AGL Credit Management priced in May a $600m CLO. The transaction, with a two-year reinvestment period, was the largest of the coronavirus era — quite something from a firm founded only in 2019.
But the firm already has pedigree in being led by Peter Gleysteen, who previously founded CIFC Asset Management, one of the largest US CLO managers, where he was CEO from 2005 to 2014.
GlobalCapital: What do you think the CLO market has learned during this period?
Peter Gleysteen: The first thing that the marketplace relearned is that every crisis and recession is caused by something unexpected. No matter how much modelling, risk management, and stress testing you do, when the crisis occurs, it is always different from the one before. And this recession is radically different as it is a health driven crisis that has changed human behavior. Who could have predicted that no one could travel, go to a store or to a movie?
No one expected that many businesses would have such correlated negative financial performance and that entire industries would shut down. This was unexpected, but everyone understands that now. It is a new lesson learned.
GlobalCapital: How do you predict CLOs will cope with the expected wave of defaults in leveraged loans?
Peter Gleysteen: The CLO structure is very robust and it will be fine. We expect some CLOs will perform better than others, but as a group they will be OK. The key is the degree of diversification that CLO structures require, which together with the copious cash flow that broadly syndicated loan portfolios generate, provide the double benefit of limited exposure to loss plus excess cash returns to amply offset the cost of any losses that occur.
GlobalCapital: What would you consider to be the most difficult period in the last three months since the outbreak?
Peter Gleysteen: In mid-March we knew we had a crisis and it seemed possible, even likely, that something like the bubonic plague was happening. There was this fright, this incredible escalation and prospect of unknowable damage in human and economic terms. By April, it was clear that it wasn’t as bad as we perceived. In May, people concluded that it was even less bad. Right now, while there is a level of concern, it is still a fraction of the worries everyone had in March. We hopefully have seen the worst.
From a financial perspective in mid-March it seemed there was no floor to financial asset value destruction, and as we know the markets panicked. Much has retraced since but projecting valuations remains more difficult than ever before. There are more variables to try to model and no stable baselines. At the core it is the uncertainty on the pace of a behavioral shift from fear to caution to sustained confidence. How quickly or slowly this happens, and whether with lots of ups and downs, is the big uncertainty.
GlobalCapital: AGL priced and closed a $600m CLO with two-year reinvestment period, the largest CLO since the crisis began. What have been the primary challenges in pricing new deals in this period and in pricing the largest?
Peter Gleysteen: For the first CLO we did post-Covid, our expectation was that the cost of CLO debt would be more expensive, but that all-in loan spreads, that is contractual spreads plus purchase price discounts, would widen more and so it was possible to do a CLO in April. We wanted to explore whether or not the portfolio math would still work with pricing liabilities. We had to make a go- or no-go decision, and we decided to be brave and step out into the market and see whether the market would accept this. What we found was that it did and we were well-received.
Having been successful and with a very strong reception, we decided to do a second post-Covid CLO. The second time the reception was even stronger and we were planning to do a $500m CLO which we upsized to $600m. Having done two, and not one CLO, is very good news that the market is open and improving. AGL broke the ice.
GlobalCapital: The CLO market has been characterized mostly by shorter duration reinvestment or static deals since March. What does the market look like through this summer?
Peter Gleysteen: Our CLOs were not static and we expect the duration will keep lengthening. Whenever a market goes into a huge disruption, but then stabilizes, participants take small steps. It was the same for AGL, where we did the first deal which was good and the second one was better.
I think the reinvestment period will lengthen and the terms will keep improving. The two CLOs we did had both old loans and new ones — that is they had ones we had invested in pre-Covid-19 as well as after Covid-19. The future ones will be all post-Covid investments. So these recent CLOs can be seen as transitional ones whereas the next ones will be a new generation.
GlobalCapital: AGL is backed by the Abu Dhabi Investment Authority. Can you talk about the appetite for CLOs among middle eastern investors?
Peter Gleysteen: This is a very broad category, but I would say that there is an appetite worldwide, including in the GCC [Gulf Cooperation Council] countries for investments that are based on BSL [broadly syndicated loans] in very different fund formats, including CLOs. Which BSL product type depends on what the return target is on the investment.
GlobalCapital: Do you believe that this period can attract more investors and what types would you expect to see?
