Hello, and welcome to The Credit Edge, a weekly Markis podcast.

My name is James Crombie.

I'm a senior editor at Bloomberg.

And I'm Stefan Kovachev, a senior credit analyst at Bloomberg Intelligence.

This week, we're very pleased to welcome Matthew Sestar, president of Arene, the London based hedge fund.

How are you doing today, Matthew.

I'm doing super well.

Great to be here.

I'm a huge fan of the podcast and so it's great to play a rold today.

Oh great, Thank you for joining us.

Matthew oversees Arene's private credits strategies and Lee's It's direct lending business, launched earlier this year through a sourcing partnership with loz Art.

Before joining Arene, Matthew was global head of Credit at ICG, and prior to that, held various leadership rules at Credit SUITEE in London and New York.

We're looking forward to his insights on the private credit landscape and more broadly, on where the most attractive credit opportunities may be in twenty twenty six.

Of course, we have loads of questions for you, Matthew, but let's start with private credit.

There is drama out there at the moment.

We're seeing more defaults, repayments in kind, and debtholders becoming equity owners after borrowers failed to pay.

Blue Out scrapped, a private debt fund merger after investor's bolt debt significant implied losses, and a black Rock YLO failed over collateralization tests after it took one hundred percent loss on a private loan.

Big US private debt managers meanwhile talking down previously lofty return expectations, just as the fast growing asset class enters the mainstream, and the bond king himself, Jeff Gundlack is calling private credit quote garbage lending.

There's a lot of doom mongering out there.

The golden age seems to be over.

But what is your take, Matthew, You're out there selling the product.

That's the case for going private at this point, particularly when you can get pretty good yield right now on publicly traded debt.

Yeah, so, I think I think the real thesis is to focus on other geographies, other capital structures, different sized businesses.

As you know well, James, the lion's share of the growth in private credit has been a US phenomenon.

It's really been around, you know, financing sponsors, and it's really focused on the upper middle market in large cap sort of arenas, and so that's been a theme really for the last ten to fifteen years.

We're doing something a little bit different.

We're focusing not on the US, not on the large cap, not on the sponsor financings, but we're really looking at Europe, and we're looking at the middle market, and we're largely looking at these non sponsor areas.

And so as we were just chatting as we began, you know, that's where we see value.

We see it less where there's been a lot of yield compression particuling the US, where leverage levels have stepped up, and where some of the you know, the traditional productions of the credit lenders have really leaked out through some of that stuff.

And so I think some of those commons Youdis mentioned are really kind of a US phenomenon.

And that's why our investors and our focus is really and largely in Europe.

And what's the typical size or maybe structure or tenor pricing of the deals you target.

Yeah, so maybe i'll just do it just a mini history lesson on what happened in Europe.

I'm an American by background, though I've been there for about twenty five years.

This market in private credit in public capital markets really grew post the GFC.

This is when these markets were growing at a rate of you know, five to tenfold in that period of time, and most of the activity, again was focused on larger borrowers, bigger companies, sponsor backed sort of arenas, and not dissimilar to your dialogue in the US, that's where you've seen in Europe equally real compression of yields and an uplift in MS in terms of leverage.

And so what we've been focused on and where we think there is value is staying just below the size of the public capital markets.

And so that means kind of facility sizes in the context of probably one hundred to four hundred million, and that's very much by design, because the public markets and the large cap private credit markets are really focused on that four hundred level and up.

And so in those areas, you're getting you know, spreads in the private markets as tight as kind of the low four hundreds.

You're seeing public market activity at all time, sprite tight spreads in the kind of the mid three hundreds.

What we're finding if you step down below those public capital markets and really focus on the non sponsor component, you're picking up spreads kind of north as six hundred basis points.

And so that's the dialogue that we've been having for you know, quite a long time at ARENI, which is really to unpack some of the complexity in Europe.

So when you come to Europe, given all the jurisdictional vagaries, given all the national regimes, given all the languages and cultures, you get paid additional spread to come there.

And then what you want to do is not just think about Europe as a main but you want to think about how do you penetrate some of those areas where banks are either pulling back or the public capital markets aren't aren't focused.

And so if you're focused on the size, as I just referenced a moment ago, that think we think that's kind of the sweeter of the sweet spots where you enjoying nice margin, you are having leverage levels that are below the sponsor community.

And then very importantly you're really able to design your own credit agreements.

And so James to your point, which is a lot of the activity and a lot of the noise, particularly the UAS is because there's been a convergence and you're almost perfect convergence between the public markets, particularly the large cap in the private markets, and so in Europe it's a little bit of a different story.

So I'd welcome unpacking that as we continue the discussion, and we.

Have a fascinating perspective because you've been in Britain for twenty five years, but you are originally American.

