Private markets outlook: Private credit

In this episode of the Private Markets Outlook series, we sit down with Scott Giardina, Managing Director and Head of Trading for Future Standard’s Global Credit Team, for an in-depth look at the current state of private credit.

Scott joins Research team members Alan Flannigan and Andrew Korz to discuss the benefit of specialization in private credit, why lender protections matter more than ever and what it means for investors.

The Private Markets Outlook podcast series from Future Standard features portfolio managers from across our firm, each bringing unique perspectives on private equity, private credit and real estate. Subscribe and stay tuned for more.

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Transcript

 [00:00:10] Alan Flannigan: Welcome to the fourth installment of our private Markets Outlook series A five-part series focused on our midyear 2025 outlook titled Follow the Value Not the Herd. Today's discussion will be focused on the private credit market, which continues to offer investors compelling yields even as the Fed embarks on an uncertain easing cycle. However, the asset classes, anything but monolithic as it has expanded, the differences between segments of the market have sharpened. In this episode, we want to focus on those distinctions and leave our listeners with a clearer understanding of the opportunities and risks in private credit. Today, as we've observed across private markets, capital has become concentrated within private credit pooling within a select cohort of lenders and pulling similar strategies within the same segment of the market. Combined with renewed competition from the broadly syndicated loan market, this has compressed new deal spreads in large direct lending deals causing investors to recalibrate expectations going forward.

But as the asset classes continue to grow and gain market share from traditional lenders, private credit execution is becoming a solution for a broader base of borrowers with a wide range of financing needs. This provides investors an opportunity to take part in the next phase of private credit's growth where diversification and specialization shine, and to tap into the alpha potential that comes from providing solutions, not just options. Today we'll speak with someone with terrific insights on this evolution as he sits right at the intersection of public credit, private credit, and the need for specialized strategies. He's the managing director on the Future Standard global credit team and the head of Credit trading. Scott Giardina, thank you for joining the show today.

[00:02:04] Scott Giardina: Thank you for having me. I'm excited to join and talk about what we do on a day-to-day basis,

[00:02:09] Alan Flannigan: And as always, I'm joined by my Esteem colleague and leader in investment research, senior vice president Andrew Korz.

[00:02:16] Andrew Korz: Alan, how are you?

[00:02:18] Alan Flannigan: Doing great. Excited to sit down with you today, Scott. Like we said, you're right at the center of a lot of the evolution within private credit right now, and your part of the firm is such a fascinating business with a lot of different lines and strategies that are employed across the team. So I think you're really the perfect guest to sit down with us to cover this portion of the outlook. And I'd really like to get started, Scott, just by give a brief introduction of yourself and what your team focuses on and as the head of trading, could you describe what that means as applied to your role both on the public and private credit side of the business?

[00:02:55] Scott Giardina: Sure, sure, absolutely. So in the global credit business, we manage several different funds. We manage a Forti Act fund, we manage BDC, we manage an interval fund, and we also have tactical opportunities. And each of those funds have similar but maybe slightly different strategies at different points in times depending on the markets. So the way we think about our business and creating really good returns for our investors is we're always focused on the best opportunities and the best risk adjusted return. Most recently, those returns have existed in private credit and we can talk about that as we go further in our discussion, but there's points in times that public markets get significantly interesting because public markets will trade off depending upon news. For example, after COVID markets really traded down. And when that happens, private credit stops completely, meaning buyers and sellers and private credit can't really get together on pricing, but immediately public credit will trade down.

So we opportunistically will sometimes go into public markets to capture that really excess spread and take care of that or take advantage of that liquidity premium that the market has at that point in time. So for when we think about trading in private credit itself, there is not a lot of trading, but in public credit we can see it. But one of the things that I think we do very well as I grew up in public markets and now focus most of my time on private credit is we're very good at looking at the value between those two markets by looking at public markets. We can price private markets very precisely and we'll talk about how the BSL market helps us do that as well when we're looking to price deals. But I think there's this really, if you're doing private credit well, you really need to understand where public markets are, where the value is to really price those private deals correctly.

[00:04:58] Alan Flannigan: And one of the things that's really interesting about your team, many of you worked together at Goldman Sachs previously in their special situations groups. So there's a lot of distress credit investing experience within the team and many senior people that have been together for a long stretch of their careers together, and that's relatively unique. I think within private credit, and we'll pull on this a little bit throughout the interview, but could you just introduce for folks a little bit of the value of having distress credit experience and some lessons learned in that market over your career?

