00:00:23:14 - 00:00:25:08 Thank you for joining us today. 00:00:25:08 - 00:00:30:02 Given the market environment, we thought it was a very opportune time to hold another 00:00:30:02 - 00:00:33:22 Leveraged Finance Mizuho Market Mindset discussion. 00:00:33:22 - 00:00:39:09 I have with us Jim Boland, who's my partner and runs Capital Markets, and Stefan Kullberg, 00:00:39:09 - 00:00:41:22 who helps run our CLO business. 00:00:41:22 - 00:00:43:07 So thank you for joining me, gentlemen. 00:00:43:07 - 00:00:49:18 The impact of AI on the software sector has left a big void in the market, and we've all 00:00:49:18 - 00:00:54:15 read endless articles about the impact on the term loan B market, the private credit 00:00:54:15 - 00:00:59:01 market, and to a lesser degree, the high yield market, but it really has spilled over throughout 00:00:59:01 - 00:01:01:01 the whole market. 00:01:01:01 - 00:01:06:03 What I want to talk about today is something that isn't covered as much, and that's the impact 00:01:06:03 - 00:01:07:15 on the CLO asset space. 00:01:07:15 - 00:01:12:21 And so, Stefan, can you talk to us about your market a little bit and how this is impacting 00:01:12:21 - 00:01:13:21 your investors? 00:01:14:03 - 00:01:15:00 Yeah, of course. 00:01:15:00 - 00:01:21:10 I would say software started becoming a concern Q4 of last year. 00:01:21:10 - 00:01:26:07 The CLO market from a primary perspective and a secondary perspective was largely business 00:01:26:07 - 00:01:28:14 as usual over the first two months of the year. 00:01:28:14 - 00:01:35:10 So the primary side, since February, did slow down a little bit as software became less 00:01:35:10 - 00:01:39:12 of a focus in terms of managers to be able to ramp into new issue CLOs, whereas liabilities 00:01:39:12 - 00:01:40:03 widen out. 00:01:40:03 - 00:01:44:12 Now, it's not perfectly correlated in terms of why do liabilities widen out, because we 00:01:44:12 - 00:01:47:06 did have the Iran war in the background as well over the last month. 00:01:47:06 - 00:01:51:17 But the reality is, on the new issue side, liabilities widened out. 00:01:51:17 - 00:01:57:18 Managers have decided to ramp into a smaller software bucket today, which has made the 00:01:57:18 - 00:01:59:04 arbitrage a little bit worse off. 00:01:59:04 - 00:02:02:15 And so that slowed down primary volumes over the last month or so. 00:02:02:18 - 00:02:04:14 What do you think turns that around? 00:02:05:14 - 00:02:10:15 So I think that managers are still going to be focused, at least in the near term, on issuing 00:02:10:15 - 00:02:11:01 So I think that managers are still going to be focused, at least in the near term, on issuing 00:02:11:01 - 00:02:13:21 new CLOs with a smaller software allocation. 00:02:13:21 - 00:02:20:12 So whereas pre-headlines in February, managers were comfortable ramping anywhere from a 10% 00:02:20:12 - 00:02:27:18 to 15% software bucket, new issue CLOs today are ramping with about a 5% to 8% software bucket. 00:02:27:18 - 00:02:31:15 What that means is there's probably a smaller universe of loans to buy. 00:02:31:15 - 00:02:34:10 It does make the asset side a little bit more difficult. 00:02:34:10 - 00:02:39:18 And since liabilities did widen out, largely because of the Iran conflict, a little bit 00:02:39:18 - 00:02:42:18 due to software, the arbitrage has been more challenged. 00:02:42:18 - 00:02:44:06 That has started to clear. 00:02:44:06 - 00:02:47:07 The Iran war risk premium has dissipated a bit. 00:02:47:07 - 00:02:50:12 So we are seeing AAAs as well as MSBs come tighter. 00:02:50:12 - 00:02:53:10 And we are seeing the new issue market start to open up again. 00:02:53:10 - 00:02:59:08 Jim, on our side of the fence, we've been in a very bifurcated market for some time 00:02:59:08 - 00:03:01:09 where there's have and have-nots. 00:03:01:09 - 00:03:05:12 And that's both on the industry as well as specific credits. 00:03:05:12 - 00:03:10:05 When you think about the wave of acquisition finance that came through over the last four 00:03:10:05 - 00:03:13:02 to six weeks, there was one very common theme. 00:03:13:02 - 00:03:21:03 Issuers saw a very muted term loan, new issue demand, but yet a very strong high yield bid. 00:03:21:03 - 00:03:27:02 As a result, those structures flipped from bank-to-bond for many of those transactions. 