0:00
As much as the infomercial that is CNBC wants to convince you that everything's great in the economy is is just clearly not.
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0:06
I can make a pretty strong argument that public companies will actually benefit from the tariff regime.
0:10
This is a full contact version of distressed investing.
0:14
Acquire assets that are troubled, reimagine what they could and should be, and then apply force to make that happen.
0:32
Andrew, I think you and I have talked about doing this for 5 years.
0:34
On and off, I think that's right.
0:37
>> You don't do this a lot or ever? I don't.
0:39
I I love the category of guests that are the first and only interviews of this type, and so I'm so excited to do it with you.
0:44
And I'm especially excited because your style is so distinctive.
0:49
And we'll talk about a million things related to how you invest and your your personal story in getting here.
0:53
But I thought a framing exercise that would be great starting place would be for you to describe this notion that you have of the K-shaped economy. Yeah.
1:01
You do something that's very very specific, and we're going to talk about all aspects, but I want to start broad.
1:07
So, tell us what the K-shaped economy is from your perspective.
1:11
Everybody in the US economy, at least, has this underlying sense that there are some parts of our economy that are doing exceptionally well.
1:20
But at the same time, they have this internal notion that there are other parts that are just worse than it seems.
1:26
That there's a nagging slowness or a lagging nagging underperformance to the economy in broad areas.
1:33
They can't quite put their finger on it because they look at CNBC and Bloomberg, and they read the Wall Street Journal, and there's green arrows in the ticker tape economy.
1:41
Those companies and those wealthy individuals who have access to capital, who have access to resources, and can drive, you know, unbelievable profits and great outcomes.
1:55
But there's a broad part of the economy, and I think we see this in the political sector being expressed pretty acutely.
2:04
There's broad pieces of the economy that are just dissatisfied with their earnings power, with their ability to benefit from the promise of the American economic system.
2:16
That discrepancy, I think, is really hard for people to understand.
2:18
But when we say K-shaped economy, it immediately resonates with people because they see it themselves.
2:25
They feel it in real time. >> Yeah.
2:27
They understand intuitively that there are those who are having fabulous success, but they also understand but that there are people and companies that are just not getting their piece of the pie.
2:37
There's this amazing data set that you've just spent time exploring.
2:39
I want you to explain the data set and then all the findings.
2:42
But it's What I want you to focus on is So, if you think about the K-shape, we all know the upper part.
2:48
It's the S&P 8 or as we're calling it now, you know, fang stocks or whatever, AI companies.
2:53
Like We know the story that's going well. Right.
2:55
Um so, maybe talk about this investigation that you've done recently about what's going less well and why and what you learned.
3:04
Well, I'll start with, you know, at Marble Gate, we focus on the middle market.
3:06
And the reason we focus on the middle market is A, it's like 1/3 of US economy.
3:10
And by the way, over time, it has represented, you know, something north of 2/3 of all restructurings, bankruptcies, etc.
3:19
So, it's the area of the most, let's say, action.
3:22
It's also the area of the economy people know the least amount about.
3:26
Uh the companies there don't file publicly their financial statements.
3:31
They typically aren't listed on stock exchanges.
3:33
So, the only people who really have an insight into how the middle market is doing are individual lenders to it, to individual companies, or individual owners of individual companies.
3:46
And so, a lot of the talk about the middle market tends to be anecdotal.
3:47
It tends to be self-referential.
3:50
It's inferred, but there's not a great data set that gives us a good insight into a broad section of the US middle market.
4:00
A good friend of mine ran a company called Rapid Ratings.
4:03
Rapid Ratings does credit counterparty risk assessment for like the Fortune 500.
4:09
So, they'll assess the supply chains, the vendor relationships, trade relationships of large companies.
4:17
They rate those their vendor relationships and other supply relationships, and create a financial health score that then that Fortune 500 company uses to determine terms of trade and how they're going to deal with that supplier or trade counterparty.
4:31
We worked with them taking that anonymized data and winnowing it down to the US middle market.
4:38
And for us, that's companies between 100 and 750 million of total enterprise value.
4:44
And we said, "Okay, let's strip out everything that isn't like a US company with those characteristics."
4:48
We were left with a data set of just over 1,200 companies.
4:53
We've been looking at this data now for several years.
4:54
We measured it pre-COVID period and then over the past 3 or 4 years.
5:00
In those 3 or 4 years post-COVID, what we've seen is a real decline in the earnings power in the US middle market.
5:08
Now, we look at a lot of factors. We look at EBITDA. We look at margins.
5:13
We're looking at pure cash flow.
5:13
We're looking at leverage and liabilities.
5:15
And then importantly, we focus on interest coverage because look, at the end of the day, companies can remain insolvent for a long time, but you know, my first boss on Wall Street used to say, "Nothing so focuses the mind like a coupon payment."
5:32
And um that that is very true.
5:34
When you have to make that contractual payment that is I'll say, generally speaking, non-negotiable, um you get to a point where you have to make a hard decision about do I need to restructure or can I persist?
5:50
When we looked at the data set over time, we've seen a few like important characteristics.
5:53
The middle market EBITDA essentially deteriorates every year.
5:58
It just gets worse and worse.
5:58
Now, we compare that data versus uh public filers and and we look at the Russell 3000.
6:07
So, in that same period, those companies have public market access.
6:09
So, they tend to be better capitalized.
6:11
They have um you know, let's say, broader management teams.
6:18
They have more access to resources.
6:20
Those companies have done persistently and consistently better.
6:25
Uh EBITDA is strong and growing.
6:28
Margins are steady, generally in the mid-teens.
6:31
In the middle market, EBITDA is challenged.
6:34
I mean, there's no other way to put it.
6:36
Um I think over the measurement period in the most recent data, uh EBITDA has been down sort of 20, 25% since 2019.
6:45
That's a really a difficult sort of place to exist.
6:51
Margins in the middle market are also much much much narrower.
6:54
So, if the public market, on average, has a mid-teens starting EBITDA margin, in the middle market, we're talking about mid-single digits.
7:03
So, there's just less room for maneuvering, less room for error.
7:08
Uh those companies do also tend to have um structurally constrained or more difficult balance sheets.
7:14
So, they're strapped up more by their lender.
7:19
Middle market tends to access bank finance rather than, let's say, broadly syndicated loans or private credit, which will have more flexible covenants and characteristics to the credit agreements.
7:30
So, it's a tighter, less flexible capital structure they're starting with.
7:37
When we look at cash flow in those two areas, we see net profits after tax in the public market strong, persistently growing.
7:46
When we look in the middle market, we see that um that net profits after tax is down uh almost 200% over the measurement period.
7:53
So, that is it is consistently negative over the past 2 years.
7:59
Uh it's a troubling place for the middle market.
8:01
Like I said earlier, there's this nagging feeling that everyone has that there's trouble in the economy.
8:08
What we do in that data set is put some numbers to that.
8:10
We sort of can illustrate to people, "Look, we understand what you're seeing in the ticker tape economy.
8:15
We understand what you see when you turn on Jim Cramer and he's screaming about it's a buy buy buy."
8:22
But we also understand that when you go home at night and you're thinking about the world, you have this feeling that things are tough.
8:29
There's a third of the economy that has this like aggregate problem. Yeah. I have three questions.
8:34
You can take them however you want.
8:34
One is, who owns these things?
8:35
Like, who owns the equity in these things?
8:38
Um why is this happening?
8:42
And like, what does it mean prospectively?
8:43
There's a A, who owns them? It's a mix.
8:45
Uh it tends to be smaller sponsors, families, some individuals.
8:52
Um these are companies that you know, a lot of the management teams have grown up inside the companies.
8:57
Um Maybe they're families that control them, maybe not.
9:01
If they do have, you know, professional management teams, often times, you know, these are not management teams that went through the GE training program.
9:08
Um as a consequence, they're making intuition-based decisions or pattern recognition-based decisions.
9:16
Uh they're not sort of relying on what you and I might think of as sort of data-driven decision-making. Why is this happening?
9:25
Like, so, you get this hollow It sounds like kind of like a hollowing out of a third of the economy.
9:28
Uh in fact, that's the exact language we use.
9:32
And there's all this decline in EBITDA, declining cash flow, interest burdens that are higher, scary-sounding stuff. Like, Right.
9:38
what are If you had to narrow down the couple of reasons for what's driving that, what do you think they are? I think market power.
9:45
So, the middle market companies typically don't serve the end consumer. Yep.
9:49
They typically serve the larger public company.
9:54
So, these larger public companies which have pricing power with their customer who tends to be the end consumer Yeah.
10:00
uh also have pricing power over their supply chain. Mhm.
10:02
So, they're pushing costs um they're pushing financing down onto those middle-market companies while taking that margin.
10:10
It's like a corporate class system. It is. Yeah.
10:12
I mean, there's no other way to understand it uh in that the rich are getting richer and the poor are getting poorer. Yeah.
10:18
As again, I go back to you know, we see this expressing itself in the political sphere.
10:22
um Because people are looking for some kind of outlet, some sort of expression of this frustration because they feel it in their everyday lives and their businesses and how they go about work.
10:33
These companies just have fewer resources, they have less to stand on and so they have less bargaining power.
10:40
What do you think it means?
10:40
Like what is this just an inexorable trend that's going to keep going and the rich are going to keep getting richer?
10:47
Uh we'll talk about the workouts and bankruptcies and all that fun stuff next.
10:51
But before we close the chapter on what's going on Yeah, what what's to be done about this if anything?
10:57
So, look, there's a few different ways this can resolve itself, but it probably will resolve itself with a bang in some way.
11:03
Um now that bang can be a long drawn-out you know, something that looks like um you say the early 2000s where we had just a years of you know, persistent restructuring across large portions of the economy. Yeah.
11:18
It could also look like the late '80s, early '90s where you know, we had a real credit contraction uh as people dealt with over leverage from the direct lending crisis or some people call it the S&L crisis of the late '80s, early '90s.
11:32
Um that sort of feels like we're the world we're heading into.
11:36
Uh there are other scenarios you could imagine that are more punctuated.
11:40
Let me go back to what I said earlier about debt service coverage.
11:43
Um interest coverage is a funny problem because again, you got to make that coupon payment.
11:47
If you're unable to make the coupon, uh you have a couple of options.
11:51
You can go to your lender and try and work something out or your ultimate resources, you can go petition the courts for protection.
12:00
In the 2023 data, we saw that almost 25% of the companies in the data set couldn't make their debt service coverage.
12:08
So, um surprise, surprise in 2024, business bankruptcies hit like a 14-year high.
