CLO Clash, Twitter Debt Drama; Technology Focus

seems too much, too fast. Where does it all end. We'll get to that in a little bit, but before we do, I've got windmills on my mind. Of course, we all love sustainable energy. Everyone wants to save the planet. But did you read the wind turbines taller than the Statue of Liberty are falling over. There was a great Business Week story this week on that they set the scene out there in Oklahoma, a beautiful place. I used

to live. There by the way, on a calm, sunny day, a man was feeding his cattle when he got the call from a local sheriff's dispatcher. A motorist reported that one of the huge turbines at a nearby wind farm had collapsed in dramatic fashion. The steel tower, which was hundreds of feet tall, was buckled in half, and the turbine blades, whose rotation took the machine higher than the Statue of Liberty, was splayed across the wheat fields below. What do you make of this? You know? Is it

the end of sustainable energy? What about windmills? Who likes windmills? Here? What do you think, Paula, I'm just trying to imagine watching this thing fall straight down. I want to know the thud that it makes when it hits the ground. But yeah, I mean, I don't know. I hope they sorted out because I definitely want more wind energy. Personally, I think my biggest concern would be that the price of weed is going up and I have to pay more for my bagels. Possible A good angle, good angle.

Don't get me started on ESG investment though, it's another topic for a different episode, I'm sure, But anyway. Paula Sellison, she's our ACE reporter in New York City covering all things credit. She's been behind some of the biggest scoops on your Bloomberg terminal over the last few years, and it's great to have you here in the studio. Thanks for having me. The latest big story from Paula. Well, it's a bit technical, but we're going to go into

it and break it down. Feel free to interrupt anytime, Robbie if you have any questions. Here's the headline, fed up CLO buyers push managers to reject terms of libel switch. So let's start with the obvious one. What is a CLO and why do we care? That is a great question, and I am happy to be in a podcast where I can get pretty wonky because usually I can't get into this much detail normally. So CLO stands for collateralized

loan obligation. That's a really fancy way of saying it's a structured product where people basically buy a bunch of really risky leverage loans, which is a form of corporate debt, and then they put it together in a big pool, and then they sell slices of it in the form

of bonds in different tronches. And this could be triple A tronch which is very very safe, almost no chance of losing money, all the way down to double A and lower and then Eventually you get to the equity portion, which essentially gets what's left over in the structure at the end of each period. And you know, this is

essentially a way to find It's a way. It's it's a lot of demand for leverage loans, so clos buy roughly two thirds or more of the leverage loan market, and so they also drive demand for buying leverage loans. It's a way. It sounds like a total casino here. You've lost me already. Is it like a CDO, the thing that blew up the financial system in two thousand and eight. I'm glad you asked that, because everyone in the CLO market hates that comparison, and they remind me

of it all the time. Structurally, it is similar to a CDO with the tranches and things like that. But as participants in the space like to remind everyone, clos did not blow up. In fact, even though they are, you know, part they use leverage loans, which are risky, highly indebted companies that have borrowed money. But the way the loans are structured, they're what's called secured, which means there's a lot of assets backing the loans. So even

if that company went bankrupt. This type of lenders should be made fairly whole of assuming everything goes well. So it's both risky also safe at the same time. So they buy leverage loans. They also sound really scary. What a leverage loans? Can you break that down for us? Yeah, So, if you think about sort of the universe of investing, there's equity and then there's debt, right, and so debt

is split up pretty much by its ratings. Anything above a certain rating is considered investment grade, which is fairly safe, and anything below a certain rating is considered high yield or junk. And so within that space you have two types of debt. You have junk bonds and leverage loans. And so leverage loan just means it's a loan where it is borrowed by a company that is rated high

yield by ratings agencies. And these distinctions are very important because the types of investors who buy each form of debt are very different often and it's sort of split up within a portfolio. You know, this is our sector that's buying just hiled bonds. This is our portfolio manager who's just buying investment grade bonds, and so leverage loans

are just sort of part of this overall universe. One of these big loans made to companies are the companies that we've never heard of that are lurking in the shadows, the household names. It's usually not household names. The household names borrow with investment grade bonds and you've heard all of them before. You know, high yield rated companies can range from you know, some oil and gas companies to

