Absolute Credit Series

LT (00:07)
Good morning and welcome to Absolute Credit. I’m Lindsay Trapp. I’m a partner in Kirkland’s New York office, but joining you today from very sunny Phoenix, Arizona. I’m really excited today. We have a very special guest with us, Marc Pinto from Moody’s Ratings. Hi, Mark. How are you?

MP (00:23)
Hi Lindsay, good to see you. We’ve got a little sun here in New York as well.

LT (00:27)
Excellent. Well, thank you for joining us today. We have lots of fun things to talk about, but I suppose I just wanted to get your views on, you know, private credit generally this year, rated funds, CFOs, you know, have been pretty hot products. So what are you guys seeing over there at Moody’s?

MP (00:48)
Yeah, I would say on the fund finance side, we’ve seen a lot of rated note feeders, ABLs, NAVs, sublines a little bit less, but a lot of activity. Private credit though, as you know, is a really big space. And it seems like the hot topic today is all about the perpetual non-traded BDCs and the redemption requests that are going on there. But that’s a whole ‘nother story.

LT (01:11)
It is indeed. So where are you guys seeing a lot of the drive for ratings? Is it largely in, say, more the traditional fund finance or are we still seeing quite a bit from the rated funds and CFOs or is it just all of them are having a bit of a boom for ratings?

MP (01:27)
It’s all of the above, to tell you the truth. I mean, there’s still a big institutional drive to get into this space, particularly the insurance companies. They’re very interested in what the fund finance world can offer them in terms of duration, diversification and higher yield, quite frankly. And, yeah, the train has left the station, and interest just keeps rising, quite frankly.

LT (01:54)
Indeed. And are you guys seeing a lot of other assets or are we still just kind of pretty heavily in the private credit realm these days?

MP (02:03)
No, you know, I think the market has really started to evolve, and we talked a little bit about this in our private credit outlook for this year. You know, we really started this business looking at direct lending, middle-market direct lending, and it’s morphed into real estate, infrastructure. And then what we’ve been seeing and what we’ve been hearing at a lot of conferences, probably what you’re hearing at your conference as well is, you know, the esoterics, but the esoterics are becoming everyday, right? So by esoterics I mean royalties, music royalties, sports — there are sports assets now that we are seeing going into fund finance vehicles. So the number and the types of assets just continue to grow. I mean, I can’t even imagine what we’ll be talking about 12 months from now.

LT (02:52)
Absolutely, we are seeing quite a lot of things as well — stuff like aircraft, definitely royalties as well. So it’s interesting to see the expansion of these kind of things that would be more traditionally in ABS now kind of making their way into more of a fund format. But you mentioned your private credit outlook for 2026. So I know you guys put out these great publications. Do you want to take us through some of the findings that you guys had there?

MP (03:20)
Yeah, some of the big picture items are, again, this asset class changing, right? From middle-market direct lending to more asset-based finance and esoterics. We’re seeing the business become much more global. I mean, the U.S. has really been the epicenter for private credit, but we’re starting to see more and more interest in Europe, the Middle East and also Asia. And I would say as well, when we started and it was sort of the nature of the asset class, it was more high-yield in nature, speculative grade in nature. And we’re seeing a much broader spectrum of risk within the context of the private credit assets and what’s going into the fund. So more investment-grade, quite frankly, and that makes a lot of the investors who are seeking investment-grade assets very excited about more opportunities in terms of getting involved in this space. So those are some of the high-level things that we’ve been focusing on. Maybe just one other thing to mention here as well: Not only is the asset base changing, but the investor base is changing with more and more retail investors getting involved in this market as well. And I think that’s changing the nature of the products as well as just how this market is functioning, quite frankly.

LT (04:41)
Yeah, I would agree with that. We’re certainly seeing some more interest from the retail side, but also retail assets as well, with different types of registered funds becoming collateral in CFOs, in particular, and also in rated feeders. That’s certainly been an interesting thing. But also, I think there’s quite a lot of innovation and activity happening in sort of the underlying structures of a lot of retail products as well with JVs and other types of financing mechanisms that we’re certainly seeing. I’m not sure if that showed up in your outlook as well.

MP (05:20)
No, it absolutely did. And you and I saw each other in Vegas at the Structured Finance Conference. And what I was impressed by there was how much the fund finance world is merging or converging with the structured finance world. And I know that you guys have been involved in a lot of deals as well. Things that we’re seeing in fund finance today, we weren’t seeing 12 or 24 months ago. You’re seeing more tranching, right? You’re seeing more unique structures that combined lots of different aspects of the structured finance world and bringing it over into fund finance. So I think that’s a new innovation as well. There’s more complexity to this market. Complexity doesn’t mean more risk per se, but it does mean more due diligence and more in-depth analysis for investors who get involved in this market. And quite frankly, for us who are rating a lot of this market as well.

LT (06:18)
Yeah, absolutely. So I guess in some of those other instruments, for instance, subscription facilities, there’s always been information that you guys would need and that kind of stuff. Has the way that this has been changing or even the asset mix within the structures, has that changed what you guys are looking for or needing in regards to information? And has the change in investor mix helped that in any way?

MP (06:45)
Yeah, I would say the more investors that can get involved in this market, the more transparency that’s being required and more information that needs to flow, particularly when you involve retail. There can be no slips or falls when you get retail investors involved in a market. This market hasn’t been very transparent. It’s been fairly opaque in many regards. But I think, again, new investors and new structures are creating more questions. And so we need to come up with the answers. One of the things that maybe you’re alluding to, in the past, when we were often presented with information, we couldn’t get everything that we wanted because, for example, when limited partners sign agreements to be involved in these funds, they protect their information. I think the new documents that are being written understand that these funds may have a life of their own and move into lots of different areas within the financial services investment community. And so we’re seeing even the initial documents for limited partners saying, “We will protect your information, but if we need to disclose it with an NDA to a rating agency, for example, to be able to analyze that data as these assets move into another form, that’s being allowed.” When we didn’t have that, we couldn’t rate the deal.

LT (08:11)
Yeah, certainly, having documents drafted that way has been something we have seen an evolution of over the last many years, you know, going from what used to just be sort of investor letters to now having very broad-based information on what will be shared within the LPAs themselves or the indentures, depending on how we’ve got them structured. That’s certainly something there. I guess in...

MP (08:02.414)
You know what, Lindsay, just one point. I think this is great for the market, though. Right? More information allows this market to mature, people to have more confidence in this market. And I think when it was a small portion of either institutional or even retail portfolios, you sort of get a pass on, “Well, okay, it’s just a small portion of my portfolio.” But as it grows, having more information, having third-party assessments, all of these types of things help this market grow in a mature, responsible way.

LT (09:07)
Yeah, for sure. I think given particularly in sort of the private assets market and as insurance companies started investing in this market, that was a lot of the push originally, at least in my view, from the NAIC when they started discovering how much in the private asset market that insurers were involved in. It was kind of, “Well, there’s not a lot of information on these assets. How do we get information on these assets? What do they look like? How do they behave in this market that we have been involved in for very long time,” but it is very true. Very different from maybe more liquid loans, you know, so I think that that’s been helpful and good. I think it helps regulators understand a bit more about how things are going, but it also creates, let’s say, more market precedent as it goes, right? Because the more information that’s out there, things start to standardize a bit more than they maybe have been.

MP (10:10)
More consistency, exactly. And more comparability. I think those are really important things. And as you said, the insurance industry, if I look at the U.S. life insurance industry, if we sort of divide their portfolio into the public bonds and then everything else, kind of the private credit world, we used to call it alternatives. It now seems that everything’s kind of pushed into that market. Roughly a third on average of U.S. life companies general accounts are in private assets. So I think it’s really important, as you mentioned, the regulators are very focused on this. They’re looking for more transparency. I’ve been involved, as you mentioned as well, with the NAIC. They’re looking at this very closely and making sure that the risk that’s on the insurers’ balance sheet is appropriately capitalized and appropriately accounted for.

LT (10:59)
Yeah, absolutely. You mentioned some other things around the way that assets, maybe they start out in one form or they start out in one way, and then they evolve into different parts of the sort of fund finance ecosystem. So I wanted to talk to you a little bit about something that we’ve, you know, seen a little bit of and maybe our folks are looking a little bit more for. So things like using some of these loans, we can talk about, you know, subscription finance lines, maybe for for some of that or even just some of the private credit loans that maybe are originated by funds themselves being packaged then into something else like a securitization? Are you seeing some of that type of development more so than just traditional continuation vehicles, but actual asset bases being changed into a different type of product?

MP (10:52)
No, absolutely. And it’s part of the maturation, I think, of the market that you start out originating, you create consistency, then you’re able to monitor the cash flows and understand the consistency of those cash flows, which then make these assets very attractive to either a securitization or a fund finance vehicle. So we’re seeing more and more of that. I think today sponsors and, quite frankly, the investment bankers, they have a lot more roots that they can travel on. In the past it was, “All right, we have this asset consistent, we will now do an asset-backed securitization.” Well, today they can go in that direction; they can go in the fund finance direction. And as I was mentioning earlier, you’ve got attributes of each in both fund finance and securitization. So I think what we’re seeing today, and really this is what private credit is all about, it’s a new tool in the toolbox that we didn’t have previously. And if it results in more asset-liability matching and a better way of segregating and understanding risk and allocating capital within an economy, that’s a better way of thinking about how to grow the economy, quite frankly.

LT (13:08)
Yeah, so what do you guys, if you were looking at something like that from a ratings perspective, would you need those underlying loans themselves to be rated? Is it something that’s more about the consistency of the types of loans and sort of how they work or information, or is it sort of a combination of all of those things?

