GLOBAL CREDIT FORUM

Credit’s role in the economic recovery

Sep 30, 2020
  • BlackRock

Outlooks from global markets

James Keenan, BlackRock’s CIO and Global Co-Head of Credit, led team members in a discussion of the outlook from global markets followed by a focus on the distressed and default cycle to come.

  • James Keenan: Thank you, Tim.  I'm Jim Keenan, the CIO and co-head of the credit business here at BlackRock and your host for the next hour.  The previous speakers gave great insights on the dominant market forces that we’ve seen up to this point.  Monetary and fiscal policy, geopolitical risk, all that could impact the markets in the months ahead.

    Now that the stage has been set, we’re going to explore how these forces are really shaping up today’s credit markets and opportunities and we have two panels here to help do this for us.  First, I'd like to bring three of our global leaders of our credit platform here at BlackRock to brief us on the outlook around the world.  Mitch Garfin, co-head of our leveraged finance business, is going to give us a view around the US, Neeraj Seth is going to give us a view around Asia, and Jose Aguilar, head of our European business, will cover Europe.

    So, welcome to each of you and thank you for joining us.  As our previous speakers noted, central banks have provided nearly unlimited liquidity to the markets on the onset of the crisis, followed by massive fiscal aid to bridge the gap of demand.  This has allowed companies to build liquidity and caused investors to look for both returns and income.

    Now, we want to understand how the markets are evolving and what you’re seeing across the region.  Neeraj, since the virus really started in the Asia market, why don’t you start and give us an outlook of what you’re seeing across Asia?

    Neeraj Seth: Sure, Jimmy.  Thanks a lot.  Before I go into the market opportunities and what has happened since the impact of COVID, might be spending – worth spending a couple of minutes on the growth of the markets in Asia, because that’s not something which is very well understood.

    If we look at the markets in Asia and the dollar denominated credit markets, we’re seeing the markets growing from roughly $200 billion at the start of the decade to around $1.2 trillion equivalent right now.  Equally important is the growth and the opening up of the local currency credit markets, which are close to approaching $10 trillion and this is an area where we don’t see a lot of global participation.  So, overall, from a growth perspective we do see strong growth across the public and the private markets in Asia. 

    Now, coming back to the impact of COVID and what has happened, if I look back since March 23rd, in fact when you had the big Fed action, there is a reasonable amount of retracement of the spreads post the widening, maybe 50% to 70% depending on the parts of the credit spectrum.  But the Asian market has lagged the US market on the BM in general driven by two factors.  One, unlike the US or the European market, there is no central bank for Asia.  The Asian credit, it’s a regional market.  Every country has a different policy mix.  And the second is the state of affairs in terms of the US/China tension has kept somewhat of the flows light in my view, which could have been heavier in case of a normal situation.  So, I do think obviously some retracement has happened, but not all. 

    And now, looking forward, where do we go from here?  I do believe Asian credit actually looks quite attractive.  Overall, when you think from a fundamental perspective the default risk or the fallen angel risk is actually quite low in Asia.  It’s low to mid-single digits.  The overall spread premium or the spread pickup in Asia relative to rest of the world is actually still very attractive.  And when you think about the issuance, it’s actually not very high in Asia.  We’re still tracking low single digit in gross terms of our 2019 level and, in fact, lower than 2019 in terms of net issuance.  So, all-in-all, I think we’re still in a good spot in Asia across the public and private credit spectrum, Jimmy.

    James Keenan: Thanks, Neeraj.  Great points.  Mitch, how about the US?

    Mitch Garfin: Great.  Thanks, Jimmy.  The coronavirus and the ensuing economy shutdown, followed by the mask – massive fiscal and monetary policy has certainly created significant opportunities in the credit markets.  Initially, the most compelling opportunity was in the investment grade market, where companies looking to raise liquidity came in at relatively wide spreads and pretty significant new issue concessions.  Money flowed into the credit markets to take advantage of this dislocation with huge flows in investment grade and high yield and that obviously is in contrast to what Neeraj just mentioned.  This demand for credit also helped to reopen the high yield capital markets as well, with most COVID-sensitive names sourcing liquidity primarily on a secured basis at what we thought was very attractive yields. 

    As risk premiums narrowed throughout the year, more and more issuers came to market, more on an unsecured basis to refinance higher coupon debt, to push out near-term maturities, and to build liquidity, and this dynamic has created an opportunity to increase spread duration in many of our preferred issuers and put capital to work at relatively attractive levels.  Given the uneven recovery so far with the expectation for this to continue in the coming months and quarters, we think the most significant opportunity today is to take advantage of sector and issuer dispersion by active – actively managing risk in the portfolio.

    James Keenan: Thanks, Mitch.  Jose, what about Europe?

    Jose Aguilar: Thank you, Jimmy.  I would like to take the opportunity to highlight as unprecedented as this COVID crisis has been so far, the economy is actually following a very normal recovery playbook.  So, we started in March with a, you know, shocking and very sharp downturn that was followed by the reaction from governments and central banks.  I mean I think a key moment on that was when the Fed announced that they’re going to start buying corporate bonds following what the ECB and other central banks were already doing.

