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SIMON BROWN: I’m chatting with Warren Buhai. He is senior portfolio manager at STANLIB Asset Management. Warren, I appreciate the time. You recently published a paper on early signs of stress that we’re seeing in the global private credit market – this after years of plentiful and cheap liquidity in the market.
Is this long era of abundant liquidity slowly unwinding? Are we seeing early stages of a systemic crisis unravelling in the US private credit market?
WARREN BUHAI: Thanks for having me on, Simon. I wouldn’t say a ‘systemic’ problem. It’s just for us the changing of the liquidity environment. As you mentioned, we went through a period of extremely low interest rates post Covid, probably over-stimulus. A lot of companies took advantage of that and raised loans at very low rates.
Obviously rates now are a lot higher than that, even though we’ve been through a cutting cycle over the last 18 months, and refinancing therefore becomes a lot more expensive.
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Thrown on top of that, you’ve seen changes in AI, a gentle pool rollout, and you’ve obviously got the Iran conflict going on, which is causing oil prices to go a lot higher – and energy prices in general.
This whole confluence of events is clearly weighing on things like private equity, private credit and especially the software sector within profit credit.
SIMON BROWN: In essence, this is the life cycle of credit, of debt. This is nothing new, really, at all.
WARREN BUHAI: Correct. Nothing new, although it has come at a time where AI is new, and certainly the rollout of logistic tools, which you’ve only seen this year starting to impact especially the software companies – where you’ve seen announcements of a lot of them laying off staff because the AI tools can do a lot of the coding work. That’s obviously putting question marks over the sustainability of the revenue models in the software companies.
It’s coming at a similar time to that since the war started in Iran; you’ve had a change in the kind of environment as to what people expect central banks to do.
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If you remember going into the war expectation was still for a couple more cuts in most countries, including the US. That has kind of evolved now to where many countries are expected to hike rates two or three times this year because of what’s going on with the energy prices.
So I’d say [with] those two, while it’s a normal evolution of a cycle, we haven’t really seen a big downturn in the credit cycle essentially since the GFC. So it could be the start of a big event, but it’s very early days to tell if it’s going to become bigger than that.
SIMON BROWN: I take your point that the cycle is not new, but the timing of the positioning of it is what’s new. This is primarily a US private credit issue. Does it extend much beyond or is it really just a US issue?
WARREN BUHAI: Certainly at the moment we think it’s concentrated in the US, purely because that’s where most of the big software loans are in the software companies. In our estimates, from what we’ve seen in the research, around 25% of the private credit market in the US is exposed to the software sector, and most other parts of the world don’t have that level of exposure to things like software and the kind of sectors that we are currently worried about.
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So at the moment it’s definitely focused in the US. They also have a lot more complex structures in the US. They’ve tried to do some restructuring of those loans, but most other parts of the private credit world, including South Africa, are a lot more vanilla and don’t have the same exposure that the US private credit market has at the moment.
SIMON BROWN: Gotcha. What are realistic contagion channels into South Africa, if any?
WARREN BUHAI: Usually in times like this it’s only going to be through the global event. We don’t think there’s big risk underlying in the South African private credit market, but certainly a spillover effect usually comes through things like the oil price staying higher for much longer than expected.
It feeds into inflation expectations, therefore feeds into central bank expectations of hikes instead of cuts, as I mentioned before the war. And then just the normal kind of selling of liquid emerging markets.
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While it’s good, the story looks better than it has for a long time for South African assets, but the reality is in times of stress, when people sell assets globally, they often come to South Africa in the emerging market context because we have some of the most liquid equity, bond and currency markets. So that’s kind of where it feeds into us.
We kind of have a spillover because we are liquid, rather than because of any idiosyncratic problems in South Africa itself.
SIMON BROWN: Yes. I see that often we are almost a proxy as an emerging market currency. You want to trade an EM currency; you trade because of that liquidity that we see.
For investors in South Africa, what should we be watching from a portfolio perspective?
WARREN BUHAI: I think the obvious things to watch are the things that you can get access to quite easily, including US public credit spreads, or the high-yield spreads. How that’s behaving is usually a good early indicator of the stress that’s going in the credit markets publicly, and that often tends to feed off what’s happening in private markets. And then the normal ones that come with higher oil and energy prices and the geopolitics going on at the moment.
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So look at what happens with inflation expectations. Those tend to come out every month in different surveys, both globally and locally. What are expectations for growth going forward from here with high energy prices?
And then things like recession risk – is there going to be a picking up? If the oil price does stay kind of above $90/barrel for many more months, that’s eventually going to start feeding into expectations of slower growth – and does that feed back into emerging markets? Those would be the obvious ones at the moment.
SIMON BROWN: And the flip side of it – you mentioned oil there – I’m not sure that this is a base case, but a sudden deceleration in the oil price back into the ’80s, maybe even ’70s, would that sort of remove a lot of the risk and concern around the space?
WARREN BUHAI: It would certainly ease the very short-term concern, because what that would allow – if energy prices could come back quite materially, as you mentioned, closer to prices as they were before the war – is for central banks to start thinking about not having to hike rates again this year, and almost going back into a cutting cycle that they started 18, 24 months ago.
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They are still central banks. The good thing at the moment is they still say they’re in a tightening environment, so they still think interest rates are too high in the long run. But they do certainly need oil prices to come down quite materially, as you mentioned, for them to even think about cutting again.
SIMON BROWN: Yes. And whether that happens is a whole different story, which we’ll leave on its own.
We’ll leave it there. Warren Buhai, senior portfolio manager at STANLIB Asset Management, appreciate the time.
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