Marathon Asset Management

Grow, baby Grow! Everyone has been focused on the Election Results and markets have also voted with equities and rates higher. However, I wanted to take a moment to share eight investment-related questions I was asked today that are worth considering. 1. What’s your perspective on investing in this environment? 2. What’s your outlook for 2025? 3. How does deal flow compare to last year? 4. What’s the competitive landscape like? 5. How is the regulatory pressure on banks impacting private credit? 6. What’s the next frontier for private credit? 7. Do you expect private credit will expand or contract as an asset class? 8. Is this a watershed moment for private credit? My answers are: 1. With the election behind us, focus will turn back to investing and the outlook looks highly favorable. With the economy growing 2% for 2025 (E) and the Fed on a path to reduce rates, US equities should continue to perform, however the better risk reward is to invest in credit. Private credit should have a great run as default rates decline and deal flow surges into the coming year. 2. Debt and Equity markets will have a great run, the 60-40 model should perform well in this environment, the best set-up it has had in years. Equity Markets are fully priced with the top 10 companies trading at ~50x PE multiple, while S&P500 trades >21x. Earnings growth estimates for 2025 is nearly +14% so there is room for disappointment. 3. IPO will be slow to recover, but Private Equity will get back on track in 2025, and with this Private Credit will have an incredibly strong year. PE has been slow to deploy capital during the past 2 years, and most concerning has been weak DPI resulting in sub-par IRRs. This next vintage will be strong, so keep your faith in PE. 4. The past two years has weeded out poor performing asset managers from CRE to Venture Capital. Those managers who performed well in the past several years are very well positioned for the future. The landscape is always competitive, but deal flow is picking up significantly, I can speak firsthand that Marathon Asset Management is enjoying its best deal flow ever. 5. Basel 3-Endgame will prove to be a strong catalyst for Asset Based Lending as banks pivot more conservatively within their private lending business from CRE lending to ABL. More strenuous CET1 ratios allows a more favorable tilt creating an advantage for private credit lenders. 6. The convergence of public and private credit is the next frontier, with multi-asset credit solutions becoming a key product offering for investors. A niche example Marathon has focused on is equipment finance/capital leases. 7. Grow, baby Grow! I expect 10-15% CAGR: Direct Lending +10%, ABL +20% per annum. With less distressed debt, more Capital Solutions. Less Mezzanine because Uni-tranche is here to stay. 8. Private Credit is the #1 asset class for net-new capital deployment in 2025 as Alts investors remain under-allocated. How would you answer these questions?

Stiff Upper Lip Today is Election Day, the day we have been waiting for with bated breath. Donald J. Trump is the only candidate representing their party in three-straight elections besides Franklin D. Roosevelt who did this in the 1930’s/40’s. Unlike FDR who won each election, Trump has had one win & one loss -> so we have a good handle on market reaction in the event of his win or loss—which is fascinating given the algos with their factor weightings have this wired once the outcome becomes known. Expect heavy trading volume with potential for volatility. There is one small matter that I would like to discuss today: It’s common wisdom that in the event of Trump 2.0, it would carry significant tariffs that everyone concludes is inflationary. While I agree with this conclusion, I ask the follow-on question as to how inflationary are tariffs? This is a tough one to calibrate since we would have to evaluate the size of the tariffs, the countries, and industries they would apply to, and to what extent that cost would be absorbed by the exporter/importer who sells the product to the US consumer. Fact: 75% of US GDP is domestic not impacted by trade. Trade accounts for 25% of GDP and a big part of this is exports, which has no impact on inflation since we do not purchase our exports (by definition). Imports subject to tariffs impact inflation. Imports are running at ~$3.8T vs ~$28T GDP (or 13.5%). It is hard to gauge, but what makes this even more difficult to evaluate is the that the US dollar will likely appreciate vs our trading partners if Trump were to be elected; and a stronger US dollar would provide greater purchasing power for the US consumer, which creates the opposite effect on inflation. Remember, during Trump 1.0 -> inflation was very well behaved despite the large tariffs that were imposed. While I believe large tariffs will be inflationary, I believe it will be much more muted than what everyone seems to think. Just some food for thought as we wait for the election outcome. As our British friends like to say, it’s best to keep a “stiff upper lip” at times like this, to remain composed as 50% of US voters won’t be happy with today’s outcome. I know we will maintain an unwavering perseverance that will rule the day as we Stay Calm and Carry On.