    That to me is what started the repair phase.  And in the repair phase, as my colleague Mitch has mentioned, that’s where you can buy very high-quality assets like investment grade at discounted levels, stay defensive, and that was the right opportunity at the time. 

    As the economy reopened and those stimulus packages, you know, helped the economy, we saw global beta starting to rebound.  In regions like Germany or France, we’re seeing already the consumers’ expenditure getting to levels higher than pre-COVID and in the IPs or industrial production getting to levels above 90%.  That data is showing that now we are in the recovery phase and that recovery phase is where credit usually tends to outperform on a risk-adjusted basis.

    In Europe right now, you have companies that are, you know, the economy’s benefiting from that amount of liquidity from that backstop for corporate bonds.  At the same time, corporates are focusing on fixing the balance sheets and raising liquidity.  The – there are inflows coming into the asset class and investors remain cautious.  All that is a great, you know, mix that helps the recovery in our market and makes high yield extremely attractive.

    In Europe, the market offers right now close to 500 basis points of spread.  That spread is very attractive on a relative basis.  It’s four times what you’d get in investment grade at the time.  But, it’s also very attractive versus the default risk.  Those spreads are implying default risk over 12% per annum over the next five years.  We think that’s never happened and it’s very unlikely to happen.  In fact, year-to-date defaults in Europe are around 3%. 

    For all those reasons, high yield remains very attractive.  We think that it’s a great opportunity to generate income.  It’s a great opportunity to benefit from spread compression as fundamentals continue improving.  And it's a great opportunity to generate alpha because the recovery is going to be, you know, very different in different sectors and regions.  So, it’s going to be a lot of dispersion.  Thank you.

    James Keenan: Thanks, Jose.  All great points about the value of the credit markets here and where spreads are.  But, Condoleezza Rice, Secretary Rice, just gave us a preview of all the geopolitical risks that are in the market today.  Talk to us a little bit about what we see in the fall and, you know, the potential risks and the volatility that we may see come out of either more data around the virus, the US election, or other risks that may come out.  How may they affect the volatility of the spread markets today?  Mitch, why don’t we start with you?

    Mitch Garfin: Great.  Thanks, Jimmy.  You know, I think all of these potential sources of volatility are all significant risk factors heading into the fall.  I think there’s a very high probability that all of them will flare-up over the next few months. 

    On the virus front, the market has been, and I think will continue to be very reactive to vaccine or virus-related news.  We see this as an opportunity to actively manage risk in the portfolio as we’re underwriting to a longer dated economic environment. 

    With respect to the elections, obviously a lot of uncertainty as to how this is going to play out with very competitive races in the Senate and for the Presidency.  I'm increasingly concerned about the market’s reaction to what I would describe as a contested election.  I think this has the potential to be maybe somewhat destabilizing for markets for maybe a brief period of time.  Ultimately, I think regardless of the outcome, and this is, you know, I think the most important point is that policy will remain relatively easy post-election given the weaker economic environment we’re in and the still very elevated level of unemployment.

    In the event of a democratic sweep, I am concerned about tax policy and the potential impact to equity multiples and valuations for risk assets.  And I guess, finally, we expect volatility and dispersion at the sector level based on the election results with energy, healthcare, technology perhaps among the sectors that will be most impacted.

    James Keenan: Thanks, Mitch.  Neeraj?

    Neeraj Seth: Sure, Jimmy.  Just adding to some of the points actually Mitch already covered, I think one of the things in addition to the uncertainty or the election noise that’s going to pick up is a very important aspect of the US/China relationship.  And we do expect that there will be some escalation in terms of the tensions going into the elections, the risk of obviously additional sanctions, some form or shape of the ... discussion coming back to the table.  I think these are the factors that will matter for Asia and going into the election something that we are worried about. 

    Now, the way we are looking at it at this point is we are very focused in the region on the more domestically focused stories, looking at companies and the credits which are less impacted by the geopolitical noise or any impact of the – any sanctions that we can expect.  So overall, going into the election, the US/China relationship and noise around that would matter.  Once we are through the election, as Mitch touched on, I think the outcome and the policy outlook from there will be important for the markets.

    James Keenan: Thanks.  Jose?

    Jose Aguilar: I would like to add just Brexit here as another potential source of volatility.  But, you know, my view is that all those reasons that we have commented are well understood.  Some of them are here to stay for a long time.  And while they will add volatility in the next few months, I think they shouldn’t derail the recovery.

    What we are particularly focused here is that counterbalance between the news around the virus and the policies that have been put in place to counterbalance that downturn.  Particularly, for example, we’re very focused on the end of some of the furloughs programs and unemployment support that have been put in place, as well as the support for liquidity for small companies. 

    If the virus were to get much worse than it is right now or there is a policy mistake and those help programs were removed in a manner that creates some tension, that could result in increase in unemployment.  You know, we have estimated, we have seen estimates of UK unemployment going to over 10%.  And increasing defaults in small companies, I think that will be very detrimental for the recovery that we’re seeing right now.

