Outlook for Corporate Credit and Special Situations Investing

Elana Margulies-Snyderman:

Hi, Loren, thank you so much for being with me today.

Loren Remetta:

Oh, thank you for having me, and it's a pleasure to be here.

Elana Margulies-Snyderman:

Absolutely. So, to kick off the conversation, Loren, tell us a little about the firm and how you got to where you are today.

Loren Remetta:

I've been involved in credit derivative markets going back 20 years, and our team is really pioneering investors in the asset class beginning in the early 2000s. And specifically in the credit index market and the index tranche market is really where our specialization resides, and that's the area that we're focused on with developing Bow Bridge and we think that credit markets have really adapted and changed beginning of the Spring of 2022. And the cycle has begun and it's going to be a much more prolonged and interesting cycle with bouts of volatility as there are certain factors that come into play that we've seen that are different from past cycles with the advent of private credit but also a large amount of debt issuance that took place in 2020 and 2021.

And myself specifically, I started trading and investing in credit products in the early 2000s as a proprietary trader at various investment banks. And after that I moved to Bank of America and helped build their credit derivative business in London and in New York in the early 2000s. And then after the global financial crisis, I moved to the hedge fund side of the world in London at PVE Capital and we were a structured credit specialist team there and was there for close to a decade and then returned back to the United States after 14 years of living in London and now with the cycle changing, we started looking at building Bow Bridge in early 2023 and the opportunity set is looking good as a new cycle has begun for the next five to seven years.

Elana Margulies-Snyderman:

Loren, that segues nicely into the first question I have for you about the state of the high yield debt and index tranche markets.

Loren Remetta:

Yes, that's really an important factor for why we've designed and built the business. And one of the key contributors to a different cycle, we think a much longer credit cycle, is that the amount of debt the high yield market had issued during 2020 and 2021. And there was about $850 billion of total issuance during that time period of very low rates and very low spreads. And as a consequence of that, the cycle is going to take longer to develop or occur. And within that though, there's a lot of dispersion within default rates in high yield and leverage loans. So, if you look at it on a more micro and by rating and by type of company, you'll see a divergence across credit issuers. So, if you look at the default rate in the leveraged loan market, that's tracking around 6.5%, which is what you might expect more broadly in this point into the cycle. But if you look at the high yield bond market, right now it's around 3.5%. And then if you look at the CDS market, which is where we specialize; in the CDX High Yield 100 Index, which is the 100 most actively traded high yield credit default swaps, the default rate is currently 1%. So, one name defaulted in the last 12 months, and that was Rite Aid. So, what you've seen is larger cap companies within the high yield universe had a lot of access to liquidity back then; so, their maturity profile is further away. But then you have smaller companies that are typically more floating rate issuers that have less access to capital markets and have higher expense ratios in terms of interest right now. So, you have dispersion across companies, but also from leveraged loan to high yield to the how it impacts the CDS market.

Elana Margulies-Snyderman:

Great. Loren, as a follow-up, private credit has become increasingly popular, and I wanted to ask you, how has it impacted public credit in the CDS markets?

Loren Remetta:

Yeah, that's another important factor for the current cycle is the advent of the private credit and the growth of going to be close to $2 trillion in total debt outstanding as we get through this year. And that market, it's still developing and the impact of it is being learned as we progress throughout the cycle, but it is extremely meaningful. And it's meaningful for unsecured bond holders, but it's also maybe even more important from the creditor's point of view because it really is another option. If you think about when a name became distressed or wanted to look at restructuring options in the past, they could either go to their banker, or they would go to their existing debt syndicate and talk to them about what their options were. And now they have a third arrow in the quiver with the private credit market.

And you've seen that occur so far first in a year ago here in a large cap with Carvana, which is a really interesting exercise where you had Apollo as one of the largest debt holders in the company, and they went and did a coercive exchange, which was not a hard default. So, they exchanged bonds, they had about $5 billion of debt outstanding, haircut that by about $1b billion, issued new equity where the Garcia family, who is one of the primary owners, bought some of the new equity, which they've done spectacularly well on and it's a situation where it's worked out very nicely for basically everyone involved.

And then if you look at how that impacted the credit default swap market, and this is what's interesting is at its worst point, the CDS market was trading at 70 points upfront essentially with assuming around a 30% recovery in the credit. And now that's rallied all the way back to par. So, that's a spectacular return for everyone involved. But if that syndicate did not include Apollo and PIMCO and was more broadly syndicated, as you would have historically, I think it would've been far more likely that it would've ended up in a restructuring in a court situation.

Elana Margulies-Snyderman:

Loren, how does your approach to credit differ from other traditional managers?

Loren Remetta:

So, at Bow Bridge, we take a very top-down approach to credit markets and our specialization resides in credit derivatives and credit default swaps. And we feel that our market where we operate in the indices in index tranches, which comprises about two thirds of our exposure. And within there, we feel that there is still a blue ocean, shall we say, within a very commoditized credit landscape. And the tranche market is very akin to the CLO market and we're mezzanine focused. So below us there's the equity tranche, and then above us there are senior tranches. And in the CLO market, we're similar to a double BCLO tranche would be, but there's a key difference between what we do and what the CLO market is. And there's two key differences. One is that it's an unfunded market, so it's margin based. So, there's constant collateral exchanges on a weekly or monthly basis between the two counterparties and then more importantly is that our index tranche market is unrated. So, that takes away about two thirds or so roughly of the fixed income global participants who could come into the space due to it being an unrated security. So, we feel that there are certain inefficiencies that are produced by that. So, there are less natural economic buffers that'll come in during periods of higher volatility. And during those periods where there's a divergence between corporate fundamentals and market pricing is where we like to come in and take part long and short where today spreads are very, very tight.

The high yield market is around 300 basis points over and to give a comp, we were at around 650 basis points over in the fall of last year. So, that creates a lot of volatility within mezzanine credit because of the leverage within that part of the capital structure is about three times the market. So, if the high yield bond market moves 20 basis points, the index tranche market mezzanine CDX 100 moves about 60. And we've had quite a bit of volatility, as we said earlier, with just a 1% default rate. So, we think that's fairly inefficient, and we have the skillset to tackle that from macro credit trading, a structuring point of view and a fundamental credit analysis.

Elana Margulies-Snyderman:

Loren, we've covered a lot of ground today and wanted to see if you have any final thoughts you'd like to share with us.

Loren Remetta:

Yeah, we really are business builders first and hedge fund managers second, and we think there's meaningful tailwinds within the asset class, particularly in structured credit and credit derivative products. And that's what we've built upon and have a 20 plus year history in that space and the liquid special situations credit strategy is designed to capture associated opportunities and we're looking at 15% type net returns and we're going to be in a fund format and managed accounts beginning in the coming months.

Elana Margulies-Snyderman:

Loren, I want to thank you so much for sharing your perspective with our listeners.

Loren Remetta:

Well, thank you for having me, and thank you for the time.

Elana Margulies-Snyderman:

And thank you for listening to the EisnerAmper podcast series. Visit EisnerAmper.com for more information on this and a host of other topics. And join us for our next EisnerAmper podcast when we get down to business.  

Transcribed by Rev.com