MP (13:27)
You’ve hit the nail on the head. It’s a great question. It’s a combination of these things. So we’ll look at sector concentrations. We’ll look at underlying loans. To some extent, some of them are already rated. If they’re a big portion of the portfolio, we will go out and get a credit estimate, kind of an internal rating on some of these exposures. And in fact, what we need to do often in a lot of these transactions is bring the entire corporate analyst community within Moody’s to bear. So if we’re looking at a real estate transaction, we’ll go to our real estate group. If we’re looking at music royalties, and we have expertise within the organization, “Hey, we’re looking at music royalties in a fund finance transaction. You guys have done it in structured. Can you bring over your experts to our rating committee? And as we put together the analysis, can you contribute there?” The other aspect to this is maybe a little inside baseball, but at a rating agency, we cannot assign a rating unless it’s associated or hung on a methodology. So in the past, methodologies were quite rigid: “This is the methodology we use for tech companies. This is the methodology we use for real estate mortgage-backed securities.” Today, because of the blurring of lines and maybe multi-asset funds, we might need to use multiple methodologies, and we’re having to update our methodologies or even create new methodologies in order to meet the market where it is today and where it’s going. So I think within the rating agency community at large, we’re all looking at our methodologies to make sure that investors understand how we’re arriving at our ratings by looking at methodology or think of it as a framework.

LT (15:17)
So you guys kind of combine methodologies. I think that seems to be a fairly common theme, right? There’s a funds methodology or an idea that you can then add bits and pieces to. So one of the biggest things we’ve seen in CFOs is a very wide variety of asset classes now being brought in, right? In very olden days, probably pre-crisis, mainly CFOs were LP-led, usually using primarily private equity funds as collateral, but that’s changed substantially over the last kind of five years. Pretty much everything at this point is GP-led that we are seeing and doing anyway. And in doing that, we’re seeing everything from real estate and infrastructure to even multi-asset SMAs within those structures, private credit. How do you guys look at something like that in the context of a CFO? What’s the sort of ratings grouping of methodologies, or how does that kind of factor into a CFO?

MP (16:20)
Yeah, so we currently don’t rate CFOs, but we will be doing so very shortly. And so as we go through the process to get this framework in place, we’re looking at, again, how we view this on the structured side, as well as how we view it on the fund side. And I would say, as well, to your point about multi-strategy, that’s becoming very, very attractive to investors. So they don’t have to choose, all right, “Do I take a little bit of this real estate fund or another fund that has infrastructure assets or middle-market lending?” By investing in a multi-strat fund, some of which the big alternative GP, alternative asset managers or GP sponsors are offering to market, they can say, “We’re gonna offer you the best of our underwriting in a multi-strategy form.” And insurance companies have really cottoned onto this. They really like this. And we’re seeing a lot of success in this area, both from a GP fundraising point of view and how the insurance companies are getting involved in it.

LT (17:25)
Yeah, so how are you guys thinking about this methodology as you’re coming through to it? I forget it hasn’t come out yet. So how are you guys kind of working on developing that one?

MP (17:34)
It’s on its way. It’s on its way! Yeah, I mean, we did have a collateralized fund obligation methodology in the past, and it was not used very much for the last decade or two, quite frankly, and so we retired it. So what’s new was old, or what’s old is new. So it’s really brushing this off and thinking about how cash flows are going to move in various scenarios. I always like to say the market has been quizzed, but it hasn’t been tested. So we’re really trying to run lots of different scenarios to make sure that the resilience of those ratings is there when we assign them.

LT (18:24)
Excellent. So let’s maybe move a little bit more toward, specifically, rated feeders. You guys are definitely making great advances in the context of specifically real estate debt. So I wanted to talk a little bit with the audience about what you guys are looking at in the context of ratability for something that’s, let’s say, largely or all a blind pool of real estate debt.

MP (18:54)
Yeah, I mean we have a lot of history at Moody’s about how these assets will perform. You know, you’re looking at trophy assets in some cases. You’re looking at different parts of the real estate market. And as I mentioned, we have a very good sense for the consistency of cash flows, the value of these assets and, quite frankly, what’s also very important is the manager of these funds. Manager performance is very, very key to our overall rating outcome. So these three things, as well as how leveraged you have, you know, we’re looking at loan-to-value ratios, we’re looking at any additional leverage that the fund might employ to increase the overall return. All of these things are very, very important, and we can use decades of experience looking at this asset class, and I think that’s really important, again, in developing the scenarios and understanding where the rating should come out based on the resiliency of the cash flows and the values that are underlying the overall obligation.

LT (20:02)
Is it important in those structures to have, let’s say, a quite set or tight geographic set of locations where some of the underlying could be, or can it be a little bit more broad, and the managers can say it’s maybe more of a regional area or something like that?

MP (20:22)
Yeah, I think each one of those considerations bring different risks, whether you’re in a major metropolitan area or there are still some very resilient regional areas, for example, within the United States that have performed quite well. But that’s part of the calculus of the number of assets, the type of assets, the geographic location of the assets. You know, quite frankly, diversification is often your friend. They say it’s the only free lunch in investing, right? Diversification, diversification, diversification. It’s like location, location, location in real estate, right? We need diversification within a lot of these funds. But it doesn’t mean you can’t have a single asset. But again, that’s a different analysis and a different way of thinking of things. Diversification typically improves the overall ratings outcomes, I would say.

LT (21:05)
Excellent. Yeah, I think that certainly in some of the things we’ve seen, particularly I think in the esoteric assets, it seems to be that, you know, at least a quite widely diversified portfolio by number, at least, maybe not necessarily sectors or areas, but by number seems to be quite important as well. Is that also kind of what you’re seeing, say something in royalties or something?

MP (21:27)
Yeah, mean, think about, you know, we talk about esoteric music royalties, you know, who is it? Is it ABBA or is it, you know, somebody who I might listen to but no one else listens to? You really need to figure out what are the quality names within a portfolio, what is the consistency and what is the durability of that music versus maybe something that’s more on the fringe and might not have as long a shelf life or have a strong as a cashflow generation as some other asset. So yeah, the devil is in the detail. The devil is absolutely in the detail.

LT (22:07)
It’s always in the detail. Excellent. Well, one of the things I wanted to just sort of give folks maybe a little bit of a flavor for is how you guys do your ongoing surveillance of the portfolios as the market changes and kind of what that process is like, you know, just for folks who are interested in maybe coming into this market for the first time. What is the ongoing surveillance process once you’ve issued a final rating?

MP (22:38)
Right, once we’ve issued a final rating, we get either monthly or quarterly valuations on the underlying portfolio of assets. We work very closely with the risk professionals at the organization to understand what is their process. Process is very, very important to the overall ratings. And we want to make sure that we understand any changes in the process, that the process is being implemented. Again, around the frequency and valuations, which I just talked about, understanding how they value. Do they use third-party valuers to come at the ultimate valuation? Are they using models? So really, again, understanding the process, which can include outside contributors or outside service providers, is very key. What we also look at is when we’re looking at the valuations, we’re making sure they’re consistent with what we had anticipated when we set the ultimate rate when we assigned the rating. And if the valuations start moving such that LTV or something else is moving outside our band of what we expect, then we might go, for example, to committee and review the numbers again, and then either change the outlook or the ultimate rating. But it’s a very rigid process, and one that’s followed very closely, as you would imagine, to make sure that the rating is always correct.

LT (24:05)
Absolutely. How does that interplay in a blind pool with, let’s say, you rate off of a hypothetical scenario, and how does that help with the building of that portfolio?

MP (24:18)
Yeah, so that’s a very good point, a great question, because oftentimes we’ll assign the rating based on the strategy of the fund, and it’s not fully funded as yet. So we watch as assets are built within the fund. And as you can imagine, they don’t all come in exactly, you know, 5% of, you know, 20 different sectors. You might see a sector be 10% or 25% of the portfolio in the early ramp-up stage. So we watch that very closely. If we see it get out of whack, greater than our expectations, we’ll go back to the risk manager and say, “What are you planning? What are the next investments? We’re watching this.” So there’s a little bit of trust and faith as the portfolio gets built up, and the manager knows what we’re watching. So if all of a sudden 20% of the portfolio is in one particular sector, that is ultimately supposed to be 10% or 5%, they’re going to be very careful about making more investments in that one particular sector before they bulk up some of the other sectors. So it is usually a two-to-three year ramp up-period. So it may not be perfectly aligned in those first two, three years with the overall strategy. But again, this is why it’s so important to understand the manager, the credibility of the manager, the track record of the manager, because you’re relying on that manager a lot in the first couple of years as this portfolio gets built up.

LT (25:51)
Yeah. Absolutely. It’s quite an interesting process as folks go through ratings, but very tried and true. I think most managers manage to get to where they sort of expected when they tell you, so I think that’s great. Last question, and this was just something that I saw. You had posted that you recently were part of an SEC roundtable kind of discussion. Anything interesting coming out of that from a rating agency perspective?

MP (26:21)
Yeah, I think we have said this before, as well. As retail investors get into this market, it creates a little bit more risk because retail investors invest in a slightly different way than institutional investors. I like to say institutional investors have ice cold water running through their veins. We as retail investors, we can sometimes engage in animal spirits when we move in and out of markets. And I think one of the things we talked about at the SEC presentation is the responsible inclusion of retail investors in private markets. And there is a lot of disclosure out there, but I think it will take some time for investors to understand that when you invest in a private credit vehicle, this is not like investing in a mutual fund. And it’s not that the retail investor can’t embrace that, because they understand the liquidity features of buying a home. You know, we don’t buy a home one day and sell it the next. They can understand the liquidity features of buying a car. And they very well understand when they’re talking about their investments, the liquidity features of a mutual fund, for example, or an ETF. They haven’t fully embraced the features of investing in a private asset vehicle. And I think the SEC is out there trying to make sure that investors are well-educated and use the information that’s at their disposal. So I think that is an important aspect of what came out of the conference. Private credit is lightly regulated compared to the banking market and compared to the public fixed-income markets. They have certain features which can provide benefits but also provide risks. So I think the more that the market becomes educated, the investor base becomes educated, the more transparency, like we were talking about earlier, the better for this market and the confidence and the maturation and responsible growth of this market going forward.

LT (28:26)
Yeah, absolutely. I certainly think education is a key there. The documents for all of these vehicles are drafted and looked at with the SEC, and they are quite heavy on disclosure about these things. But I think sometimes it comes down to a question of how much folks understand exactly what the impacts of the things that they’re reading necessarily are. So it will certainly be interesting to see where this goes as more folks start getting into this market from the retail side. But it’s great to have, you know, folks like you out there looking at all of these different aspects of the market. Anything else that you’d like to, you know, highlight to our viewers?

MP (29:12)
No, would just say, Lindsay, you’re writing these documents and spending a lot of time and effort on them. People should read them.

