“Extend and Pretend”: Moral Hazard in the Debt Markets

Published on
June 23rd, 2020
43 minutes

“Extend and Pretend”: Moral Hazard in the Debt Markets

The Interview ·
Featuring Daniel Zwirn

Published on: June 23rd, 2020 • Duration: 43 minutes

Dan Zwirn, founder and CIO of Arena investors, returns to Real Vision to discuss credit investing in perilous and perplexing markets. He and Real Vision’s managing editor, Ed Harrison, discuss the rise of so-called "cov-lite" loans and the state of collateralized loan obligations (CLOs). Zwirn delves into the details surrounding the deterioration of credit quality across the fixed-income landscape, and he explores the various way shrewd credit investors can protect themselves, such as put-optionality and convertible bond arbitrage. Zwirn and Harrison also comment on the Federal Reserve’s role in propping up credit markets and what opportunities there are in permanently impaired sectors such as retail, airlines, and cruise lines. Filmed on June 18, 2020.



  • RO
    Richard O.
    25 June 2020 @ 08:40
    Zwirn is definitely the "Credit master" , Fresh insights for every new interview !!
  • BD
    Bryan D.
    24 June 2020 @ 09:21
    Two main drivers in my view of the rapid rise in the CLO market have not been mentioned here and that is the rise of CPM (Credit Portfolio Management) functions (Dan alluded to it but this is the formal name of the banks internal functions) in banks more actively managing a banks back book of loans to optimise other constraints such as capital, funding, banking relationships since the early 2000's but more aggressive since prudential regulations were overhauled post GFC and the Volcker rule which came into effect in 2014 with full compliance required in 2015. CPM functions actively manage the loan credit exposures on banks balance sheets particularly for large clients to optimise capital and funding by selling down exposures after collecting origination fees and potential cross sell opportunities. They even have an industry body where you can see who their members are and what they see their function as (http://iacpm.org/about/) This helps with relationships as you can keep writing more lending business for a particular sector or client that your institution is at or near credit limit on while still satisfying the customers appetite for borrowing. Since the GFC with the introduction of more capital, funding, liquidity rules has made optimisation of these functions more important. Pieces of loans can be sold off to asset managers or other investors similar to buying a bond but would not have standardised terms, loan documentation and active secondary market like bonds generally do. Under the Volcker rule bonds are within scope but loans are not as bonds are viewed as securities hence the Volcker rule applies for bonds but not for loans. This means that bank trading desks caught under Volcker (i.e. all US Banks and most banks with US operations which is pretty much all. Market makers had an exemption to hold a certain number of bonds on their books under the RENTD exemption (Reasonably Expected Near Term Demand: a calculation they would have to be able to demonstrate was a reasonable amount of inventory they should hold for client flow.) This didn't apply to loans so there was an incentive for banks to move their credit positions from tradable securities into loans. Over time the loans could be sold off individually or packaged into securities and sold (i.e. CLO's). I even know of one college friend who finished work on the credit trading desk as a credit analyst on a Friday before Volcker came into effect and moved into the private side loan business on the Monday analysing the same credits for loan trading. CLO's don't go as far as the CDO market did though in terms of liquidity risk mismatch and using synthetic underlying credits pre-GFC. When you buy a CLO to the best of my knowledge you are getting a portion of the loan and not a synthetic exposure through a vehicle like CDS. Also as CLO's are sold off bank balance sheets for regulatory purposes they don't run the liquidity mismatches the CDO SPV's were leading into the GFC that would issue Commercial Paper in their own names then buy longer dated bonds and run a liquidity mismatch though I may be wrong on this just have not seen it. Bonds are just really loans with standardised terms and a quoted and active secondary market so its not really a surprise the CLO market has gone down a few of the same paths of CDO's.
    • RO
      Richard O.
      25 June 2020 @ 08:29
      Very pertinent point ! Thanks for sharing.
  • PE
    Paul E.
    24 June 2020 @ 20:06
    This is one of those interviews that reminds me of how much I don't know! Thanks guys!
  • SD
    Scott D.
    23 June 2020 @ 08:33
    The level of understanding needed varies a lot from video to video lately. It would be good if the interviewer was briefed to dumb down some of the terms used in a brief sentence or 2 for those with less knowledge before deep diving into a subject. A small thing that would make many videos much more accessible to all.
    • RL
      Remmelt L.
      23 June 2020 @ 10:21
      I fully agree. This interview was very technical and Ed could you explain something more. Ash did a good job yesterday with daily brieving about bonds.
    • JB
      Jamie B.
      23 June 2020 @ 10:27