people who make you know, aftermarket auto parts. It's often a really key part of the world, but it's kind of the part that you don't notice day today. So thank you for that. I think it's becoming clear now. But going back to the headline, fed up clo buyers push managers to reject terms of libel switch. What's the situation with the managers pushing back? Why are they doing that? That's a great question. So I kind of have to take a step back to explain the libor switch to

begin with. So libor, the London interbake offer rate, sorry, London Interbank Offered rate, is this key benchmark that was used across the world for many, many years. As the financial crisis unfolded, it was discovered that this was basically being fixed by a bunch of banks in London. It was a huge scandal and regulators across the globe decided

they had to get rid of it. One of the key differences is as they've transitioned away from LIBOR, is that instead of it being one rate for the whole world, now each region has its own rate, and so the overall preferred replacement rate in the United States is for something called the secured Overnight Financing Rate or SOFUR. So we're in the midst of this transition. It's very complicated

and very messy. So essentially everyone who is doing new deals had to stop using LIBOR at the beginning of twenty twenty two, but any existing deals have until the middle of twenty twenty three to make that switch. And we are in the very final stretch the last six months of this and the one point four trillion dollars US leverage loan market. Only about twenty five percent of these loans of switch so far, so we have about seventy five percent left now. Enter CLOS and what's going

on there. So, as I mentioned before, Clos they are one of the biggest buyers of leverage loans, So what CLO managers are doing really impacts the entire leverage loan market. So within that you have the cloquity investor that's buying the riskiest tranche of clos And essentially there's this issue, which is that libor and sofur are not the same. SOFA typically prints consistently lower than libor. So if you just switched a loan from libor to sofur, the lenders

who lend that money immediately lose money. It's only a few basis points. It depends on the day because all of this moves around. It could be you know, a point oh five percent, maybe point one percent, depending on what's going on, But that can add up a lot

if you have a multimillion dollars portfolio of these assets. Right, So for CLO equity investors specifically, because they're getting the left over and what's left in the CLO after everyone else has been paid this interest, if there's a mismatch, it really hurts them and they can be on the line to lose millions of dollars. So it's all about the money. It's always about the money. Yeah, So basically CLO equity investors care because if they don't have what

they consider a fair switch from Libor to sofur. They are the ones who lose money specifically. And so the big news that myself and my colleague Carmen Arroyo were able to break this week is that the Cello equity investors are actually organizing. So typically these markets are very you know, maybe you call your friend, maybe you instant message someone, but they're fairly unorganized and each actor is

sort of acting on its own. But Eagle Point Credit specifically organized a call in early January to get a bunch of equity investors on the phone, and they all essentially discussed how they wanted a specific type of transition from libor to sover. They wanted this special rate that's the maximum rate they can get between the two benchmarks, and so they essentially said, okay, guys, we've talked about this.

Now you should go to the Cello managers, the ones actually making these decisions, and ask them to ask for this highest version of this rate as these companies try to transition. Fascinating. Thank you for breaking that down. Clos leverage loans. Let's watch for more news on that, But before we go to Rob for a deep dive, into tech.

Let's ask you, also, Paul It about Twitter, because you've been following that one very closely, and they have some money that they have to pay on some debt because Elon Musk spent billions buying the thing and then breaking it all apart. What's going on there? Yes, so the first deadline is coming up. Let's rewind for a second.

When Elon Musk decided to acquire Twitter, he raised thirty three point five billion in equity commitments, but he also raised roughly twelve billion dollars of debt from a bunch of banks. And those banks actually had to fund all of that debt themselves because they weren't able to sell it to outside investors. So banks are the Twitter lenders right now, not like institutional asset managers like we normally see. And so you know, before Twitter's interest expense was less

than one hundred million dollars a year. Now that Elon Musk added all this debt onto the company's balance sheet, it's annual interest expense is exceeding one point two billion dollars a year. So just think about how impactful that is for a company that wasn't making a ton of money to begin and so the way all this works is the first coupons should be coming due roughly three months after it closed, which should place it around this Friday.