00:03:27:02 - 00:03:28:14 Is this the new normal? 00:03:28:14 - 00:03:31:22 I don't know if it's the new normal, but in the high yield market, you are definitely 00:03:31:22 - 00:03:35:18 on firmer footing relative to the CLO term loan B market. 00:03:35:18 - 00:03:37:19 And then you got a large portion — 00:03:37:19 - 00:03:42:16 a large dynamic of there is just the CLO market has been the 00:03:42:16 - 00:03:47:03 bigger investor in legacy LBOs in the software sector, more so than the high yield market. 00:03:47:03 - 00:03:51:07 It's probably up to a factor of, let's say, three to one. 00:03:51:07 - 00:03:58:00 And as a result, you see a lot more selectivity in that loan market, in the CLO market, largely 00:03:58:00 - 00:04:00:10 because it's just they're trying to afford mistakes. 00:04:00:10 - 00:04:06:03 And it's starting to spread outside of software into adjacent sectors that could also be exposed 00:04:06:03 - 00:04:08:01 to displacement from AI. 00:04:08:01 - 00:04:13:23 The high yield market has been sort of a savior, especially on a few transactions we were involved 00:04:13:23 - 00:04:19:01 with in the last couple of quarters around the ability to resize that transaction into 00:04:19:01 - 00:04:20:22 the better demand in the high yield market. 00:04:20:22 - 00:04:22:03 the better demand in the high yield market. 00:04:22:03 - 00:04:26:07 And again, it's TBD how long this is going to play out. 00:04:26:07 - 00:04:33:19 It probably really came to the forefront, I'd say late February, early March, when AI 00:04:33:19 - 00:04:38:13 started to become a big focus as a risk to displacing some of these software names. 00:04:38:13 - 00:04:44:18 And as a result, you've got perfectly performing credits that have traded into the 70s. 00:04:44:18 - 00:04:51:04 So if you're a CLO owner, historically, you haven't been the rescue money in the market. 00:04:51:04 - 00:04:57:06 So and if you're looking to mitigate exposure, you've got, again, a credit that's performing 00:04:57:06 - 00:04:58:17 by all metrics. 00:04:58:17 - 00:05:04:02 Do you really want to monetize that hit in the 70s or the 80s, even if that bid is really there? 00:05:04:02 - 00:05:09:04 Because my sense is if you try to show up with any type of size into that market to 00:05:09:04 - 00:05:12:06 sell, it's going to gap down from there. 00:05:12:06 - 00:05:18:12 So the quandary is, do you just sort of play this out and try to figure it out over time? 00:05:18:12 - 00:05:22:19 But right now, there's definitely greater strength in the high yield market than there 00:05:22:19 - 00:05:24:05 is in the CLO market. 00:05:24:05 - 00:05:28:17 And then obviously, you also have the private credit market, over there, which 00:05:28:17 - 00:05:36:13 is also over indexed to software assets, and at the same time is facing redemptions. 00:05:36:13 - 00:05:41:20 So for the last six to eight quarters, we've seen a lot of private credit deals refinance 00:05:41:20 - 00:05:46:11 into the term loan market, mainly because the interest savings is very attractive. 00:05:46:11 - 00:05:48:19 Do you think that's sustainable? 00:05:48:19 - 00:05:51:08 And where does that paper get refinanced? 00:05:51:12 - 00:05:57:05 I think the trend of, especially on the software side, of refinancing private credit into 00:05:57:05 - 00:06:00:20 the term loan B market is effectively dead. 00:06:00:20 - 00:06:05:16 That was, I think, there was a decent amount of migration, I think, in 2025. 00:06:05:16 - 00:06:09:16 But there's also, at the same time, direct credit was still very much alive in a lot 00:06:09:16 - 00:06:13:02 of these M&A processes and very competitive. 00:06:13:02 - 00:06:17:17 And we found, as of late, especially with the redemptions that's going on in the private 00:06:17:17 - 00:06:21:03 credit side, that they seem to be less— 00:06:21:03 - 00:06:25:11 you run into them less in M&A processes as a competitor 00:06:25:11 - 00:06:28:13 for financing, especially on the larger transactions. 00:06:28:13 - 00:06:33:07 They still seem to be somewhat active in some of the smaller transactions, especially in 00:06:33:07 - 00:06:34:10 the middle market. 