March 7, 2024 • 37 mins
Credit derivatives and securitizations offer high yields and can perform well even if the US economy tips into recession, says Jonathan Dorfman, managing principal and chief investment officer at Napier Park Global Capital. “In credit, for the first time in 15 years, you can actually create portfolios that give equity-like returns,” he tells Bloomberg News’ Lisa Lee and James Crombie and Bloomberg Intelligence’s Tolu Alamutu, in the latest Credit Edge podcast. Standardization and improved transparency have reduced risk in structured credit, which can make better inflation-adjusted gains than corporate bonds, he says. Dorfman also raises concerns about private credit — which doesn’t mark to market — noting “extraordinary” differences in pricing of the same asset by managers. In addition, Alamutu weighs the outlook for real estate as rates stay high for longer. That’s pushing more companies in the sector to borrow in public bond markets, she says. Listen to this episode on Apple Podcasts and Spotify.
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Episode Transcript
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Speaker 1 (00:18):
Hello, and welcome to the Credit Edge, a weekly markets podcast.
My name is James Crombie. I'm a senior editor at Bloomberg.
This week, we're very pleased to welcome John Dorfman, chief
investment officer at Napier Park Global Capital. How are you, John,
I'm very well, James, Thank you so much for joining us.
We're very excited to hear your market views and outlook.
We're also delighted to welcome back Lisa Lee, who covers
(00:39):
credit markets for Bloomberg News in London. Great to see
you again, Lisa, great to be here again. And last
but absolutely not Lise from Bloomberg Intelligence. Excellent to see
Tollu Alamutu, also in London. Welcome back, Tolu.
Speaker 2 (00:50):
Thank you.
Speaker 3 (00:50):
James.
Speaker 2 (00:51):
Great to be here as always.
Speaker 1 (00:52):
So let's start with you John, Thanks very much again
for joining us on the Credit Edge. Before we dig
into the specifics of your portfolio and what you see
the best opportunity right now and of course the risks,
let's talk about your macro views, and in particular on
my mind is the Federal reserve rate cut. Bets are
being dialed down right now. Options traders, some of them
are even betting on hikes by the Fed this year.
(01:15):
Compare that to only a few months ago when we
were absolutely pricing very dubbish policy from central banks with
a lot of rate cuts coming starting as soon as
this month, you know, March. That's obviously all flipped as
inflation data continues to come in high. At the same time,
the US economy seems to be strong. Consumers are still
buying despite higher prices. Maybe the dreaded recession won't actually happen.
(01:39):
But where does that leave credit? John everyone comes in
on this show and is very, very bullish, even though
rates will probably stay high for longer. What's your take?
Speaker 4 (01:48):
I think, to step back a moment, we went into
this year basically explaining to our clients that our central
investment view was that the magnitude of rate cuts that
priced in the interest rate market was far too many.
So we were always of the camp that the economy
wasn't weak enough to merit the rate cuts that were implied.
(02:10):
And I still feel that way. And so from a
credit perspective, you know, we think the real economy decent
and the real negative part of the credit market is
the bottom end, so it's the most levered industries, the
most levered consumers and businesses that rely on leverage because
(02:31):
the cost of leverage is so much higher.
Speaker 1 (02:35):
So how do you position for that? What are you
doing too? I mean you obviously got that call right,
a lot of people didn't, But what's your strategy around that?
Speaker 4 (02:45):
So what we're really looking for at this moment are
asset classes that provide a significant risk premium relative to
the amount of defaults that might happen if the economy
were to develop more recessionary cycle. So we see that
mostly in the credit intensive structure credit market. I think
(03:07):
when we compare it to you know, on the run
high yield for example, the spreads are very very low currently.
Speaker 1 (03:14):
So when you talk about structured finance, I mean, is
that securitization? Is that repackaging of debt like consumer loans
or company debt? I mean, what does that mean? It
covers obviously a huge range of things.
Speaker 4 (03:25):
It's it's all of the above. You know. From our
point of view, what we're really focused on is non
investment grade structure credit, frequently securitizations. It can also be
private structures where loans are basically bifurcated into different asset classes.
And we're looking kind of corporate mortgage, consumer auto US
(03:48):
in Europe, and what we found is those markets don't
move together at all, so the capital is highly fragmented.
Speaker 1 (03:54):
Currently, we talk to other investors about how much flow
is coming out of banks? Is that where you're finding
these opportunities to buy?
Speaker 4 (04:02):
Typically it comes from three different sources. One is banks,
the second is asset holders that have received redemptions for
really liquidity reasons from underlying clients. And the third is
originators themselves, So loan originators that have held too many
loans on their own balance sheet and really need to
(04:26):
sell off the loans to be able to generate more origination.
That's very common in things like auto lending. It's common
in our US residential real estate lending.
Speaker 1 (04:37):
So when we talk to other guests you know, about
this opportunity, I mean they are very excited obviously, but
I do again ask the question, you know, why do
you have to become you know, why do you have
to get fancy with credit given that you can get
very very high yields for playing vanilla stuff, you know,
even in investment grade. I mean, why do you have
to stretch for yield in this environment?
Speaker 4 (04:58):
I think it's a great question. A lot of it
to depends on the overall acid allocation of individual investors,
family office investors, and institutional investors. I think for kind
of a I want yield that's highly highly liquid. I
think the on the run hiled investment grade give yields
(05:18):
that are very high relative to the last fifteen years,
but if you adjusted for inflation, it's not quite as high.
What we find is we're focused on the component of
the acid allocation that is more yield seeking, so it's
more as an equity alternative or as a risk asset
alternative credit. For the first time in fifteen years, you
(05:40):
can actually create portfolios to give equity like returns, and
that's something we haven't seen since before the GFC.
Speaker 3 (05:48):
John my opinion colleague, wrote about banks coming back into
credit derivatives mostly as a capital relief trade, and I
know you've been here since the early days of credit derivatives,
and to hear about your thoughts on this and also
what trades Napier has done and how it's changed since
you've started.
Speaker 4 (06:07):
That's a really great point, Lisa. There's been a lot
of focus on banks transferring loan portfolios through what they
call credit risk transference or CRTs and SRTs. I was
actually involved in one of the first ones ever done,
which to date myself was almost thirty years ago when
(06:29):
I was in Europe. So this is a very very
long standing technology and right now I think it's going
to be an area of significant growth. And the reason
I think that is what this technology is designed to
do is to free up capital for banks when banks
equity prices trade below book value. This is a much
(06:54):
much more efficient way to effectively create equity capital than
any other method, and so I think we're going to
see continued growth in this space. It happens in two
kind of formats. One is you could think of as
a public syndicated securitization and the other is a private
bilateral risk transfer and Napier Park's been involved in both.
(07:18):
And as I said, this is something that we've been
involved in for many, many.
Speaker 3 (07:22):
Years, and it seems to be happening more in Europe
than in the US. Do you see this happening for
the US firms or is just the cost of capitals
to invest or will the basil end game actually change
things up?
Speaker 4 (07:36):
I think you will see more in the US, but
I think one of the main reasons you see it
more in Europe is the point I made about European
banks trade at much lower levels relative to book than
US banks, so US banks have, you know, many more
options in terms of ability to effectively create equity and
(07:58):
tier one capital. But I do think you'll see more
in the US. Right now. What we're seeing in the
US are sales of whole loans rather than securitizations. But
there are some US banks doing the credit derivative synthetic scuritizations,
It's just not as common as Europe.