So Twitter will have to pay interest of roughly three hundred million dollars to a group of banks led by Morgan Stanley. There's been some questions are they going to pay it? Are they not going to pay it? I think? I mean, look, it's Elon Musk, so who knows. He is a wild card. He might do things that are

very unexpected. But there's no real reason for him not to pay it at this point because if he did not pay this interest, or I should say, if Elon Musks not have Twitter pay this interest to the banks, then after some period of time, the banks could force a default which would force it into bankruptcy, and then

the banks would probably end up owning Twitter. So really, unless it was some kind of strange negotiating tactic, there's no reason for Elon Musk to not have this interest paid unless he's willing to walk away from the company, which I don't think he's there yet. Do we think the banks want to own Twitter? I think they do not want to own Twitter. I think that they wish they could have sold this debt. Banks don't want to

hold this type of debt. They want to sell it and move it off their books and just make a huge fee in the tune of multimillion dollars. So they want to move it. So I think what they probably most sincerely hope is that Elon Musk works a miracle, makes Twitter amazing, and then they can offload this debt in a few quarters. And the interesting thing is, yeah,

I covered Twitter, and bondholders made out great. Bondholders had a one on one change of control, so not just equity holders got paid here, but original bondholders, legacy bond holders got paid. So the only ones really who are left holding the bag right now is Musk himself with all his equity exposure and the banks. And I agree. Banks never want to hold on to loans. They want to sell them as fast as I can. And if there was a bid for those loans right now, they'd

be gone. Eventually, they'll reach a price where I think institutional investors will own them, but it's probably going to take a little while. Great story, and we'll be watching for your updates. Poor as we hit the deadline for repayments and Also, as you said, it's Elon Musk. Anything could happen, so it's gonna be exciting times. So let's switch gears now, rub rub Shiftman, bloom Bug Intelligence. You specialize in the tech sector and that's really where a

lot of the drama is right now. Um, you know, big tech stock and bond returns with significantly negative last year. But we're going through earnings. Now what do we expect from that? And you know, are the fundamentals deteriorating? And you know, what do we expect for this year? What's the outlook? Yeah, my world is so much easier than Paulus. You know, my companies they sell a lot of gadgets, make a lot of money. Stocks go up, bonds go up, they sell a lot less stuff, and you have the reverse.

The reality is there's a huge economy between technology equity performance and bond performance. It looks like last year that returns were similar. You know, in general big tech was down, say twenty five percent, and tech high gratee tech bonds were also down twenty to twenty five percent. But the reality is mom and pop might be buying Apple or

Microsoft or Google, but they're not buying their bonds. Institutional investors are buying their bonds, and rather than just just outright taking rate risk and credit risk, institutional investors hedge. So excess returns on tech last year were really like three hundred basis points, you know, not that much of a loss. The vast majority of loss for bonds or we're affected by rising rates. So what do we have

as we walk into the beginning of this year. We have rates that have stabilized to gone down, spreads that have stabilized to gone down, and we've got positive returns across the board. Lo and behold. We walk into early earning season with hopes that the worst is gone, and you have Microsoft in Texas Instruments report both huge bellweathers. Right, Microsoft has this massive cloud business and they're saying that

it's going to continue to decelerate next quarter. Texas Centuriance is an analog semiconductor business, which means that pretty much they sell to every business incorporation that provides any gadget that's not a phone or a PC, but pretty much everything else. And their business is down as well. So it sort of bodes poorly for Industrial America. It boats poorly for big tech, whether it's cloud businesses like Amazon or Alphabet, and it also continues to bode poorly for

semiconductors across the board. That being said, credit quality for big tech is dramatically better than people perceive equity valuations. Equity valuations might be down twenty five thirty five percent, but credit quality across the board last year really didn't change, and in fact, in many cases it actually got better. And I I think that's going to be the model for this year, is that we're going to worry when we really hit the bottom, and whenever we do, that'll

define when we can see a long standing rally. But in the meantime, tech credit is a place for people to put their money, hide, tuck it under a pillow, and worry about other things. We're not worried about the supply chain though, because that was a really big issue last year and there are problems with the China and all sorts of other issues around the world. I mean, how does that affect this sector. Well, listen, bond folks

worry about everything, you know. I worry about whether or notf the train is going to be on time, or how much snows there is going to be tomorrow. So yeah, there's Listen, there's lots of macro headwinds, whether it's wars, whether it's COVID, whether it's supply, whether it's demand. We're always concerned that. Being said, the margin of error for

big tech is enormous. Like I tend to wonder when when we really think about credit quality, does it matter if Microsoft has sixty billion of free cash flow this year or fifty billion. You know, it does matter, But it matters more to the equity holder because they're going to get less returned. The bond holder is still going to get their coupon. This is not a question of Twitter and whether Musk is going to make a coupon payment.