[00:05:30] Scott Giardina: When we think about private credit, we can come up with the valuation of a company and think about where we're loaning within that capital structure. But one of the most important things is not every investment goes exactly the way you think it will go. And so you really need to approach investing in private credit, looking at your downside risk and managing your downside. And the way you do that is one, through your attachment point of how deep you're willing to go, but two via the kind of protections that you get in the document or what we call covenants to make sure that we are protected in certain scenarios that we think a company could potentially have in a downside case. And being distressed investors, that's how we all grew up. We grew up seeing companies that either had, were in the middle of bankruptcies or headed towards bankruptcies, and we know what those kind of problems look like. So we create documentation and attachment points to put us in the best positions if something like that were to happen.

[00:06:29] Andrew Korz: That makes perfect sense. I think leads us well into kind of getting into our current market fuse. Before we do that, as Alan sort of alluded to in the intro, I think we wanted to just define for folks some of the different segments within private credit. You hear lower middle market core, upper sponsor, non-sponsored. One thing that I've been thinking about recently is the extent to which the market over even the past five years has just sort of been stretched. And those lines or delineations between segments have gotten a lot more important because of that. You think back to 2017, if you were in direct lending, you were basically in middle market lending. Maybe you had lower middle market, but by and large you were sort of doing similar things. You were lending to companies that maybe couldn't access or access efficiently the public markets.

And that's changed pretty quickly over the past five years or so, or you've got a significant part of the market now that competes with the broadly syndicated loan market that looks to finance these large buyout transactions. We could call it upper middle market, large cap lending borrowers with 150, 200 million in ebitda. So the market's changed a lot over even the past five years or so. I think as you see the market today, maybe just give our listeners an idea of what we mean when we talk about lower core, upper middle market, large cap lending and then nitty non-sponsored versus sponsor lending as well.

[00:07:53] Scott Giardina: Yeah, absolutely. So maybe the simple way that I can explain it for people who might not be in private credit and understand it is just step back and explain why our market exists and who really uses it. So private equity firms do something called an LBO, right? What they do is they buy a company say for a billion dollars, but they don't want to pay fully for the company in cash. So they put some equity in normally let's say in this case it'd be about 40% or $400 million, and then they borrow $600 million from the market where they borrow that money from dictates is it public market or private market? If it goes to an investment bank and goes to what we call the broadly syndicated loan market, it's generally called a public transaction and it will trade after it gets issued, right? The big buyers in that broadly syndicated loan market or something called CLOs, which are structured vehicles that are very ratings driven, so they don't want to buy too many low rated loans because they actually to buy their loans, they sell liabilities on the other side, they don't want to pay fully in cash either.

So private equity firms love that BSL market and it's their first stop for capital. If the CLOs like the loan that the private equity firms are showing, the reason they want to go there is because that market is the best pricing for them and it has the weakest covenants or protections for the investor who's making the loan. If it doesn't fit the CLO market, then what they'll do is assuming it's a large cap kind of company, let's say EBITDA's over a hundred million dollars, they'll go to what we call the upper middle market of private credit. They'll go to people who can write big checks and make that loan and those investors will get some better protections that you would normally not get in the BSL Market

And they'll get wider pricing. So to give people an example, and my example may be that loan would be s plus 3 25 in the broadly syndicated loan market. S is SOFR, just think of that as 4%. So in the broadly syndicated loan market, that loan would be about seven and a quarter percent to the person who was making it. If it went into the upper middle market, it would be s plus four 50. Right now that's eight and a half percent. So s is 4% plus the four 50. So you're getting greater return in the upper middle market for private credit and you're getting better documentation. And then finally, if the companies are less than a hundred million of ebitda, they are called middle market kind of companies. And when they go to market and do those same kind of loans, they would be s plus 500 to maybe even higher. So that's sort of 9%. And when you think about our business over the course of the year, what we've been able to do is the average yield on our deals is s plus 600. So we're more like 10%, and we very much focus on documentation and people do in the middle market focus on documentation more. You have greater negotiating power

Because there's only a couple of people in the loan. So you can negotiate better protections for you. So when I think about the sliding scale of the markets, the cheapest pricing for private equity is the BSL market and they get the weakest covenants. The worst pricing for them is the middle market and we get the best covenants. So for investors, when we think about where the best risk adjusted return is, we clearly think it's the middle market and it's a place that future standard focuses.

[00:11:29] Andrew Korz: And Scott, I mean a big part of what you're talking about, this interplay between the syndicated market and parts of the private credit market, I mean a lot of it comes down to competition and how much capital there is looking to be deployed into a certain segment of deals. And when you talk about the upper part of private credit versus public credit, I think one of the key value propositions of private credit is that it tends to be a steadier market. You get the BSL when it's open and when it's risk on it tends to price really tight and the borrowers like it. But when things sort of turn in the market and investors get skittish, then all of a sudden maybe the market isn't quite as open. And if you're a borrower who's looking to price an LBO, that can be a challenge when you have that type of uncertainty.

