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Global credit funds & CLO's

April 2024 | Issue 263

Published in London & New York.

April 2024 | Issue 263

Opinion CLOs

The Last Tranche with Christine Ferris

Tom Davidson

Managing editor

Christine Ferris

Global head of CLO primary JP Morgan

In the latest edition of The Last Tranche podcast we talked to JP Morgan’s global head of CLO primary Christine Ferris about why she loves working with debut managers, despite the extra challenges they face coming to market.

Tom Davidson:

Thanks again for joining me, Christine. It’s great to have another female guest on the podcast, especially one running a major global team. I’d love to hear about your history and how you came to be here?

Christine Ferris: It’s funny. I’m an accidental banker in a lot of ways. I started as a psychology major at undergrad at Yale University. And I loved the major. But I realised I don’t like the work of being a psychologist. So in my junior year I went back and all the big investment banks were recruiting. I came to JP Morgan and have been here ever since. I started in structured credit sales right after the financial crisis. We were doing a lot of derivatives, working with banks to restructure. And that led to when the cash product and CLOs started coming back, with me being a structured credit salesperson selling CLOs. I remember the head of the primary business and the head of secondary trading were like, “Hey, you’re good at selling CLOs. We should get you more accounts.” I was given the opportunity to join the CLO primary team, and I was tasked with helping to rebuild CLO syndicate and distribution. JP Morgan had a huge team pre-crisis, maybe a hundred people, and that was whittled down to two. Then my manager left, and I was lucky at a fairly young age to be given the opportunity to run the CLO primary business globally.

I said that triple-As would be at 140. And there was actual snickering

TD:

It’s a great story. Before we get into new managers, can we talk about the primary market?ow has the risk sharing market evolved?

CF:

Absolutely. If I had to summarise it, I’d say the market is open and investors have cash. I would say we’ve started the year really strongly. We’ve had close to USD 80bn of issuance in the US year-to-date. It’s up 150%. We’ve had just over USD 13bn of new issue and refi/resets in Europe. That’s up about 100%.

I think that, not only are we running ahead of last year’s pace from a new issue perspective, but there’s also been a huge uptick in refi/resets, and that’s all as a result of compressing spreads.

I was at the ABS Miami conference in October of last year, up on a panel, and I was asked to give my forecast and projections for the year ahead. I said that based on technicals in the market, I thought that triple-As would be at 140. And there was actual snickering in the audience. But in my mind, having been in this market long enough, we know that when loans have been approaching par, CLO triple As have been in and around that 140 area. And the technicals were just so strong, both from a loan and a CLO tranche perspective.

We knew there wasn’t as much loan issuance. We knew there was an uptick in CLO issuance, especially in Q4 of last year. We also knew that 40% of CLOs in the overall market would be out of reinvestment by the end of last year. And so those are a lot of really powerful supply and demand technicals coalescing around triple-A spreads having to go tighter, barring any huge macro disruption, which of course is a possibility.

And that’s exactly what we saw to start the year. In December, we were at 170bps. We came back from that and we quickly priced a deal for Palmer Square at 165bps, setting new tights in the market. Then we did a CIFC deal at the end of the year at 160, and that really set the stage to open the year around 150-55. That’s where we are today. So, I think we’ve seen a quick and impressive — but not terribly surprising in my opinion — compression in triple-A spreads, and that’s also catalysed greater demand in equity.

Last year, so much of the equity that was distributed was retained by managers until Q4, when we did distribute a decent amount. This year, I would say that the majority of equity that we sell/raise is actually sold to true CUSIP investors and third parties. It’s a huge difference. I think the CLO arbitrage, just given the compression in spreads, looks attractive, and the demand on the equity side of things is pretty healthy as well.

TD:

I was there in Miami. I wasn’t snickering, but I was a little sceptical. We’re still in the low 150s in the US. Do you think there’s a little bit more tightening to go for the rest of the year?

