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Trinity Capital CEO Kyle Brown talks interest rates roller coaster and what that means for the financial sector (1:10). Liquidity is really important and private credit is real (4:25). Why there’s been an increase in interest in BDCs (7:50).
Transcript
Rena Sherbill: With the FOMC minutes coming out today and constant and continuous talk of interest rates. Where does that leave the financial sector today?
As another day goes by that we miss Kim Khan’s hosted Wall Street Lunches, I hope you’ll enjoy this special conversation I had with Kyle Brown, CEO of Trinity Capital (TRIN), a special kind of BDC and he explains what’s going on broadly speaking in the financial sector, how that pertains to interest rates. What that means for financial companies.
You can catch the full interview of this conversation by the way on Investing Experts where Kyle graciously gets into more about Trinity’s makeup and strategies and place and place within the broader marketplace and how investors may be thinking about the about this part of the market.
What would you say or how do you think about the macro factor in terms of interest rates, in terms of maybe cuts coming down the line? How do you think about that in context of how you’re trying to grow the business?
Kyle Brown: We saw rates shoot up. We’ve seen rates now start trickling down. And during that timeframe, we’ve actually increased earnings per share. So I hope that could be a good reflection of what we think about it. We’re showing it through our earnings per share. It hasn’t impacted our ability to deliver on that dividend.
We actually have pretty limited down exposure to rate sensitivity. The majority of our portfolio, you can see it right in our Schedule Of Investments. The majority of our portfolio, 90-plus percent, has floor rates that are over 12%.
And so when rates come down, if they can continue to come down, we actually have some great kind of downside protections there because we have floating rates for our corporate debt. We have a $500 million revolver with KeyBanc. When rates go down, our cost of capital goes down. So does our ability to raise bonds and private debt, that goes down, but our underlying portfolio does not decrease in the same way.
And so income is really not at risk. If rates go down, we actually have this slide in our presentation. If rates go down another 100 basis points, that’s only $0.02 per quarter. We’ve already got that covered in our earnings per share.
And then we also believe that the RIA that we launched, which we’re now generating new income above and beyond the loans that we have issued out there, that is more than making up for any kind of rate decreases and sensitivity that we have there.
So we feel really comfortable, kind of regardless of what rates do in our ability to keep that dividend steady and growing.
You have a massive amount of retail dollars and institutional dollars that are flowing to private credit. It’s a big buzzword, right? Private credit, private credit.
The majority of that capital is flowing to 12 large trillion-dollar firms, right? Those firms are all chasing the same deals in the upper middle market, and it’s been a race to the bottom on pricing. And they’re all chasing beta-type returns at this point.
They can’t write $20 million to $100 million checks and we can’t. And we love that kind of lower middle market space, particularly with enterprise SaaS deals.
There’s actually a massive amount of opportunity right now. And M&A activity for us has picked up 20% quarter-over-quarter, 15% year-over-year in Q3. We’re seeing a lot of acquisitions begin. And so the opportunities there, there’s less competition because the bigger alternative asset managers have moved upstream and then banks are lending less because of regulations that have come down on them since the banking volatility began.
So we’re seeing just great opportunities, great spreads, less competition. And that’s giving us the ability to generate great kind of low to mid-teens kind of gross yields, which ends up being a great return for our shareholders.
RS: If anything, what has you the most concerned, either in general or in this upcoming year, let’s say?
KB: Liquidity is really important. Equity, liquidity and money flowing is really important, I think, for really kind of all of our businesses. There’s a massive amount of dry powder sitting on the sidelines and it has been for a couple of years. Record amounts of venture capital, record amounts of private equity.
Money flowing is really important. I think right now with the administration changing over, there’s a lot of uncertainty. This could be good, but it could also, I don’t know, there’s scenarios where maybe it’s not great for the industry, or maybe inflation sticks around longer than we thought. But I don’t know.
I think primarily our biggest concerns from like a macro sense are that we cannot figure out this debt situation, which is going to drag down all industries and all kind of financial stocks. We have a really significant kind of overhang on debt in this country. And we continue to kind of kick the ball, kick the can down the road. And that’s a problem for all stocks, but certainly for financial stocks.
RS: What else would you say about the financial sector and things that investors should be paying attention to, broadly speaking?
KB: Private credit is real. I think it’s here to stay. Banks are going to be lending less. They have regulation that’s coming down on them. They have less deposits, which means they can lend less.
And so I think just generally speaking, banks are going to be lending less and they’re going to be doing more receivable-type financing. So there’s a gap, right?
Everyone is looking for access to private credit and the majority of investors have decided over the last couple of years to move it into large entities. Those entities are having a very difficult time deploying that capital, which has created less than desirable returns, I think. And larger asset managers are really dependent upon M&A activity picking up.
And with the new administration, there’s a lot of euphoria around the idea that, hey, things are going to be better in the economy and that will probably lead to this dam breaking and M&A activity picking up. I don’t know that that happens.
I think it’s leaking. But what’s happened in 2021 and 2022, or companies with that policy, zero interest rate policy was companies receive valuations that were just astronomical.
And over the last two or three years, they have really been trying to work into those valuations, but they did that with rates increasing, with a lot of macroeconomic and geopolitical kind of issues going on. They haven’t been able to work into those valuations.
So for the dam to really break and for M&A activity to pick up and for P/E dollars to flow and for all of this to happen, it’s going to require companies to kind of face the music on a valuation standpoint and take the dilution that’s really been continued to just get kicked down the road.
And so there’s a lot of money. There’s a lot of money that wants to do deals in that. And once it starts, that money flows. It flows downstream. It flows back to private equity. It helps with fundraising. It flows into the VC world. It helps with fundraising that flows to companies like it’s all – it will all be good. But it does require companies to bite the bullet on valuations that they -that are just unrealistic.
RS: Do you find that there’s points in the market where people are more interested in BDCs than they are less interested? What do you feel like is that’s predicated on for the most part?
KB: There certainly has been an increase in interest in BDCs. That’s more of a statement on just private credit. Investors are trying to understand how do I get into private credit, right? And you really, you have limited options if you’re a high net worth or family office, you can dump your money into Blackstone’s umpteenth fund that they just launched, or you can search outside of that. And BDCs offer a really interesting entry point for investors who are wanting to invest in debt in private companies.
And so the reason it’s picked up is because there’s been more interest there for groups trying to figure out more niche and different strategies other than some of the big boys.
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