combined leverage, actual and structural is around 60%, varies about based on market conditions, rising for example when Cliffwater uses lines of credit to meet redemptions. Even with that they are much less levered with average BDC at about 100% and can go as high as 2x I believe, so not misleading at all.
How do you calculate ~60%? The numbers I have below are from CCLFX's financial statement and an my assumptions on fund and CLO leverage (which are not wild guesses). The 32% I calculated is on balance sheet leverage. That is not up for debate, but you are correct that number should be read as +/- 5%. The fund investments are 15% of CCFLX equity but do not contribute to balance sheet leverage, but they are levered. The Private CLO investments are 25% of equity and also do not contribute to balance sheet leverage, but they are highly levered. I cannot understand how anyone can know what these assets are, look at the CCLFX balance sheet, and believe this fund is under 100% levered. And for what it's worth, it's absolutely fine for these assets to be 100% levered - that's why its the industry norm in an industry that has a great track record. It just seems like there is either misleading commentary coming from Cliffwater or a gross misunderstanding of where leverage exists vs what is reported.
I have gone over the leverage and it is on look through basis between 60-70%, about 30% on balance sheet and remainder from their own CLOs as I said and from the look through to the special vehicles. The mistake that may be made by those that don't ask is they might make assumptions about the leverage of the off balance sheet leverage, using averages which as you know can be very misleading-you can drown in a river of an average depth of 6 inches.
With that said can say Cliffwater reports their "look through leverage" at about 60%. And the leverage in Cliffwater's private CLOs is about 1.5X (vs. BSL CLOs which can be 8-10x and private BDCs 1-2.5x)
On point 3, I'm not sure you're acknowledging the leverage embedded in the underlying assets of CCFLX. The Fund is currently running D:E of 0.32 based on the 25Q3 balance sheet. If we assume the underlying fund investments (15% of equity) are 1:1 debt:equity (it would be odd if they were not levered), and the private CLO investments (25% of equity) are 3:1 debt:equity (low end of what is normal for private middle market CLO equity tranches), that gives a look through debt:equity of 1.21. That is above the average direct lending BDC or private fund. It is not to suggest that there is anything nefarious about this hidden leverage - these assets can handle 1.21 debt:equity, but it is extremely misleading to investors to suggest CCLFX is less levered than BDCs or private funds.
On point 5, I think you made an error. A line of credit tied to an unfunded commitment is not a contingent asset tied to a contingent liability. The line of credit is a contingent on balance sheet liability; the unfunded commitment is an off balance sheet liability. The contingent asset is the additional loan the fund acquires when it trades the commitment for cash investment (financed by the line of credit). Adding leverage to finance the acquisition of more loans/fund investments is part of the CCLFX strategy, but on balance sheet financing for an interval fund is hard capped at 0.5 debt:equity. If CCLFX met all of its unfunded commitments (loans and funds) without raising additional equity, the Fund's debt:equity would be 0.67, beyond the legal cap. There is absolutely a situation in which CCFLX is a forced seller of loans/funds to pay down leverage to stay within the cap, and if net flows to the fund are negative, this asset selling program would need to accelerate, which would in turn create bad press and likely more redemptions.
Just a quick note Roger, the fund in fact has sold assets recently at above par, taking advantage of the assets being purchased below par (typically 98-99) and spreads narrowed. And the vast majority of assets could be sold at mark. But I do expect more redemption requests, likely above the almost 7% last quarter due to noise and naive investors and advisors. Just like what happened at BREIT despite underlying assets being okay as evidenced by the sale of > $10b at or above par and positive returns following the REIT crisis. Fund up like 95 last year.
Thanks for the reply, Larry! I appreciate your coverage of private credit and CCLFX. I'm with you that most of the big players will see excess redemption requests this quarter, and as you've correctly noted in other articles, it's all fear based - there is nothing wrong with the assets (apparently to the dismay of financial journalists). On CCLFX loan sales, you are spot on that Cliffwater is a sharp group and have proven their ability to sell assets and clip a profit when it suited them. My concerns stem from a low (but still real) chance that they become forced sellers of loans to meet redemptions/unfunded commitments because the Fund is at its legal limit of on balance sheet leverage. Forced selling in this scenario would occur at a loss and likely create enough negative headlines to generate more redemptions and more forced sales. The difference between this hypothetical and BREIT and other recent comps is that interval funds have low leverage limits compared to BDCs and REITs and mandatory quarterly liquidity (REITs and BDCs can suspend tenders/interval funds cannot). There are less tools available and more problems to worry about for CCLFX if they get in a liquidity bind, and they way they've managed this fund, they are leaving the door open to there being a liquidity problem. In my mind, the most likely scenario that triggers this event is credit spread widening that stays wide for a year+ (lower than expected principal repayments, increased fund calls, risk asset selloff -> redemptions).
Directionally agree but what I believe you are missing is that say 80% of the portfolio has nothing to do with the SAAS risk the market and media focused on. And those assets are trading very near par (typically bought at 98-99) or even slightly above par as spreads did tighten over past few years. So they could easily sell significant assets without any or nominal impairment I believe. Now if we get a severe recession, that changes the outlook but of course would likely be far worse for other risk assets like equities and junk bonds. Hope that is helpful
Agreed. This comment is something the media is badly missing "would likely be far worse for other risk assets like equities and junk bonds." If private credit assets are widely impaired, the implication of that statement is a worse than GFC event for all risk assets. I'd be happy to take my private credit -15% and climb into my bunker!!
