Episode 59

JULY 20, 2022

Richard Stevenson on below investment grade markets

Richard Stevenson, Managing Director and Portfolio Manager at Crescent Capital Group LP, discusses shifts in the below investment grade market and where he is finding opportunity.

Steve Peacher: Hi everybody it's Steve Peacher at SLC Management, thanks for listening to this episode. Today I’m with Rich Stevenson, who is a managing director and portfolio manager at Crescent Capital working in their capital markets group. Rich, thanks for taking a few minutes today.

Richard Stevenson: Sure, thanks for having me on Steve.

Steve Peacher: So we want to talk about the below investment grade market, and you know there's a lot going on in the markets and the economy and the global geopolitically today. And that's, those are the kind of markets that create opportunities, so you know let's just start with a general question about what you're seeing in the below investment grade markets today.

Richard Stevenson: Sure, so we've been seeing a lot of pretty significant shifts this year, you know first thing I’d probably highlight is just the interest rate risk versus credit risk. Fixed rate high yield bonds have sold off very materially this year, and floating rate leverage loans have really been the beneficiary. So, if you look at funds flows there's been about $25 billion of capital that's flowed out of high yield bonds[1] and about a similar amount has flowed into leverage loans. So as a result loans have been really the best performing asset class across us tradeable credit. More recently we've seen some of that reverse, loans have given back some of this relative outperformance and it’s really been driven largely because there's been a shift, I guess in interest rate risk has been overshadowed to a certain degree by recession fears. So you know if you think about credit quality in the high yield market versus the loan market, really the high yield market is more of a double B market if you look at average ratings, whereas loans are a little bit lower rated but being a single B asset class. In the last month or so we've really seen a pretty strong flight to quality, and hence rated high yield bonds have really been a beneficiary, they've been pretty beaten up and you've seen kind of a move away from lower rated loans. Double B bonds also have a higher duration and so that high interest rate sensitivity was a big reason why they sold off. And then during the early part of this year, you know triple C bonds did remarkably well and that's not really the type of behavior you typically see in an economic slowdown, so what we're seeing right now it's actually much more reflective of what we might have expected would happen.

Steve Peacher: So, can you talk about your particular investment strategy? I know you're connected to the opportunities strategy at Crescent and so your strategy, your philosophy as you as you filter through the opportunities in the market that you see today?

Richard Stevenson: Yeah, there's a few things I kind of highlight: one is you know we really like large, liquid credit. We typically see that sell off strongly and early within a dislocation. And when I’m talking about large liquid credit, I’m talking about tranches that are a billion dollars in size and larger. You know, I think that sort of adage that during periods of distress investors sell what they can not what they want to definitely holds true. And you know we like the segment because they're really resilient companies with decent diversity to their businesses and when financing markets do reopen, they're usually the first ones in line to get back in. The second thing I’d point to is we very much like the stressed market as opposed to the distressed market. And the reason we like that is that these opportunities tend to have a pretty quick recovery and there's a lot, they’re a lot simpler to exit from. So you know, we can offer shorter commitment periods for investors and a lot of them really like that flexibility of having a shorter window. I know I think one of our sort of central tendency is we are always looking to leverage our overall credit platform, so you know we manage long only pulls in capital for investors through good times and bad, and as a result we have a pretty deep knowledge around you know, a wide swath of companies and those are really where most of these opportunities come from and it allows us to move really quickly in and out of the opportunity set. Typically what we do is we’ll stress test these companies if we're going into a recession. We know them well, but we also want to make sure that you know they can hold up through it, and so it's definitely very much a bottoms up, analytical type of approach. I think the last thing I’d probably point to is that we've found some pretty interesting opportunities also in adjacent areas, one obvious one is fallen angels. Typically you see spreads widen out there in anticipation of downgrades out of investment grade into high yield, and then those spreads tend to tighten as high yield managers add those names to their portfolios. So, generally speaking we’ve seen very low default risk with those, and they've been an excellent opportunity for investors to get nice risk adjusted returns. The other areas in CLO debt, within that market, we have pretty deep knowledge of the underlying loan assets themselves, so we can kind of leverage off our experience there. And then we also track all the various CLO managers and understand their debt structures, so that's a big component of being able to adequately analyze and diligence those types of opportunities.

Steve Peacher: You mentioned stressed securities, but let's talk a little bit about the distress debt market, it’s an area where I know you've got experience, so what are some of the themes that you've seen over time in the distressed that into the market?

Richard Stevenson: You know I would say credit dislocations in general we've seen them become shorter and shorter over time. We think that by and large the spoils kind of go to those who are prepared and ready to act when the dislocation happens. You know we've seen that the Fed has gotten extremely creative in the way this they were able to stimulate. Maybe at one point we thought they would be limited in some way, but that really hasn't turned out to be the case, you know, whenever the economy is kind of melting down. Another theme I’d point to is credit documentation, it's definitely become weaker over time. We're talking over years and years here, and so what that's led to is kind of a trend of what people call creditor on creditor violence. And so that's really just kind of a pejorative way, maybe of saying that some distressed investors are looking to generate the returns by sort of picking the pockets of other creditors as opposed to necessarily relying completely on the improvement or turn around at the company itself. I think another factor that we've been much more sensitive to over time is who else is in the capital structure? As performance let's say for a given company deteriorates, you know you tend to see the investor base turnover and, if you take the loan market for example, about 75% of all loans are purchased by CLOs[2]. But CLOs is generally don't have a lot of capacity to hold triple C rated securities because they have limited baskets for that. So, as a result you tend to see CLOs start to sell and then distressed managers buy into those credits. And what happens is that you know you end up with an investor base that has very, they’re in a very different cost bases, they have very different objectives. The CLO managers really you know, want to have performing security and they really just want to get paid back. The distress manager may be looking to own the company, so that really creates quite a bit of complication and that combined with the credit documentation issues, I think that that creates an opportunity for distressed players to take advantage of the documentation.

Steve Peacher: As well as somebody who was very involved in the high yield markets in the 90s, and into the 2000s, you know these are the kind of markets that are the most fun, because you've got things dislocated so, it's no fun to see thing trade down but it's where the opportunities are, so I’m sure you're finding it to be interesting. Let me ask you a personal question, I know before you got into the credit markets you were an engineer and worked at DuPont. So, what were you focused on there, what did you do at DuPont before you made the shift into finance?

Richard Stevenson: Yeah, I had a few different roles there, but I thought one of the more exciting ones was working in product and process development. So I don't know if you remember STAINMASTER, the stain resistant carpet. So DuPont had been a player in the nylon market for a very long time, and so I was part of a team that went back, and we basically mined the patent library that DuPont had, for going back 30 years looking for interesting technologies that they'd never really exploited. And we put a package of those together and kind of rolled it out onto a production line and then tested new products, and it was it was fun to see something go from a, just a concept to a commercialized reality.

Steve Peacher: Well it's amazing to think about some of those manufacturing companies like DuPont that have so many patents over the years, you go back and can actually mine their patents. Well, Rich thanks for taking the time and thanks to everybody for listening to this episode of “Three in Five.”


[1] Reuters, 2022

[2] Bloomberg, 2022.


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