LT (29:20)
Thank you. Yes, please do. Please do read them. Excellent. Well, Mark, we really appreciate your time.

MP (29:38)
No, thank you, see you at the next conference.

LT (29:41)
Absolutely. Thank you.

LT (00:00)
Good afternoon and welcome to the Kirkland & Ellis Absolute Credit vlog. I’m Lindsay Trapp. I’m a partner based in our New York office, and today I’m very excited to be joined by my partners Bruce Gelman and Kate Luarasi to discuss another tool in the toolbox, insurance-dedicated funds. Hi, Bruce and Kate.

KL (00:24)
Hey, Lindsay, thanks so much for having us. We’re excited to be on here and to discuss one more avenue by which we can incentivize insurance company investors to invest more into structures. These are a growing vertical within a lot of our sponsor platforms and Bruce and I do a lot. Bruce is actually the OG around these parts. Will let Bruce talk a little bit more, but it’s always great to be working alongside Bruce and to be able to deploy one more means of regulatory capital efficiency for our clients.

BG (01:04)
I know you mentioned insurance companies being interested in these products, but we can certainly talk about that. I hope we do. We will. But there are lots of other types of investors, including high-net-worth investors, foundations, endowments that can use the product very efficiently, and lots of reasons to do that.

LT (01:24)
Well, with that, why don’t we just give a little bit of background of what is an insurance-dedicated fund?

BG (01:31)
Sure, I’ll start. All an insurance-dedicated fund is, is an investment fund that invests in … it could be credit investments, private equity, hedge fund, real estate, really anything. It’s structured to be owned by insurance companies’ separate account. And all that means is the only investors, direct investors in the insurance-dedicated fund are insurance companies. The question is, how do you get access to them? It’s not as if any one of us can make an investment directly in an insurance-dedicated fund. You have to buy, if you’re an individual, you have to buy, get investments, get access through a private placement life insurance or a private placement variable annuity contract. And if you’re an insurance company, you typically get access through a private placement variable annuity contract.

LT (02:18)
So, what’s the purpose of them, ultimately? These are not like the products that Kate and I do on the other side, which is structured credit, where you’re looking to get long-term bond treatment. So how does an IDF help?

BG (02:33)
Yeah, so the question is, why do you set these up? And we can talk initially about what you and Kate brought up, which is the insurance companies making the investments. And that’s typically for regulatory capital benefits. If an insurance company makes an investment in one of our sponsors’ private equity fund, they like to do that, except there’s a capital charge for doing that. So it’s very expensive from a regulatory standpoint. But if they make the investment through an insurance-dedicated fund, there typically is no capital charge for those investors coming into the fund. Lots of our other clients, lots of our other sponsored clients set these up for other reasons though, not only to attract insurance company capital, but also to attract high-net-worth capital, family offices capital, private foundations or endowments. And the reason is as follows. When we invest in credit, for example, as an individual, it’s obviously a very good return, but it’s, depending on what state you’re in, could be 40 to 50% tax rates. When you go through an insurance-dedicated fund and structure through, whether it’s an annuity contract or a life insurance contract, there’s no taxation. So there’s a lot of tax alpha generated from going through these products. In fact, if you think about 40 to 50% tax rates, if you’re thinking about a 10% net return from a credit fund, you’re left with $5 or $6 after tax in a taxable credit fund. But if you go through an insurance-dedicated fund, that 10% return, there’s a little bit of leakage from the insurance company costs, but you’re typically looking at 9.5% effective return. If you extrapolate that over a lifetime, 40 years, it’s a much different return profile over that period versus paying tax year-in and year-out in a credit fund.

LT (04:18)
So there’s really a big tax angle to it.

BG (04:21)
Yeah, and I mentioned the foundations and endowments and pensions. Those investors we see coming into these products, because a lot of our sponsors generate what’s called UBTI to those investors or tax for those tax-exempt investors. Using these products, a sponsor can do whatever it wants, and it doesn’t generate UBTI to the investors. What the investors are receiving in those cases are just annuity income free from UBTI or free from tax, as long as they don’t borrow to make the investment in the underlying annuity contract.

KL (04:50)
So I think one of the things that’s like maybe the most interesting and probably foundational aspect of this is Lindsay and I are immediately seizing on the fact that this is great for risk-based capital purposes. But as Bruce just highlighted, this is actually something that came out of the code. This is ultimately a tax structure that happens to have attendant benefits for insurance company investors, but it’s actually set up for all kinds of investors and can really be a thoughtful and compelling way to increase AUM for our clients. Bruce just highlighted it’s investment strategy neutral. So you don’t need to … like some of our rated products will require a certain part of a certain portion of the portfolio composition downstairs to be credit or income-generating products. The beauty of IDFs is that they don’t have that requirement. So long as you meet investor control doctrine and diversification and other requirements, which we’ll go through in a bit, it’s actually investment strategy neutral. So you do not have the rating requirements and you do not have the credit strategy requirements downstairs.

BG (06:06)
That’s right, Kate, you know, the benefits to the fund manager. Why would a fund manager be interested in this? And you really highlighted that, like it’s a way to get regulatory capital, insurance company capital into a product that … into investment strategy that they might otherwise not do or might otherwise not make as big an investment. But it’s also, you know, that capital then, whether it’s individuals like high-net-worth families or whether it’s insurance companies, it’s very sticky capital. You know, whether the sponsor has a closed-end fund, where you have a 10-year fund, you’re constantly raising capital for the next fund or an open-end fund. This capital tends to be much stickier in the sense that people, whether your insurance companies that are investing or individuals, they’re thinking very long-term. And it is just another strategy, another arrow for the quiver for fund managers to use to provide another option to get capital indirectly into their flagship fund or something else.

LT (07:07)
So that leads me to the next question from my side, which is: How do these structures ultimately fit within the wider fund structure? Are they the feeder, of sorts, or is this going to be a standalone structure?

BG (07:21)
There’s lots of different ways. Many of the ones we see are just … effectively, we’ve got sponsors that have lots of different funds, a flagship fund and lots of other funds. These can be standalone in that they can invest on a side-by-side basis with the flagship fund and some of their other products, or they can be like a fund-to-funds model where this, that this insurance-dedicated fund is going into the flagship fund and also lots of other products by the sponsor. As Kate mentioned, and we can get to this later, there are diversification requirements which need to be met, not a big issue for most of our sponsors.

LT (08:03)
So, generally, I’m guessing this is also a Delaware partnership structure, or is there corporation or trust type structure more like a ‘40 Act fund?

BG (08:16)
Typically, we see these as ... they can really be anything, they tend to be Delaware partnerships or LLCs, and the reason for that is the ultimate owners of these assets, whether it’s the insurance company owner at the top or the individuals, they’re effectively buying policies from an underlying life insurance company. And the underlying life insurance company as the sole effective owner of the policy effectively doesn’t pay any tax in the sense that all of the income, whether it’s credit or private equity or anything else, flows through to the insurance company investor. But the insurance company investor gets a credit, gets a reserve deduction for everything it ultimately has to pay out to the … whether it’s an individual or the policy owner that’s a life insurance company. And so what you want effectively is something that’s otherwise not taxable in the structure. So a partnership or LLC is typically what we expect.

LT (09:10)
So we’ve talked a lot about how these are not necessarily new products. Certainly I know I’ve heard about IDFs for quite a long time, but it doesn’t seem as though they are something that every single manager out there just has one, the same way that they’re setting up some of their regular fund strategies. So do these tend to start small, get big? Particularly as it seems that often they’re single investor type of structures, as well with the kind of one insurance LP, are they often smaller on size? What’s the typical range, I guess, and how big have these gotten in the market?

KL (09:53)
That’s a great question. So here at Kirkland, we’ve done a lot of these and continue to do them. There is a pretty wide spectrum in size. So, you know, some of them can be as low as $25, $50 million. On the other end of the spectrum, you know, there’s IDFs in the market with $5+ billion. I would say the bulk of concentration, especially for managers, you know, launching their first IDF would probably be closer to the $100 million, $200 million size. We do see a lot of concentration there for first time IDFs. Certainly, you know, and happily for our clients, we also see increased size in subsequent and successor IDFs. So if the first one’s $100 million, you know, the second one is pretty often like $200 million plus. It really honestly comes down to you know, if there is an anchor investor and to the extent that that anchor is an insurance company, a lot of them are actually just single investor vehicles or they end up being single investor vehicles. So I think one important point that we should probably highlight is the cost efficiencies. For the first one, there is a lot of learning. It’s a curve for sure. And to the extent that there is a very small ticket on the line, maybe the cost efficiencies aren’t there. A lot of our clients make the decision that if they’re starting with a $25 million ticket for their first IDF, it’s really more of an investment and efficiencies of scale can be reached on multiple successor IDFs. But really, if we’re looking to hit that cost efficiency mark on the first one, we’d probably advise that, you know, be looking at an anchor investor with around $100 million in that ticket size for your first IDF.

BG (11:52)
And that’s especially true with the ICOLI investors where they’re coming in as a single investor. They know what they’re putting in. It’s typically $100 million or so. Those tend to be closed-end funds. They’re coming in for 15 years, 20 years or something. And that’s it. A number of ones in the market that we see are commingled funds with lots of different kinds of investors, taxable investors who are using PPLI products or variable annuity structures for the institutions. And those tend to be ... they can be closed in as well, but they typically open end in the sense that they go on forever. And so the money comes in like a hedge fund, no distributions like a hedge fund. And when you’re ready to redeem 20, 30, 40 years from now, you redeem. And those tend to be not the single investor ICOLI products, but the commingled products for other investors, the taxable investors and the foundations endowment type investors.

LT (12:46)
So can be a very good long-term investment for a manager to not only, you know, for the immediate fund that they’re looking at, but to build a platform that can ultimately grow in size over time and cover seemingly any strategy that they can think up, which is also fantastic. So, let’s say a manager decides that they would like to pull the trigger on doing one of these structures. About how long would you expect it to take to set one up? Is it similar to setting up a fund? Or is this something that takes a little bit longer because you’re dealing with the IRS or is it, just kind of, you set it up to meet the code?

