Kieran Goodwin – Private Credit Concerns (EP.494)

0:00I've looked throughout my career for asset liability mismatches, and I truly believe that asset liability mismatches cause liquidity crunches, and liquidity crunches can cause credit crunches. Credit is correlated when it gets stressed. The bear case, which I'm not saying it's going to happen, but what happens is you get redemptions, you get some real defaults, you get force selling of private credit. And in the interval funds, you just run out of what's liquid and the bar to gate is really high. That goes on a feedback loop of where's the actual bid for private credit. It's hard to say.

0:46I'm Ted Seides, and this is Capital Allocators. My guest on today's show is Kieran Goodwin, partner at Saba Capital. a$6 billion hedge fund manager that seeks to identify dislocations in credit and equity markets to generate convex returns in volatile times. Kieran has been one of the top credit traders on the street for the last three decades, across roles in investment banks in the 90s and early 2000s, King Street, his own hedge fund, Panning Capital, and most recently, Saba, that he joined in 2024. Our conversation covers a tour of Kieran's background, including early experience with credit derivatives, growth at King Street, lifespan of panning, downtime between stints, and re-engagement with Boaz Weinstein at Saba.

1:37We then turn to risks in the private credit market, including its rapid growth, asset liability mismatches, pricing marks, leverage, liquidity, default risk, and the potential for reflexive problems. Kieran shares how managers should navigate the environment and how he's positioning Saba to benefit. Before we get going, after a long winter, we're starting to see green shoots in the changing of the season. Spring training for baseball, March Madness for basketball, and the sunshine double in tennis all remind us that hope springs eternal. But these days, it's harder to be optimistic about another list of challenges.

2:21Private market liquidity, peace around the world, and keeping up with my son Eric in creating witty spread-the-word clips. Now, I can't figure out what will happen in private credit, how the private equity bottleneck will ease, what benchmarks should replace the S &P 500, or why so many people have reached out commenting on Eric's lack of interest in the show. But I do know that the answers await from our incredible guests, and you should encourage all your colleagues to listen in and find out that truth. Thanks so much for spreading the word. Please enjoy my conversation with Kieran Goodwin. Kieran, thanks for doing this.

3:03Happy to be here, Ted. Great to see you. Why don't you take me back to what led you into finance in the first place? I was a computer science major at Duke my junior year. A good friend of mine gave me a book. He said, I think you'll like this. And it was Liar's Poker. I read it in one night. Literally, it was a party that night. I stayed in my room, read the book in one sitting. I know Michael Lewis thought it was a way to dissuade people, but I took it the other way. I like math. I like puzzles. I liked risk in a sense. Learned how to play poker with my grandparents when I was young. I hadn't really been much exposed to the markets, but after reading that book, I was like, this is something that fits me.

3:42And what was your experience like on the street? Another buddy from Duke's dad was looking for an analyst at Smith Barney. My friend recommended me. I had a job in consulting at Anderson Consulting, which became Accenture, like a computer science programming job. Interviewed there, which was fortunate. Did that for a year as an analyst and became a sales trader at Smith Barney. With my math background, tried to get into equity derivatives. There was no seats. I got into interest rate derivatives at Smith Barney, which great first four years, then left there in 1995. to go with a senior trader who's an interest rate trader to Citibank to become a credit derivative trader, which I actually didn't even know what that meant, but I trusted the guy and left with him.

4:24What'd you see in the differences across banks in your time on the street? When you're talking 25 years ago, culturally, the places were much different. Smith Barney, for example, was Italian and Irish Catholic. Morgan Stanley was more WASP-y. Then I moved to Citibank, which were strong derivatives, really international mix, which was unique at the time. Then I went to Merrill, which was like Mother Merrill. Many people got jobs on the street because they had a relative that was doing it or they grew up in the tri-state area or had some connection. It was much different than now. What led you to go from that initial step from one bank to another bank during your time there?

5:04I got enamored with this idea of derivatives and options and swaps, thinking about edge in the form of knowing the bond math better in a sense. Starting interest rate derivatives, creditors seemed like a green field and I was pretty young at the time. Citibank, they had a strong derivative culture, but really weren't talking to investors. So I figured out I needed to make a move if I was doing creditors to a place that actually traded credit. I went to Solomon Brothers, which was a great experience. That was the beginning of real creditors with the Asian contagion of 97. Then I had an opportunity to join Merrill, which I interviewed prior.