00:06:34:10 - 00:06:40:14 But as a whole, I think the damper on both sides, both in the CLO market and the private 00:06:40:14 - 00:06:45:22 credit market, has effectively brought M&A in software to a lull. 00:06:45:22 - 00:06:46:22 credit market, has effectively brought M&A in software to a lull. 00:06:46:22 - 00:06:50:22 So you've got a lot of existing stuff that I'm sure some of these sponsors would love 00:06:50:22 - 00:06:55:20 to sell in this market, but they're going to have to take a decent haircut around valuation 00:06:55:20 - 00:06:57:13 just because I don't think the leverage is there 00:06:57:13 - 00:07:00:02 to support those transactions in this environment. 00:07:00:02 - 00:07:04:20 It's very much a risk off, the sentiment in both private credit and the CLO side. 00:07:04:20 - 00:07:10:14 Now, the difference here is the beauty of the CLO market versus a lot of these private 00:07:10:14 - 00:07:15:03 credit structures, which are set up as private BDCs, is they're obviously subject to these 00:07:15:03 - 00:07:20:21 redemptions, which you see obviously in the newspapers and on all the business channels 00:07:20:21 - 00:07:24:11 around the issues they're running into there with excess redemptions. 00:07:24:11 - 00:07:28:23 The CLO market is most of these vehicles, and Stefan, correct me here if I'm wrong, 00:07:28:23 - 00:07:32:21 but most of them are set up as 12-year locked up money. 00:07:32:21 - 00:07:35:06 You've got a lot more flexibility. 00:07:35:06 - 00:07:38:06 You're not subject to quarterly redemptions in that market. 00:07:38:06 - 00:07:43:08 So you can sort of play the string out a little bit on the risk side on a lot of these software 00:07:43:08 - 00:07:48:03 names, whereas on the private credit side, you're much more under the gun just to manage 00:07:48:03 - 00:07:49:01 these redemptions. 00:07:49:04 - 00:07:49:19 That's correct, Jim. 00:07:49:19 - 00:07:53:06 CLOs are essentially a long-term 00:07:53:06 - 00:07:56:13 non-mark-to-market vehicle, and so there is no forced 00:07:56:13 - 00:08:01:05 selling pressure from managers on underwater, underperforming software loans. 00:08:01:05 - 00:08:06:16 Now, while there are some metrics within the CLO structure that do limit things such as 00:08:06:16 - 00:08:11:06 CCC migration, defaults, etc., that may catalyze a manager to act sooner than 00:08:11:06 - 00:08:13:10 later, as of right now, managers have been 00:08:13:10 - 00:08:15:20 patient on the software exposure in their portfolios. 00:08:16:00 - 00:08:21:06 Do you think that they can play through this, or do you anticipate LMEs and other ways that 00:08:21:06 - 00:08:25:04 they have to kind of fix some of these problem spots in their portfolios? 00:08:25:04 - 00:08:31:11 I think the takeaway right now is maybe manage your exposure on the margin. 00:08:31:11 - 00:08:35:10 So there has been a little bit of lightening up on software exposure, particularly for 00:08:35:10 - 00:08:40:08 managers that have been overweight in that asset class, but the reduction in exposure 00:08:40:08 - 00:08:44:07 has been pretty small, about 50 basis points only across their portfolios. 00:08:44:07 - 00:08:46:20 Other managers have been taking a little bit of an advantage. 00:08:46:20 - 00:08:50:11 They've been bringing an underweight a little bit up, but again, it's been a pretty small 00:08:50:11 - 00:08:53:20 percentage of the overall portfolio size in terms of what they're moving. 00:08:53:20 - 00:08:58:14 Most managers right now are largely focused on managing the market values of portfolios. 00:08:58:14 - 00:09:05:10 So, willing to do swaps as in I can sell this loan at 95 and maybe buy another loan that 00:09:05:10 - 00:09:09:17 I like a little bit better at 95 as well to keep the market value in line with what was 00:09:09:17 - 00:09:12:05 existing before the software loans went down. 00:09:12:12 - 00:09:17:10 And the jet fuel for our market is really the new CLO creation. 00:09:17:10 - 00:09:22:23 You know, the last couple of weeks we've seen very anemic volumes. 00:09:22:23 - 00:09:27:20 How's the health and stability of the AAA bid, both from a cost to capital perspective 00:09:27:20 - 00:09:28:22 as well as from a demand? 00:09:29:04 - 00:09:30:09 AAA bid's very strong. 