October 2, 2025 • 44 mins
Collateralized loan obligations, particularly those backed by middle-market borrowers, are a growing opportunity for investors, according to Crescent Capital Group. “You have to work really hard to blow those structures up,” said John Fekete, the company’s head of tradeable credit, speaking of CLOs generally. Middle-market deals will make up a “larger and larger percentage of CLO issuance,” he tells Bloomberg News’ James Crombie and Bloomberg Intelligence’s Jody Lurie in the latest episode of the Credit Edge podcast. We also discuss leveraged loan relative value, the outlook for US consumers and casinos, tariff damage and the impact of liability management exercises.
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Episode Transcript
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Speaker 1 (00:17):
Hello, Welcome to the Credit Edge of Weekly Markets Podcasts.
My name is James Crombie. I'm a senior editor at Bloomberg.
Speaker 2 (00:23):
And I'm Jody Lurry, senior credit analyst at Bloomberg Intelligence.
This week, we're very pleased to welcome John Faquett, head
of tradable Credit at Crescent Capitol Group.
Speaker 3 (00:31):
How are you, John, I'm great, good to be with
you both today.
Speaker 2 (00:34):
Yeah, it's fantastic to have you. It's such a treat
to have you on today. For those listeners who don't know,
Crescent Capital is a leading alternative credit firm with forty
eight billion in assets under management and invests in corporate
credit across the capital structure. John has been dedicating twenty
four years of his life to the firm and overseas
over eleven billion in assets under management in high yield bonds,
(00:56):
high income and syndicate credit solution strategies. Obviously, he worked
at Trient and Capital Partners in HI old research covering
and I'll focus on the most important to me, gaming
and lodging and then of course common cable. So I'm
going to send it over to James now.
Speaker 1 (01:13):
Yeah, So, as we keep saying, Jody credit markets are
red hot, with bond spreads at the titus in almost
three decades, as demand keeps getting bigger and the net
new supply just isn't there. The largest leverage buyout ever
for electronic arts is dominating the headlines this week. At
the same time, though, we're seeing more distress defaults and bankruptcyes.
First brands, the Cleveland based auto Supply, which had been
(01:35):
trading close to par just a few weeks ago, went bust.
It followed Treacylare Holdings, the company that sold used cars
to low income and undocumented immigrants, which also went down
this month. For those who have been around for a while,
a fifty five billion dollar LBO triggers some troubling echoes
of two thousand and seven, just before the global financial
market's meltdown, and that nobody wants to see again. So, John,
(01:58):
you're close to the action on the ground in credit.
How worried should we be about all this? Is it
the GFC all over again? Or is it really that
different this time?
Speaker 3 (02:06):
I never like to say it's different this time. I
am a student of history, so I try to learn
from the past. What I'll say is that there are
certainly pockets of vulnerability, James, and we're seeing you mentioned
a few recent anecdotes. Broadly speaking, what we see in
the marketplace is a sentiment that's somewhat gloomy, but when
(02:28):
you look at the data, the data is generally fine.
So what I mean by that is some of the
things that we tend to look at to try to
assess the health of levered bar wars to determine where
defaults are going. One thing would be leverage levels. So
I think this is kind of interesting. I saw statistic
recently from JP Morgan saying that leverage for highield barwers
(02:49):
today is sitting around four times and that's the lowest
level in about twenty years. I don't think most people
would know that. Most of your listeners or those that
just read the press would probably we assume, based on
some of the anecdotes you just gave, things might be
heading off off a cliff, and statistically speaking, that's that's
(03:09):
not true. Again, there are going to be some examples,
and we can talk about happy to talk about some
sectors maybe that are where there's pockets of vulnerability, But
broadly speaking, leverage is in good shape. And another thing
that we look at I like to look at is
the pending debt maturities. I think this is a good
way to try to get your arms around what's going
(03:30):
to happen one, two, three years from now. And when
we look at the amount of debt coming due and
high yield for example, over the next three years, it's
about two hundred billion, which is about twenty percent of
the market. To give perspective, a good year in the market,
you see about two hundred billion dollars of refinancing activity.
(03:53):
So put another way, one year of refinancing activity would
cover all the debt coming do and in the high
yield market over the next thirty six months. It's a
similar number. For leverage loans, it's actually smaller to about
one hundred and sixty billion. So when you look at
things like that, to me, it says that the market
(04:13):
is constructive, it's relatively healthy. Let's go to the default activity.
You mentioned. There is some credit stress, and it's in
what I would say a handful of sectors. Media is one,
retail is another sector. It seems like retail is always
a vulnerable stress sector. In the twenty plus year career
(04:34):
I've had. What's interesting is technology has been on that
list too, and I think a lot of folks might
be surprised to hear that. One of the reasons why
is because technology has a higher leverage level than any
other sector. People felt like, well, these are like low
capex companies, they're very high recurring revenue. We can put
more leverage on a tech company than on an industrial company.
(04:57):
And the reality is that when rates shot up in
twenty twenty two, it created a lot more stress. So
it's interesting for me to see technology on that list
of a handful of sectors where there is stress.
Speaker 2 (05:11):
So, John, I want to dig in a little bit
into some of the points you said. So you said
four times leverage on average for high yields, and I'm
just curious when you think about the HILD market, you know,
post COVID and actually post GFC, but particularly post COVID,
we've seen it shrink over time with a preference to
private credit issuance. So I'm just curious if we're not
(05:36):
actually seeing the whole market.
Speaker 3 (05:38):
You're certainly true like your comment about the high market shrinking, Jody,
that's that's been something that we've seen and it's really
been offset. You mentioned private credit, but also leverage loans
as a whole. Leverage loans as a hole has been
a much faster growing market than let's say, high heal bonds.
Borrowers and their private equity sponsors have favored or leverage loan,
(06:01):
whether they be syndicated or private solutions in the last
few years, and that trend has been I think many
years in the making. Now. One of the side effects
of that on high yield has been an increase in
credit quality. So if you look at the average credit
rating and high yield, it's higher today than it's ever been.
(06:22):
It's one of the things I point to. People will
often ask me, hey, why is high yield so tight?
And James mentioned spreads are quite low, and they are,
but one of the reasons is that you've seen convergence
between high yield and investment grade. In fact, high yield
has a double B average rating investment grade as a
triple B average rating. They're the closest they've ever been
(06:45):
in terms of credit quality, and they're also the closest
they've ever been in terms of spread. So that tells
me the market is fairly efficient. Now, loans is a
different story. You've had a slow but steady degradation in
credit ratings in that particular market, single B is the average.
You know that colos are a big driver in that
(07:06):
market as well, which have their own technicals when something
gets downgraded to triple C, so oftentimes that's that's something
that investors, I think need to be aware of. Lme activity,
triple C downgrade, the technical that the clos's I think
it's a little more tricky today to invest in loans
(07:26):
than it is in high yield bonds. And that's crazy
for me to say, because when I started my career,
leverage loans were considered like a cash alternative and high
O bonds were considered to be the wild West.
Speaker 2 (07:39):
Just thinking about the fact that there's such a tight
spread between triple B and double B and we're seeing
that on our end, I mean, I'm seeing that with
a lot of my companies who are working towards investment grade.
So there's that component of it where they're just barely
blow investment grade. But beyond that, I mean, does that
mean that a lot of companies don't necessarily see the
(07:59):
value of being investment grade, or does it mean that
investors are more willing to reach for riskier investments because
they're not necessarily getting rewarded at the higher level of
high yield.
Speaker 3 (08:14):
That's a really interesting question, Jody, because with the way
you said it like our companies not maybe putting as
much value or priority on being investment grade. Again, I'm
going to sound like back in my day, but quite honestly,
you know, twenty years ago, every company in high yield,
(08:37):
even if they didn't their actions didn't show it, they
would pay homage to we want to be investment grade rated, right.
They would say that on their quarterly earnings calls. You
don't hear it as much today, and even with fallen Angels,
I find that to be quite interesting. You know, the
reason high yield is increased in quality is because we
had many former IG companies that were downgraded into our
(09:00):
h yield universe, and they did not prioritize going back
to investment grade. They were happy to borrow at six
percent instead of four percent. It's still worked for their
business model, and they're good double B companies and they're
large caps. So I think it's safe to say that
it maybe is not a priority for every company. You know,
some companies, if you're financial, for example, you don't see
(09:22):
a lot of junk bond rated banks. I hope that
we don't see a lot in the future party risk lore. Yeah, yeah, exactly.
So it's it's more sector bisector specific.
Speaker 1 (09:35):
But John, to go back to what you were saying
about the risk pockets of risk and to Jody's point
that you know this spread kind of collapsing between the
different ratings buckets, to me, it suggests more complacency than
anything else. You know, if you if you're valuing a
triple C risk very close to single B and single
BE very close to double B and you're not really differentiating,
(09:58):
it's just speaks to me more about the excess cash
in the system and not enough supply. And to that point,
you know, the pockets of stress that you mentioned at
the beginning, how widespread are they and how do you
spot them?