Speaker 2 (08:16):
John, one of the things that you mentioned right at
the start was the vulnerability of the most indebted parts
of the economy. How do you then square that with,
as you said, going for equity like returns and for
going for high yield rather than investment grade. Are you
concerned then that those higher yields might just be reflecting
(08:40):
the concerns that people have about those parts of the economy.
Speaker 4 (08:47):
I think in a lot of single name investment situations
that actually is the case. The yield is there because
it's not clear the company is going to survive, So
you could think of it as a lot if you
think of it a rating based It's a lot of the
triple C based companies are in that situation. Now. That's
why we're focused more on structure credit because we're buying
(09:08):
diversified portfolios where we can stress test it against an
elongated recession and make sure that we still don't have
any impairments. But on the single name side, it's it's
less obvious.
Speaker 1 (09:21):
Currently, John, on the equity like returns, I'm just looking
at the S and P against some of the debt
markets that we cover. S and P over the last
twelve months up thirty percent. I yield neverage loans up
around eleven percent. Are we talking about thirty percent returns here?
Speaker 4 (09:37):
I wish that were the case. I think you will
be in the low to mid teams returns, which is
more consistent with what most investors feel. The upper end
of equity returns will be on a forward basis for
the next three to five years rather than what they've
been for the last year or two, because I think
(09:59):
the last year or two is really been dominated by
artificial intelligence and the growth you know, in particular of
the US of the large tech companies, and back to
credit returns. You know, it's interesting last year, our credit funds,
the money in the ground always invested funds, we returned
(10:20):
twenty percent net to our clients, and our drawn return
vehicles returned of thirty three percent net to our clients.
So actually those were you know, definitely equity type of returns.
Speaker 1 (10:35):
When you start talking about securitization and to add about derivatives,
why why is it, you know, not a hugely risky proposition. Now,
why why is this a good thing?
Speaker 4 (10:47):
I think there's a lot of standardization and transparency that
has developed in the derivative and securitization markets over the
last ten or twenty years. Certainly in the early days
there were a lot of financial accidents, but that's less
the case now. I think from our point of view,
it's worth highlighting that if you look at just the
(11:08):
US high market, there is more credit the trades through
the index derivative than there is in every higher bond
put together. So this is a very, very common accepted
method of transferring corporate credit. I think, you know, if
you look at things like mortgage risk, there have been
(11:30):
many derivative blow ups over the years and a lot
more leverage, but in corporates it's much less.
Speaker 2 (11:35):
So John I had a question about the returns figures
that you mentioned. I mean, obviously extraordinarily impressive, So congratulations
on those figures for twenty twenty four. Do you think
those sorts of returns will be repeatable? Could you see
that again? And given that we've been talking a little
bit about US versus Europe, where do you think those
(11:57):
sorts of returns could more likely come from either US
or maybe here?
Speaker 4 (12:02):
I think in Europe a pretty significant part of our
businesses in Europe. Both Jim, my business partner, and I
have spent a lot of time in Europe. I was
there for about fifteen years investing in trading credit, and
I think last year Europe was I believe our second
most significant profit contributor, so it was very significant. I
(12:25):
think this year overall returns, as I said, will probably
be in the teens type area in our strategies, and
probably slightly higher in the US than in Europe, mostly
because Europe has caught up so much over the last
six month period.
Speaker 3 (12:42):
When you talk about Europe, John, are you worried about
sort of the economic divergence? It seems like the US
might avoid a recession and actually might start to see
inflation going up again, Europe doesn't seem to be quite
as robust. So when you're as a credit person, how
do you think through investments there? A lot of the
(13:02):
people I talk to say is a great diversifier, But
in and of itself, how do you play Europe?
Speaker 4 (13:09):
I think generally Europe has less I mean, just back
to my triple C comment, Europe has less of those
kind of borrowers that are able to access the public market,
and so the credit quality is generally, on average, slightly
higher when you're particularly when you're looking at the tail
kind of credit, the bottom ten percent or the bottom
fifteen percent. So what we're really focused on is the
(13:32):
same type of thing in Europe that you know I
was talking about, generally underwriting to recessions, whether or not
there is one, And I think right now Europe's particularly
interesting because Germany is really struggling, which I think is
very common knowledge. But if you strip out Germany, the
rest of the economies in Europe look relatively decent. And
(13:53):
so what we're trying to do is underwrite for a
situation that Europe worsens, whether or not it does.
Speaker 1 (14:00):
What kind of a default rates are you expecting, John.
Speaker 4 (14:03):
I think. I think the leverage loan default rate last year,
I'll touch on Europe and in the States, leverage loan
default rate last year was five point seven percent, with
the exception of a couple months during COVID, that was
the largest, the highest since the GFC, and that's for Moody's.
I think it'll continue around that rate at least for
(14:24):
the next six months, potentially the next twelve months, and
then taper off pretty dramatically. Europe, I think the default
rates will be about two percent lower, simply because there
just are less triple C type borrowers. And you'll see
the same thing with default rates tailing off in both
the US and Europe. We see defaults as more visible.
(14:46):
It's more clear to us which companies are going to
default than it would have been a year ago.
Speaker 1 (14:51):
But do you think that's priced into the current credit markets,
given how tight spreads have become.
Speaker 4 (14:56):
I don't.
Speaker 1 (14:57):
And then what happens next is does it have to
repres I mean nos is looking at how much dubbish
policy was priced in at the end of last year
that hasn't unwhelmed yet. On top of that, you've got
the default risk you're talking about. It should there be
a shakeout in the junk bond market.
Speaker 4 (15:12):
I think there'll be a repricing. The reason it's so
expensive is most investors buy on yield, they don't buy
on spread. So they say to themselves, Okay, if I
could buy at six percent or eight percent or ten percent,
obviously depending on the type of risk you're looking at,
I'm happy. And they're not really looking at what's the spread.
(15:33):
The other thing that really concerns us is the index
credit quality has deteriorated in the high old market because
there's and strangely enough, in a really unusual manner, it's
because so many companies have been upgraded to investment grade,
not because the companies are doing poorly. It's just if
you take really large borrowers and upgrade them, they fall
(15:57):
out of the index, and the residual index is meaningfully weaker.
So we do think there'll be a correction in HYO.
I think the magnitude of it is really going depend
on what happens with interest rates because of this gross
yield based buying behavior.
Speaker 3 (16:12):
John, you have a sizeable COLO shop in both the
US and Europe, so you can talk tip to that market.
The leverage loan market as seen as there's been a
huge repricing and colos are now almost at the record
pace to start a year. Do you think that could continue?
And is there any worries about that market, any kind
of repricing stalling? There? Are we giving a little bit
(16:32):
ahead of ourselves.
Speaker 4 (16:34):
I don't think the market is ahead of itself, because
there was very little COLO activity for the last couple
of years relative to some of the stronger years. And
I think because the economy in both the US and
Europe has weathered both the geopolitical risks and the interest
rate changes, I actually think this is pretty sustainable, the
(16:54):
growth in the COLO market, because keep in mind, newer
vintage loans frankly speaking, are much stronger credit wise than
those of you know, three, five, seven years ago, because
it's been difficult to finounce over the last few years
until very recently.
Speaker 2 (17:11):
Thank you for that, John. I had a sort of
follow up question on something you mentioned. You know, you
said Germany is sort of seen as the sick man
of Europe, if you like. But one of the areas
where I guess there is also concern looking say at
the real estate sector is in the Nordics and to
a lesser extent in the UK. So when you're looking
(17:33):
across Europe, is real estate one of the sectors that
you're thinking is looking worth investing in or are there
other areas that maybe you think are looking much better
than the real estate sector?