    James Keenan: Thanks, Jose.  We’ve talked a lot about the macro forces here and how they’re impacting the overall market.  But, as businesses continue to see some of the reopening here and we’ve seen some of the recovery, although it may be fairly dispersed between some of the speeds, different industries, and different regions, how do we think about the recovery to get back to the levels of 2019 when you think about unemployment, consumption, investment?  Talk about what we’ve learned from the Q2 environment and that recovery and ultimately how do we see that playing out over the next couple of years?  Neeraj, why don’t we start with you just because Asia’s obviously a little bit ahead of the market here?

    Neeraj Seth: Sure, Jimmy.  Asia has been on the forefront in this case.  Unfortunately, we did see the impact of the virus first and we’re seeing, in fact, some of the Asian economies coming out of it strongly.  I would say three important patients worth highlighting what we have learned so far, Jimmy, from the macro data, as well as the second quarter earnings and the forward-looking outlook. 

    The first is the country and the sector as a unit of risk has become more important and you see that in terms of the performance year-to-date.  You see it in terms of the risk premium and that’s something which is still evolving. 

    Second, in terms of the countries which have been actually more a first in/first out from a COVID perspective, we’ve seen meaningful recovery in more of North Asia and within North Asia when you think about it, China is leading the recovery and obviously is something that’s very clear from the data we see.  Specific sectors, real estate doing very well in China.  We’re seeing the construction activity picking up.  We’re seeing the earnings which were slightly weaker in the second quarter but clearly picking up looking forward.  The earnings in the technology sectors will be picking up.  In consumer we have seen to some extent still a slower recovery, although last month’s data out of China was actually strong.  So overall, a lot of these sectors are coming back very quickly in North Asia.

    The third part is where we see slower recovery and that’s part of Southeast and South Asia, larger economies like India, Indonesia are still in the midst of the coronavirus spread.  The macroeconomic data remains weak.  And there we have seen, with the exception of technology, telecom, and a few other sectors, most of the sectors still having weaker earnings and unclear or somewhat lack of a strong outlook from here.  

    So, from the implication of that sad point, we are still tilted very much towards quality in some of these countries where we see less of a clarity from a growth path perspective, whether it’s India, Indonesia.  We like the telecom, technology.  We like the renewable sector in India.  But outside of that, the small and medium sized enterprises we still are somewhat cautious on in the region.

    James Keenan: Thanks, Neeraj.  Jose?

    Jose Aguilar: I would like to highlight how resilient the consumer has been in Europe.  We have seen sectors like cyclicals doing really well.  Financial is seeing almost no distress and very little default so far and that’s in line with what we were saying, like the support that the consumer and employers and employees have received so far has been key on keeping this recovery going.

    On the negative side, I would highlight the sectors on the retail, leisure, travel are still on, you know, very far to get those levels of recovery.  Particularly, it has been quite negative to see that versus initial expectations of a very slow but steady recovery.  The number of infections that we have seen over the summer and the need to put in place additional measures to remove that capacity of people to travel has resulted in a downturn and a backtrack of that recovery and that has been very detrimental for those industries.  We think that it will take a few quarters for that normalization in those sectors.

    James Keenan: Thanks, Jose.  Lastly, Mitch?

    Mitch Garfin: Great.  Thanks, Jimmy.  So, second quarter results were definitely better than expect albeit from very low expectations.  Dispersion across sectors and issuers was very significant as the economy stabilized and began to recover.  And I realize there that it’s maybe the second or third time I'm mentioning dispersion, but I do think that’s one of the most significant opportunities in today’s credit markets.

    Just at the sector level, within tech not surprisingly COVID has definitely accelerated the digital transformation and cloud adoption leading to robust demand and growth.  Within energy, companies are focused, again not surprisingly, on making permanent cost saves and optimizing their cost structure in order to breakeven in this fairly low commodity price environment.  On the healthcare front, volumes troughed in April but some meaningful increases in the back half of the quarter.

    And then, similar to what Jose mentioned with respect to COVID-sensitive sectors, gaming, lodging, restaurants, retail, etcetera, they’ve struggled given the shutdown.  But, many of them have been able to access the capital markets and raise liquidity.  And finally, the most common theme from the second quarter was that outlooks have generally been uninspiring as visibility into the second half of the year remains low.

    James Keenan: Thanks, Mitch.  And great overview from everybody.  We’re going to wrap it up here with a lightning round which I know is the question on everybody’s mind.  But, where do the three of you see the greatest value or opportunities in the credit markets today?  Mitch, why don’t we start with you?

    Mitch Garfin: Sure.  You know, to that point, you know, spreads in the high yield market remain attractive.  We’ve seen a pretty strong rally, you know, off of the wides.  We’re still nearly 175 to 200 basis points wider.  That said, implied cumulative defaults, which was mentioned earlier, still remains very elevated in our market, 20% to 25%, which would be among the highest levels we’ve experienced during any downturn.  We don't think that’s likely to be realized.  We think we’re going to outperform that and have materially lower defaults over the next three to five years and that will create many compelling opportunities for us.