5:41I had a bunch of friends there that I wanted to work with that I thought were talented people. Moved there in 98. Trying to optimize, maximize my quest to make credit derivatives a real thing. When you first moved to the buy side, what did you think you knew that you didn't going from prop to a hedge fund? It's funny. I remember there was this client at Citadel, Dave Snyderman, who's now the head of Magnetar. He gave me some insight. He's like, when you're on the sell side, you buy on the bid and sell on the offer. That's what you're trying to do. And then when you go to the buy side and you initiate a trade, you're automatically down because you're paying bid offer.

6:22And especially in credit derivatives, corporate bonds at the time, the bid offers were real. But I was like, wow, you have to be much more intentional. You have to come into the day with a plan. And I feel like I had a plan on the sell side, but I was also reacting to flow and reacting to clients. The strategy of thinking about how you want to create a portfolio, trading positions, also exit strategy. All of that hits you in the face when you go to the buy side. What was your time at King Street like? It was awesome. It was a blur in a sense. I met a friend behind me, Brian Higgins, in the late 90s.

6:58When I was at Merrill, a friend of mine who was a salesperson knew them. And we pitched them the idea of credit derivatives as a way to go short because they had been short in high yield bonds. This was a more efficient way to go short, non-recourse in a sense. We had a great relationship there. I talked to them when I was going to the buy side. They weren't ready. I went and traded a prop for a couple of years. Then I was getting recruited as Fran for a reference. He's like, why don't you come here? At the time, I understood the credit markets. I understood derivatives and how credit derivatives fit in and the relationship between bonds and credit basis.

7:33I wanted to go deeper into distressed investing, thinking about value. It was magical in the sense that Fran was this amazing distressed investor, a great analyst. I had this other skill set, which not a lot of buy sides have. So the combination was so much synergy, coupled with amazing amount of volatility in the markets, starting in 05 with some mini default cycle, then LBOs and then subprime and into GFC. What'd you learn about navigating all those choppy times? Learning options. I remember when I became an interest rate trader, I got the John Hall book about option theory and went through it.

8:12And it was probably some of the deepest studying I ever did. I was always more comfortable being long options and short options. The goal was, how do you find the cheapest options with the lowest amount of theta in the markets? Meeting someone like Fran, who intuitively understood options from a distressed investor standpoint, that was eye-opening. We were always long options in the sense that we were buying either distressed debt or we were shorting credit. We embraced the volatility and probably did our best during times of volatility. When markets are calm, I'm not that good. But you started early on in credit derivatives, bringing that over to the buy side as a short mechanism, distressed when it was still a cottage industry.

9:01How did you think about navigating the changes in the credit markets over the years of your career? I was learning from the ground up, coming over there, and there were still remnants of Enron's, which was a great case study to understand how you have this going through Chapter 11, which for Enron was pretty much a liquidation. And credit drivers at the same time was developing complexity as far as all the tranches of indices that were trading in synthetic CDOs and correlation trading. That was all happening. I looked at what Fran and Brian were comfortable as investors. How does that translate into what I know?

9:35For instance, in late 05, we had this many default cycle in auto parts and airlines. there were all these correlation trades that blew up such that when you were tranching portfolio credit synthetically via CDS, the equity tranche got really cheap. It reminds me today where you just had one or two sectors having a lot of stress like we have today and the SaaS with respect to levered loans. And we're seeing it in CLO equity has way underperformed the relative loan market because all of the damage has been in one sector. As the first loss, the equity piece, you're getting the brunt of that. What did you see differently as a trader working with fundamental investors?

10:19When I was a sell side or trading prop for a couple of years, my timeframe was a few months, maybe six months. When you're doing value investing, whether it's distressed or stressed, Lehman position, for instance, many of these distressed firms had for 10 years. It's a book, which the chapters, you don't know what's going to happen and pivot. You have basic ideas of where you think value is, but that can change. And trying to always be curious on a situation for years at a time, that takes a level of concentration that me as a trader didn't come naturally to. Over your time at King Street, how did you think about your own career when you went to leave?