KL (13:30)
They can actually be pretty quick. I guess the two most dispositive factors of consideration in answering the question are going to be, has the manager done one before? Are they familiar with it? And two, are they using an administrator? If they’re using an administrator, there’s two very prominent ones in this space. And they cut some of the guesswork and some of the admin headache. There are really two main documents. Now, they’re fundamentally important, but there’s two main documents. One of them is the advisory agreement. That tends to be fairly simple. Obviously, you’re going to have regulatory components. You’re going to have critical tax components and you’re going to have the manager weighing in on what can work for them operationally. The other piece is essentially a supplement, and that is going to govern the terms of the IDF. And it’s also going to have something that kind of looks like a PPM in the back. So it’s going to describe the manager and the strategy. Depending on how many fund products and strategies that IDF invests in on the platform or with third-party managers, the disclosures can be 50 to 500+ pages. So the number of documents is not large, but it does require critical thinking at very specific inflection points. Again, if you have a manager that’s done them before and is familiar with the process, and if you have an administrator that’s coming in and taking on some of that noise and admin headache, it can actually be a very, very quick process, and there’s no, you know, there’s no filings, et cetera. You just activate it and the investors sign on and you can go.

BG (15:25)
There are two ways to go. One is, which Kate and I have done, which is where the manager goes in alone. They want to create their own IDF. And that typically takes a little longer because the manager typically hasn’t done this before. But it looks very much like their traditional fund. You go through the whole fund process. We have to add our tax mumbo jumbo and insurance company language into the documentation. It ends up being a little longer compared to the administrators in the space. And as Kate said, there are two administrators in the space, and we work with both of them. They’re both very good. From beginning to end, if you go through the administrator process, it probably can be done in 90 days or maybe a little quicker if that’s what needs to happen. It also depends on: what kind of capital are you raising? With raising insurance company capital, those tend to be single investor products, single investor IDFs where the insurance company wants to allocate to you $100 million to the manager. That realistically can be done in 60 or 90 days if we hustle and everyone desires to do that. If you’re raising taxable money or foundation money for the tax benefits, that typically takes longer, not for the lawyers, because documentation can be quick, but it’s really to go out and get a new insurance policy from an insurance company, the individuals have to get it underwritten and that typically takes time. So the legal documentation is quick. It’s really just the process of going to get a life insurance policy, there’s medical underwriting, everything else. I would say that’s three to five months typically. For institutions where you don’t need a life insurance policy, you can rely on an annuity, those can be quick. And then you’re back to the 60 to 90 days from beginning to ready to close.

LT (17:11)
So, certainly something to factor in if you’re in the middle of the wider fundraise, let’s say, and this is going to be one pocket of that.

Switching gears a little bit: There is a term that you guys use when we were chatting about this last week, and I was wondering if you could give a little bit more information on what an ICOLI is.

BG (17:33)
So, many of the IDFs we’ve seen in the last couple of years have been ICOLI investors. And in fact, probably done a dozen or so IDFs in the last two years, many of them, not all, but many of them have been ICOLI investors. Those are really just insurance company investors that, as we said before, can invest in these products, can invest with the managers. But if they invest directly with those managers, there’s a capital charge, a regulatory capital charge to them. So the structure of the insurance-dedicated fund structure is really just that. It’s just in its structure to solve the regulatory capital charge issue that those investors have. So if they go through an insurance-dedicated fund, they’re typically, as we said before, no capital charge to them. So what ICOLI is, is really just an insurance company-owned life insurance policy, series of life insurance policies that invest in these products. They do get a tax benefit too, but it’s primarily for the regulatory capital charge benefit.

KL (18:34)
Bruce, as a corollary, some of our clients, especially those that set up and understand these structures, are eager to participate and set them up for, let’s say, knowledgeable employees or other employee participation. Where is that line drawn for purposes of investor control doctrine if the participating employee is also in charge of, let’s say, the directional investment strategy of the IDF? Is it possible for them to participate as an investor to the extent that the insurance policy is set up with a different beneficiary, for example, a spouse or a child or someone along those lines?

BG (19:20)
Look, we like to say that anything is possible. So what happens typically in these structures is when we talk about the opportunity to fund managers, not only for ICOLI and other insurance company investors, but for individuals, the tax benefits really drive these alternatives. And so when the managers hear that their investors can come into credit with no taxation over 40 years, or if you invest on behalf of your children over 80 years, depending on their life, that really draws a lot of attention. One of the easiest ways to raise capital, of course, is from insiders. The reason that we pause on those types of structures and why we have to look at those very closely is that one of the reasons these structures work is that the underlying insurance company investor that’s making the investment into the IDF is the tax owner of the assets, not the policy owner. So, Kate, if you buy a policy from an insurance company and you invest in an IDF through, you know, ABC Insurance Company, it’s the ABC Insurance Company that’s the investor and the tax owner of the assets, not you. In order for the insurance company to be treated as a tax owner and not you, you can’t be seen as controlling the investment. You can decide to invest and ask ABC Insurance Company to invest in the underlying IDFs, but you can’t make investment decisions. So if you’re a fund manager, you can certainly buy private placement life insurance and go out and make investments in unrelated funds, no problem. But when you talk about making investments in your underlying funds, the question is, are you making those investment decisions? If you’re a fund manager, portfolio manager or fund, it’s gonna be very difficult to make those, make a private placement life insurance investment in your IDF where you’re managing the investments. If you’re a retired partner, we’ve had some sponsors, you know, retired partners who really have no control over the investments. They don’t have full transparency on the investments. Those are types of people that are what I would call former insiders that can make investments in these products. Everything else is a slippery slope, and there’s no bright line. It’s just shades of gray, and we have to get as comfortable as we can depending on the facts.

LT (21:24)
In summation, maybe on these structures, certainly flexible. We always like to be able to offer insurance and other products that can have many diverse underlying assets. But certainly it seems like obviously there’s a restriction on the types of investors that can come in directly or that do come in directly. And then dealing with these kinds of control and diversification tests are certainly something to manage. Definitely interesting as well that from an investor’s side, they will have this indirect relationship. So it’s something for them to kind of think through and perhaps understand a little bit more when they’re going out to purchase these policies about how that ultimately is going to work for them and how much do they actually want or need sort of that oversight position. So very interesting stuff.

Thank you guys so much for joining. For all of those of you out there watching us certainly get in touch if you are thinking about an IDF or want to discuss it more because you haven’t heard much about it before, we would absolutely be happy to discuss this as another option for raising capital into your funds and particularly for the insurance capital market. Thank you very much and we’ll see you in the next episode.

LT (00:10)
Good afternoon and welcome to another episode of Kirkland & Ellis Absolute Credit. My name is Lindsay Trapp. I’m a partner based in our New York office, and I’m joined today by my partners, Jared Axelrod and Michael Urschel in our debt finance group. Welcome guys.

JA (00:26)
Hey Lindsay, great to be here.

MU (00:29)
Thanks very much, Lindsay. Much appreciated.

LT (00:31)
So today we thought that we would bring back an oldie but a goodie, U.S risk retention, which of course after the LSTA decision and those kinds of things sometimes gets forgotten about in certain aspects of the market, but we thought that it would be helpful to have a good refresher. So with that, let’s get right into it. Michael, we’ve got a lot of things in relation to U.S. risk retention that folks maybe, you don’t know that much about the background and the history of it. So can we discuss the origin of the rule and the problems that we were looking to solve when this came into place?

MU (01:07)
Sure, happy to help. My role today is to play the dumb traditional asset securitizer. We’ve got funds and CLO colleagues who in fairness have made some great advances in just understanding risk retention. But let’s take it all the way back to Dodd-Frank in 2009. Obviously, as everyone knows, the original reason for the risk retention regulations were concerns after the global financial crisis around the originate-to-distribute model, right? So as we all know from like 2005 to 2007, the big problem in the market in structured finance, which caused the global financial crisis in many people’s minds, was the originate-to-distribute model, taking risky mortgages or other risky financial assets, bundling them up, getting them off one balance sheet and then onto other investors’ risk balance sheets. And then, you know, those were rated, those were tranched, et cetera. What came out of Dodd-Frank, of course, was the risk retention rule, which said originators or securitizers had to keep skin in the game. So, if you are securitizing a portfolio of asset-backed securities, which loosely defined, is securities which payments depend primarily on cashflow from self-liquidating financial assets, then you need to comply with the risk retention regulations and you need to hold 5% in either of the three permitted forms of risk retention. We’re all used to that. We’ve all been dealing with that for 17 years or so now, particularly in the types of transactions that our team does in the more cash flow-based asset-based securitizations, most of our transactions comply with risk retention. So any mortgage-related transaction, anything that’s tied to a lease or some other financial asset that has a specific term with which it makes its payments, you that’s pretty much automatically subject to the rule. If you’re issuing securities backed by that, of course, obviously loan-based transactions are outside the rule in the U.S pretty much completely. That’s not the case of the EU obviously, but as things have gone on, obviously more things have been securitized than were securitized in 2009. In 2009, the esoteric securitization market was very small. It was basically wireless towers and a few other things. Nowadays, we have whole-business securitizations at scale. We have wireless towers, we have fiber, we have data centers, we have solar cash flows, we have other things. And there has been, especially in infrastructure, oil and gas, etc., there have been a lot of transactions where we actually take the view that it’s not a self-liquidating financial asset. Really good example, for example, is some of the first deals that we decided were not self-liquidating, or the franchise whole-business securitizations where the franchisor has to maintain its menu. It has to maintain its intellectual property. It’s a royalty stream over time that doesn’t have a defined term to it. So these are not self-liquidating financial assets. These are operating assets. And so across the market, we’ve taken the position that operating assets are not self-liquidating financial assets, therefore aren’t subject to the rule. Bottom line is a lot of these things are whole-company securitizations or other securitizations where as a practical matter, the equityholder of the business is holding way more than 5% anyway. So it’s really not an originate-to-distribute model either. And so even though we take a position that it’s not a self-liquidating financial asset, there really is still a lot of equity skin in the game. But let’s take it back to that though, because one of the big themes today is going to be what does it mean to be self-liquidating and what does it mean to be originating an asset to distribute it. And so really when you’re thinking about risk retention and whether it should apply, you kind of need to come at it from both angles. And we expect over time, continued analysis, continued regulatory developments on this. The tricky part though is there hasn’t been very much enforcement. There hasn’t been a lot of good case law. And so rarely are we seeing legal opinions given. Oftentimes we prepare memorandums, we prepare reasoned analysis of why we think a position is correct. Or we’ll even state in document sometimes, hey, we’re complying with risk retention solely out of caution, but if we ever get legal advice that this transaction doesn’t have to comply anymore, we can stop. So we do have things like that. But again, that’s the sort of transactions that our complex securitization team sees from an esoteric point of view or a traditional asset-securitization point of view. One thing where our colleagues in CLOs and rated funds have started making some real intellectual leaps, again, also helped by a court case, is what does it mean on that origination arm? Like, what does it mean if you’re originating or whether you’re creating a structure that originates its own assets? So with that, I’ll take it over to Jared to talk about the LSTA case and how the CLO market sees that.