Speaker 3 (10:11):
It's been relatively modest thus far. If you look at
as a percentage of the market, it's still well within
historical norms, which you know, there's two sides to every trade, right,
One person could look at that and say, well, geez,
high yield default and bank lone default rates are at
historical levels or even elevated above that, and that could
(10:31):
be a cause for concern. Another person could look at
that and say, well, geez, we had this huge increase
in interest rates in twenty twenty two. Rates have been
higher for longer than most people expected, and yet still
three years into a rate hiking cycle, the historical default
rate is still only sort of in line with the
long term average. So it's not not a lot to
(10:54):
be terribly worried about. I do think there is some
complacency in the market. That's one way to look at it.
There's a lot of cash, as you said, James, that
is across asset classes, right, We're not just talking about
syndicated bonds and loans. Private credit has raised a lot
of capital. Flows into investment grade have been robust recently,
(11:16):
so there is a lot of capital. And when you
have a lot of capital, companies can get bailed out.
And we see that. We see more examples of lower
rated companies that look quite vulnerable and they are able
to secure financing solution, which could cause the price of
the bond or loan to jump by ten or fifteen
(11:37):
or twenty points. So it's both an opportunity because if
you can correctly identify those companies, you could do quite
well but it's also a risk. Those are the kinds
of companies that have been vulnerable. And why I say
there will be failures. If you're a levered company and
(11:59):
you have a very high level of leverage and we're
multi years out of the pandemic, I'd be worried about that.
So our team is really focusing more on looking at
cash flow, looking at what's going on in the capital structure,
a little bit more up in quality given the nuances
(12:19):
in the economic outlook. What I mean by that is
in the high yield and bank loan side, preferring more
of the higher single be rated credits and you can
still get a mid to high single digit return in
a good quality portfolio, which I think for modest level
of duration risk, that's not a bad outcome right now.
Speaker 1 (12:41):
So the view on the risk then in terms of
you know, these pockets of stress, that's more idiosyncratic. It's
very specific to names and possibly certain industries. You don't
think it's a widespread credit issue.
Speaker 3 (12:53):
Not yet. Again, being a student of history, usually these
default cycles begin with a few idiosyncratic examples, right, and
then it becomes more systemic. We're not seeing that today,
and that sort of brings I think to the point
about what is twenty twenty six going to look like?
(13:15):
Is twenty twenty six going to be a recession year?
Where's twenty twenty six going to be a rebound year?
And I think a crisp argument could be made for
either of those. So it's not quite clear that we're
about to see a default cycle increase. A lot of
folks think defaults are more likely to go down in
(13:37):
twenty six as the economy starts to reaccelerate. We'll have
to see which direction we take now.
Speaker 2 (13:43):
Donnie mentioned a few sectors that you don't like, such
as retail, But what sectors are you leaning towards as
a result of retail? Sort of? I mean, I use
retail as an example, But the few sectors that you
don't like, which ones do you actually like? And which
ones are you seeing there being value going into this
(14:04):
uncertainty in twenty six.
Speaker 3 (14:07):
Retail is interesting. I want to make sure I just
to set the record straight, not that I don't like it.
I mentioned it as one area where there is elevated
level of default risk. But interestingly enough, I think expectations
in retail were so incredibly low that we've actually seen
(14:29):
positive earning surprises in the most recent quarter. This was
across different types of retailers, so we saw department stores
put up better than expected numbers, apparel stores, even pet
retailers put up better than expected numbers. And there's been
some pressure on the pet space coming out of the
COVID pandemic. So it's interesting, Like it's a sector, I
(14:52):
bet a lot of people would say, I don't want
to touch it. But interestingly enough, when you start to
peel the onion, you see that expectations so low, there
may be some idiosyncratic opportunities there in that sector as well.
On the other side, you know, everybody will talk about
having exposure to healthcare business services, things that are CAPEX light,
(15:15):
high free cash flow conversion. Generally, these types of businesses,
these business models do pretty well. Healthcare, though, is one
area that is well. Has very little little tariff impact
other than maybe pharmaceuticals, a lot of regulatory risk, right
stroke of the pen risk, change of the budget, and
suddenly reimbursement rates for hospitals and providers is down. So
(15:38):
there are a lot of challenges to navigate in a
healthcare sector, even though that's one of the largest sectors
that most investors have in their high yield and bank
long portfolios.
Speaker 2 (15:49):
I think for the healthcare space to are my colleague
Jy and Mike Colland write about this a lot in
terms of the tariff effects of that. Now a lot
of the companies I cover have more kind of indirect
terriff effects in the leisure gaming spaces, And drawing on
your background in gaming, you know, something that we've seen
(16:10):
recently is the weakness coming out of Las Vegas, a
little bit less exciting growth in Macau. And so I'm
just curious if you sort of see that as any
kind of canary, if you see that as just descriptive
of a lack of catalysts, or are we in fact
seeing the consumer get a little bit more concerned because
(16:30):
of tariffs.
Speaker 3 (16:33):
That's a great observation, Jody, and one that I've seen
throughout my career in gaming. And this is you know,
a little bit of inside baseball for gaming. But since
you have expertise there and I covered it, I think
it's something that is a repeatable pattern for the listeners,
which is that when consumers start feeling a little bit pinched,
(16:55):
the first place you see it in gaming leisure and
lodging is usually in the loss of Vegas strip data,
you start to see visitation come down. You start to
see people spending a little bit less on shows and
dinners and gaming, and instead you see them reallocate those
dollars to local or what we call regional casinos. So
(17:17):
if you're in southern California like I am, maybe you're
going to the tribal casinos that are an hour away.
Or if you're living in Philadelphia, you've got a lot
of casinos there. You don't necessarily need to fly to
Las Vegas and have a monumental weekend trip. You can
have a fun time for a few hours in your region.
(17:38):
And regional gaming is also so prevalent today. You know.
I remember having a map up in my office when
I first started as a gaming analyst, and I actually
could put like a few pins where there were casinos
legal casinos in the US, and it was like just
a few pins. You know, if I did that today,
the map would you know, would be punctured, tod probably
(17:58):
fall off the wall. Because gaming is legalized in I
think forty eight out of the fifty states, so there's
a lot more opportunity for consumers who maybe are reallocating
their dollars and thinking about how they're spending it. So
if I started to see the regional data turned down,
then I think that would be a sign of a
more pervasive downturn.
Speaker 2 (18:20):
One thing I've struggled with, and not to get too
deep in the weeds about gaming, but I do think
that it's analogous to other sectors is we now have
online gaming and sports betting legal in fourteen states, right,
and so we have some component of not this time
as different, but we do have this time as different. Right,
people might not even be as willing to go to
(18:43):
regional casinos now if they could do it from their phone. Similarly,
we've had that argument in retail right where why am
I going to go to the store when I can
do it on my phone? But we are still seeing
people go to the store. How are you kind of
thinking about that? Because so many of the companies in
the hy old space have this component of tech replacing
(19:03):
traditional operations, and how do you then say, Okay, this
is happening, but we're still seeing the cash flows there,
We're still seeing these companies as beneficial.
Speaker 3 (19:13):
A lot of that is driven by demographics, right, So
I think about go back to casinos for a second,
since that's kind of a fun sector to talk about.
I always think so part of it. It's not just
the bet, right, It's not just the This is why
when you look at the revenue that a casino has,
and I'm generalizing, it varies depending upon whether it's a
(19:35):
casino in Macao, Las Vegas, or Indiana, but generally speaking,
the revenue from the gambling is half or less than
half of the total revenue a casino makes. Because so
many people put a great deal of value on the
experience of having a nice meal with your family, or
going to a really cool show at the Sphere in
(19:58):
Las Vegas and seeing something amazing that you can't see
anywhere else, or going shopping and treating yourself. Right. So
even though yes, technically, if if all you care about
is making a bet, you could bet online, it's a
very very different experience than going to do all these
all these things that we're talking about. So I think
(20:20):
it's important to understand the motivation, like what's driving the
consumer and the behavior and is it, you know, just
just that bet that's going to eat into some casino
business for sure, But for a lot of people, it's
just a way to you know, maybe have have a
good time for a few days and get and get
away from get away from home. So it's I think
(20:43):
there's demand for both for.
Speaker 1 (20:44):
Sure, or is it the fact that we're also worried
about recession coming out that we just need to distract ourselves.
Speaker 3 (20:49):
Like you'd be a great fixed income investor, James, because
you're glass to have empty you'd be you'd be perfect.
That's exactly the kind of culture we cultivate on our team.
We're always we're always looking at, you know, what could
go wrong because it's an asymmetric asset class. Best case
(21:10):
we get our money back. Worst cases, you know, we
get twenty or thirty cents on the dollar.
