidity was raised and the runway was extended, the prices of the securities across the entire capital structure, debt and equity, improved as the long-term viability of the business improved.  We and the market believe the additional leverage will be absorbed over time and the recovery and resulting defaults will be minimized.

Carly Wilson:  Thanks, Brent.  You know, from my seat I certainly agree that, you know, there have been many interesting opportunities in this environment where, you know, you have the ability to look through 2020 numbers and think towards 2021.  We’re going to go back to you again, Brent.  You know, I think another topic we wanted to explore around, you know, the evolution of capital markets is how, you know, companies have – we’ve seen this notable shift in companies tapping private markets, seemingly prioritizing, you know, certainty of execution above some other considerations.  And it’s certainly been particularly pronounced in a second lien loan market.  You know, this was touched on by Peter, too, to a degree.  But it’s definitely been very noticeable there.

So, Brent, I'm thinking, I'm curious how you’re thinking about this balance as well.  So, you know, I'm an issuer.  How should I think about that public versus private dynamic and what are the pros and cons to be thoughtful there?

Brent Patry:  Yeah.  Well, look.  It’s clear that the emergence of a private market has helped borrowers, issuers, and financial sponsors as they all have more choices as to the market and products they can choose.  And in general, this is a positive development for the overall credit markets. 

We believe that the private market has opened up capital raising for a segment of the market, particularly in the middle market, that didn’t really exist before or are now – is now – or are now being overlooked by the banks.  Many banks are reducing overall risk exposure and shying away from either tougher to understand credits for the public markets or from the upper end of the middle market, which previously was very well-served by the second lien syndicated loan market and that market has largely disappeared, as we all know.

And in many cases, the private market offers an alternative that’s quick to market, a certain outcome in some situations in companies that may be more difficult to raise in the public markets.  The private market has been more supportive to those companies in more difficult industries or have complicated stories.  And more recently, the private markets have also been serving mainstream leveraged finance transactions and while the issuers are still paying for this certainty of execution with higher rates, that premium has clearly converged to the public markets. 

As far as limitations in the private markets in the current environment and while the credit market, private credit market AUM is growing fairly rapidly, it is also somewhat limited in scale per transaction.  The private market is very efficient for deals starting at say $50 to $100 million and upwards of a billion dollars, but somewhat less efficient for those situations that need significant scale.  And in these larger situations, the mere dollars required to be raised necessitates either the syndicated loan market or the high yield market or, frankly, both private and public markets. 

In the case of the recent large buyout of the ThyssenKrupp elevator business, the sponsors wisely tapped both private and public markets to really diversify the financing sources and to a certain extent have the markets compete against each other for the well needed paper in their portfolios.  And this was also at a time, by the way, where the public markets looked somewhat less stable, so opening up another market and diversifying those financing sources into the private side was actually very, very smart, very wise.

We at BlackRock are fairly agnostic to which markets our issuer clients access, as we try to diversify our product offering to create attractive solutions from either side of the market.  Clearly, these trends are going to continue.

Carly Wilson:  Thanks, Brent.  Yeah.  It’s absolutely been an interesting push and pull.  You know, I think for companies, though great outcomes all around, and for investors some compelling economics as well. 

Peter, we’re going to turn back to you.  I'm curious how your risk appetite has changed, you know, as an underwriter.  Are there deal types, you know, maybe even looking back in March and April, were there deal types that were hard nose then?  And then, kind of looking at it today, are there deals that you would still categorize as such today?

Peter Toal:  Yeah, Carly.  It’s a really good question.  You know, when you talk about behavior and has that changed, you know, I assume you’re talking about risk appetite on the part of banks or at least on the part of Barclays.  And let me just start by saying, you know, regardless of the market backdrop, whether things are tough or, you know, deals are easy to underwrite and distribute, you know, we pride ourselves as a – and I’ll speak as a credit committee member and voter on our what we believe a very thorough and complete diligence process and a deeply embedded credit culture.