00:09:30:09 - 00:09:35:11 You know, I would actually say that largely the move that we saw over the last month in 00:09:35:11 - 00:09:41:10 change has been driven more due to Iran headlines and just general repricing of relative value 00:09:41:10 - 00:09:45:01 across both securitized products as well as credit asset classes. 00:09:45:01 - 00:09:47:13 And so CLO just moving out in kind with that. 00:09:47:13 - 00:09:53:08 Maybe on the small margin, there's been a little bit of a reshuffling of manager tiering. 00:09:53:08 - 00:09:58:14 But I think in terms of overall CLO spreads, that was reacting more to macro factors rather 00:09:58:14 - 00:10:01:06 than micro factors, i.e. the software market. 00:10:01:11 - 00:10:07:14 And by managing tiering, do you mean top tier managers versus maybe smaller new entrants? 00:10:07:14 - 00:10:11:14 The gap of cost to capital has increased over time? 00:10:11:19 - 00:10:12:13 Definitely. 00:10:12:13 - 00:10:18:15 It's definitely an opportunity for smaller managers to show their performance. 00:10:18:15 - 00:10:21:03 Either they're lower exposed to software. 00:10:21:03 - 00:10:23:04 Some are starting to ramp new issue CLOs or come to market today. 00:10:23:04 - 00:10:24:17 Some are starting to ramp new issue CLOs or come to market today. 00:10:24:17 - 00:10:28:00 It's definitely an opportunity for them to grab market share and grow faster than 00:10:28:00 - 00:10:28:03 It's definitely an opportunity for them to grab market share and grow faster than 00:10:28:03 - 00:10:29:06 they were expecting. 00:10:29:06 - 00:10:29:12 they were expecting. 00:10:29:12 - 00:10:36:16 Whereas existing managers with higher software exposure, they're more or less managing their 00:10:36:16 - 00:10:40:08 existing client base, explaining their portfolios, etc. 00:10:40:08 - 00:10:46:22 I don't think there's going to be a large move away from the large tier one managers 00:10:46:22 - 00:10:49:13 just because they're so embedded in the market. 00:10:49:13 - 00:10:50:16 These are large institutions. 00:10:50:16 - 00:10:52:23 People have faith in terms of their credit abilities. 00:10:52:23 - 00:10:55:07 And so guys will still stick with them over the long run. 00:10:55:15 - 00:11:01:11 And Jim, from a new issue perspective in the secondary, it's super interesting because 00:11:01:11 - 00:11:08:16 absent a few sectors that are very challenged, other parts of the market, deals are getting 00:11:08:16 - 00:11:12:23 printed at tighter credit spreads than we saw in Q1 or even Q4 last year. 00:11:12:23 - 00:11:17:14 And so again, it's that bifurcation that we're seeing. 00:11:17:14 - 00:11:26:02 How do we leg out of this market and what is your guess of the trajectory as we begin 00:11:26:02 - 00:11:28:19 to cure these more problem spots in the market? 00:11:29:03 - 00:11:29:11 You know Jeb, you're absolutely right. 00:11:29:11 - 00:11:30:22 You know Jeb, you're absolutely right. 00:11:30:22 - 00:11:37:01 Away from software and some tangential sectors to that, you are definitely seeing old economy 00:11:37:01 - 00:11:40:14 names embraced in part of this market. 00:11:40:14 - 00:11:44:08 And some of them are, from a pricing standpoint, as good as it was last year 00:11:44:08 - 00:11:48:01 pre this shake out in the software sector. 00:11:48:01 - 00:11:55:00 What sort of solves this is historically when you look at some of these cycles where you've 00:11:55:00 - 00:11:57:18 gotten credit as a whole has gotten disintermediated, 00:11:57:18 - 00:12:01:05 it's usually been an opportunistic new money 00:12:01:05 - 00:12:04:10 investor or an existing manager bringing up a new side pool of capital to take advantage 00:12:04:10 - 00:12:07:17 investor or an existing manager bringing up a new side pool of capital to take advantage 00:12:07:17 - 00:12:09:17 of the dislocation. 00:12:09:17 - 00:12:16:07 I think since this has really been a so far two-month play or sell-off in the software 00:12:16:07 - 00:12:21:07 sector, you haven't seen that opportunistic capital arrive yet. 00:12:21:07 - 00:12:25:09 But at some point, it's just going to get so cheap that it's going to get really interesting. 