Speaker 1 (21:17):
But just switching gears a little bit. Clos have been
a big feature on this show for many months, including
some of the biggest asset managers in the world talking
about that as a as a huge opportunity. You know,
there's a pickup to playing vanilla credit, which is trading
very tight. One large portfolio manager described them as bulletproof.
(21:37):
But at the same time, there are concerns, as we've
already discussed about the economy about the ability of the
highly indebted companies to keep up with debt payments, especially
on leverage loans, which are floating at a time, you know,
when underlying rates have come down a tiny bit, but
they're still much higher than we had expected them to be.
So how does this all shake out? John? Is this
great opportunity or is it another potential troublespot.
Speaker 3 (21:58):
Generally, we've been constructive on clos I still think in
this day and age, even though they've been around for
for a long time, they've had quite an evolution. Practitioners
investors in the COLO space, we'll talk about CLO one
point zero versus two point zero and and they're referring
(22:19):
to structures before the Great Financial Crisis and after. And
there were a lot of I think important needed and
valuable changes that were made after the GFC to strengthen
these structures, make them more bulletproof. You know, nothing is
ever bulletproof, per se. That's why you're getting you know,
(22:39):
relatively high mid high single digit yields. But there is
a misunderstanding. I cannot tell you if I had a
if I had a dollar, every time I asked an investor,
you know, what their perception is a clos The most
common answer is, oh, it caused the twenty oh eight
financial crisis, And I would say, well, actually that was
(23:00):
the housing market and our mbs and CMBs and it
wasn't corporate debt. And people are like, what are you
talking about? You know, these are all the same acronyms
and CDOs.
Speaker 1 (23:10):
People have come back with.
Speaker 3 (23:12):
That is a four letter word. Yeah, we're not going
to talk about let's stick to the CLO. But there
is a misunderstanding, and you know, we're kind of laughing
about it. But that's what drives an opportunity oftentimes, is
when you have things that are misunderstood and you have
to educate yourself a bit about it. There are opportunities
(23:33):
and I've and I've heard some of your guests in
the past talking about the opportunity there. Historically it was
an institutional opportunity only meeting only institutional investors had access
to it. More recently, explosive growth in clos ETFs ETFs
that had COLO debt in it. So this is a
(23:54):
way that retail investors can access the market which previously
they had never been able to do. One of the
interesting areas that I think is you're going to hear
more about, and this is related to clos going forward,
is something called middle market COLO or private credit COLO.
(24:14):
It's a relatively small part of the total COLO universe today,
but I think it's a very interesting area of focus
because it's one of the few places where there's strong
convergence of liquid and private credit. And what I mean
by that is we know colos and structure credit. It's seasoned,
(24:34):
it's been around for thirty years, it's time tested in
the liquid credit market. But instead of buying large cap loans,
these structures can also buy originated, directly originated private credit
loans in them and that's what the middle market COLO
industry is, and it's quite interesting. It has recently been
(24:56):
about twenty percent of total new issuance in recent years.
One out of every five dollars that's raised in the
COLO market is going into these middle market clos. I
would say that a few years ago that was close
to zero, like at the beginning of the decade. So
it's a relatively new phenomenon, even though the structure has
(25:18):
been around a long time and private credit loans themselves
as an asset class have been around a long time.
As well. This is something new. It's interesting for investors
because there's an opportunity to get a relatively high incremental
spread anywhere from twenty five to fifty basis points above
what you would get in a BSL type CLO. So today,
(25:41):
if you look at a triple A probably like five
and a half percent yield in a triple B rated
middle market COLO seven and a half percent. Know, as
we know, that's a very big incremental spread over an
investment grade rated corporate bond. So there is something there
potentially for rating sensitive investors as well as another way
(26:05):
for any investor to access private credit. But in a
credit rating friendly wrapper.
Speaker 1 (26:10):
Does it continue to grow at the same pace? Do
you think from here?
Speaker 3 (26:13):
We do think so. We see we see allocators as
being under index to this particular asset class. So I
think for investors, this is going to be a growing
part of the CLO set. It'll be a larger and
larger percentage of COLO issuance going into the middle market
type structures.
Speaker 1 (26:30):
Does it end up being half the market for example?
I mean at some point in the future, you think.
Speaker 3 (26:34):
I don't see any reason why I couldn't. I haven't
really tried to quantify what I think the cap would be,
So I don't I don't want to say it'll be
half the market in a few years. But the growth
and the value proposition, I think it certainly will continue
to grow it and it bears watching.
Speaker 1 (26:54):
But again back to the risks, because these are structures
that repackage leverage loans. You know, they're their loans out
to companies that are subinvestment grade. They are also being
repriced very very rapidly at a much lower margin. So
the underlying is getting more expensive. You're trying to make
some kind of arbitrage. How do you do that just
adding more leverage and what problems come from that something?
Speaker 3 (27:16):
Certainly to be mindful of the manager. The structure is
critically important. How much leverage they're putting in the structure.
As you said, there's an element of leverage on leverage, right,
So you want to make sure that you have a
manager who's seasoned, who's been through various cycles. You want
to make sure that you understand the loans that are
being underwritten, particularly in these middle market structures, because there's
(27:39):
not as much information available about it publicly, right. These
are not large cap syndicated loans. These are privately originated
or small small clubs, so you really want to make
sure that the managers that you're backing are managers that
have performed well throughout credit cycles. They're not trying to,
(28:03):
you know, put every dollar of leverage that they can
in there. So manager selection and the structure is critically important.
It's pretty rare though I know it's come up in
your other podcasts. It's pretty rare for these structures to fail,
and almost unheard of in the investment grade rated portion.
(28:23):
So really the most vulnerable part is the equity. There's
the potential for a very high risk, but also the
potential for you know, a very high reward in the
equity moving up in the capital stack. Triple B, single A,
double A. There it tends to have historically, you have
to work really hard to blow those structures up.
Speaker 2 (28:45):
And how do you view the risk related to the
concentration on the buy side. By that, I mean is
that we've seen certain buy side managers just get so large,
and they're participants in different parts of the deal right there,
the underwriter, they're the manager, they're also the ones buying
the clos How do you sort of think about that
when when you think of the I guess, flow of
(29:07):
funds and the health of the pipeline of the market,
how are you sort of wrapping your head around that
that we have just a few very very large managers
or a few very very large you know, by side participants.
Speaker 3 (29:22):
There certainly are large managers that are getting larger and
they have an issue with deployment. Right. You know, we
as a firm, Crescent forty eight billion dollars. Now that's
six times larger than it was when I started my
career at Crescent. But relative to some of the big
(29:44):
guys that you're referring to, you know, we're still quite
quite small. And that means we don't have to worry
about doing every deal. We're not taking in hundreds of
millions of dollars a month in capital where if we
don't deploy it, we don't get a management fee. Right.
So I always like to think about the incentive you know,
I have as a manager or in my retirement account,
(30:07):
that the funds and vehicles that I invest in, you know,
as the manager making decisions based on fundamental credit, or
are they making decisions because they got to push this
dollar out another dollars coming in tomorrow. And that is
a growing dichotomy in credit, not just private credit, but
in liquid credit as well, which is are you an
(30:29):
asset aggregator or are you really an investor? And you know,
I think there's a value to being with a more
mid sized manager that is not under the pressure to
have to buy every deal, because that's when you really
run into problems and you don't have differentiation in your portfolio.
I think that's really interesting in private credit. While I'm
(30:50):
not a private credit guy per se, one of the
value adds that were alpha generators in private credit was
having proprietary sourcing. But if all the law large managers
are out there doing the same thing and their portfolios
all look the same over time, that alpha dissipates, right,
and then it's just you're just a beta play. We've
seen it in high yield, We've seen it in BSL,
(31:12):
and I think that's what you're going to see, a
split between those who are truly delivering alpha and those
who are just delivering a beta experience in private credit.
Speaker 2 (31:22):
And do you think it gets to a point where
the size gets so large that they need to separate
or they need know in order to be efficient sometimes.
I mean, you see it with companies all the time
that they say, you know what we have to we
have to split the baby because it's not efficient. And
is there a point where we reach that? I mean,
(31:43):
we saw not to harken back to James's intro related
to comparisons to two thousand and seven, but you know,
when you think about the risk to the markets in
O seven, it was we had two big to fail banks, right,
and we had these massive struct and thankholding companies and
insurance companies that probably shouldn't have gotten into areas that
(32:05):
they got into the market, right. And here now we're
sitting and you know, you mentioned your firm and it's larger,
but it's nowhere near the size of some of these
other ones. At what point does it get to be
problematic that they're just such a large mass amount and
to your point, they're not. Actually, you know, they might
not create as much value as they could because they're
(32:26):
just so large.