The vast majority of tech names and large internet names our investment grade have tens if not over one hundred billion dollars of cash generate tens of billion dollars of free cash flow. I do think this is going to be a continued down earning cycle. I think revenues are going to continue to trend downwards. And what we've seen to start off earning season is that we have not reached the bottom. Nobody is forecasting yet. When we've seen

an inflection point in revenues and cash flows. So headwinds are going to continue to be out there, but I think incrementally relative to the concerns that people had last year, the vast majority of the bad news is already baked into most of these names. Again, I'm not an equity guy, but I think it's mostly from the equity side as well as from the credit side. But as you say, they've got billions on their balance sheet, why do they keep issuing new debt and they issue about one hundred

billion dollars a year. Yeah, we get to ask that question all the time. And you know, part of it is weighted average cost of capital issue. You know, if your cost of equity is ten percent and your weighted average cost of debt is only one percent, you know, economics just say, let's issue more debt that's really done in a little bit of a lower rate, higher valuation

and environment. You know, one of the main reasons that big tech, whether it's Apple, Microsoft, Google, Amazon, or now Meta has come to the market is because they want enhanced financial flexibility to buy back stock. We are seeing just you know, massive record breaking stock and dividend payments. I don't think that's going to end. You know, when you see valuations go down, you buy back more. You

don't need to be more conservative. Apples sitting one hundred and seventy billion dollars of cash, they've got nothing to buy. What do you do with the money? You give it back to shareholders, and you give it back in size. You know, we've projected for a name like Apple, over the next couple of years, they're going to get to a point that in the past, in the past decade, they're gonna have given back a trillion dollars of cash

in both share buybacks and dividends. So you borrow more and give it to shareholders, and that's, you know, all a risk that bondholders always have to take. I think we're going to see more of that. There's little need for M and A financing, though there are a couple deals out there that need to be funded. You know. One of the tails is like is Microsoft is trying to buy Activation for sixty nine billion dollars of cash. They don't have a bank loan, they're not relying on

the capital markets for that. They're sitting on close to one hundred billion dollars of cash. They just write the check,

But what do they do afterwards? To me, they write the check, and then they go out and issue fifty billion of bonds and reload on cash to either give back to shaholders or do some form of other M and A. In some of the big tech space, you know, if you're an alphabet or a meta or even an Apple, the government is going to try to block everything, so it's hard to write a big enough check for a transaction that's going to put your balance sheet at risk. So I think we continue to see this pattern, so

it's going to be pure opportunistic financing. I think as soon as rates start going down again, even though companies don't need it, tech borrowing is going to click back over that hundred billion dollars annually that we've seen over the past decade. Are there any particular issues or parts of the tech sector that you like and you think

we'll outperform over the next twelve months. Yeah, listen, I think tech overall is going to outperform, particularly high quality tech, And I think you want to take a Barbell approach. You know that there's there's sort of two ways to play it. Super high quality names that are really liquid, they trade tight, but have limited volatility. That Apple Microsoft, Google, and even Amazon Amazons is a ton of debt. They've had so much in terms of warnings of their business,

cash flying out the door, and bonds barely move. So I think you move up the quality for names like that, and then you move down in quality to the triple B space where names have either levered up for M and A or buybacks, but know that they've reached the point where they can't put their their investment grade ratings at risk. And that's a broad calm or an intel. You know, massive balance sheets, large transactions that that's levered up.

That's levered them up. They've borrowed a ton, but spreads are now much wider than other triple B industrials. Yet fundamentals suggest that they can deliver pretty rapidly. And you know the benefit that you have from buying large triple B tech that's been aggressive is that if you have fifty billion, seventy five billion, one hundred billion dollars a debt, you cannot be a junkraded company because you cannot stay in business. You're seeing that with Twitter on a much

smaller scale. So you get to that point where you push the boundaries of low trip will be and then everybody becomes a bondholder's best friend, and you deliver. Bonditors can take advantage of that. You add to those names, and as soon as they go through that delivering process and they start stabilizing and they get ready to reload on that next deal or that next big buyback, that's when you get out. But you can pick incremental yield down the curve, and you can get safety up the curve.

