CJ Doherty: Welcome to the Lending Lowdown. I'm CJ Doherty, Director of Analysis at LSEG LS LPC. And today we're going to focus on the US CLO market, that's collaralized loan obligations for anyone who might be unfamiliar with the acronym. In what is our 21st podcast in the series. The US CLO market has grown to over 1 trillion in size and is the biggest buyer of leverage loans. And based on our most recent stats, the CLO market share of institutional leverage loan outstandings is roughly 70%, so it dwarfs other lenders in this market segment. In turn, conditions in the CLO space have a large impact on activity in the broadly syndicated loan market. Today we'll discuss the current dynamics and trends in the CLO market and look ahead to the remainder of 2024. Also given Bain Capital Credit's position in the broader loan markets. I want to touch on the current competitive landscape between the broadly syndicated and private credit markets. To discuss all of this, I'm delighted to be joined by John Wright, Global Head of Credit at Bay Capital Credit. John, it's great to have you here.
John Wright: Thanks for joining me. Thanks for having me. Cj, happy to be here.
CJ Doherty: As usual, we want to start with a little bit of background, and so can you tell us a bit about Bank Capital Credit, and your background and the current role before we dive into the Q and A?
John Wright: Absolutely. Bank Capital Credit is the credit affiliate of Bank Capital. We actually celebrated our 25th year anniversary last year. We're currently 45 billion of assets under management and that's split across three core strategies. The first is traded credit, generally leveraged loans, high yield bonds in separately managed account format or fund format. The second is structured credit, which is primarily our CLO business. And the third is private credit, which is a global direct lending business we've been running since our inception. My role is the Global Head, and so I oversee these three strategies and am ultimately responsible for the strategic direction of the credit business and also asset allocation.
CJ Doherty: Great. And so before we go deeper into the CLO market, specifically, do you think the broadly syndicated loan market will take back share from the private credit market this year? As obviously this is implications for CLOs and the wider loan market.
John Wright: I do what we've seen this year in the loan market is strength. And that comes from, in part a tightening in the CLO liability spread levels and that leads to demand for leverage loans. And when we look back over the last three years, the demand for the broadly syndicated loan market and the willingness of banks to underwrite new leverage loans has not been particularly robust until really the latter part of last year. And so when we look at issuance activity for new LBO financings, private credit, and in particular mega cap private credit lenders really had an advantage to step into the market void that was being created by the lack of bank underwriting. Towards the end of last year and coming into this year, we're seeing much greater interest and much greater willingness on behalf of the banks to underwrite loans. And that's driven by strength in the secondary market and the new issue market for leveraged loans. So I do think we've already started to see some market share taken by the broadly syndicated loan market. And I think we're going to continue to see that so long as we see strength in the loan market.
CJ Doherty: Okay, great. And then CLO issuance is over 27 billion year to date. I think about 22 billion of that represents BSL CLO's, so it's running ahead of last year's pace. How do you see the rest of this year playing out in terms of new issue deal flow?
John Wright: Yeah, I think investors overall have come to appreciate the value of CLO's and how, you know, through market cycles they performed quite well. And that's true for CLO debt investors. That's true for CLO equity investors. And well, you go through periods of time where there is perhaps, volatility or a lack of strong formation. Typically, once that volatility subsides, you can see pretty robust demand for CLO's and I think we've seen that really coming into this year. CLO triple A spreads have tightened significantly. Demand for equity is higher than it has been for the last couple of years. And so that really has gotten us to a place where we've had pretty robust, organic, new issuance on the CLO side. And I think that's likely to continue with rates where they are and with spreads where they are. There's still some very compelling opportunities for both CLO debt and equity investors even after this rally.
CJ Doherty: Okay. And actually, what is the current appetite from AAA and, and equity investors? What are you seeing there?