If you’re talking about risk appetite, maybe I’ll talk about what happened in, back in March and April and what’s happening now.  If you think about banks and how they operate, there’s two main areas, and I'm over-simplifying it, but two main areas that you can talk about risk and exposure.  One is the, what I’ll call the hold book, which is where we lend money to companies mostly in the form of revolving credit facilities and term loans.  And the other area of risk exposure is, and this is within the bank, not within the sales and trading area, the other area of risk exposure is the underwrite book, the underwrite to distribute book. 

And let me be clear, risk and how we view those exposures is the same.  We don’t have any lower standards for the underwrite to distribute book, but it is a different area of the firm. 

On the hold side, on the revolving lender side, in the pandemic not surprisingly we saw a great deal of demand for drawings on those revolvers and that’s not at all surprising.  Like I said, every time a cycle turns that happens.  And so, you know, drawdowns spiked, risk-weighted assets at banks spiked, and reserves spiked as well.  And if you listen to the Q1 and even Q2 earnings on the part of the banks, you saw that banks took large reserves, which hit their income.

As that happened, and as we’ve talked about, the capital markets, you know, opened very broadly.  All the banks encouraged those borrowers or the CFOs and CEOs themselves determined they were going to go to the capital markets and ... out those drawings.  So, what’s happened since is back to a much more normal environment.  Revolvers generally got repaid, maybe not so much in the very affected areas but, you know, the drawdowns we saw have in many, many cases become a much more normal looking book.

Away from that, we were pretty light and were looking forward to a big M&A pipeline.  And then what happened with when the markets took a big dive down, a lot of those M&A processes just either fell apart or were put on hold.  You know Victoria’s Secret is a deal that was in the press as a deal, you know, basically that had been agreed to that fell apart.  So, we saw boards of directors really stop doing anything very strategic and M&A discussions were very muted. 

We at Barclays actually like the environments when there’s volatility in the markets, because what tends to happen is there’s less competition for underwritings.  So, even though there weren’t many underwritings happening, we were very much involved in ones that were and we see that as an opportunity for less competition among our peers and we can, you know, drive very attractive risk/reward opportunities.

With the markets now rallying, like I said the hold book is back to much more normal parameters and the underwrite book is building.  And, if anything, we’re back to really hyper-competition, mostly on the part of sponsors.  And I expect that M&A in, you know, the fourth quarter will be pretty busy barring any sort of, you know, huge spike in cases or another lockdown.

You mentioned, you know, are there any definite nos or deals that we would just ultimately pass on.  And, you know, I guess I'd say philosophically we never underwrite anything that we’re not prepared to hold.  Having said that, I, myself, subscribe to the adage of, you know, everything has a price or, you know, there’s no such thing as a bad investment and there’s only a bad price or similar thing.

So, you know, we’ll look and try and price out everything.  And, in fact, when the opportunity presents itself, we may and have called Brent and other folks at BlackRock to get a sounding on how they as a sophisticated credit investor would look at a particular situation.  Obviously when we do that, as an aside, there’s privacy issues that need to be complied with.  But, nonetheless, you know, there are a lot of difficult deals out there and, you know, we put them through our processes and may or may not commit to them.  But examples would include a request for a very large term loan B.  And like I said, the term loan B market has lagged in its recovery.  So, we would typically want flex to a secured bond deal. 

Second liens, as Carly you mentioned, you know, that market tends to be fickle overall but isn’t very deep at the moment.  You know, obviously really, really highly levered deals that are levered to perfection or priced to perfection are tough.  CCC rated deals, I talked about the returns in that segment of the market are something that, you know, we’d have to be particularly careful of. 

There’s been much written about highly adjusted earnings and obviously we, you know, scrutinize what the cash flows of the company really are.  And then, obviously, there’s sub-sectors that you need to be careful of, energy or particular ... services, bricks and mortar retail, and, you know, the obvious ones. 

So there – I wouldn’t say there’s, you know, bright line nos that we wouldn’t touch.  But there are obviously deals that require more thought, more structure, more pricing to be able to underwrite and get successfully distributed.