Speaker 4 (17:47):
Generally, real estate sector is an area that we have
not been that positive on and remain concerned about. And
I think the reason is the real state investor market
is prone to using a lot of leverage and a
lot of short term leverage. And I think, you know,
(18:07):
looking at the situation in Europe, I think a lot
of assets are going to come out of some of
the real estate firms, and I think it will be
probably more of a real by real estate is a
real asset opportunity than a credit opportunity.
Speaker 2 (18:25):
Yeah, And just would you say that that same comment
applies then in the US because obviously we are seeing
some banks come under pressure because of their real estate exposure.
Do you say that, would you say that that's different
from Europe or the same.
Speaker 4 (18:42):
It's similar the US. It's mostly real estate that's held
by regional banks. There really are very few issues with
the large money center banks. But you know, the US
needs a regional bank system and a local bank system.
So I think I think you will see assets come
out out of the regional banks that are real estate related.
Speaker 2 (19:03):
If I could just ask one more within that US
real estate landscape, do you think that there are areas
of opportunity. One of the things that some people have
been talking about is, uh, you know, sunset belt versus
coastal and so on or so of sector within real
(19:25):
estate that might begin to start looking to look interesting.
Do you see any kind of differentiation happening or do
you think that it's just best to be cautious on
the entire sector.
Speaker 4 (19:36):
No, Actually, we see some areas of you know, very
significant opportunity. Kirk currently, because I think all real estate
has sort of been tarred with a negative brush, we
have originated about five billion dollars of residential real estate
whole loans in the last five years, generally in transitional
(19:59):
lending or either public market public homebuilders who are doing
specific developments in the residential space, so that's single family homes,
and we also do it with professional developers that have
groups of say five to ten homes that they're renovating
and then selling. So there is an interesting opportunity in
(20:19):
the US because there's a fairly significant housing shortage in
certain places, and the yields that you get to lend
are meaningfully higher because there's less liquidity in the system.
So we do think there's some pretty interesting opportunities, and
it's more in the form of direct origination than anything else.
Speaker 1 (20:39):
But what about the risk, John? On the consumer side,
I mean, the consumer is coming under more pressure obviously
with inflation and housing costs are very very high. There's
lots of signs now that maybe the buying, the post
COVID buying revenge spending is drying up. Do you think
that we're exposed now to more consumer defaults?
Speaker 4 (20:58):
I think that you'll likely see rising consumer delinquencies and
defaults in the bottom quintile of the income distribution and
potentially the second quintile. Most of it will depend on
whether wages are higher than inflation or lower than inflation.
(21:19):
They have been lower than inflation until the last twelve months,
and now wage increases have been higher than inflation. Usually
that improves consumer spending, but it's not equally distributed.
Speaker 3 (21:32):
So that does seem like a worry to you, John,
What else are you worried about as you look through
this year and the global landscape and credit and are
you worried about your political risk about some of the
elections coming up.
Speaker 4 (21:45):
You know, the thing I'm most worried about is the
I guess what I'd say is still extremely optimistic market
pricing of interest rate cuts in the short term and
the next you don't call it to twelve to eighteen months.
I think if those don't happen and the economy doesn't
(22:05):
grow in the US and Europe, then you're going to
see some pretty significant capital markets volatility. Geopolitics typically are
short term effects on markets unless you get a very
expansive war, so that's less of a concern. And the
election cycles are always a concern, but I think that's
more about volatility than anything fundamental for twenty twenty four.
Speaker 2 (22:30):
John, I mean, given the history of your institution, I mean,
obviously you've worked within a bank before. One of the
things that's come up in a recent podcast is the
potential for institutions like yours to either partner with banks
or to get stakes in banks. Do you think that
(22:50):
that is something that you would consider given the history
of your institution, or is that something that you think
is firmly in the past.
Speaker 4 (22:58):
Now I think for us it probably doesn't make sense
because our real interest is being able to be opportunistic
in our investing, and typically if we partner with a bank,
where that becomes more of a flow agreement where we're
locked into working with that particular bank, whereas we prefer
to have the flexibility. We've done that a lot with
(23:20):
non bank originators, where we have a lot more pricing
power in terms of our ability to buy and price
the assets that we're getting involved in. But with the
banks it's a little trickier just.
Speaker 2 (23:36):
To follow up on that. Then, one of the issues
that's coming up is potential regulation or more oversight of
non bank lenders. Is that something that concerns you or
is that something that you don't think that the market
should be worried about.
Speaker 4 (23:55):
Well, we would welcome more supervision of non bank lenders
because one of our biggest concerns is the growth of
private credit as a non marked market asset and the
extraordinary differences in holding prices of the same asset across
different managers. That's really concerning to us. I think that
(24:19):
you need to have consistent valuation across all asset classes,
And I think because that's a reasonably new asset class,
it's really become an asset class that is heavily driven
by what we would call volatility washing, and that's a
concern as it gets bigger and bigger and bigger.
Speaker 3 (24:36):
So how do you think when you think through private
credit and this marked to market issue, because you're right,
there is wide disparity. How do you think do you
have any ideas on how we can get from where
we are now to that point or do you think
that really requires regulation?
Speaker 4 (24:53):
It would only happen through a regulatory response.
Speaker 1 (24:57):
So if you look at all of the stuff you
get to see every day on which sounds fascinating, and
you're talking about equity, you like returns in some parts
of it, but we're also considering, you know, significant risks.
Where is the best relative value right now for you?
Speaker 4 (25:12):
I think for us, the two areas that we feel
have the most relative value are opportunities in the credit
derivative markets, and that's really a large corporate risk in
the US and Europe that's non investment grade. And then
completely unrelated is the area I was discussing previously, residential
(25:33):
lending in the United States in single family homes.
Speaker 1 (25:36):
So the second one makes a lot of sense to
me in terms of understanding it. But trunched credit derivatives.
Can you explain that to my grandmother? Please?
Speaker 4 (25:44):
Sure? The basic idea is taking pools of credit derivatives,
so you take like one hundred different credits and it's
trunched into a first loss, a mezzanine, and a senior,
just like a clo. So it's basically like creating clos
but with credit derivatives instead.
Speaker 1 (26:03):
Of loans and clos. For those out there who don't understand,
it's repackaging of company debt, typically the riskier debt, the
leverage loans. But it hasn't defaulted. It's done quite well,
hasn't it over history?
Speaker 4 (26:16):
That's right. They sound complicated and they sound very scary,
but in actual fact, the default rates for the same
rating are much much lower than they are for single name.
Speaker 1 (26:28):
Credits, and the returns are high.
Speaker 4 (26:31):
The returns are higher. Yeah, okay, the faults lower, returns higher.
Speaker 1 (26:35):
And that's a sustainable, long term business. It's not just
a hot money trade.
Speaker 3 (26:40):
No.
Speaker 4 (26:40):
In fact, there's less and less hot money and more
and more kind of what I call real money investing.
We've also seen the development of ETFs buying clos so
that's a new development. The reason the risk premium is
so high is it's a very fragmented market and it's
very institutional. But I think as you see etups develop,
(27:04):
it will create a much broader distribution for the asset class.
Speaker 1 (27:09):
And presume the increased liquiditys was that the next step,
because I mean they're not very liquid right now and
ets need liquidity. That's right, yes, yeah, okay, so you've
got the rates call right at the beginning of the year,
A lot of people didn't. Where else do you think
you're very contrarian? Where do you think that you'll write?
And other people may may not be right?
