Welcome to Thoughts on the Market.
I am Vishy Tirupathur, Morgan Stanley's Chief Fixed Income Strategist.
Today is a special edition of our podcast.
We are joined by Dan Toscano, Chairman of Markets in Private Equity at Morgan Stanley and a seasoned practitioner of credit markets over many, many credit cycles.
We will get his thoughts on the ongoing evolution and revolution in credit markets.
It's Wednesday, January 7th at 10 a.m. in New York.
Dan, welcome.
Glad to be here.
So, to get our listeners familiar with your journey, can you talk a little bit about your experience in the trade markets and how you got to where you are today?
Yeah, sure.
So I've been doing this a long time.
You used the nice word seasoned.
My kids would refer to it as old.
But I started in this journey in 1988.
And to make a long story short, my first job on Wall Street was buying junk bonds in the infancy of the junk bond market, when most of what we were financing were LBOs.
So if you're familiar with Barbarians at the Gate, One of the first bonds we bought were RJR Nabisco reset notes.
And I've been doing this ever since.
So over almost four decades now.
So the junk bar market evolved into high yield market, syndicated loan market, CLO market, financial crisis.
So talk to us about your experiences during this transition.
Yeah, I mean, one of the things these markets do is they finance evolution in industries.
So when I think back to the early days of financing leveraged buyouts, they were called bootstrap deals.
The first deal I did as an intermediary on Wall Street as opposed to as an investor, was a buyout with Bain Capital in 1993.
At the time, Bain Capital had a $600 million AUM private equity platform.
Think about that in the scale of what Bain Capital does in private equity today.
Back then, it was corporate carve-outs and trying to make the global economy more efficient.
And you remember the rise of the conglomerate.
And so one of the early things we financed a lot of was the deconglomeration of big corporates.
So they would spin off assets that were not central to the business or the strengths that they had as an organization.
That was the early days of private equity investing.
There was obviously the telecom build-out in the late 90s and the resulting bust, and then into the GFC, and we sit here today with the distinctions of private capital, private credit, public credit, syndicated credit and all the amazing things that are being financed in what I think of as the next industrial revolution.
In terms of things that have changed a lot, a lot also changed following the financial crisis.
So, if we dig deep into that, one thing that happened was the introduction of leveraged lending guidelines.
Can you talk about what leveraged lending guidelines did to the credit markets?
Yeah, I mean it was a big change for underwriters, because it dictated what you could and couldn't participate in as an underwriter or a lender.
And so it really cut off one end of the market that was determined by and I think the thing most famously attributed to the leverage lending guidelines was this maximum leverage notion of six times leverage is the cap, nothing beyond that.
And so that really limited the ability for Wall Street firms to leverage, underwrite and distribute capital to support those deals.
And inadvertently, or maybe by plan, really gave rise to the growth in the private credit market.
So, when you think about everything that's going on in the world today, including what I'm sure we'll talk about, the relaxation of the leveraged lending guidelines, it was really fuel for private credit.
So private credit, this relaxation that you mentioned.
A few weeks ago, the FDIC and the OCC withdrew the leverage lending guidelines in total.
What do you expect that will do to the private credit markets?
Will that make private credit market share decrease and bank market share increase?
I think many people think of these as being mutually exclusive.
We've never thought of it that way.
It exists more on a continuum.
And so what?
I think the relaxation of those guidelines or the elimination of those guidelines really frees the banks to participate in the entire continuum, either as lenders or as underwriters.
And so, in addition to the opportunity that gives the banks to really find the best solutions for their clients, I think this will also continue the blurring of distinctions between public market credit and private market credit, because now the banks can participate in all of it.
And when you think about what defines in people's minds, public credit versus private credit.
In many cases it's driven by what terms look like customary terms for a syndicated bond or loan versus a private credit loan.
Also, who's participating in it.
These things have been blurring, right?
There's a cost differential or a perceived cost differential that has been blurring for some time now.
That will continue to happen, in my opinion, anyway.
I totally agree with you, Dan, on that.
I think not only the distinction between public credit and private credit, but also within the various credit channels secured unsecured securitized, structured all these distinctions are also blurring.
So in that context, let's talk a little bit more about what private credit's focus has been and where private credit focus will be going forward.
So what we will call private credit 10 focused predominantly on lending to small and medium-sized enterprises.
And we now see that potentially changing.
What is driving private credit 2.0 in your mind?
Well, the elephant in the room is digital infrastructure.
Absolutely.
When you think about the scale of what is happening, the type of capital that's required for the build-out, the structure you need around it, the ability to use elements of structure you mentioned several of them earlier to come up with an appropriate risk structure for lending, is really where the market is heading.
When you think about the trillions of dollars that we anticipate is needed for the technology industry to complete this transformation, not just around digital infrastructure, but around everything associated with it.
And the big one I think of most often is power.
Right.
So you need capital to build out sources of power and you need capital to build out the data centers to be able to handle the compute demand that is expected to be there.
This is a scale unlike anything we have ever seen.
It is the backbone of what will be the next industrial revolution.
We've never seen anything like this in terms of the scale of the capital needed for the transformation that is already underway.
We are very much on board with this idea as well Dan, in terms of the scale of the investment, the capital investment that is needed.
So, when you look ahead for 2026, what worries you about the industrial revolution financing that is underway.
Given all that's going on in the world, this massive capital investment that's going on globally around digital infrastructure.
We've never seen this before.
And so when I look at the capital raising that has been done in 2025 versus what will be done in 2026, I think one of the differences that we have to be mindful of is that Nothing's gone wrong while we were raising capital in 2025, because we were very much in the infancy of these build-outs.
Once you get further into these build-outs and the capital raises in 2025 that are funding the development of data centers start to season, problems will emerge.
It is the essence of credit risk is there will be problems.
And it's really trying to predict and foresee where the problems will be and make sure you can manage your way through them.
That is the essence of successful credit investing.
And so there will definitely be issues when you think about the scale of the build-out that is happening, even if you look just in the US, where you need access to all sorts of commodities to build out and people focus on chips, but you also need steel and roofing and importantly, labor.
And as we talk to people about the buildouts, one of the concern is supply of labor, supply and cost of labor.
So when you run into situations where maybe a project is delayed a bit or the costs are a bit more than what was expected, there will be a reaction.
And we haven't had that yet.
We will start to see that in 2026 and how investors and the markets react to that, I think will be very important.
And I'm a little bit worried that there could be some overreaction, because people have trained themselves in 2025 to think of like I'm operating in a perfect environment because we haven't really done anything yet.
And now that we've done something, something can and will go wrong.
So we'll see how that plays out.
I am very fixated in 2026 on the laws of supply and demand.
When I think about what's going on right now.
We usually have visibility on demand and we usually have some level of visibility on supply.
Right now we have neither.
And I say that in a positive way.
We don't know how big supply demand is in the capital world to fund these projects.
We don't know how big that can be.
And almost with every passing day, the supply and what we're hearing from our clients about what they need to execute their plans continues to grow in a way that we don't know where it ends.
In the scale, we're talking trillions of dollars, right?
Not billions, not millions, but trillions.
And so I look at that not so much as something I worry about, but something I'm really curious about.
Will we run out of money to fund all of the ambitions of the industrial revolution?
I don't think so.
I think money will find great projects.
But when you think about the scale of what we're looking at, we've never seen anything like it before.
And it will be fascinating to watch as the year goes on.
Thanks, Dan.
That's very useful.
Thanks for taking the time to speak to us and share your wisdom and insights.
Well, it's great to be here.
And to our audience, thanks for listening.
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