John Wright: Sure, Well, appetite for AAA is certainly strong. We've seen spreads come in substantially from say, the end of the third quarter of last year into the mid part of the first quarter of this year for a new issue deal. AAA are now clearing somewhere in maybe even high 140 to mid one '50s. And that's much tighter than what we've seen for a good portion of the last two years. Demand has been strong from AAA investors. I think we're seeing some banks come back into the fold that hadn't been active and there continues to be demand from a lot of the traditional buyers. On the equity side, equity is really bifurcated into what I would call committed equity funds that are primarily controlled and managed by some of the larger CLO managers in the market. And then what I call CLO equity demand, third party CLO equity demand for new deals has not been particularly robust up until really the last, I'd say three or four months we've seen that demand start to come back. And I think that's a healthy sign for the market. It shows more market sensitive participants coming in and saying they view CLO equity as attractive. So I'd say on both AAA and equity demand is higher, especially for those managers that have good access to the loan market.
CJ Doherty: Okay. And apart from what you've already discussed, when you're putting together a new CLO these days, what else are investors focused on? Any common themes there?
John Wright: Sure, most investors I think are focused on both long term and short term dynamics. For a given CLO, you know, manager performance through a cycle is certainly one, I think manager's ability to get transactions done. When we see heavy issuance activity like we've seen this year, the market gets a bit crowded. Meaning if you're a CLO debt investor, you might have a dozen CLOs that you're looking at at once. And so the good part about that is that you can choose which manager you want to partner with, but also you're going to want to partner with a manager that you believe that CLO is going to happen and going to happen on the timeline that's being described to you. I think long term performance of the manager as well as short term dynamics around a specific deal. Things like how much subordination there are to debt investors. What the ramp price of the portfolio is. What the ramp strategy is for the remainder of the portfolio. All of those are very topical with investors today.
CJ Doherty: Okay, great. And how is the market looking from a credit quality perspective? Do you expect rating downgrades to pick up this year? To what extent will CCC buckets come under pressure?
John Wright: Sure, we've seen CCC buckets be relatively stable. Maybe ticking up a bit in the US. I think what's important to appreciate about that is that prices for CCC assets actually have been rallying quite significantly. So while the buckets may be increasing slightly in the US, I think we feel very constructive around manager's ability to trade within those buckets given the strength in the secondary market. You know, overall I think we believe the macro outlook is reasonably stable, if not constructive. And so we're not too concerned about a significant increase in default rates. Although as credit investors, that's something we obviously spend a lot of time focusing on.
CJ Doherty: Great final question for you. If you had to pick one for each, what is the biggest opportunity and the biggest risk in the CLO market this year?
John Wright: Sure, that's a great question. On the opportunity side, I think we still believe there's a lot of really interesting opportunities in junior CLO debt. This can be in the secondary market or the new issue market. When you look at the long term track record of CLOs, the debt tranches historically have had very robust performance, but that's matched with a lot of volatility. And one mistake we've seen investors make is after you've had some recovery, not willing to step into a market, fearing that you've missed the bottom. And I think we're at that point now on the CLO debt side where we have seen a pretty significant recovery, but in our view there's still quite a bit of tightening that could potentially still be in front of us, and so we're very constructive on that from an absolute perspective as well as relative to other pockets in the credit market. And then on the risk side, I think the single biggest risk for CLOs and for loan investors is really recovery rates on leverage loans. We've really seen a deterioration in the first recovery outcome on restructuring, both from the standpoint of average recovery as well as dispersion around those recoveries. And that's something that I think the market's going to have to do a better job of sorting out as it relates to getting back to a higher recovery for first lien senior secured lenders.
CJ Doherty: So much to keep an eye on in the remainder of the year. We'll definitely stay tuned. That's all we have time for today. John, thank you so much for sharing your insights and your perspective with us.
John Wright: Thank you so much for having CJ
CJ Doherty: And thank you all for tuning in. I invite you to check out our CLO news and analysis at Loan Connector.com and also at our sister LS company, IFR. Follow us on X at LPC Loans. I'm CJ Doherty, subscribe to the lending load and on your favorite podcast platform, AD: When you contribute your fixed income deals to LSEG, they'll reach over half 1 million buy and sell side professionals around the world and be included in our industry leading league table rankings. To ensure we're capturing your entire deal flow, visit contribute.lseg.com/fisignup or contact our team at contribute@lseg.com. Make your deal count.