So that's why in a lot of cases you have borrowers who are willing to pay 150 basis points more and spread right for that sort of certainty of execution within private credit. So I think maybe if we can take it to the market today, over the past, call it 12 to 18 months, you've seen by and large the syndicated market has been pretty active and you kind add on top of that that you've had significant fundraising into this sort of upper end of the private credit market that are sort of competing for the same types of large cap transactions. So I guess when you think about that type of competition and what you've seen from a pricing perspective, you've seen spreads come in for both private and public credit deals. How is that type of competition, or I guess is that type of competition impacting the types of deals that you look at in the sort of lower to core middle market areas?

[00:13:07] Scott Giardina: I agree that private credit is much more competitive than it was even if we look back three years ago. But the way that I describe what we do, which is slightly different than general what I'd call private credit is we buy houses, not cars.

And let me give you a little analogy. I think it just rings very true and then I'll apply it to the market. But if you were going to go buy a new car today and you wanted a gray car, black rims, let's say you wanted a Ford Mustang, you call the dealership and they're like, yep, the car's here, come on down and buy it. And when you get there, they go, sorry, we just sold the car. You're actually not going to be too upset because either they can call a dealership two towns over to get it or they can order it for you, but you're going to get your exact same car. Take the other example of a house. So now there's a house in the town, you grew up on the hill, had a white picket fence, had a certain lot, had a great view, a house you always admired for sale, sign goes up, you call the broker and say, I'd like to see that house.

They're like, great, we're having an open house tomorrow. Come on down. You come down the next day and actually there's no open house. You call the broker, the broker's like We just sold it, but you can't buy that house now. Or if you do, you have to buy it from the person who bought it. It's going to cost you more money. So I call cars sort of the broadly syndicated loan market or maybe even we can say that is a little bit tethered to large cap where people get these big deals and they have less negotiating power. It's not that specialized, it's not that special. Whereas middle market, when we sort of go to look for things, the house is more specialized, but what you have to be able to do is source it.

If you can't source it, you can't underwrite it. So we have limited supply. Let's say it's 150 million, $200 million deal. You have to have found it, get it under exclusivity, underwrite it, get the person who's looking for the capital depending on the situation, sponsor, non-sponsored to want to work with you. And if you can do those things, then you have a very specialized thing that other people don't have, they can't have unless they were to try to buy it from you. So what we focus on is the sourcing aspect and then that underwriting aspect. And when we do that, like the pricing I gave you before in the markets, that's where we get the S 600 with excellent documentation because we've spent so much time looking for those custom houses in my example.

[00:15:31] Andrew Korz: And first of all, I want to thank you for bringing back bad memories of my home search a couple years ago. The market's a little bit better now, but to kind of pick up on your point there, so this is a more fragmented more call it informationally, inefficient part of the market that you're playing in. And to your point, that can be a challenge and it can be an opportunity. So if all you're bringing to the table is capital and that's sort of like the only thing you're bringing to a deal, you're probably not going to win that deal necessarily, right? If you don't have a differentiated sourcing pipeline, it's going to be a challenge to actually source enough deals to fill a portfolio. On the other hand, if you have those things, if you have a unique sourcing capability, if you're really able to solve problems for borrowers, the rewards in terms of pricing and in terms of the types of terms that you can extract in deals are pretty significant, which you've sort of outlined already. So I think given that setup and given the types of unique characteristics that you need to have on a team, can you walk us through how you build out a team to go after this opportunity versus maybe a team that might be targeting the upper middle market or large cap segment?

[00:16:45] Scott Giardina: Sure. Another great question. If you're looking at a broadly syndicated loan, everyone gets to see it. If you have an account set up with Goldman Sachs and they have deals, they'll show it to you. Same with B of A, same with Citibank, same with JP Morgan. Everyone gets to see it. It's simple. If you sat in my seat, you would see every deal. But really what you need to do to have differentiated returns is to find those unique things that are priced advantageously for you and really good risk adjusted returns. One of the lessons I learned when I first worked at Goldman was just because of trade worked doesn't mean it was a good trade. How much risk did you take for that trade? And so we very much focus on the risk adjusted returns of what we're investing in. And so to find those deals and to make sure that we have a really good pipeline of deals to invest in, we have dedicated sourcers, our entire team of 26 people, we're all required to source even if your primary job is not a sourcer, but we have a good portion of our team that is literally on the road sourcing on a daily basis.