Roger The estimate of losses in a 2008 type is probably less than 10%, though near there. Now might be worse if AI is more disruptive than expected
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combined leverage, actual and structural is around 60%, varies about based on market conditions, rising for example when Cliffwater uses lines of credit to meet redemptions. Even with that they are much less levered with average BDC at about 100% and can go as high as 2x I believe, so not misleading at all.
How do you calculate ~60%? The numbers I have below are from CCLFX's financial statement and an my assumptions on fund and CLO leverage (which are not wild guesses). The 32% I calculated is on balance sheet leverage. That is not up for debate, but you are correct that number should be read as +/- 5%. The fund investments are 15% of CCFLX equity but do not contribute to balance sheet leverage, but they are levered. The Private CLO investments are 25% of equity and also do not contribute to balance sheet leverage, but they are highly levered. I cannot understand how anyone can know what these assets are, look at the CCLFX balance sheet, and believe this fund is under 100% levered. And for what it's worth, it's absolutely fine for these assets to be 100% levered - that's why its the industry norm in an industry that has a great track record. It just seems like there is either misleading commentary coming from Cliffwater or a gross misunderstanding of where leverage exists vs what is reported.
I have gone over the leverage and it is on look through basis between 60-70%, about 30% on balance sheet and remainder from their own CLOs as I said and from the look through to the special vehicles. The mistake that may be made by those that don't ask is they might make assumptions about the leverage of the off balance sheet leverage, using averages which as you know can be very misleading-you can drown in a river of an average depth of 6 inches.
Roger, let's take this off line. Send me email and I can share some things with you.
lmswedroe@charter.net
With that said can say Cliffwater reports their "look through leverage" at about 60%. And the leverage in Cliffwater's private CLOs is about 1.5X (vs. BSL CLOs which can be 8-10x and private BDCs 1-2.5x)
On point 3, I'm not sure you're acknowledging the leverage embedded in the underlying assets of CCFLX. The Fund is currently running D:E of 0.32 based on the 25Q3 balance sheet. If we assume the underlying fund investments (15% of equity) are 1:1 debt:equity (it would be odd if they were not levered), and the private CLO investments (25% of equity) are 3:1 debt:equity (low end of what is normal for private middle market CLO equity tranches), that gives a look through debt:equity of 1.21. That is above the average direct lending BDC or private fund. It is not to suggest that there is anything nefarious about this hidden leverage - these assets can handle 1.21 debt:equity, but it is extremely misleading to investors to suggest CCLFX is less levered than BDCs or private funds.
On point 5, I think you made an error. A line of credit tied to an unfunded commitment is not a contingent asset tied to a contingent liability. The line of credit is a contingent on balance sheet liability; the unfunded commitment is an off balance sheet liability. The contingent asset is the additional loan the fund acquires when it trades the commitment for cash investment (financed by the line of credit). Adding leverage to finance the acquisition of more loans/fund investments is part of the CCLFX strategy, but on balance sheet financing for an interval fund is hard capped at 0.5 debt:equity. If CCLFX met all of its unfunded commitments (loans and funds) without raising additional equity, the Fund's debt:equity would be 0.67, beyond the legal cap. There is absolutely a situation in which CCFLX is a forced seller of loans/funds to pay down leverage to stay within the cap, and if net flows to the fund are negative, this asset selling program would need to accelerate, which would in turn create bad press and likely more redemptions.
Just a quick note Roger, the fund in fact has sold assets recently at above par, taking advantage of the assets being purchased below par (typically 98-99) and spreads narrowed. And the vast majority of assets could be sold at mark. But I do expect more redemption requests, likely above the almost 7% last quarter due to noise and naive investors and advisors. Just like what happened at BREIT despite underlying assets being okay as evidenced by the sale of > $10b at or above par and positive returns following the REIT crisis. Fund up like 95 last year.
Thanks for the reply, Larry! I appreciate your coverage of private credit and CCLFX. I'm with you that most of the big players will see excess redemption requests this quarter, and as you've correctly noted in other articles, it's all fear based - there is nothing wrong with the assets (apparently to the dismay of financial journalists). On CCLFX loan sales, you are spot on that Cliffwater is a sharp group and have proven their ability to sell assets and clip a profit when it suited them. My concerns stem from a low (but still real) chance that they become forced sellers of loans to meet redemptions/unfunded commitments because the Fund is at its legal limit of on balance sheet leverage. Forced selling in this scenario would occur at a loss and likely create enough negative headlines to generate more redemptions and more forced sales. The difference between this hypothetical and BREIT and other recent comps is that interval funds have low leverage limits compared to BDCs and REITs and mandatory quarterly liquidity (REITs and BDCs can suspend tenders/interval funds cannot). There are less tools available and more problems to worry about for CCLFX if they get in a liquidity bind, and they way they've managed this fund, they are leaving the door open to there being a liquidity problem. In my mind, the most likely scenario that triggers this event is credit spread widening that stays wide for a year+ (lower than expected principal repayments, increased fund calls, risk asset selloff -> redemptions).
Directionally agree but what I believe you are missing is that say 80% of the portfolio has nothing to do with the SAAS risk the market and media focused on. And those assets are trading very near par (typically bought at 98-99) or even slightly above par as spreads did tighten over past few years. So they could easily sell significant assets without any or nominal impairment I believe. Now if we get a severe recession, that changes the outlook but of course would likely be far worse for other risk assets like equities and junk bonds. Hope that is helpful
Agreed. This comment is something the media is badly missing "would likely be far worse for other risk assets like equities and junk bonds." If private credit assets are widely impaired, the implication of that statement is a worse than GFC event for all risk assets. I'd be happy to take my private credit -15% and climb into my bunker!!
Well done!