So just one area of jug and that popped out when you were talking barbell approach. What on earth do you mean by that? Well, you know, listen, you can look at my physique and you tell a workout a ton. You know, when you load up a giant barbell, you put heavy weights on both sides, it sort of bends in the middle and both ends stay much lower to

the ground. That's what we're talking about. You can buy both ends of the spectrum that offer potentially lower risk and higher reward without all stress of being in the middle of those names that are smaller, that have much more violatility, that could bounce around that much more. But the the outlet you're giving is quite rosy. One we're potentially heading into a recession. You know, the inflation hasn't gone away, as you mentioned, all the geopolitical noise out there,

and you know, earnings maybe maybe getting pretty tough. And also we've had a huge rally in the first month of the year, I mean, the best best January for investment grade globally. Ever, it looks like based on our data, so is there still value and you know, is there's still room to perform better even at that level or do we expected to sort of cool off a bit from here? Yeah. Listen, if I had the crystal ball that could call returns, I wouldn't be sitting in this seat.

I'd be sitting in a much more leathery, plush sort of seat. That being said, I think, you know, in this space, the risk is reasonably limited, excess financial flexibility, high quality, free cash flow. I do think, like you know, the street gets way ahead of where fundamentals are. The you know, stock and bond prices saw this last year. The vast majority of the pain was taken well before it showed up in fundamentals. So now that we start

to see fundamentals finally declining, it's really no surprise. And that's where when I say we look for hints of this inflection point, because I think once you find that bottom is when things get much much better and valuations improve dramatically. So I think even though the fundamentals are are really starting to show up as negative, it's actually a brighter point when it comes to valuation, particularly for those that have higher credit quality and don't have that

same sort of downsize risk. So you know, I know it sounds overly bullish. Um, it's because these names are super super well positioned. You know, you could even throw out names like I cover China. Um, names like Ali Baba and ten Cent that got absolutely annihilated over the last two years, you know. And what's happened over the last just a few months. You know, there's been this huge uptick in both bond and equity prices, just on the hope that the worst is starting to come to

the end. You're still seeing um negative fundamentals, but once you realize that the downside is mostly out of the way, that's when markets rally. So um, you know, I listen, I don't I don't know what returns are going to be over the next two minutes, two hours, two days, through months, two years, But I do know this space is much better position than generic industrials and that you know, these companies that sell tens hundreds of billions of dollars

of goods do so for a reason. They've got they've got the products that people want, got the financial muscle to take smaller players out of business. They're running pseudo monopolies, and as soon as demand picks up, they're going to get at all. So it's just a matter of more more cyclical concerns than secular ones. Okay, thank you. But also, being a journalist, I'm extremely pessimistic just by nature, and also i'm a credit journalist as well as that just

makes me doubly pessimistic. And that's being British also makes me even more pessimistic. But that's what makes markets. Apple sorry no alphabets. Google recently sued by the Department of Justice, and you know that's not good news. Surely, what does that all mean? Yeah, I hate to sort of pooh pooh what seems to be pretty bad news. You know a lot of these companies also, you know, not only are they going through legal fights with the government, but

they they've been firing a bunch of people. You know, oftentimes you see stocks rally when you fire peoplecause you're gonna save costs. You know, generally those moves are sort of small when when it comes to legal risk. Listen, legal risk takes a long time to play out, years, if not decades. You know. A lot of this is political theater. Tech names, whether it's it's meta, Apple, Microsoft, Alphabet have been under scrutiny um for a long time, you know, but they also have a lot of political

capital on their side. And I think that you know that when the government wants to show strength, they they they hire lawyers and start a lawsuit. In the end. You know, do I think Alphabet's going to get broken up? No? Do I think they'll have to change some business practices and maybe pay a small fine. Yes, we've seen this game before. It takes a long time to play out, you know. I actually think when when names trade down on something like that, it's more opportunity than than true

downside risk. You actually saw Alphabet barely budged when these headlines came out. Also, this has been in the works now for you know, more than a year, so it hasn't really surprised anybody. Um, So we're looking for like new real news I just don't think this is it from a credit perspective. You know, Alphabet only has um you know, a little over ten billion of bonds outstanding. They trade supertight with double A ratings. I just don't