Speaker 4 (27:28):
Well, I think the main contrarian view we've had is
for almost eighteen months, we've had the view that neither
the US nor Europe will go into a recession that
is significant enough to affect market valuations negatively. You know,
at the time, that was hugely contrarian, and that allowed
us to invest a lot of capital about a year
(27:50):
and a quarter ago and through the course of last year,
when very few investors were willing to because they basically
had the view that the economy would go into a
pretty severe recession and therefore they wanted to wait rather
than invest.
Speaker 1 (28:05):
So if you don't think of recession, then presumingly that
means very few or no rate cuts from the Fed.
Speaker 4 (28:12):
I think that's distinctly possible.
Speaker 1 (28:14):
Yes, zero rate cuts.
Speaker 4 (28:16):
Zero is hard to say. My instinct is that there'll
be some, but I don't think. I don't think it'll
be as much as you know, three to five, which
is what's been spoken about.
Speaker 1 (28:28):
Great stuff. John Dorfmann, chief investment Officer at Napier Park
Global Capsule, thank you so much for joining us on
the Credit Edge.
Speaker 4 (28:34):
Thank you very much.
Speaker 1 (28:36):
And Lisa Lei with Bloomberg News in London, brilliant to
see you again.
Speaker 3 (28:38):
Cheers, cheers. Thanks for having me and.
Speaker 1 (28:41):
Tolo Ali Mutu at Bloomberg Intelligence. Stay where you are.
We're going to ask you more questions, So just a
quick update. You look at real estate, which we could
definitely discuss all day long and certainly on every episode
of The Credit Edge. I wanted to ask about rates though.
First the whole no cuts narrative has suddenly gained traction.
That's not good for borrow especially those sitting on underwater
(29:02):
office loans that they're trying to refinance. There seemed to
be a bit of a light at the end of
the tunnel coming into this year, but that's gone away.
What's the situation right now?
Speaker 2 (29:10):
Yeah, So thanks again, James. The thing is, as you said,
we can talk about real estate for twenty four hours,
seven days a week, and you know I can definitely.
But anyway, just considering what's happening in funding markets and
to real estate issuers, I think some of them have
adjusted to the fact that or the likely fact that
(29:32):
rates may stay elevated for longer. And I think one
of the ways that that is being reflected is that
we're seeing many more issuers come to the public bond market.
So even though some of them would have paid near
zero or close to zero yeah rates for their bonds
(29:53):
prior to twenty twenty two, they're coming in and issuing
at much higher coupon levels. This week, we have seen
the likes of City con come to the market, but
you know, through this year, we've had quite a few
issuers that have come to the market and pay those
higher rates to get funding done. So I think that
is a small positive, especially given what you said about
(30:18):
banks potentially potentially tightening the belt a little bit when
it comes to lending to the sector or taking a
different view on what their current exposures are.
Speaker 1 (30:29):
So great news that they are getting the access to capsule,
but you say that they're paying higher rates. Are these sustainable?
Sustainable rates for the borrow?
Speaker 2 (30:36):
I think what you will see is that potentially interest
cover ratios and other metrics will come under some more
pressure as they replace maturing sometimes cheaper funding with more
expensive debt. But in many cases not all the the
(31:00):
gap between the current interest cover ratios and the threshold
that they have in the bond documentation or loan documentation
is okay enough or adequate enough for them to take
on more expensive debt.
Speaker 3 (31:15):
Uh.
Speaker 2 (31:15):
The other thing that I think you will see, or
we're already seeing, is issuers doing disposals and also trying
to raise equity capital as a way of offsetting the
impact of higher funding costs. So we're seeing small size
and also some significant disposals. And then on the capital
(31:38):
raising side we have seen is issue place equity specifically
to offset the rising leverage that they're seeing on their books.
Speaker 1 (31:51):
And in terms of actual companies, are there any anyone
under more pressure or anyone doing better than mighty last book.
It was only a few weeks ago, but but how
things change.
Speaker 2 (32:00):
Yeah, I think it definitely was only a few weeks ago.
But as we said, we can talk about real estate
twenty four seven. I think one of the issuers that
has received a lot of attention this week in particular,
has been city Con. This is a Nordic based retail
real estate issuer that reported results that showed a loss
(32:23):
because of negative valuation adjustments. But shortly after that loss,
they issued new equity and then they tended for a
bond and they issued a new bond as well. So
it's come into focus because of all the measures that
I think management is trying to take to put the
company on a farmer in a firmer position. So that's
(32:43):
been one interesting one. And then on the other side,
we had this week an issue called time starten a
B which is the parent company or the majority the
main owner of an ncity called time Start, and Bosstad,
which is a residential real estate landlord, and that sure
has come out to say that they will not be
paying the interest on their deeply subordinated instruments that are
(33:07):
called hybrids so that led to a drop in in
the value of those securities. So and the reason that
they're not able to do that is because their subsidiaries
not paying dividends, so they don't have enough to maybe
cover the cost of those hybrids or cover the interest
on those hybrids. So you're still seeing quite different moves
(33:28):
by issuers within the sector. So I think differentiation will
remain a theme through the rest of this year.
Speaker 1 (33:36):
What's your take on Citicon though the management say that
they're doing something to sort the company out, but are
they really are? Are you hopeful on that?
Speaker 2 (33:43):
As a credit analyst, I can never sort of turn
down more equity, right, so I have to say at
least you know they're taking the right steps in terms
of equity. What I think is has been concerning for
me looking at is valuation. So they only revalued their
(34:05):
portfolio with external input once last year, and that was
at the end of the year, and that resulted in
the loss that I mentioned earlier. So it'll be interesting
to see how they approach valuations this year. But the
other thing that they're doing, apart from the equity and
apart and raising unsecured debt, is that they're looking to
(34:26):
do more disposal. So they're doing some of the right things,
but I'd say how they delivers through the rest of
this year will still be important. I can't as a
credit analyst ever say that you know an entity is
in the all clear. We're always looking forward to what
will happen in the next quarter.
Speaker 3 (34:46):
You know.
Speaker 1 (34:46):
The investors we've talked to recently, like Fortress, I mean,
that was a great episode, by the way, for listeners
out there, you should go back and try and find it.
It's tons of great detail from their co CEO talking
about how they're trading this what they call trillion dollar opportunity.
But other than then, than them totally, who else is
potentially benefiting from this?
Speaker 2 (35:04):
A number of people are looking increasingly to real estate,
not necessarily just private credit, but even judging from the
questions I get regular long only money is looking increasingly
at whatever opportunities you might be able to get in
real estate. Also looking at the equity capital raises that
(35:27):
we've had recently, Given that I think the last two
we've had were oversubscribed, that tells you that your typical
equity investors have probably in some cases willing to step
in to look at some of these companies again, whereas
maybe a year ago they might have been less willing
to do so. So I think your traditional investors are
(35:47):
still looking. Where we are concerned more about pullback is
on the bank side, given issues around more regulatory overside
and about potential losses on existing exposures, they might be
further poor back there. But you're some of the regular
(36:09):
public credit public equity investors are coming back. And of
course we've talked about the alternative asset managers or private
credit increasingly interested in real estate too.
Speaker 4 (36:21):
Annie.
Speaker 1 (36:22):
Thanks Talo alam two with Bloomberg Intelligence in London.
Speaker 2 (36:24):
Thank you James.