Carly Wilson:  Thanks, Peter.  Makes complete sense.  And oftentimes, we like to think of those as opportunities for us in certain cases at least.  You mentioned some behavior or alluded to some behavior on sponsors.  I wanted to dive into that a little bit in the few minutes we have left. 

So, you know, you both, Brent, Peter, you both work with sponsor-owned companies, also public companies and thinking through financing solutions.  I’ll go back to you, Peter, for a minute here.  You know, are there particular differences in behavior you’d highlight, either what we had been seeing or what we’re seeing now as you compare these privately owned companies or sponsor behavior versus publicly owned companies?

Peter Toal:  Well, yeah.  And we do a lot with the sponsor community here in – at Barclays and I think every major leveraged finance department on the Street, you know, would say the same thing.  The behavior, look, financial sponsors are typically – and I don’t mean to make stereotypes.  But, they're very sophisticated; they’re very aggressive users of the capital markets.  And while cost of capital is important for any company, whether it’s sponsor-owned, publicly-owned, otherwise privately-owned, the sponsors for obvious reasons view it as hugely important as the amount of debt and the cost of that debt directly impacts private equity returns.

You know, corporates tend to – and again, I don’t want to make vastly overly over-generalizations.  But I would say sponsor or corporates tend to look at the capital markets as a permanent part of their capital structure.  If they’re going to issue debt it’s, you know, maybe it’s going to get repaid, but they typically would refinance that debt.  It’s part of their capital structure that they want to build and the capital structure is strategic to their equity owners, which is why in the IG market you could pretty much point to in the next quarter or certainly the next six months or year the amount of supply that’s going to come, because they are serial refinancers.  And I would say, like, you know, corporate issuers, even in high yield think for the most part the same way.

Sponsors, they buy companies with a lot of leverage.  They try and improve the operations, improve the cash flows, pay down debt over time, and then look to exit and hopefully get some multiple expansion on top of some EBITDA growth, and that’s how they generate outsized returns.  Because of that dynamic and as they repay debt, they create more equity value, they tend to want non-permanent debt in their capital structure, i.e. term loans that can be repaid with that free cash flow.

So, I think today if you ask sponsors, most would say they prefer an all loan capital structure, first lien loan, second lien loan, and equity, rather than a bond capital structure that’s not easily cullable with either free cash flow or an early sale.  So, I think that’s the main difference.  But, you know, we compete with our peers to underwrite deals and even corporate-owned, you know, public corporate companies compete us aggressively.  So, we often live on that knife’s edge of comfort and, like I said before, rely on folks like Brent to help us structure those deals and, obviously, distribute them into the hands of the ultimate risk owners like BlackRock.

Carly Wilson:  Thanks, Peter.  It’s interesting to think about, you know, what you just mentioned on sponsor behavior and sponsors looking, you know, for prepayable debt and coupling that with the trend towards secured bond issuance that we’ve seen.  And I guess from my seat I would argue there’s been some convergence and sort of structural components with high yield call pro getting a little shorter at times, loans adding LIBOR floors.  So, I feel like there’s a bit of convergence, understandably so, in these markets, you know, trying to appease sort of all stakeholders. 

Brent, I guess we’ll turn the last question with our limited time left to you.  When you think about all we’ve covered here and all the more recent trends in global capital markets, you know, of these trends, you know, what do you think’s here to stay for the longer-term?

Brent Patry:  You know, look.  At the end of the day, I think we can all agree that low interest rates are here for a long period of time.  And at the same time, the demand for yield product is also here, which really makes the competition for capital very severe, and whether it’s sponsors as we just talked about, corporates or others really trying to take advantage of that.  There’s a tremendous amount of capital chasing the same deals.  In some respects, we call them tourists.  They’re people who are coming into the market to take advantage of certain opportunities right now and certain blips in the market, as we saw back in March or April.  And to a certain extent that’s going to continue for a while. 

