Thomas Majewski, managing partner and founder of Eagle Point Credit Management, answers SCI's questions

Q: Eagle Point recently announced its expansion into the ABS, MBS and SRT markets, which will be led by Karan Chabba as head of ABS, MBS, SRT and speciality finance (SCI 19 July). What were the motivations behind branching out into these markets?
A: In terms of relative interest, the order we are looking at these is SRT, ABS and then MBS. We have been studying the SRT market for many years and were close to entering the market a couple of times, but never fully dove in. As we look at the broader dislocation going on in the markets currently and our expectation that volatility will likely persist over the medium term, it feels like an opportune time to be ramping up a portfolio in that strategy.

At Eagle Point, we have invested in a number of SRT transactions on a smaller basis and SRT has a lot of similar attributes to CLO equity, in terms of being a residual cashflow - although it does have some differences as well. As we have studied the asset class and worked to understand how issuers use the market as a sort of just-in-time capital solution, we think it presents a very attractive investment opportunity and a nice complement to our broader CLO strategy.

We believe that the investment opportunity also aligned very well with the core competencies of Eagle Point, which are proactive investment sourcing, structuring expertise and collateral evaluation. So, that is really our starting point on SRT.

Where Karan - who we have appointed as the head of ABS, MBS, SRT and speciality finance - holds a great deal of investing experience is in private asset-backed transactions with more bespoke transactions on a bilateral basis, with individual companies that are in need of financing and typically have a pool of financial assets to pledge. Karan has an excellent track record with over a decade of both originating and investing in these transactions, so we are very pleased to have that in our wheelhouse.

Looking at Karan’s investment experience, he has shown over the years a real ability to toggle between the US and European markets too. While most of what we do is US-centric, there are occasions in which we look to capitalise on some interesting opportunities in Europe, which ultimately Karan has a deeper set of skills to be able to identify and consider the relative value of opportunities overseas.

Q: What makes now the right time to branch out into ABS, MBS and SRT?
A: The main ramification of quantitative tightening – or negative quantitative easing – is that the largest investor in the world had been buying for a long time, but now it is selling. While the market has rallied back somewhat, if you think about the US loan market as an example, just weeks ago it was pricing in at a 15% default rate over the next two years.

While that is improbable to happen, the US Fed slowly letting the air out of the balloon has created a price distortion that’s not warranted by the credit risk, but instead is warranted by the fact that the Fed is moving from a buyer to a seller. So, as we look at opportunities, that’s usually a great time to get started – when people are selling for reasons other than the fundamental merits of the investment.

Q: Looking forward, what do you hope is Eagle Point’s role in the ABS, MBS and SRT markets?
A: It is a medium-term instrument, and I expect it to be a permanent part of our investment strategy. While sometimes markets will be richer and other times cheaper, after having studied the SRT market for well over a decade, I think you really would have struggled to find a bad time to get involved. Whether rates were up or down, or whether markets were raging or limping, if you had the benefit of medium-term or permanent capital, we think it fits very well into our broader structured credit investment set.

We are very focused on investments that are in inefficient markets, generate high current income and earn a complexity premium. Over the last decade, investors have come to expect us to deliver unique opportunities that are often overlooked by others and sometime do not fit perfectly in most institutional investors’ asset allocations.

CLO equity and CLO double-B debt are great examples of investments that deliver high current income and are broadly misunderstood by many investors. The SRT asset class shares many of these same qualities, despite both CLOs and SRT having a very good track record.

Q: What role do you expect synthetics to play in the business going forward?
A: Being involved in synthetics themselves is not an objective; it is more a result. We are not seeking to get exposure synthetically. We like the embedded terms and the structural leverage – we don’t need to juice it on the side with synthetic leverage where possible.

The dynamic of all the SRT securitisations is synthetic and, if anything, it’s a slight drawback being an unsecured creditor of a bank if things do go haywire. But, it’s still a reasonable cost towards what is overall an attractive investment product. Bottom line, our goal is to generate the best risk-adjusted return for our investors - whether that be via cash or synthetically, as long as we have a comprehensive understanding of the risk. 

Q: How do you expect branching out into SRT, ABS and MBS will impact the existing CLO business?
A: It is certainly not a negative impact, and really any impact would be positive because it’s just a natural evolution and continuation of our investment strategy. We believe we are the largest holder of CLO equity in the world at this point – we control about 5%-7% of the market – so we are well ensconced there.

That standing in the CLO market helps us get access to the SRT transactions too. Like the CLO market, the SRT market is a relationship market as well. There are some intersections between the pair, which have helped us become a more meaningful participant in the SRT world and a trusted partner to the banks issuing SRT.

Q: How do you see Eagle Point’s place in the CLO market in the coming years?
A: I think we’ll very much continue to be a thought leader within the CLO market. We’ve done this long enough to know things get choppy every two to five years, and you never know exactly why or for how long things will last, but having the right long-term minded capital base allows us to outperform.

The nice thing is that as a CLO equity investor, while some others may invest in shorter-dated CLOs closer to the end of the investment period - or maybe even amortising - we give a lot of credit to buying CLOs with a long reinvestment period. Right now, we are savouring that – the average triple-A financing level for our CLO equity book is approximately 125-over, although new issues were clearing at 225-over as of a few weeks ago.

You couldn’t recreate the financing of our portfolio, and in my view the CLO market doesn’t give sufficient credit to the ‘in-the-moneyness’ of the CLO debt financing in existing CLOs. We didn’t do anything intricate with the CLOs we issued last year. We just created and reset a bunch of CLOs last year, with long reinvestment periods and triple-As at approximately 125-over. In fact, we believe that Eagle Point was the most active participant in the refinancing and reset market last year. 

Many people like to talk about defaults in the CLO market. But in my opinion, what is far more important is: what’s the prepayment rate going to be? How much are loans repaying?

The long-term average repayment rate for US syndicated loans is about 35% per annum. Even in choppier markets, you still see 15% for repayments - and in a world like we are in today, where you can reinvest it and capture some discounts to par, it may be three to six cents of upside to par.

Everyone has a few mistakes or problems in a portfolio, but the ability to make back any losses - by investing the proceeds back into a discounted market - is as good as can be. Our role is to make sure our CLOs are at the leading edge of that and have the most flexibility possible to capitalise on it.

At the same time, they’re benefitting from long-term capital and we have a public fund - which trades on the NYSE under the ticker ECC - which is a permanent capital vehicle, which offers us a ready source of capital at all times to continue investing and buying what others are selling. Then, because that fund has no right of redemption for the shareholders, we are able to invest without worrying about getting money back to people by 30 September - which makes it a lot easier.

On the market, what I would say is that I do think the market is oversold. Although defaults are close to zero, they can only go up, but they can’t really go down.

Overlay the technical of the Fed selling - it’s always good to be a buyer when there are other people motivated to sell and we’re happy to be that buyer. Things could go down from here – but things are at pretty attractive levels right now, so I think there’s only more good opportunities to come.

Claudia Lewis