Joe Cass   00:00:00

Hello, and welcome. My name is Joe Cass, Senior Director at S&P Global Ratings and a host and creator of the FI15 podcast. On this episode, we have James Keenan, Chief Investment Officer and Global Head of Private Debt for BlackRock, alongside Ruth Yang, Managing Director and Global Head of Private Markets and Thought Leadership at S&P Global Ratings. A quick reminder that the views of the external guests are their views alone, and they do not represent the views of S&P Global Ratings. Okay. Thank you so much, James and Ruth, for joining today. Ruth, welcome back. Would you be able to provide the audience with kind of a dummies guide overview of the different areas of private markets, including things like secondaries, NAV lending, asset-based lending and synthetic risk transfers.

Ruth Yang   00:00:46

Sure. I think one of the challenges of explaining private markets, is that they are constantly changing and evolving. They're responding to changing market dynamics. So, the elements that you just raised are an important part of the market today. I would guess that tomorrow, as market conditions change, those characteristics, those elements will also evolve, particularly in private markets, change drives change. And so, let's start with the basics and then we'll kind of come back to the specific elements you called out, right? So, fundamentally, private credit consists of, I like to think, three parties. One, there's the general partner, the private equity who's raising investment funds from. Number two, limited partners who are looking for a strong total return ROI, which is based upon buying and selling assets. The fund is the structure in the middle that holds the investments, the company buyouts, the real estate, the infrastructure, whatever it might be. Then these investments are levered. The fund only provides a piece of the buyout funding, the equity contribution. And the rest of the funding is borrowed against the valuation of the asset being acquired. This is really where the third party, the lender provides funding. Lenders fund the buyout deal and subsequent debt raised, and this is how the traditional loan and bond markets kind of fit into the equation. Their investment return is the interest income off of the money that they're lending. It's important to note that there is a correlation between the lenders and the LPs, right? This is the institutional market, pension funds, endowments, family funds, insurance companies. Then, of course, fund structures will act as a lender as well. For example, a BDC in the U.S. is a really good example of how a fund structure lends and then they open up kind of the investment in the asset class to U.S. retail investors. Ultimately, I think where we are today is the rise of fund financing NAV, subline feeders, the evolution of ABS, SRTs. This reflects the impact of today's changing and challenging market conditions. For private markets, higher for longer has resulted in a turn to alternate methods of raising liquidity in response to slowing fundraising. Public markets are also responding, but they're less dynamic and they're less adaptive. We see the rise of these elements in private markets because they can innovate to changing market conditions, and this is why we're seeing all of these market structures kind of comes front and center. But fundamentally, I always remind people that, that three-party structure remains the base foundation of private markets.

Joe Cass   00:03:22

Excellent. Thanks, Ruth. James, can you share with the audience your roles, your responsibilities and why private markets are such a growing area, BlackRock?

James Keenan   00:03:33

Sure. Thanks, Joe. And I'll take some of the things Ruth said as well and tie it into how we're building our business at BlackRock. But in general, I would say private markets is a very, very broad term and private debt is a broad term. I would say what the last ten years looked like in private debt is going to be different than what the next ten years will look like. As Ruth said, this is an evolving kind of asset class. Simplistically speaking, private debt is really, I would call it, transactions or loans that are private between the borrower and the lender. So, a lot of the information around that loan is not necessarily public. Therefore, it's harder to price or trade in the global markets. That being said, the underlying assets of those loans can be very, very broad, right? So, as we think about corporate or just generally fixed income, there are a lot of asset classes that make up the fixed income market, right? And think about private debt as a whole in the same way. We set up our organization at BlackRock to focus on five verticals. You have your private corporate; you have real estate debt; you have infrastructure debt; you have things that we now refer to as asset-based finance, or ABLs; and then, you generally have your structured product or securitized instruments, which usually wrap a lot of the other assets that exist in the prior four verticals into a different structure for different risk points associated with that. So, as broad as fixed income is, private debt is equally broad. As Ruth said, I think there's a lot of things evolving in the market today, right? And all of those asset classes have traditionally been banked asset classes, where the global banking system has lent on those behalves. I think, with new regulation, as well as innovation around different products, it is giving access to more and more people. So, I would say there are two sides. On one side, there are people who want to own private instruments because of their yield and diversification, but they may want to own them unlevered. There's a giant evolution of the private investment-grade market, which a lot of our insurance accounts are looking for, and there's a lot of growth in that. All the way through different income products to things that might be more equity replacements that compete in that kind of 15% return profile. So, I think of things like venture lending, opportunistic investments, and distressed assets, which might have a higher correlation to the equity market. So, all of our clients are very interested because, in many aspects, more and more of these assets or loans are becoming more investable today than they have been in the past. This is because there's more available thanks to regulation, and there’s more innovation around products. In which case, there's an interest in it. Simplistically speaking, clients are interested because of the yield enhancement, as well as the diversification they get, which optimizes their own asset allocation strategies. We're talking about trillions of dollars becoming available for clients. And so, regardless of what kind of client—retail, institutional, insurance—that pool of assets is additive to building out an overall portfolio. That's why clients are moving toward this space.