10:58I left in early 10, 2007, 2008, 2009. We were in the thick of it. It was exhilarating and satisfying, worked with amazing people, but it was draining. I had young kids at the time. We had done as a firm way better than I thought. We started when I got there at 4 billion, we're up to 22 billion. For the six years I was there, the S &P was flat and we were up over 100%. And then personally, I did a lot better. I needed a reset. I wasn't thinking about what was next as much as I just know that right now I need to pause. So what'd you do? For two years, I failed to reinvent myself many times. I went to work for Mayor Bloomberg as an unpaid consultant.

11:41I think I lasted three months. Then I went back to school to get a master's education. It lasted four months. The pace of play was way too slow. I bought a farm upstate. I worked with a farmer on some greenhouses. Nothing took. Then a great friend of mine, Frank Edmonds, who is at King Street, was leaving King Street. I was like, what are you going to do? And he's like, I'm hoping to start a hedge fund. I'm like, oh, that's interesting. With whom? And he was like, my goal was to convince you. That was the perfect partner for me. Frank was lead analyst, head of research at King Street, trained a bunch of analysts.

12:16We were complimentary in the sense that he was more calm and collected than I was and Southern gentleman. And I was like, well, if I'm ever going to have a chance to start a hedge fund, this would be an ideal partner on so many levels. Take me through that journey. Frank ended up staying at King Street for another year. I started panning on my own. It was fun in the sense that the day I left King Street, there were five different LPs that reached out to me. Most called me. It seems foreign now that no one calls each other. At first, we're like, thank you for your efforts. You really helped King Street do well for us as an LP, which was gratifying.

12:54If you ever want to start something, we'd love to talk to you. I dismissed it, but remembered who those people were. I think four of them invested on day one out of 10 investors, which is great. You have that confidence is amazing. Even with that, you do 100 meetings, you get 10 investors. It's hard. Starting a hedge fund is difficult. Anyone who does it successfully, I always have a hat tip to because you're out on your own and it's easy for people to say no. How big was panning out of the box the first couple of months? We launched with$600 million. We did really well. And one of the mistakes I made was we took in money too quickly.

13:34So we grew pretty fast. Had$2.5 billion within 18 months or so. What happened over the couple of years you were running? You ran it for six years. I personally made a lot of mistakes in running panning. One was not necessarily understanding that we were in this low vol regime and it wasn't really going to change. Getting the macro right sometimes, even as a fundamental investor, is crucial. That was a painful lesson to learn. But we started off so hot in 2013, we were up 20 % net that it's also like, oh, wow, this is easy. That's the worst thing you can think about as an investor, I think. Every day, you have to assume you start with a zero next to your name.

14:19You're probably going to have some hurdle or adversity to overcome. 2014, we're doing well. It got tougher. We're up one for that year. 15 was a really hard year. We were down five, then up five or six in 16. I just got tired of it, to be honest. I had too mature of a team. I was better as a manager training younger people. That was my experience at King Street. I learned that in real time. I had a talented team, but it didn't fit the way that I operated the best. What were some of the other mistakes you made? Every manager at some level gets away from what they're good at. sometimes that makes you uncomfortable and gives you bad wrist positions.

15:02So you stretch on what your comfort level was. For instance, I was in the Fannie Freddie Preferreds early. A good salesperson called me. He's like, this is a cheap option. This guy had a great nose. I was like, oh, that is, that does make a ton of sense. So we bought them at three and they were at 13. I remember thinking, wow, now this becomes a legal bet. The Delta went from a five or 10 Delta to 40 Delta. That's not my strong suit. Even if it's not mission drift, you just have to get out of trades. There were a bunch of trades that we went into. They were in my wheelhouse, and then they did well, and they got out of my wheelhouse, and some of them were really bad reversals.

15:41So you got a step away the second time, probably knowing that the slow pace wasn't going to work for you. How did you spend those next couple of years? I left in 18. Then my kids were older. It was great to be with them. They were in high school or coming to high school and were super busy interacting with them and helping them navigate their days and assisting them. That was super rewarding. Going to see their event, helping them with homework, thinking about their college journey. I was definitely busy with that. I remember getting the advice when I left King Street, you should meet with as many people as you can.