JA (05:47)
Thanks, Michael. So CLOs, like most other securitizations, were subject to the risk retention rules coming out of the financial crisis. So the rule came into effect in 2015, 2016. CLOs, both kinds, you have the BSL CLOs, you have the private credit, which at that time were referred to as middle-market CLOs, were subject to the rule. Shortly after implementation, there was a court case filed. This is commonly referred to as the LSTA court case or the district, the DC district court opinion case. And essentially what the LSTA was getting at was that risk retention should not apply to CLOs. The focus of the opinion in the case turned on this idea of transfer. In particular, the risk retention rules identify the sponsor of a CLO as the party who organizes and initiates the transaction by transferring or selling the assets into the securitization issuer. And the argument was that BSL collateral managers, that is collateral managers of broadly syndicated loan CLOs, do not ever transfer the assets into the issuing entity. CLO managers are never the party who take these loans on their balance sheet. They don’t actually possess the loans at any time. They are acting as an agent on behalf of the issuing entity who is actually buying the assets. And that was basically what the court case turned on, was this idea that the managers are inappropriately identified as the per se sponsor because they don’t actually take possession or transfer the loans. That’s the basic gist of the LSTA decision. There was no argument about whether or not loans were self-liquidating. I think, you know, everyone’s in agreement that, you know, a standard BSL loan or even a private credit loan would qualify as a self-liquidating asset, it really turned on this idea that there is no transfer and therefore there is no sponsor for these securitizations. And if you don’t have a sponsor, the rule doesn’t apply.

MU (08:13)
Appreciate that, Jared. And look, again, one thing we want to keep people thinking about today as we turn to the next part of this presentation is, again, why was all this put together? Because if you go back to 2004, 2005, the securitization market was the 144A or the public market where securities were structured under 144A or in a registered format in order to sell those tranches out to the market. Nowadays, 17 years later, and my favorite phrase, the rise of private credit, means there’s a lot of private credit capital out there. There’s a lot of managed capital out there that is sophisticated, that thinks about risk in a different way. But more importantly, there’s a difference between originating something to distribute risk and otherwise understanding and allocating risk on your own balance sheet and getting it to the right pockets of capital within your organization. And so a lot of times when you’re talking about complicated fund managers who have multiple sources of capital they need to deploy, it’s less about originate-to-distribute. And it’s more about allocation of risk to the right, you know, temporal time concern. You know, if you want to have a five-year or a 10-year or a 15-year bond, you maybe have insurance capital that’s got a much longer horizon than shorter, you know, higher-grade capital, lot of different places to put risk. And it’s more about that. So when we think about this stuff, obviously the rules need to evolve over time, but I think right now the sort of prevailing view is, look, if you’re structuring bonds and you’re going to sell bonds out into the market and it’s self-liquidating financial assets, yep, you’re probably subject to the rules. If you are structuring bonds, but it looks more like a corporate and you’re really just securitizing a corporate credit on a whole-business level or some other operating asset, probably not inside the rule. But the fun part, and again I’m just learning this from our new colleagues also, is: What about when you’re looking at this stuff from the lens of a fund? When you are a credit investor who is hungry for credit risk and you want that stuff on your balance sheet and you want to look at that asset and think about how you’re going to evaluate it, rate it, hold it on your own balance sheet, what does that mean for risk retention for you and whether you need to either nominally comply with the rule or not comply with the rule at all?

So for now, I’ll take it over to Jared and Lindsay to talk about how their funds clients and their CLO clients are thinking about these risks and how it looks from their perspective as far as when they’re actually trying to acquire the risk and how does that affect their portfolio.

LT (10:37)
Sure. Thanks, Michael. So I guess, you know, from the structured capital & insurance solutions team side, we certainly do have to think about and think through risk retention a fair amount when we’re doing different types of structures. Rated note feeders obviously are very popular product. That would be a structure that in a lot of ways may look like a securitization, but also oftentimes wouldn’t necessarily be considered a securitization depending on how it is structured. But ultimately the asset that’s going to be held by the issuer is a limited partner interest. So an equity interest. So from that perspective, in general in the market there’s been a lot of consideration around, well, is that really just in that case not a self-liquidating asset even if the underlying assets of the fund might have some self-liquidating properties. The other thing there is that funds as a general rule are always going to have a reinvestment period. So, assets are going to be bought on a blind pool basis or originated on a blind pool basis. And then they’re going to churn for several years. So even if you started, it’s very unlike a CLO where you have a warehouse set of assets, and then those go into a box and then that’s kind of your asset base more or less for the entirety of the transaction. So in a general sense, not to say that there aren’t any specific cases, but in a general sense, it doesn’t tend to be the case that risk retention comes up much in feeders. However, in rated funds that are a standalone issuer, definitely something that we consider quite a bit. There are different features. Does it look more fund-like does it look more securitization-like you know and then what are the underlying assets that we’re talking about? Those are the types of things that start coming up in rated fund land. But certainly Jared you know for CFOs we have similar discussions and you know kind of how those structures operate is a little bit different than a rated fund.

JA (12:47)
Yeah, that’s right, Lindsay. So oftentimes, maybe not oftentimes, there are instances in the market where we hear parties use rated note feeder and CFOs interchangeably. Frankly, in our view, they’re not the same, right? So for a rated note feeder, it’s an entry point into a single fund. Whereas you compare that to a CFO, that is a SPV that holds multiple fund interests that are the collateral for the notes that are being issued. So first and foremost, just wanted to clarify like what the basic differences are between these structures. So for CFOs, right, the underlying assets are going to be fund interests, right? So same as rated note feeder, it’ll be an LP interest in multiple different funds. First and foremost, right, are those self-liquidating assets? I think the market’s pretty clear that limited partnership interests, equity interests are not self-liquidating, in part for many of the reasons that Lindsay already went over. So then there’s a question of, you know, who are the relevant parties and is there a sponsor to this securitization? So with the CFO, you’re gonna have the same sort of cast of characters that you would see in many other securitizations. My background’s in CLOs, so that’s what I, you know, the lens through which I see these structures. And they are very similar in that regard to CLOs. So you’ll oftentimes have an investment manager, a trustee, third-party investors, collateral administrator. If it’s offshore, you’ll have Cayman fiduciary services, legal, etc. And so of those parties that are involved in the transaction, the question comes down to who, if we even need to get to the sponsor analysis, because as Michael indicated earlier, you need self-liquidating assets in order for that to be ABS securities. You need them to be ABS securities in order for the risk retention rules to apply, so assuming we get to the point where we’ve established that there are self-liquidating assets, the question is, is there a sponsor? And again, going back to what we talked about earlier with the LSTA decision, that analysis comes down to whether or not there’s a party who organized and initiated the transaction by transferring or selling the assets into the issuing entity. And more times than not, to the extent we ever even get to the sponsor question, there isn’t actually a party that transferred the assets because the assets have been originated in the first instance out of the fund or in the rated fund structure in the issuing entity.

LT (15:36)
Absolutely. And I think the underlying assets do play a part for sure. We’ve got private equity funds and credit funds and CFOs tend to make a mix a lot of times of having sort of both types, not always, but in a lot of ways they do tend to get there. And now we’re seeing a massive expansion, you know, similar to the way that Michael was saying, where there was a large expansion in the types of ABS that were done, we’re following suit here in fund world and we’re starting to see funds that are investing in more esoteric types of assets. And then we’ve got a lot of open-end and evergreen funds where there just simply is going to be constant churn of those assets over and over and over again. So I think that all of those positions become very relevant to what we’re looking at. And in CFOs, I know Jared, you and I have discussed is there a tipping point? And when you’ve got maybe all credit funds or all PE funds, maybe there’s a brighter line in that discussion. But ultimately, even if you get there, there is a lot, including in the context of a standalone rated fund, that is going to come back to do we actually have a transfer in or a sponsor? And so for standalone rated funds, if you do have some warehousing, and sometimes in rated feeders as well, there’s considerations around if there’s warehousing before the fund starts and there is a transfer in off the balance sheet. We do probably need to dive a little bit deeper and take a look at that. But ultimately, I think one thing that’s quite interesting about U.S risk retention compliance as well, at least from my perspective, comparative to my background in European risk retention compliance, is that there tends to be different people that can participate in the compliance from the sponsor side if there is a sponsor, or if there isn’t one, there just isn’t that retention requirement. So I think that’s quite a big difference with the EU and the U.S. And that can make it easier. But there’s also disclosures that we certainly put in on occasion as well about whether or not something should be compliant or if it’s determined if it should be compliant who that retainer would be. And so I think for CFOs and rated funds for sure, there’s a lot of interesting analysis that goes into those things. And from an investor’s standpoint, certainly something you should consider and look at when you’re looking at these types of deals and kind of make your own assessment or discussions that you should have with your counsel when you’re investing into these types of deals. I guess, you know, what are the motivations, Michael, as we’re driving transactions that end up being, you know, compliant or what were the motivations to even get here in the first place?