I have been in America for twenty five years and I am originally British.

So between us, we shall get to that.

That's why the dialog is so good, which you.

And I we've arranged as a swap by the King.

But the size of the deal is up to four hundred million euros, right, and you can get six hundred basis points over Sonya each.

Yeah, in the main, that's what you're finding.

So but when you focus on this corporate world, you're picking up between one hundred and fifty two hundred fifty bases points of incremental spread, and so that gets you from kind of that mid to four hundreds to something north of the north of six hundred.

So that's an important dynamic.

I think what you're finding, you know, in Europe is leverage levels are just lower than the US, and so if you look at the data very carefully, it tends to be depending on the industry, of course, between one and three turns less levered, particularly in the non sponsor space, because these family companies in Europe, which are private companies that dominate the economies, tend to be multigener generational, and what they're looking to do is not maximize a return in some finite period three to five years.

What they want to do is hold the asset really to the next generation, and therefore they tend not to maximize leverage.

And so we very much like that dynamic.

So less leverage and you're enjoying these higher spreads in large art because you're providing a solution to them.

You're providing certainty.

And James, you'll know Europe quite well, which is generally there was not a romance in the you know, the private company space with the public appal markets.

They never really like the anonymity of large syndicates, large public you know, groups of investors accessing their private data.

And so what I found in my career and having done that for a long time in Europe.

Is a solution works well if it really solves an issue.

And the issue that we're really solving in Europe is a pullback of the banks, a skipping over this market segment by the large you know, asset managers that are deploying in scale, and you're finding a community of borrowers, companies, families that need solutions and they're relatively you know, not being serviced in a proper way.

And so we found that to be a really attractive segment, and we think is a scale segment in large part because when you look at Europe, Europe is a middle market type continent.

Companies are just smaller given the regional footprint of these twenty six you know, separate countries.

And so we get a lot of dialogue from the US, which is, if it's not scale, that must be a problem with the underlying business, and we say, no, no, no, no, that's not the case.

What you find is we've been financing what are kind of regional champions in each one of the underlying countries and they haven't enjoyed scale, in part because the cross border nature in Europe tends to be more difficult cultural linguistic amongst other areas.

And so we found this middle market space in Europe broadly away from some of the sponsors.

Now though we clearly finance sponsors when it's attractive lending opportunities, that tends to be a very stable area to generate some attractive returns.

But the banks, you know, they have stepped back a little bit, but they're not absent, so you know, they are active, they have local currency balance sheets, they probably have very competitive terms.

Why would a company in Italy, say or Germany go to you instead of the you know, the bank that they've been going to for years and does the payroll and everything else.

Yeah, it's a couple things.

So one is that the big banks, the muscular big banks, large like large deals, and they would rather lend on a portfolio basis than do the underlying company by company type lending activity.

And so that's an easier underwrite for them.

It's one that's flattered from a regulatory and a capital perspective.

So unbalance, the banks are certainly resurgent in Europe, but they're doing it really on a portfolio level, and so they're looking to finance not only individuals like ourselves, but other managers, and so you see that happening quite a bit.

What you also find is you segment the market.

I think I talked about, you know, kind of this kind of two hundred and fifteen four hundred million facility size or loan size.

This is kind of the sweet spot because you go below two fifty, there's a tremendous amount of local bank demand and all the national champions a country by country, UK, Germany, Italy, France, Benelux unusually strong and very very inexpensive financing, and so you want to step out of that.

And then, as I said, when you go north or four hundred, you run right into the public capital markets, and particularly in the sponsor community have converged those marketplaces, and so we're finding that kind of middle space desirous of financial solutions.

They want someone who is who understands their businesses and someone who can move in a reliable sort of way.

So that's been a kind of a steady stem of you know, opportunity set for us.

And what about private credit trading?

How developed is the secondary market for private credit and what's the outlook for greater trading activity?

Maybe?

Yeah, So I think it's been a theme in the US and the investment grade space.

We haven't seen that in Europe yet.

So, you know, the lions share of what's happening in Europe is been on the below investment grade side.

It's been largely sponsored backed, and just given the illiquidity and the private nature of those assets, there hasn't there hasn't been that level of focus.

We'll have to see you in the coming years if that's going to be a topic that's relevant to Europe.

But I to be candid today, that's really not you know, not a not a topic.

The bigger topic in Europe is this you know, multi decade retrenchment banks.

So when you think about when I came twenty twenty five years ago to Europe, all the corporates in that space where one hundred percent bank financed, and you look now you dial forward in the date we are today about twenty percent of corporate borrowers finance either in the public markets or in the private markets, the institutional markets, but it's still seventy five eighty percent through the banks.

That's why there's this big structural shift that will you know, it's been throughout my career and will continue well beyond mind which is this this de leveraging of the banks who really don't like complexity, who don't like single name borrowers.