Joe Cass   00:06:59

Fantastic. Thanks, James. Ruth, from a credit ratings perspective, what areas of private markets are we seeing interest in, and from what type of investors?

Ruth Yang   00:07:09

Yes. So, I think sometimes there is this misconception, right, that ratings are purely a public market construct, and that's not true, right? Private markets, to James' point, have a lot of transactions between insurance companies and arrangers, and those insurance companies will need a rating. Private markets value and utilize ratings. They are an important part of providing clarity and transparency on the risk of the instrument, as well as to meet regulatory requirements. There's a lot of need for ratings. Insurance companies, institutional investors, and banks all need ratings throughout this market. For private debt, for example, we provide ratings on private borrowers in the broadly syndicated market, as well as associated investment vehicles, CLOs, and prime rate funds. With the growth of private credit and direct lending, we rate middle-market CLOs and have credit estimates on the underlying assets. And then, with the rise of fund financing vehicles, where we started this conversation, bank and insurance lenders frequently need our ratings. So, we see that our coverage of fund structures, as well as the associated NAV, sub-bonds, and feeders, is rapidly growing. And then, for these same investors - again, a lot of the assets that James referred to - we rate an array of vehicles, including esoteric ABS, real estate structures, project finance, and infrastructure. There are a lot of touch points between ratings and private markets. In particular, right now, I think that as market conditions have become more challenging, there has been an increased push for ratings from both investors and arrangers. Investors, of course, not only want them for regulatory requirements, but they also frequently want them for risk management. Meanwhile, arrangers are increasingly becoming aware that asking for a rating helps ensure a smooth and efficient syndication and funding process. I think what's important is that the need for ratings in this market isn't just about a regulatory requirement because that is minimal. It's really about ensuring that we provide a value-added insight on the risk, based upon our expansive understanding of credit markets.

Joe Cass   00:09:19

Great. Thanks, Ruth. James, going into specific sectors, how are private markets supporting things like energy transition? And what risk can you see around the real estate space?