Speaker 3 (32:28):
I know, speaking from experience in the liquid tradable credit side,
there's pretty much a well regarded established pattern whereas managers
get larger and larger, their relative ability to relatively outperform
a benchmark diminishes. There's just too much capital they own
portfolio as you look at you can look at them
online because these mutual funds are online. And you see
(32:51):
four hundred five hundred positions in a high yield fund
and you say, well, there's two thousand issuers. If you
own one out of four, I mean, aren't you sort
of a proxy for the market? And and then you know,
you sort of like an ETF right, You're you're not really,
it's not an active thing. I don't know what that
number will be. On the private credit side, that's that's
(33:16):
you know, somebody else closer to private credit could perhaps
answer that, but but I do. I do know. We've
seen it in the tradable credit side, which is again,
if you want to be liquid, you want to be nimble.
You know, we didn't talk about lms today, but one
of the best way to avoid getting caught up in
LME is to have a position size that you can
(33:36):
actually trade if you want to get out of something.
And that's a big difference. You know, if I have
a ten million dollar position and my competitor has one
hundred million dollar position and we both come to the
same credit decision, like, oh my gosh, we got to
get out of this. This thing is headed to an lme.
Guess who's going to be more likely to reduce their
position the guy who has ten million or the guy
who's got one hundred million of that of that leverage
(33:59):
loan or that high yield bond. It's just, you know,
it's just the way it goes. So there is a
value to being kind of mid size and being able
to be nimble.
Speaker 1 (34:09):
How much leemy is affecting your ability to operate in
the CLO world at the moment, John.
Speaker 3 (34:16):
It's It's definitely a factor that I believe is here
to stay. Some of it has been somewhat mitigated by
the development of these cooperative agreements, but I never underestimate
uh smart attorney's ability to find loopholes or or create
other you know, other other structures are other ways to
(34:37):
get around this. Our view, Accrescent, is this is here
to stay. You've got to think about this when you're
underwriting a credit. We've actually brought resources to bear internally,
like workout resources that are embedded in our performing credit team,
because it's become prevalent more on the loan side. You
typically don't see this on the high yield side. Now,
(35:00):
I know you've talked about this in the past, so
I'm just going to touch on it. But not every
LME has a terrible impact, right, Sometimes the recovery in
your l ME is much uch higher than it would
be in a traditional bankruptcy. So it's it's not necessarily
a bad thing on its own, although we do see
a lot of companies that once they go through an LME, they,
(35:23):
you know, more than half tend to have to go
through another one or end up filing bankruptcy anyway. So
it's it's a warning sign and it's just one more
thing that a skilled credit team has to has to manage.
Speaker 1 (35:36):
So you've had a bunch of lawyers basically to protect
you in these how have you expanded your operations to accommodate.
Speaker 3 (35:44):
You need people that have workout experience, You need people
that have legal experience. You need people who know who
the right advisors are. You know that that was something
earlier in my career. If a credit went into like
a watch list and then one to restart structuring, you
would bring someone alongside to assist you. And now we
(36:06):
want those that expertise that that knowledge embedded in the
front end before we make a decision, you know, what
have we seen with this kind of company? What should
we look for in the documentation? How many lenders are
in it? Are there bad actors that we need to
be worried about. Maybe we've had a bad experience before,
so we say, look, we're gonna We're not going to
(36:27):
underwrite this credit. It's manageable, but it just adds, you know,
more items to your checklist for sure.
Speaker 2 (36:35):
I mean even you know, when I look at some
of my companies and I look at the cap structure
and I sort of see, you know, the secured and
how complicated it's started to get for some of the companies.
Some of my companies are trying to avoid Chapter twenty two,
let's just say, and it is something that I think about.
I say, okay, does security even have some value here?
(36:56):
But I wanted to actually switch a little bit to
a question I had around the recent rate cut thinking
about loans and thinking about exposure. So you know a
lot of loans are floating rate security there further short duration,
and so when you are heavily invested in the loan space,
how are you balancing that out to ensure that you know,
(37:20):
you're not quote unquote losing out in the environment, or
you're not over exposed to one side over another.
Speaker 3 (37:27):
Yeah, very topical. Right. The expectation that rates base rates
will start to come down, at least on the slow
and sustained basis, that's going to result in lower coupons
for all floating rate assets, whether they be large gap
syndicated loans, private credit loans, clos, they're all going to
be They're all going to expect to have a reduction
(37:50):
in their coupon. The offset to that, though, is less
interest expense for our borrowers. Right, So it's important for
for everyone to remember that perhaps the worst is behind us.
If you believe that we are going to see a
sustained pace of rate reductions, maybe not as quickly as
(38:10):
some would like, but that should result in lower interest expense,
which means better interest coverage ratios, which likely means less
credit stress in twenty twenty six. So from an investor's perspective,
am I okay getting maybe a half point lower coupon
or point lower coupon, but it also likely means there's
(38:34):
less credit stress. My sense is there's a fair amount
of that that's being priced into the market today, which
is why investors are comfortable with spreads where they are,
because they expect that. I don't ever want to say
smooth sailing. It's never smooth sailing in leverage finance. But
I'll go back to that phrase. The worst may be
(38:56):
behind us in terms of the impact of higher coupon
on borrowers, and that's where, you know, just to kind
of close this thought off, one of the things that
I'm monitoring very closely is are these rate cuts coming
in time or are they too late? And that, to me,
(39:16):
is one of the biggest things that I worry about,
is the possibility that we're going to see rate cuts.
It seems clear. I mean, the FED said we're getting
more neutral but not neutral. That to me means more
cuts are coming. But has the impact already gone through
the economy right or can they pivot and be nimble
(39:38):
enough to allow the GDP to accelerate like a lot
of people think it will next year generally speaking, if
they can control that. I mean, if the way I
think about it is if you have an environment of
call it one to two percent GDP and inflation is
two to three percent, that's usually pretty constructive for the
(40:00):
kind of assets that that we manage. I think that's
a fine environment, and most of our borrowers would do
fine in that environment.
Speaker 1 (40:09):
So all that said, John, if you look ahead, let's
say twelve eighteen months or so, where's the best relative
value in the credit market.
Speaker 3 (40:16):
I like syndicated loans. They've fallen a little bit out
of favor relative to high yield. As we mentioned, there's
been a fairly significant dispersion in performance. I like higher rate,
single B type loans. I think there's interesting opportunities there.
Companies that are not at risk of downgrade have spreads compressed, sure,
(40:40):
and our base rates coming down. Yes, But even when
you factor in what is expected. You can look at
one year forward sofa right, you know, everybody can look
at this and say, I think that's reasonable, or I
would make it a little higher or lower. Even when
you factor in the forward SOFA curve, the carry that
you can get on a single B rated loan is
(41:00):
much much higher than on a high yield bond. So
you could have you know, four rate cuts in the
next twelve months and loans will still have a higher
coupon than bonds. I think that's an opportunity you just
have to make sure that you know you're doing your
homework on the individual loans and that there's are performing
companies and they have have no near term maturities, they're
(41:26):
not on watch for downgrade. So yes, to me, that
looks like an interesting area of the marketplace today that's
a little bit out of favor and clos. I think
colo middle market clos are going to be something to
watch in the future. Perhaps dare I say even investors
someday may make a strategic allocation to it. Today it's
(41:49):
still relatively nascent, but I think that there'll be great
opportunities to monitor there as well.
Speaker 1 (41:56):
But on the loan side, John, the higher default rate
than bonds, low recover rees, and situations like First Brands
where they were trading at par and then suddenly went
to the teams that those things don't give you pause overall.
Speaker 3 (42:10):
Not if you're asking the right questions. You know, I
don't want to get too deep into that credit, but
there had been some, you know, questions around that credit,
notwithstanding it was trading at par. I think there were
questions about the supply chain, financing and things that some
people clearly were aware of. Right, So you do you know,
(42:33):
you do have to have a robust This is why
this is one of the one of the few areas
where active management still outperforms passive. I know folks like
to look at ETFs and large cap equities. Maybe the
way to go is just buy an ETF lo FI.
Active management doesn't create alpha in credit. There's so many
(42:56):
of these things we've talked about in the last forty
five minutes, right faults, documentation, co op agreements, lmes. There's
still a room for active management to add value, fewer defaults,
higher recoveries. So I do think that it's an essential
part of investing. So it doesn't give me pause to
(43:18):
the asset class, but it just confirms for me how
important it is to do your homework.
Speaker 1 (43:23):
Great stuff, John Fiquett at crescent A Capital Group, many
thanks for joining us on the credit edge. Thank you,
and of course very grateful to Jody Lurie from Bloomberg Intelligence.
Thanks for joining us today.
Speaker 2 (43:32):
Happy to be here for.