So, I think when you think about capital markets, you think about as an asset manager how do you really differentiate yourself to position yourself for good looks at deals, for people like Peter to call us, for allocations, for proprietary looks at private transactions.  You really have to change the way you behave.  You really have to be solutions-based.  You can’t just rely on your capital base alone.  Capital clearly is not a differentiator.  You have to operate lots of different products to come up with that ultimate solution, whether it’s public or private.  You have to be market-agnostic.  And you have to listen to what people are saying. 

And obviously the sponsors, as we just talked about, comprise a very large portion of the overall market, some 60%-65% of the institutional term loan market and a huge portion of the private markets.  So, it’s going to be important to, you know, develop relationships with them, to really partner with them, to be creative with them, to be proactive with them to really figure out solutions for their issues. 

I think some other trends will be interesting.  If you think about some of the deals that we’ve had to restructure, Carly, within our own shop and how sponsors are thinking about restructuring those transactions, and it’s really about potentially putting more capital in to support the base and support the viability of the business long-term.  But, it’s also going it in a different way where all the lenders and junior bond holders would love this to common equity, but we’re seeing an increasing trend in sponsors willing to put capital behind businesses but they come in effectively pari passu or side-by-side a lot of lenders.

And once again, documentation had probably weakened a little bit net/net over the last call it five to ten years since the global financial crisis and at the end of the day sponsors are taking advantage of that and some fairly constructively.  There’s ways to be not so constructive in the market.  But, some fairly, you know, some fairly constructively where we’re looking at things like partnership. 

So, I think overall, look, the demand for new issues, public/private, is going to stay very high.  That's not abating.  And it really is incumbent upon asset managers like BlackRock to really partner with the right issuers, to really differentiate amongst the issuers we really want to back, and shy away from those that we want to protect our self and protect our clients, but be solutions-based overall because the competition for capital is significant and we have to put, you know, our clients’ capital to work as, you know, as properly as we can.

Carly Wilson:  Thanks, Brent.  I'm going to try and quickly wrap here.  I guess as I'm hearing you guys talk and thinking about what I’ve been seeing in the markets as well, you know, borrowers have been incredibly active, record-breaking deal volumes across many markets, though not all.  And while there are, you know, some hard-nose, whether you're thinking from an underwriter perspective or an investor perspective, most companies, you know, including some very challenging sectors, most companies have been able to access capital, extend runway for a reasonably long time.  And then I guess zooming in, you know, within lev-fin it’s really been high yield and private credit that have been the most active, you know, although across the board it’s been very active.

Conveniently, in our next panel we’re going to explore some additional themes and trends in private credit with some of our most senior private credit investors.  So, stay tuned for that. 

Thank you very much, Peter.  Thank you very much, Brent, for your insights.  And thanks, everyone, for listening.

Peter Toal:  Yeah.  Thank you, Carly.  Thank you, Brent.

ALTSH0920U-1336542

Carly Wilson:  Now let’s turn to our panel on private credit. We’ll take the next 20 minutes or so to dive deeper into the global private credit markets with a particular emphasis on industry-specific and company-specific trends. 

We’re fortunate to be joined by Stephan Caron, head of middle market private debt, Brad Pritchard, head of venture lending, and Raj Vig, President of BlackRock TCP Capital Corp and investment committee chairman for US private credit.  Welcome to all three of you and thanks for joining.

Raj let’s turn to you to set the stage.  Private credit players have certainly been busy, particularly in the last few months, deploying significant capital.  Can you discuss what themes you’ve been seeing under the hood?  What differentiates companies that are finding it easy to access credit today from those that aren't?

Raj Vig:  Sure.  Thank you, Carly, and greetings, everyone.  I'm just going to pick up on that opening point you made around the last panel and the strength of the private capital markets.  You know, as practitioners I think all of us on this panel here would, you know, would agree that this is a established, I think well-established and deep asset class.  I think that really that point really came home through the COVID period as the markets not only did not close but were open and active to a range of participants, you know, being able to deploy scale, capital to capital needs and in an efficient manner to, you know, companies that have been typically accessing private credit, but also to a broad range of companies that perhaps weren’t, you know, normally looking at this asset class until times when they needed it.