And what you find is in Europe, just again given the size of the companies, they tend to be below investment grade.

Because they're smaller, they have less diversification by company, by client base and the like.

For it's below investment grade.

So this theme will continue on sort of unabated.

James, you know the US market incredibly Well, it's just the inverse here.

So traditionally this this segment of the marketplace corporates in the US, twenty five percent of that is really intermediated through the banks.

Seventy five percent or so it's through the public capital markets or securitization market.

So it's the inverse.

But we're seeing you know, strong growth.

You know, in connection with that, do.

You take the whole loan down yourself as it bi lateral or you in a club with other lenders.

Yeah, So that's the other distinction versus the US, And thanks for asking that, which is US public capital markets private markets now are broadly syndicated also, so you're looking at syndicate private lenders are coming in in Europe that happens certainly on the sponsor back financings, certainly on the large cap deals.

And that's one of the things where less we find less attractive in the market, which is it's not just leverage that's attractive in Europe, it's lower, it's not just spread that's higher, it's around the document itself.

And we're you know, highly cognizant of the product, the products that we're involved in, which are loan products which we've got a cap on the return uh.

And so the most important thing for those type of funds and for our investors is downside protection.

And the best way to ensure a down downside protection is having a very tight credit agreement.

In what we find in what we're focused on, particularly in the middle market where we operate, is we're able to write our own credit agreement, and so that really protects the underlying collateral and it protects against some of the some of the flexibility you find in the public markets, which you're going to know very well, whether it's distribution to the equity or it's allows you prioritization of debt, you know ahead of yourselves.

The leakage of asset value or cloutter value outside the borrower group.

And so yeah, so we focus on being the sole lender or being the co lender, and that's that's where we've been deploying capital.

I think it's it's critical from a risk perspective, but what you also find from a borrower and company perspective, particularly again in this non sponsor area, these companies, these families, they want to know who they're dealing with.

Europe is still very relationship oriented.

It is less transactional, and it was a maybe it was an unnatural period for a period of years where these companies and families were borrowing from the public markets and so as that shifted really after the rate change in twenty two, public markets were less supportive of smaller companies in Europe, and we can talk about why that was.

This product has stepped into that and it's a it's a better product for the families and for the private companies in the main.

One thing that's giving people a bit of wherey here is the amount of pick coming out in the US.

You know, so companies instead of paying the interests, they're paying with new debt, some of them parently, you know that they arrange that in advance.

So it's a good pick, but I honestly you can't see the difference how much pick you sing in Europe and how much of it you know, how much flexibility do you give your borrow is in the case they do get into trouble.

Yeah, so you're seeing that as as you say, James, rightly, it's really been a US phenomenon.

It's really been the sponsor phenomenon, and it's really in the tech and software spaces, and so some of those some of that under writing underwriting activity was you know, predicated on growth, and when growth has been stalled or disrupted, loans aren't able to be cash paid, and hence they're moving to this this this pic arena.

And you can see that very readily in some of the public data you're seeing around the BBC's some.

Of that's happened in Europe.

Also.

What I say, however, in Europe is the software and tech areas are less represented versus the US.

In the main we for example, are really just financing real economies in Europe, and the real economy is in Europe tend to be industrial businesses, hard asset businesses, some consumer businesses, some service businesses, and there's those are not predicated on underlying growth of those companies, and so we're not offering pick you know, into our portfolios.

That presage is that you.

Know, the capital structure somehow is not right sized for the underlying cash flows.

And so we see that quite a bit in the US, and that's something that we're trying to stay away from.

You do see it, as I said, on some of the larger cap you know, sponsor oriented trades in Europe as you know us, James, we have you know, a mixture of businesses at are any liquid businesses, structure credit businesses, private market businesses.

We do take some real insights from our public market activities.

You know, so in public market activities, if you have a non accrual or you have a pick, that generally means there's a default or downgrade, and in private markets, heretofore that hasn't been the case.

And so we've taken some of the lessons, some of the risk management techniques we have in our public businesses and utilize those in our private businesses, which I think is a little bit differentiated.

You know, we run scenario analyzes, downside scenario analyzes based on different different you know, macro events, different rate events, different drivers of underlying economies, and that that scenario and risk analysis is bedrock in the public markets, and many many folks don't don't think about that in you know, in private markets, and so generally a non or cool or a picking of your underlying instrument.

In the public markets, that's a default, and in the private markets has been it's been a little bit it's a little bit different from that.

We find also that you know, what's one thing that it's interesting about public markets is the feedback loop is is very important and it's it's readily available.

So when you make a public markets investment, you get feedback in three, six, nine, twelve months in terms of what the market thinks about that underlying with the third party recognized agencies think about that that investment.