16:15I was like, no, I want to try to help New York City. I want to try to be a teacher. This time I was more open. I would literally meet with anybody for coffee that was interesting during that time. I met you for the first time. I was more open-minded about it and more relaxed about it. With maturity, you get some wisdom. How did you think at that time about what you wanted to do next? I was resigned to the fact that I probably wasn't going to be an investor again. I didn't think there would be a third act. It was somewhat by chance. I failed again trying to reinvent myself, But they were more fun failures.

16:49I took a stand-up comedy class and performed. When you do these classes, they intermix real comedians because otherwise it could suck for the audience to see a bunch of people that weren't really good. Through my kids' school, I became friendly with Jim Gaffigan. So I technically opened for Jim Gaffigan. I went on right after. Or else I would have pursued that. COVID was literally the next day and I lost some momentum. I created a game on an app. That was a fun project. So I was not trying to necessarily save the world, but just pursue things that were fun for me. Then Boaz, who I've known since the late 90s, he reached out to me in 21.

17:27He was like, oh, I'm putting up a board for a proxy fight on a closed-end fund that owns Levered Loans. Would you want to do it? I'm like, sure. I know a lot about Levered Loans. I've got time. I did that. A couple of years later, I was still on the board. He was like, hey, can you come in? I'm thinking about making a bid for Sculptor. They have a credit business that's long, fundamental credit and you know more about that than I do. Would you help me? And I'm like, sure, I'll help you. We went through that process. I'd never been in a hostile takeover situation. The bidding group was super interesting people that he's friends with.

17:58That took six months and we didn't win. But that got me, maybe there is an itch to scratch. I honestly, before that, hadn't thought about what could I do. We lost around Thanksgiving. After the holiday season, I went into Boaz in early 24. Hey, listen, that was cool. He's like, not for me because I spent a lot of legal money, but we made a lot of money for the shareholders of Oxif or Sculptor. I was like, I have a couple ideas. Hire me as a consultant and I'll run these down. And if nothing comes of it, then we'll part ways. I was like, I want a wisdom role. And I had these ideas. I didn't necessarily want to trade anything per se.

18:36So that's how I got to Saba. Take me through the path of private credit from financial crisis, replacing banks to where we are today. From the financial crisis, the idea was banks aren't necessarily the best vehicle to make loans because they have deposit flight risk. Also, you had the six-time lever rule. I forget the name of the rule, the guideline. Banks, we don't really want you lending to six-time lever companies. Some companies that are six times levered, like a software company, could be a good credit risk. Private credit had been around. It's not like Golub started Aries and even Silverpoint.

19:16There are a lot of people doing private credit, but this idea of, okay, let's do an institutional style drawdown fund. The duration of that fund matches the assets. And we take away this asset liability mismatch. Everyone talks about direct lending. There's all kinds of private credit, but let's just talk about direct lending for now. That made total sense. But then you had this idea of we still can make more loans, but we're tapping out of demand here a bit. Maybe we do a non-traded BDC, which was now up to 2018. That's where I was like, well, this is the original asset liability mismatch that you tried to cure by doing a drawdown fund because you might have all the investors looking for the exit.

20:00But even though it's definitely 100 % on page one of any prospectus or there's a gate, you're going to get 5 % liquidity, it grew really fast. Zero to$350 billion in non-traded BDCs from 2018 to now. That's unprecedented. As you look at the rest of the interval fund structure and the growth of the wealth channel into this space, what are some of the strengths and weaknesses in the various differences between the original drawdown structures? mentioned the non-traded BDCs, now the Interval Fund. The Drawdown Fund has got the best asset of the liability mismatch. I'm invested in a bunch of different kinds of drawdown funds, and they're ugly.

20:40You get capital calls, you get distributions, you're getting a lot of K-1s. I'm in a good fund, started in 2012, still have a 10 % position in it. They last a long time. They the demands of retail from that standpoint, then you have the non-traded BDC, which I do think that there is a potential for a non-traded BDC to work with the right private wealth client. The marketing happened pretty fast and furious, and there might be a mismatch of the right client to the product. The level of sophistication of the private wealth channel is varied. I don't know if it's like, we're going to videotape you saying that you understand about gates.

