Mon 05/16/2022 10:29 AM
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FTLive Reorg Global Alternative Credit Summit Panel Summary May 5, 2022 from Reorg's Americas Core Credit team.

“Medium to high” levels of volatility in financial markets offer considerable opportunity for patient investors in the alternative credit asset class, according to Joel Holsinger, a partner at Ares Credit and co-head of the firm’s alternative credit business.

Holsinger spoke at the FTLive and Reorg Global Alternative Credit Summit in New York on May 5. The panel, which also included Sound Point Capital Managing Director Morgan Dean, CDPQ Managing Director David Latour and MGG Investment President Greg Racz, discussed topics including the characteristics and future of alternative credit, strategies during periods of market turbulence, and alternative credit within the environmental, social and governance, or ESG, framework.

Alternative credit managers tend to underwrite pools of assets, such as accounts receivable, royalties and leases whose cash flows are used to service facilities typically held off corporate balance sheets, according to Sound Point’s Dean. They offer more flexibility to the borrower and tend to be more structurally complex, she said. Alternative credit investments tend to be “senior, safe and sleep at night,” according to MGG’s Racz, compared with high yield, which tends to be more junior and riskier.

Alternative credit can be tailored to a variety of risk appetites, CDPQ’s Latour said, offering profiles from equity-like returns to investment grade and high yield. “Investors in this space have this increased flexibility and it’s an advantage as we look at patterns that may affect companies that have different financial profiles,” he said.

The asset-backed market is enormous. Holsinger said about $4 trillion in size spread between the relatively liquid market for asset-backed securities and the illiquid portions of the market. Strategies include lending against such assets or outright ownership. Much of alternative credit consists of lending “into the gaps” created by the exit of bank prop desks and certain large commercial finance firms from the market. Such assets tend to be noncorrelated with other financial market assets, which provides substantial downside protection, he added.

Activity in the Treasury market has begun to cause dislocations across financial assets, according to Holsinger. The two-year Treasury is pushing the Federal Reserve and benchmarks such as SOFR higher, indicating that market participants see the Fed as behind the curve on policy.

While there is no sign of forced selling, the ABS market has slowed dramatically, Holsinger said. Banks continue to execute securitization deals, largely for the purpose of removing assets from their books. But as the liquid market grinds to a halt, activity will begin to shift into other parts of the market, where size and scale will be of benefit to alternative credit investors.

This is creating “medium to high” volatility in markets - an environment that offers attractive opportunities for investors, Holsinger said. However, investors should be patient. While swap spreads are widening and Treasury yields increasing, this has yet to filter into the more illiquid parts of the asset-backed market. The illiquid market tends to lag the liquid market by six to nine months, and investors should wait for this process to play out, as opportunities will likely be after its conclusion.

This repricing of the market, as the front end of the Treasury market seeks to catch up with the back end, is occurring in tandem with a bifurcation among consumers. Many consumers benefited from changes in FICO calculations prior to the pandemic which boosted credit scores, as well as government subsidies which helped consumers pay down debt and build savings. This migration up in presumed credit quality is beginning to unwind, as a result of which many loans rated near-prime are actually subprime in terms of borrower ability to repay. This risk is another important datapoint for market participants to consider.

--James Holloway
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