Speaker 1 (43:34):
More credit market analysis and insight. Read all of Jody's
great work on the Bloomberg terminal. Bloomberg Intelligence is part
of our research department with five hundred analysts and strategists
working across all markets. Coverage includes over two thousand equities
and credits, plus outlooks on more than ninety industries and
one hundred market industries, currencies and commodities. Please do subscribe
(43:54):
to The Credit Edge wherever you get your podcasts. We're
on Apple, Spotify, and all other good podcasts provide is,
including the Bloomberg terminal at bpod Go. Give us a review,
tell your friends, or email me directly at jcrombieight at
Bloomberg dot net. I'm James Crombie. It's been a pleasure
having you join us again next week on the Credit
(44:15):
Edge
Hello, Welcome to the Credit Edge of Weekly Markets Podcasts.
My name is James Crombie. I'm a senior editor at Bloomberg.
Speaker 2 (00:23):
And I'm Jody Lurry, senior credit analyst at Bloomberg Intelligence.
This week, we're very pleased to welcome John Faquett, head
of tradable Credit at Crescent Capitol Group.
Speaker 3 (00:31):
How are you, John, I'm great, good to be with
you both today.
Speaker 2 (00:34):
Yeah, it's fantastic to have you. It's such a treat
to have you on today. For those listeners who don't know,
Crescent Capital is a leading alternative credit firm with forty
eight billion in assets under management and invests in corporate
credit across the capital structure. John has been dedicating twenty
four years of his life to the firm and overseas
over eleven billion in assets under management in high yield bonds,
(00:56):
high income and syndicate credit solution strategies. Obviously, he worked
at Trient and Capital Partners in HI old research covering
and I'll focus on the most important to me, gaming
and lodging and then of course common cable. So I'm
going to send it over to James now.
Speaker 1 (01:13):
Yeah, So, as we keep saying, Jody credit markets are
red hot, with bond spreads at the titus in almost
three decades, as demand keeps getting bigger and the net
new supply just isn't there. The largest leverage buyout ever
for electronic arts is dominating the headlines this week. At
the same time, though, we're seeing more distress defaults and bankruptcyes.
First brands, the Cleveland based auto Supply, which had been
(01:35):
trading close to par just a few weeks ago, went bust.
It followed Treacylare Holdings, the company that sold used cars
to low income and undocumented immigrants, which also went down
this month. For those who have been around for a while,
a fifty five billion dollar LBO triggers some troubling echoes
of two thousand and seven, just before the global financial
market's meltdown, and that nobody wants to see again. So, John,
(01:58):
you're close to the action on the ground in credit.
How worried should we be about all this? Is it
the GFC all over again? Or is it really that
different this time?
Speaker 3 (02:06):
I never like to say it's different this time. I
am a student of history, so I try to learn
from the past. What I'll say is that there are
certainly pockets of vulnerability, James, and we're seeing you mentioned
a few recent anecdotes. Broadly speaking, what we see in
the marketplace is a sentiment that's somewhat gloomy, but when
(02:28):
you look at the data, the data is generally fine.
So what I mean by that is some of the
things that we tend to look at to try to
assess the health of levered bar wars to determine where
defaults are going. One thing would be leverage levels. So
I think this is kind of interesting. I saw statistic
recently from JP Morgan saying that leverage for highield barwers
(02:49):
today is sitting around four times and that's the lowest
level in about twenty years. I don't think most people
would know that. Most of your listeners or those that
just read the press would probably we assume, based on
some of the anecdotes you just gave, things might be
heading off off a cliff, and statistically speaking, that's that's
(03:09):
not true. Again, there are going to be some examples,
and we can talk about happy to talk about some
sectors maybe that are where there's pockets of vulnerability, But
broadly speaking, leverage is in good shape. And another thing
that we look at I like to look at is
the pending debt maturities. I think this is a good
way to try to get your arms around what's going
(03:30):
to happen one, two, three years from now. And when
we look at the amount of debt coming due and
high yield for example, over the next three years, it's
about two hundred billion, which is about twenty percent of
the market. To give perspective, a good year in the market,
you see about two hundred billion dollars of refinancing activity.
(03:53):
So put another way, one year of refinancing activity would
cover all the debt coming do and in the high
yield market over the next thirty six months. It's a
similar number. For leverage loans, it's actually smaller to about
one hundred and sixty billion. So when you look at
things like that, to me, it says that the market
(04:13):
is constructive, it's relatively healthy. Let's go to the default activity.
You mentioned. There is some credit stress, and it's in
what I would say a handful of sectors. Media is one,
retail is another sector. It seems like retail is always
a vulnerable stress sector. In the twenty plus year career
(04:34):
I've had. What's interesting is technology has been on that
list too, and I think a lot of folks might
be surprised to hear that. One of the reasons why
is because technology has a higher leverage level than any
other sector. People felt like, well, these are like low
capex companies, they're very high recurring revenue. We can put
more leverage on a tech company than on an industrial company.
(04:57):
And the reality is that when rates shot up in
twenty twenty two, it created a lot more stress. So
it's interesting for me to see technology on that list
of a handful of sectors where there is stress.
Speaker 2 (05:11):
So, John, I want to dig in a little bit
into some of the points you said. So you said
four times leverage on average for high yields, and I'm
just curious when you think about the HILD market, you know,
post COVID and actually post GFC, but particularly post COVID,
we've seen it shrink over time with a preference to
private credit issuance. So I'm just curious if we're not
(05:36):
actually seeing the whole market.
Speaker 3 (05:38):
You're certainly true like your comment about the high market shrinking, Jody,
that's that's been something that we've seen and it's really
been offset. You mentioned private credit, but also leverage loans
as a whole. Leverage loans as a hole has been
a much faster growing market than let's say, high heal bonds.
Borrowers and their private equity sponsors have favored or leverage loan,
(06:01):
whether they be syndicated or private solutions in the last
few years, and that trend has been I think many
years in the making. Now. One of the side effects
of that on high yield has been an increase in
credit quality. So if you look at the average credit
rating and high yield, it's higher today than it's ever been.
(06:22):
It's one of the things I point to. People will
often ask me, hey, why is high yield so tight?
And James mentioned spreads are quite low, and they are,
but one of the reasons is that you've seen convergence
between high yield and investment grade. In fact, high yield
has a double B average rating investment grade as a
triple B average rating. They're the closest they've ever been
(06:45):
in terms of credit quality, and they're also the closest
they've ever been in terms of spread. So that tells
me the market is fairly efficient. Now, loans is a
different story. You've had a slow but steady degradation in
credit ratings in that particular market, single B is the average.
You know that colos are a big driver in that
(07:06):
market as well, which have their own technicals when something
gets downgraded to triple C, so oftentimes that's that's something
that investors, I think need to be aware of. Lme activity,
triple C downgrade, the technical that the clos's I think
it's a little more tricky today to invest in loans
(07:26):
than it is in high yield bonds. And that's crazy
for me to say, because when I started my career,
leverage loans were considered like a cash alternative and high
O bonds were considered to be the wild West.
Speaker 2 (07:39):
Just thinking about the fact that there's such a tight
spread between triple B and double B and we're seeing
that on our end, I mean, I'm seeing that with
a lot of my companies who are working towards investment grade.
So there's that component of it where they're just barely
blow investment grade. But beyond that, I mean, does that
mean that a lot of companies don't necessarily see the
(07:59):
value of being investment grade, or does it mean that
investors are more willing to reach for riskier investments because
they're not necessarily getting rewarded at the higher level of
high yield.
Speaker 3 (08:14):
That's a really interesting question, Jody, because with the way
you said it like our companies not maybe putting as
much value or priority on being investment grade. Again, I'm
going to sound like back in my day, but quite honestly,
you know, twenty years ago, every company in high yield,
(08:37):
even if they didn't their actions didn't show it, they
would pay homage to we want to be investment grade rated, right.
They would say that on their quarterly earnings calls. You
don't hear it as much today, and even with fallen Angels,
I find that to be quite interesting. You know, the
reason high yield is increased in quality is because we
had many former IG companies that were downgraded into our
(09:00):
h yield universe, and they did not prioritize going back
to investment grade. They were happy to borrow at six
percent instead of four percent. It's still worked for their
business model, and they're good double B companies and they're
large caps. So I think it's safe to say that
it maybe is not a priority for every company. You know,
some companies, if you're financial, for example, you don't see
(09:22):
a lot of junk bond rated banks. I hope that
we don't see a lot in the future party risk lore. Yeah, yeah, exactly.
So it's it's more sector bisector specific.
Speaker 1 (09:35):
But John, to go back to what you were saying
about the risk pockets of risk and to Jody's point
that you know this spread kind of collapsing between the
different ratings buckets, to me, it suggests more complacency than
anything else. You know, if you if you're valuing a
triple C risk very close to single B and single
BE very close to double B and you're not really differentiating,
(09:58):
it's just speaks to me more about the excess cash
in the system and not enough supply. And to that point,
you know, the pockets of stress that you mentioned at
the beginning, how widespread are they and how do you
spot them?
