Timing it right: A Q&A with CBAM's Don Young
Launched in 2017, CBAM Partners’ CLO platform has made considerable progress – enough to put it among the very top managers in the sector.
High investor demand drove AAA-rated note coupons to their tightest spreads in years, at the same time that a record flow of leveraged-loan issuance (to reach $1.4 trillion that year) was filling the pipeline for collateralized loan obligation assets.
CBAM took full advantage and pushed out more than $5 billion in deals to climb league tables and become the leading issuer of U.S. CLOs during its rookie year.
“A lot of it was just good timing on both markets,” co-founder Don Young said in an interview with Asset Securitization Report.
Also helping its cause was the fact that CBAM arrived armed with ample capital and experience. Young was a managing director at Och-Ziff Capital Management, and formerly a senior portfolio manager at Octagon Credit Investors, when he teamed with fellow partner Mike Damaso (from Guggenheim Investments) and managing director Jay Garrett (of MartlinPatterson Asset Management) to form CBAM as an alternative investment management business of Eldridge Industries – the private investment firm led by former Guggenheim Partners president Todd Boehly.
The pace of CBAM deal issuance has subsided somewhat since 2017 (the firm’s CLO assets currently total $9.4 billion), but CBAM is still expanding its reach by announcing plans to build a credit-strategies business in Europe.
Young sat with ASR to retell CBAM’s brief history and provide his outlook for 2020.
ASR: What were some of the strategies CBAM had in mind to ramp up so quickly?
Don Young: When we got started, our timing was great. As much as I would like to claim our early success was due to some grand strategy or brilliance, our timing was exquisite. We started buying assets in 2016 and early ‘17 when the market was growing very rapidly. The loan market had its biggest new-issue year ever, and the new-issue CLO market was wide open, so a lot of it was just good timing on both markets.
I will say our growth has been slower, because of a combination of the market not producing, and there are less high-quality assets. Our growth has slowed, but part of this is intentional. There are times in the market where either the asset quality isn’t as strong or we don’t feel we’re being compensated adequately for the risk. There were times in late 2018 and even parts of 2019 when the market was very, very strong, but either aggressive structures were being done or pricing was too tight. Usually when those things happen, we tap the brakes and slow our growth.
How do you kind of assess the leverage loan market right now?
I’d say it’s healthy, but the demand is exceeding supply right now. Because of this, there is a large portion of the market trading above par. I think some new issues are getting done that are probably priced tighter than they should be, and you’re seeing aggressive structures. But the market behaves like a pendulum, where it’ll be a buyer’s market or a seller’s market. And right now, it’s a seller’s market.
Are covenant-lite structures still concerning for managers?
In the broadly syndicated LBO loan space, pretty much every loan is covenant lite. It’s a question that people, mostly the media, like to discuss. However, that’s gone [covenant structure], and it’s not coming back. The only loans that have covenants are middle market, very small companies that have direct lending. Anything that’s big, broadly syndicated and sponsor-owned is not going to have a covenant and likely never will.
It’s mostly driven by how the bond market and the loan market have converged somewhat. In that, we’ve taken on some of their aspects and they’ve taken on some of ours. For instance, loans never had call protection before. We got that from the bond market. And we never had Libor floors either. We stole that idea from the bond market (laughs). They’re just converging a little. It’s getting to the point where a lot of these companies, their CFOs are saying to themselves, do I want to have floating-rate debt or do I want a fixed-rate debt, and then in what increments? Because they’re really managing their rate risk and their ability to prepay.
How is private-equity direct lending impacting the BSL CLO space?
I think it is impacting it significantly. It used to be that the direct lenders would do the smaller deals, up to $100-$200 million. Now there are direct lenders who are doing billion-dollar deals, and this is really eating into the broadly syndicated space, because typically a larger deal like that was the domain of large banks such as the JPMorgans and the Bank of Americas of the world. Now they’re having to compete not just with each other, but with a whole new group of lenders, and these lenders have very deep pockets. It’s definitely making the banking side of it much more competitive.