James Keenan   00:09:31

Sure. Those are very different questions covering different areas. But, I mean, at the end of the day, you think about it - what is cr edit doing? Whether it comes through the channels of a bank, the public markets, or the private markets, we're generally trying to fund businesses based on what their optimal needs are in their capital structure, right? And Ruth kind of just outlined a whole series of things that create feeders in the private markets in order for us to lend directly to those businesses. So, let's get to the energy transition. There’s a transition in energy. Obviously, a lot of people are moving from fossil fuels into broader renewables, and that trend is permeating the entire micro economy. I would say, when you think about that, add on the need for energy for AI and the build-out from AI, there is a massive amount of CapEx. You're talking trillions of dollars that need to get spent over the next decade-plus to, one, fund where the economy is going. This includes building all of the infrastructure needed to generate that power, the transmission of power, and supporting the future economy. On top of that, there’s the transition from different forms and sources of energy beyond fossil fuels, right? So, if you think about those projects, whether they’re corporate-based or project finance-based, all of that is going to need funding. And it's not just going to be equity funding. Some of those may be very long-tailored projects. Our infrastructure debt business is very focused on this, working with many of these long-tailored projects to fund them. But you’re seeing this activity from a corporate debt standpoint as well. I think private markets are going to play a very key role here. Some of these projects will either be long-dated or J-curved in the sense that they don’t have revenues upfront because their cash flows are ultimately back-end loaded as the infrastructure is built. So, all parts of the private markets will be key sources of funding for this. But with the magnitude of investment required, I would expect public markets and banks to also play key roles. This is all about growth, right? So, stepping away from energy transition, the growth of the market, the micro economy, and different industries we’ve touched on private markets will play a critical role in enabling that growth. To your comment on the real estate side, which is a broad topic, I would say real estate is broken into many different facets. Everyone generally focuses on areas where there’s been, I would call it, more troubled assets. This is primarily tied to office spaces, particularly central business office spaces. That’s largely linked to post-COVID trends regarding remote work, changing office utilization, the evolution of new technologies, and differences in the demand for newer buildings versus older ones. There’s also the general shift in the economy and population and where these buildings are located. So, there’s an idiosyncratic component in real estate. You have high-demand infrastructure and buildings, and then you have older, legacy buildings in less demand. Broadly speaking, issues are more likely to arise in the less-desired office spaces. You’re also seeing some cracks in other parts of the real estate market, such as areas of multifamily or single-family housing that are tailored toward distressed segments of the economy. However, we’re still in a relatively benign environment. In aggregate, private markets will remain critical across the overall real estate ecosystem, no different from public markets. Legacy assets or tailing-off sectors, like older office spaces or other distressed properties, might be viewed as amortizing or rolling off. Think about things like interest-only (IO) structures, where you fund as the asset amortizes away. Car batteries, for example, illustrate this point. Even as we transition to EVs, there will still be demand for gas-powered vehicles for the next twenty years. It’s not an immediate shift. Private markets will support both legacy and growth parts of the economy as these shifts unfold.

Joe Cass   00:14:12

Fantastic. Thanks, James. You kind of touched upon it there, but I'd be interested to hear your views on the evolving bank landscape. So the change in the size, the shape and activities of banks, including greater partnership with private lenders.

James Keenan   00:14:26

Sure. Yes, there’s a lot to unpack here. First and foremost, banks are great partners to almost every private credit manager out there. We touched on this a bit regarding lenders across our funds. In many cases, banks are partners across our business. This shift in market share is largely driven by the regulatory environment. For example, if you look at the U.S. banking system, there are $23 trillion in assets on balance sheets. In Europe, that figure is about $29 trillion. Based on Basel III as written today, estimates suggest around $3 trillion would need to come out of the banking system. That would leave the U.S. banking system with about $20 trillion. Even so, banks will remain significant partners across the ecosystem working with asset managers, private debt lenders, corporates, and infrastructure projects. That said, this shift creates opportunities. There will likely be far greater pools of loans or assets available for private debt and public markets. This isn’t a new trend - it’s something we’ve seen develop over the last decade as regulatory pressures make banks safer but also more constrained in their activities. Now, some banks will be forced to deleverage. This could mean reducing assets on balance sheets, especially for regional banks. These institutions may face constraints regarding asset types, regional concentrations, or other factors, and they might look to sell assets. Others might aim to optimize their balance sheets, focusing on their risk-weighted assets (RWAs) to improve returns. You mentioned SRTs (structured risk transfers) - these are tools that allow banks to optimize RWA treatment while selling down assets from an economic standpoint. For example, think about a first-loss tranche in a pool of assets that the bank retains. This is an area of innovation. Each bank will decide its own approach to optimizing returns. Simplistically, our role is to look across the entire landscape whether it’s SRTs or a pool of available assets and figure out how we can create strategies, returns, and outcomes for our clients across all of these pools.

Joe Cass   00:17:28

Ruth, what key risks should investors or would be investors be aware of if they're looking to get involved in the private market space?