    Don’t get me wrong.  There will be defaults.  There have been defaults.  We’ve seen it in energy, retail, wirelines.  And I think that will create interesting and compelling opportunities in the distressed market over the next six to 18 months.  Importantly, however, earnings are recovering, liquidity is plentiful, credit fundamentals are improving.  We’re underwriting to a mid-2021 economic environment and expect these trends to continue and spreads to tighten.  Specifically, we find value in the intermediate part of the credit spectrum, more focused on the B part of the market, on new issue, the robust new issue supply that’s coming, and in some cases the more COVID-sensitive sectors on a secured basis.

    James Keenan: Jose?

    Jose Aguilar: Very similar comments.  It’s clear that as the recovery continues, we see value in ... cyclicals, particularly in some of those fallen angels that have been coming to the market in the next few – in the last few quarters.  We also see value in Bs, as Mitch said.  We think that spread compression should continue as fundamentals improve.  And while we remain cautious on some of the more COVID-related sectors, we have seen value in some of the more, as he said, IG quality companies or secure part of the capital structure.

    James Keenan: And let’s get the last word from Neeraj.

    Neeraj Seth: Thanks, Jimmy.  I think the short answer is Asian credit.  But going a little more specific in terms of some of the strategies where we see value, it’s Asian high yield, China credit, and Asian private credit.  Asian high yield we are still looking at north of 7% overall yield in the portfolios and with low expected defaulted rate we do expect the overall outcome to be very positive for the investors.  China credit, which is obviously something I touched on earlier, a combination of the onshore local currency and the offshore dollar denominated credit,

    And the last one is Asian private credit.  This is something which is more of a nascent space in Asia.  But one thing that is happening is with the impact of COVID we have seen an acceleration in terms of the disintermediation of the banking system that is a trend that we’ve been talking about and the risk premium in Asia remains very, very attractive given the limited amount of supply of capital.  So, across Asian credit, high yield, China credit, and Asian private credit, I do believe these attractive strategies in the current low rate environment.

    James Keenan: Well, let me pick up on that last comment on private credit.  But first, thank you for the three of you for a quick but comprehensive tour around the global credit markets.  Neeraj is right that interest in private credit has certainly increased because of the illiquidity risk premiums that you can get and the diversification of the private markets and as this economic recovery proceeds, we believe one of the best opportunity sets in the stressed and distressed credit.  So, let me welcome our next three speakers to talk about these opportunities.

The distressed and default cycle to come

Dave Trucano, BlackRock’s Head of Opportunistic Credit, Jen O’Neil, BlackRock’s Deputy Global Head of Transactions and Bill Derrough, Global Co-Head of the Recapitalization and Restructuring Group of Moelis and Company discussed the opportunity in stressed and distressed credit.

  • James Keenan: Well, let me pick it up on that last comment on private credit.  But first, thank you, the three of you, for the quick and comprehensive tour around the globe and around the broader credit markets.  Neeraj is right that there’s interest in the private credit markets and this has increased because of the illiquid return premium and then diversification.  And as the economic recovery proceeds, we believe one of the best opportunity sets that we see is in the stressed and distressed credit.

    So, let me welcome our next three speakers to talk about these opportunities.  Dave Truncano, our head of our opportunistic credit platform, Jen O’Neil, our deputy global head of transactions and investments and BlackRock’s newest celebrity for her widely reported leadership role in achieving the recent sovereign restructuring with Argentina.  And a big welcome to Bill Derrough, the global co-head of recapitalization and restructuring group of Moelis and Company. 

    Welcome to all of you and as we just discussed, the rapid market recovery that has reduced the amount of debt trading of distressed debt instruments out there.  But the path forward is still slow and uneven as we think about this recovery by industry and by region.  How do you see the outlook for default evolving over the next 12 to 14 months?  Bill, let’s start with you.

    Bill Derrough: First, thanks for having me.  It’s great to be here with our friends across the BlackRock platform.  We spent the last I guess it’s six or seven months since COVID started really helping issuers.  We call it putting gas in the gas tank, raising liquidity in the credit markets, in the equity markets, selling assets, addressing covenants so they have access to cash really to give them enough gas to get through the other end of this COVID dynamic whenever that is going to be. 

    You know, the unprecedented actions by the Fed and the ECB and some of the other central banks has created this amazing access to credit.  But we’ve done a lot less actually in fixing balance sheets, in restructuring balance sheets, than we would have thought, a big part of that being this access to credit.

    So, when you step back and you look at kind of the landscape, we have all these companies who have for the most part piled on debt in order to raise cash and when the dust finally settles, the COVID dust finally settles, we believe that we’re going to be seeing a lot of companies that will have significantly higher debt balances and it’s hard for us to see that they’re going to have significantly higher cash flow, EBITDA.  In fact, most of them are probably going to be down, not up.