And the other thing that we very much focus on, and as you mentioned many of us have history back to Goldman or other really great places that people on our team have worked is we all have our reputations. People know us, they know what we will do, how we will invest. They know that we're fair on our terms, so people come to us as well because they know that we're a very good source of capital and that we're good partners for them. So a part of it is you have to find it, but part of it is you have to convince people that you're the person that they should be working with. A little bit like Shark Tank where people are trying to choose which is the best deal. Well, sometimes the best deal isn't always the best deal if you're working with someone who's going to be very difficult and maybe try to steal your company. So we're very focused on our investors returns, but we're very focused on making sure that we're viewed as good partners and that we get to see the opportunities because we think that benefits our investors the most.

[00:18:46] Alan Flannigan: And Scott, that unique structure of your team that you just outlined I think is a perfect example of what we describe in the outlook as the period of specialization as the next step in private credits growth as an asset class. So if we revisit as we outline in the paper the phases of private credits growth and maturation as an asset class, you have first the period of supplementation pre GFC period taking down more junior focused risk that maybe banks wouldn't finance as an addendum to the senior position that the banks were extending. Then you follow that with the period of replacement post GFC where banks were really hamstrung by the new capital regime and the post-crisis reforms and direct lenders had the opportunity to step up the capital structure in more of a first lien senior secured position. And then after proving successful execution for a period of time and attractive levels of income for investors, those direct lenders started to get some additional scale and some additional fundraising into the space that followed really by what we think we're still somewhat in, which is the period of preference where private credit execution in terms of that terms certainty, the ability to do committed lines of financing, the ability to be very bespoke in terms of the loan documentation with the borrowers is really one of the value adds that has caused the most recent leg of growth and application of private credit execution in new markets where it may not have existed before like commercial real estate and asset-based finance.

But what we talk about in the period of specialization is that for the next leg of private credits growth as an asset class, that this is a pathway that is more focused on outcomes that are beneficial to investors and doubling down as much on that direct competition with the BSL market or pushing into investment grade in a significant way where all of the inefficiencies that were harvested in these prior phases of private credits growth, that really was the basis for that market income. It's not obvious that they exist as much within the investment grade market. And so providing exposure that is unique, providing exposure to a unique skillset of the lender and applying that private credit execution in new parts of the market where there are still these structural inefficiencies, that seems to be something that is a much more sustainable course forward for the market.

And this is really where your team shines is in focusing in these areas where there are these inefficiencies and inefficiencies and access to capital with underbanked businesses, the informational barriers that we alluded to previously, and again, the need for flexibility for borrowers in terms of the terms of the deal. So there's much more of a clear role for private credit as a solution here and not just another option of capital. I didn't really put a question in there, Scott, but is that kind of how you see the market shaping up and where you kind of see that more compelling aspect of the next leg of private credits growth forming?

[00:21:52] Scott Giardina: A lot of the points you say really resonate with us as a team. And by that I mean there's plenty of private credit are what people call private credit that is very vanilla. It truly is. It looks almost like the BSL market and sponsors putting in a big equity check. I don't have to do much work to determine the valuation. I look at the credit agreement looks interesting. Yes, and we call that private credit. That's not what we do. Really what we are are capital solutions providers. That's the way we think about our desks. There's some capital need that needs a solution. And we do everything from sponsor to non-sponsored to creative financings. We just did a first out last out structure where the first out was S 600, the last out sort of was about a 15 to 18% yield on the backend that was only 60% LTV. So for people that don't know what LTV is, it means that we think that was very a hundred percent LTV would be paper that is just covered.

We think there's significant cushion in that paper. And it also had a multiple of money guaranteed on the backend piece. So a very creative kind of financing that we did with a sponsor who was looking for a certain solution. And you need certain kind of team members and people in your group who can do that. So we have certain people who are very good at these creative deals focused on the non-sponsored kind of area. And the other point about it is to do what we do, you really need either distressed or private equity type experience. Andrew Beckman, who runs our group, grew up in private equity and met of us, grew up in distressed, but we can really determine the value of a company. I'll pause there for a second or just step back is there's two types of investing you can do relative value investing. Hey, listen, I think an apple is worth a dollar and an orange is worth a dollar 25. And if I know where an apple is priced, I can probably price an orange pretty easily. Well, what we try to figure out is what is the apple worth? And we do that valuation work very deeply on our desk, and once we figure out where valuations are, then we figure out where we want our attachment point to be and we figure out what that pricing should be with the right documentation. So it's a very specialized, bespoke kind of solution that we're creating for a company, and that's where we get the extra value and the extra spread for our investors. And like I said, even though it's a complicated process,

Do you have more protections in the documentation generally than you would have in these other investments where you don't have as much negotiating power on the document that governs your investment? So I agree with you. I think it's a very specialized market, but there's just not any firm or any team is particularly well suited for that complexity. And we always say we like complexity because there's not as many people around it and we really feel like we can figure that out and put the right protections in place.