Marathon Asset Management’s Head of Direct Lending, Curtis Lueker, joined a panel moderated by Noel Hebert for Bloomberg’s Future of Fixed Income event.   In a wide-ranging discussion, Curt provided insight into the proliferation of partnerships between banks and private credit lenders, current market conditions and the outlook for private credit heading into 2025, and how direct lenders can differentiate themselves.

Marathon Asset Management provides Senior Secured Credit Facility to finance H.I.G. Capital’s acquisition of SkinCure Oncology, a leading provider of image-guided superficial radiation therapy (IG-SRT). “The power of Marathon's integrated investment platform, utilizing the expertise and combined capabilities of our dedicated Healthcare Finance and Direct Lending teams, enabled us to provide a reliable, thoughtful, and efficient financing solution,” said Bruce Richards, Marathon’s Chairman and CEO. Marathon’s Private Credit platform is designed as a one-stop shop, offering corporate, asset-based, and capital solutions, including senior and junior financings ranging from $50 million to $250 million.

Two Big Events, and Only One Matters This week brings two BIG events: U.S. election & Federal Reserve meeting. While the Fed will likely cut rates 25bps making it relatively uneventful, the election outcome is ginormous: impacting stocks, bonds, currencies, and commodities, not to mention geopolitics. Trump 2.0 should be most favorable for these 10: - Banks (regulatory relief and greater growth prospects) - Oil Services (“Drill Baby, Drill”- while not necessarily positive for oil prices given greater supply, oil services are a big winner) - Industrial/Manufacturing (tariffs protect domestic producers i.e., US Steel, as imports will be more costly) - Bitcoin is a winner regardless, but bigger with Trump) - Elon Musk (Tesla - no more tax credits for EVs favors Tesla vs. Ford, SpaceX, X, XAI, Neuralink, Boring Company) - For-profit Prisons (tough on crime) - Hospitals (Obamacare will prevail, but free services for non-citizens will be reduced) - USD (Under Trump $ strengthens as tariffs are negative for MexPeso, CAD, Euro, Yuan)- the #1 reason USD trades up is due to interest rate differential, # 2 is trade- both buoyed by Trump - S&P 500 (under VP Harris, corporate tax rates rise/5% corporate earnings hit if tax rates go from 21% to 28%). - M&A accelerates, PE Sponsors/Private Credit Managers see increased activity VP Harris victory are favorable for these 10: - Clean Energy (Inflation Reduction Act provides funding for Green Energy initiatives w/massive tax credits which Trump would likely discontinue) - Infrastructure winners (Bechtel, Fluor) with construction, civil engineering firms involved in energy, transportation, and mining stay busy - Healthcare & Big Pharma are subject to massive regulatory pressures, but generally perform better under Democrats, despite lower drug prices for select Medicaid purchases - Defense contractors (Lockheed, Raytheon, Northrop Grumman) likely to benefit as government spends bigger under Harris for national defense - Treasury Bonds rally as growth/inflation is perceived to be lower under VP Harris - Government Services (Accenture, Leidos, Booz Allen, SAIC) would benefit vs. Trump who plans to introduce DOGE to create a government efficiency/streamline spending - Federal Reserve independence wins/would not be questioned under VP Harris - Import dependent companies who rely on global trade benefit from lower tariffs, in-place foreign-based supply chain with access to cheaper goods - Large Container ships as global trade is stronger under VP Harris (smaller ships with 3,000 TEU will do just fine under Trump running shorter routes) - Volatility rises under VP Harris as Trump-trades get unwound (higher corporate taxes, stricter regulatory framework, and government crowding-out are net-negative for equities) Irrespective of who wins, I believe the credit markets are set up for a win-win with either candidate -> US economy is on strong footing, Fed will ease rates—thus providing a positive backdrop.