    So, unless the world is going to be willing to live with just, you know, 50% to 75% higher leverage multiples, we firmly believe there’s going to have to be a lot of surgery done.  And it may be minor cosmetic surgery, a little nip and tuck here, or it may be major surgery replacing joints and organs and things like that, meaning really fundamental restructurings.  That's kind of what we see happening in the next 18 to 24 months.

    James Keenan: Thanks, Bill.  All great points.  Obviously, the amount of liquidity that’s really come into the market has allowed for some of these corporations to I would say buy some time.  But we all know the sense that when you have – you still have to put too much debt, you still have to burden the company with regards to that debt, that interest expense then really starts to limit.

    Let's go to Dave.  Dave, how do you see this playing out on  some of the opportunities that you see playing in the market now?

    Dave Truncano: Sure.  So, I’ll echo a lot of what Bill said.  Knowing Bill for a long time, I tend to agree with him unless he’s sitting on the opposite side of a transaction, in which case I vehemently disagree with him. 

    So, I think the short answer as we look back over the course of the last six months and we went through three phases, you obviously had the shock and response, which has been unprecedented.  You had everybody trying to raise liquidity and, frankly, in most instances doing it at a very significant price relative to cost of capital previously.  We’re kind of now at that phase where we’re trying to digest, and companies are trying to figure out what the forward path really looks like. 

    And I think there is a slowdown, you know, in defaults and I think we’ve had about 180 year-to-date.  I think that the only other time that’s had a comparable amount is to go back to 2008-’09.  It’s about 270.  So, you know, we were trending towards I think, you know, ten-year highs in defaults.  But we’ve taken a pause.

    And so, you know, I think when we look at the forward we have a very similar view to Bill.  A lot of the problems have been solved.  Larger companies’ access to capital markets, the need to digest exactly what it means to be more highly levered in a more uncertain environment, I think companies and boards are grappling with as we sit here today.

    You know, from our standpoint we’ve never been busier, and we think about the environment, one where leverage has gone up, earnings are flat to down, and in certain instances down the credit curve, significantly down.  From our perspective, that’s creating an environment where defaults have one direction to go, despite the slowing that’s occurred over the last several months, which is up in 2021 and beyond.

    So, you know, from our standpoint, you know, obviously there are factors that can come in that can push that out, no different than what’s happened in March, April, and May.  There is a lot of money sitting on the sideline.  There’s lots of private equity dry powder.  But, at the end of the day when we look at the companies we invest in and across, you know, it is a position where companies typically default because of exogenous shocks.  We’ve had one.  They tend to default when liquidity runs out.

    There’s a number of companies that we could talk about in another forum that, frankly, have access to liquidity.  You don’t have to worry about those.  There’s those that don’t.  That's where the problems are going to be.  There aren’t the covenants that have historically existed.  They don’t exist in, frankly, levered credits anymore.  So, the reality is it’s a function of time and we really do think the default cycle has a significant opportunity to increase into 2021 and beyond.

    James Keenan: Thanks, Dave.  Obviously that 170 to 180 number already is pretty significant.  But I think as you touched on this, even if you looked at the public markets it’s still implying in the CCC credit about 40% to 50% assumed default rate when you look at those credits.  So, still a lot to do even though liquidity’s been in the system.  Jen, what do you see from your lens?

    Jen O’Neil: Yeah.  Definitely agree and echo what Bill and Dave have said.  I think the biggest thing we’re seeing through more of a legal lens and just general refactoring community lens is the impact of the uncertainty, right.  So, it’s very difficult to predict.  There's a ton of liquidity, as Dave said.  We’re looking at lower earnings.  EBITDA will be lower.  Leveraged multiples will be higher.  But the timeline is very challenging in light of COVID and in light of the ancillary effects of COVID.

    And so, attempting to do the right thing at any particular point in time right now is extra challenging.  That's leading to, you know, different behaviors and different approaches, depending on the company, depending on the industry.  And it’s there’s a lot of reliance on outside advice and events away from who you would normally see advising.  Normally you see the bankers and the lawyers and it’s just a bigger community right now, because of the exogenous event of COVID and the impacts on all of these companies.

    James Keenan: Thanks, Jen.  And to that point, I think we’ve talked a bit about the uneven impact, just the effects of the virus in itself and the dispersion that it creates across industries and regions.  Dave, maybe talk a little bit about what opportunities you’re seeing in which sectors and how things are playing out from different opportunities.

    Dave Truncano: Sure.  You know, I don’t get accused of talking macro very often, so I tend to focus on the micro and the bottom up.  And I think as a general rule, I mean a lot of the names that people talk about are really, you know, kind of the second and tertiary effects of what’s happened with COVID, because the companies that have access to capital, the big, large corporates, the kind of BB up space if you will, they’ve solved a lot of their liquidity problems.

    And I think when we look across the landscape of opportunities, obviously travel and leisure’s an area where that’s been hit extremely hard.  And I think really the question then becomes when you provide liquidity to a company what’s the runway that’s required.  I think the uncertainty has gone up. 