[00:24:45] Alan Flannigan: So Scott, I'm really interested. We've talked a lot about the underwriting side of the business, and this is something that everybody listening, it's probably like, well yeah, sure every lender has these in-depth underwriting skills, but speaking with you, it's really interesting to hear how differentiated that part of a business can be. And when you think about comparing, like we were talking about earlier, sponsored versus non-sponsored loans, and you look at capital concentration that's occurred in the upper end of the market, similar types strategies in terms of first lien, direct lending, sponsor backed loans, which are really good as a base for a portfolio, but it has become a more competitive segment of the market. And so we have this chart in the outlook where we show sponsored versus non-sponsored spreads, and you can kind of look and see, okay, capital's flowing in and sponsored spreads are kind of marching sequentially lower quarter by quarter on firstly new direct loans, but non-sponsored spreads. It's kind of up this quarter down the next quarter, up this quarter. It doesn't seem to be defined by the same trend. And so obviously there's something unique and different about that market. And it kind of makes me think of something you talked about earlier, which was this private equity style underwrite when you're doing those sorts of deals, could you elaborate on what that looks like in terms of underwriting those non-sponsored deals? When you

[00:26:06] Scott Giardina: Look at A BSL or a large cap kind of private credit deal, there's a lender presentation. There are very good clean financials. You can analyze the company pretty quickly. You can see what the private equity firm paid for it, and you'll do some diligence around that as well. But it's not that difficult of an underwrite for most people who have been in the credit markets for a decent amount of time. The difference with a non-sponsored kind of deal, and some of our best investments to date have been these sort of non-sponsored deals. You have a company that you can see has a very interesting business model that is maybe was a family owned company or you just owned by a couple of people who don't have really their financials together the way they would want to see them, that they might need some direction on how to grow their business. And you see a potential investment. And what we're willing to do is work a very long period of time with that company to try to set up the investment and we have our desks set up such that we can take some people offline to just focus on that investment.

And what we'll do then is we'll hire an accounting firm, we'll do a quality of earnings analysis, we'll go visit them, we'll work with them. And we've had deals where we've worked on 'em for upwards of a year to make sure that the numbers are what we thought they were and how good the earnings potential is and determine what the value of that company is. That is called a private equity underwrite. It takes a long time. And one of the things that people take comfort from when they invest in the BSL market or large cap private equity or private credit is a private equity firm has looked at the company for a year and they're investing a lot of money.

We don't have that same kind of certainty when we're doing a non-sponsored deal. So we have to do that work ourselves, and that's the kind of underwrite that we undertake. And once we've undertaken that, we have such a competitive advantage. We understand that company inside and out and other people don't. And as a result and the amount of work that we put into it, we can get better. Pricing is really good documentation. And sometimes you also get the equity upside as well because we've worked with that company extensively. So it's just a different kind of investment. A BSL will come to market and within a week it will be issued because everything is canned in these sort of non-sponsored deals. It's far from canned and it can take you a very long time to understand it. So we will invest in those situations, but only if they pass a very rigorous sort of underwriting process.

[00:28:51] Andrew Korz: Sounds pretty specialized to me. I don't know. I think so Scott, to kind of end things, I want to maybe zoom out a bit and get your thoughts on credit markets at large today. And if you really think about credit investing, and I'm oversimplifying here, but there's really two ways that you drive sort of excess returns in credit through a full cycle, right? It's either, number one, you get more attractive pricing than somebody else by being in a different part of the market maybe, or by bringing specialized skills or number two, you protect your downside, right? You draw down less, you take less in credit losses when a default cycle comes, for example. I think right now we've seen a handful of higher profile defaults in recent months. In some cases it seems like maybe there was fraud. That seems pretty idiosyncratic, but I think in other cases maybe the business was just underperforming. Obviously there's a lot of uncertainties right now around tariffs, policy uncertainty, growth in certain sectors of the economy. I'm thinking housing certain areas of consumer from where we sit in the aggregate metrics, the credit health still looks pretty good, but obviously the media absolutely loves a good default or bankruptcy. So I think folks are starting to ask questions. Is this a canary in the coal mine from where you sit when you look at the overall picture of credit markets, how does the health of the market look to you today?