In private markets, you really haven't you haven't had that right.

And so particularly in Europe, what you find in.

Europe is.

Maybe five percent or so of the public high heel market has been restructuring pretty much every year.

But we haven't seen that that that parallel event in private markets.

So there's quite a bit of disparity between those two, which is you know, quite concerning, and that's something we're you know, we're watching, you know, relatively relatively carefully.

And what kind of all in returns are you targeting in your direct lending business?

So, looking at European high yield market for instance, as somewhat of a proxy, the average yield to wurds here in Europe is about five percent, roughly four percent for double B, six percent for single B names, and twelve for three plus C rated credits.

But when we factor in the illiquidity premium typical for private investments, what all in annual yields and returns are you aiming for?

Yeah, so we think about a little bit in spread terms.

So and maybe if you're a listener based because you have a lot of listeners here in the US, we do the build up really from the US to Europe, particularly in private markets.

And so you know, what you find is when you move from the like private market investment in the US to Europe, you earn about fifty basis points in incremental spread.

So you're getting paid for that complexity.

But I talked about it's not additional risk, it's complexity.

Twenty six separate countries, disparate solvency regimes, languages, cultures, and the rest.

And so you pick up about fifty basis points.

When you step into the middle market in Europe, you enjoy another fifty basis points.

So if you're doing middle market direct lending, you know, in Europe versus some of the larger cap stuff in the US, you're picking up a spread of about one hundred basis points.

And so that's the bedrock of the business.

What we find interesting in this part of the cycle, and we're find value.

We're finding more value in the corporate non sponsor space.

And when you move from this middle market sponsor area to non sponsor, you're able to enjoy you know, another one hundred and fifty basiness points of spread.

And so that's that's something that I think we think is valuable, our clients think are valuable.

And so when you do the math through that, that's how you get to these kind of mid mid to six hundred type spread type environments and you can see what the yield equivalent would be on that.

Interested and why you're staying away from the sponsor space.

You know, private acty firms they say have already raised some of their last funds, maybe a big shakedown coming in private actually is that the concern or are you just finding that's to commoditize in terms of the actual lending going on there.

It's really a risk analysis where we're finding value in the marketplace.

And so, as I said, in the large cap space, there's a lot of capital focusing on very few few deals and therefore through that auction process in private markets you're finding that spreads are being compressed, sponsors are enjoying higher leverage, and then they've really converged the credit agreements with the public market, and so that that's been less less of an interest.

We certainly do finance and middle market sponsors, and we do the non sponsor base.

We do both of those, but I was just walking through this sort of the relative value in this part of the cycle is more compelling in a non sponsor space.

For in the main the challenge with Europe is getting access to those and this is no I think if you and I've heard a number of folks you've spoken with, James, I think people on the main will say that the sort of the corporate business is on balance less risky, it's lower leverage, you enjoy more spread, and you're able to really drive the document the challenge in Europe, however, is how do you get access to that in a scale way.

So at our firm, we we have a number of investors and originators in relationships with all the corporates and we think that's highly highly differentiated.

But we did something a little bit different.

We also up a strategic partnership with Lizard and we did that very purposefully.

We did that and again your US folks will know, well, they're eight or ten of these partnerships in the US, many of which are very successful.

We wanted to do something a little bit different.

We wanted access to a firm that covered the middle market.

They had pan European coverage and that was a leader in each one of the key markets UK, France, Germany, Italy, Bentelouques, amongst others, but in a scale way.

And so our firm is approaching four four and a half years of age.

Lizard has been around for one hundred and seventy five years and so they're they're really the corporate listener to private families across Europe and that's given us lots of boots on the ground to originate in a scale way, and that just used that to complement our own origination techniques and so we think it's a little bit different.

Through my background, I know, you had to have long standing you know, advisors in market to be able to see a big enough tam of opportunities that it's very hard to do that from London.

Many people try to do the fly in, fly out type model, or they'll put one originator in Spain and one in Italy and two in Germany and think that's origination.

So we've tried to unpack this.

We're thinking it a in a unique sort of way.

One that helps mitigate some of the conflicts because they're not a balance sheet lender.

So that's the other way that we've kind of really complemented what we do in the sponsor community.

Plus this non sponsor sort of sort of avenue.

Not a bad place to fly around that wouldn't mind you know, Madrid or Barcelona today.

But this took back up in zoom out a little bit, Matthew, the concept of Europe for an American investor.

You know, I'd say, you know, six months ago when the tariffs hit was very exciting for a lot of people.

You know, let's we suddenly realized that we need to be diversifying a bit more geographically, and everyone was so long in the US and there's trouble here, so let's look and what's the nearest place Europe, So let's have a look at that.