21:28I don't know if that's the right thing or not. It's probably not. And interval funds, honestly, didn't know what an interval fund was until recently. It's a concept that's somewhat strange in the sense that it's less levered. So that makes sense. Then how do you meet that demand? The bar, you can't really gate. You have to give the 5%. The 5 % or so liquidity every quarter. That's a great feature. That has to be cash. As long as you have assets that you can turn to cash or you have lines. At the heart of any of these non-traded BDCs or interval funds, what's the risk management? How thoughtful was the risk management?

22:06Is this contemplated for assets going down? How long can you sustain outflows for? I started a hedge fund. You launch, you take in money. You're like, this is great. King Street was a wild ride. We were growing assets all the time. It's hard to think about the downside. What happens if we suck for a while? Then what? No one really wants to talk about that. What would proper risk management look like in one of these products? Good risk management would be a bigger liquidity sleeve, so maybe more levered loan BSLs. Trying to minimize unfunded commitments would be good. Unfunded commitments, whether it's a delayed draw a term loan or a revolver.

22:48No one wants those. There's the economy that cost of doing business. That's why credit derivatives was started. Banks didn't want those on. Let's hedge them out. You're not getting paid as much and you have the same credit risk. That would be one. And then being transparent on what is in the portfolio. Apollo came out, we're going to mark every month. That's a good move. But having marks that are as accurate as possible, it's hard sometimes. I'm not saying that there isn't going to be variance amongst marks, especially on private credit. But really being good about marks, whoever explains their portfolio the best, does that mean one pagers, which you get in an institutional fund?

23:24Or does that mean a teach-in? That's where I'd like to see it to go. Even though you're like, well, how is that risk management? The better that you inform your investors about your process and the investments that are in the vehicle, whatever the vehicle is, the more comfortable they get, the less they're going to rush to the door. I'd love to walk through a couple of the issues that commonly come up. You mentioned two of them, leverage and marks. But when I start with the marks in the private credit world, when you look at loans underneath one of these portfolios, where do you have concerns that the marks may not be accurate?

23:56There's some obvious ones where you see, let's just say public BDCs that own the same club deal, the same loan. One BDC versus another or two or three versus a fourth BDC. There's a massive variance in a second lien, especially where you're like, wait, the first lien we know is stressed a bit. So maybe it's worth 90 or 85. Not that it's impaired, but we'll throw it out a bad sector. It's a stressed SAS loan and it has a second lean. The second lean has got to be below 85. Then you have one where a bunch of guys are marking at 60 and then there's a fourth one marking 85. Come on, you can do better than that.

24:39Yeah, maybe if you marked at 70. So there's some wild variants, easy ones. When you look at the volume of those situations where it's easy that there's a wild discrepancy, How does that roll up into whether that's a systemic problem in the space? If you rated the big non-traded or public BDC managers on a scale of one to 10, 10 is the best marker and one's the worst marker. What's the NAV difference? If the guy that's rated 10, he's at the top of the heap, his NAV is probably the most accurate snapshot for this. Obviously, there's delay here as well because they mark by quarter, which is Apollo trying to do.

25:20What is the guy that's rated one? What's the difference in NAV? Four or 5%, maybe six. It compounds a bit. Then you have micro situations where loans are getting marked from 100 to zero in one quarter. Everyone goes to the worst because credit is about believing. You have to believe. Credit means to believe. And when you lose belief, it happens really quickly. Trust is the biggest thing. Recently, there have been this wave of redemption requests above that 5 % threshold in the non-traded BDCs and interval funds. And that question of belief comes into play of what happens the next quarter. How do you think about the difference between the reflexivity that comes from the investors redeeming and the underlying fundamentals of the loans in these portfolios?

26:16How does a normal person think about the fundamentals or some crazy bear like me? I've looked throughout my career for asset liability mismatches, and I truly believe that asset liability mismatches cause liquidity crunches and liquidity crunches can cause credit crunches. Credit is correlated when it gets stressed. I have a good pulse on retail mindset in that this is an income product. That's why the Private Wealth Channel cares about it. It's not like this is Apple stock. 10 years ago, Private Wealth loved MLPs. That was the income product. Then we had the energy crunch in a mini default cycle in 2015-16.