That ability to stay open and to, you know, deploy capital in meaningful opportunities, you know, I think through cycles but especially during COVID, has resulted in a premium that we typically see, you know, illustrated in both the pricing, the spread itself, the protective structures that we typically get, and also the documentation. 

You know, the other thing I would say is, just to answer your question on what types of companies are accessing the capital markets now, the private capital markets, you know, we always have a leaning and a bias towards more defensive industries.  I think we’ll pick up on that a, you know, a few times through this discussion.  That doesn’t change during the post-COVID period.  In fact, it probably, you know, is in that direction.  So, these are companies with very defensive business models, you know, resilient models as we call it, you know, highly visible revenues and earnings, and also, you know, relatively more stable values, enterprise values and corporate values, that we rely on for protection and for collateral for our credit.

So, I’ll turn it back to you.  But, I do think, just to hit it home, private capital is as active, it’s, you know, it’s here, it’s here to stay, and we think of it as, you know, a very well-established asset class that I think our investors, you know, find appealing and attractive and hopefully that’s the case going forward.

Carly Wilson:  Great.  Thanks, Raj.  And I certainly agree.  Brad, let’s turn to you.  Are the themes in venture lending consistent with what Raj was just describing, consistent with broader capital markets as well?  And if at all, are you seeing any differences in your market?

Brad Pritchard:  Yeah.  Thanks, Carly.  What I’ll say is the venture market, unlike Raj’s comments on the broader direct lending markets, venture lending was actually really bad back in March and April.  Some of you may remember Sequoia Ventures came out with their Black Swan of 2020 presentation.  This was similar to their Rest in Peace Good Times presentation back in 2008 that preceded the great recession.

So, I mean just to kind of put things in context, compared to pre-COVID pricing was probably 200 basis points wider than it was before and the levels of debt that you could get within the venture lending market was anywhere from 25% to 50% lower, if you could raise any at all

However, as bad as things were back then, the venture market, both for debt and equity, has come, you know, roaring back dramatically over the last several months.  Let me share just, you know, a few numbers.  According to PitchBook, fundraising in ... for 2020 was almost $43 billion.  That's already 80% of 2019 levels and it’s approximately 60% of 2018 levels, which was an all-time high.

And so, now with all that money coming into the market, it has to go somewhere.    So, definitely a lot of activity coming back into the equity markets.

Now, you know, notwithstanding this recovery, a number of companies back earlier in the year were forced to rethink their capital structure and were much more conservative now about deploying capital.  So, the last few years we looked at venture companies that were characterized oftentimes by high growth, high burn business models.  A number of them – I spoke to one company yesterday – they’ve pivoted now to more of a low growth/mid-growth go-to-market strategy.  But with that now they’ve also significantly lowered their burn.

In addition to lowering the burn, companies to try and bolster their liquidity are looking at adding cash to the balance sheet.  We don’t know how long high unemployment might remain and, you know, we don’t know if there could potentially be a second wave of COVID that would disrupt access to the capital markets.  So, that’s one area.

The other area, the IPO window is currently wide open.

So, there’s a number of companies that are now looking at going public and to do that, though, they want to make sure that their balance sheets have enough cash to project strength in their filings and then also to extend runway if that window temporarily closes.

Carly Wilson:  Great.  Thanks, Brad.  You know, it’s busy in fundraising, busy in deployments, busy with catalysts, just busy across the board really.  And certainly, some nuances that you covered, that Raj covered.  But also, I would say, you know, from my seat at least, many overlapping themes of liquid credit too where we’ve seen this evolution.  And we sit in a position today where, you know, it’s hard to imagine looking back on March and April.

So, Stephan, we’re going to turn to you.  Which sectors do you think today in your market present the best opportunity, you know, when you take into account current spreads?  How much potential total return is there available now in some of the tougher sectors and are there any areas where you are comfortable dipping down in quality?

