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Eagle Point Credit's Majewski on CLO Market
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* 00:00I want to start with Lisa Cook, a Fed governor who came out earlier
today and
* 00:05really raised concerns about the non-bank financial institutions and
* 00:09risks that were building up within those.
* 00:11What's your take when you hear things like this?
* 00:14Well, it's certainly the. Thank you very much for having me.
* 00:16The trend in the market of private credit funds in a number of different
* 00:20forms growing is a very real trend and there are ways to identify that.
* 00:24One of the things that makes most private credit funds, be it a private
LP
* 00:28structure backed by pensions or even a public BDC, which there are quite
a few
* 00:33of these entities. These entities have a steady hand.
* 00:37They're not subject to depositors pulling their money.
* 00:39A private credit fund will typically be a ten year life fund and a BDC
is
* 00:44actually a permanent capital vehicle. So they're making loans to
companies in
* 00:48many cases that banks aren't making, but they're doing it with a real
steady hand
* 00:52that the average bank unfortunately doesn't have.
* 00:54So then what do you think the heads of PIMCO's private credit unit were
talking
* 00:58about? And they said things like, it's
* 01:00staggering when you look at what happened since the global financial
* 01:03crisis and how much more leverage there is in the system just pointing
at
* 01:07private credit in particular. Oh, it's a very real trend in the
* 01:11market. But the difference is that those
* 01:13entities, by and large, I'm sure there's a few exceptions that hold
these private
* 01:17credit loans. These are big secured loans.
* 01:20Many cases, billion dollar loans to American companies have a steady
hand
* 01:24and can see those loans through to the end of their life.
* 01:27I'll compare that to banks who own mortgages, in many cases backed by
the
* 01:31United States government. But the mortgages dropped in value and
* 01:34people pulled their money. That can't really happen in the average
* 01:37private credit fund. So given the steady funding mechanism
* 01:41that you have here, how concerned are you About a half a trillion of
loans
* 01:46that are going to be have to they're going to have to be refinanced for
the
* 01:48next three years at a time when there are some questions about how much
demand
* 01:53there is for that kind of debt. Sure.
* 01:55The ability for companies to refinance is obviously driven by a number
of
* 01:59things in the syndicated loan market. Just a few percent of the
outstanding
* 02:04loans are subject to refinancing before the end of 2025.
* 02:07Many companies have been very proactive in managing their balance
sheets, even
* 02:11if they have to pay a higher rate or a higher spread to get more
maturity.
* 02:15And frankly, if you want to find the watch list of credits, that could
become
* 02:18very interesting. Let's look at those that still have 20,
* 02:2124 maturities. Well, so herein lies the issue.
* 02:24At what point do companies kind of run out of leeway?
* 02:27You're saying that we're already seeing that With respect to those that
haven't
* 02:30pushed back the maturities, do you expect that to be a significant
pitfall
* 02:34with some real pain or do you think that it's going to be manageable?
* 02:37I think it will be manageable. The default rate for large cap corporate
* 02:41loans over the last year is roughly half the long term average.
* 02:44Interest rates have gone from basically 0 to 5 plus percent.
* 02:48Companies are paying higher debt. Many of these companies have floating
* 02:51rate debt, but they're still able to service their debt.
* 02:54There will be some problems that pop up, but when we consider we've had
a 5%
* 02:58increase, many companies have doubled or tripled their interest expense.
* 03:01The default rate is still less than one and a half percent over the last
year.
* 03:04How do you make sense of this? You know, so many people I remember back
* 03:06in 2013, 2014, we had a Fed governor saying that it was like people had
beer
* 03:12goggles on and they're looking at everything and seeing wonderful
things.
* 03:16And when the tide moves back, things are going to be in a world of hurt.
* 03:20Why haven't we seen that? Well, companies are living, breathing
* 03:23things. A couple of things going on.
* 03:25It's not just the static top line revenue.
* 03:28Some revenues are going up. Some are going down.
* 03:29The average below investment grade company is growing both revenue and
EBIT
* 03:34over the last year. Jp morgan just put out research,
* 03:37frankly, that said, they're seeing companies that are below investment
* 03:40grade showing record profit margins. So while their interest expense is
going
* 03:44up, on average, companies earnings are growing at a handsome rate in the
below
* 03:48investment grade market. At a certain point, rates become
* 03:51punitive. I was looking at the average rate I had
* 03:53before the incredible rally last week, and they're almost 10%.
* 03:57Just an average public high yield bonds. At what point does it become a
financial
* 04:01liability, a fiscal liability in and of itself that you have investors
like
* 04:05those in Japan that were such significant buyers of triple A-rated CLO
* 04:09paper pulling back because they can find better value back at home.
* 04:12Well, they're starting to versus Japan buying similar triple AA is
certainly a
* 04:17very attractive rate compared to many of the things they can get there
for now.
* 04:20Fellows that triple-A might earn 7% interest, which if we were talking
two
* 04:25years ago we would have said that's 2% interest.
* 04:27So so their continued interest I think is quite strong against that in
the CLO
* 04:32market issuance is down year over year, but I think a lot of that is the
market
* 04:36differentiating those who have really outperformed and those maybe whose
CLO
* 04:40management performance has struggled. But at what point does it make it
* 04:44financially non-viable to be issuing a C a low where you have to pay
seven and a
* 04:49half percent on the top tier of the debt that you're issuing to finance
some of
* 04:54these leveraged loans? Banks are buying loans at ten or 11%.
* 04:57We can make it work all day long, but at what point does it become?
* 05:00Physically difficult to make that ten or 11% interest carry the.
* 05:03That's that's the question. And what we're seeing, by and large,
* 05:07again, is companies revenues and profits in below investment grade land
are still
* 05:11going up. Frankly, Citibank just put out research
* 05:14yesterday or last week saying that the average there are more companies
getting
* 05:18upgraded than downgraded in the market today.
* 05:20So while rates keep moving up, if we're at ten or 15% on the three year
on a
* 05:24three month Treasury, certainly that's a significant impact on the
market.
* 05:29Companies ability to handle even another 100 or 200 basis point increase
at the
* 05:33short end of the curve. While it will increase defaults likely a
* 05:36little bit, I don't think could cause us significant pain.
* 05:38So while things are going well, these companies can handle it and not
just
* 05:43handle it, but they're thriving. What's the threshold for that to shift
* 05:47to? What kind of risk scenarios are you
* 05:49modeling out with a potential weakening economy that could lead to a
different
* 05:53outcome? Sure.
* 05:54There's a number of things going on in the world.
* 05:55Certainly rates getting to a certain point, banking and systemic risk.
* 06:00To the extent we're starting to worry about our banks again in January
or
* 06:03April and March of this year, everyone is where's your cash deposited
was a
* 06:07common question. We also have two wars going on in the
* 06:10world and then there's obviously unknown unknowns.
* 06:13Do any of those cause a short term or a significant shift downward in
GDP in the
* 06:18United States? That would be something that's a
* 06:19principal risk At present. Those events seem contained.
* 06:24Whether they stay contained or not remains to be seen.
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EAGLE POINT CREDIT'S MAJEWSKI ON CLO MARKET
November 8th, 2023, 12:32 AM GMT+0100
Eagle Point Credit Management Managing Partner and Founder, Thomas Majewksi,
discusses Wall Street's hope for a CLO market revival. He speaks with Lisa
Abramowicz on Bloomberg TV. (Interview occurred on November 6, 2023) (Source:
Bloomberg)
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