12:15
Fast forward, the 24 data that we're living with now in 25 showed that another 20% of the data set couldn't make their debt service coverage.
12:25
So, um based on the data we see to date and the bankruptcies that we've already seen in 2025, we would expect 2025 to show persistent and possibly higher number of business bankruptcy filings. Yeah.
12:37
Uh we're also interestingly starting to see some larger companies suffer that as well.
12:43
So, you know, it goes back to um you know, as much as the infomercial that is CNBC uh wants to convince you that everything's great in the economy, it's just clearly not. >> Mhm.
12:54
You know, how do we resolve it?
12:54
Um look, I think there is uh there's broad-based weakness in this economy. Um We can spur growth.
13:04
You know, sort of get everybody buying, everybody that you know, there are some macro things you could do.
13:09
You could pump more liquidity into the economy.
13:10
Of course, you risk an inflationary spiral which we're probably you know, on the cusp of again.
13:17
Uh You can do some sort of wholesale debt restructuring and get try to get through it quickly.
13:22
That would be recasting a resolution trust company type idea.
13:28
I don't know that there's even the beginning of the political will or discussion to do that at the moment.
13:31
So, I sort of go to the meander solution is way this probably goes where we just slowly work through this over time and we solve problems one by one.
13:43
It's a good time to ask for your definition of distressed investing. It's a great question.
13:49
Like distressed investing covers a lot of things.
13:51
You know, the the the term has been I would say um abused in recent years.
13:58
When I got into the business, it meant buying the debt stock of an individual company and then exercising the rights and remedies under the credit agreement to drive an outcome that generally involves some amount of operational improvement.
14:10
Now look, back when I got into the business, credit agreements were tighter and so companies got themselves into tougher spots in a narrower range.
14:20
So, um the covenants were such that if your performance started to decline, you know, bat it back into the middle of the fairway or deal with the problem.
14:30
Today, covenants are much more much wider and as a consequence, when you violate a covenant or get to a place where you need to restructure one way or another the business is just worse off generally and needs a much bigger operational reworking.
14:49
So, when we think about distressed investing, it is provisioning capital into difficult situations that are capital constrained.
14:55
Now, some people look at distressed investing as uh you know, when the market pukes out, we're going to step in and buy.
15:04
And watch it ride back up.
15:04
That happens, you know, every 10 years there's a big puke out.
15:09
That's a tough investment strategy to prosecute. >> Yeah.
15:13
The reality is that the data is pretty clear.
15:15
In each and every year, there is some portion of the economy that is running at a two to three times the average default rate in the system.
15:24
So, that is to say there's several sectors, a handful of sectors that have a much higher um than average default rate.
15:31
That can be as a consequence of um uh of sector risks or um some sort of factor input that that input that impacts broadly across that sector.
15:42
Can be a change in consumer preferences that impact a number of companies, change in government policy.
15:47
What is it today just like ground people in it like what are the couple examples of those sectors?
15:52
>> Unfortunately today, it's everything.
15:53
The most acute is of course the tariff risk. >> Yeah.
15:56
Um and by the way, we have some data.
15:58
We have some thoughts about what that might look like for companies.
15:59
Uh but the indecision of tariffs Yeah, the uncertainty. Yeah.
16:04
That somebody said to me recently, well, Christmas is canceled.
16:10
Why is Christmas canceled?
16:10
Well, you have to put your orders in now.
16:11
So, if you're a business trying to make a decision about what your Christmas book is going to look like >> Yeah.
16:17
How do you even make that choice today?
16:19
I think there's lots of challenges in the economy.
16:20
There's lots of things that you know, people are having um having to make big bets where you don't know which way anything's going to go.
16:30
Are you going to be able to have your supply chain continue to be in China?
16:34
Are we going to have a persistent trade problem with them?
16:36
Tariffs, our data looks at again across the middle market and then we look at the public market and say, what are the likely impacts and how does this work through the balance sheet and what would you suspect happens?
16:50
I can make a pretty strong argument that public companies will actually benefit from the tariff regime.
16:55
And you know, again, I'm going to assume that the West Wing is um is being thoughtful in its analysis and its deal-making strategy and they've probably come to a similar conclusion.
17:06
I think the Treasury Secretary speaks pretty confidently uh and directly about this and I agree with their assessment.
17:13
For the ticker-tape economy the tariffs are not going to be terrible.
17:17
In fact, they could be constructive.
17:19
For the middle market though, um anything above like a 5 or 6% tariff will have a devastating impact on margin and consequently on the ability to service their debt stock.
17:30
So, um any persistency to tariffs uh will be um will will crush the US middle market.
17:39
>> And so, I like your definition of distressed we talked about earlier which is basically just like capital where there's no supply of it. >> That's right.
17:44
Um and and so, just say like a little bit more about what it's what it feels like to do your style of investing, maybe even this lay out a little bit more about Marblegate and how you prosecute things.
17:53
Um because obviously like this style one might be really useful and important in this workout that you're talking about.
17:59
Um but also for people that are, you know, interested in returns, like could also be a source of high returns, especially if there's limited capital chasing it.
18:08
So, say a bit more about Marblegate and what you do and and then we'll talk about some fun examples.
18:10
Marblegate started in 2008, 2009.
18:12
2008, um my business partner Paul Arway called me up. He was at Bear Stearns.
18:19
I was at another distressed investing uh firm called Epic Asset Management.
18:22
And he said, look, all great distressed investment firms are born out of crises and this one's ours.
18:30
And we sat down and talked about like how would we go about building an investment firm and how would we go about accessing uh investment opportunities in the distressed market.
18:40
Now, Paul and I had done a lot of business together over the years and we liked focusing on the same types of businesses.
18:46
We saw this middle market area as being, you know, wildly underinvested.
18:53
As we grew up in the business and I oftentimes refer to Paul and I as the youngest of the old group of distressed investors, what we saw were um the Oaktree's and the Apollo's and and those folks who had sort of cut their teeth investing in distressed getting bigger and bigger and bigger.
19:11
And a lot of that mimicked or mirrored the growth in the LBO market.
19:13
Um you know, we oftentimes refer to the LBO business or the private equity business as our manufacturing division um because they will produce a certain amount of problems pretty consistently.
19:27
So, as the LBO's got bigger, uh a lot of the investors who had been built to invest in their problems similarly got bigger.
19:35
But that left an entire portion of the market just underinvested, under-prosecuted, under-looked at, under-analyzed.
19:42
And we saw it as pretty rich pickings.
19:46
So, when we sat around to build Marblegate, we said, look, we're going to focus on that middle market.
19:48
Um at the time, you know, we were convinced that there was um going to be good opportunity.
19:54
We couldn't have imagined that it would persist with as much duration as it has.
20:01
Our focus uh in accessing that um is around the US banking system.
20:04
The middle market continues to get most of its capital out of the banking system.
20:08
We hear a lot about private credit and at Marblegate we talk a lot to private credit, think a lot about it, and have a lot of views on it.
20:17
Uh we think about the broadly syndicated market also.
20:19
We think about all sort of forms of corporate credit, but the reality is we access most of our investment opportunities out of the banking system.
20:29
We built Marblegate with the idea that we would go talk to banks, um source our product um directly from them.
20:37
So, we built a sourcing team and our sourcing team goes out and talks to, you know, hundreds of lenders um across the United States.
20:44
I like to say that we are the number one buyer of steak dinners in the middle market and in middle America.
20:50
We also um built, of course, an analyst team.
20:53
We have in-house financial restructuring.
20:57
So, today a lot of, you know, the folks that call themselves distressed investors, again, I I I view them as buying cheap high yield and sort of participating as pure financial investors and uh portfolio traders.
21:08
Um But, they will outsource all of that critical thinking.
21:14
At Marblegate we say there is no outsourcing of critical thinking.
21:18
And so, we think about the financial restructuring in-house.
21:20
We also built an operational restructuring team in-house as well.
21:27
Again, going back as Paul and I looked at the market evolve, we saw the those covenants widening and the businesses deteriorating.
21:33
And so, we knew that when we were taking control of them or inserting ourselves into their capital structure and their ongoing operation and resolution, that we needed to bring to bear resources.
21:45
Now, there are some great firms out there, FTI, Alvarez Alex Partners that specialize in doing that.
21:52
You know, again, particularly on behalf of the portfolio investors who are more traders in this space than investors.
21:57
Um but A, those those firms are large, they have large cost structures, and they're generally more than a middle market firm can bear.
22:12
>> And you're very much a roll up the sleeves guy.
22:13
Like like I think you've had like personal security at times cuz you're dealing with things that are really hard.
22:18
Like this is That's not This is This is a full contact version of distressed investing.
22:22
And so, I want to talk about like all aspects of it.
22:27
But but I want to start with maybe like a story.
22:28
So, the first the first story you ever told me, I don't know if it's the best one, but it's the first one you told me and I remember it viscerally, was you buying like some crazy percent of the taxi medallions in New York City.
22:38
Can Can you tell that story just as like a representative example of the sort of thing that you do?
22:42
My partner Paul came into my office and said, "I'm talking to a bank who wants to sell some um loans against New York City taxi medallions."
22:50
And I said, "That is the worst idea I've ever heard." He said, "Okay."
22:54
And we went about our way.
22:56
A few weeks later he came back to my office and said, "You know, I just spoke to that same bank again and um they want to know if we would be willing to look at those loans against taxi medallions."
23:05
Remains the worst idea I've ever heard.
23:08
>> This is like peak Uber ascension.
23:08
So, it was exactly it was two 2016.
23:13
Uh and so, Uber had come to New York in 2015 in a big way and had made a huge push into the market through '15 and '16.
23:21
Uh they were subsidizing every ride and uh the real problem, by the way, and this is super interesting, there was this perception that they were taking riders away from from taxis and that was not at all the case.
23:33
The data was super clear.
23:35
They were expanding point-to-point car service in New York.
23:41
Um they were taking drivers away from yellow.
23:44
And so, yellows were stacking, parking themselves, not generating revenue as a driver went to Uber.
23:49
And the driver was going to Uber uh because Uber was subsidizing every ride.
23:56
So, the driver's earning power was accelerating.
23:58
Uh people were making rational choices.
24:00
By the way, more people were switching into Uber from other modes of transportation, bus, um uh private car service, subway, because Uber was subsidizing New York.
24:14
Uh New Yorkers are the most sophisticated, price sensitive consumers in the world.
24:19
They were getting uh brand new cars cuz all the drivers were going out and buying new cars.
24:23
They're getting brand new black cars and subsidized service.
24:28
New Yorkers were saying, "This is a deal.