Stephan Caron:  Thanks, Carly, and hello, everyone.  Look, I think first of all we’re coming out of a period where obviously there was a significant slowdown in M&A activity during the confinement, right.  Since May and June, we’ve seen a significant pickup in M&A activity.  And I would say a lot of that activity, both in the US and Europe, is really happening in sectors that haven’t been so much impacted by COVID-19.  Good examples of that are software, technology, telecom infrastructure, you know, food and beverage, utilities, insurance brokers where there’s been a lot of consolidation, both in the US and in Europe, and then healthcare of course.

Within the healthcare sector, which is obviously a white sector, I'd say we have a preference for outpatient care services, in vitro diagnostics, respiratory care, telemedicine, and specialty pharma, right.  A lot of these sub-segments obviously have benefited some of the tailwinds from COVID. 

In terms of investment themes, we’re definitely seeing a pickup in corporate carve outs.  There is a lot of talk about a pickup in public to private activity, but we haven't seen so much of that yet.  I think that may be just a question of time.  There's certainly a lot of talk about, you know, some of these deals being in the works.  So, I expect it’s just a question of time.

In terms of yields, I would say that the assets which have been impacted by COVID are definitely pricing much wider.  However, good assets, good companies which haven’t been impacted by COVID are really pricing, you know, almost to the level where they were pre-COVID.

There’s obviously a lot of uncertainty with the macro environment.  You know, Brad talked about the risk of a second wave and we know that defaults are likely to increase as well.  So, in this type of environment, you need to build resilience in portfolios.  That comes with investments in defensive sectors, having more control over facilities, better information rights, and proper maintenance covenants.  And I think that’s one of the reasons why we’re seeing, you know, many institutionals continue to increase their allocations to direct lending, as Raj mentioned, as well earlier.

Carly Wilson: Thanks, Stephan.  Sounds like overall, you know, healthy differentiation and discipline in your market.  You know, definitely a tough time to underwrite some of these more difficult credits. 

Raj, back over to you.  Thinking more deeply about, you know, in what sectors and maybe even more specifically in what companies have you been seeing management teams best navigate the downturn?  And how do you think about this?  Is it because they acted quickly and decisively; they quickly cut costs?  Or is there more to it?

Raj Vig:  I think generally speaking the lessons, you know, learned that we’ve seen is across the board, across sectors, the ability and the will to act quickly and decisively is always better in times of stress.  You know, you can make the same actions one or two quarters later and, you know, the difference will be one or two more quarters of burn or weakness or capital expended.  So really, the ability to have experienced management teams in place and teams that can make the tough decision and have the governance and the ability to carry that out as, you know, as an overlay is a very important factor and certainly something we look at even in healthy times is quality of management.  It’s specifically one of the things that is a diligence point for us.

I think when you come down to sectors, you know, really Stephan hit it on the head in terms of what we’re looking at today.  It’s I think it’s similar by region.    So, you know, where you have good visibility in – through cycles and in tough markets, like those software companies with recurring and contracted revenues, business service companies with, you know, monthly payments and very high stickiness of their customer base and subscription base, you know, sector themes like healthcare and financial services, which are growing through even, you know, tougher economic times, I think those management teams and businesses have a little better visibility at the margin than more cyclical, you know, industrial and commodity names and as such can also put in place actions within the context of that visibility that just have a better impact. 

They can cost cut knowing what their revenues will be.  They can cut, you know, sales and marketing or capital expenditures and have a good understanding of how they’ll still preserve revenue.  So, you know, outside of the just will to do it, within those industries the ability to do it is just more impactful on preserving the value of the business. 

One interesting footnote, you know, in all of this and, Carly, I know you’ve kind of heard this in some other sectors is when you think about the private capital markets it really is disproportionately active in the middle market.  You know, and we think of the middle market as very well-established businesses, still, you know, several hundred to billions of enterprise value, but markets that don’t access the liquid capital markets on a regular way basis. 