But that all seems to have kind of gone away very quickly, and I'm wondering, you know, when you're here in the US and you're talking to potential investors, potential clients, you know, what kind of questions are they asking you about Europe?

Beyond the complexity beyond you know, there's lots of different countries and everyone speaks different languages, and it's terribly confusing.

What what are they asking you about Europe that you know that you know expresses some interest and real like sense that they will diversify their portfolios.

Yeah, I think it's it's what you say, James, which is the private markets in the US have had such a lead lead versus Europe, whether it's in the equity product or the credit product that many allocators globally have, you know, a lot of exposure there and they're looking for the next they're looking for from a diversification perspective, where else can I allocate capital in size?

Where there's rule of law, there's a set of quality companies, uh, there's transparency in the like.

And what we found and I found over my my career, is that from a US perspective, Europe can be fetish.

So a lot of global investors come for a few years as they wax and wane, and I've seen this over the last twenty years or so, and so I think the point that we emphasize is, you know, we're dedicated in Europe.

We're focused in Europe.

We've got boots on the ground in Europe.

You know, our investment committee is our CIO, all of which make decisions based in Europe.

And so clients want to make sure that you're there for a long time, a long period of time.

And then equally from the borrowers side, borrowers in Europe, particularly on this non sponsor component, are quite suspicious of you know, people are coming in for fetish sort of sort of reasons.

And so that's a lot of the dialogue you know that we have, you know, in that space, and so yes, some of the some of those tailwinds have dissipated in terms of this interest in Europe.

But I have to say, once you unpack it across the countries across the sectors.

The fact that there's not a reliance really on tech tech and software and you're in a debt product.

We're diversification and downside risk is the most important thing.

I think it's made people interesting interested rather in the European credit experience.

There's a lot of question marks around the equity story in Europe, and I'm not an expert in that, but I see the equity value created in the US, particularly in the tech in AI space.

Europe really doesn't have that.

And so our thesis is you don't need equity story on a credit investment.

You need to have credit credit metrics, cash flow, downside protection in order to generate interesting returns.

So Europe in the main is on balance is probably have better credit investment than an equity investment.

Uh.

And that plays to kind of where we have our expertise.

I had a question about the sub sectors you're investing in.

In the industrial space I cover in Europe, I'm seeing a bit of a K shaped recovery.

So the clear winners are aerospace, defense, maybe energy, great companies who have big backlogs, while traditional heavy industries such as steel, chemicals maybe autoparts still continue to struggle.

So how does ARENI allocate capital across different industrial segments in Europe?

Yeah, I think that's I think we would probably agree with some of those comments.

So I think that's wisely put.

What we've done is really sectorized all our teams.

And so for your US audience, it sounds like an obvious thing.

Most of the big alternative asset managers have deep sector expertise industrials, chemicals, consumer services, healthcare and the like.

In you in however, they run a business called Europe, which just given the complexity of both borrower type, country type and the like, stress as unusual.

Uh.

And so that's why we've generated I think some attractive returns over time, is that we've been dedicated in each of these key sectors.

And that's how it really we're organized, which is we use this reservoir sector expertise and to express views across a variety of areas.

And then what we're talking about today in direct lending is we use that expertise around that and we're just unusually focused on cash flow generation, downside protection and the next lender analysis.

And so unlike some of the large cap deals which are really predicated on an exit in the public markets or an m and a transaction.

That's not what we focus on.

And so you know, some of the sectors you mentioned, some of these more cyclical sectors have definitely been under pressure and clearly we've been underweight those opportunity sets.

What's interesting about Europe in this middle market set is these tend to be national champions, so local, local clients, local suppliers, local ecosystem and so they've been a little bit more immune to some of the tariff winds, some of the trade winds which you've seen express certainly the large cap large cap European companies, particular the chemical space for example.

You've seen that really expressed in the equity uh, the you know, the share price performance of those companies.

And so again when you focus on this middle market, they tend to be not immune, but more insulated from some of those those global trade winds, tariff wins and the like.

Uh and we're seeing that in the underlying performance of our companies.

Can you give us an example of, you know, a deal that you've done that you're totally excited about.

Just to make it a bit more tangibly, you know that we're talking middle market, we're talking about real essays, but and local champions.

What does that look like?

Yeah, so I just give you just in the main.

So we've done some financings in each one of the geographies, but we've done really one recently in France.

And this is very, very typical, which is a multi generational family looking to move the asset from the patriarch to the next generation.

They need financing and connection with that.

Maybe there's a distribution of capital that happens back to the patriarch.

And what you find is, you know, banks tend to be very cookie cutter, and so you know, if you're delivering a little bit of flexibility, providing a solution and in connection with a generational change in ownership, that's very ripe for us.

And what you're finding in Europe, this is a theme.

You're finding in France, you're finding it in Germany, you're finding it in northern Italy, which has a lot of similarities to the doc region.