24:29
Yeah, yeah, I'll do this every day."
24:32
So, um Uber was having a tremendous amount of success and they were pulling those drivers away.
24:37
The interesting thing is when we started doing our research and by the way, we spent two years researching it uh before we ever did anything.
24:43
I mean, my favorite party trick, actually, is um uh as part of that as part of that research I became a uh New York City taxi driver. And I still go out here.
24:59
I I still go out and and drive. Um That's funny. Yeah.
25:03
Well, you have to stay connected to the market.
25:05
But we we spent two years researching the space.
25:10
Um a lot of time in Queens going garage to garage, uh learning about the market, learning about sort of how it works cuz it's pretty complicated ecosystem, to be honest.
25:19
It's emerged over 100 years and employs literally thousands of people in New York City.
25:25
It also is an important on-ramp uh to American commerce for the immigrant population.
25:31
When I did my um my taxi driver's license, you have to do a pretty complicated and long set of of uh classes.
25:39
It's It's no London, but it's still demanding and expensive.
25:42
But, the um I was the only native-born American in the room.
25:47
Uh everyone else had sort of come to the United States in search of a better opportunity.
25:54
Uh so, it's an important spot for New York commerce uh in particular.
25:58
And by the way, uh what people don't realize is the bulk of New York City taxi medallions are owned by individuals that are driving the taxi.
26:08
So, it's a small business in and of itself.
26:14
By the way, pre-Uber coming to town, uh taxi medallions had been worth over a million dollars. They peaked at 1. 2 million dollars. For one medallion? For one medallion.
26:23
And by the way, again, if you look back um and sort of look at it purely on a cash flow basis and where interest rates were and alternatives, not the craziest thing to have happened.
26:34
I mean, you or I would never have done it, but um I can understand why somebody might have made that decision.
26:42
Again, not a decision I would make, but not the craziest thing.
26:47
Now, that being said, the average unpaid principal balance of a taxi medallion loan ended up being about $550,000.
26:55
So, the average taxi driver owed $550,000 on their medallion loan. Crazy.
26:59
It was It was a lot of money.
27:03
So, we spent, you know, we did a bunch of uh survey work.
27:07
Uh we came up with our own understanding of what uh an Uber driver's net earnings were.
27:14
And what also became pretty clear to us is that um Uber was taking advantage of an information asymmetry.
27:20
So, they understood that a driver didn't really understand the full picture of their cost structure and that they were making a very cash-based decision, uh but they were pushing a lot of those non-cash or non-immediate cash costs onto the driver.
27:38
Uh they were taking those liabilities on.
27:40
And ultimately, when you adjusted earnings for all of that, uh the driver was really under-earning what they should.
27:48
You also saw a lot of turnover in those days because I think drivers were coming to the conclusion over time that the their own individual return on invested capital wasn't sufficient.
27:56
We sort of started to understand that.
27:58
In fact, when I was out with a um 70-year-old garage owner who I think had grown up as a taxi driver, his his father I think had bought medallions in the '30s, he said to me, "Andrew, you know, the reality is nobody's reinvented the economics of driving a car yet.
28:15
And until that happens, taxis remain the most durable cash flow in the system."
28:23
And over time we proved that out to ourselves, at least.
28:25
Um we got we convinced ourselves and obviously our investors that what was available here um was uh an unbelievable market that for lots of reasons had been under-invested in terms of operations.
28:40
So, there'd been lots of leverage put into the system.
28:42
I would say that the folks who had uh owned medallions and operated fleets had been extractive.
28:49
So, they hadn't been investing in the business, they hadn't sort of treated the driver the way they should.
28:56
You know, I used to begin every conversation with somebody in the space the same way.
28:59
Tell me who your customer is.
29:02
Do you know what the answer was from like 100% of them? What? Well, who would you say? I don't know, the rider. Right?
29:08
That was the answer everybody gave. >> Yeah.
29:12
I as the medallion owner have absolutely no economic relationship with the rider. The driver pays me.
29:17
My customer is the driver.
29:22
Everyone gave me the exact same answer.
29:23
They gave me the passenger as the answer.
29:26
I said, "But the driver pays you."
29:29
Uh well, okay, sure, I guess. Yeah.
29:29
But they weren't treating their customer the right way.
29:34
They were being I don't abusive. Yeah.
29:36
I mean, it was uh it was obvious what was going on.
29:42
So, there's really negative relationships in the industry.
29:43
The industry was as a consequence sort of set up as combative.
29:50
Even though all this capital had gone in and it was literally billions of dollars of capital that had gone in.
29:55
There were 13,587 New York City taxi medallions.
29:58
And if I told you what the average unpaid principal balance was, the math pretty easy. >> Yeah. Right?
30:04
So, you're talking about billions of dollars of capital that had gone in and by the way, fleet owners on yachts and taking helicopter services out to the Hamptons while the drivers were struggling to make ends meet.
30:18
And it was it was just the worst setup imaginable.
30:20
Didn't you also at some point go into some government office and ask for some data set and they're like, yeah, no one's ever asked for this before.
30:27
So, the TLC who's been a who's like a great agency inside of city government and at the time the commissioner was Meera Joshi who later went on to become deputy mayor in New York.
30:39
The current TLC commissioner is David Do who's terrific to work with.
30:45
But we went to the commissioner and said, can we get some of the data you have on the taxi market and Uber and Lyft and all of these guys?
30:54
And she said, sure, you know, just put in a foil request. We're happy to serve.
30:58
She said, but what are you looking for? I said, well, all of it.
31:01
What do you mean all of it? I said, everything.
31:02
She said, nobody's ever asked us for all So, she gave us like terabytes and terabytes of data.
31:05
We had to Ride level data, right?
31:09
Ride by ride, the entire data set.
31:13
It was it was a lot of data.
31:13
It was we tried to load it into Excel.
31:16
Excel was like, you got to be joking me.
31:20
So, we have couple of data scientists on staff at Marble Gate.
31:26
Sort of ingested the data into various data systems.
31:30
And we started to cut it up and what we found again, you know, there were some immediate insights.
31:36
The one I mentioned earlier where Uber wasn't taking rides, they were taking drivers.
31:40
That popped out immediately.
31:42
We also saw some really interesting data in when people were making choices to take Ubers versus taxis.
31:49
I think every New Yorker has an algorithm in their head.
31:52
Time of day, where am I going, what am I wearing, what's the weather, what do I think the traffic pattern looks like, day of the week.
31:59
And they say in that with that algorithm they make a decision.
32:03
Am I going to take a taxi, an Uber, a bus, subway, a private car, am I going to drive myself?
32:09
They are figuring that out real time.
32:14
What popped out really quickly was if you were going to go east-west in Manhattan, you're almost always going to take a taxi.
32:22
If you were going to take ride on a Saturday night from the Upper West Side to TriBeCa for dinner, you're probably going to call an Uber.
32:33
And when we looked at the data, I mean, what I love about like data analysis in companies and sectors is when you really dig into it The truth pops out. >> And it's obvious. It's it makes sense.
32:45
You you relate to it intuitively.
32:45
You saw how New Yorkers were making decisions. Exactly.
32:48
And so you saw how New Yorkers were making decisions.
32:51
And like I said earlier it squared with the economic reality that Uber's going to subsidize my Friday night date. Great. Let's do that.
33:03
So, um how New Yorkers were making decisions, how drivers were making decisions was also super interesting because we could track individual driver behavior.
33:14
And so we could tell successful driver behavior looked schematic. It was symmetrical.
33:18
They were following almost predetermined patterns.
33:22
Now, not the same pattern.
33:24
Each driver had their own system that they had developed but it was thoughtful and looked thoughtful and looked intentional.
33:34
Drivers who were under earning looked like a Rorschach test.
33:36
It was just a scattergram of behavior.
33:41
And as a consequence, they were under earning what we thought they could and should.
33:45
By the way, fast forward later when we set up our own operation, we ran a bunch of experiments with drivers where we said, look, you're likely to make, let's say, $200 a day at that point net.
33:58
We'll guarantee your $200.
33:58
But we want you to run an experiment with us.
34:02
So, if you will just follow these patterns of behavior >> see as the most profitable, yeah. >> Right. We'll guarantee the 200.
34:10
And by the way, if you earn more than 200, keep it.
34:14
We ran dozens and dozens of experiments.
34:16
How many payouts did we make?
34:18
Tons of payouts above the 200. Right. So, we paid nothing.
34:20
The driver always out-earned when they followed the data-driven decision-making.
34:24
I mean, my favorite was the what I called the NASCAR loop.
34:28
So, the data showed that if you picked up at the bottom of Broadway, you were high probability, you know, around sort of Columbus Circle, you were going to drop off somewhere north on Broadway.
34:42
I'm going to make the left turn. Yeah.
34:43
Because the data also showed if you picked up at the top of Broadway, you were going to drop off somewhere midtown around the bottom of Broadway.
34:53
So, we just run that NASCAR loop. Left-hand turns only.
34:57
And it turns out to be a super profitable circuit.
35:00
And there's lots of pockets of opportunity around New York.
35:02
The other thing by the way is the fleets did a terrible job of telling their drivers when there was a Knicks game.
35:11
Did a terrible job telling them when there was a Rangers game.
35:15
Terrible job telling when concerts were going to be. All at MSG obviously.
35:17
And you know, I know you're a Knicks fan.
35:21
You've come out of out of MSG and you wonder where the hell are the cabs?
35:26
Uh Don't they know there's a game letting out?
35:28
The answer is they didn't know there was a game letting out.
35:31
And as I said to you earlier, most of our most of the drivers are not native New Yorkers.
35:38
You know, we later on opened what we call a taxi clubhouse.
35:43
I can go into why we opened it.
35:43
Pretty pedestrian reasons but it's been wildly successful.
35:47
In there we have TVs on our our drivers are soccer fans, football fans.
35:55
They don't pay a lot of attention to the sports that drive American Americans or New Yorkers.
36:02
So, there's just like a cultural divide.
36:04
They don't know all the time where to go.
36:06
The best drivers figure it out over time and again, develop a system.
36:08
We sort of took all that data from the TLC and we immediately got tons and tons of insights.
36:15
As we got invested into the space we started pulling more data.
36:18
As we built our own operation, we get more data.
36:23
All that data goes to data-driven decisions.
36:26
Because again, as I think about distressed investing broadly, one of the things we talk about is moving companies.
36:32
Earlier I said management teams make intuition or pattern recognition-based decisions.
36:41
We want to move everybody, whether you're middle market manufacturing company or taxi driver to a data-driven decision. Right?