[00:30:20] Scott Giardina: Yeah, excellent question and one we hear often, and I'll give you a couple stats and then I want to give you another analogy that I like to give to people to describe protections versus non protections. Currently in the first lien levered loan market or what we call the BSL market recoveries are lower than they've ever been. Meaning if a company goes bankrupt, recoveries are lower than they've ever been. When I first started in the market recovery on first lien levered loans were effectively always 100 or par because they were true first lien loans with really heavy documentation that had maintenance covenants in them. Now the recovery on first lien loans hovers somewhere between 40 to 50 cents on the dollar, and that has to do with one the weak documentation that you potentially have, but it also has to do with that market has allowed a bit more leverage to creep into it over time such that investors are at higher LTVs when they're making those kinds of loans. So if you think about it, should you be concerned if you're in the BS L market? Well, there's a higher risk for loss in the BSL market. If I sort of equate that to an analogy I like to give people, when we had our summer interns this summer, I started a donut shop with them and I said, listen, you have this great recipe and you want a capital to start your donut shop. So you come to me and you say, Hey, I'd like an investment sort of shark tank.

So I tell you, I'll give you $10,000 and I want half of your company, but this donut recipe is very valuable. You think it's a multimillion dollar kind of recipe, so you don't want to just give it up for $10,000 for half of it. So you asked me if I'll give you a loan, and I'm like, sure, I'll give you a loan, I'll give you a loan at 12% a year. And they're like, great, done. And I was like, well, let me tell you what my covenants or protections are in this one. You can't sell any of the equipment out from underneath me. And two, you have to pay me interest on this schedule and I'll go through a whole litany of protections that I need. And then they start to think, I don't know about that loan because I could lose my recipe if we go bankrupt.

So there's this give and take. And when I think about that kind of overlay over private credit versus public credit, I agree that in the public markets, protections are not great. Leverage is a bit stretched. But when you get to create your own solutions in the private credit market and you have real negotiating power and you're at the table and you can negotiate documents and negotiate pricing, you're in a much better position. So when I look at the recoveries that you see on BSLs today, the recoveries and people can obviously go back and look at our data from our years here at Future Standard. You can see that our recoveries are significantly higher than what you reaped in a BSL market because it's a customized solution with real protections underneath it.

[00:33:14] Andrew Korz: And that's really when a lot of this shows up. You don't really see these protections until you need them. It's maybe one or two years out of every decade where this really shows up, but when it happens, it's asymmetric when that default cycle occurs. And nobody really knows when you're going to go through a credit cycle. But when you do, that's when folks who took the hard route and actually did the work to get this documentation in, that's when it shows up. And the folks who didn't make it washed out.

[00:33:45] Scott Giardina: Well, I'll give you another example, and this is another example to think about. I would make the argument you don't even need a default cycle to have these bad outcomes in the BSL market.

I'll tell you why. If you think about a private equity firm, let's just go back to COVID. Let's say right after COVID private equity firm bought a company and their debt at the time was s plus three 50 s was effectively zero. So they were financing that company three point a half percent. Fast forward four years s was four and a quarter. So their cost of capital that they paid every day it was a floating rate loan went up dramatically. So it went up to seven point a half, 8%. The problem is private equity firms like to turn companies over every five years. They don't want this capital to be out there forever. They want to get a quick hit, they want to make their money, but now the next person they're trying to sell it to has to pay eight and a half percent to finance that purchase to use borrowed money to finance the company purchase. You think they're going to pay more or less? They're going to pay less. And that's why m and a activity has been down dramatically. So what have private equity firms tried to do, they're trying to extend the time they own the investment and not lose it to creditors.

So what they then do is they then take advantage of the weak documentation. So if you were to really talk to a private equity firm, they'd say they have two assets. One asset is the company they bought, the other asset is the weak documentation in the BSL market, and they do exercise. What they are entitled to under their credit agreements is when people bought those loans originally, they didn't negotiate in a way that they were able to get those protections. So when you look at recoveries now and you think about this 40, this 50 cents I'm talking about, that can happen virtually any loan without a default if a private equity firm is really pushed against the wall and the document doesn't protect the investor. So when we do give people another example, every deal we close goes through a closing checklist process, and part of that huge closing checklist, and we have huge bring down calls, is to make sure that we have all the right document protections. It's been reviewed by outside counsel and that we have it buttoned down to the way we want it buttoned down. So we're not subject to this, Hey, a sponsor is backed against the corner and now we're getting a bunch of value taken away from us.