Speaker 1 (36:26):
Check out all Tolerance research on the Bloomberg Terminal. It
really is great stuff. Or contact her directly if you
need more info and join her webinars. They can be
found on LinkedIn and the terminal. Thanks again, and thanks
again to John Dorfmann, chief investment officer at Napier Park,
and to Lisa Leeve with Bloomberg News in London. Read
all of Lisa's great scoops on the Bloomberg Terminal and
(36:46):
of course at Bloomberg dot com, and please do subscribe
wherever you get your podcasts. We're on Apple, Google, Spotify,
give us a review, tell your friends, or email me
directly at Jcromby eight at Bloomberg dot net. I'm James Crumby.
It's been a pleasure having you. See you next time
on the Credit Edge.
Hello, and welcome to the Credit Edge, a weekly markets podcast.
My name is James Crombie. I'm a senior editor at Bloomberg.
This week, we're very pleased to welcome John Dorfman, chief
investment officer at Napier Park Global Capital. How are you, John,
I'm very well, James, Thank you so much for joining us.
We're very excited to hear your market views and outlook.
We're also delighted to welcome back Lisa Lee, who covers
(00:39):
credit markets for Bloomberg News in London. Great to see
you again, Lisa, great to be here again. And last
but absolutely not Lise from Bloomberg Intelligence. Excellent to see
Tollu Alamutu, also in London. Welcome back, Tolu.
Speaker 2 (00:50):
Thank you.
Speaker 3 (00:50):
James.
Speaker 2 (00:51):
Great to be here as always.
Speaker 1 (00:52):
So let's start with you John, Thanks very much again
for joining us on the Credit Edge. Before we dig
into the specifics of your portfolio and what you see
the best opportunity right now and of course the risks,
let's talk about your macro views, and in particular on
my mind is the Federal reserve rate cut. Bets are
being dialed down right now. Options traders, some of them
are even betting on hikes by the Fed this year.
(01:15):
Compare that to only a few months ago when we
were absolutely pricing very dubbish policy from central banks with
a lot of rate cuts coming starting as soon as
this month, you know, March. That's obviously all flipped as
inflation data continues to come in high. At the same time,
the US economy seems to be strong. Consumers are still
buying despite higher prices. Maybe the dreaded recession won't actually happen.
(01:39):
But where does that leave credit? John everyone comes in
on this show and is very, very bullish, even though
rates will probably stay high for longer. What's your take?
Speaker 4 (01:48):
I think, to step back a moment, we went into
this year basically explaining to our clients that our central
investment view was that the magnitude of rate cuts that
priced in the interest rate market was far too many.
So we were always of the camp that the economy
wasn't weak enough to merit the rate cuts that were implied.
(02:10):
And I still feel that way. And so from a
credit perspective, you know, we think the real economy decent
and the real negative part of the credit market is
the bottom end, so it's the most levered industries, the
most levered consumers and businesses that rely on leverage because
(02:31):
the cost of leverage is so much higher.
Speaker 1 (02:35):
So how do you position for that? What are you
doing too? I mean you obviously got that call right,
a lot of people didn't, But what's your strategy around that?
Speaker 4 (02:45):
So what we're really looking for at this moment are
asset classes that provide a significant risk premium relative to
the amount of defaults that might happen if the economy
were to develop more recessionary cycle. So we see that
mostly in the credit intensive structure credit market. I think
(03:07):
when we compare it to you know, on the run
high yield for example, the spreads are very very low currently.
Speaker 1 (03:14):
So when you talk about structured finance, I mean, is
that securitization? Is that repackaging of debt like consumer loans
or company debt? I mean, what does that mean? It
covers obviously a huge range of things.
Speaker 4 (03:25):
It's it's all of the above. You know. From our
point of view, what we're really focused on is non
investment grade structure credit, frequently securitizations. It can also be
private structures where loans are basically bifurcated into different asset classes.
And we're looking kind of corporate mortgage, consumer auto US
(03:48):
in Europe, and what we found is those markets don't
move together at all, so the capital is highly fragmented.
Speaker 1 (03:54):
Currently, we talk to other investors about how much flow
is coming out of banks? Is that where you're finding
these opportunities to buy?
Speaker 4 (04:02):
Typically it comes from three different sources. One is banks,
the second is asset holders that have received redemptions for
really liquidity reasons from underlying clients. And the third is
originators themselves, So loan originators that have held too many
loans on their own balance sheet and really need to
(04:26):
sell off the loans to be able to generate more origination.
That's very common in things like auto lending. It's common
in our US residential real estate lending.
Speaker 1 (04:37):
So when we talk to other guests you know, about
this opportunity, I mean they are very excited obviously, but
I do again ask the question, you know, why do
you have to become you know, why do you have
to get fancy with credit given that you can get
very very high yields for playing vanilla stuff, you know,
even in investment grade. I mean, why do you have
to stretch for yield in this environment?
Speaker 4 (04:58):
I think it's a great question. A lot of it
to depends on the overall acid allocation of individual investors,
family office investors, and institutional investors. I think for kind
of a I want yield that's highly highly liquid. I
think the on the run hiled investment grade give yields
(05:18):
that are very high relative to the last fifteen years,
but if you adjusted for inflation, it's not quite as high.
What we find is we're focused on the component of
the acid allocation that is more yield seeking, so it's
more as an equity alternative or as a risk asset
alternative credit. For the first time in fifteen years, you
(05:40):
can actually create portfolios to give equity like returns, and
that's something we haven't seen since before the GFC.
Speaker 3 (05:48):
John my opinion colleague, wrote about banks coming back into
credit derivatives mostly as a capital relief trade, and I
know you've been here since the early days of credit derivatives,
and to hear about your thoughts on this and also
what trades Napier has done and how it's changed since
you've started.
Speaker 4 (06:07):
That's a really great point, Lisa. There's been a lot
of focus on banks transferring loan portfolios through what they
call credit risk transference or CRTs and SRTs. I was
actually involved in one of the first ones ever done,
which to date myself was almost thirty years ago when
(06:29):
I was in Europe. So this is a very very
long standing technology and right now I think it's going
to be an area of significant growth. And the reason
I think that is what this technology is designed to
do is to free up capital for banks when banks
equity prices trade below book value. This is a much
(06:54):
much more efficient way to effectively create equity capital than
any other method, and so I think we're going to
see continued growth in this space. It happens in two
kind of formats. One is you could think of as
a public syndicated securitization and the other is a private
bilateral risk transfer and Napier Park's been involved in both.
(07:18):
And as I said, this is something that we've been
involved in for many, many.
Speaker 3 (07:22):
Years, and it seems to be happening more in Europe
than in the US. Do you see this happening for
the US firms or is just the cost of capitals
to invest or will the basil end game actually change
things up?
Speaker 4 (07:36):
I think you will see more in the US, but
I think one of the main reasons you see it
more in Europe is the point I made about European
banks trade at much lower levels relative to book than
US banks, so US banks have, you know, many more
options in terms of ability to effectively create equity and
(07:58):
tier one capital. But I do think you'll see more
in the US. Right now. What we're seeing in the
US are sales of whole loans rather than securitizations. But
there are some US banks doing the credit derivative synthetic scuritizations,
It's just not as common as Europe.
Speaker 2 (08:16):
John, one of the things that you mentioned right at
the start was the vulnerability of the most indebted parts
of the economy. How do you then square that with,
as you said, going for equity like returns and for
going for high yield rather than investment grade. Are you
concerned then that those higher yields might just be reflecting
(08:40):
the concerns that people have about those parts of the economy.
Speaker 4 (08:47):
I think in a lot of single name investment situations
that actually is the case. The yield is there because
it's not clear the company is going to survive, So
you could think of it as a lot if you
think of it a rating based It's a lot of the
triple C based companies are in that situation. Now. That's
why we're focused more on structure credit because we're buying
(09:08):
diversified portfolios where we can stress test it against an
elongated recession and make sure that we still don't have
any impairments. But on the single name side, it's it's
less obvious.