36:50
That data-driven decision has more persistency to it.
36:52
It has a higher probability of being right because it's informed.
36:58
It also you can push decisions down where you're they're not top-driven, they're operator-driven.
37:03
And the operator is going to use that data to make the decision and where they need to adjust around the edges, then they can use their intuition or their pattern based decision-making to uh sort of shape it around the edges.
37:18
But we're starting from a better place.
37:20
You get this insight and all of a sudden it goes from the worst idea you've ever heard to like a maybe feasible.
37:26
Talk about the transaction or transactions to buy into the into the space.
37:30
So, a bank has the loans.
37:33
Your counterparty is the bank and you get comfort with the value of the medallions.
37:38
And so then what do you do?
37:39
Like how what what are the investing steps?
37:41
Actually, our first investment was um definitely I knew at the time but clearly in retrospect the riskiest trade that we did.
37:50
As we went around and talked to banks, they would say, well hasn't been really any transactions. Like many markets.
37:57
Like one of the good indication of when a sector is going to or a company is going to tipple over is it gets super illiquid in its securities or loans or whatever.
38:09
The taxi market had gotten super illiquid.
38:10
There were no medallion transactions happening.
38:12
Buyers and sellers moved too far apart, nothing ends up happening.
38:17
One of the all-time great indicators of when something is going to really sharply move.
38:22
So, there'd been no transactions.
38:22
And the banks were saying to us, well, look, there's no transactions happening.
38:28
We'll give you a discount because we know it's not great out there.
38:29
But we think maybe $350,000 per medallion is where we would exit them.
38:37
Not not going to pay that today.
38:37
And and we think you're going to have to restructure large large portions of this market.
38:44
So, there's a lot of work and time that's going to go into it.
38:45
Both of those things we're going to we and our investors are going to need to be compensated for.
38:51
So, we were walking around talking to all these banks and really nobody wanted to transact with us.
38:56
And then you know, God smiled on me one day.
39:00
Guy by the name of Gene Friedman who the post used to like to call the taxi king of New York had gotten in a fight with his lender which was Citibank and Citibank had exercised remedies against him, seized his collateral and we're going to auction it off.
39:13
Now, the auctioneer was a guy out in Brooklyn that we knew.
39:19
And we called him up and said, hey do you have a stalking horse bidder for these medallions?
39:24
And by the way, it was 48 outright medallions, not loans, outright medallions.
39:30
He said, stalking horse bidder?
39:32
We're going to go to the Airport Marriott and open outcry this.
39:36
I said, listen, call the lender up and tell them that I'll be be stalking horse.
39:41
He said, okay, what price?
39:44
Now, I gave him a price that was way, way, way below $350,000. >> you give him?
39:49
Uh $150,000 per medallion. Okay.
39:51
He said well, they'll never do that.
39:54
Well, but it's a free option. I'm the backstop.
39:56
We'll we'll do the open outcry.
39:58
Uh we just we we're your backstop. Yeah.
40:03
So, he said okay, well, I'll call them up.
40:05
About an hour later, he called me back.
40:07
He said, they won't do a penny less than 160.
40:12
So, uh I said great, you're done.
40:12
Uh we went through the uh auction.
40:15
And the way the auction rules worked, you kind of had to buy all of the medallions, or it really didn't satisfy the lenders' needs.
40:25
And the truth was uh the combination of the way we structured the bid and the auction rules were such that it was going to be really hard for anybody other than Marblegate to win the auction.
40:37
So, we walked away with 48 outright medallions.
40:39
But most importantly, we had created a mark that then we we then had sort of hand delivered to every lender in the space.
40:49
Now, they had direct evidence of a meaningful number of medallions transacting at a at a level way below where they had previously estimated it would.
40:58
And by the way, we did that to them uh at the very end of November, beginning of December.
41:03
So, they're looking at a year-end mark Yeah.
41:06
that didn't feel so great. >> Yeah.
41:08
Surprise, surprise, come January, the conversation becomes pretty serious with a number of the lenders we had talked about.
41:13
And they wanted to engage at much more reasonable levels.
41:18
We ended up buying um the largest uh portfolio available from a federally chartered bank.
41:26
It's an important understanding when you're dealing with banks what their regulatory scheme is.
41:29
Um state chartered banks, credit unions, federally chartered banks, they all have slightly different ways they operate and how they're regulated.
41:38
Because at the end of the day, banks always make um decisions for three reasons.
41:44
Regulatory, regulatory, and regulatory.
41:48
Uh they people think of banks as economic actors, they're not.
41:49
They're regulatory actors.
41:52
So, um this compromised their regulatory position.
41:55
For a federally chartered bank, those tend to be much larger banks.
41:58
Uh this was a very small piece of their portfolio, and so they can more quickly get to a place from an earnings power impact and a balance sheet impact that they would dispose of the portfolio at a sharp discount.
42:11
So, we went to the federally chartered banks, we went to the largest portfolio, and began a negotiation with them.
42:17
Moved through that pretty quickly, and took that portfolio over.
42:19
That automatically made us the largest independent lender into the space.
42:27
It also um now you have multiple transactions.
42:29
Uh the largest group of lenders into the space were the credit unions.
42:37
The credit unions faced with uh prospect of a sharp decline in the asset value on their balance sheets, found themselves essentially insolvent because um prior to 2015, or ultimately 2000, let's say 18, 19, when this part of the story is happening, taxi medallion loans were considered gold.
42:59
Because look, they are um remain an important part of New York City's infrastructure.
43:06
Uh they're important when you talk to New York City, uh to the regulators, uh to transportation department, city planners, transportation consultants, all of them point out New York City has a hard time operating without taxi medallions.
43:20
Also, it's a meaningful portion of the New York City budget.
43:25
So, for all of those reasons, we felt like um New York City would take a pretty active role in uh supporting it.
43:31
The market understood that for years and years.
43:35
So, the haircut on a credit union's loan was next to nothing. >> Yeah.
43:41
If you were a credit union in New York, you could not lend to the space. It was so profitable.
43:47
Now, with the sharp decline in assets, uh the NCUA, which is the FDIC of the credit union space, essentially seized a number of those credit unions.
43:54
So, it ended up that the largest lender to the space was the federal government.
44:02
That allowed us to begin a conversation with the federal government, with the NCUA, about acquiring those assets.
44:09
It took a long time uh for one really important reason.
44:11
Uh the NCUA wanted to make sure that the way we were going to deal with um the borrowers in the space and sort of respected the dignity of the borrower, uh that we were not going to be rapacious.
44:24
All of these loans had personal guarantees.
44:26
Uh and so, drivers who had levered up to buy a taxi medallion uh had really at risk their home, their livelihood, everything.
44:34
Uh and the NCUA understood that we needed to be commercial, but also wanted to make sure that we weren't going to be abusive to the borrowers.
44:43
And you know, so they spent a lot of time understanding uh how we were um dealing with problems.
44:51
Uh now, a part of the story I left out earlier is that you know, we ended up with 4,500 individual line items in this portfolio.
45:02
Prosecuting that is a just a huge lift.
45:05
Uh you have to send out bills every month. You have to collect.
45:06
You have to call people when they don't pay.
45:08
So, there's a servicing aspect to this.
45:12
We went to speak to virtually every servicer out there about, you know, could they help us?
45:16
And um the answer for 97% of them was absolutely not.
45:22
We want nothing to do with this.
45:23
Uh politically sensitive, there's uh you know, tough space, tough borrowers.
45:28
Our borrowers will spend two, three months out of the country, typically going back to their home to spend time with family.
45:37
Just a setup that a lot of servicers didn't want to take on.
45:39
The servicers who were even willing to have the conversation, which there were only a couple, their pricing was ex- itself extractive.
45:48
They There was no way we could do a deal.
45:50
So, we actually stood up a servicer to service the space, which today has almost 30 people in it, a collection of lawyers, paralegals, uh phone bangers, people sort of calling borrowers.
46:02
As we thought about taking down the government's paper, they wanted to understand how we were doing that servicing and how we were sort of enforcing if that was necessary, and what our thoughts were about ultimate resolution.
46:16
When we got deeper in, so we ultimately became by far the largest lender in the space, by far the largest participant.
46:23
Give us a sense of scope of that, like the number of medallions, or like what's what's like the right the dollars deployed or something.
46:28
Yeah, so uh it was over $600 million deployed into the space. >> Wow.
46:33
Uh we had, you know, over 4,000 individual assets uh on the balance sheet.
46:37
Out of Out of 13,000 medallions? 13,587. Big chunk of them.
46:43
Now, you're the taxi king of New York. Hardly.
46:48
But uh I think one of the good pieces of advice that we got um actually from uh uh Risa Heller, who has a runs a firm called Heller Communications, who has advised us throughout this.
47:00
And uh Risa had come out of Chuck Schumer's office, and you know, has a sort of great connectivity into the New York political scene generally.
47:11
She said to me very early, you need to go explain everything you're doing and plan to do to every regulator and politician that touches this or is interested in this.
47:22
And so, we spent a lot of time going and seeing individual council members, um individual regulators, went to the mayor's office.
47:31
We sort of laid out for them, look, these are the problems we see.
47:34
This is what we think the solution set looks like.
47:37
We think it's going to be difficult, but we think the outcome looks like the following.
47:41
And by sort of being transparent about what our plans were, even though we weren't sort of advertising ourselves or what we were doing broadly, we were making sure that the people who would be most interested and the people who were going to have the most political sensitivities to this were informed and well informed.
48:00
So, by going out and and getting in front of that, as we became large, um we I would say had a very constructive dialogue with um everybody in the system.
48:12
I think the other thing that we did, again, I think that has worked to our benefit over time.
48:18
I described earlier there was this contentiousness in the space.
48:22
Uh labor, operator, capital, nobody really even talked to each other, much much less liked talking to each other. >> Right.
48:31
As people figured out that Marblegate was playing a larger and larger role, one of the first things that happened, um our offices are here in Greenwich, Connecticut, we were picketed by uh the Taxi Workers Alliance, which is the de facto union for the space.
48:46
One of the things I I'm most proud of is we had water and sandwiches delivered to them.
48:50
Uh it upset my team, uh and I actually don't even think the Taxi Workers Alliance knows this, uh but I actually uh you know, put on a baseball cap and a t-shirt, and went out and marched with them, and talked to the drivers, and Showed them your license?
49:06
And said, grabbed a sign, and said, I want to sort of understand Yeah, what's going on?
49:09
What what what's on your mind?
49:10
Like, what Tell me tell me what's Tell me what you need. Tell me what's going on.