Speaker 3 (10:11):
It's been relatively modest thus far. If you look at
as a percentage of the market, it's still well within
historical norms, which you know, there's two sides to every trade, right,
One person could look at that and say, well, geez,
high yield default and bank lone default rates are at
historical levels or even elevated above that, and that could
(10:31):
be a cause for concern. Another person could look at
that and say, well, geez, we had this huge increase
in interest rates in twenty twenty two. Rates have been
higher for longer than most people expected, and yet still
three years into a rate hiking cycle, the historical default
rate is still only sort of in line with the
long term average. So it's not not a lot to
(10:54):
be terribly worried about. I do think there is some
complacency in the market. That's one way to look at it.
There's a lot of cash, as you said, James, that
is across asset classes, right, We're not just talking about
syndicated bonds and loans. Private credit has raised a lot
of capital. Flows into investment grade have been robust recently,
(11:16):
so there is a lot of capital. And when you
have a lot of capital, companies can get bailed out.
And we see that. We see more examples of lower
rated companies that look quite vulnerable and they are able
to secure financing solution, which could cause the price of
the bond or loan to jump by ten or fifteen
(11:37):
or twenty points. So it's both an opportunity because if
you can correctly identify those companies, you could do quite
well but it's also a risk. Those are the kinds
of companies that have been vulnerable. And why I say
there will be failures. If you're a levered company and
(11:59):
you have a very high level of leverage and we're
multi years out of the pandemic, I'd be worried about that.
So our team is really focusing more on looking at
cash flow, looking at what's going on in the capital structure,
a little bit more up in quality given the nuances
(12:19):
in the economic outlook. What I mean by that is
in the high yield and bank loan side, preferring more
of the higher single be rated credits and you can
still get a mid to high single digit return in
a good quality portfolio, which I think for modest level
of duration risk, that's not a bad outcome right now.
Speaker 1 (12:41):
So the view on the risk then in terms of
you know, these pockets of stress, that's more idiosyncratic. It's
very specific to names and possibly certain industries. You don't
think it's a widespread credit issue.
Speaker 3 (12:53):
Not yet. Again, being a student of history, usually these
default cycles begin with a few idiosyncratic examples, right, and
then it becomes more systemic. We're not seeing that today,
and that sort of brings I think to the point
about what is twenty twenty six going to look like?
(13:15):
Is twenty twenty six going to be a recession year?
Where's twenty twenty six going to be a rebound year?
And I think a crisp argument could be made for
either of those. So it's not quite clear that we're
about to see a default cycle increase. A lot of
folks think defaults are more likely to go down in
(13:37):
twenty six as the economy starts to reaccelerate. We'll have
to see which direction we take now.
Speaker 2 (13:43):
Donnie mentioned a few sectors that you don't like, such
as retail, But what sectors are you leaning towards as
a result of retail? Sort of? I mean, I use
retail as an example, But the few sectors that you
don't like, which ones do you actually like? And which
ones are you seeing there being value going into this
(14:04):
uncertainty in twenty six.
Speaker 3 (14:07):
Retail is interesting. I want to make sure I just
to set the record straight, not that I don't like it.
I mentioned it as one area where there is elevated
level of default risk. But interestingly enough, I think expectations
in retail were so incredibly low that we've actually seen
(14:29):
positive earning surprises in the most recent quarter. This was
across different types of retailers, so we saw department stores
put up better than expected numbers, apparel stores, even pet
retailers put up better than expected numbers. And there's been
some pressure on the pet space coming out of the
COVID pandemic. So it's interesting, Like it's a sector, I
(14:52):
bet a lot of people would say, I don't want
to touch it. But interestingly enough, when you start to
peel the onion, you see that expectations so low, there
may be some idiosyncratic opportunities there in that sector as well.
On the other side, you know, everybody will talk about
having exposure to healthcare business services, things that are CAPEX light,
(15:15):
high free cash flow conversion. Generally, these types of businesses,
these business models do pretty well. Healthcare, though, is one
area that is well. Has very little little tariff impact
other than maybe pharmaceuticals, a lot of regulatory risk, right
stroke of the pen risk, change of the budget, and
suddenly reimbursement rates for hospitals and providers is down. So
(15:38):
there are a lot of challenges to navigate in a
healthcare sector, even though that's one of the largest sectors
that most investors have in their high yield and bank
long portfolios.
Speaker 2 (15:49):
I think for the healthcare space to are my colleague
Jy and Mike Colland write about this a lot in
terms of the tariff effects of that. Now a lot
of the companies I cover have more kind of indirect
terriff effects in the leisure gaming spaces, And drawing on
your background in gaming, you know, something that we've seen
(16:10):
recently is the weakness coming out of Las Vegas, a
little bit less exciting growth in Macau. And so I'm
just curious if you sort of see that as any
kind of canary, if you see that as just descriptive
of a lack of catalysts, or are we in fact
seeing the consumer get a little bit more concerned because
(16:30):
of tariffs.
Speaker 3 (16:33):
That's a great observation, Jody, and one that I've seen
throughout my career in gaming. And this is you know,
a little bit of inside baseball for gaming. But since
you have expertise there and I covered it, I think
it's something that is a repeatable pattern for the listeners,
which is that when consumers start feeling a little bit pinched,
(16:55):
the first place you see it in gaming leisure and
lodging is usually in the loss of Vegas strip data,
you start to see visitation come down. You start to
see people spending a little bit less on shows and
dinners and gaming, and instead you see them reallocate those
dollars to local or what we call regional casinos. So
(17:17):
if you're in southern California like I am, maybe you're
going to the tribal casinos that are an hour away.
Or if you're living in Philadelphia, you've got a lot
of casinos there. You don't necessarily need to fly to
Las Vegas and have a monumental weekend trip. You can
have a fun time for a few hours in your region.
(17:38):
And regional gaming is also so prevalent today. You know.
I remember having a map up in my office when
I first started as a gaming analyst, and I actually
could put like a few pins where there were casinos
legal casinos in the US, and it was like just
a few pins. You know, if I did that today,
the map would you know, would be punctured, tod probably
(17:58):
fall off the wall. Because gaming is legalized in I
think forty eight out of the fifty states, so there's
a lot more opportunity for consumers who maybe are reallocating
their dollars and thinking about how they're spending it. So
if I started to see the regional data turned down,
then I think that would be a sign of a
more pervasive downturn.
Speaker 2 (18:20):
One thing I've struggled with, and not to get too
deep in the weeds about gaming, but I do think
that it's analogous to other sectors is we now have
online gaming and sports betting legal in fourteen states, right,
and so we have some component of not this time
as different, but we do have this time as different. Right,
people might not even be as willing to go to
(18:43):
regional casinos now if they could do it from their phone. Similarly,
we've had that argument in retail right where why am
I going to go to the store when I can
do it on my phone? But we are still seeing
people go to the store. How are you kind of
thinking about that? Because so many of the companies in
the hy old space have this component of tech replacing
(19:03):
traditional operations, and how do you then say, Okay, this
is happening, but we're still seeing the cash flows there,
We're still seeing these companies as beneficial.
Speaker 3 (19:13):
A lot of that is driven by demographics, right, So
I think about go back to casinos for a second,
since that's kind of a fun sector to talk about.
I always think so part of it. It's not just
the bet, right, It's not just the This is why
when you look at the revenue that a casino has,
and I'm generalizing, it varies depending upon whether it's a
(19:35):
casino in Macao, Las Vegas, or Indiana, but generally speaking,
the revenue from the gambling is half or less than
half of the total revenue a casino makes. Because so
many people put a great deal of value on the
experience of having a nice meal with your family, or
going to a really cool show at the Sphere in
(19:58):
Las Vegas and seeing something amazing that you can't see
anywhere else, or going shopping and treating yourself. Right. So
even though yes, technically, if if all you care about
is making a bet, you could bet online, it's a
very very different experience than going to do all these
all these things that we're talking about. So I think
(20:20):
it's important to understand the motivation, like what's driving the
consumer and the behavior and is it, you know, just
just that bet that's going to eat into some casino
business for sure, But for a lot of people, it's
just a way to you know, maybe have have a
good time for a few days and get and get
away from get away from home. So it's I think
(20:43):
there's demand for both for.
Speaker 1 (20:44):
Sure, or is it the fact that we're also worried
about recession coming out that we just need to distract ourselves.
Speaker 3 (20:49):
Like you'd be a great fixed income investor, James, because
you're glass to have empty you'd be you'd be perfect.
That's exactly the kind of culture we cultivate on our team.
We're always we're always looking at, you know, what could
go wrong because it's an asymmetric asset class. Best case
(21:10):
we get our money back. Worst cases, you know, we
get twenty or thirty cents on the dollar.
Speaker 1 (21:17):
But just switching gears a little bit. Clos have been
a big feature on this show for many months, including
some of the biggest asset managers in the world talking
about that as a as a huge opportunity. You know,
there's a pickup to playing vanilla credit, which is trading
very tight. One large portfolio manager described them as bulletproof.