Speaker 1 (09:21):
Currently, John, on the equity like returns, I'm just looking
at the S and P against some of the debt
markets that we cover. S and P over the last
twelve months up thirty percent. I yield neverage loans up
around eleven percent. Are we talking about thirty percent returns here?
Speaker 4 (09:37):
I wish that were the case. I think you will
be in the low to mid teams returns, which is
more consistent with what most investors feel. The upper end
of equity returns will be on a forward basis for
the next three to five years rather than what they've
been for the last year or two, because I think
(09:59):
the last year or two is really been dominated by
artificial intelligence and the growth you know, in particular of
the US of the large tech companies, and back to
credit returns. You know, it's interesting last year, our credit funds,
the money in the ground always invested funds, we returned
(10:20):
twenty percent net to our clients, and our drawn return
vehicles returned of thirty three percent net to our clients.
So actually those were you know, definitely equity type of returns.
Speaker 1 (10:35):
When you start talking about securitization and to add about derivatives,
why why is it, you know, not a hugely risky proposition. Now,
why why is this a good thing?
Speaker 4 (10:47):
I think there's a lot of standardization and transparency that
has developed in the derivative and securitization markets over the
last ten or twenty years. Certainly in the early days
there were a lot of financial accidents, but that's less
the case now. I think from our point of view,
it's worth highlighting that if you look at just the
(11:08):
US high market, there is more credit the trades through
the index derivative than there is in every higher bond
put together. So this is a very, very common accepted
method of transferring corporate credit. I think, you know, if
you look at things like mortgage risk, there have been
(11:30):
many derivative blow ups over the years and a lot
more leverage, but in corporates it's much less.
Speaker 2 (11:35):
So John I had a question about the returns figures
that you mentioned. I mean, obviously extraordinarily impressive, So congratulations
on those figures for twenty twenty four. Do you think
those sorts of returns will be repeatable? Could you see
that again? And given that we've been talking a little
bit about US versus Europe, where do you think those
(11:57):
sorts of returns could more likely come from either US
or maybe here?
Speaker 4 (12:02):
I think in Europe a pretty significant part of our
businesses in Europe. Both Jim, my business partner, and I
have spent a lot of time in Europe. I was
there for about fifteen years investing in trading credit, and
I think last year Europe was I believe our second
most significant profit contributor, so it was very significant. I
(12:25):
think this year overall returns, as I said, will probably
be in the teens type area in our strategies, and
probably slightly higher in the US than in Europe, mostly
because Europe has caught up so much over the last
six month period.
Speaker 3 (12:42):
When you talk about Europe, John, are you worried about
sort of the economic divergence? It seems like the US
might avoid a recession and actually might start to see
inflation going up again, Europe doesn't seem to be quite
as robust. So when you're as a credit person, how
do you think through investments there? A lot of the
(13:02):
people I talk to say is a great diversifier, But
in and of itself, how do you play Europe?
Speaker 4 (13:09):
I think generally Europe has less I mean, just back
to my triple C comment, Europe has less of those
kind of borrowers that are able to access the public market,
and so the credit quality is generally, on average, slightly
higher when you're particularly when you're looking at the tail
kind of credit, the bottom ten percent or the bottom
fifteen percent. So what we're really focused on is the
(13:32):
same type of thing in Europe that you know I
was talking about, generally underwriting to recessions, whether or not
there is one, And I think right now Europe's particularly
interesting because Germany is really struggling, which I think is
very common knowledge. But if you strip out Germany, the
rest of the economies in Europe look relatively decent. And
(13:53):
so what we're trying to do is underwrite for a
situation that Europe worsens, whether or not it does.
Speaker 1 (14:00):
What kind of a default rates are you expecting, John.
Speaker 4 (14:03):
I think. I think the leverage loan default rate last year,
I'll touch on Europe and in the States, leverage loan
default rate last year was five point seven percent, with
the exception of a couple months during COVID, that was
the largest, the highest since the GFC, and that's for Moody's.
I think it'll continue around that rate at least for
(14:24):
the next six months, potentially the next twelve months, and
then taper off pretty dramatically. Europe, I think the default
rates will be about two percent lower, simply because there
just are less triple C type borrowers. And you'll see
the same thing with default rates tailing off in both
the US and Europe. We see defaults as more visible.
(14:46):
It's more clear to us which companies are going to
default than it would have been a year ago.
Speaker 1 (14:51):
But do you think that's priced into the current credit markets,
given how tight spreads have become.
Speaker 4 (14:56):
I don't.
Speaker 1 (14:57):
And then what happens next is does it have to
repres I mean nos is looking at how much dubbish
policy was priced in at the end of last year
that hasn't unwhelmed yet. On top of that, you've got
the default risk you're talking about. It should there be
a shakeout in the junk bond market.
Speaker 4 (15:12):
I think there'll be a repricing. The reason it's so
expensive is most investors buy on yield, they don't buy
on spread. So they say to themselves, Okay, if I
could buy at six percent or eight percent or ten percent,
obviously depending on the type of risk you're looking at,
I'm happy. And they're not really looking at what's the spread.
(15:33):
The other thing that really concerns us is the index
credit quality has deteriorated in the high old market because
there's and strangely enough, in a really unusual manner, it's
because so many companies have been upgraded to investment grade,
not because the companies are doing poorly. It's just if
you take really large borrowers and upgrade them, they fall
(15:57):
out of the index, and the residual index is meaningfully weaker.
So we do think there'll be a correction in HYO.
I think the magnitude of it is really going depend
on what happens with interest rates because of this gross
yield based buying behavior.
Speaker 3 (16:12):
John, you have a sizeable COLO shop in both the
US and Europe, so you can talk tip to that market.
The leverage loan market as seen as there's been a
huge repricing and colos are now almost at the record
pace to start a year. Do you think that could continue?
And is there any worries about that market, any kind
of repricing stalling? There? Are we giving a little bit
(16:32):
ahead of ourselves.
Speaker 4 (16:34):
I don't think the market is ahead of itself, because
there was very little COLO activity for the last couple
of years relative to some of the stronger years. And
I think because the economy in both the US and
Europe has weathered both the geopolitical risks and the interest
rate changes, I actually think this is pretty sustainable, the
(16:54):
growth in the COLO market, because keep in mind, newer
vintage loans frankly speaking, are much stronger credit wise than
those of you know, three, five, seven years ago, because
it's been difficult to finounce over the last few years
until very recently.
Speaker 2 (17:11):
Thank you for that, John. I had a sort of
follow up question on something you mentioned. You know, you
said Germany is sort of seen as the sick man
of Europe, if you like. But one of the areas
where I guess there is also concern looking say at
the real estate sector is in the Nordics and to
a lesser extent in the UK. So when you're looking
(17:33):
across Europe, is real estate one of the sectors that
you're thinking is looking worth investing in or are there
other areas that maybe you think are looking much better
than the real estate sector?
Speaker 4 (17:47):
Generally, real estate sector is an area that we have
not been that positive on and remain concerned about. And
I think the reason is the real state investor market
is prone to using a lot of leverage and a
lot of short term leverage. And I think, you know,
(18:07):
looking at the situation in Europe, I think a lot
of assets are going to come out of some of
the real estate firms, and I think it will be
probably more of a real by real estate is a
real asset opportunity than a credit opportunity.