49:14
And look, what we ultimately did do that across the table from each other in a conference room, but the reality is you get a sense of things by really going and speaking with people and understanding really what's driving their decisions and how they really are interacting with you or the problem that they're facing. >> Yeah.
49:30
By spending time with drivers in informal settings like that, but also formal settings uh with the taxi workers alliance and particularly with the leadership of the taxi workers alliance.
49:43
Look, I found their concerns to be completely valid and real.
49:44
I thought that the pressures they were facing were obvious and unavoidable.
49:51
Um it was very clear to me that the system was not working for them and in order for the system to thrive, look, again, they're my customer.
49:57
I needed it to work for them.
50:00
And so we began a really constructive uh conversation and relationship with the taxi workers alliance.
50:07
Um I'm very happy to say and I I I think the leadership of the taxi workers alliance would agree, we continue to have a very constructive, productive, and partnership-like relationship.
50:18
>> How do you think about that now?
50:18
So you you're X amount of dollars in you own 4,000 something odd medallions.
50:22
Walk us through the end of the story or at least the current snapshot of the story.
50:27
Actually, just a few weeks ago, we took our entire taxi operation public. Oh, wow.
50:34
So it should have a very durable and persistent cash flow that should be able to be valued by the market.
50:38
And I think there's sort of some like pretty exciting and compelling things that we can do in continuing to grow that operation, add other services, other pieces of the ecosystem in because the ecosystem does work.
50:54
Um it had been too disaggregated.
50:57
There were too many people taking a profit margin out of it.
50:59
The reality is we needed needed to be much more efficient.
51:03
We needed to be much more cost constrained.
51:05
We needed to be much more sort of operationally focused on efficiency and delivering to the customer. Right?
51:12
The customer wasn't getting enough value out of the relationship.
51:16
The only way you can give that customer more value is if somebody else gets less value.
51:19
And the only way you can get sort of squeeze those margins through consolidations and efficiency.
51:22
So that's where this market ultimately goes.
51:25
We're I think the obvious sort of candidate to do it.
51:29
>> Why take it public instead of instead of sell it to some huge, you know, private equity firm or something else?
51:33
I think there is um there is legitimate concern about what the shape of this market looks like as we go into things like autonomous vehicles.
51:43
I think it What does What does the future hold?
51:45
Um I think the sort of simpletons answer to that is oh, well, you can't fight technology and the reality is um while I think autonomous vehicles pose a real threat to the livelihood of the individual driver, when I separate driver from asset, and I think about what are New York City's interests, um I think the medallion has, again, persistency to it.
52:12
Look, the medallion system was introduced in the 1930s by Fiorello LaGuardia, uh the famous mayor at the time, under what was called the Haas Act.
52:24
Because in the sort of days af- during and after the depression, New York City's streets get super clogged because people were out of work and they would get in their car and drive people around as a service.
52:36
LaGuardia looked at the system and said, "This is terrible. Nobody can get around.
52:39
We need to shrink congestion, get cars off the street so that the city can operate."
52:45
They introduced the medallion system.
52:48
Look, that basic intuition, that basic imperative hasn't changed.
52:53
In the world of autonomous, actually, I think it accelerates in some ways.
52:59
You know, you and I are sitting in Greenwich, Connecticut while we were doing this interview in a fully autonomous world, theoretically, we could sit down and send our cars to do a little work in New York while we were doing this.
53:09
They'd be back by a certain time.
53:12
That's not great for New York City's operation.
53:15
I would also say that, you know, people with like less scruples might say, "Go down to New York City and work, but don't take any rides, you know, north of 125th Street."
53:27
Things that would just be absolutely repugnant operationally, but also in strict violation of New York City's operating rules around taxis and how rides can be taken and and serviced.
53:40
So I think the city has an ongoing invested interest in regulating the system.
53:45
The the method of that regulation is the medallion.
53:50
I also think, look, there is a sort of true moral imperative to the city persisting around the medallion system.
53:57
By far, look, we're large participants in the space, but the largest set of owners in the space continue to be individuals that own medallions.
54:06
So the city, and we can talk a little bit about this, we cut a unbelievably forward-looking deal with New York City to protect individual operators.
54:16
The city has essentially invested a huge amount of money in protecting those drivers and their livelihood and the capital that they've put into the system.
54:25
If you were to completely displace that capital, it would obviate all the work and investment that the city has done.
54:31
I don't think the city has a real interest in doing that.
54:37
And while autonomous will probably someday displace the driver and therefore displace their earnings power, you can swap that earnings power for the ability to contribute capital. Right?
54:49
So the medallion becomes a capital asset that they contribute into the system and they can cut an individual economic relationship with whatever autonomous operator is in the system at that time.
55:00
If you look back on this relative to everything else you've done in investing, how good of an investment would you say this was? Excellent. Why? Is is that an IRR?
55:06
Is it a risk-adjusted thing?
55:09
Like how do you measure it?
55:09
So we do think about risk-adjusted returns.
55:13
The companies and assets that we invest in have lots of I mean, they're distressed, right?
55:18
Like they we don't I would say to our investors, we don't have the benefit of looking at opening up the paper and saying, "Well, you know, I think this Google thing's got legs.
55:28
Let's let's put some capital in it."
55:30
We're looking at problems.
55:32
The problems that we end up chasing as investors are problems we think we can solve.
55:36
We think that there are structural fixes.
55:38
We think there are operational fixes.
55:39
But importantly, they are fixes that we think we can tackle.
55:45
These are challenged businesses. The risk is real.
55:49
And so when we insert ourselves into a company or a collection of assets and we use the rights and remedies that are afforded us, we're both using those rights and remedies to drive value, but also contain risk.
56:02
And you have to work on sort of both legs of that.
56:04
And so it is risk-adjusted return.
56:07
What are the big investing lessons that you take away from this specific story that you feel are like generalizable to what makes great investments of this type possible?
56:19
So distressed assets, you said it earlier and it's a line we use all the time.
56:22
It's a full contact sport.
56:24
You have to be willing to engage.
56:27
If you're investing in distressed assets and you are not taking an active role in both the financial and operational restructuring, you're just taking sort of weird and unquantifiable risk that you are not participating in.
56:39
I would argue it's almost like investment malpractice to invest in a distressed asset not taking an active operational role in addition to the financial restructuring role.
56:52
Yeah, it's an incredible it's an incredible story, one of my favorite investing stories.
56:55
Like probably no one's ever thought of the New York City medallions as like an asset class or something.
57:01
I'm curious how you would describe the key components aside from the steak dinners of interfacing well with banks.
57:07
Like if that's the channel through which you find everything and that they're motivated by regulation, regulation, regulation, what is it like?
57:14
Like what sorts of things do you see?
57:15
How do you know what to dig in on?
57:16
What makes for good relationships with with that key counterparty of yours?
57:22
Well, a good relationship with anybody is about respecting their needs and constraints. >> Yeah.
57:25
And you know, one of the things that I think we're really good at is understanding the needs and constraints of our counterparty, whether they're a bank, a borrower, a sponsor, a taxi driver, anyone.
57:36
We spend a lot of time thinking about the other guys' needs.
57:43
You know, I tell everybody I'm going to tell my kids, it's easy to know what you want.
57:47
You look in the mirror and tell it to yourself every morning.
57:51
The real exercise, the real effort has to be focused on understanding the other person.
57:57
And that understanding can come both from conversation and and look, that's a easy and direct way.
58:01
I think it's an important way.
58:02
You have always have to put boots on the ground.
58:04
You know, lots of the investments that we've made, the management teams have said, "Well, you're the first lender ever to show up and see the facility." Crazy. Crazy.
58:18
Uh so we spend a lot of time just getting to understand how a counterparty is thinking.
58:25
Again, we also spend a lot of time looking at data because people have an intuition about what they want, what they need.
58:31
Data sometimes says something different.
58:35
Now, there are times where we want to share that data with somebody to help them understand their own needs.
58:39
There are other times maybe we want to keep that data to ourself in a negotiation.
58:44
But we're looking at all dimensions of how to inform ourselves about what the other person's needs are.
58:48
Um understand what their real hard constraints are.
58:54
And one of the things that um I every time I deal with somebody, I try to guarantee them is you tell me you've got a hard constraint and we can understand that that is true, that you have that hard constraint.
59:06
We're going to respect it in the negotiation.
59:10
You have to you Any negotiation, any resolution can't be a zero-sum game.
59:15
It has to be that somebody has to get both sides have to get something out of it.
59:21
By the way, also when we're selling assets, um you have to leave something in for the next owner.
59:29
Um if you try to extract all the value that they're going to get, well, then they don't want to do the deal. >> Right.
59:36
Trying to understand what the other guy needs is a huge portion of what we do.
59:40
You've done a lot of negotiation um, in in interesting, unique circumstances, often and as you pointed out in very hard circumstances for people around the table.
59:49
Any other like ironclad principles of negotiation apart from the one that you just laid out that you sort of live by?
59:55
You know that saying um, you know, I learned everything I need to know in kindergarten? Yeah. Uh, that's really true.
1:00:00
Treat other people with dignity, treat them with respect, be honest, be as transparent as the situation demands, right?
1:00:06
So, you don't have to show all of your cards.
1:00:09
You are playing poker to some degree, but you want to deal with people on a heads-up and honest basis.
1:00:15
Uh, you also want to operate on a reasonable pace.
1:00:20
And pace is an important part of any deal discussion.
1:00:26
People get an intuitive sense whether or not there's something to do just by how you're engaging with them or how they're engaging with you.
1:00:33
So, uh, that doesn't mean you need to hurry to things.
1:00:35
Um, but if you're not sort of moving things along, people get anxious. >> Time kills deals. Time kills deals. >> Yeah.
1:00:44
I'd love to talk about other types of transactions that Marble Gate will engage with.
1:00:48
We were talking earlier about an example with the federal government of some credits that you were buying up.
1:00:53
And the reason I like this example which you could tell briefly is understanding why the opportunity can exist.
1:01:00
Like Like very often when something sounds too good to be true, you start wondering well, like why why am I so lucky that I can get such a great risk-adjusted return.
1:01:07
So, maybe use that example as one where there is an incredible risk-adjusted return that you can walk through.
1:01:13
But but also like the very keenly the reasons why it's possible in the first place when like usually there's smart people like you looking for places to earn a great return.
1:01:21
And yet it's still available.
1:01:23
We've been buying something called the employee retention tax credit.
1:01:24
And so now this is a like uh, an opportunity that comes out of the CARES Act.
1:01:30
Everybody's seen these commercials that ran almost every commercial break on every channel at one point.