MU (18:40)
Thanks, Lindsay. You know, one thing I wanted to bring up today, just by analogy, is a little bit of a lens of practicality. I think this is going to be a good illustrative piece for some folks. I mean, think back to when risk retention started. I mean, look, the basic model of risk retention is that the originator of the securitizer has to hold 5%. But at the very beginning, there was a permissible exception in the form of CMBS B-pieces. CMBS B-pieces are allowed to have a third party hold the risk retention piece as long as they’ve been around at the beginning for the portfolio selection, they’ve done diligence on the underlying assets. So even at the very beginning of the rulemaking, people realized in CMBS it was important and there were people who understood that bottom-piece risk, were excited about being a part of it and that the transactions were structured to allow that. And so I think we always have to think forward-looking like that, and I think you have to think about how you’re structuring a transaction. I mean, if you’re specifically structuring a transaction because you want to offload risk and then go off and originate new assets, and then primarily all of the risk is going to be held by third parties afterwards, you know, it’s a self-liquidating financial asset, etc. That’s something you should think about what the risk potential is. If instead, you’re setting up a vehicle that’s a fund because you crave that risk, and you want to be able to understand that risk, hold that risk, tranche it different ways for different accounts on your own institution, et cetera, then it’s a little bit more on the other side of the spectrum. So I think it’s important that we think about these things in these ways, think about the reason for the rules being set up in the first place. And it’s kind of a smell test as you’re structuring a transaction as to how much risk there really is on whether something has to actually comply with the letter and spirit of risk retention rights. And I think, again, as these products become more hybridized as structured finance and fund finance interact more, we’re going to have to a lot more of these conversations. We’re going to have to think about who are the parties to the transaction, how sophisticated are they, where the different pockets of capital sit, and where the financial assets sit within the structure. When are they originated? How are they originated? Who’s holding them? Obviously, basic questions, but important questions to ask for all these products. And we’ve got to ask, I think, for each new product in an independent way and thinking about how those products are set up.

So eventually I think we’re going to get to the point where there’s certainty in all this stuff. But I think right now we do have to look at every single transaction in its own lens based on, first of all, what’s the nature of the product being created? Is it a security? What’s the underlying asset? How do the parties understand it? How are the parties working together to set up the transaction? And when in the cycle of the transaction are the assets being acquired? You have to look at all of that. And again, on some of the stuff, there is no perfect answer. I have clients in my space who I wrote them a memo that said, you guys shouldn’t have to comply with risk retention. They said hey, we want to do it anyway because we don’t want to take any risk. And that’s the client’s choice. In certain asset classes that we’re pretty sure that people don’t have to comply, there are people out there complying anyway. And that’s always someone’s choice as well. Rarely do we see people taking extraordinarily aggressive positions. I think everything is generally defensible. People on all sides of the transaction often expect reasoned memorandums from law firms saying it’s a position that while it’s not without doubt, it is a reasonable position to take where there’s other people taking the market, that sort of thing. So look, I think things are generally at a pretty good space. But I do think as this sort of hybridization of structured finance and fund finance continues, and I think we all on this call predict that there’s going to be a lot more of that, it will only lead to more opportunities for us to have these questions, have these discussions. And, you know, there’s probably going to be going forward, some people going for more certainty on a regulatory basis. I mean, I could see people going for no-action letters or for other things as we move forward, hopefully. And we’d like to see more color like we got out of the LSTA case.

JA (21:43)
Yeah, so Michael brought up lot of good points there. One of the items that sort of follows logically from what you just touched on is, you know, whether or not it’s appropriate, and we’ve seen this come up a few times in different deals, whether or not it’s appropriate to do what people refer to as a look-through analysis in some of these structures. And what we mean by that is rather than looking and stopping the analysis simply at the LP interest level in the case of a CFO or rated note feeder, whether you should look through the structure and look at the underlying funds and the type of assets they hold. And usually the analysis as to whether or not to move forward with that look through, I think turns largely on whether or not there’s any cute behavior or cute structuring taking place, meaning if the parties are putting these structures in place to evade the application of the risk retention rule, I think in those instances, which frankly, we rarely, if ever, see anything that comes close to that type of behavior. But if that were to exist, I think there’s an argument to be made that one should look through to the actual fund and look past the LP interest. And so you’re not just saying, hey, look, the CFO, the collateral are LP interests, so therefore it’s not self-liquidating, therefore risk retention doesn’t apply. Rather, you would look through and say, okay, you know, the underlying fund, what does that hold? Are they self-liquidating assets? Are they sufficient in the, you know, in the aggregate relative to the other assets that they meet the definition of self-liquidating for purposes of ABS securities? And then is there a sponsor, right? And I think that’s the right way to go through the analysis. And, you know, I think largely, not largely, the vast majority of market participants aren’t trying to evade any of the risk retention rules. They’re really putting these structures in place in good faith in order to, you know, expand their LP or investor universe to, you know, get efficient financing, things like that.

LT (25:32)
Excellent. Well. Jared and Michael, as always, it is wonderful to not only get to work side by side with you, but to have you here on the show. And to all of our wonderful clients and other market participants who watch, we hope this has been helpful and informative. And certainly, as you’re doing these new products, as you are moving forward with new asset types, all of those types of things certainly keep retention in the back of your mind. And we are always here to help.

Thank you for listening to us today and we look forward to seeing you in the next episode.

LT (00:10)
Good morning and welcome to the Kirkland & Ellis Absolute Credit Vlog series. I'm Lindsay Trapp. I'm a partner and co-head of the Structured Capital & Insurance Solutions Group and I'm very excited to be joined today by Bill Cox, the head of ratings at KBRA. Hi Bill, welcome.

BC (00:26)
Hi, Lindsay. Thanks for having me.

LT (00:28)
Awesome. So congratulations on your new role. We're very excited to see you in this post and really honored that you come on here to talk to us a little bit today. Some of the stuff I wanted to … I have like a million questions for you, but I will temper myself. So, you guys put out one of the most amazing pieces in the market this autumn around rated funds and CFOs and what you guys are seeing in trends in the market there. Could you give us just a little bit of overview of that and maybe we can walk through some of your findings?

BC (01:04)
Sure, sure. Thank you. And thank you for that. And it's an honor to be with you and congratulations on your new role as well. Thank you. We're glad to continue to work with you always. Yes, that piece was an effort across a number of our different teams in funds debt ratings. And the broad message is that ever since the NAIC in particular clarified its treatment of rated note feeders, tranches and so forth, we've seen an absolute explosion of new platforms who are using investment vehicles. We've also seen a geographic expansion, meaning the collateral types are increasingly diverse across geographies. We've also seen the type of collateral become more diverse. So, while it used to be private equity and secondaries and traditional direct lending part of private credit, now we're seeing a lot of different collateral types be put into these feeder note and CFOs. And then just generally, volume growth and complexity growth has also been highlighted in that report.

LT (02:16)
Well, we do like to keep you on your toes! You know, make sure that we can come up with something new and fresh to keep you guys alert. Excellent. Well, I think you have some slides for us, which is awesome. So maybe we can go through some of the findings that you guys had in this paper.

BC (02:35)
Sure, sure. And if you think it's helpful for any of your viewers who don't know as much about KBRA as I know you do, Lindsay, I can give a quick background.

LT (02:44)
Absolutely, please do.

BC (02:47)
For those who aren't familiar with KBRA, we're just a 15-year-old rating agency founded in the shadow of the financial crisis by Jules Kroll and Jim Nadler, who is our CEO. And the goal was to have a rating agency that filled what we perceived to be a void and being able to respond to market changes and be absolutely focused on investor needs. So, in just 15 short years, we're now up to over 650 employees. We've rated over $4 trillion of debt. Over 80,000 ratings have been issued, and it's increasingly a global footprint. So, we're based in New York, Chicago, Dublin, London and most recently Tokyo.

And, Lindsay, it's because of the growth in feeder notes, CFOs, NAV facilities, which I know you've worked with us on a lot of those transactions, the amount of investor interest in Japan and in Asia broadly has increased dramatically. And they're certainly pulling us into that market. So, we're excited to have just opened an office in Tokyo. And then on the next slide, with regard to the footprint of KBRA, slide three. When we talk about private credit, typically in the market folks talk about private credit, they're either thinking direct lending or they're thinking about some other part of private credit or they're some article that doesn't understand private credit. And we look at it across the whole landscape of a broad trend from a rating agency perspective that we're seeing that's tied to a macro trend. And that macro trend is growth in private markets, the growth of AUM associated with private markets. And then alongside that is this increased investor appetite for having fixed income exposure to a variety of private market strategies and asset types. This is a global phenomenon. It's not just U.S. insurance companies. It's not just insurance companies.

It's occurring in Europe, in Asia, and it's occurring across different investor types. So, the broad macro strategy that KBRA has been involved in, which has led to our work in feeder notes and CFOs, is this incredible growth in private markets and the desire by many investors to have a fixed income version of exposure to that market. So, that is essentially the story. And then if you go to slide four, we have a ton of research about all of those different categories and happy to go through them. And then with regard to the specifics in feeder notes, maybe a little bit of definition if you move on to slide six. And Lindsay, this is where you might want to pop in with some specific questions. We get this question increasingly: And that is, what are we rating exactly? If we're doing a feed or no transaction or a CFO and that it's especially relevant because there are an increasing number of rating agencies that define things a little differently entering the space. And to bring it sort of to the core of what we're rating in these transactions in a funds context, there are two broad categories of funds ratings that are most active in the market and with KBRA. One is a category of fund finance where we're rating leverage to a fund in the form of either a subscription facility or a NAV facility or what we call fund investment vehicles. Our methodology is actually broken down into fund finance and fund investment vehicles. Fund investment vehicles are basically special purpose vehicles that are investing in one or more funds and it is the collateral or the cash flow or the underlying assets in those funds that are repaying debt instruments that are the way that that special purpose vehicle has raised capital in order to invest in those strategies. Why is that important to distinguish? There are some rating agencies that rate a fund.

We do not rate a fund as a starting point. We essentially are looking at the ability of the underlying collateral or the assets or the cashflow or the ability to call capital. The ability of those things to repay the debt instrument that we're rating pursuant to a waterfall, which you very carefully create, which can change over time, and therefore, we model cashflow analysis against that waterfall that can change with time, with value, with performance. And that is in essence what we have been doing in both the rated note feeder and CFO space for some time now.