Speaker 2 (18:25):
Yeah, And just would you say that that same comment
applies then in the US because obviously we are seeing
some banks come under pressure because of their real estate exposure.
Do you say that, would you say that that's different
from Europe or the same.
Speaker 4 (18:42):
It's similar the US. It's mostly real estate that's held
by regional banks. There really are very few issues with
the large money center banks. But you know, the US
needs a regional bank system and a local bank system.
So I think I think you will see assets come
out out of the regional banks that are real estate related.
Speaker 2 (19:03):
If I could just ask one more within that US
real estate landscape, do you think that there are areas
of opportunity. One of the things that some people have
been talking about is, uh, you know, sunset belt versus
coastal and so on or so of sector within real
(19:25):
estate that might begin to start looking to look interesting.
Do you see any kind of differentiation happening or do
you think that it's just best to be cautious on
the entire sector.
Speaker 4 (19:36):
No, Actually, we see some areas of you know, very
significant opportunity. Kirk currently, because I think all real estate
has sort of been tarred with a negative brush, we
have originated about five billion dollars of residential real estate
whole loans in the last five years, generally in transitional
(19:59):
lending or either public market public homebuilders who are doing
specific developments in the residential space, so that's single family homes,
and we also do it with professional developers that have
groups of say five to ten homes that they're renovating
and then selling. So there is an interesting opportunity in
(20:19):
the US because there's a fairly significant housing shortage in
certain places, and the yields that you get to lend
are meaningfully higher because there's less liquidity in the system.
So we do think there's some pretty interesting opportunities, and
it's more in the form of direct origination than anything else.
Speaker 1 (20:39):
But what about the risk, John? On the consumer side,
I mean, the consumer is coming under more pressure obviously
with inflation and housing costs are very very high. There's
lots of signs now that maybe the buying, the post
COVID buying revenge spending is drying up. Do you think
that we're exposed now to more consumer defaults?
Speaker 4 (20:58):
I think that you'll likely see rising consumer delinquencies and
defaults in the bottom quintile of the income distribution and
potentially the second quintile. Most of it will depend on
whether wages are higher than inflation or lower than inflation.
(21:19):
They have been lower than inflation until the last twelve months,
and now wage increases have been higher than inflation. Usually
that improves consumer spending, but it's not equally distributed.
Speaker 3 (21:32):
So that does seem like a worry to you, John,
What else are you worried about as you look through
this year and the global landscape and credit and are
you worried about your political risk about some of the
elections coming up.
Speaker 4 (21:45):
You know, the thing I'm most worried about is the
I guess what I'd say is still extremely optimistic market
pricing of interest rate cuts in the short term and
the next you don't call it to twelve to eighteen months.
I think if those don't happen and the economy doesn't
(22:05):
grow in the US and Europe, then you're going to
see some pretty significant capital markets volatility. Geopolitics typically are
short term effects on markets unless you get a very
expansive war, so that's less of a concern. And the
election cycles are always a concern, but I think that's
more about volatility than anything fundamental for twenty twenty four.
Speaker 2 (22:30):
John, I mean, given the history of your institution, I mean,
obviously you've worked within a bank before. One of the
things that's come up in a recent podcast is the
potential for institutions like yours to either partner with banks
or to get stakes in banks. Do you think that
(22:50):
that is something that you would consider given the history
of your institution, or is that something that you think
is firmly in the past.
Speaker 4 (22:58):
Now I think for us it probably doesn't make sense
because our real interest is being able to be opportunistic
in our investing, and typically if we partner with a bank,
where that becomes more of a flow agreement where we're
locked into working with that particular bank, whereas we prefer
to have the flexibility. We've done that a lot with
(23:20):
non bank originators, where we have a lot more pricing
power in terms of our ability to buy and price
the assets that we're getting involved in. But with the
banks it's a little trickier just.
Speaker 2 (23:36):
To follow up on that. Then, one of the issues
that's coming up is potential regulation or more oversight of
non bank lenders. Is that something that concerns you or
is that something that you don't think that the market
should be worried about.
Speaker 4 (23:55):
Well, we would welcome more supervision of non bank lenders
because one of our biggest concerns is the growth of
private credit as a non marked market asset and the
extraordinary differences in holding prices of the same asset across
different managers. That's really concerning to us. I think that
(24:19):
you need to have consistent valuation across all asset classes,
And I think because that's a reasonably new asset class,
it's really become an asset class that is heavily driven
by what we would call volatility washing, and that's a
concern as it gets bigger and bigger and bigger.
Speaker 3 (24:36):
So how do you think when you think through private
credit and this marked to market issue, because you're right,
there is wide disparity. How do you think do you
have any ideas on how we can get from where
we are now to that point or do you think
that really requires regulation?
Speaker 4 (24:53):
It would only happen through a regulatory response.
Speaker 1 (24:57):
So if you look at all of the stuff you
get to see every day on which sounds fascinating, and
you're talking about equity, you like returns in some parts
of it, but we're also considering, you know, significant risks.
Where is the best relative value right now for you?
Speaker 4 (25:12):
I think for us, the two areas that we feel
have the most relative value are opportunities in the credit
derivative markets, and that's really a large corporate risk in
the US and Europe that's non investment grade. And then
completely unrelated is the area I was discussing previously, residential
(25:33):
lending in the United States in single family homes.
Speaker 1 (25:36):
So the second one makes a lot of sense to
me in terms of understanding it. But trunched credit derivatives.
Can you explain that to my grandmother? Please?
Speaker 4 (25:44):
Sure? The basic idea is taking pools of credit derivatives,
so you take like one hundred different credits and it's
trunched into a first loss, a mezzanine, and a senior,
just like a clo. So it's basically like creating clos
but with credit derivatives instead.
Speaker 1 (26:03):
Of loans and clos. For those out there who don't understand,
it's repackaging of company debt, typically the riskier debt, the
leverage loans. But it hasn't defaulted. It's done quite well,
hasn't it over history?
Speaker 4 (26:16):
That's right. They sound complicated and they sound very scary,
but in actual fact, the default rates for the same
rating are much much lower than they are for single name.
Speaker 1 (26:28):
Credits, and the returns are high.
Speaker 4 (26:31):
The returns are higher. Yeah, okay, the faults lower, returns higher.
Speaker 1 (26:35):
And that's a sustainable, long term business. It's not just
a hot money trade.
Speaker 3 (26:40):
No.
Speaker 4 (26:40):
In fact, there's less and less hot money and more
and more kind of what I call real money investing.
We've also seen the development of ETFs buying clos so
that's a new development. The reason the risk premium is
so high is it's a very fragmented market and it's
very institutional. But I think as you see etups develop,
(27:04):
it will create a much broader distribution for the asset class.
Speaker 1 (27:09):
And presume the increased liquiditys was that the next step,
because I mean they're not very liquid right now and
ets need liquidity. That's right, yes, yeah, okay, so you've
got the rates call right at the beginning of the year,
A lot of people didn't. Where else do you think
you're very contrarian? Where do you think that you'll write?
And other people may may not be right?
Speaker 4 (27:28):
Well, I think the main contrarian view we've had is
for almost eighteen months, we've had the view that neither
the US nor Europe will go into a recession that
is significant enough to affect market valuations negatively. You know,
at the time, that was hugely contrarian, and that allowed
us to invest a lot of capital about a year
(27:50):
and a quarter ago and through the course of last year,
when very few investors were willing to because they basically
had the view that the economy would go into a
pretty severe recession and therefore they wanted to wait rather
than invest.
