HYH Interview - Anon Opportunistic Credit Analyst

Welcome back!

It’s time for another interview, this time with an experienced opportunistic credit analyst. We covered a variety of topics - including advice for younger analysts, opportunities in the credit markets, and what the future holds. I appreciate his time and it was a very informative conversation.

An Interview with an Anon Opportunistic Credit Analyst

1) Obviously we want you to stay anon, but can you give us a high level view of your background and expertise?

I have 7yr+ of experience, I’m a sr. analyst focused on opportunistic credit investing across IG, HY, distressed and some structured credit markets and some private situations as well. Previously worked at a public distressed HF and multi-strategy HF doing private special situations lending and some distressed PE in the LMM. 

2) What's the typical background for someone who wants to get into opportunistic credit?

RX IB is probably the most common background, see some folks make the jump from performing HY / CLO investing and some move over from PE as well.

3) Pros of a career in credit vs. classic path (IB, PE/HF)

Class credit investing (i.e., performing HY / LevLoans) is not as sexy as other industries because you have fixed upside and your downside can be 0, so people kinda hate on it. Performing credit is very scalable, however. Look at all the firms that have minted millionaire and billionaire founders by establishing massive CLO franchises. Whether you are a credit or equity analyst, you should try to think beyond your job as just analyzing businesses and making buy / sell recommendations. You are part of an enterprise contributing to the success of a product (CLO / SMA / HF vehicle). If you are successful at helping your business sell successful products, then you should eventually look to have a larger seat at the table. Not a lot of people think this way.

4) Do you regret having a career in Credit relative to Banking, Private Equity, or Public Equities?

No, credit has made me a better investor than equity could have. I suppose lifestyle is relative. You couldn’t pay me enough (you could, but only $$$) to trade equity quarters with little job security. But that is also not indicative of every equity seat. Just as boring and low-test isn’t indicative of every credit seat.

5) The world of private special sits and distressed PE transactions is a little foreign to most people - can you shine a little light on these type of situations?

My lending experience was capital solutions based…companies couldn’t raise capital from traditional sources often due to distress or other idiosyncratic issues and almost exclusively were non-sponsor backed. Lending against esoteric or real assets also qualifies as special situations...things like commodities, music rights / royalties, consumer assets, etc…these assets typically aren’t distressed but may have no natural capital provider which creates an opportunity. We managed a small PE portfolio to use as platforms for bolt on opportunities we’d find in bankruptcy or in off the run / broken sales processes, but this was a secondary focus. When we closed a deal, it almost never looked like the first draft shown by a banker or what the company suggested. Special situations investing, particularly if you’re the sole lender, is very cool because you can pick and choose the deals you want to do and only invest on terms and structure acceptable to you; think of capital structures as a sandbox that can be altered instead of something set in stone. This also isn’t “fire and forget”, we remain engaged with the borrower, counsel, and other third parties on a regular basis from deal close to final payoff. This differs from some types of direct lending where loans move to another team post-underwriting or aren’t really revisited unless there’s a problem.

6) I remember in early/mid 2020, the window to really take advantage of depressed loan and bond prices lasted about a month before the bulk of the market immediately ripped back. Walk us through what you saw during that timeframe and the takeaways.

I was investing in public markets in early 2020.The mid-March / early-April timeframe was crazy, and decisions needed to be made in minutes/hours…there was no multi-week research period before putting a trade on. Only the most critical numbers mattered…access to cash/revolver availability, credit doc triggers, and other balance sheet liquidity (i.e., high current asset mix). Most businesses never plan on operating with zero revenue coming in and that is exactly what was happening…many people would be surprised to know most companies, even large cap, can’t operate for more than several weeks or months if no revenue is coming in. The best risk adjusted trades turned out to be buying discounted IG paper and SPACs where you could put shares back in exchange for cash in escrow accounts.

7) Let’s talk about one of the most topical rides in HY Credit - Carvana. Ultimately, Carvana needed to restructure their bonds and converted from cash interest to PIK. Let’s talk about this situation, but also do you think the transition to PIK is going to become a trend for further restructurings? And if it does, will it be sustainable or will the accrued debt really eat away at equity value and the EV story?

PIK is a prominent feature in amend & extend transactions…but lenders should ask themselves if they’re PIKing to alleviate a short-term cash flow interruption or if the timeline for real positive free cash flow is down the road. Investing in the latter situation isn’t really lending, its venture capital and your return is tied to equity risk. These capital structures need more equity, not debt. Carvana has some real assets which helps, but if a business doesn’t generate free cash flow the can kicking can only last for so long.