      I would have completely agreed with you 2 months ago. However the more you watch different interviews the more you pick up and the more you understand the next interview. My opinion now is: Don't ask for the interviews to come to you. You need to come to the interviews.
    • JB
      Jon B.
      23 June 2020 @ 11:04
      I think they need some "certification" rating and the production team decide how they segment their audience - what balance their pipeline of interviews - retail-friendly or pro. for example. They can always dumb down the pro version with some overlay / voiceover later
    • DG
      Dave G.
      23 June 2020 @ 11:24
      Maybe what is required is some kind of summery by the interviewer separately to put in simple terms what his take was on the interview and how it will effect markets in the future. My take is Dan says there is a bubble but timing the collapse is impossible but it will most likely collapse.
    • MS
      Michael S.
      24 June 2020 @ 04:08
      It's okay to not get it all. I'm glad when stuff is beyond my understanding, because I think I may have a chance to learn something.
    • SL
      Sean L.
      24 June 2020 @ 04:10
      just google the terminology they are using
    • SB
      Stewart B.
      24 June 2020 @ 13:25
      In relation to 'dumbing it down', if this was done, it should be a separate video. That is, have the main video, which uses terms that industry professionals use, and a second video, if necessary, which explains any terms and tradeables.
    • SS
      Stephen S.
      24 June 2020 @ 17:45
      Yeah I found this one a bit hard to follow particularly towards the end
  • SS
    Stephen S.
    24 June 2020 @ 17:08
    When it comes to convertibles I tend to like Porsche, BMW, or Classic Mustang. Mazda is a good more affordable option as well.
  • SS
    Simeon S.
    23 June 2020 @ 09:52
    „How can you be so certain?“. I like RV, but RV has been certain that markets will crash , return to the mean, for as long as I have followed it.
    • CD
      Christopher D.
      23 June 2020 @ 13:18
      I think that is the issue with most newsletters or smaller media, scaremongering creates the needed engagement. Although, given how crazy the times are it's hard to blame anyone for scaremongering. Plus Raoul has had pretty nuanced views in his Recession series last year, and perfect foresight/timing of panic trades earlier this year. So while nothing is perfect, to me life still feels so much better with RV than before it. I wish to learn enough so this wont be true any longer, but even then the diversity of views and community aspect mean I'll still be interested by the offer.
    • WG
      Wade G.
      23 June 2020 @ 20:33
      Not sure how long u've been here or when RV started... I've been here 2+ years, but in any case I assume we're talking maybe 5 years? I'd argue that during that time frame, we've been 25 years (now 30) into bull bond market; 7 years (now 12) into an economic expansion; and 7 years (now 12) into an equity bull market. All of these, historically, are cyclical, with their own distributions of time frames. I've never heard any of the RV folks ever talk about certainties. It seems to me they go out of their way to talk about a range of outcomes, with different probabilities. So I'd say your complaint is not accurate, but to the extent that they've been bearish in their base case, there seems to me to be plenty to support their view. They present ideas and evidence. Accept or reject it.
  • MT
    Melvin T.
    23 June 2020 @ 16:09
    Always love seeing Dan on RV, great interview.
  • AR
    Anthony R.
    23 June 2020 @ 15:17
    Finally, Ed gives a fair interview. I was worried his views would be too political, instead he was spot on with his questions, without any hint of personal views. Great job Ed!! Loved the in depth and poignant questioning.
  • OA
    Oliver A.
    23 June 2020 @ 11:56
    Could one of the brilliant pros in this community explain to me and the other amateurs the arbitrage trade they’re discussing towards the beginning? Thank you!
    • CD
      Christopher D.
      23 June 2020 @ 13:13
      not a pro of converts but if you go long convert and long put (or short corresponding equity delta), you're long straddle convexity in equities, and the convert yield pays for more than the put premium from what i gather, because of the disconnect between credit in permanently impaired sectors and equities which retail buys even if bankrupt. So Conv + Put for Eq going to zero will pay you recovery + put strike and for Eq lifted by the surrounding craze will repay a nice yield / equity upside greater than the put premium. that's qualitatively the trade at least.
  • sc
    steve c.
    23 June 2020 @ 06:42
    Dan Zwirn makes some great points and I agree a lot with his general outlook... the worst is yet to come
    • DG
      Dave G.
      23 June 2020 @ 11:25
      Dan is a very rational person in these truly irrational times.
  • FN
    Frans N.
    23 June 2020 @ 10:44
    Hi guys Please make available transcripts. Also for the Steve Keen video.
  • SS
    Simeon S.
    23 June 2020 @ 10:10
    Great interview.
  • RC
    Robert C.
    23 June 2020 @ 10:07
    Ed, that was a great conversation. I always have a question in mind pop up during the interview to have it answered 5 minutes later in your chain of questioning. I'm not sure if you are familiar with Jalen Rose, but you are giving the people what they want!
  • sp
    spencer p.
    23 June 2020 @ 07:11
    that was a very pleasurable interview ;)