(21:37):
But at the same time, there are concerns, as we've
already discussed about the economy about the ability of the
highly indebted companies to keep up with debt payments, especially
on leverage loans, which are floating at a time, you know,
when underlying rates have come down a tiny bit, but
they're still much higher than we had expected them to be.
So how does this all shake out? John? Is this
great opportunity or is it another potential troublespot.
Speaker 3 (21:58):
Generally, we've been constructive on clos I still think in
this day and age, even though they've been around for
for a long time, they've had quite an evolution. Practitioners
investors in the COLO space, we'll talk about CLO one
point zero versus two point zero and and they're referring
(22:19):
to structures before the Great Financial Crisis and after. And
there were a lot of I think important needed and
valuable changes that were made after the GFC to strengthen
these structures, make them more bulletproof. You know, nothing is
ever bulletproof, per se. That's why you're getting you know,
(22:39):
relatively high mid high single digit yields. But there is
a misunderstanding. I cannot tell you if I had a
if I had a dollar, every time I asked an investor,
you know, what their perception is a clos The most
common answer is, oh, it caused the twenty oh eight
financial crisis, And I would say, well, actually that was
(23:00):
the housing market and our mbs and CMBs and it
wasn't corporate debt. And people are like, what are you
talking about? You know, these are all the same acronyms
and CDOs.
Speaker 1 (23:10):
People have come back with.
Speaker 3 (23:12):
That is a four letter word. Yeah, we're not going
to talk about let's stick to the CLO. But there
is a misunderstanding, and you know, we're kind of laughing
about it. But that's what drives an opportunity oftentimes, is
when you have things that are misunderstood and you have
to educate yourself a bit about it. There are opportunities
(23:33):
and I've and I've heard some of your guests in
the past talking about the opportunity there. Historically it was
an institutional opportunity only meeting only institutional investors had access
to it. More recently, explosive growth in clos ETFs ETFs
that had COLO debt in it. So this is a
(23:54):
way that retail investors can access the market which previously
they had never been able to do. One of the
interesting areas that I think is you're going to hear
more about, and this is related to clos going forward,
is something called middle market COLO or private credit COLO.
(24:14):
It's a relatively small part of the total COLO universe today,
but I think it's a very interesting area of focus
because it's one of the few places where there's strong
convergence of liquid and private credit. And what I mean
by that is we know colos and structure credit. It's seasoned,
(24:34):
it's been around for thirty years, it's time tested in
the liquid credit market. But instead of buying large cap loans,
these structures can also buy originated, directly originated private credit
loans in them and that's what the middle market COLO
industry is, and it's quite interesting. It has recently been
(24:56):
about twenty percent of total new issuance in recent years.
One out of every five dollars that's raised in the
COLO market is going into these middle market clos. I
would say that a few years ago that was close
to zero, like at the beginning of the decade. So
it's a relatively new phenomenon, even though the structure has
(25:18):
been around a long time and private credit loans themselves
as an asset class have been around a long time.
As well. This is something new. It's interesting for investors
because there's an opportunity to get a relatively high incremental
spread anywhere from twenty five to fifty basis points above
what you would get in a BSL type CLO. So today,
(25:41):
if you look at a triple A probably like five
and a half percent yield in a triple B rated
middle market COLO seven and a half percent. Know, as
we know, that's a very big incremental spread over an
investment grade rated corporate bond. So there is something there
potentially for rating sensitive investors as well as another way
(26:05):
for any investor to access private credit. But in a
credit rating friendly wrapper.
Speaker 1 (26:10):
Does it continue to grow at the same pace? Do
you think from here?
Speaker 3 (26:13):
We do think so. We see we see allocators as
being under index to this particular asset class. So I
think for investors, this is going to be a growing
part of the CLO set. It'll be a larger and
larger percentage of COLO issuance going into the middle market
type structures.
Speaker 1 (26:30):
Does it end up being half the market for example?
I mean at some point in the future, you think.
Speaker 3 (26:34):
I don't see any reason why I couldn't. I haven't
really tried to quantify what I think the cap would be,
So I don't I don't want to say it'll be
half the market in a few years. But the growth
and the value proposition, I think it certainly will continue
to grow it and it bears watching.
Speaker 1 (26:54):
But again back to the risks, because these are structures
that repackage leverage loans. You know, they're their loans out
to companies that are subinvestment grade. They are also being
repriced very very rapidly at a much lower margin. So
the underlying is getting more expensive. You're trying to make
some kind of arbitrage. How do you do that just
adding more leverage and what problems come from that something?
Speaker 3 (27:16):
Certainly to be mindful of the manager. The structure is
critically important. How much leverage they're putting in the structure.
As you said, there's an element of leverage on leverage, right,
So you want to make sure that you have a
manager who's seasoned, who's been through various cycles. You want
to make sure that you understand the loans that are
being underwritten, particularly in these middle market structures, because there's
(27:39):
not as much information available about it publicly, right. These
are not large cap syndicated loans. These are privately originated
or small small clubs, so you really want to make
sure that the managers that you're backing are managers that
have performed well throughout credit cycles. They're not trying to,
(28:03):
you know, put every dollar of leverage that they can
in there. So manager selection and the structure is critically important.
It's pretty rare though I know it's come up in
your other podcasts. It's pretty rare for these structures to fail,
and almost unheard of in the investment grade rated portion.
(28:23):
So really the most vulnerable part is the equity. There's
the potential for a very high risk, but also the
potential for you know, a very high reward in the
equity moving up in the capital stack. Triple B, single A,
double A. There it tends to have historically, you have
to work really hard to blow those structures up.
Speaker 2 (28:45):
And how do you view the risk related to the
concentration on the buy side. By that, I mean is
that we've seen certain buy side managers just get so large,
and they're participants in different parts of the deal right there,
the underwriter, they're the manager, they're also the ones buying
the clos How do you sort of think about that
when when you think of the I guess, flow of
(29:07):
funds and the health of the pipeline of the market,
how are you sort of wrapping your head around that
that we have just a few very very large managers
or a few very very large you know, by side participants.
Speaker 3 (29:22):
There certainly are large managers that are getting larger and
they have an issue with deployment. Right. You know, we
as a firm, Crescent forty eight billion dollars. Now that's
six times larger than it was when I started my
career at Crescent. But relative to some of the big
(29:44):
guys that you're referring to, you know, we're still quite
quite small. And that means we don't have to worry
about doing every deal. We're not taking in hundreds of
millions of dollars a month in capital where if we
don't deploy it, we don't get a management fee. Right.
So I always like to think about the incentive you know,
I have as a manager or in my retirement account,
(30:07):
that the funds and vehicles that I invest in, you know,
as the manager making decisions based on fundamental credit, or
are they making decisions because they got to push this
dollar out another dollars coming in tomorrow. And that is
a growing dichotomy in credit, not just private credit, but
in liquid credit as well, which is are you an
(30:29):
asset aggregator or are you really an investor? And you know,
I think there's a value to being with a more
mid sized manager that is not under the pressure to
have to buy every deal, because that's when you really
run into problems and you don't have differentiation in your portfolio.
I think that's really interesting in private credit. While I'm
(30:50):
not a private credit guy per se, one of the
value adds that were alpha generators in private credit was
having proprietary sourcing. But if all the law large managers
are out there doing the same thing and their portfolios
all look the same over time, that alpha dissipates, right,
and then it's just you're just a beta play. We've
seen it in high yield, We've seen it in BSL,
(31:12):
and I think that's what you're going to see, a
split between those who are truly delivering alpha and those
who are just delivering a beta experience in private credit.
Speaker 2 (31:22):
And do you think it gets to a point where
the size gets so large that they need to separate
or they need know in order to be efficient sometimes.
I mean, you see it with companies all the time
that they say, you know what we have to we
have to split the baby because it's not efficient. And
is there a point where we reach that? I mean,
(31:43):
we saw not to harken back to James's intro related
to comparisons to two thousand and seven, but you know,
when you think about the risk to the markets in
O seven, it was we had two big to fail banks, right,
and we had these massive struct and thankholding companies and
insurance companies that probably shouldn't have gotten into areas that
(32:05):
they got into the market, right. And here now we're
sitting and you know, you mentioned your firm and it's larger,
but it's nowhere near the size of some of these
other ones. At what point does it get to be
problematic that they're just such a large mass amount and
to your point, they're not. Actually, you know, they might
not create as much value as they could because they're
(32:26):
just so large.
Speaker 3 (32:28):
I know, speaking from experience in the liquid tradable credit side,
there's pretty much a well regarded established pattern whereas managers
get larger and larger, their relative ability to relatively outperform
a benchmark diminishes. There's just too much capital they own
portfolio as you look at you can look at them
online because these mutual funds are online. And you see
(32:51):
four hundred five hundred positions in a high yield fund
and you say, well, there's two thousand issuers. If you
own one out of four, I mean, aren't you sort
of a proxy for the market? And and then you know,
you sort of like an ETF right, You're you're not really,
it's not an active thing. I don't know what that
number will be. On the private credit side, that's that's
(33:16):
you know, somebody else closer to private credit could perhaps
answer that, but but I do. I do know. We've
seen it in the tradable credit side, which is again,
if you want to be liquid, you want to be nimble.