So that's something that we would we would do and have.

Done on it.

And you'll find that if it's a family and it's private, what they don't want to do is have all their confidential information put in some kind of offering documents syndicated very very very broadly, and so they want the the tailoring of a financing solution, They want it done in really a confidential way, and they oftentimes want to work with someone who actually understands their their their under underlying.

Sector that they operate in.

So what we do is we pull in our private credit team, who are you know, structuring experts, diligent experts, and then we marry them up with our sector team.

And so if you're dealing with something in whether whether it's autos or industrials or consumer, it's that that sort of interaction of industry knowledge plus the unwriting sort of acumen which unlocks these deals.

And so I think you'll see a lot of that coming from us.

On the sponsor side, where we're finding is it's not the large cap sponsors who have dedicated capital markets teams.

It tends to be much more industry driven sponsors.

So these could be a collection of former executives who have domain expertise, who are partnering with families as they think about the next steps with their platform.

So whether it's growing across border, making a disposal, doing a buyout, but those types of private equity firms tend to be much more operationally focused, country based, and then there's a sector in which they are unusually strong, and that's what we're finding most of the time.

To be clear, these aren't stressed or distressed companies because we do know ARENI because of the founder Hamza Lemsiga, who made a lot of money doing great distressed trades.

And you do do some rescue financing some I'm interested in sort of how you differentiate those two because you are doing some private lends full you know, just press credit, So what's the balance there.

Yeah, So what I've been focused on is really performing loans for mid sized companies, which is a very scalable sort of opportunity set, and we're using that same bench of sector analysts to give us a view to really drive each one of our investment decisions around that.

And so we spent I don't know, eighteen twenty four months really thinking about the best risk reward in private markets in corporate in Europe.

And as I said, we looked at this small MidCap and small to competitive in the marketplace with the commercial lenders where they're willing to do lending activity on the large cap north of kind of three hundred and four to four hundred million facility size, huge capital markets sort of competition.

And so it's in this mid market area where we're finding if you can underwrite performing credit profind a solution and be consistent with the borrow, where it's quite a scalable market opportunity.

And that's where we've been doing the line share of our activity.

And what's your review on credit d folds in Europe?

Do you expect defaults to rise potentially creating attractive opportunities for you to deploy capital in the coming quarters.

It's interesting.

So again you've seen this expressed in the public markets, where you know, numbers are different.

Two to five percent of the public markets have been restructured in some sort of format in Europe, and you haven't seen that, you know, at all in the private side of the marketplace.

And so I think, you know, again, you know, private credit is really financing some of the similar type of companies, and so I think what you're going to find is you'll see an uplift not just in the public markets, but you also see it, you know, in the in the private markets.

And so this is you know, some of the reflection of this rapid and transformational growth both in private markets and public markets in Europe, which as I said in the beginning of our conversation, had grown, you know, five or eightfold after that GFC period.

And so when high yield was trading at three percent, sovereigns were negative, there was tremendous amount of credit creation.

Some of that activity, some of that restructuring, some of that dispersion of outcomes is highly evident in the public markets.

So you know, eighty percent roughly of the highield market is trading at the all time tis, and then there's a portion of it that it's trading very poorly.

So a huge amount of credit dispersion that you've seen in public markets, and the collari will have to be that must be happening also in private markets.

Is those fund managers really grew those portfolios in the zero rate environment.

You think of it also, if sovereign rates were negative, high yield was at three percent and some of the private credit lenders were lending a ten percent, so it tells you there's quite there could be quite a bit of credit credit risk embedded in those portfolios.

And so we'll see how it unfolds in the coming years, but something we watch out very carefully.

You no doubt hearing all about the AI craze while you're here.

I'm wondering how it's affecting Europe and how much private credit will be involved in how you might be involved.

But I'm also we hear a lot about European defense spending, so that's potentially another big area of investment and capsule raised.

Are there either of those interesting for ARENI?

I think so.

We spend a lot of time in Germany, and so it's all the sort of the so called middle stock companies is mid size family run companies that are really providing the sort of the industrial backbone to the country.

And so all those end markets aren't necessarily defense.

They can be broadly diversified.

But that's a very interesting area to spend time on.

We have great expertise in some of those those those areas from a sector perspective, and then our origination partner at Loazard has a fantastic business there also, So I think that's a very interesting, very ripe area.

As you know, they Germany becomes a bit more muscular and fiscally sort of expands in that area.

On the AI topic that we haven't been involved in that.

You know, we're highly highly aware of our products, right, so lending products are capped, you're trying to get back, you're trying to get it, enjoy a coupon in your money back, and so that whole dialogue between equity and credit in connection with technology is a more challenging one.

So we've been.

Steering clear of that.