Ruth Yang   00:17:37

Yes. So, when James explains the market, right, over the last couple of questions, it really resonates that there are a lot of risk factors, but they make sense when James talks about how the market works. And you talk about energy transition, for example, right? Everything they say about risks in the market is true, right? It’s opaque, it’s illiquid, and it has more risk in it because there’s a lot of leverage and buyouts. This is the main part of the investment strategy. But it’s really important to remember that these characteristics don’t exist to make the market risky and complicated. They are a byproduct of the market structure and how it fits into the economy, basically. Private markets are opaque because they are largely unregulated. And, to be fair, most transparency in financial markets occurs to meet regulatory requirements, right? Nobody really wants to show their hand unless there’s an outcome that makes sense and you have to do it. They are illiquid, but most of the borrowers and the assets need long-term, committed capital. When you think about energy transition, right? These are long-term investments - venture capital, growth equity, the rest of infrastructure, digital transition, right? We’re seeing this rise of data centers and real estate. These are all assets with long-term investment horizons. The investment strategy looks at total return, maybe buying and selling an asset. The illiquidity aligns with the strategic need for this long-term commitment. And then these are mostly spec-grade transitions in private credit. M&A is the backbone of private credit. That’s how you get these very nice ROIs, these total returns that are based on buying and selling assets. So, the illiquidity is related to the strategy, which then drives the return profile of these funds. For the most part, these are non-investment-grade assets. I have definitely seen what James talks about, which is the rise of investment grade, but the majority of these are really spec-grade assets. However, this is not true of all assets. Infrastructure and esoteric ABS, for example, can also be investment grade. The structures- middle market CLOs - these are investment grade for most of the tranches. Fund financing vehicles can also be structured to meet investment-grade rating requirements. As with everything, it’s really important for investors to recognize the fundamental nature of any investment and the associated risk profile.

James Keenan   00:20:05

Hey, Joe, just to jump in there for a second-I just want to touch on the opaque nature, right? I just want to clarify: the opaque nature is for people outside the transaction. Inside the transaction, I think it's important to note that usually, you have an information edge, right? In general, you are signing an NDA and getting proper and usually much greater detail of information than you might get in the public market between the borrower and the lender. So, it's not that they're opaque and you don't have the information; it's just that the bespoke transaction and the information shared are not shared more broadly. That allows us as a lender to be more, I would call it, informed to structure that transaction to protect us as a lender. I think that, in general, has led to lower loss ratios than you would see in the private market versus the public market. The perception that opaqueness means more risk, I think, is a false assumption, and it’s proven out by the loss ratios you see in some private instruments versus the public market. The illiquidity comes from the reality that a third party can't price those instruments because they don’t have the same information that exists between the two parties involved in the bespoke transaction. You can still trade these instruments - it just may take longer. You have to run a process, sign multiple NDAs with people, and get them up to speed. So, the timing by which you might transact is going to be much longer than in the public market. On top of that, you are now seeing more evolution of things like credit secondaries or LP secondaries, similar to what you've seen grow in private equity. I think you'll continue to see that grow in private credit as owners and LPs want to, as they have more managers, strategies, and vintages, ultimately look for more liquidity in different ways besides just selling the pool. I think this will continue to evolve. But I think it's important to understand the opaque nature doesn't mean more risk. The lack of liquidity doesn't mean more risk. It means, simplistically, that the markets can't price that at the speed at which, again, the public markets - where things are more standardized or more public - can.

Joe Cass   00:22:24

Great. Thank you both. Very interesting. Ruth, if you had a crystal ball, what would it be telling you private markets may look like in 5 years' time?

Ruth Yang   00:22:36

If I had a crystal ball, I don't know that I'd be here doing this role, but okay. I don't think it's really a 'may'. I think I can say fairly confident, right? Private markets are here to stay, and they will continue to evolve as a third leg of the capital markets. James, you mentioned all the rising partnerships between banks and private credit. I think that is absolutely positively indicative of where we are going. Private and public markets will not become one market, but I think the efficiencies in raising capital in both markets for one transaction will increase. And I think that there's no doubt that these relationships between public and private will continue to strengthen, and we'll see a lot more of this. As a result, I think private borrowers will have a choice of bonds, loans and private credit, and they're able to pick a capital structure that's tailored to meet their needs and risk profiles, and that is clearly in the best interest of capital markets across in all aspects.