Peter Gleysteen: Yes, I do. Let me step back and point out that we are in a recession and there is higher risk everywhere. However, many strong borrowers have the ability to have good credit performance in the recession. The point is that while the risk is higher the returns are even higher. BSL portfolios can be excellent investments to begin with, and now better returns are available for the same amount of risk. And if you didn’t know BSLs beforehand this is a really good time to get to know them as an asset class.
So it is a great time to be a first time BSL investor. But it must be emphasized that BSL products best fit the long-term investor. The defining asset class characteristics of BSLs are safety and stable cash flow streams that occur over time, including across cycles. This is not captured at a moment in time, and so the right valuation lens is multiyear cash returns, not day to day price marks. So this is a good fit for pension funds, endowments, sovereign wealth funds and insurance companies, all of which have clear-cut long-term obligations or goals to achieve. What could be better than investments whose performance is cash based versus fluctuating price expectations?
So we see long term investors seeking safe and stable returns will increasingly allocate to BSL based absolute return products.
GlobalCapital: Where in the capital stack is offering the best opportunities for investors right now?
Peter Gleysteen: Each one is very attractive. A CLO equity investor is completely different in identity, purpose, and goal from a triple-A investor. For the big banks that prefer the triple-As, they are incredibly effective, as it is for insurance companies that like triple-Bs. These are attractive at every layer which each suiting a different asset allocation objective.
GlobalCapital: Do you perceive that primary market access has been restricted to only a select few managers?
Peter Gleysteen: Right now I would say that some managers have more access based on past performance, and who have the confidence of investors to make sound decisions especially in these unprecedented, uncertain times. Historically, because the CLO structure is so strong, and with improved economic and market stability, there will be a wide variety of managers that can access the market.
GlobalCapital: But you still need to have the ability to get investors as a manager.
Peter Gleysteen: In a reshaped and tough market, the managers that are highly experienced and have a top track record are the ones who can attract investors and come first, but over time, as before, there will be low barriers to entry. Right now the bar is set higher because investors gravitate to stronger, better known, better track record managers. But over time, more managers including new entrants can bring CLOs to market given the strength of the structure. But experience and performance do matter and there will be as always, a variety of realized investment outcomes ranging from mostly OK to best in class.
GlobalCapital: Would you expect to see a period of consolidation in the aftermath of the crisis?
Peter Gleysteen: I don’t think it has anything to do with the crisis. The long-term trend is for fewer and larger managers because institutional investors seek more differentiation and less duplication of strategies and styles across all asset classes. So the trend is to allocate capital to fewer managers. Also a long-term trend in the investment world is not to spread out too thinly. A lot of pension funds, for example, concluded that they just have too many managers.
GlobalCapital: What sector have you been closely watching in the leveraged loan space? Have any surprised you during the crisis?
Peter Gleysteen: We have always worked to identify and prioritize sectors and businesses whose credit performance has low correlation to GDP. We don’t want to have all the credit risks happen at the same time but spread out over time. The less dependent a business is on GDP, the more diversified the portfolio. Most people think about this in industry terms, but it is actually the underlying business model that matters most. There are many businesses with recurring revenues that are not affected in their core business whether a recession is happening or not.
A surprising and historical example is the health care sector that has been always viewed as having low recession correlation. If there is a recession, you still go to the dentist. During Covid-19 all elective procedures have been deferred, so suddenly we found that many sectors of health care have contracted sharply. This surprised everybody and is an example of an industry that historically had low recession sensitivity but today has high recession correlation. All businesses where human proximity is integral to the model have been similarly affected. Travel, physical retail and hospitality top the list as we all know.
How has your experience been of working remotely? Do you expect this event to shape work habits in the market and what challenges have you encountered in working away from the office?
I have been really surprised how well it has gone, how effective, and how much communication and collegial activity happens using Zoom and similar tools.
We all miss the human contact and I think that it is especially hard for younger colleagues. The challenge of virtual working is that sometimes it is hard to know when the day or the week should end. The virtual workspace has less structure.
I do think that in the future it will change how we work with hopefully a better work life balance. For many businesses it will likely be a hybrid of part office and part not. Until there is a vaccine the big unknown for many businesses would be less about the office itself but getting to the office, especially in cities like New York. My guess is the return to the office will be slow.