The other impact of it is if you look at the number of second liens that have been issued. It used to be, two years ago, that we would see a lot of broadly syndicated second-lien loans. By contrast, we’ve seen just one this year. In the back half of last year, we saw basically zero. The reason for this is these loans are all being privately placed – frequently with these large direct lenders or BDCs, or many times it’s also LPs of the private equity sponsor.
The part that’s unfortunate for the banks is that if you’re a leveraged finance banker at pick-your-large-bank, you used to get fees on distributing the second lien. All of those second liens are now being privately placed by the financial sponsor, by the private equity firm. So that’s a large portion of fees that no longer exists for the regular-way bank lenders. So underwriting an LBO is significantly less profitable than it was, say, two or three years ago for the leveraged-finance bankers.
How is the investor base changing?
The investor base for CLOs hasn’t changed much. The only difference really is that different subgroups of that investor base are more or less motivated at any particular given time. But it’s still a relatively small universe of investors. And that to me is something that needs to change for that asset class to really thrive. It needs to become more standardized and less bespoke. Every deal is its own work of art with a 200-page document.
Other securitization asset classes are far more standardized and therefore, they’re more liquid and there are bigger investors that look at it. There are also a lot of large allocators out there. CLOs are just too painful because each one requires so much analysis of the structure.
But in terms of the investor base, ours hasn’t changed much. I mean, we’ve grown it and we’ve diversified it, geographically and otherwise. But I would say the investor base, other than some large Asian investors coming in the market and others leaving the market, it’s largely the same. There is more interest out of Canada than there was before. But those are those are probably the only real big differences I’ve noticed.
How will CBAM’s new $60 million credit facility impact the firm’s strategy?
I think investors like to see that the manager has skin in the game, so we intend to use that credit facility to seed growth into different investment strategies. For the Europe move, I don’t think we’ll need to draw on our credit facility. But yes, that is one of the areas we are expanding, and Europeis a market that we think is going to be a very interesting one for us.
What is the equity strategy for CBAM?
We have historically done deals with third-party equity, and we’ve done deals where we’ve contributed and retained some of the equity. In our first five deals, back when we had the [U.S.] risk retention requirement, we retained a significant portion of 5% of the vertical slice of the entire deal. In all of our early deals we had a significant amount of investment in those, and we still do. In the deals since then, we’ve not done this, but we have invested in a couple of them. Usually this has been alongside third-party equity investors.
What do you see for refi and reset trends for 2020 in the CLO market?
I think it’s significant. We’ve known for a long time about the deals that were done in 2017, including all of our deals, were done in the 120s in terms of the triple A spread over Libor. Now is the first time in a long time where you can get a deal done in that neighborhood again, and if you’re willing to do a shorter-dated deal, you can get it done inside of there. So I think you’re going to see a significant amount of refis and resets – probably more refis and resets – but I think it’s going to be a much bigger part of the issuance this year than new issue. The equity arb is still a little difficult for new-issue CLOs.
Do you expect any impact from any regulatory proposals?
One of the interesting developments is that CLOs are going to be able to have small bond baskets again. For years, coming out of post-crisis, you went loan-only in your CLOs, and the pre-crisis deals all had bond baskets. Some people used them with great success, others did not. But I think in the right hands, it can be a very helpful tool for protecting your investors’ capital.
Contrast the state of the CLO industry today compared to earlier points in your career.
It’s been interesting for me to see how big some credit managers have gotten. If you went back 15-20 years ago, people in the U.S. liquid credit space weren’t anywhere near as large as they are today. And I think some of that is the result of mergers and acquisitions. I also think asset managers are realizing that you have to offer your investors a broad set of options. The ones who can do that are more able to grow, because their investors frequently are saying, "I’m not sure I want to have so many specialists working for us." They’ll say, "I’d much rather have one firm that can offer me performing credit, CLOs, high-yield bonds, distressed, multiple different credit-related strategies." It’s a lot easier to do that with one or a few large managers than it is to have a ton of little specialists.
But I think it’s been both good and bad for the industry. It’s good in the sense that I think it makes the manager have a broader perspective and be less insular in their strategies. The bad part is that in many credit managers’ eyes right now, they feel as though they have to expand and that they have to get bigger because they’re competing with some mega-managers.