And in that market, you know, there is a I would say disproportionate ownership of private equity sponsor.  And the one thing I will say, going back to my first point, is what we have also seen is, and maybe it’s lessons learned from the past, even if the management teams would not have normally moved as quickly on their own with the overlay governance and, you know, a strong suggestion I’ll put it of this – of their private equity owners to take actions quicker, more significantly than they would’ve on their own I would say has been a more uniform, you know, observation in this period where the private equity funds have really, you know, battened down the hatches, you know, encouraged their firms to make the tough decisions. 

Carly Wilson:  Thanks, Raj.  Really interesting.  You know, I guess it’s the power of a strong management team and the power of strong, thoughtful equity owners, you know, and the marriage of those perhaps being the strongest of all. 

We’re going to turn the tables and poll the audience really quickly.  So, for the audience, when you think about your allocation to private credit, which of the following four choices is the most important?  We’ll make sure we still have you with us.  Is it the yield pickup versus liquid markets?  Is it the covenant protections that you still have, the low volatility nature of the asset class, or for ESG considerations?  I guess we’ll kind of pause, give everyone a minute to answer. 

And then, Stephan, we’re going to turn back to you.  Can you talk more?  We’ve highlighted some of those factors, but I wanted to see if you could talk more specifically about how your underwriting and monitoring processes may have evolved during this time.  You know, for new underwrites have you rethought or fine-tuned your sensitivity analyses?  Are your covenant asks different these days or how are you thinking about that?

Stephan Caron:  Yeah.  No.  That's a good question, Carly.  It’s something, I think the first thing is obviously we’ve all been running stress tests across all of our portfolios and refreshing them regularly, in particular during the lockdown period.  We also have more controls in place for any drawdown requests for acquisitions.  You want to make sure that these are genuine and that they’re – you know, conform with the documentation. 

In terms of portfolio monitoring, we’ve definitely increased the frequency of our interactions with the management teams.  I think as we mentioned earlier, you know, given that we’re the only lender or part of a small club, it’s very easy to do that, right.  You can just pick up your phone and call the CEO or the CFO to get an update on the business and understand how they’re, you know, how they’re managing through COVID. 

We’re also working very closely with our sector experts and I think that’s really helpful, right, just to understand the broader industry trends and anticipate potential disruptions.  Obviously, a lot has gone – a lot has happened during COVID and it’s really forced a lot of companies to really think about how they operate in their individual, you know, industries. 

And then I'd say, you know, for new underwrites I think we’re getting used to doing due diligence remotely and virtual visits as well, right.  We never thought that we would visit sites using a laptop or a webcam, but I think we’re having to adjust to this new reality. 

And then, the other thing as well is I don't think anybody’s ever thought about stress testing companies with zero revenues.  But I think that’s something that needs to be incorporated now with the risks of a second wave, right.  This whole pandemic I think has really changed the standards of underwriting and I think that’s probably here to stay for the long-term.

Carly Wilson:  Thanks, Stephan.  It’s certainly sobering to think about, but important.  Absolutely agree. 

Carly Wilson: Brad, let’s turn to you.  You have a different perspective being that you look at tech companies.  I'm curious, though, for you too, has COVID changed the way you view risk/reward in your space?  Any material changes to the way you’re viewing your underwriting process?

Brad Pritchard:  Yeah.  Well, so thanks, Carly.  As bad as COVID has been for all of us individually and society as a whole, it has impacted companies in the technology industry differently.  For a few of the companies, COVID has actually been a tailwind.  As an example, the shift to working from home has accelerated the digital transformation and we are seeing companies in the communications, collaboration, commerce verticals just as an example experiencing 50% to 75% to even 100% year-over-year growth. 

However, as you would imagine, there are still sectors and verticals that are experiencing weakness, sometimes extreme.  As an example, there we’ve seen weakness somewhat as expected in companies that are focused on small and medium-sized businesses or on the consumer and are in an area such as sports or restaurants or gyms or salons.