And again that's not been the opportunity set really really in Europe.

And to kind of zooming on what's going on right now based on a little this noise we're hearing from the US.

How is that affecting pricing in Europe?

If it's all right?

Yeah, So so on the I think there's been sympathy in the public markets between the public eh yield markets uh, in both geographies, and so that's that's the media trans transmission sort of mechanism.

So you can you can see that.

You've also seen in the large cap direct lending, you've seen some flow through of that because of the the nature of those types of deals and oftentimes is the same sponsored buyers in that and so there's been a you know, a rethought process around those in the middle market.

You haven't seen that.

So we haven't seen a real change in the in the margins, the opportunity set and the rest, and it seems to be a bit asynchronous with the larger markets.

And hence what we think that's you know, probably a place to spend more of our time and so that that'll be my commic jams.

And the other thing people do worry about here is the marks on the loans in the portfolios.

I mean we've seen wide divergence, you know, ten points in some cases, you know, the mark the loan is marked at path and then suddenly it drops to eighty and then everyone freaks out, what what is your view of that?

Now?

Does that work in Europe?

Yeah?

So I think it's absolutely critical to have third party organizations marking your books and so that that's been one of the challenges where it's you know, if you're marking your own homework so to speak, that is that's a more challenging area.

So what we do is we have a third party mark and everything that that sort of transparency is going to be required.

I think for the continued growth and scaling of the business.

It's and you see that again, you know again we have a number of public businesses at the firm, and it's really that that that belief that you know, marking happens on a very frequent basis.

It's not something that's stalled, uh And that's ever flection of sort of the structures of some of the funds.

But it's also a demand by the underlying investors for that transparency.

So I think that's a long term trend that will probably unfold in Europe, not just similar to here, and I know there's a lot more noise around it in the US at the moment, but it's critical to have that third party validation outside of the investment teams.

And that's that's going to be the health I think of a barometer of the health of the growth of the marketplace.

But the concerns about you know, valuation, about all the risk, all of this concealed trouble that's brwing up, you know, all the way to the IMF and the regulators.

Do you think it's overdone?

Based on what you're saying, you're much closer to the action than they are.

You see what's going on.

You know, the quality of the firms you're lending to and how they're paying you back.

What do you make of that compared to all of the noise.

What I think is, I think the regulators and the and the like are very concerned with the opacity and so just giving the growth in size of these marketplaces.

You know, as I said, the public markets in Europe are about a trillion dollars.

There's some numbers in the corporate private corporate private corporate area could be also another trillion dollars of private credit, and so those are just you know, it's a very big marketplace that's broadly outside there, you know, sometimes outside of their net.

And you can see why there's quite a bit of focus on that.

And again it tends to be larger companies, tends to be larger corporate companies.

But you've got to be very cognizant of that.

And I can see why there's been, rightfully, you know, a lot of focus on that.

They see the rapid ballooning of these markets and and it it only makes good sense for them to, you know, spend more time.

The counter argument for private credit is really that you get to see everything.

You have so much more transparency because you are doing everything.

You know, they use the farm to table analogy.

But is that do you think that's fair?

I mean for private credit that you really are so much more hands on that you are way more protected as a lender.

Yeah, so the merits are we talked about a little bit.

You have a little bit like less leverage in the public markets, you get you enjoy a higher spread, and then you have downside protection around you know, the the credit agreement, but you you hit around a grade point.

Which is the other huge benefit is you're doing primary diligence, so you're meeting companies, meeting management teams, understanding their operating models, and having time to understand the underlying investment.

That's one of the challenges is you know, given the public you know public markets or the syndication of private credit, is it becomes one or two steps removed from doing primary diligence.

And so we pride ourselves on our sector expertise, in our underwriting acumen, and by getting direct access to companies, not in an accelerated way, because what you find is in public markets or in the syndicated private markets, it's always a timetable.

You've got to come back in three days, are you inigure out?

And there's all this pressure and then it, you know, adds an unusual dynamic on your underwriting process.

And so I think this fourth area where the real value in private credit is just that which is doing primary diligence largely on site, meeting management teams, operating teams, and then making an underwriting decision.

It's kind of old school, old school lending, I believe it or not.

It's almost like leverage loans used to be twenty five years ago.

But it's in terms of a renie you know when we talk to I mean, this is maybe more of a US perspective, but there is a sense that and I think Golden stat Season said it a year and a half ago that there'll only be eight potentially players left after a huge amount of consolidation that needs to be done in private credit because you have to be big to do this kind of business.

How do you scale up?

Do you need to scale up, do you need to hire people, do you need to acquire?

What's the long term strategy?

Our strong belief is that public markets in private markets in Europe are converging, and so we need to express views around those, and so we have certain products that are all public only.

