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Nicolle Liu

Brett Klein, Sculptor Capital’s global head of corporate credit, manages both performing and distressed corporate credit investments at the firm. In a conversation with 9fin, he detailed the firm’s strategic approach to liability management and discussed how Sculptor Capital is preparing for looming macroeconomic and political challenges.

1. You started your career at Sculptor investing in credit. What are the big trends/differences in today’s market, compared with when you started at the firm?

Having been at Sculptor for over 22 years, I've seen significant evolution in both credit markets and in our approach to continue to stay ahead of the curve.

For example, when I first started at Sculptor, our corporate credit business was strictly confined to distressed investments. Granted there were a number of distressed investments to make around the bursting of the tech bubble and then again around the GFC.

Since then, not only do we believe distressed market dynamics have changed, but we've also evolved our model to be through-the-cycle credit investors.

One important development that has given us an edge in investing through the cycle was the construction of our CLO business. We have a team of performing credit analysts with sector expertise that provide our opportunistic credit business with constant insights while also helping to source opportunities.

In a market with increased sophistication and competition, our entire credit engine is well-equipped to tackle the most important aspect defining credit markets today — liability management exchanges.

2. There are a lot of headwinds in the media and broadcasting sectors for credit investors at the moment. How are you approaching these industries?

There have been numerous headlines regarding large credits in the media and broadcasting space. There is a significant offensive opportunity for our business, but we need to be mindful of protecting our capital given recent trends.

On the CLO side, we are approaching these sectors very carefully and keeping our exposures manageable while giving ourselves the flexibility to grow or shrink as more information becomes available. Simultaneously, our opportunistic credit team looks to capitalize on this dislocation by utilizing our holistic approach to credit investing and the broad resources of the firm.

The single biggest concern and driver of these headlines is related to liability management and how equity owners plan to address their upcoming maturities of highly leveraged capital structures. A key component of how we invest in these companies broadly is to understand and anticipate what a company and its creditors can do vis-à-vis their credit documents. This is often more art than science as we determine what is possible.

With regard to our CLOs, getting an early read on these situations, having specialists who are experts in complex credit markets, and understanding the latest technology deployed in such transactions have helped us prevent some of the very aggressive LME transactions that were consummated over the last 18 months.

In instances where industry weakness or the fear of liability management creates a value opportunity, our opportunistic credit team looks to creatively solve a borrower’s capital structure needs. By structuring new instruments or amending existing ones, we can help reposition the capital structure, offering tailored solutions that address both immediate liabilities and long-term strategic goals. This offensive and defensive approach not only mitigates risks in existing positions but also leverages market dislocations to find value for our investors.

3. We have seen lenders organizing increasingly early for potential liability management exercises at struggling companies. How is this impacting the way you think about your loan portfolio?

We have taken measures to have smaller and more numerous positions which enables us to more easily rotate our positions when we believe there may be a LME deal on the horizon or if fundamentals deteriorate further.

While being a large creditor does have some benefits in an LME transaction, we have found that from a portfolio management perspective, there is a net benefit to maintaining the flexibility afforded by smaller positions.

In addition, by having an Opportunistic Credit business alongside our CLO business, we can take a view on the situations where we might want to co-invest from different pools of capital in order to actively work with the borrower on solving their immediate needs. Ultimately, our best ideas come from being in the driver’s seat and influencing outcomes.

4. Loose credit docs from deals underwritten in hot markets often permit sponsors to make controversial maneuvers in some of these LMEs. Do you think this will impact the willingness and ability of investors to push for tighter docs in today’s new issue market?

One would think that as a result of aggressive LME, some of the negative outcomes we have seen in the market would lead creditors to demand stronger protections. While some of the acute issues with credit agreements over the past decade have been partially addressed, documents today are weak compared to those of a previous generation.

It is surprising given the fact that LME is the biggest fear and topic of conversation among creditors. In the past, following periods of distress, creditors demanded stronger agreements, but these protections tend to fade over time as demand outstrips supply on the new loan creations side. This, in turn, leads investors to give up certain protections in order to secure allocations to a new issue, with the hope to never need to rely on those protections.

As LME technology has advanced, I would argue that you always want protections on changes to documents and collateral, regardless of how you expect the company to perform.

5. CLO formation is running at record pace so far this year. How do you think 2024 deals will perform for equity investors relative to other recent vintages?