1:01:39
Get $26,000 per employee payroll tax refund.
1:01:44
Because uh, the policy imperative at the time was get as much money into the system as they possibly could.
1:01:52
Now, the problem is like the the federal government is a big place.
1:01:54
Uh, the IRS is overburdened already.
1:01:57
Um, and there's lots of changes in the IRS, lots of new agents.
1:02:02
Now, a lot of agents coming out.
1:02:05
Uh, they're charged with covering a lot of territory with not a lot of resources.
1:02:10
So, um, they got foisted on them this new thing where they were there was a separate filing that had to be done by companies.
1:02:16
The language of um, the legislation which passed under the CARES Act is that a company who um, had either a 20% decline in their revenue during the measurement period or had been substantially impacted by a government order.
1:02:34
By the way, not a federal government order, a government order.
1:02:35
So, state, local, anything uh, qualified.
1:02:41
That's really loose language.
1:02:41
Um, I think in if the like authors of that had opportunity to go back and rethink it, they might have.
1:02:50
And there's been a couple of attempts to.
1:02:51
Problem is getting anything done in Washington's hard these days.
1:02:56
So, it is the law that's on the books.
1:02:58
Um, companies uh, started to apply for this. It is a separate filing.
1:03:03
Uh, it is a paper filing.
1:03:06
It requires you to go get, you know, some sign-off from your accounting firm or your auditors.
1:03:14
You have to, if you're going to do it responsibly, you need to put together a package that sort of explains, should you be asked, um, what why your claim is valid.
1:03:23
So, it's a fair amount of work.
1:03:25
And then uh, the government was really slow in processing it.
1:03:27
Again, we have an overburdened IRS and an overburdened, you know, number of people that are working there.
1:03:33
So, processing was just slow.
1:03:37
I think when the government did this, um, we've heard some estimates that say they anticipated it to be a $50 billion program.
1:03:45
Um, about a year in, they had paid out $200 billion. Holy cow. That was a year ago.
1:03:52
So, the numbers are unbelievable.
1:03:55
Again, it's probably a poorly written law.
1:04:00
So, uh, we started going out to um, companies uh, to uh, tax preparation firms, uh, people who deal in tax credits, uh, law firms, payroll processing firms and saying to them, "Look, we'll buy those credits from people.
1:04:16
Uh, now the reality is it's not a credit, it is a transfer payment.
1:04:19
The government sends you a check."
1:04:23
It took us a while, took us several months to design that system. Uh, it's complicated.
1:04:27
There's a lot of paper to process.
1:04:29
It's just so much manual labor required.
1:04:33
Um, and so we started processing uh, credits looking at individual uh, companies and who wanted to sell us their claim.
1:04:41
Now, we passed on huge numbers of them.
1:04:44
Uh, particularly because at the beginning it was pretty loosely written law and we said, "We will kind of want to be Caesar's wife in our underwriting here to make sure that we're well within what we believe is reasonable."
1:04:56
Our standard uh, was much tougher than what the government ultimately had.
1:05:01
So, we were buying credits that we felt really, really good about um, that would be non-controversial and would get paid.
1:05:10
Um, we were paying about 85, 86 cents on the dollar.
1:05:14
One of the provisions of the law was that um, from when you filed, the government owed you an interest rate uh, while you waited for the refund. That was 6 or 7%.
1:05:22
So, we were also just sort of earning a natural rate on the capital provided.
1:05:30
Um, as a safety mechanism, we also sort of built a system that allowed us to put back uh, claims should they become problematic with the government, should they be disallowed or there be a, you know, some sort of deficiency found.
1:05:40
Um, and if we were able to put back, the company owed us our capital back plus a rate.
1:05:49
So, you might ask yourself, well, why were why were people it was Yeah, it's like the US government counterparty risk. >> would you do this?
1:05:53
Goes back to what we were saying earlier about the K-shaped economy.
1:05:57
Most of our sellers, if not all of our sellers, are in the middle market. >> Yeah.
1:06:01
Uh, all of them capital constrained, earnings power constrained, and they they saw this asset that they could monetize.
1:06:09
And we were, you know, relatively easy to work with, I would say.
1:06:12
We tried to process things pretty quickly.
1:06:14
We could have an answer turned around and documents done within 2 to 3 weeks.
1:06:20
I know you it's kind of a similar order of magnitude of like capital deployed as what we talked about with the taxis.
1:06:26
That's a big that's a big amount of capital to go in to get I think it's like, you know, a minimum return-ish of 12%, a lot higher if if everything goes as you think it's going to go.
1:06:34
Um, counterparties the US government.
1:06:36
Like this is very different than taxi medallions.
1:06:39
Like taxi medallions at the time, of course, you tell this narrative was like, "Oh god."
1:06:43
Whereas like the US government, I don't know, probably going to pay. Why was this available?
1:06:46
Like why why didn't Apollo do this?
1:06:49
Or why didn't some big enterprise why didn't Baupost distressed Baupost guys do this?
1:06:53
Like what what makes it so that this was available given that it was a big amount of money and sort of like what seems like a no-brainer type of return.
1:07:01
Yeah, like what what stopped why is this possible?
1:07:06
Well, look, I A, um, I think we do a pretty good job looking in nooks and crannies. Yeah. Seeing things first.
1:07:14
>> We want to be uh, detail-oriented thinkers.
1:07:18
And I would also say um, you know, all profits emanate from the variant view.
1:07:22
If you have the market view, you get the market return.
1:07:24
If you want to generate an above-market or a differentiated return stream, you have to think in a differentiated way, have a variant view, and prosecute your investments in a variant fashion.
1:07:37
And so from, you know, going back to the foundation story of Marble Gate, you know, when Paul and I sat down, we said, "Look, the world has a Howard Marks and um, the world has a uh, Mark Rowan.
1:07:45
The world has a lot of things.
1:07:48
Uh, what doesn't it have?
1:07:51
And in order to grow our business, we've made sure to try to do things that we thought were interesting, unique.
1:07:57
The thing is, we like the intellectual challenge.
1:08:00
We like to think about things other people haven't thought about.
1:08:05
Years ago, we did um, some investing in around Native American gaming assets.
1:08:13
The reality is that sits on sovereign territory.
1:08:15
How you restructure those is super complicated.
1:08:18
And how do you generate a return that is sufficient?
1:08:23
And so we had to explore kind of new space in order to find the pathway through. We like doing new.
1:08:29
We like sort of exploring ideas, bringing new technology, interesting ways to look at things and access that value uh, to bear in our investing style. It keeps it interesting.
1:08:41
What is the hardest thing that you've ever had to pull off as part of Marble Gate's entire story? That's a great question.
1:08:49
You look, we're constantly seeking new challenge.
1:08:50
Um, when we were, you know, starting, um, it was, you know, Paul and I and uh, an analyst and our CFO.
1:08:59
Um, we couldn't exercise a huge amount of control.
1:09:01
We had $50 million in assets under management.
1:09:03
Uh, it was the, you know, late winter of 2009.
1:09:07
The world was falling apart.
1:09:11
Um, you know, the strategy that we prosecute today is the same strategy that we prosecuted then.
1:09:16
We just do it on a slightly larger scale.
1:09:20
Um, in those days, uh, we had to be clever.
1:09:23
We had to outthink the competition in order to make an impact.
1:09:28
And so, we've always we've maintained that framework of thinking.
1:09:33
We also, in those days, um locked up capital was not available.
1:09:35
So, we started our business in an open-ended structure.
1:09:39
Now, it had long commitment terms, but it was essentially it was at its core an evergreen structure.
1:09:43
And so, it demanded that we have this discipline of how are we going to get that capital back to people.
1:09:51
And that process of, you know, getting capital allocated into a distressed situation and then finding the resolution mechanism that brings it home is sort of built into the DNA of the firm.
1:10:04
It's how we think about investing generally.
1:10:07
Now, the interesting thing about distress is um you have to use capital to get capital back.
1:10:13
Um it there's this cycle of capital, capital contribution, resolution that cycles.
1:10:18
And so, you're always thinking about how am I going to drive this investment and and create something else out of it, then I'm going to create something else out of that, and you create this sort of daisy chain of opportunities.
1:10:32
One thing leads to another.
1:10:35
And so, if you had to isolate like the most difficult workout or the thing that like kept you up the most at night, is there one or is it always there's just always a component of that?
1:10:42
You know, one of the things that my partner Paul always says is every single investment is both a complicated business problem and a human drama.
1:10:52
And, you know, each one of our investments has had some you know, greater or lesser mix of those two things.
1:10:59
Look, to the individual in these situations we we do this for a living and we've done it essentially our entire careers. Uh it is familiar to us.
1:11:06
We understand how things are going to work out, how they don't work out.
1:11:11
We're comfortable with the level of ambiguity and uncertainty that other people generally are not.
1:11:19
And so, um each one of these are the most difficult thing that the other people in are ever going to go through.
1:11:27
And again, you got to be sensitive to that reality.
1:11:29
It goes to their decision-making.
1:11:31
It goes to um how they enter engage with you, how they engage with the business or the assets.
1:11:39
And so, each situation is difficult it's difficult in its own way because that human drama tends to be the unknowable thing as you're walking into a situation.
1:11:49
I'm curious since it's people going through the hardest thing they've ever gone through, how often that spills over onto you?
1:11:54
Like, how often do you do you feel like they believe you're the villain in the story and how do you deal That would seem very stressful to me.
1:12:03
Do you just become stoic about it? Does it happen often?
1:12:05
Or talk about that part of this whole I mean, we are the avatar of people's frustrations.
1:12:13
Um and look, it's not I don't I don't sort of love it.
1:12:16
It's not I don't wake up Nobody Nobody I'm not excited about this.
1:12:20
>> Yeah, nobody You know, there's this saying um that I repeat often, nobody finds distress, distress finds you. Yeah.
1:12:27
And and that's true in business, it's true as an investor.
1:12:32
Nobody sort of graduates from college and it's like, you know, I'm going to go into companies and be reviled by management and argued with by sponsors and, you know, yelled at by banks.
1:12:45
It's not something that people sort of like go into with that ambition. Yeah.
1:12:50
It tends to find people and it self-selects people.
1:12:55
Like, I think the the way we deal with it is again, back to first principles.
1:13:00
Deal with people with dignity, with respect, compassion for the reality that they exist in, compassion for the fact that this is the hardest thing they're ever going to go through.
1:13:11
Uh and that they don't like this. It's upsetting to them.
1:13:14
It's having an impact on their home life, on their kids.
1:13:18
It often times destroyed their life savings.
