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| Roger Crandall |
Roger Crandall runs Babson Capital Management's corporate securities group, which includes a wide range of structured funds and traditional fixed-income strategies. He has spent his entire 17-year career at Babson and its parent company Massachusetts Mutual Life Insurance Co., starting out in the commercial real estate area of the MassMutual investment division. Crandall led Babson Capital's growth into the leveraged loan area in the early 90's and has been a high yield and leveraged loan portfolio manager. Crandall discusses Babson Capital's acquisitions, whether the market is rational and why leveraged loans are still attractive. How is Babson set up and what distinguishes the firm from its major competitors?
We are very much fundamental credit guys. One of the major reasons we acquired Duke Street in Europe was that the people really see the world very much the same way we see the world. They are bottom up-analyze companies first and look at broad macro trends second. We cover a lot of credits and we build very diversified portfolios, but in markets where we can, such as U.S. leveraged loans, we are also willing and able to trade. If we see something deteriorating we will get out of it, but then if it gets cheap enough we'll get back into it. So we're an interesting mix of very fundamental credit with a big enough staff to be able to follow a lot of credits that build a diversified portfolio, but then we're also as tied into the market from a trading perspective as anybody is in these asset classes.
We have over 60 credit analysts across the firm and different teams concentrating on different asset classes. Our U.S. bank loan team has the biggest group of assets run in CLOs, but they also run in separate accounts and those fall into two separate areas. Relative return management-e.g. really charged with beating the leveraged loan index benchmark. The other piece is custom mandates, which is a specialty of ours, where a client has some specific objectives other than just beating an index. Babson also runs structured credit and absolute return vehicles-which in its most aggressive form would be a hedge fund that can go both long and short and use leverage.
How does Babson manage the public/private split?
We are organized so that the bank loan and private placement group has access to private information. Our public side works together and talks to our equity analysts when it makes sense. But those two sides cannot cross. We need dedicated teams because if a client hires us for leveraged loans, they want you to get access to all the information the market has to offer. It's very difficult to not get access to information that other market participants have. We do have some management on the public side, where the high yield managers buy bank loans on a relative value basis but this is small and they do it with public information. That's one of the huge things that has happened in the bank loan market in the last five years, it's become a much deeper more liquid market. It's still tough to trade as there are a lot of operational issues, which is one of the reasons I like it as an asset class and as a manager as there ultimately are going to be barriers to entry. There will never be a thousand people buying loans.
Why did Babson move into European leveraged loans?
We are really interested in European loans for a couple of reasons. First the whole credit market in Europe is relatively young. It's the third inning of a nine inning game. There has been lots of buyout activity and it has moved from being a sterling-based U.K. market to being a very pan-European market and euro based and we saw that trend continuing. But we also thought it was great value. The deals are well structured, the pricing is attractive, and it's still a market that's predominantly a principals market-75% of leveraged loans actually sit on bank balance sheets.
Is the firm still considering acquisitions and in what areas?
One of the beauties of having a parent like MassMutual is that they see every deal out there and then we see virtually everything that's going on in the loan and CDO space. I don't have a strategy of I'm going to make an acquisition in this or that area, but if tomorrow I saw something that if the people were good, they fit our culture well and the price is right, absolutely I will make another acquisition. But I could easily not make another acquisition for another five years and our business could grow very nicely organically.
We acquired IDM from Wachovia in 2002. At the time we managed $2.7 billion in leveraged loans and they managed $3.5 billion. We had known their firm because we'd invested in several of their funds and we knew Tom Finke, who ran the firm, and several of their senior analysts. We looked at it and said, the leveraged loan business is getting increasingly difficult to get up in the top five status because there is such a problem of finding assets given the amount of runoffs that occurs regularly and we had a lot of new entrants coming into the market because it was attractively priced. There is also an operational component that actually gives some benefits to scale and that acquisition made a ton of sense.
Where is the main organic growth coming?