The one thing that has proven invaluable over time in the CLO market is strong liability execution. In 2024, we have seen AAA spreads tighten to inside S+140bps, which is basically back to where we were on a LIBOR basis in 2021, translating to the CLO 2.0/3.0 tights. Mezzanine tranches have also tightened meaningfully which, in a vacuum with tighter AAA levels, should lead to higher long-term returns.

While loans have also benefited from the tightening environment, we believe CLO equity will benefit from the current market structure. CLOs are modeled to invest for five to seven years (for a five-year investment vehicle) and have historically been able to capitalize on wider spreads throughout their reinvestment periods.

The one thing that can never be replaced, though, is tight liability execution, which exists for the lifetime of the deal. We believe this transaction structure, combined with underwriting vigilance and a dynamic approach to collateral protection, will be materially beneficial to CLO equity.

6. What does competition for talent look like in the credit market at the moment? Where’s the greatest demand for resources coming from on the hiring side?

While there has been significant demand for talent across all facets of the credit markets given strong investor interest in all forms of credit strategies, we believe that has started to abate, particularly for those that are attracted to working on behalf of a collaborative opportunistic platform.

Over the last six months we have hired meaningfully across our broader Credit business. This expansion has allowed us to strengthen our capabilities and enhance our team's expertise, ensuring we are well-positioned to navigate the complexities of the current market environment with a broad and flexible talent bench. As we continue to grow our credit business, we have invested in areas including our CLO platform as well as our Opportunistic Credit business.

7. How is the growth of private credit impacting fundraising for CLO and broadly syndicated loan funds?

The private credit market has been active for a long time, though it was largely billed as the middle market for many years. Over the past decade we have seen significant growth in this asset class. Specifically, we now see the private market in many of the same type of transactions that historically were covered by the syndicated market.

From mid-2021 through mid-2023, with the BSL markets largely closed and CLO formation at its local lows, many investors turned to private credit lenders for loans. And while the issuance market seems to have swung back the other way in 2024, private credit markets have not necessarily slowed down.

Competitive tension is key for borrowers in the credit markets, and they will naturally gravitate toward the market that suits them best at a given time. It is not uncommon to see a single company approach both the public market and the private market to evaluate its financing opportunities at this point.

We believe that there is a place for both BSL and private credit, and the size of each market will grow and fall depending on where the other one is at the time. Individual lenders have more choice and can determine if the specific needs of the company align with their lending standards.

8. Things are looking good in the market right now, but with a busy election year and ongoing geopolitical issues, how do you think the LevFin market will handle macroeconomic pressures in the coming months?

Within our CLOs, we continue to be very cautious with our credit selection. We are weighted more heavily toward the higher credit ratings end of the spectrum which can be seen by our very conservative Weighted Average Ratings Factor (WARF) metrics as determined by any measure.

Companies have been living with higher interest rates for some time now, and management teams and investors generally understand the impact this is having on balance sheets and the liquidity of stressed borrowers.

We are still on the lookout for the lasting impact of inflation (both goods and labor) and watching the employment market. Consumers’ bank accounts and balance sheets are on our radar. High growth companies that are predicated on consuming capital to grow may be challenged and may struggle to hit their lofty growth targets. We have already begun to see this trickle into credit markets, and we are prepared to act if this risk spreads.

The upcoming election could have an impact on tariffs and other economic factors which could impact affordability in the US and abroad. That said, these factors have been highly discussed already and the market has been afforded significant time to consider such outcomes. We have witnessed significant resilience from all risk markets over the past several years and given the long lead time of these issues, we believe these risks are quite manageable in the short to medium term.

9. We heard that you are a fan of live music. What’s the best performance you’ve seen?

In 2006, Martin Scorsese was preparing a Rolling Stones documentary and wanted to film a live concert. The band decided to play a special show at the Beacon Theater, which is an intimate and amazing venue particularly for a group that usually plays to much larger audiences. The crowd was generally reserved for the biggest fans and special guests, but a friend somehow got tickets for me and several friends. It was an incredible performance. I did not previously think of myself as a huge Rolling Stones fan, but when they asked everyone to come back the second night so they could get some more takes, I became forever a fan!

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9Questions — Brett Klein, Sculptor Capital — Liability management in focus

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