LT (08:02)
Yeah, I certainly get a lot of questions and I am very grateful that I get to spend a lot of time with you guys. So, I can answer some of them around, you know, kind of "What are you guys looking at? What should I be expecting in the context of the ratings process?" and that kind of stuff. And one of the things that I think folks are — because of the expansion of asset classes and also just the kind of ever-increasing number of CFOs that are being done in the market that are mixed assets or finance companies, right? Which are, you know, kind of standalone rated structures where there might be mixed assets. How do you guys kind of look at those? I know, you know, in the past I've had some things where I'm dealing with maybe some of the folks in the funds team, but you also might have somebody from a different, like very specific asset class team that's looking at those things. So, how do you kind of approach something that has multiple types of underlying assets?

BC (09:01)
That is a great question. And I think a point of pride for KBRA, in particular, because one of our hallmarks is our ability to work across different business units that are expert in different areas. And that's part of why we're able to respond to new debt instruments in the market or new complexities in the market. So, for example, when we're doing a feeder note into a direct lending strategy, there are essentially three teams involved, always. One team is the funds debt rating experts, which are the ones who apply the funds debt rating methodology to the transaction in the ways I just described. The other is the corporate team. Our corporate team is expert at providing credit estimates on underlying loans that are in a feeder note as collateral. And we've now done, for example, over of 4,000 credit estimates this year alone on 2,200 unique companies. And that portfolio, which continues to grow in terms of the size of the companies, the diversity of the companies in terms of regions, that portfolio of credit estimates now accounts for over a trillion dollars of debt. So, if you think about that as a snapshot of what's going on in direct lending, our corporate team has among the best data sets available anywhere, including in the platforms themselves, because they know their own loans and they know their own co-lending loans, but they don't know everybody else's loans. We have loan level data, we have credit memos, we have financial information on those companies. And So, when we talk on a quarterly basis about the performance in that portfolio, it's from a really strong position of data.

But let me get back to your question. That's the point. In that context, the corporate team is involved, the funds team is involved, and then your favorite, the ratings legal team, led by none other than John Hogan, who is responsible for making sure that our interpretation of the documents, the waterfall, aligns with how the funds team builds the cashflow model. And then the funds team will grab the estimates and the expected performance of the underlying collateral. And those things coming together is how we create one example of a rating type, a feeder note into a direct lending strategy. But as you said, there is increasingly large numbers of different asset types that are in these fund strategies. So, our ABS team has been very involved in our work with ABF strategies, which have ranged, continued to grow in a lot of different directions, but it's probably among the hottest topics, right? ABF collateral being inside of a funds debt rating strategy. And that can be anything from consumer and commercial finance. In fact, I think there's a slide later on. Let me see, how about ... slide 14, if you don't mind, let me tie this back to what folks may be hearing. So, you hear the CEOs of a lot of the big private equity platforms talking about private credit being now a $30 or $40 trillion opportunity, but we all know that direct lending space is somewhere between $1.5 and $2 trillion. So, how do you get there? This is a map of how they're thinking about it. These are the different parts of the lending credit markets that are traditionally in the hands of banks and other non-bank financial institutions that now a lot of the private credit platforms are pursuing. So, we've seen music royalties, all sorts of consumer finance, commercial finance assets now migrating into funds. And therefore, if it is mortgages, residential mortgages, then our RMBS team is involved. If it's music royalties, then our Esoteric ABS team is involved in analyzing the collateral in the same way that I described that our corporate team does in a simple feeder note into a direct lending strategy. So, a lot going on in that space and a lot changes depending on the structure that you create with your client with regard to how that waterfall performs and whether we're doing top-down analysis or bottoms-up analysis of individual assets varies considerably depending on the structure that you create.

LT (13:44)
Absolutely, and the asset class expansion has been phenomenal and interesting and fun for me. I came from the just traditional private credit background. So, it's lovely to see new and interesting things that folks are putting together. And I suppose sort of linking some of the other stuff you were talking about, we're seeing a bit of a rise as well in funds that are themselves doing subscription facilities for other funds and kind of packaging that up now or securitizations if they're not rated funds but securitizations as well in that space. So, is that one where you would kind of have two methodologies together or would it be more of a fund and we're just looking at those as sort of their specified assets?

BC (14:37)
Yeah, that's a great question. It's the same methodology, but it would be different teams. So, in that case, the way that I described the corporate team being the provider of the collateral analysis in the case you just described, part of the funds team would be the collateral analysis providers to the other part of the funds team that's working on either the feeder or the NAV facility. So, yeah, when we think about ABF, fund finance is increasingly an ABF category. And depending on who you talk to, they say, "No, no, no, that's not the case." But it is, right? So, whatever that collateral type is, the experts that are best able to assess that collateral type obviously play a really important part of the transaction.

LT (15:30)
Awesome. That's very, very interesting. And the results here are for someone who does this for a living as well, it's heartening to see the big results and kind of how much this market has grown. I think it's just absolutely fantastic. And the paper was really just filled with insights and interesting things. So, I think that's also available on your website as well, right? I think you can sign up to be a part of the website and get a copy of that as well.

BC (16:05)
Yeah, and if you want, I can go through some of the sort of high-level stats that are in there that have actually been, you know, continued since that was taking data through the first half of the year. We just recently did a, you know, an update on the third quarter and how it impacted those stats. And it's pretty remarkable in terms of the growth and all the ways we talked about.

LT (16:30)
Absolutely love to do that. That was about where I was just going was to ask you about how many numbers have we have we seen this year and ever presently growing?

BC (16:40)
Yeah, if you go to slide 10, it lays out some of those big picture trends that I mentioned before. And again, the big picture trends in this space of feeder notes and CFOs, geographic expansion. One of my favorites as an example, because it's not just geographic expansion of the collateral type, it's also geographic expansion of the investors and of the issuer. So, we recently worked on a CFO that was a U.S.-based credit platform combined with an Asia-based private equity platform coming together, originating assets, and then selling or marketing the CFO into Europe, the Middle East and North America. It was really remarkable in terms of the overlap of the different types of geographic expansion that's taking place. And we see that sort of having a multiplier effect given the number of investors that are interested in different geographies and in other region assets. The second one is investor types. So, obviously among the most significant that folks may be familiar with is the increasing presence of third parties providing the equity in CFO or feeder note structures. It's not taken off as much as we would have thought, but it's definitely increasing and we expect it to increase even if it's at a slower pace than than original expectations. Another investor type that is now appearing in these structures is the retail investor, which takes on a whole layer of complexity.

And this is more with regard to NAV facilities into perpetual strategies that include retail investors, less so feeder notes. But we have seen at least one feeder note that combines institutional investors with retail investing using quarterly sweeps into or from the wealth platforms and then into the given strategy, which was a phenomenal transaction to work on, if you can imagine the complexity. ⁓

The third thing that I didn't mention earlier, and that's just the duration that we're seeing in these transactions, which mirrors to some extent the migration into perpetual strategies, but also the general appetite amongst especially insurance investors in the U.S. and Bermuda and parts of Asia and increasingly in Europe for long duration exposure to these given strategies. It just marries up well with their balance sheet liabilities. And so an increasing number of 30-, 40-year transactions, but usually around 20. And then the collateral type that we've already talked about. So, those are the big picture trends. On slide 11, we have essentially through the first part of the year, we saw 13 new managers do feeder notes by count. And the dollar amounts we expected to exceed prior years. And the same for CFOs, as you can see on the right part of that slide. But if you go to slide 12, you can see that we're already past last year. So, feeder notes as one example, we expect it to be possibly 30% more this year than last year. And we see no end in sight in terms of the number of managers increasing presence of very large transactions, billion-dollar plus, as well as these different regional components coming together to impact the number, the size, and the complexity of transactions.

LT (20:41)
Yes, so we were very excited to work on at least one of those, well, it actually $2 billion plus deals with you guys, which was great. And I think this firmly explains why myself and our team have not slept in about two years. But hey, it's good, it's good. Yeah, this is fantastic. And I do think, you know, just from our side, we are seeing so many people, so many different types of managers, you know, really starting to come into this to want to do a number of deals, you know, instead of kind of just, well, we might do one for this fund now, we're getting a lot of approaches for, hey, you know, we want to set up, yes, a first one to kind of do it, but then the goal is to essentially put a rated fund on every fund complex that it possibly can be rated, which is fantastic. And I think it just really shows how far this market has come. And with the help of folks like you that you're kind of looking at, hey, there are ways to measure cash flows off different asset types that we can kind of work together and make things. And one of the things I also saw on that last page was the rise of evergreen funds and as we were talking about, I think that that has probably been one of the most interesting things to watch and see. That's really just a wider private funds market expansion is into evergreen structures, be they BDCs or private evergreen structures. And I was lucky enough to work on one of the very first funds with you guys into a perpetual BDC and have done more than I can count now with you guys and with structures that have evergreen funds in them, but they are very unique in the way that they work, obviously. And we will leave aside the evergreen rated fund that we just did, which has been out there in the market. I think we're leaving that to a very special webinar that will be done on that structure. But I think from your guys' side, a lot of folks want to sort of understand how the ratings process goes when you have evergreen structures in there. And we're seeing an increasing number of evergreen structures in CFOs, which in a rated fund, obviously have worked through that a number of times. We have mechanics on different ways that that can be done. But particularly in CFOs, is there anything from a ratings perspective as maybe the weighting of having let's say more of the CFO's capital into an evergreen fund or multiple evergreen funds that kind of comes into play when you're thinking about that.

BC (23:37)
Yeah, is, Lindsay. First of all, you're being modest. You've been more than just a participant in the evolution of this part of the market. You've been a leader in more ways than I can describe on this call. But I'm sure we'll have time to talk about that on that other call. So, thank you for that. You've been very thoughtful and helpful to us and to the market. We have seen the trend that you just described play out with several particular platforms who have basically seized on the precedent that you and we and some others set with some of the earliest transactions. the complexity is this, right? You have a perpetual fund, which means that you don't have a natural liquidation of the assets that lead to an amortization of the debt, right? So, the challenge is how do you get to a point of amortization?

And in the earliest structures, simple single fund, you're basically doing things that are somewhat awkward or difficult to accomplish, like carving out assets on a pro rata basis for the feeder structure to allow those assets to pay down and amortize the debt instruments. But as the types of perpetual fund strategies have become more complex, making it more difficult to do things like you described. There are other very complex mechanisms to grab cash flow and over a longer period of time, carve out distributions and allow for the notes to be repaid. But the big step forward, again, I'm just talking about a single strategy example.