    I think if you think about we’ve spent a fair amount of time in and around old technology.  There’s obviously a lot of disruption taking place.  Old technology is an area that has become a very significant exposure in the indices for those that invest across the levered credit space.  And I think the amount of disruption that’s taking there, place there and the amount of leverage is significant.  So, you know, the opportunity set is growing in old tech.

    And I think when we look at retail and we obviously – that’s a long-told story.  There’s a secular shift taking place.  You know, it’s an area that, frankly, has not been a great place to make money for a lot of investors in the space.  We think there’s niches within retail that have to recapitalize that are actually very interesting.

    So, we spend a lot of time in and around retail companies.  And I think, you know, two other areas generally speaking that not a lot of people talk about is the REIT space, so retail estate investment trusts, particularly around the corporate landscape or specific specialty real estate assets in and around travel and leisure.  There’s interesting opportunities there, particularly as a lot of those companies used to be investment grade and now they’re, frankly, trying to figure out how they can actually go collect their rents.

    So, those are the types of opportunities that as a broad stroke from an industry standpoint we spend time around.  And I would just say there’s a couple of other thematics that we try to talk about.  You know, the convertible market scenario, a huge opportunity as companies have tapped the market to try to capitalize on, you know, lower cost of financing.  And Bill can give his perspective on some of the experiences there in and around convertible issuance when it goes bad.

    I think from our perspective you're also seeing a lot of inner creditor dynamics, which we’re going to talk about, creating opportunities for those that can write and commit capital into very complicated capital structures.  Given who owns credit now, sometimes they’re unable to put money up to defend their positions and we think that’s an interesting opportunity.

    And then I think the most important thing, you know, frankly is making sure that when you invest across a distressed landscape you don't make mistakes.  And I think there’s a lot of and I think the challenge in the market has been a lot of investments are going to result in permanent losses around oil and gas and kind of the big legacy retail companies. 

    So, we take an approach to distressed which is more picking your spots, you know, getting into the ventures understanding what’s going on.  Those opportunities I referenced previously are where we spend a lot of our time.  But most importantly trying to avoid the mistakes that, you know, with a lot of money occur when people are trying to go search for yield and, frankly, the default risk is pretty broad-based despite what the market recovery has suggested otherwise.

    James Keenan: Great points.  Thanks, Dave.  Jen?

    Jen O’Neil: Yeah.  You know, echoing what Truncan – Dave said on the inter-creditor dynamics, which is actually one of the biggest changes I think we’re seeing currently, it’s creating a lot of opportunities.  It’s also creating a lot of unnatural acts and dynamics amongst creditor groups.

    To Dave’s point, there are opportunities to come into complicated capital structures, even if you’re not in them.  And there are certainly opportunities when you’re in an existing capital structure to up-tier, to exchange, to do something coercive and we’re seeing a lot more of those types of transactions and exercises.  That's leading on the front end to a lot of I’ll say very deep dives into the documents to pinpoint exactly what’s possible, which is a slightly different process side approach than we’ve seen in the past. 

    Typically, there’s an idea about what liability management exercise or restructuring exercise should occur and then you obviously work with lawyers to make sure that the art of the possible works in reality.  Now, it’s a bit more people, like I said, not knowing exactly what to solve for and combing through the documents for what could possibly be available to them in the toolkit.  And then, again, depending on the need and the consent levels, etcetera, you do see smaller creditor groups forming as opposed to more of a unified creditor front that we had seen in the past and through the past cycles as well.  Now, you have a lot more creditor groups, which leads to more friction obviously, higher costs and fees absolutely, and a trickier, perhaps even more contentious dynamic overall as you’re running through these liability management or restructurings. 

    James Keenan: Thanks, Jen.  Bill?

    Bill Derrough: Well, we don’t invest money, so we come at it from a very different perspective.  We’re looking for opportunities where we can get hired to represent BlackRock on the creditor side or represent the company.  And I don’t want to repeat what Jen and Dave said in terms of industry specific.  I will add a couple. 

    If you are a supplier to the tip of the spear companies, so aircraft manufacturers, suppliers to aircraft manufacturers, all those kinds of businesses are going to be tremendously challenged going forward.  You know, you look across the United States fiscal landscape in terms of states and municipals and counties.  The tax challenges they’re going to face are going to be enormous and they’re either going to have to borrow a ton of money and then you’ve got to think about the credit ratings of those entities or they’re going to have to cut back.  And I think it’s going to be a combination of those two.  And we have to think about who supplies what to those entities and how are they going to be impacted.  If you're a company that relies predominantly on people gathering in large places, like the BlackRock cafeteria and eating at the salad bar, you probably need to be thinking about, you know, maybe adjusting your business model. 

    So, there’s just so many different areas that we have to think about.  You know, what’s business travel going to be like?  We can do these events now through Zoom.  And as much as I love, would love to shake everyone’s hand here tomorrow, this makes it a lot easier to see someone’s face.  So, will I not travel as much from New York to Chicago to see clients I already know?  I know a lot of people think that’s going to be the case. 