00:12:25:09 - 00:12:30:21 There's a lot of talk around high yield sort of stepping in to pick up some of these 00:12:30:21 - 00:12:38:15 discounted assets or for new money deals since they're less impacted by the software exposure 00:12:38:15 - 00:12:44:09 you're seeing in the CLO market as being a place to go in terms of selling some of this 00:12:44:09 - 00:12:45:18 risk into. 00:12:45:18 - 00:12:47:19 It just feels early. 00:12:47:19 - 00:12:51:02 It feels like a lot of these credits that are performing should not be trading where 00:12:51:02 - 00:12:55:16 they are, but it's just a fundamental of the current marketplace. 00:12:55:16 - 00:12:57:14 So I'd say only time will tell. 00:12:57:14 - 00:13:02:08 But usually what sort of steps in here is there's new money that's sort of targeted 00:13:02:08 - 00:13:03:13 at this dislocation. 00:13:03:13 - 00:13:05:01 We just haven't seen that in size yet. 00:13:05:04 - 00:13:07:12 Yeah, and look, it puts into perspective. 00:13:07:12 - 00:13:09:08 It is a quarter-plus that we've seen this. 00:13:09:08 - 00:13:12:16 It just feels a lot longer that we've been in this market environment. 00:13:12:16 - 00:13:18:02 And I would just add, I think the dearth of M&A and the lack of pipeline that's across 00:13:18:02 - 00:13:22:19 the street will help carry the market as well because people will have to eventually look 00:13:22:19 - 00:13:24:10 for ways to put money to work. 00:13:24:16 - 00:13:26:07 I would completely agree. 00:13:26:07 - 00:13:30:22 You're definitely, especially after the latest larger transactions that just went 00:13:30:22 - 00:13:37:17 through the market, there is definitely a drop-off in the backlog in terms of near-term 00:13:37:17 - 00:13:41:20 M&A volumes or new money volumes coming to this market. 00:13:41:20 - 00:13:46:06 We're starting to see a little bit of a pickup on that on the M&A side, but there's 00:13:46:06 - 00:13:52:11 definitely going to be a supply drop-off where some of this existing paper that's trading 00:13:52:11 - 00:13:57:07 at deeper discounts, you may see a little bit of upside or a little bit more interest 00:13:57:07 - 00:13:58:12 in picking up some of that exposure. 00:13:58:17 - 00:14:04:09 And one last question, what KPI are you watching that you think is important for investors 00:14:04:09 - 00:14:06:15 and issuers to keep an eye on? 00:14:07:00 - 00:14:11:03 I think for individual software loans, earnings are going to be closely watched because largely 00:14:11:03 - 00:14:11:21 I think for individual software loans, earnings are going to be closely watched because largely 00:14:11:21 - 00:14:15:06 we've had this price migration despite earnings staying 00:14:15:06 - 00:14:18:19 relatively decent across the entire sector. 00:14:18:19 - 00:14:20:13 We've seen this big move in price. 00:14:20:13 - 00:14:23:18 Rating agencies said, “look, there's been a move in price, but there hasn't been any 00:14:23:18 - 00:14:26:21 catalyst for us to actually think about downgrading these ratings.” 00:14:26:21 - 00:14:32:18 Obviously, if the software sector starts becoming more at risk of downgrades, there could be 00:14:32:18 - 00:14:36:21 more price pressure there as managers do start to think about CCC migration within 00:14:36:21 - 00:14:38:01 their portfolios. 00:14:38:01 - 00:14:42:23 Absent of that, one catalyst to the upside is definitely loan inflows. 00:14:42:23 - 00:14:48:00 I do think that one of the bigger drivers of the price action that we saw in February 00:14:48:00 - 00:14:52:07 was more ETF loan outflows, retail loan fund outflows as well. 00:14:52:07 - 00:14:57:00 Because like I said, CLOs were not the seller of BSL software loans back in February. 00:14:57:00 - 00:14:59:00 They sold on the margin in small amounts. 00:14:59:00 - 00:15:05:16 It was largely just loan outflows and more of a repricing of what bid do these loans clear at. 00:15:05:22 - 00:15:08:01 Well, look, never a dull moment. 00:15:08:01 - 00:15:10:12 There's always curveballs thrown at us. 00:15:10:12 - 00:15:15:08 And as Jim said appropriately, we're in the early innings of this market and it's balanced 00:15:15:08 - 00:15:18:16 with a very constructive market for the vast majority of issuers. 00:15:18:16 - 00:15:21:07 So we look forward to smoother market environments 00:15:21:07 - 00:15:23:23 and continuing discussions on the market. 00:15:23:23 - 00:15:24:23 Thank you for your time today.