TCW's Koch Says Rates Could Stay Elevated

Tell us about this deal with PNC. Yeah, sure. We’re just by background, you mentioned TCW as a $200 billion global asset manager. We were an early entrance of private credit that is LED for us by the extraordinarily talented Rick Miller, our CIO of private credit, a 23 year track record in that asset class of conservative lending that’s allowed us to outperform with a low loss ratio. And we’re really proud to be partnering with PNC, which is of course one of the leading U.S. financial institutions. They’re ranked 4th and middle market lending. They have an extraordinarily talented and tenured management team, a strong balance sheet and great client relationships. And this has been a partnership. Just to answer a question how it came about, it’s actually 15 years in the making. So we’ve worked together very closely for a long period of time. Over that period we’ve done 40 Co financings and it is also true that they are our number one fund finance partner, which means that actually PMPMC has to underwrite TCW and our capabilities in order to provide leverage to our funds. So this is a very, very strong partnership and I wanted to just end Carol by saying that there are this is different than other partnerships that have been announced and this strong relationship we have with each other has allowed us to create something really differentiated for three quick reasons. The first is that it’s very middle market focused. So we’re going to target loans to companies with about 15 to 75 billion of EBITDA. The 2nd is that it’s a shared investment approach. So we’re both putting in investors to this partnership. We’re going to work together on the underwriting and the origination. Of course it will be shared by Rick and that’s because we have a shared credit culture of conservative lending that allows us to do to share the investment approach. And then finally, it’s shared economics. We’re targeting 2 1/2 billion dollars of equity this year and it will be strong contributions both from PNC and from TCW and our affiliates. So that economic alignment aligns our interests with PNC and also of course with our clients. So Katie targeting 2 1/2 billion. How big could this partnership get though? We think this partnership could expand significantly over time and that’s important because private credit managers and banks, we think those partnerships with us and others will continue because banks are under some regulatory pressure and private credit managers, they have the capital to allocate into lends and banks have great origination capabilities. And those two things are going to have to cooperate. So we can continue to put credit out into the US market. What does significantly mean? I’m not going to give you the exact billions of dollars, but I will say the double from the initial 2 1/2 are many times actually for our credit alternative platform broadly. We’ve already doubled the AUM of that platform over the next couple of years and we’re expecting it to be many multiples over that. And this is going to play a very important role in the growth of TCW alternative credit platform. Carol mentioned at the start that you’ve been busy. Another I guess, deal, if you will, was the conversion of two mutual funds to ETFs in the AI space. Talk a little bit about why you may. Well, first of all, mutual funds in general, we think that they have a place. We’ll continue to have a place in the market, very important part of our business, still a big part of TC, very big part of TC and will continue to be a relevant vehicle. It is also true that clients are looking at the exchange traded fund vehicle because of the liquidity, the tax efficiency and the transparency and ease of trading of those vehicles. And so we are going to convert several funds and launch new ETFs. We did want an AII do want to emphasize, I am a believer in generative AI. We have been managing AI strategies for seven years. So this isn’t something we just launched because ChatGPT is full. It’s we saw that transformative technology almost a decade ago and and launched a strategy on that. We’re investing in the technology enablers of AI and also the companies that will. That’s what I’m curious is what is a portfolio of AI stocks, he says because if you ask someone else that question, they would just say, well NVIDIA, maybe Microsoft and that’s it. I assume this is part of the we we have some of those in there. So these companies that are driving the technology of AI, but then also the companies that are the beneficiary and what is actively managed and it’s relatively focused. And So what we’re going to do is shift the shape of the portfolio as that narrative of AI changes over time. I I do just want to say one thing ’cause I I think it’s important to be balanced on these issues. I do believe in the transformative potential of AI, but it is a story that’s going to play out over the very long term. And so a vehicle like this is appropriate for people who can take that long horizon. And this is said a lot, but I think it’s a very good reminder. The Internet was also an incredibly transformational technology, but that didn’t happen in year one and year two and year it took 20 years. But if you stuck with that narrative for a couple of decades and many of our clients have that type of durability of capital, it was one of the greatest wealth creation opportunities in the US economy. And so we are excited about it but balanced in telling people this is a great vehicle, be active, be selective which we are be with a manager that can evolve with the narrative. It would also be long as you know of our investment narrative. Just generally speaking take the big broad macro, Katie, what are you seeing right now? How would you describe the environment? I would say that we are long dispersion, the idea of dispersion across all of our portfolios. It’s really hard to predict this in short increments. But what I would say to you, whether it’s private credit or it’s public credit, we think that the the spreads and I’m going to talk about public because it’s just a little easier to point to valuations which are at record heights in credit markets in their post global financial crisis history. At record heights. That valuation is inconsistent with some of the obvious challenges that we have in this economy regardless of whether or not we get a recession. Let’s take the scenario where we muddle forward and have some type of soft landing, but rates we all believe will stay elevated because inflation still pressure. That is it would create a credit event right when rates are this high. And these companies were already starting to see stress in certain parts of the credit market not priced into credit spreads. So in our liquid portfolios where we do take macro views, which is in the core, core plus space, remember that’s people’s retirement money. So we’re managing that for their retirement assets over many decades. We’re conservatively positioned. We’re overweight agency MD’s which is carrying over the index and we’re being very patient and eventually this is going to break and when it does we’ll lean into those specific credit opportunities. If on the other hand I just we do get the recession, then we’re going to have a credit event anyway in both public or private markets and that will create dispersion. Are you suspicious that the default rate is in something different than what it is today? So, so this is a good point. Default rates are actually where we would expect them to be in the traditional levered loan market. They’re low and actually went down in the first quarter in the private credit market. And I’m glad you asked that because we think that’s really masking some serious liquidity challenges in in the private credit market and what we and you. So the obvious question is, is why? Why is this happening? Well, I would ask first, why is there stress? The reason that we think there’s actual stress that’s not showing in default rates yet is because from 9 from 2019 to 22, these capital structures were highly levered with the view that rates would stay zero forever, right. And that didn’t happen and now mass taken over and they’re under pressure now. Why haven’t the defaults gone up? My answer to you on that is that if you look at last year, the amendments of these loans were three to four times normal and we don’t generally amend loans when things are going well. So this cannot be extended forever and eventually those default rates will rise. I’m going to end with just bring it back to dispersion. If you look at the last 15 years in the private credit world, the dispersion between the top and bottom quartile manager is about 15 basis points. This is, this is not high dispersion. That number could 10X or more over the next couple of years as these defaults rates rise. And that’s why you obviously want to be with a manager like TCW that does conservative lending diligence, very high levels of diligence, very significant underwriting. And we feel really great about how we’re going to manage this environment for our clients.