    I'm a pretty social person.  I like going out to dinners and lunches.  But, you know, I think firms also will be saying, well, do we need to spend $5,000 on travel and hotel?  Can’t you do it via Zoom?

    So, what that’s all going to look like in the end I, you know, I don’t really know.  I don’t think we, any of us know.  The acceleration of I think job losses as a result of technology is going to be great and there’s just going to be a lot of dislocation globally that – and then the individual companies’ capital structures will then kind of determine whether they have enough legs to transition their businesses without defaulting or restructuring or are we going to need to do some type of this surgery we talked about.

    James Keenan: Thanks, Bill.  Each of you then have touched a little bit on how important structure is and some of the nuances associated to that.  I want to double-click on that a little bit, because we all know even though that we are in a recovery and there is an opportunity in some of these stressed and distressed markets, knowing and understanding that idiosyncratic element of the process and structure is critically important in investing in the space.

    So, maybe give the audience here a little bit of an understanding of how things have evolved.  We talked a lot about how the markets have evolved.  But, each one of you touched a little bit about how fund structures have changed, the global investor base has changed, and the type of opportunities when you think about where they’re coming from and who owns them, CLOs, BDCs, other private funds and things like that.  Let's just get a little bit deeper there so the audience can understand that.  So, Jen, let’s start with you.

    Jen O’Neil: Yeah.  So, you know, it is true that the market has certainly evolved.  There’s a ton more private debt funds that hold a lot of capital.  They’re sitting on a lot of capital right now.  They’re looking to get into structures and they’re already in some structures. 

    We’ve also seen a huge uptick in CLOs in these restructuring names.  Eventually, it drives different outcomes insofar as CLOs themselves have specific requirements that are very technical with respect to the instruments they can or cannot hold.  And in any given restructuring what we’re used to is everybody deciding what the right thing is to do, both for the creditor base and for the company to kind of maximize the value overall.

    Now, we see I’ll call them unnatural limitations.  Although, the more we live with them, the more natural they feel.  Some of that can be as simple as if you have certain funds that can’t take equity.  You see in the market people have understood the restructuring landscape enough that most funds that perhaps had that limitation now have created some level of exception where they can hold reorganized equity.  But you have a lot of funds that are in a tough spot if their mandate or their legal limitations are strictly debt and they’re stuck in a junior tranche that's going to equitize in a restructuring transaction.

    The CLOs, for instance, need cash pay.  They need ratings.  So, that drives what some takeback paper will look like or even on some dip opportunities that we’ve seen in court. 

    So, the fund structure has certainly become far more creative.  I do think the fund structure specifically has allowed more players in the space, which is not a bad thing.  It just creates a different environment when we go through a cycle, because you’ve got a lot of inexperienced people that haven’t been through the cycle where it’s not a supernatural fit that our, perhaps I’ll call them, distressed players lite, but they’re not super-well-versed in the art of restructuring.  And that’s where it gets a little tricky and you have a mash, mishmash rather, of people who do understand and people who don’t.

    And so, again, back to the inter-creditor issues, I do think that’s a driver there as well.  But, there’s certainly a different landscape now in restructuring than I think we’ve seen before.  It makes them more complex and, you know, Bill, Dave, you jump in with what you think, but I think it makes them inordinately more difficult.  But again it’s, you know, there’s evolution of markets all the time.  So, it’s natural.  In the end, I hope it’s probably better for everyone.  But it does feel a little difficult and a little bit like running through mud at times when you’ve got a lot of these different players now on the scene.

    James Keenan: Right.  Thanks, Jen.  Dave or Bill, anything to add there?

    Bill Derrough: Yeah.  We used to say that restructurings, when I would try to explain what the restructuring world is like to sort of regular investment bankers or happy deal investment bankers or maybe some of the young people coming into the business, you know, should you come into restructuring?  I'd say, well, okay, think of chess or checkers.  That's like regular deals and restructurings is like that three level chess game in Star Trek, because you have instead of being a bilateral negotiation, it’s usually at least three or four or five defined parties, you know, the company, the first lien lenders, the second lien lenders, the unsecured bond holders. 

    But we’ve had deals where we had a first lien, a 1-1/5 lien, a 1-3/4 liens, a 1-7/8 lien, then the second lien, then the third lien.  And then, as Jen said, within those tranches you'll have subgroups.  You’ll have some people who own one thing or, you know, a little bit of this, little bit of that.  And so, I'm not sure it’s even the Star Trek three level chess game.  It’s like an exponential dynamic and it keeps moving.  It keeps moving.  People trade in and trade out. 

    But, it’s very hard to know what things are going to look like at the very end and I think it’s really why we need in restructurings to try to put together quick, ideally out of court or prepackaged, deals and not allow them to languish for periods of time, because all you’re doing is sort of opening the door to mischief makers.  So, if you’re a major holder as a creditor, it’s in your interest I think and it’s one of the company’s perspective to move things very quickly and sort of get it done before mischief makers show up and sort of, as Jen said, like you’re trying to walk through mud. 