Joe Cass   00:23:33

Perfect. Thanks, Ruth. James, a high-level question for you now. What opinion or view on investing do you have that few others would agree with you on?

James Keenan   00:23:43

Well, maybe I'll ask Ruth's crystal ball. I don't know if there's something that I have that is different than others. I mean, there's a lot of great investors out there and lots of different thoughts around that. I mean, I come more from a philosophical standpoint: the world is always changing, technology is changing, and markets are changing. So, from an investment process standpoint, you want to stay disciplined. And one of those disciplines is constantly challenging your investment process the same way you would challenge your underlying assets or your loans, right? And so, think about what's working, what's not working, and the reasons why. Continue to challenge that to enhance your strategy. If you just look at all of the tools that are available, the information, if you were static with your process, I would say you would be low relative to adjusting to all of the available tools. And you think about the growth of AI—all of these things are going to be incredibly additive in trying to come up with the proper information, and the speed at which you're able to do that, in order to come up with your investment thesis as well as your underlying portfolio construction. So, I wouldn't say it's out of the norm, but I would always just say: challenge and enhance your investment processes and stay disciplined to them.

Joe Cass   00:25:12

Great. Thanks, James. Ruth, can you name one person within S&P and one person outside of S&P you look to for inspiration or that you admire?

Ruth Yang   00:25:24

Yes. So I'm going to take James' words about challenging and enhancing, right? And I think this is true of how I look at people who inspire me and how I want to be a better version of myself, right? So many people have inspired me. And for me, it's really never been about one person is more like being guided by a constellation of people so that I'm constantly enhancing what I'm aspiring for myself to be. Outside of work, it's friends and family as well as a mix of people who I maybe met briefly, but their stories have really impacted and moved me. I don't think I can aspire to be one specific person, but to be the best version of myself maybe based upon all these lessons that I'm learning from others. Within S&P, I have to mention that I'm very privileged to be part of a company that has so many senior women in particular, who can inspire me. They all impact me. I get to look and learn from them every single day. But also to James' point about how the world is changing around us, I just want to mention that I am always inspired by an amazing generation of younger female leaders who surround me. In my team, I work Molly Mintz, Nicole, Serino, Liu QingYang, and each of them bring something unique to my world. And every day, I learn something new. These women do the job of credit analysis and research, but they seamlessly weave in strategies necessary to meet today's digital world, right? They understand and execute strategies that incorporate digital engagement, social media, machine learning, generative AI, and it amazes me how they can do this and keep us at the forefront of the market. If you left me in charge, I'd still be writing things in a notebook and printing things in paper. So I'm immensely grateful to them.

Joe Cass   00:27:08

That's great. Thanks, Ruth. James, last question goes to you. Over the course of your entire career, what's maybe the best piece of advice you've ever been given and who gave it to you?

James Keenan   00:27:22

The best advice, maybe as Ruth said as well, there's lots of people who have given advice along the way. I would credit my dad early days, very early days. I think I was probably maybe ten or eleven years old. Where he had me on a Saturday tiling our bathroom. And I was looking to probably cut corners and go out on play, and I just remember this. My dad looking at me like, if you got to do a job, do it right. And the simplicity of that is don't be complacent, right? be organized, be structured, be efficient. I think I've kind of approached work in the same fashion or form, which is, again, in our investment world, there's a lot of people doing it. You're trying to create outcomes, but there's an enormous amount of, I would call, process that kind of goes into that. And so that's something that always stood out to me from advice from my dad. So I'll give him credit.

Joe Cass   00:28:23

Fantastic. That's great. Thanks, James. Thank you so much to you, Ruth, and you, James, for your time today for everyone watching and listening. See you next time on fixed income in 15.