You know, we didn't talk about lms today, but one
of the best way to avoid getting caught up in
LME is to have a position size that you can
(33:36):
actually trade if you want to get out of something.
And that's a big difference. You know, if I have
a ten million dollar position and my competitor has one
hundred million dollar position and we both come to the
same credit decision, like, oh my gosh, we got to
get out of this. This thing is headed to an lme.
Guess who's going to be more likely to reduce their
position the guy who has ten million or the guy
who's got one hundred million of that of that leverage
(33:59):
loan or that high yield bond. It's just, you know,
it's just the way it goes. So there is a
value to being kind of mid size and being able
to be nimble.
Speaker 1 (34:09):
How much leemy is affecting your ability to operate in
the CLO world at the moment, John.
Speaker 3 (34:16):
It's It's definitely a factor that I believe is here
to stay. Some of it has been somewhat mitigated by
the development of these cooperative agreements, but I never underestimate
uh smart attorney's ability to find loopholes or or create
other you know, other other structures are other ways to
(34:37):
get around this. Our view, Accrescent, is this is here
to stay. You've got to think about this when you're
underwriting a credit. We've actually brought resources to bear internally,
like workout resources that are embedded in our performing credit team,
because it's become prevalent more on the loan side. You
typically don't see this on the high yield side. Now,
(35:00):
I know you've talked about this in the past, so
I'm just going to touch on it. But not every
LME has a terrible impact, right, Sometimes the recovery in
your l ME is much uch higher than it would
be in a traditional bankruptcy. So it's it's not necessarily
a bad thing on its own, although we do see
a lot of companies that once they go through an LME, they,
(35:23):
you know, more than half tend to have to go
through another one or end up filing bankruptcy anyway. So
it's it's a warning sign and it's just one more
thing that a skilled credit team has to has to manage.
Speaker 1 (35:36):
So you've had a bunch of lawyers basically to protect
you in these how have you expanded your operations to accommodate.
Speaker 3 (35:44):
You need people that have workout experience, You need people
that have legal experience. You need people who know who
the right advisors are. You know that that was something
earlier in my career. If a credit went into like
a watch list and then one to restart structuring, you
would bring someone alongside to assist you. And now we
(36:06):
want those that expertise that that knowledge embedded in the
front end before we make a decision, you know, what
have we seen with this kind of company? What should
we look for in the documentation? How many lenders are
in it? Are there bad actors that we need to
be worried about. Maybe we've had a bad experience before,
so we say, look, we're gonna We're not going to
(36:27):
underwrite this credit. It's manageable, but it just adds, you know,
more items to your checklist for sure.
Speaker 2 (36:35):
I mean even you know, when I look at some
of my companies and I look at the cap structure
and I sort of see, you know, the secured and
how complicated it's started to get for some of the companies.
Some of my companies are trying to avoid Chapter twenty two,
let's just say, and it is something that I think about.
I say, okay, does security even have some value here?
(36:56):
But I wanted to actually switch a little bit to
a question I had around the recent rate cut thinking
about loans and thinking about exposure. So you know a
lot of loans are floating rate security there further short duration,
and so when you are heavily invested in the loan space,
how are you balancing that out to ensure that you know,
(37:20):
you're not quote unquote losing out in the environment, or
you're not over exposed to one side over another.
Speaker 3 (37:27):
Yeah, very topical. Right. The expectation that rates base rates
will start to come down, at least on the slow
and sustained basis, that's going to result in lower coupons
for all floating rate assets, whether they be large gap
syndicated loans, private credit loans, clos, they're all going to
be They're all going to expect to have a reduction
(37:50):
in their coupon. The offset to that, though, is less
interest expense for our borrowers. Right, So it's important for
for everyone to remember that perhaps the worst is behind us.
If you believe that we are going to see a
sustained pace of rate reductions, maybe not as quickly as
(38:10):
some would like, but that should result in lower interest expense,
which means better interest coverage ratios, which likely means less
credit stress in twenty twenty six. So from an investor's perspective,
am I okay getting maybe a half point lower coupon
or point lower coupon, but it also likely means there's
(38:34):
less credit stress. My sense is there's a fair amount
of that that's being priced into the market today, which
is why investors are comfortable with spreads where they are,
because they expect that. I don't ever want to say
smooth sailing. It's never smooth sailing in leverage finance. But
I'll go back to that phrase. The worst may be
(38:56):
behind us in terms of the impact of higher coupon
on borrowers, and that's where, you know, just to kind
of close this thought off, one of the things that
I'm monitoring very closely is are these rate cuts coming
in time or are they too late? And that, to me,
(39:16):
is one of the biggest things that I worry about,
is the possibility that we're going to see rate cuts.
It seems clear. I mean, the FED said we're getting
more neutral but not neutral. That to me means more
cuts are coming. But has the impact already gone through
the economy right or can they pivot and be nimble
(39:38):
enough to allow the GDP to accelerate like a lot
of people think it will next year generally speaking, if
they can control that. I mean, if the way I
think about it is if you have an environment of
call it one to two percent GDP and inflation is
two to three percent, that's usually pretty constructive for the
(40:00):
kind of assets that that we manage. I think that's
a fine environment, and most of our borrowers would do
fine in that environment.
Speaker 1 (40:09):
So all that said, John, if you look ahead, let's
say twelve eighteen months or so, where's the best relative
value in the credit market.
Speaker 3 (40:16):
I like syndicated loans. They've fallen a little bit out
of favor relative to high yield. As we mentioned, there's
been a fairly significant dispersion in performance. I like higher rate,
single B type loans. I think there's interesting opportunities there.
Companies that are not at risk of downgrade have spreads compressed, sure,
(40:40):
and our base rates coming down. Yes, But even when
you factor in what is expected. You can look at
one year forward sofa right, you know, everybody can look
at this and say, I think that's reasonable, or I
would make it a little higher or lower. Even when
you factor in the forward SOFA curve, the carry that
you can get on a single B rated loan is
(41:00):
much much higher than on a high yield bond. So
you could have you know, four rate cuts in the
next twelve months and loans will still have a higher
coupon than bonds. I think that's an opportunity you just
have to make sure that you know you're doing your
homework on the individual loans and that there's are performing
companies and they have have no near term maturities, they're
(41:26):
not on watch for downgrade. So yes, to me, that
looks like an interesting area of the marketplace today that's
a little bit out of favor and clos. I think
colo middle market clos are going to be something to
watch in the future. Perhaps dare I say even investors
someday may make a strategic allocation to it. Today it's
(41:49):
still relatively nascent, but I think that there'll be great
opportunities to monitor there as well.
Speaker 1 (41:56):
But on the loan side, John, the higher default rate
than bonds, low recover rees, and situations like First Brands
where they were trading at par and then suddenly went
to the teams that those things don't give you pause overall.
Speaker 3 (42:10):
Not if you're asking the right questions. You know, I
don't want to get too deep into that credit, but
there had been some, you know, questions around that credit,
notwithstanding it was trading at par. I think there were
questions about the supply chain, financing and things that some
people clearly were aware of. Right, So you do you know,
(42:33):
you do have to have a robust This is why
this is one of the one of the few areas
where active management still outperforms passive. I know folks like
to look at ETFs and large cap equities. Maybe the
way to go is just buy an ETF lo FI.
Active management doesn't create alpha in credit. There's so many
(42:56):
of these things we've talked about in the last forty
five minutes, right faults, documentation, co op agreements, lmes. There's
still a room for active management to add value, fewer defaults,
higher recoveries. So I do think that it's an essential
part of investing. So it doesn't give me pause to
(43:18):
the asset class, but it just confirms for me how
important it is to do your homework.
Speaker 1 (43:23):
Great stuff, John Fiquett at crescent A Capital Group, many
thanks for joining us on the credit edge. Thank you,
and of course very grateful to Jody Lurie from Bloomberg Intelligence.
Thanks for joining us today.
Speaker 2 (43:32):
Happy to be here for.
Speaker 1 (43:34):
More credit market analysis and insight. Read all of Jody's
great work on the Bloomberg terminal. Bloomberg Intelligence is part
of our research department with five hundred analysts and strategists
working across all markets. Coverage includes over two thousand equities
and credits, plus outlooks on more than ninety industries and
one hundred market industries, currencies and commodities. Please do subscribe
(43:54):
to The Credit Edge wherever you get your podcasts. We're
on Apple, Spotify, and all other good podcasts provide is,
including the Bloomberg terminal at bpod Go. Give us a review,
tell your friends, or email me directly at jcrombieight at
Bloomberg dot net. I'm James Crombie. It's been a pleasure
having you join us again next week on the Credit
(44:15):
Edge
Host
James Crombie
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