We have products that are convergence of public and private and then we have private and so I think to be relevant in Europe, to be relevant to our clients and be relevant to borrowers, you need to provide all of those solutions.

And so what you find in the main in Europe is that there tends to be a lot of specialized managers.

Some just do structure credit, some just do public liquid credit, some just do private credit.

That that's a much more narrow way to do the business, and it's one of that doesn't leverage the connectivity between those marketplaces.

And so I think we've had relevance and we've enjoyed some good growth in large part because we're a European focused credit manager and we can express our views in just different risk profile depending on the underlying liquidity of that risk.

And so that's how we differentiate ourselves.

That's how I think we'll continue to be relevant in Europe.

And that's you know, that's really been the game plan and we're just you know, kind of day to day executing on that and we'll see that where that takes us in the coming coming period.

And what keeps you up at night, Matthew, is it the risk of an a AI bubble, maybe political risks in Europe, more coproaches emerging from cracks in the walls, or something else.

Entirely, I think it's I think it's just risk risk.

You risk transparency.

So you know a lot of that risk transparency has been you know, clouded in private markets, and you know, as that unfolds in the coming period, it's you know, we're not expecting any kind of cataclysmic issue, but you know, when there's been less, less transparency, less third party marking, you know, that's an area that we're that we're keeping a very very close eye on.

It's again in Europe, you've seen this sort of the very wide dispersion of credit performance in public markets, but heretofore you haven't seen it in the private markets, and it's probably the same are similar underliars, uh And therefore that's that's something that we keep an eye out for, and that's you know, in the coming period, that's an area of focus for certain.

So you've spotted this opportunity in European middle market private credit.

Once show goes out, everyone else will be piling in.

How do you stay ahead of that competition?

How do you differentiate what's your edge.

I think it's I think it's relatively hard to do for a couple of different reasons.

One is you need to have deep research teams that are sectorized and deeply relevant to each one of the underlying borrowers.

That's a big teams.

It's got a lot of expertise from a company by company perspective.

Two is Europe is not just looking at underlying cash flows, it's also understanding structure.

And so having had teams that have worked a long time in Europe, some of them have great restructuring capabilities, allows us to bring forward that sort of legal analysis, that legal underwriting analysis upfront.

And so I think that combination of sector focus, a very strong legal analysis, and being acutely focused just on Europe is really differentiating ourselves.

And I think what you as I said before, what you find is Europe for a lot of the non European managers tends to be something that is in vogue.

Sometimes they wax and weigh down Europe.

And I've seen this five or six times in the last twenty years, and I think, are you know, our longevity is really focused on the fact that we're European specialist.

We have this sector expertise, We understand the the insolvency regimes, uh, and we're looking very holistically, holistically across as public and private sort of convergence theme.

And I think that's that's enough for us to focus on for some period of time.

And if you have to pick one product, one sector, one country, is our best relative value idea, You've got tons of.

Yeah, I really like this.

We like this senior middle market direct lending activity from a risk adjusted perspective.

We don't like it in just one country with like on a pan European basis, and we're generating really attractive, you know, risk adjusted returns for that.

And so that's that's what we've been focused on in this partnership and part with Lizard and using our own investment teams, and so I think that's something we'll come back hopefully, James, and I'll give you an update in the coming years.

No particular industry that you really love for city in Europe that you love to visit to do this sort of business.

We like northern Europe quite a bit.

We spend a lot of time in Germany, a lot of time in the Nordics, a lot of time in UK, and those are pretty rich environments for US.

And in terms of fundraising, how's that going generally?

I mean, I don't need to getting specifics, but do you find that there is appetite for what you're describing in terms of when you go out and see big pension funds, big institution investors in the US.

I think there are two themes.

One is, I think a number of the communities continue to be investment communities are underweight credit, and with rates staying at the level they are and so higher for longer they're in the main, there's interest in credit product, particularly alternative credit product we can enjoy an uplift and spread and so we're finding that to be a theme in many of the geographies the US, the Middle East, Asia, amongst others.

So this movement towards credit.

And two is the geographical which is they've been many investors have enjoyed the US private markets equity and credit.

Now theen a real compression of returns and therefore they want to focus on a place where they think there's rule of law, where they think there's opportunity set and that's really been Europe.

And so that's a theme that it's not going to be fatish.

I think it's one that has, you know, medium term growth in it, and that's when we've been enjoying quite a.

Bit great stuff.

Matthew Sestar, President of IRENI, It's been a real pleasure having you on the Credit Edge money.

Thanks James, a treat to be here and we'll see you very soon.

And of course very grateful to Stephan Kovichef from Bloomberg Intelligence.

Thank you for joining us today.

Thank you, and for more credit market analysis and insight, read all of Stefankovicheff's great work on the Bloomberg Terminal.

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