And then finally, we have companies that are in between, you know, such as ones that are based on or that have ad based revenue models where originally we saw weakness there as advertising dried up, but lately there has been some recovery as people are online, you know, more than ever.  So, taking this all together, our underwriting process continues to be very detailed.  It’s focused on principal protection and it’s customized to each specific situation. 

Visibility into bookings and revenue in general is more limited than previously and we are getting some data points now.  It’s a little bit better as companies now have two, three, four months of operating in this environment and we can start to see which companies are being successful and which ones continue to have a challenge.  But in general, what we’ve seen, new business continues to be a challenge for a number of the companies, no matter the vertical.  But, some of them, renewable –renewables and up-sells are often ahead of plan.

So, how do we address this risk?  There’s a couple different ways.  One is that we’ve shifted our focus to higher quality, more mature companies where enterprise value is more established.  And then the second thing is we rely even more than we did before on structure to protect against downside surprises. 

So, it’s interesting times to say the least.  Back to you, Carly.

Carly Wilson: Thanks, Brad.  Last question for all of you.  We’re going to take a page from Jim Keenan’s playbook here and do a quick lightning round.  We’ll go around the horn.  We’ll go with Stephan then Brad then Raj.  Which trend that emerged during COVID do you all think is here to stay?

Stephan Caron:  Yes.  I’ll start, Carly.  I think ESG, but in particular, you know, climate change within ESG.  I think with global CO2 emissions that are lowered by 8% this year as a result of COVID, I think it’s really brought to attention that, you know, if you want to limit global warming to less than the 1.5, you know, degrees above pre-industrial temperatures to meet the goals set in the Paris Agreement, we would need to reduce emissions by 8% each year for the coming decade, right.  So, I think each one of us has a responsibility to drive that climate change agenda going forward and that’s definitely here to stay.

Brad Pritchard:  ... in, Carly.  I would say, you know, the trend I'm looking at is digital transformation.  What do I mean by that?  I mean the shift from storing, sharing, and analyzing data on paper and spreadsheets to now applications, whether they’re on prem, in the cloud, or mobile.  This definitely started pre-COVID, especially in the enterprise.  But, COVID has accelerated this transformation to where now it’s becoming common also in small and medium-sized businesses and for the consumer and I don't see us going back on that trend.

Raj Vig:  Yeah.  And for me, Carly, I think it’s, you know, everything fill in the blank from home, you know, whether it’s work from home, distance learning.  Even this conference is an example of the behavioral change and acceptance of doing things remotely and digitally.  You know, perhaps that also means the leisure wear market is something to look at that follows.  But I do think that we’re not really going to go back to the way it was.  There’ll be some hybrid, which will really incorporate a lot of the flexibility that these – this IT enablement allows us to carry our activities out.

Carly Wilson: Great.  Thanks, everyone.  I'm going to do my best to try and wrap up everything we just learned in about 20 seconds.  So, I think overall I'd say three main takeaways.  You know, private credit’s really taken on a significant outsized role during this crisis, providing reasonably compelling or very compelling solutions for companies and in many cases taking the place of what would have been a liquid credit solution in the past.  This seems like we’re well set up for that to continue.

And then I guess secondly, sector and single name dispersion has been particularly pronounced.  This pertains to private credit.  It’s something that we heard highlighted in one of Jimmy’s prior panels and it seems this will also be key to performance going forward, both the balance of this year and into 2021. 

And then lastly, and a lot of what we heard just in the last lightning round, you know, COVID has no doubt accelerated business transitions that were perhaps well underway, and it feels as though there’s really no looking back.  So, with all that said, I guess many thanks to Raj, to Brad, to Stephan for your time and your insights of course. Next up, we’re going to turn things over to Mark McCombe, who’s the Chief Client Officer here at BlackRock. 

Mark wears many hats.  He’s also the co-head of Global Client Portfolio Solutions, helping clients take a holistic approach to portfolio construction and asset allocation.  He’ll bring all this together that we’ve covered thus far and discuss credit’s place in the portfolio.  Over to you, Mark.

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