Howard Tiffenis a managing director withVan Kampen Investmentsand senior portfolio manager for Van Kampen's senior loan funds. Tiffen discusses Van Kampen's approach, floating-rate notes, second-lien structures and current challenges in the market.
How is Van Kampen's loan group set up and what distinguishes its approach from other participants in the market?
Van Kampen's loan group is set up to be able to service the needs of retail investors, primarily, but also institutional investors, currently through structured vehicles. What distinguishes us from many other groups in the marketplace is the number and experience level of the analysts that we bring to bear on the business. Our goal is to deliver to our shareholders a relatively stable portfolio performance. Given the relatively low volatility that the asset class experiences, the only way you can really do that and avoid bombshells from defaults is to be very heavily diversified. Diversification is key, but you can only do that effectively if you have the experienced heads around you to be able to help make credit decisions.
Is Van Kampen in the process of ramping up new CLOs, retail funds or other vehicles?
We're always raising money in the retail market and the institutional market is more opportunistic. We don't have anything in the works right now, but we are continuously looking at possibilities. The arithmetic in the CLO market, given where spreads are working their way to at the moment, makes it really tough to be able to demonstrate to potential investors that they are going to have a healthy return on their investments.
Do you purely invest in leveraged "B" loans, or do you buy revolvers?
We'll buy anything that is senior secured, floating rate and governed by a security agreement that incorporates protective covenants. So all kinds of loans whether they are revolver or term "A" or what have you.
What about floating-rate notes?
It depends how much they look like loans. What a lender gets that a bond investor doesn't get is privity of contract with the borrower in a way that really supports the quality and the value of the underlying investment. Most securities don't grant the same rights and obligations to the parties as loans do. That's a real weakness when you get into a circumstance where you need agreement from the parties to a particular course of action if plans haven't quite worked out as expected. There are many circumstances that unfold during the life of a loan where you need to have a dialogue with your lender and that often is impossible if that lender is an anonymous note holder. If you're in a pure floating-rate note, your only course of action may be to resort to the secondary markets to sell and I prefer the belt and suspenders that a loan agreement typically gives us. We look at everything that is alleged to be in the loan market space, but we're probably going to be less enthusiastic about notes than we are typically about loans.
What sectors do you favor and what are those areas right now?
We typically look at everything regardless of the sector that it's derived from. There are some sectors that you'd traditionally think of as being poor performers in the senior loan arena--anything that is driven by fashion, emerging technology, most kinds of retail. It's very difficult to leverage businesses in those sectors, but every now and again there is the exception that proves the rule. You mine an awful lot of ore to get it done. We'll shuffle through all kinds of things in the auto sector to come across the one or two deals that really make sense. We favor defensive businesses typically. We think they just generally produce better senior loan opportunities. It doesn't mean to say we don't look at the whole marketplace for opportunities from time to time.
What kind of credits do you like banks to bring to you?
We like to have as much granularity in our portfolio as we can reasonably accomplish without getting silly with very, very small allocations. We like banks to bring us transactions where there is an outstanding management team with experience in running a leveraged business, where the senior and total leverage is within the guide post that the market has set over the last three or four years--so leverage isn't too high, the balance sheet looks sensible--and where there is a second way out that is real. It doesn't help us a great deal to have a company that is generating good cash flow but which may be in an industry which is cyclical and our security interest is in something we couldn't sell if we wanted to. So the second way out, the collateral position, has got to be real. At the end of the day, the only thing that distinguishes senior loans from bonds is our security interest and our ability to be able to rely on that in the event of a default.
What do you want/need from the market?
We need spreads to stop going down. We need to avoid allowing structures to get so weak so that if things begin to go sideways we can't get to the table and negotiate either higher pricing or a better collateral package. I don't really mind that spreads fall. I do mind that structures don't give the ability to be able to raise spreads if credit conditions worsen for a given company.
What is your outlook on spreads and why?
I just don't know that they can go much lower, but I've been saying that for a year. It's amazing how some kinds of investors are taking traditional senior loans alongside non-traditional first-portion investments in our market--bonds, second-lien positions, things of that kind--to generate the return that they're looking for. So maybe that is disguising the need for spreads on traditional senior loans having to go up.
But we've seen a small backup in long-term rates in the last week--there are hints that China will have to revalue. There are what look like inflationary pressures popping up around the market. We're seeing pricing power reestablish itself in commodity businesses--all of these things suggest that bonds will become a less attractive place to be for the next six months than they have been for the last 12 months. This means there will be less competition for people like us to have to contend with from the bond market because you won't be able to sell bonds as easily as you can right now. Therefore spreads are likely to have reached a bottom. Even if interest rates don't immediately go up, spreads may well be at or close to the bottom of the cycle.
What is your view on second-lien loans?
Investing in second-lien loans isn't a bad thing to do at all because so many of them actually end up having much stronger positions than some might wish. As a first-lien lender our biggest worry about second-lien loans is when we're not in them, and as a first-lien lender you don't have the ability to keep those other investors away from the negotiating table. There are different ways these things can be structured and there are different circumstances in which a second-lien loan could be perfectly acceptable--where you've got good asset coverage, total leverage isn't too high--you really don't mind that it's structured that way.
But there will be other circumstances where collateral coverage is thin, leverage is high--you really want the second lien to be subordinated debt in drag. In those circumstances, you want more distance between the first and the second lien. Where we get really nervous is where that distance isn't really there and the second lien, rather than being subordinated debt in drag, is actually a first-lien loan in drag. That becomes a real problem because then you've got someone at the table with a relatively weak collateral position with no standstill agreement, no payment stays available to the first-lien lenders and it puts the first lien in a really difficult position.
Are there too many firms now investing in the loan market?
I don't know all the people who run these funds but typically when we've seen an explosion in a particular kind of business like this, it has come to an unhappy end for some of its participants. There are only so many ways that you can run long and short positions in multiple asset classes.
One of two things will happen--either the arbitrage opportunity that the hedge funds allege exists will disappear or somebody will try to take too much risk without being hedged and will find that actually this is a very dangerous place to be, leveraged corporate America, and they will have their capital removed from their grasp much faster than they actually acquired it in the first place.
What are the major challenges you face in the current environment?
Miserable allocations from some lead lenders and arrangers. There are a number of arrangers who value the contribution that firms like ours have made over the last 15 years and know we're not going to go away, and we are building stronger relationships with firms like that at the expense of companies that seem to favor dancing with the newest pretty girl.