Since 1991 when we got into the business managing high-yield bonds, basically every asset class has been securitized. It comes down to whether the arbitrage makes sense and whether investors think that there is enough fundamental value in the underlying asset that they want to own it in a cash-flow CDO format. So, for example, investment-grade cash CDOs just do not work. There is not enough arbitrage, and there are too many premium bonds in the market. So people have moved to synthetics deals, which will continue to grow, because it takes some of the problems of premiums out of the market. I think we will continue to see ABS/MBS/CDO of CDOs grow--which is another area we run. Europe has great potential and the question really is how quickly the market develops. Loans will continue to be very active as the arbitrage works. Although asset spreads have fallen, liability spreads have fallen too, keeping the arb alive.
Looking across all this, there is no reason we cannot comfortably grow assets in the mid teens to low 20s for several years. That's a nice rate of growth. It's enough to keep you busy and give you money to invest in people and systems, but not so much that you get overwhelmed with a tidal wave. We're very aware that one way asset managers blow up is they grow too quickly.
What have been the big improvements in the loan market over the last few years from the perspective of an institutional investor?
The market has become more efficient, but there are pluses and minuses to an asset class becoming more efficient. A plus is you start to see more liquidity, bid-ask spreads start to come down, more dealers are involved and it allows you to express trading views on credit quality more easily. Right now, if you have any concerns about a loan, it's very easy to sell, whereas when we first got into the business 10 or 12 years ago, you really had to go back to the arranging bank and there might have been a small syndicate and it would be kind of tough to get out.
The market has come a long way as we have gotten minimum assignment size and trading down easier and that has made it much better. Settlement is down about as easy as it can be. Our trading volume is up 500-600% from a few years ago. We are much more active traders and we are cutting loans into much smaller pieces.
The downside is that it's gotten more efficient, so the excess return across the market--the beta return--has come down, and you see that through repricings and through the market being very aggressive at working through things, so you have to add more value through active management.
Have banks been irresponsible in aggressive repricings this year?
Banks aren't irresponsible, but the market can at times get irrational. It can get irrational on the downside, it can get irrational on the upside and this market is no different than any other. If you have lots of people trying to buy in at one time, a lot of buyers, not a lot of sellers, spreads are going to come down. I'm much, much more concerned about deal structuring and credit quality than I am about pricing. All over the world, spreads and risk premium are way down. Volatility in equity markets is remarkably low given some of the fundamental geopolitical issues that are going on. Whether its B, BB, BBB single-A, CMBS spreads, they are all certainly closer to their tights than to their wides.
I am much more concerned from our portfolios perspective about credit because it's important to remember whether a deal prices at LIBOR plus 200 or LIBOR plus 400, it doesn't really matter if the deal gets in trouble and you take a 30 cent or 50 cent loss. Leveraged loans are an asset class that is all about not losing money. No one gets rich buying loans at par at any spread. Right now, the average loan is trading in the secondary market at 100 1/2 to 101, so you have to really be right on credit. A lot of times you are buying at 100 1/2 assuming it does not get refinanced for six-nine months and hoping you are not going to earn less than your coupon.
I am much more concerned about structure and the market doing a reasonably good job of that. Three years ago you could not do a cash-out dividend deal and now the market is awash in them. The thought of doing a triple-C zero-coupon holding company bond in 2002 is unbelievable. But this is very similar to 1991 and right after the LTCM crisis and Russian crisis of 1998. Stepping back and taking this longer view, credit cycles come and go. They create a lot more price volatility today than they did in the past, because markets hold more assets as opposed to principals. In the early 90's, banks held most leveraged loans. If a company got into trouble they all sat down and figured out how to work it out. Today some of them are selling. Some will sell at 90 some will sell at 70. There is a whole wave of investors that are in the market to look for those opportunities. It's the way markets work and you set yourself up to take advantage of them. Is the market riskier today than it was in hindsight two years ago-of course it is, but leveraged loans are still a pretty attractive asset class, especially compared to all the alternatives. Every other market is tighter today than it was two years ago.