[00:36:15] Andrew Korz: Right, right. Well, final question, Scott, and you mentioned you touched on m and a activity that obviously was really sluggish through a lot from the second half of 22. As the Fed raised rates through, I would say beginning of this year, a lot of people expected a groundswell of activity with the new administration. We got sort of the opposite with the tariff chaos and liberation day. But I think if you look at the data now, actually it seems like things are starting to get chugging again. So in Q3, just in the US you had almost 900 billion in m and a activity that was up almost double from last year. We just got the Q3 private equity deal activity. It's up like 37% by volume, 10% by count over last year. So it seems like things are picking up maybe later than folks expected, but the Fed is easing, the economy still looks reasonably strong. I guess, does that fit what you guys are seeing within your own origination pipeline? And I guess on top of that, when you look at your pipeline today, yields are still pretty attractive, right? Again, it looks like deal activity is improving. What types of deals are really getting you excited today?

[00:37:24] Scott Giardina: Yeah, well first I agree with you on the increase in m and a. So equity markets at effectively all time highs, multiples have definitely expanded. It's not that financing costs have come down so much, but we've seen this equity expansion and we are definitely seeing a lot more sell side mandates and we see that in our pipeline. So those deals are definitely out there and we're seeing a particularly large increase in middle market kind of mandates, which again, is right in our wheelhouse and something that we're very excited about. But I think when we think about constructing our portfolios for investors, obviously that middle market part, which we increased activity on, we like a lot, but we're really excited about the non-sponsored, the more eclectic, the more complicated deal that we can structure and that we end up working on over a longer period of time because that's the place that we really think we add value to investors is when we get a chance to structure and do the deals. But overall, I think the pipeline is strong. I think that the m and a activity will increase because of the multiple expansions, and we know that rates are projected to go lower. But if that really happens, I do think you'll see a lot of pent up m and a activity really come. And when that happens, pricing will get better for us because now people, we focus on a lot more deals. So I think the opportunity ahead and especially middle market, private credit and non-sponsored is excellent.

[00:38:51] Alan Flannigan: That's awesome. Scott. I'm so glad we got to speak with you today. I think you've added a lot of nuance to the conversation around private credit, both in terms of some of the headlines, but also how differentiated the market is across the board. I think as we said in the intro, private credit is really not a monolith and there's a lot of different strategies and access points into the market, even within direct lending strategies, for example, and the unique background of your team, how you're organized and some of the experiences and lessons you've shared today. I think hopefully really underscore that for folks.

[00:39:26] Scott Giardina: Thanks for the time. It was great to chat with you both.

[00:39:28] Alan Flannigan: Yeah, of course. Thanks for joining us, Scott. Thanks, Scott.

[00:39:32] Commercial: The mandate for private markets is to deliver alpha and investors will need to dig beyond the surface level to find it going forward. Read the complete midyear private markets outlook from future standard, click the link in the description to download.

[00:39:51] Alan Flannigan: So Andrew, that was an awesome conversation with Scott and we've been fortunate now as part of this series to have several PMs join us in this endeavor. And one of the things that was really a main takeaway for me was orienting the organization of a team to the opportunity set that you're pursuing. And when you're targeting a different unique segment of the market, the team looks different as well too. We talked about sending boots on the ground to verify all the performance metrics that they've gotten about the company to run that revenue into the ground, to stress it, to test it, to make sure it's there, to make sure it is what you've been reported to. And I think having personnel dedicated to different segments of the business with different niche specializations. You've got a non-sponsored focus team, you've got your industrials team, you've got all different hats kind of operating together in sync across the platform.

[00:40:45] Andrew Korz: Yeah, I mean, just because everybody's talking about AI right now, obviously not that it even is relevant here, but just thinking about areas of the market that you just can't automate. This is still such a people focused business.

[00:40:59] Alan Flannigan: Absolutely.

[00:41:00] Andrew Korz: Right. I don't see any period where you're going to be able to just fully automate, operationalize this type of work. It's truly like you need people with relationships, with knowhow, with experience to actually drive these

[00:41:15] Alan Flannigan: Deals and the time in the market. This is a team that's been together for over a decade in terms of doing deals together, long track record, and Scott touched on it, reputation matters particularly in this segment of the market that you're going to be a fair operator with the companies that you're lending to and you're not going to necessarily hold them to the fire over inconsequential small terms, but you're going to focus on the things that matter and look to scale that business together. People trust you.

[00:41:40] Andrew Korz: Yeah,

[00:41:41] Alan Flannigan: Exactly.

[00:41:42] Andrew Korz: So I had a couple on top of that. I had a couple more takeaways. I had a lot of takeaways actually, but I'll just pick two. The first one was when he talked about the two different types of investing relative value versus absolute value. And you talked about the apple and the orange.