CF:

I think it’s going to be push and pull. The arbitrage looks good. Refis and resets that seemed like they would never be in the money are very much in the money. And so while financing spreads are attractive, that’s going to be met with a lot of supply.

All year there’s going to be a bit of seasonality. Payment dates in CLOs happen typically the month after quarter end. So when we see a payment date, given the fact that 40% of the market is out of reinvestment, we’re going to see pay-downs. And ahead of that, we’re going to see investors, triple As especially, look to redeploy capital.

TD:

Let’s move on to bringing new managers to the CLO market.

CF:

It’s a passion of mine. You know, I grew up as a marketer. When I became co-head of the business in 2016, I really was the new kid on the block. All my peers were MDs, pre-crisis MDs in most cases. Even people that were running syndicate were MDs, let alone the person running the business.

I was realistic about the fact that this is a relationship business, and I didn’t have 10, 15, 20 years of relationships that some of my competitors had. And I love marketing and I love building and being part of people’s story as they try to create something and really grow their own careers. But just out of necessity, I was also realistic about the fact that we both have a clean slate.

I should add that it doesn’t hurt, obviously, that JP Morgan has 20 to 30% market share in leveraged finance. Clearly, if you’re a new manager, you need access to loans, and JP Morgan is a pretty good place to be aligned with. I think because of a combination of all those things, we ended up as a firm doing more new manager deals.

I still get involved in every new manager deal because when somebody’s trusting you with their first deal, they’re trusting you with their livelihood. It’s about holding somebody’s hand and walking with them and saying, “I’m committing to you that I’m going to help you build your business and not just in the context of this trade.” But the consequence of having had 50% market share in that domain for 10 years is that we’re good at it.

It’s much easier to have a business where all you do is the most liquid managers. The majority of my business is working on real marketing projects, so when we have a really liquid manager in a harder market environment, we are super well equipped.

You see that time and again when we’re executing print and sprints or when there’s a hairy situation. We get good feedback. So, I think that one of the benefits is just our ability and athleticism around marketing and distribution because we focus so much on the new manager space.

In somebody’s first deal, they are trusting you with their livelihood

TD:

Looking back over that 10-plus years, are there any managers who particularly stick out?

CF:

It’s hard to pick a favourite because I love and believe in the space so much. I think it’s the most exciting part of my job. But I recently came up on the 10-year anniversary of my first new manager mandate, which is Palmer Square, and they’ve obviously been a tremendous success. I’m lucky enough that thus far, they’ve entrusted me with every new product category they’ve launched.

So, we did their debut deals. We launched their static deals in the US. We launched their static deal in Europe. I couldn’t be prouder of the role that we played in that. And, clearly, the hard work is on them in terms of doing what they said they were going to do. But you see success stories like that, and it’s easy to see why it’s an interesting space.

TD:

It’s crazy to think it’s only 10 years ago that they got into the CLO management business.

CF:

And that’s CLO 2.0, right? In some ways it feels like just yesterday. If you think about our market, I think about 2017 and before. The market was so different, especially post-COVID. There are so many new investors, and the perception is totally different. Pre-COVID, I think people were always worried about what’s the next thing that’s going to break the CLO market, when will defaults tick up, etcetera. But in the great financial crisis, and also through COVID, CLOs proved really resilient.

So, the cumulative default rate of double Bs — and it doesn’t get talked about enough — is like one-and-change percent over a 30-year track record. That’s double Bs: generally the lowest-rated debt tranche in the entire capital stack. After the COVID crisis and after the performance was shown to be very robust once again, it’s brought in so many new investors. Our market has more than doubled in size in the past five years.

TD:

How easy is it for a new debut manager to price in the US?

CF:

I have to say, I never like it when people use the word ‘easy’ to describe CLO originations. Even in the best of times, there’s just so much involved.

There’s a manager who has their opinion about how they want to manage the portfolio. There are investors, both debt and equity, who have their opinions about what’s good for them. Even within a class of triple-A investors, different investors can have different opinions about how they want the deal to look. Coordinating all of that is never easy. But on a relative basis, I would say that if spreads are any indication, it is easier now than it has been.