Speaker 1 (28:05):
So if you don't think of recession, then presumingly that
means very few or no rate cuts from the Fed.
Speaker 4 (28:12):
I think that's distinctly possible.
Speaker 1 (28:14):
Yes, zero rate cuts.
Speaker 4 (28:16):
Zero is hard to say. My instinct is that there'll
be some, but I don't think. I don't think it'll
be as much as you know, three to five, which
is what's been spoken about.
Speaker 1 (28:28):
Great stuff. John Dorfmann, chief investment Officer at Napier Park
Global Capsule, thank you so much for joining us on
the Credit Edge.
Speaker 4 (28:34):
Thank you very much.
Speaker 1 (28:36):
And Lisa Lei with Bloomberg News in London, brilliant to
see you again.
Speaker 3 (28:38):
Cheers, cheers. Thanks for having me and.
Speaker 1 (28:41):
Tolo Ali Mutu at Bloomberg Intelligence. Stay where you are.
We're going to ask you more questions, So just a
quick update. You look at real estate, which we could
definitely discuss all day long and certainly on every episode
of The Credit Edge. I wanted to ask about rates though.
First the whole no cuts narrative has suddenly gained traction.
That's not good for borrow especially those sitting on underwater
(29:02):
office loans that they're trying to refinance. There seemed to
be a bit of a light at the end of
the tunnel coming into this year, but that's gone away.
What's the situation right now?
Speaker 2 (29:10):
Yeah, So thanks again, James. The thing is, as you said,
we can talk about real estate for twenty four hours,
seven days a week, and you know I can definitely.
But anyway, just considering what's happening in funding markets and
to real estate issuers, I think some of them have
adjusted to the fact that or the likely fact that
(29:32):
rates may stay elevated for longer. And I think one
of the ways that that is being reflected is that
we're seeing many more issuers come to the public bond market.
So even though some of them would have paid near
zero or close to zero yeah rates for their bonds
(29:53):
prior to twenty twenty two, they're coming in and issuing
at much higher coupon levels. This week, we have seen
the likes of City con come to the market, but
you know, through this year, we've had quite a few
issuers that have come to the market and pay those
higher rates to get funding done. So I think that
is a small positive, especially given what you said about
(30:18):
banks potentially potentially tightening the belt a little bit when
it comes to lending to the sector or taking a
different view on what their current exposures are.
Speaker 1 (30:29):
So great news that they are getting the access to capsule,
but you say that they're paying higher rates. Are these sustainable?
Sustainable rates for the borrow?
Speaker 2 (30:36):
I think what you will see is that potentially interest
cover ratios and other metrics will come under some more
pressure as they replace maturing sometimes cheaper funding with more
expensive debt. But in many cases not all the the
(31:00):
gap between the current interest cover ratios and the threshold
that they have in the bond documentation or loan documentation
is okay enough or adequate enough for them to take
on more expensive debt.
Speaker 3 (31:15):
Uh.
Speaker 2 (31:15):
The other thing that I think you will see, or
we're already seeing, is issuers doing disposals and also trying
to raise equity capital as a way of offsetting the
impact of higher funding costs. So we're seeing small size
and also some significant disposals. And then on the capital
(31:38):
raising side we have seen is issue place equity specifically
to offset the rising leverage that they're seeing on their books.
Speaker 1 (31:51):
And in terms of actual companies, are there any anyone
under more pressure or anyone doing better than mighty last book.
It was only a few weeks ago, but but how
things change.
Speaker 2 (32:00):
Yeah, I think it definitely was only a few weeks ago.
But as we said, we can talk about real estate
twenty four seven. I think one of the issuers that
has received a lot of attention this week in particular,
has been city Con. This is a Nordic based retail
real estate issuer that reported results that showed a loss
(32:23):
because of negative valuation adjustments. But shortly after that loss,
they issued new equity and then they tended for a
bond and they issued a new bond as well. So
it's come into focus because of all the measures that
I think management is trying to take to put the
company on a farmer in a firmer position. So that's
(32:43):
been one interesting one. And then on the other side,
we had this week an issue called time starten a
B which is the parent company or the majority the
main owner of an ncity called time Start, and Bosstad,
which is a residential real estate landlord, and that sure
has come out to say that they will not be
paying the interest on their deeply subordinated instruments that are
(33:07):
called hybrids so that led to a drop in in
the value of those securities. So and the reason that
they're not able to do that is because their subsidiaries
not paying dividends, so they don't have enough to maybe
cover the cost of those hybrids or cover the interest
on those hybrids. So you're still seeing quite different moves
(33:28):
by issuers within the sector. So I think differentiation will
remain a theme through the rest of this year.
Speaker 1 (33:36):
What's your take on Citicon though the management say that
they're doing something to sort the company out, but are
they really are? Are you hopeful on that?
Speaker 2 (33:43):
As a credit analyst, I can never sort of turn
down more equity, right, so I have to say at
least you know they're taking the right steps in terms
of equity. What I think is has been concerning for
me looking at is valuation. So they only revalued their
(34:05):
portfolio with external input once last year, and that was
at the end of the year, and that resulted in
the loss that I mentioned earlier. So it'll be interesting
to see how they approach valuations this year. But the
other thing that they're doing, apart from the equity and
apart and raising unsecured debt, is that they're looking to
(34:26):
do more disposal. So they're doing some of the right things,
but I'd say how they delivers through the rest of
this year will still be important. I can't as a
credit analyst ever say that you know an entity is
in the all clear. We're always looking forward to what
will happen in the next quarter.
Speaker 3 (34:46):
You know.
Speaker 1 (34:46):
The investors we've talked to recently, like Fortress, I mean,
that was a great episode, by the way, for listeners
out there, you should go back and try and find it.
It's tons of great detail from their co CEO talking
about how they're trading this what they call trillion dollar opportunity.
But other than then, than them totally, who else is
potentially benefiting from this?
Speaker 2 (35:04):
A number of people are looking increasingly to real estate,
not necessarily just private credit, but even judging from the
questions I get regular long only money is looking increasingly
at whatever opportunities you might be able to get in
real estate. Also looking at the equity capital raises that
(35:27):
we've had recently, Given that I think the last two
we've had were oversubscribed, that tells you that your typical
equity investors have probably in some cases willing to step
in to look at some of these companies again, whereas
maybe a year ago they might have been less willing
to do so. So I think your traditional investors are
(35:47):
still looking. Where we are concerned more about pullback is
on the bank side, given issues around more regulatory overside
and about potential losses on existing exposures, they might be
further poor back there. But you're some of the regular
(36:09):
public credit public equity investors are coming back. And of
course we've talked about the alternative asset managers or private
credit increasingly interested in real estate too.
Speaker 4 (36:21):
Annie.
Speaker 1 (36:22):
Thanks Talo alam two with Bloomberg Intelligence in London.
Speaker 2 (36:24):
Thank you James.
Speaker 1 (36:26):
Check out all Tolerance research on the Bloomberg Terminal. It
really is great stuff. Or contact her directly if you
need more info and join her webinars. They can be
found on LinkedIn and the terminal. Thanks again, and thanks
again to John Dorfmann, chief investment officer at Napier Park,
and to Lisa Leeve with Bloomberg News in London. Read
all of Lisa's great scoops on the Bloomberg Terminal and
(36:46):
of course at Bloomberg dot com, and please do subscribe
wherever you get your podcasts. We're on Apple, Google, Spotify,
give us a review, tell your friends, or email me
directly at Jcromby eight at Bloomberg dot net. I'm James Crumby.
It's been a pleasure having you. See you next time
on the Credit Edge.
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