The IMF & World Banks hosted their annual meeting in Washington DC last week, and members from Marathon Asset Management’s Emerging Markets team were in attendance along with multilateral development bank officials, Fed officials, US Treasury officials, Finance Ministers from most EM counties, academia, economists, national security advisors, pollsters, institutional investors, and investment bankers. Here is a summary of Ana Jelenkovic’s notes that we shared with our clients: - Strong consensus with no US or global recession forecasted for 2025 (survey of attendee: 20% probability) - EM growth forecast: +4% in 2025 (E)-- see table below - Interest Rates expected to be higher for longer with greater volatility as fiscal outlook leading to larger deficits in U.S. and DM - Debt-to-GDP ratios are favorable as EM sovereigns are rewarded with credit rating upgrades at a faster clip - Select restructuring stories were discussed, while now resolved, noteworthy reflection by the IMF for the need to expedite in the future - IMF emphasized its strongly committed to governments that are committed to improving fiscal and external balance sheets - China’s recent monetary, regulatory, and fiscal measures are a sign of shifting policy priorities, but long-term measures remain highly uncertain - US Election and Trump 2.0 dominated discussion by panel experts who focused on tax, tariffs, and foreign policy (survey of attendees expected a small margin of victory for Trump) - Trump 2.0 is better for stock market, expected to result in higher rates, and stronger dollar as seen in market moves Bottom line: 2025 should be a good year for EM fundamentals. Russia/Ukraine, Middle East Conflict, China-Tiawan are the trouble spots, but growth, development and capital flows are highly favorable in most regions. As a realist and optimist, I have faith that certain conflicts will be resolved in the coming year. Marathon is actively deploying capital in EM with our strong dedicated team.

Stocks & Bonds The probability of a Trump victory has risen and so has stocks and rates. Trump is viewed as pro-growth by the markets, which has implications for inflation, rates and equities. BIG 3 is my focus for today: 1) Taxes: Trump’s tax cuts in 2017 are set to expire next year. VP Harris will allow Trump’s tax cuts to expire in order to raise the rate to 28% (from 21% currently). The delta between the 2 candidates equates to a 5% difference in S&P500 EPS. Tax cuts are expensive, yet it creates stimulus; the opposite is also true. Lower taxes increases the fiscal deficit in the near term, however, in the intermediate term if GDP growth is substantial, debt-to-GDP can remain constant as GDP grows commensurately. During the Reagan-era best known for lowering taxes, deficits soared, as did growth. 2) Regulatory: in the event of a Trump victory, the heavy regulatory pressures which have been weighing on corporate America will likely be lifted creating a pro-business environment and a significant step-up in M&A activity. Less regulation is bullish for heavily regulated sectors (Banks, Tech, etc). I think Jamie Dimon would agree, right Jamie? 3) Budget: To offset revenue from lower taxes, Trump will look for revenue from tariffs (unlikely to fully offset lost tax revenue). If elected, Trump would roll back select Biden-era fiscal stimulus programs such as Inflation Reduction Act that offers massive tax credits for green initiatives. These credits, which are approaching $1T in tax credits and can be sold to big companies has resulted in huge hidden loss of tax receipts. Washington loves to spend yet cost cutting will come into focus as Elon Musk is tasked with his greatest challenge since rocket reusability at SpaceX. Stocks are nearly fully discounting a Trump victory, BUT if the VP Harris prevails, watch out as Trump trades unwind & policy differences described here-in reverse out. Credit markets will likely perform well with either candidate the victor.