[00:41:56] Alan Flannigan: Fascinating,

[00:41:56] Andrew Korz: And I sort of think of it as first principles investing. So you think about capital markets, so much of what goes on in capital markets is one asset being priced off of other assets. And we were just talking before, I mean that presupposes that asset A or asset pool A is correctly priced. And that's how you get into trouble is when a whole group of assets is mispriced and then you've got a bunch of assets that are being priced off of that mispricing.

[00:42:24] Alan Flannigan: That's right.

[00:42:25] Andrew Korz: And I think the way that they approach things is just so much different. It's truly the absolute value. What is this company actually worth in different scenarios? And as a result of that and the risks around that valuation, what do we need to be compensated for to invest in this type of deal?

[00:42:43] Alan Flannigan: And I like it because it's like you're going to be accountable for the performance of the assets that you've went to. Why would you trust somebody else to do their homework Totally instead of doing it yourself? Yeah, it's It's hard. It's hard. And it takes a team that's been invested in and together and cohesive for a long period of time, and that's why it's unique and that's why that segment of the market that Scott talked about is where so much of the awful lives and

[00:43:05] Andrew Korz (43:05): You need to be able to say no too, right? I mean, I think that's so much of what we talked about throughout this conversation, the concentration of capital and the need for a lot of these managers to deploy so much capital. And when that's the case, you don't have the opportunity to say no as many times or demand terms or say that like you're saying, this company's worth a billion, I think it's worth 700 million. We're going to pass. That's something that when you have a specialized strategy like his team has, you can say no more.

[00:43:36] Alan Flannigan: Right? And what you're saying is probably especially true over the past year or so where deal volume has been a little bit more muted, m and a has been a little bit slower. So you've kind of seeded some of those assets within that segment of the market that maybe if there was a more robust volume and pipeline a foot, which you're leading

[00:43:55] Andrew Korz: Me into my second takeaway, which was something he mentioned at the end there, which was a potential m and a rebound that we're kind of the beginning of here. We talked about this, but it's been a sluggish two and a half, three years. Most people came into 25 really jazzed up about unlocking all of this liquidity, especially in private equity. That didn't happen. You look at the data now, and I think it's been so long that I think people are just like, well, we're in this slow m and a environment. You look at the data now, and again, your Q3 was almost double what it was last year in terms of m and a volume PEs up 37% as I mentioned, year over year. So you're starting to see it. And I think what's really interesting, and Scott has such a boots on the ground view on the middle market specifically, I think a lot of people saw, you saw some of these mega deals, whether it's ea, whether it's some of the other deals we saw maybe during the summer, and it seemed like the headline numbers were there, but maybe it wasn't as broad based of a

[00:44:51] Alan Flannigan: Recovery. It seemed very concentrated in those big take private deals.

[00:44:55] Andrew Korz: Exactly. Yeah. And I think to hear Scott talk about this more robust, broad rebound in middle market m and a specifically, I think first of all, it speaks really well to the direction of the economy, I think, right? That's a positive, right? It's getting capital flowing again, which is good, but especially for middle market focused equity or lending strategies, I think it's what we've been waiting for, and it sounds like, knock on wood, but it may finally be here,

[00:45:21] Alan Flannigan: And that deal activity wouldn't be uptick if those partaking at it couldn't underwrite a solid, steady rate of growth going forward. So again, to your point, the activity itself is good to get capital freed up and in motion, but the people provisioning that capital obviously have a clear outlook and a positive outlook on the state of the economy going forward. Absolutely. Well, Andrew, that's awesome. I really appreciate the opportunity to recap Your insights on the conversation are great as always. That's been the fourth episode in our series and the last of our asset class focused episodes, and we have just one more episode in this five part series, the grand finale, if you will, which we've teased throughout the series. So Andrew, what do you think? Should we spill the beans here? Yeah, we're pretty jazzed about it, so why don't you do the honors.

Yeah, absolutely. Our final episode will be a sit down interview with future standards co-president and chief investment officer Mike Kelly. Mike's going to sit down with us at our New York offices in person and shares with us lessons on leadership, formative experiences in his investing career and how we delivered the new private markets imperative here at Future Standard. So thanks as always to my esteem cohost Andrew Korz. Thanks again to Scott Giardina, managing director of the Future Standard Global Credit Team for sharing his insights with us today. For more on the private markets outlook, including listening to previous episodes in the series, please check the links in the show notes. You can also find our full library of investment research, including the recently published Q4 economic outlook, artificial intelligence, real economic impact at futurestandard.com/insights. This has been future standard.