1:13:20
It's a big deal for people.
1:13:23
And so, they are going to be angry at you.
1:13:26
They are going to be angry at the decisions, the hard decisions that you're making on behalf of those assets or that company.
1:13:35
Uh but I always say, look, we're we're the eat your vegetables guys.
1:13:39
We're not doing this because we have some sort of personal animus to you.
1:13:41
I never met most of the people that we deal with, but we are doing what's in the best interest of the asset and what we believe is in the best interest of generating a durable return and a durable business. What motivates you?
1:13:56
Like, what is what are like if you just if I kept asking that question like eight layers deep, where would I get? >> question.
1:14:02
Look, I I like the problem-solving of it.
1:14:04
Um it it you know, my partner Paul sometimes has said that my superpower is being able to find that intersection of needs and wants in a multi-party negotiation.
1:14:18
I just love that problem-solving.
1:14:22
I like sort of finding a way through.
1:14:24
I like um taking things that are uh undervalued, misunderstood, and getting them back into a condition where they can be again durable, profitable, and a success.
1:14:39
If I was to go see your whole life story in a movie or something, um let's say like pre-college or something early part of your life, and isolate the stories or the things that were most formative, that most like shaped who you are, what what are those things? Hands down.
1:14:54
It's not a thing I talk a lot about, but my father passed away when I was very young. How old were you? About 11 years old.
1:15:00
Uh he and I were super super close.
1:15:02
Um we did everything together including we uh um we used to sit together and go over the Wall Street Journal stock pages every day.
1:15:13
We tracked certain stocks.
1:15:14
We invested together even though I was really young.
1:15:19
He sort of brought it to a level that I could understand.
1:15:21
My dad was an immigrant to the country.
1:15:22
Um loved the American system, loved that his son was an American, loved that to participate in American commerce. He was an entrepreneur.
1:15:32
Um and and dealt with um unions and dealt with large capital projects and used to bring me to to meetings he would have.
1:15:44
He He would come to New York on business.
1:15:47
He would bring me go to I grew up in a little town in Southeast Texas.
1:15:51
We would go to Dallas and he'd wear a suit and we would He'd sit me in the corner and I would just listen.
1:15:59
Uh so, from really early ages, we spent a lot of time together.
1:16:01
Uh so, when he passed away, he had a heart attack.
1:16:05
We were on a Boy Scout campout.
1:16:08
And that was a obviously a devastating time and a devastating moment.
1:16:15
And, you know, it shaped who I am and it shaped who my sister is.
1:16:17
It completely reshaped my mom's life and sort of how she saw herself and what her role was.
1:16:25
It it changed our whole trajectory.
1:16:25
It also, by the way, showed the colors of people around us.
1:16:30
So, there were people who I would say we were um uh we thought were good friends and close and reliable counterparties.
1:16:43
And at the moment of truth, um you know, people don't like messes.
1:16:45
They don't like difficult situations and we saw people retreat.
1:16:49
And I took a lot away from that.
1:16:51
Uh at the same time, we also saw people of uh real character lean in.
1:16:58
Uh people who to this day I consider like family because they just embraced us and took care of us.
1:17:04
People who have become entrepreneurs, who have shaped the world around them.
1:17:10
Very strangely, the most common pattern is someone that lost their father at a young age.
1:17:13
So many of my mentors have this pattern.
1:17:18
And so, I'm very interested in it because it's a tragic thing which nonetheless comes to define and shape people in a very unique way.
1:17:25
And the common pattern that I see is on the other side of it, this tremendous amount of agency.
1:17:32
That it's sort of like almost like the person wakes up in that moment and realizes like, oh, it like I need to I need to be agentic.
1:17:39
I need to like shape the thing like I need to take care of business. Yeah.
1:17:42
And I'm curious if you had that experience coming out of that tough time and and any other reflections you have on agency and the importance of agency in life.
1:17:52
So, my mom grew up in Southeast Texas.
1:17:55
For a while as a child, she had lived in the Middle East in Baghdad.
1:17:59
Interestingly, she when uh when the king was overthrown, she and a lot of the American families were taken hostage.
1:18:06
It's a super fascinating story.
1:18:09
Um she and her mother and brothers while the men were forced to work by the rebels.
1:18:16
So, um my mom had had this really interesting life, but had married my father at a pretty young age.
1:18:23
And my father had a big personality and himself had um had a sort of interesting, colorful life.
1:18:30
And um so, when he passed away, you know, she was 35 years old and had, you know, these two young kids.
1:18:37
My sister's 7 years younger than me, so she was really a baby.
1:18:41
You know, my mom really pushed us to take control of things and to make decisions on our own and get out and challenge ourselves and drive ourselves to create our own outcomes and um find our own path.
1:18:57
Uh she really pushed us I I love my hometown.
1:19:01
I love the community I grew up in.
1:19:03
It was like super nurturing and really like a lovely childhood and always other than the one we discussed, great people.
1:19:11
But she really pushed us to leave.
1:19:13
She said, you know, I want you to go out into the world and find your own way.
1:19:19
Um and and look, I I come from a good tradition of that.
1:19:21
My uh grandfather uh when he was just after bar mitzvah age had um was living in what is now Ukraine.
1:19:32
Um It was part of uh Romania then.
1:19:34
But he um he and his oldest brother walked down to uh the Black Sea, caught a boat, ended up in Curacao, and uh would make enough money to bring each brother, and there were five brothers total, um over.
1:19:49
They moved their parents into mandatory Palestine.
1:19:55
Uh and then uh ultimately they'd go back for a shidduch for the arranged marriage, and as there were ultimately not a lot of uh Jewish girls running around in Latin America in those days.
1:20:08
And he uh had gone to Eretz Israel to get married.
1:20:11
My father was born there, but then raised in Latin America, came to this country for education. Uh couldn't get a visa.
1:20:19
There were constraints on uh Jewish immigration in those days.
1:20:23
And so um went back to Venezuela.
1:20:26
Had met a guy here in the United States uh that he uh had gotten to be pretty friendly with, and uh they sort of had this this uh correspondence back and forth about how to start a business and what would they do.
1:20:39
And ultimately uh my father after several years was able to come back to the United States, and he and his business partner um went to my hometown, uh Beaumont, Texas, and started uh their first business was a precast concrete business.
1:20:54
And they grew that and they grew that into a number of other businesses that ultimately service the oil industry.
1:21:01
I mean, this is like uh the stuff of the classic American dream and story, 100%.
1:21:06
To map that back onto where we started with the K-shaped economy, to give us your just like sense, like your state of things and how you feel about it, having been, you know, a person produced by one of these amazing stories, and then a group of people that came here for that story, and and have challenges.
1:21:24
Like I I just love your kind of closing reflections on that.
1:21:27
America is like the greatest system that has ever existed.
1:21:31
Um it is the greatest economy, it's the greatest um economic system, greatest political system that has ever existed.
1:21:38
But countries, like companies, are delicate. They're fragile.
1:21:46
They require care and feeding. They require respect. They require engagement.
1:21:50
They're subject to abuse.
1:21:53
And so uh look, I don't like what I see in the K-shaped economy.
1:21:57
Uh I don't think that it's great that we have this growing divide between the haves and the have-nots.
1:22:01
I think that the magic of America is that anyone can make it, my father included.
1:22:09
Um and I think that it is lost his father at an early age could end up in Greenwich, Connecticut, sitting across from you talking about the things we're talking about.
1:22:19
I mean, that's a really remarkable opportunity that doesn't exist anywhere else in the world.
1:22:24
I mean, it really doesn't.
1:22:24
My father um who came to this country in the 1950s, uh in order for him to be able to come back uh as the next to whoever, uh we need to have a system that works for everybody.
1:22:39
We need to have a system that provides for opportunity and access.
1:22:43
It has to be a system where you can work hard and earn a good living, but you can also take entrepreneurial risk and be rewarded for it.
1:22:50
I think the that when we design a system or allow a system to calcify such that the haves will perpetually have and the have-nots will perpetually not have, uh that's a system that is we stand at a moment in time where we have some hard decisions to make.
1:23:16
And it's not by the way, this is not a political comment on any individual party or person or any of that.
1:23:19
It's more of philosophical view on where America is and where the system is.
1:23:25
I think we as a system, we as a country, have to have a lot of grace for each other and a desire to see not just the guy in the mirror win, but the neighbor.
1:23:39
I mean, we need to see our neighbors win.
1:23:40
We need to make sure that the people who um make America great enjoy its prosperity.
1:23:46
Is there anything about the world and how it works on the investing side that we haven't talked about that you think is most surprising or interesting?
1:23:55
Your style of investing is very different from the style I I normally feature here.
1:23:59
I think there's lots of interesting ways that people are investing.
1:24:02
I'm sort of always interested in how, you know, friends, colleagues, uh people I meet are allocating capital, how they're thinking about things.
1:24:12
I would say, like I sense a lot of laziness out there.
1:24:13
I think there's a lot of wash, rinse, repeat.
1:24:15
Um we do it this way because we do it this way, or um you know, we're investing to model, or it just the only way that I can describe it is lazy.
1:24:29
Uh that A, I think is intellectually bankrupt, but I also think it's worrisome because when we go on to autopilot, things don't tend to work out.
1:24:38
And and I feel like large portions of the investing world are now on autopilot.
1:24:46
Where do you see that most acutely?
1:24:46
Big parts of the credit market.
1:24:48
The primary vehicle for credit creation in corporate credit over the past 10, 15 years has been uh the CLO.
1:24:57
So, CLOs are a magical device.
1:24:57
Just describe them for anyone that doesn't know what it what that means.
1:25:01
Collateralized loan obligations.
1:25:01
So, uh this is the um these are a package of loans that are um assembled as a group of assets, and then against those assets there is a stack of liabilities that are sold with equity underneath.
1:25:18
So, um an individual investor will put up the equity, and then a number of lenders will uh provide stacked layers of capital, so orders of priority, which allow the purchase of that portfolio of assets.
1:25:34
Now, the investing uh relies primarily on diversification and over-collateralization as its method of risk control.
1:25:43
There is this sort of pretend system that's going on at the moment where there are analysts um looking at each individual credit, and I don't want to disparage the entire CLO industry.
1:25:51
There are some unbelievably good CLO managers out there.
1:25:55
They're all smart and sophisticated and thinking very hard about how they are managing those pools of assets.
1:26:07
But there are a lot that are not.
1:26:07
Um and so you're getting this laziness that's happening.
1:26:13
I would also say one of the things I don't like that's happening out there is um the productization of investment decisions.