    James Keenan: The old tough mudder.  All great points and thank you for that.  And obviously, it goes into the sense of not just having a thesis and understanding of a view of the company itself, but really knowing and understanding how to create value from that process and structure, because we all know if these linger there could be some value destruction as well.

    So, great there.  I'm going to wrap it up here with the same question that I asked the last panel, which is where are you all seeing the most value or the best opportunities in today’s market?  Dave, I'll start with you.

    Dave Truncano: Sure.  We typically don’t talk about individual names, so I’ll just go to high level.  We typically are focused in and around the technology space, the wireless space scenario where we think there’s ample opportunity given the amount of change that’s taken place.  We typically stay away from the larger capital structures, because they're heavily trafficked.  When you look into those situations, you know kind of who owns it and why and what their incentives are.  So, we tend to focus more on the middle market space, at least to this point in time in the cycle given how much asset values have returned.

    And then, we’re spending a lot of time in and around the busted convert space.  And then I also referenced things tied to the real estate market.  And, you know, the one good thing about restructurings and the good thing about debt is, you know, at some point in time they have to pay it back and you have a contractual right and that comes along with that.  So, when you can actually get through the weeds and actually understand what the rights and priorities are and what a debtor or a company can do to you and, therefore, what your tools are.  And particularly when they’ve been issued by people in bull markets, they don't really pay attention to the fine print.  You know, we think that’s opportunity and broadly speaking we like things that are complex, to Bill’s point, you know, secured debt, you know, unsecured first lien, second lien in and around those industries I just referenced.  That's where we think the value can be extracted from a distressed market which has struggled with returns over the course of the last several years and even this year when there’s been a lot of opportunity.  I just think you have to pick your spots and being in the bigger names where a lot of money exists I think has been a mistake as a way to invest across the distressed landscape.

    James Keenan: Thanks, Dave.  Jen?

    Jen O’Neil: Yeah.  Building on what Dave said there at the end, I think we focus – we’re not afraid of complexity and we’re not afraid of a deal with a lot of hair on it.  And so, I think we have the ability to get in there to understand documents and structures in a very superior way, in which case it allows us to invest in spots where people aren’t going to either take the time, dedicate the resources or just don’t have the ability to do that. 

    So, you know, a little industry agnostic.  When we see a complicated structure with a potential opportunity, we’ll dive in there and see if there’s something to be done.  And away from that, you know, any of these companies, everybody needs liquidity right now.  So, there is a lot of opportunity.  I think it’s trickier to be smart about where you're investing right now.  I personally think that, you know, the next 12 maybe even 18 months is where you’re really going to see a ton of opportunities and a ton of dislocation, notwithstanding what we have right now.  So, as Dave said earlier in the panel, you know, focusing and knowing how to focus and choose your spots is really, really where we see value in the current market.

    James Keenan: Thanks, Jen.  And we’ll give the last word to Bill here.

    Bill Derrough: Well, I think Dave and Jen touched on it.  If I was an investor, I would spend a lot of time reading the documents and throwing a lot of stuff up against the wall to figure out what the company might do to me if I owned this instrument, because as the banker to the company that’s what I do.  I spend – I get in there and I try to figure out how can I shrink the balance sheet by doing what I do in management transactions.  And it’s I'm not trying to pick winners and losers, but my goal is to, you know, deleverage the company.  And if you happen to be sitting in an instrument that’s pretty weak, I'm probably going to take advantage of that.

    So, I think what Dave and Jen said absolutely is critical and it’s what they’re really good at and what I think differentiates the BlackRock Credit team from many other shops.  And I will echo what Jen said about experience.  The last cycle was 12 years ago.  Probably more than half of the people on Wall Street weren’t even working on Wall Street then and they are making decisions on creditor committees, they’re making decisions, maybe not the portfolio decision, but convincing the PM to buy something and experience matters.  You know, having seen this movie maybe in a different iteration with a different actor in a slightly different setting, but you’ve kind of seen it before is really important and, you know, hopefully will allow those folks who have that experience to avoid pitfalls that other people will not. 

    James Keenan: Great points, Bill.  And thank you for a great session here.  I do want to thank all of you for joining us today and sharing your thoughts on this part of the market.  We’re seeing a rapid increase here from our investors, as well as the breadth of the market opportunity continues to expand.  So, thanks again for a great session.

    Now, let me introduce and pass it over to our next host, Carly Wilson, Portfolio Manager for our bank loans and our global long/short credit strategies.  Carly?

James Keenan
CIO and Global Co-Head of Credit, BlackRock
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Jose Aguilar
Head of European High Yield Strategies, BlackRock
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Mitch Garfin
Co-Head of Leveraged Finance, BlackRock
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Neeraj Seth
Head of Asian Credit, BlackRock
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Bill Derrough
Global Co-Head of the Recapitalization & Restructuring Group, Moelis & Company
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Jen O’Neil
Deputy Global Head of Transactions and Investments – Legal, BlackRock
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Dave Trucano
Head of Opportunistic Credit, BlackRock
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