8) Less of a credit question - but are you in the soft landing or hard landing camp?

I put this into the “too hard” camp and just try to find situations where, rain or shine, I should be ok.

9) We’re seeing Private Credit really start to eat into standard Broadly Syndicated Loan market origination and refinancing - any thoughts on if you think this continues or if the tide changes at all? I think the tide will change at some point as private credit gets even more commoditized and if there’s a few blowups, but many of these private credit shops are massive, too big to fail operations that probs come out winners with another strategy if direct lending/private credit slows.

A lesser talked about reason for why private credit is taking market from BSLs is because the majority of BSL capital comes from CLOs, and at current rates the equity spread does not incentivize new CLO creation, so as a result there is less capital supporting BSL transactions. You can also see the impact of this dynamic in new deals which may feature larger secured bond components. At a certain point I expect we’ll see private credit portfolios feel the pain of rising interest rates and any economic slowdown, I just don’t see how that can be avoided. A sole or small club of lenders can workout a problem loan relatively quietly and give themselves new loans.

10) Can you walk us through what the "opportunistic" environment looks like in the direct lending market? How does it compare to the public credit markets? Given the youth of the larger direct lending market I think a lot of people are wondering what exactly happens from a special situations/opportunistic lens in a higher default rate environment.

I think a lot of private credit opportunism can be found in “hung” public market syndications that end up getting pulled. Some borrowers may elect to pay up for a private credit transaction vs. try a public bond or loan given certainty of closing. In stressed / distressed, the line between “public and private” credit has always been blurred because capital solutions are almost always provided by a subset of new lenders; a fund may be “public” but the dynamic isn’t different than a direct lending process. “Public” distressed funds have always had a healthy mix of illiquid assets in their portfolios.

11) How do you view the importance of having a nimble, or flexible mandate?

I think mandate flexibility is the key to capitalizing on opportunities in the market. There are plenty of smart people who can punt capital structure ideas, but only so much AUM that is truly nimble with ability to say instead of buying that bond I’ll just do a new money deal directly with the borrower. Or why should I waste time on tight HY bonds when the EETC, MBS, or other structured markets have opportunity. Some of the largest buyers of IG paper in March 2020 were distressed HFs. Another key is being able to frame the risk / reward of any given trade, you want to look for asymmetric opportunities that offer right tail optionality. A stock offering 50% upside and 30% downside isn’t interesting, but a stock offering 500% upside and 100% downside could be compelling. Some might balk at the idea of losing 100% on an investment, but all risk has a price. A chance to make 5x your money or lose it all could be interesting pending diligence.

Within distressed, the traditional “fulcrum equity and buy from selling CLOs/MFs” model is mainly done. CLOs & mutual funds aren’t dumb money in credit anymore. These days edge has come from creative DIPs, non pro rata creditor deals, creditor on creditor violence, stalking horse deals, etc. It’s very important to be nimble and adapt to the situation.

12) Lender on Lender violence is at the forefront of people’s minds. When Cap Stacks got lopsided relative to EV, then it leads lenders to fighting for value. How do you think about the recent credit skirmishes and about the lender wars to come?

Creditor-on-creditor violence is just one side trying to position themselves better in the capital structure. Most capital structures with creditor-on-creditor violence still wind up in bankruptcy down the road, so it is more about posturing for the future in that sense. The worse a situation is getting the more likely, docs permitting, future lender wars will see similar types of actions because participants will proactively try to mitigate their exposure.

13) I’m a firm believer and may have tweeted out that we’re actually going to be in the Golden Age of Opportunistic Credit, as opposed to the Golden Age of Private Credit (as several heavyweights tell Bloomberg and outlets, and we mockingly make fun of). I generally think when we reach a period of volatility or distress, the opportunistic guys will be ready to act faster and will have the fund structure to go out and do a variety of things. How do you think about this sentiment and who is best positioned to manage the next cycle?

I generally think that winning platforms will be those that are most nimble and able to respond to situations as they arise across asset classes. Whether a situation is “direct lending”, “public”, or “opportunistic” is irrelevant so long as you are able to deploy capital into attractive situations.

14) Solve a riddle for me - who are the smartest guys in credit? Restructuring guys think they are, while general Credit guys think they're tools. Feels like we all like to make fun of each other in one way or another - whether it's calling direct lenders deal monkeys who are bad underwriters, CLO guys asleep at the wheel, or restructuring guys who don't have much to look at until there's choppiness in the markets.