1:26:20
So, there's a lot of outsourcing of critical thinking because I can go to this person that can that'll make this decision for me, and I'll go to this person who will make that decision for me.
1:26:31
And so, again, we're bankrupting the decision-making process, the the investor, that's even what you want to call them, becomes more of a general contractor, and they're not actually doing anything and I don't think adding a whole lot of value other than choosing other people to do the thinking, who by the way um are misaligned because those folks are motivated by a stream of fees rather than an investment outcome.
1:26:59
And so, I think the system I don't love what is happening in the CLO system.
1:27:02
I think that there's a big opportunity to be much more active and engaged in that.
1:27:11
Now, it probably means that you can't be 100 billion dollars of CLO capital thinking like that.
1:27:18
That being said, there people are going to do 100 billion dollars of CLO that will do just fine under the system that exists.
1:27:24
So, I don't disparage everything that is happening, but I do think that there is an opportunity to be much more actively engaged in that portion of the market.
1:27:33
>> So, any other commentary on private credit and private credit markets in general, and then also on equities?
1:27:36
You have such a unique vantage point, so just like big picture view on those two big spaces.
1:27:41
Private credit in particular is a is a really interesting space.
1:27:43
Um you know, so in 2011 uh the federal government issued an update on what is called the guidelines on leveraged lending.
1:27:52
And that is the sort of perspective on the rules out of the center, right?
1:27:57
Because we do bank regulation in a really interesting way in this country.
1:28:00
So, policy is set at the center.
1:28:02
Primary policy makers are the Fed, the FDIC, and the OCC.
1:28:07
Um and they issue guidance.
1:28:07
Now, we have we have uh individual and independent Federal Reserve banks around the country that apply the guidance.
1:28:18
So, it's up to the individual Fed regions and Fed presidents and boards and employees as to how that uh regulation is applied.
1:28:25
Policy set at the middle.
1:28:27
And the guidelines on leveraged lending that were issued in 2011 created the dynamic that pushed credit out more leveraged credit out of the banking system because after the financial crisis, the federal government adopted, correctly I think, the perspective that they wear the ultimate risk in the banking system.
1:28:48
And so, you know, he who wears the risk makes the rules.
1:28:51
Um they said, "Look, we're wearing this risk.
1:28:57
We don't want, you know, anything above X leverage in the system. So, we want that out."
1:29:03
That allowed the private credit market, which has always been there, but really to flourish in the aftermath of the financial crisis.
1:29:14
Where there's an a and there's been an immense amount of capital that has gone into the space.
1:29:20
You know, where there is over allocation, there will be mistakes, and I think we see those mistakes rearing their head today.
1:29:29
According to Fitch, about 82% of the private credit market exists in the single B- minus and lower credit credit quality space.
1:29:39
Look, we have 40 years of data that tells us how various credit quality equivalents perform.
1:29:46
Triple Cs, for instance, default at about a 3-year 30% cumulative default rate.
1:29:54
So, you know, the largest portion of private credit, according to Fitch, is in triple C equivalent.
1:30:01
Now, show me a private credit manager who reports something north of a 1 and 1/2 percent default rate. How's that happen?
1:30:08
Well, one of two things is true.
1:30:08
Either, you know, in the aftermath of the great financial crisis, we have some private credit managers have invented a new way to underwrite credit, which avoids all losses, risks, and defaults, or they are misleading you about what the actual default rate is. And how do they do that?
1:30:27
Well, defaults are the most easily manipulated statistic in the world.
1:30:31
A default doesn't exist unless I, the lender, call it.
1:30:36
And so, if I don't want defaults in my portfolio, I simply don't call them.
1:30:40
Or So, I always tell people don't ask the default rate of a private credit. Ask the waiver rate. Ask the amendment rate.
1:30:47
How much are they having to put hands on their credit to reorient the documents to fit the reality of the company they're operating in.
1:30:57
Look, we have some also some evidence in the BDC market.
1:31:00
The BDC markets of business development corporations are essentially public direct lenders, and there's a instrument or a device in credit called PIK debt.
1:31:10
The sort of formal name is payment in kind.
1:31:12
So, rather than pay you a coupon, I will pay you more debt.
1:31:18
Now, we oftentimes say PIK means payment isn't coming.
1:31:25
Because when you look at the data, what you see is when there's a lot of PIK in a particular instrument, typically that company is going to default, and you ultimately will not recover that PIK debt.
1:31:37
So, it's a bit of a mirage that individual loan officers or credit committees will use to disguise maybe a less than let's say fullsome credit decision.
1:31:54
Or, by the way, there are legitimate uses for it, but if a company can't pay you a cash coupon, you are taking some amount of equity risk.
1:32:02
So, the larger the portion of PIK debt in a particular instrument, the more credit more equity risk you're taking in that investment. Pretty straightforward.
1:32:13
We see some portfolios in the BDC market that have 17, 18% PIK debt.
1:32:19
I mean, they're not they're no longer lenders at that point.
1:32:22
They're taking massive amounts of equity risk in companies that are probably, again, they exist mostly in that middle market space.
1:32:30
So, they're under pressure, they start from more difficult position with, you know, declining margins, declining earnings power. It's not a great setup.
1:32:40
I don't see great things ahead for large portions of the private credit market.
1:32:46
Now, that being said, there are some private credit firms that are spectacular. I mean, superior.
1:32:50
That list is pretty straightforward.
1:32:55
You know, firms like Ares or let's say Golub are, you know, stellar at what they do, and they have great credit cultures, they have really complete teams that deal with underwriting and workouts should they get to that.
1:33:10
The private credit universe used to be a direct origination business.
1:33:16
There is some direct origination that goes on in private credit today, but it's largely a brokered market, which is a kind of a dirty little secret people don't like to talk about.
1:33:27
You know, the Houlihans or the Lincolns are doing a huge amount of sort of placement of private credit.
1:33:32
So, naturally, what are they doing?
1:33:37
They're going to the biggest, best, most well-known lenders first. Ares, Golub, etc.
1:33:44
If they pass, then they go to the next cadre, and the next cadre, and the next cadre.
1:33:48
So, there's a real tiering in terms of access.
1:33:50
The biggest, best-known firms do have the best portfolios because they get first choice, and they have the most complete access to capital, and the best teams, etc.
1:34:01
So, I think there is there's great things happening in private credit.
1:34:04
I think there are some scary things happening in private credit.
1:34:06
What's your commentary on private equity, which is a key counterpart to that? I love those guys.
1:34:14
That's my manufacturing division.
1:34:17
Look, like everything, there are some people who are doing like really interesting, really compelling things.
1:34:22
The firms that I like are fundamentally value-based investors.
1:34:27
They do what I would call scratch and dent type private equity.
1:34:28
So, they're buying, you know, car valves or, you know, assets that are a little unloved or difficult in some way, and then really applying force to them.
1:34:38
But I think, just like in our business, if you're just a financial investor, you're in some way a traitor.
1:34:48
If you are bringing to bear real resources to drive the company's operations forward, or to reimagine how that business operates, that I think is really interesting and really value-added, and there's going to be a future for that kind of investing in that style of private equity.
1:35:08
I think the sort of standard, you know, group of great deal makers who knows some allocators or rich families that will back them in buying companies, but they don't actually do anything other than buy the company and show up for board meetings, I think those firms are troubled.
1:35:23
I don't think they add a lot of value, and they probably don't have much of a future.
1:35:29
Looking to the future, what do you most hope you get to do more of that Marble Gate becomes, where will you spend your time and attention based on your interest right now?
1:35:39
We sit at a really interesting moment in asset management.
1:35:41
I think that what we do in our business in our investing is acquire assets that are troubled, reimagine what they could and should be, and then apply force to make that happen.
1:35:55
I think we have to look at our own business that same way.
1:35:58
I think we're at this moment in the asset management space where people are asking hard questions, the right questions about who's adding what value, and how should that value be compensated, and what are the collections of services that asset managers should be providing to their customers.
1:36:18
How should we think about our relationships with our customers?
1:36:22
Are is it really a customer relationship, or should it more of a partnership relationship?
1:36:25
I think that partnership model is the model going forward.
1:36:29
I also think that we have to think about where we're accessing capital.
1:36:34
Look, there's a big push to go into the retail channel.
1:36:38
I can make and I buy the argument that large portions of the retail market are under allocated into private markets.
1:36:47
Uh I think that there are large portions of the retail market that are probably not super well equipped to have that have a ton of exposure.
1:36:57
We're going to go bump in the night trying to figure out where those lines exist.
1:37:00
There are going to be people will make mistakes.
1:37:05
You know, investors will make mistakes.
1:37:07
Um asset management firms will have false starts, but I think there are there's product design opportunity that is exciting.
1:37:16
There are some things that have, you know, gotten a lot of heat.
1:37:19
Interval funds are getting a lot of attention.
1:37:21
I think there are some strengths and some weaknesses to that.
1:37:25
I think that, you know, everything that's happening in the insurance space is super interesting.
1:37:29
I think there's lots of ways to think about that.
1:37:31
The the sort of annuity-driven investing is super interesting, and it serves a real need and opportunity.
1:37:39
I think there are other composition of insurance assets out there that are also interesting, that are probably less well explored at the moment.
1:37:49
So, I think there's a lot that's going to happen.
1:37:53
The world of asset management that I grew up in is not going to be the one that I exist in going forward.
1:38:01
We're undergoing a lot of change, and I think people who embrace that change are going to do really well. are going to succeed.
1:38:07
And the people who sort of live a comfortable life and are sort of happy to, you know, play golf a couple of days a week, and you know, go have big expensive lunches, that's probably not going to be the successful model going forward.
1:38:22
That has never been your approach.
1:38:23
You're one of the more unique investors that I know.
1:38:25
I love talking about investing.
1:38:27
I think what you do is it's just different, and obviously it works. Proof is in the pudding.
1:38:31
I think you know my traditional closing question for everybody.
1:38:35
What's the kindest thing that anyone's ever done for you?
1:38:36
Right after my father passed away, this family that I still consider, you know, very dear to me.
1:38:49
My mom was overwhelmed, and they used to I'm going to tear up.
1:38:51
They can't have had it actually.
1:38:52
They uh They would take me to their house for breakfast every morning, and then drive me to school.
1:39:00
And they really embraced me, and provided a lot of like stability to me at a really trying time.
1:39:08
There were other families that did the same thing.
1:39:09
That was a really, really tough moment. And uh they leaned in.
1:39:11
I try to think about what I can do to pay forward that kindness. Beautiful closing story.
1:39:19
Andrew, thanks so much for your time. Thank you.