Spending Like there’s No Tomorrow: In the fiscal year that just wrapped up, the US Government ran up a $1.8 Trillion Deficit, putting the deficit squarely in the 7% deficit-to-GDP range. Kudos to Deutsche Bank for their fantastic research on this important matter who assembled the data shown in this chart below, highlighting all 46 U.S. Presidents, from George Washington to Joe Biden. Remarkably, no U.S. President has presided over a fiscal surplus since Calvin Coolidge who led our nation during the 1920’s - 100 years ago! My rule of thumb is that running a deficit is okay just so long the deficit is less than the annual GDP growth rate. For instance, if GDP is growing at 2.5%, a deficit of 2% is fine (well done Bill Clinton for accomplishing this!). When I was a young professional starting my career in the 1980’s as a credit markets trader, the debt-to-GDP ratio was in the mid-30’s -> today it is approaching 130%! Deutsche Bank highlights those Presidents that ran up the greatest deficits during their tenure. Historically, deficits soared only occurred during wartime and/or deep recessions/depression as tax receipts decline and/or huge national defense expenditures were required to keep our homeland safe. Most recently, peace time expansion has prevailed, yet we run HUGE deficits. What happens if the economy slows and tax revenues decline? What I also find remarkable is that regardless of the party who controls the White House, both Democrats and Republicans have managed to run equivalent deficits. With the election one week from now, this policy issue will be on the mind of voters, the incoming administration, the Fed, Treasury, and investment managers. The Top 5 Fiscal Deficits under the watch of these Presidents: 1. Lincoln: Civil War 2. FDR: Great Depression and WWII 3. Biden: GDP Strength 4. Trump: COVID Response 5. Obama: GFC Recovery/GDP Strength UST has $35T debt outstanding v. $28T economy (126% debt-to-GDP); +adding $1T of Debt every 100 days. The Fed cuts rates by 50bps and since they cut, the 10-year UST has moved roughly 50bps higher. In 2024, Bitcoin followed by Gold are the best performing asset classes in the world as the debasement of currency continues unabated. This long-term trend will likely continue, even though the next generation rely on us for fiscal discipline.

Home Sales Weaker, Home Prices Stronger: Since the Fed lowered rates 50bps last month, the 10-year UST has risen exactly 50 bps! So goes UST 10-yr…. So goes residential mortgage rates, they move in tandem. The 30-year mortgage rate has risen from 6.1% to 6.6% over the last 30 days. Home sales fell 1.0% last month to seasonally adjusted annual rate of 3.84 million units, the lowest level since October 2010. The South, which had been the most vibrant housing market for existing homes softened by 1.7% as Hurricane activity (Helene & Milton) caused activity to slow. The delta between renting or buying is at a historical extreme. Homebuilders are building smaller homes, on smaller lots, with more cost-efficient materials, further from central business districts, relative to historical metrics. Inventory has grown somewhat over the past year: 1.39M unsold existing homes, an of +23% y-o-y increase in supply (its weak demand, not low supply) First-time buyers account for 26% of sales, lower than average. Home prices have trended higher, becoming unaffordable for many. Key factors to consider are the result of inflation: 1. Rising Mortgage rates (inflation impact) 2. Insurance costs (inflation impact) 3. Real Estate Taxes (inflation impact) 4. Repairs and Maintenance (inflation impact) 5. High Home Prices (inflation impact) GDP for Q3 expected to be +3.4% (Fed’s forecast), which should be supportive for housing activity, yet it’s not. Inflation’s impact has hurt housing activity more than any single factor. 

The Fed Acts, the Market Reacts: The Fed lowered rates last month by 50bps & the 10-year UST rose by 50bps. SOFR was 5.35% the day the Fed lowered rates on September 18 vs. today’s SOFR rate of 4.85%. 10yr UST was 3.70% on September 18, today it is 4.20% SOFR/10-yr UST is exactly 100 bps steeper since the Fed lowered rates by 50. 8 quick take-aways: 1. Bigger NIM = Bigger bank earnings 2. Leveraged unhedged investors who benefit from steeper yield curve benefit 3. Long duration takes a hit 4. Floating rate asset continue to perform well as credit metrics improve 5. Credit spreads not impacted, as earnings/economy remains robust 6. Government funding costs higher since Fed lowered rates (net increase in issuance + higher treasury rates) 7. Home sales/refinancing slows as mortgages are predominately a long-term fixed-rate market 8. The Fed controls Fed Funds, The Market controls longer term rates (unless the Fed manipulates through QE) which they are unlikely to do at this juncture