see bond spreads going anywhere. And as you mentioned, layoffs are kind of piling up. Is that good for credit? Yeah, it's you know, it's one of those other things. You know, it's bad for main street, good for wall streets type of thing. It's certainly an indication that demand is on the decline and you want to save costs. The reality is, though, you know, when you start looking at some of these companies with layoffs. You know, Amazon for instance, moved layoffs

up from ten thousand to eighteen thousand. You know, but take take a look. You know, they hired five hundred thousand people since at the beginning of COVID, so you know, from a from a percentage of workers perspective, it's pretty close to zero impact. When you think about where they're positioned relative to two years ago, they still have many more employees. So the rate of growth is likely to slow. That doesn't mean growth is going to slow, you know,

So I listen, I hate to see layoffs. It's not good for anyone. But once when it comes to security, pricing and credit, you know, unfortunately it is generally received as positive. Thank you very much, Robert Schiffman. Bloomberg Intelligence will watch your analysis of the tech sector with great interest. And to just wrap things up here, I mean, as I mentioned at the beginning, credit markets have done a

huge amount this year. Every market has really rallied, and that's from a very low base because last year was such a terrible year and everyone wants to forget that and move on. But it seems like everyone only wants to look at the good news now and they only want to think about what could be bullish for for this sector, this asset class. I'm wondering, you know, from your perspective, both of you. I mean, you're you're watching this day and day out. I'm sort of buried in

it myself. What is your biggest fear right now in terms of the next phase of this cycle? And we are we going to suddenly be booted off our track? Is the is the bullish thing suddenly going to go bust? How does this move in the next you know, three three months or so. What's what's your view, Paula Paula Selexon from Bloomberg News. I think a lot of investors

are keen to see what private companies report. The way debt works is a lot of private companies issue debt there and so these investors have access to private company earnings. They come out after public company earnings, So it'll be about a month or so after the current rush we're seeing in the market, and that will give us a really good clue into just how impacted these companies are by really two things. Recession slash potential recession how bad

you know that's affecting revenues. But then also the cost of borrowing has increased a lot. A lot of these companies have floating rate debts, so as the FED increases interest rates, their actual interest to every quarter has increased a lot, and so that really eats into cash flow. So I think there's a very big question mark over who are going to be the losers in that and who are not going to be able to support their debt loads going forward. Yeah, I think the FED is

a positive catalyst. You know, just like I said, as you start getting near the bottom, if the FED starts slowing down and we go to twenty five basis points for from fifty basis points increases with hints that they're coming to an end. You know. I think if you see a rate rally, you know, it's obviously enorm positive for credit. From a fundamental perspective, I don't see fundamentals getting much better over the next few quarters. But again

we can separate fundamentals, um from from valuation. You know, it's UM. I think the biggest concerns that we that we have are not things like true supply and demand there they're big exogenous changes um UM, like war and covid um as is I think, UM, you know, as those issues hopefully start to go into the background, UM,

there's there's meaningfully more upside. And I just think people always need to take a step back to last big dynamic shifts in the market, you know, and the real last one, um it was the beginning of covid um. Market bounced back very quickly. If we go back to the last one and go back to OA to the financial crisis, and go back to Paul thies um collateralized

issues from the housing market that really crushed us. You know, banks are in much better financial position than they were you know eight, corporate bounce sheets are in much better financial position than they are in Oh eight. Rates historically are still reasonably low, and the cost of borrowing is historically low. And that's why I think when we start talking about recession, you're talking about not a real deep recession. So it's you know, what are those real risks to me? There? There?

It's the FED number one, and then it's always that exogenous risk. And if you can sort of avoid the Fed getting meaningfully more hawkish, and I think fundamentals as we get to the back half the year start getting better, you know, and it sets us up for I think a strong second half of the year from a credit performance perspective, as well as twenty twenty four. Thank you

very much. Rob Schiffman, who looks at the tech sects of a Bloomberg intelligence ending on a high notes, also thank you very much, indeed too, PAULA Selson, credit reporter in New York City. I'm James Crumby at Bloomberg News, and thank you very much for joining us for they Credit Edge