Episode 76

Andrew and John on commonalities in investment grade private credit and narrowly syndicated bank loans

Andrew Kleeman, Senior Managing Director, Head of Corporate Private Placements at SLC Management, and John Fekete, Head of Capital Markets at Crescent Capital, discuss similarities between two markets that sit on either side of the dividing line between investment grade and below investment grade.

Steve Peacher: Hi everybody it's Steve Peacher, president of SLC Management, and I appreciate you dialing into this episode of “Three in Five.” I've got two guests today. John Fekete, who heads Crescent's capital markets business, and Andy Kleeman, who heads SLC's private fixed income business. So, guys thanks for taking a moment today.

Andrew Kleeman: Thank you.

Steve Peacher: So, you're both on because you focus on two different markets but I think in a recent conversation with one of the big consulting firms you realized that there are lots there's actually some commonality. The 2 markets I’m talking about are investment grade private credit, which Andy is the purview of your team. And then John, narrowly syndicated bank loans, which is an area, one of the areas that your team focuses on. And as I said, I think you guys found that there actually some commonality between those, even though they sit on either side of the dividing line between investment grade and below investment grade. So that's what we want to talk about today. So maybe we can start by, each of you could comment about in your respective sectors, how are investors, how are our clients using these sectors in their portfolios today, and why?

Andrew Kleeman: Steve, so for investment grade private credit, this is really used as an alternative to investment grade public fixed income. It is investment grade investors get the same capital charges if they are an insurance company. It's mainly fixed rate, offering that duration that insurance companies and some pensions investors are looking at. But really where it matches, I think, more than narrowly syndicated loan market is around the covenant, and at times collateral. These are heavily negotiated transactions where investors are seeking a yield premium and that yield premium comes through heavy underwriting as well as detailed structuring of covenants and on occasion collateral as well.

John Fekete: For the narrowly syndicated loans, very, very similar to what Andy just said, it’s a segment of the overall bank loan universe, but it's a segment where there's more work to be done. The loans are a bit less liquid. The companies tend to skew a bit smaller in size but structurally the same. You know, top of the capital structure, seniority, collateral, floating rate coupons. And what we find is that investors are attracted to the segment because there is a higher yield due to the smaller size and less liquidity, and that makes it interesting for investors to take advantage of.

Steve Peacher: You know, in the markets a common refrain is that there's no free lunch, but it sounds like you're both talking about segments of the market where, over time, you've proven you can pick up some extra yield, but not by sacrificing meaningful amounts of credit quality. There are some other attributes that you may have to give on a bit, but it's not on credit quality, which tends to be investors primary concern when they go into the credit market. So, what's really happening here which has allowed in each of these markets you to pick up extra yield and not go down the credit spectrum.

John Fekete: You're absolutely correct, Steve. Investors are not sacrificing credit quality at all. In fact, for narrowly syndicated loans, the average credit rating for that segment is the same credit rating as the entire bank loan universe. So, in that regard it's seen as the same amount of credit risk. In fact, defaults are actually, least historically, have been lower in the narrowly syndicated world versus the entire large cap bank loan universe, and that's really due to all the upfront work that goes into sourcing and structuring the deal. So, you give up some liquidity, as you say there's no free lunch. You've got to give up a bit of market liquidity. But if you roll up your sleeves and do the work, investors get rewarded.

Andrew Kleeman: Yeah, I would echo that. There's always a question about what liquidity looks like an investment grade private credit and that can vary issue by issuer. On some of the more widely held long-term issuers my personal record trading a piece of private debt for one of the North American sport leagues, I had it priced within 8 min. That's certainly on one far side of the spectrum. There's other things that you might spend weeks or months trying to find a buyer, but for the most part if you have a performing credit there is, there is a market for it, and we've been active in that market, both buying and selling. You know it does take some time to settle this. There's some operational complexity to this which maybe is a barrier to entry. A as far as the free lunch goes, part of what we're getting compensated for here, is the fact that the issuers are coming to this market because they have a need for some flexibility. That might be the need to do an unrated piece of debt, perhaps a piece of debt with only one rating which wouldn't work in the public fixed income markets. On occasion they want an unusual tenor, whether that's a 17 year bullet that that fits their maturity schedule, or maybe it's an amortizing piece of debt, maybe it's a smaller piece of debt than what would be required to be index eligible for the for the bond indices, which would be $500 million. Or sometimes there's just noise around a credit that this market is willing to work through and underwrite through. And so you're not necessarily getting a liquidity premium. You're getting a premium for the work. and sometimes for the hassle factor around the transaction.

Steve Peacher: You know it sounds like a listening to both your answers that even still we're getting You found that over time we're getting kind of outsized extra yield relative to some give on liquidity, or maybe the need for flexibility. And I guess in most markets whenever there's some extra return over time it gets armed away. You know, the market finds the way to kind of take any extra yield over and above what it's being given for to squeeze it out of the market. But it doesn't sound like that's fully happened in these 2 segments and get any sense as to why?

John Fekete: It hasn't has it happened in the narrowly syndicated loans for over 10 years, it's been pretty consistent. I attribute it to much of the consolidation actually that's happened with respect to asset management. If you look at high yield and bank loan managers, as they get larger and larger, they tend to focus on more of the large index constituents. So, you've got these middle market loans, they fly a bit under the radar, but that's what makes them attractive. It's a less competitive part of the loan market.

Andrew Kleeman: I agree completely with that. I would also add that in investment grade private credit here is an operational barrier to entry. These are physical certificates or physical notes that you have to get into a custodian. So, from an operational perspective that can be a barrier. If you're trying to run a separate account a fund structure can ease some of that. I would also say that this market comes down to efficient origination and heavy underwriting, and you have to get compensated for that. It is a buy and hold market. So, after the work of trying to find these deals and then under item nobody's trying to sell them just because they're up a point or two, it's typically a buy and hold to maturity which kind of creates a barrier to entry for investors that might want to be arbitraging a short term pricing differentials.

Steve Peacher: Well, I know these 2 markets are near to dear to our hearts. These are areas that between SLC and Crescent have been involved in a long time. I think those clients that we manage money for in these sectors have gotten a lot of benefit out of these over time, and sounds like you expect that to continue going forward.

Andrew Kleeman: Steve, I know we usually in these with a personal question. Maybe we ask you one this time?

Steve Peacher: No tough questions, but I’ll go with it.

Andrew Kleeman: I know your youngest is now a fully graduated from college and fully launched. what do you have planned for 2023 now?

Steve Peacher: We now have to split time. We have the great fortune of having a couple of kids who have been married, but that means we have to split time with other, with in laws. And so we've got a little bit of that going at Christmas. But we're going to see a lot of our family over the holidays, and I mentioned this on a recent podcast, but we recently had our first grandchild, so that takes a lot of time, and they're down in Atlanta. So that's great for us. And we've got, so we just went through the calendar in the coming year and have a bunch of fun stuff. Fishing trips, family get together, send a hiking trip in the fall. So, a lot of great stuff looking at for us, looking at year end and into next year, too. But thanks for asking. So thanks, guys for taking the time, I appreciate it, and I appreciate everybody listening for listening to this episode of “Three in Five.”

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