ABL and hard money lenders have always impressed me. These guys just don’t seem to lose money and always have tight credit docs. Sometimes you see bank auctions for RCF commitments at a discount…that should tell you something is wrong in a situation. JP Morgan is the only lender to not lose money in Bed Bath and Beyond. I think these lenders get a bad rap for being “boring”, “sleepy”, or “not high enough return”, but some forget that credit, being a lender, is only about securing return of principal and earning your income. Nothing else. Buying a bond at 50 cents because you think asset coverage is 75 cents is not credit investing, its closer to investing in illiquid, minority private equity. 

15) I don't really think Credit Investors really need an MBA, it's more relevant if you're pivoting to IB, climbing the ladder in PE, or entering a F500 career, but do you think Credit Investors need MBAs? What about your thoughts on the CFA program?

I don’t think an MBA or CFA is necessary for credit, I have neither myself and don’t plan on getting.

16) What are the opportunistic credit exit opps? I kinda hate asking this question because there's a point where "well you're not supposed to have exit opps at this point, you already exited your investment banking analyst program years ago and should have it figured out by now."

Anything credit is probably fair game out of opportunistic credit. There’s lots of movement between opportunistic credit / distressed HFs and there should always be startup funds you can take a stab at if that sounds interesting. Probably can exit to a LO, performing credit asset manager or insurer with a great WLB and little to any focus on short term performance. Have seen some folks leave the industry and do something unrelated, but hands on credit / restructuring / business skill set is applicable to lots of things.

17) Your favorite book recs for Credit?

A Pragmatist’s Guide to Leveraged Finance, Distressed Debt Analysis, Handbook of Fixed Income.

18) What are the hardest skills for junior analysts (ppl in their mid 20s/late 20s) to get an understanding of?

Passing on situations, not getting FOMO, and sticking to your conviction is a hard skill to learn. Often, the best way to play the game is to not play, but this can be uncomfortable if all your peers are piling into a name or research analysts are telling you you’re wrong for not liking a structure. This skill can only be learned with patience and experience. The experience point is cliché, but time needs to pass in order to see deals work out, situations fall apart, management plans succeed or fail, and that is when lessons are learned. The easiest part of a trade is making the trade…folks need to experience the grind of being the 5^th or 6^th inning in on a trade, having it go against you, and have an investment thesis truly tested. By the way, its also ok to be wrong. Some analysts get married to a situation…don’t do that. Respond to the facts as they come out.

19) Can you talk about what steps junior analysts need to take to reach an analyst/senior analyst role?

I believe that after an initial 2/3 years of teeth cutting as a junior analyst your best career move is to find a seat that provides an opportunity for exponential growth in responsibility over a 5 year time frame or longer. It is tough to truly grow within an organization or rapidly increase responsibility if you are hoping jobs every couple years. In an investing seat, you will eventually need a track record, even as an analyst, of recommending and working through successful investments from cradle to grave. Especially in illiquid asset classes, it is hard to truly build a track record if you change jobs so frequently you never really see many investments from start to finish.

20) How should young credit investors start mapping out their career end game and evaluate the trade off of pay/hours?

I think it is worthwhile to spend time in a seat with direct interaction to business operations, so something like private equity. This isn’t because I think the private equity skill set is particularly important, but because its important to understand how companies actually work. Appreciate the nuance of running payroll, managing vendor payables, and ensuring treasury functions are as efficient as possible. Business distress comes from these types of functions breaking, not because EBITDA is 20% lower than guidance or something, so as a credit investor it is critical to really understand how businesses run. Small businesses, large corporations, the fundamentals of different business areas are not dissimilar. Its very doable to transition to public or private credit functions from something like that, and definitely not required for public credit investing…but the idea harkens back to something Buffett said about being a better investor because he’s a businessman and vise versa.

21) What’s the best advice you have for young credit investors, or for anyone looking for a career in credit, plus anything you wish you did as a younger credit investor.

This is not solely applicable to credit, but investing is about reps, so start getting as many in as soon as possible. This is easy to do with public companies because all the information is available, even for students. Follow some companies and familiarize yourself with the current setup and market narrative…what do you think is going to happen? Develop a thesis and track it. It doesn’t matter if you’re right or wrong, but if right, why were you right, and if wrong, why were you wrong? Have an open mind and be prepared to shift your position on a name if new information comes out that disproves prior beliefs. I wish I did more of this when I was younger. I would investigate situations and develop trade ideas, but I did not follow the results as closely as I should have because I was more focused on developing a work product, I could show in interviews vs. really learning from my mistakes and successes.

That is all for this newsletter. Thanks again to our Anon Opportunistic Credit Analyst for sharing his views.

Until next time guys.