In any given market, the basis between the tightest spread managers and new managers is a pretty good indication of how ‘easy’ it is. In a market like last year, the basis between the absolute tights and debut managers was anywhere from 30 to 40 basis points. Historically, that’s not abnormal. Today, I think that you could get a new or a second-time manager done just 15 to maybe 20 wide of where the absolute tights are. And so I think there’s been significant compression in spreads between the haves and have nots. From that standpoint, I think it’s a really good time to be a debut manager because you do have the ability to price your liabilities at levels that are more in line with the absolute types of the market.

TD:

What are some of the challenges which new managers face?

CF:

When we go into a new manager mandate I am always pushing managers to think about day two. It’s all well and good that you have USD 100m to 200m of capital, but that’s not going to last you long. That maybe covers you for USD 2bn of issuance. And USD 2bn of issuance isn’t a point where you’ve reached escape velocity as a platform, and you can self-sustain.

I think that there’s so many things you could do early on in your manager issuance process to set yourself up for success with regards to being able to raise follow-on equity capital and really be a self-sustaining business. I think the hardest thing continues to be, how do we source third-party equity or fund equity, and how do we continue beyond the first USD 2bn?

Our whole market is getting smarter by being more cognisant of PCLOs

TD:

Some of the biggest CLO triple-A buyers like long track records from managers. How do you deal with that?

CF:

Again, it’s important to educate our managers on deal one. I don’t just go and execute a trade and say, here are your three buyers. Good. Done.

I think, what is the best combination of investors for this transaction in this market environment? What’s the strategy here? And so much of it is about educating the manager about what the landscape is, who are the parties, who’s active, who can write big tickets, who’s important even though they’re writing USD 25m to USD 50m tickets. Meeting those investors as early as possible is super important for the growth of your platform.

TD:

Another thing I’m interested in is the comparison between the US and Europe.

CF:

I would say in the US, the normal run rate for debut managers was six to seven a year. In Europe, it was one to two, and then all of a sudden, you saw seven. That was eye popping. But it makes sense. In a market where there was less third-party equity to go around, there was actually a huge opportunity for new managers to come in and say, “I actually have access to equity capital.” Or maybe it was somebody that was considering buying third-party equity, but wanted to build it in-house and save on the external management fees. The math of manager-owned equity is different from third-party equity.

TD:

Are there any specific difficulties for private credit CLOs looking to launch in the US?

CF:

I love this question. I love private credit CLOs. I think it’s so exciting. To give a little bit of background, private credit CLOs historically have been about 10% of overall US issuance. Last year, it was just over 20%. And, this year, it’s on track to be around 20% as well.

Historically, CLO investors have thought about just a few categories of CLOs: private credit CLOs and broadly syndicated CLOs, in the US and Europe. And within broadly syndicated CLOs there’s tier one, tier two, tier three. That’s not a whole lot of nuance. In private credit, the range of outcomes and the range of underlying collateral is so great. In BSL, the variability that we’re talking about amongst this 150-manager pool is: “Are you a 2% triple-C manager, or are you a 3.5%?” In private credit, there are some deals that are 550 WAS and some that are 700 WAS.

The way people originate the transactions, the way they look at the collateral and manage it, is just totally different. It’s exciting because there’s a certain rigour that comes with, one, having to underwrite every manager that you invest in, but two, just getting smarter on credit and collateral.

There’s this perception that private credit CLOs are less transparent. In my opinion, that couldn’t be further from the truth. I think that there are certain metrics that don’t get publicly blasted. But if you sign an NDA, you can actually get more credit metrics in some cases than you get in broadly syndicated. There aren’t visible prices, tradeable prices, market prices, end-of-day prices. That much is true. But there’s other stuff, and I think that our whole market is getting smarter on credit by virtue of being more cognisant of PCLOs.

Search for “last tranche podcast” to find more episodes on Apple Podcasts, Spotify and creditflux.com

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