Maria Bartiromo, Co-Anchor:

Investors this week are focused on the direction of the debt market. A wave of credit problems has shaken Wall Street. And my next guest says there could be more trouble and more fear ahead of the leveraged buyout deals. Joining me now with a closer look at this credit market shakeout: Mark Sunshine is president and chief operating officer at First Capital.

Nice to have you with us, Mark.

Mark Sunshine, President and Chief Operating Officer, First Capital:

Thank you very much.

Bartiromo:

First tell us a little what you do—about what you do at First Capital. You’re doing the lending for some of the small and mid-size companies, correct?

Sunshine:

Yes, that’s right. First Capital is a senior-secured lender to small mid-size companies in North America and in the, the Asia Pacific region. We have a portfolio of about three hundred and fifty companies right now that we lend money to— typically in revolving, credit loans.

Bartiromo:

So, you’re really right there in the middle of the credit process—the lending process, really. Tell me what you’ve seen in terms of demand, in terms of practices. Have you tightened up in terms of lending?

Sunshine:

Well, we tightened up about a year ago in anticipation of the current credit cycle. We saw a lot of overleverage in the marketplace, and a lot of problems with mid-size borrowers, and a lot of problems with other lenders and credit intermediaries. And we thought that there was going to, in fact, be a jam-up in the market right about now.

Bartiromo:

And you think it’s going to continue: that we’re going to see these LBOs unable to happen. Tell us where you think things—how things will play out.

Sunshine:

Well, we see a lot of risk in the current credit markets for three reasons. The first is there have been years of LBOs and private equity fund deals, and just deals where great companies have been undercapitalized and overleveraged. And there’s a cumulative effect to that. The second reason that we see a lot of risk is because a number of the lenders that have lent money into those sectors are in fact undercapitalized and, capitalized very similar to the lenders that lent money into the subprime consumer market.

We think it’s a little like if we went out into the ocean with a hundred million gallons of oil and dropped it on the ocean. An oil slick would form. It would be very wide. It would look from the air like it was very solid, like you could land a helicopter on it. But if in fact you landed on it, you would fall right through. We think the credit markets have many of those similar characteristics today.

Bartiromo:

Do you think that theme or that idea is already priced into the market? I mean, clearly, the whole tightening process has impacted equity investors as well, as people are worried that some of these deals won’t happen. Do you think we are in for further volatility and sort of downside pressure in stocks, as a result of what you’re expecting?

Sunshine:

Yes, we do. We think that there’s a lot of opaqueness to the reporting that’s taking place in the credit markets, particularly in leveraged credits. We also think that there’s the comparison of current performance to historical performance, which makes current performance look very strong, is in fact a false comparison. That credit analysts and economists are getting a false positive reading as to the health of the credit markets.

The issue is people look at credit analysts—credit analysts that you’ve had on this show—look at the default rate for corporate credit, and they say the default rate is very low. Default is very low compared to ten years ago…

Bartiromo:

Mm-hmm.

Sunshine:

But by the same token, defaults took place because of covenant defaults. Now, there are loans that are covenant-light…

Bartiromo:

Right.

Sunshine:

…or no-covenant loans. Therefore, it’s got [unintelligible]. You can’t default something that doesn’t have a covenant.

Bartiromo:

That should’ve been the red flag right there—being able to raise a multibillion-dollar fund and, and, and—with no covenants, or covenant-light.

Sunshine:

That’s exactly it.

Bartiromo:

What other lessons should be learned by the investors? Let’s say you’ve got a large pension fund, or an insurance company, that have invested in the funds that actually are holding that debt? Look back and tell us what you know, kind of lessons that we take away from this process in the last couple of months.

Sunshine:

Well, I think the lessons that should be learned are if you don’t understand the investment because it’s opaque, if you can’t get good transparency reporting, if you can’t see what’s really happening in the underlying credits, you probably shouldn’t be an investor. If the fund itself is leveraged ten-to-one, fifteen-to-one, twenty-to-one, you shouldn’t be an investor—unless you expect to have very volatile returns and you know, the sort of risk-return profile like a venture capital fund.

Bartiromo:

What are your thoughts about the new liquidity into the market as a result of the Fed and the European Central Bank, and really, global central banks around the world? Do you think that was the right move?

Sunshine:

Yes, I actually do think it was the right move. I think if Bernanke hadn’t done that, and if the central banks hadn’t done that, there would’ve been, in fact, a liquidity crisis and a potential meltdown. I think that the move of the central banks is going to be to loosening, and hopefully the Fed will catch up with the other central banks around the world.

Bartiromo:

Are you expecting heavy redemptions when we get up to that date, when we’ll actually, get a window into whether or not we are seeing heavy redemptions in some, in some of the larger funds?

Sunshine:

The information that we’re getting is that there are going to be heavy redemptions, and there are heavy redemptions. However, the funds themselves have governors or, if you will, speed bumps in place, so that many of the funds don’t have to, in fact, honor the redemption request…

Bartiromo:

Hmm.

Sunshine:

…when everybody lines up. The redemptions might take place over a six- to nine-month period…

Bartiromo:

Well, that’s…

Sunshine:

…we do think that there are heavy redemptions taking place.

Bartiromo:

…that’s scary news! I want to get out and I can’t get out, because they have the rules in place where I can’t actually even get my money out.

Sunshine:

That’s exactly right.

Bartiromo:

Nice to have you with us, Mark. Thank you very much.

Sunshine:

Thanks a lot.

Bartiromo:

Good to talk with you. Mark Sunshine, First Capital president and COO.