The big step forward is this notion that there may be perpetual financing vehicles sitting on top of perpetual funds, right? So, rather than amortize to refinance. And if you're a long-term investor in a perpetual strategy, then expecting the ability to refinance is going to be something that will be part of that landscape, which is not that different than how BDCs operate. They're on balance sheets, right? They're refinancing the debt. They're not amortizing the debt.

⁓ So, it is a really interesting dynamic, but then that gets incredibly complex when you have multiple strategies, some of which are perpetual, some of which aren't. And there is a transition that we make that we can't define exactly, but it is a transition that we make at some point, given the amount of diversity of collateral, where we go from a top-down or bottom-up analysis to a top-down analysis, which is the manager across these strategies essentially functioning much the way of a non-bank financial institution would function and then have part of its balance sheet being managing debt, part of it being managing equity, and part of it being managing an allocation into different investment strategies. It's a difficult thing to pin down, but we have seen some platforms do CFO structures that are so large and so diverse that it becomes more of an analysis of their ability to refinance debt and to manage through the life of the various assets in a way that is consistent with the waterfall need to possibly amortize but likely refinance.

LT (27:19)
Interesting. And I think that that does raise something else that I get asked a lot, which is sort of how much does the manager and due diligence and sort of analysis of the manager play into the ratings process because it's certainly when we're rating a blind pool in particular, you know, there's a lot that history counts for a lot, let's say track record counts for a lot. So, maybe if you could just run very quickly through kind of what you guys are looking at in the due diligence and for folks that are thinking maybe they've set up a new shop or, you know, are coming into this in a new strategy. What are some of the points that you guys are going to be looking at in regard to the manager diligence?

BC (28:00)
Yeah, you hit the nail on the head with the first one, which is experience in that particular asset type. So, from the simplest example of a single feeder node into direct lending, obviously a manager having a long track record in direct lending is incredibly important. And we're looking for ability to source, to manage, to screen, to work out when necessary, looking at default history and what recovery performance was, ability to loans appropriately is also something that's really important. And basically giving us confidence that they can work through different market conditions and scenarios and different idiosyncratic events that can impact their individual transactions. I believe there's a slide, the next slide might even have in terms of the performance, rating stability. The manager is a critically important part of rating stability, right? So, the feeder notes have, for example, or CFOs have two important features that have provided rating stability, and that is the manager's experience in that particular asset class.

Second is the conservative nature of the structure, the ability of the structure to absorb potential losses or performance that hasn't quite met expectations in the base case scenario. Those two things have led to an incredible amount of rating stability. So, it begs the question with all these expansions into new collateral types, what are we doing about responding to, hey, we want to do this? We have said no to a lot of transactions where we didn't feel comfortable that that manager had enough of a track record in that particular collateral type. Or in the other extreme, had experience in that collateral type, but not yet enough to get us comfortable in a CFO-type structure. So, it is a very interesting time, but it's also a time where we continue to see incredible amounts of stability because of that conservativeness built into the structures. When we published the paper in the early part of the fall, we had not seen any downgrades in the entire year for quite a number of transactions and ratings of tranches. That's changed. We had a couple of downgrades of tranches recently.

And I'd say it is indicative of a management-driven decision process, which is dealing with ramp risk, to your point. So, you brought up blind pool, and now we've seen some of these transactions get a little bit long in the tooth without the ability to deploy against the chosen strategy, right? So, maybe they wandered off a little bit, or they got a little too concentrated. And we've had two transactions recently where that concentration was something that we responded to with a rating adjustment because concentration is, concentrated exposure of any type is an enemy of these transactions. And so we don't expect a lot of that, but we do see it as a thing that we're increasingly watching. And that is a management consideration.

LT (31:42)
Yeah, absolutely. I think, know, as we continue to do, and we too are seeing a lot of very long dated paper in these structures, you know, I think that what has historically been a fairly steady and not that many downgrades kind of, you know, overarching market, I think that as people have to go through a number of market cycles with some of this, you know, 20-, 30-, 40-year paper that's out there, you know, assuming that they don't refi shortly thereafter at some point, you but there will be a lot of market cycles, I think, involved in a lot of these structures. And it will be, you know, just like we've experienced in the past, those who can manage through it will succeed and, you know, others may not be able to, but it's great that you guys are there and watching and the surveillance clearly seems to be doing its job, which I think will give comfort to investors out there. So, that's fantastic and very interesting information put in there. That's fantastic.

Well, I just want to ask you one last question, which is where do think we're going from here? We are coming up on 2026, which is insane. I barely remember 2025 at this point, but you know, anything that you're sort of expecting to continue to see or new things that you're hoping to see or might, you know, be forecasting at this point?

BC (33:13)
Well, I'd say this is one that is a pretty important trend to watch, which is both the number and the size of defaults that may occur in the direct lending landscape. We see the structures being able to absorb this level of default. One of the things that is going to be really interesting for everyone is the amount of recoveries. So, we've seen recovery rates on some of these defaults be a bit lower than market expectations. So, we'll be monitoring that. I'd say generally though, the great majority of these companies, as the next quarterly compendium published later this week will point out, the great majority of privately owned, sponsor-backed, private direct borrowers, the great majority of them continue to outperform almost any metric relative to private markets in terms of earnings growth, revenue growth. They are by nature companies who are designed to be in some stage of growth cycle, of a growth cycle, and they are performing exactly that way. So, we'll publish more data about that. So, despite the rise in defaults, we think that overall, the collateral that sits behind a lot of these transactions will continue to perform well.

On the other side, in private equity-backed transactions, the timing of exits and the value of those exits will be something that we'll be watching quite carefully. I think we all know that exits have been somewhat delayed and we'll see if '26 changes that. I think that will be one of the most important trends to watch. A third trend will be this migration toward retail investors will inevitably lead to more scrutiny, more hearings, more regulatory poking at minimum and certainly something that bears watching. And then last but not least, my hope is that media outlets will get a better understanding of private credit so that they can talk about the real risks as opposed to the risks that they maybe are are being misguided with regard to where they exist because there are real risks and real concerns that are manageable, but that are real and they're not being paid attention to because of distractions like, gee, First Brands must be private credit because it defaulted.

LT (35:57)
Yeah, absolutely. I would say on top of those things, my predictions for 2026 are that you and I and several others will be doing a lot more evergreen rated feeders, so perpetual debt issuance vehicles. And I certainly think that CFOs are going to continue to grow in size and complexity and different asset types, which is great and very interesting. But it is as sort of these products expand outside of what was traditionally an insurance-related space. We are certainly seeing a lot of not just global insurers in these, but different types of investors that are interested in having exposure to either the debt or the equity in these structures, depending on what their goal or their appetite is in investing in that, which I think is exciting and interesting for all of us.

We are so grateful that you came on and talked to us today. This information is fantastic. And if you could just keep putting that out, we'd love it. That'd be fantastic. We are always happy to help and to feed in. But this has been amazing. And we so look forward to continuing to work with you. And for anybody who is looking for information.

All of this information, other publications are available on the KBRA website, which is a wealth of information and knowledge and, obviously, Bill and team are there and available to speak to you about your rated funds transactions, as are we here at Kirkland. And we look forward to enjoying the rest of our sunny day, and seeing how much the expansion grows as we come into the winter and into the new year.

Thank you so much, Bill, for joining us.

BC (37:45)
Thank you, Lindsay.

LT (00:10)
Hi, I'm Lindsay Trapp and welcome to the Kirkland & Ellis Absolute Credit Vlog. I am very excited today to be joined by my partner in the New York office, Jared Axelrod, who is a co-head of our Structured Capital & Insurance Solutions team with me. And today, as promised in our last episode, we are going to talk about many things that are affecting the current CLO equity market. So welcome, Jared.

JA (00:35)
Thank you, Lindsay. Glad to be here.

LT (00:38)
So I want to just kind of jump in a little bit with what are you seeing in the captive equity market or just generally selling out CUSIPs on the equity these days in both BSL and to an extent in the middle-market space as well.

JA (00:53)
Yeah, we're actually seeing an uptick in third-party equity in the market these days, mostly in the warehouse stage. We haven't seen too many deals go out to do a CLO takeout. I think that's probably driven by the fact that the ARB in the market isn't great yet. It seems that people are trying to position themselves to be able to take advantage of either an increase in the ARB or drop in asset prices to build par and increase the economics.

LT (01:24)
But in sort of sources, obviously, I do a lot of captive equity funds, which we are seeing, of course, folks still looking to raise those. But I guess other sources are you seeing like JVs, individual deals, maybe groupings of kind of, you know, “we'll do deals for three or four of your next CLOs.” Is that stuff kind of still going on in the background as well?

JA (01:50)
Yeah, I think more times than not, we’re seeing either some joint venture agreement or an agreement to commit capital for X amount of deals with the benefit of getting things like management fee rebates or certain rights that otherwise wouldn't be available to the equity provider. Rarely have I been seeing over the past year or so is third-party equity coming into CLOs without some sort of arrangement like that.

LT (02:21)
I think that's it's a tough market sometimes to raise in. Switching a little bit to our favorite friend: regulation. The European Union has added a few, let's say, wrinkles to the market this year, both with the sole purpose test and then the conditional sale discussions that happened in the beginning of August. So I've heard, since I'm here in our London office, some discussions about developments maybe on the EU front about the conditional sale arrangements. Do you have any background on that?

JA (02:56)
Yeah, I mean, this summer was a lot of fun with those surprises that we got from the EU regulators. The announcements came unexpectedly. The market, I think, was caught off guard with each of them, most recent being the focus on conditional sale agreements and how they frankly don't work for purposes of the seasoning requirements under EU risk retention. I think there's been some time to really digest what the regulators have said and what the various options are to move forward for purposes of making new deals compliant, but also for making prior deals compliant. We saw a lot of focus early on on whether or not a forward sale arrangement triggers U.S. risk retention. And we've seen some analysis from some firms where they take a view that some sort of de minimis exception applies, really haven't been able to truly understand what, how they got there on that. But I do think there is a path forward with a close reading of the rule and the LSTA decision, such that one could get comfortable that a forward sale arrangement doesn't trigger U.S. risk retention. The alternative being a forward novation agreement, which we've seen a handful of managers utilize. Definitely a minority view, but we also think that that is a viable path forward as well.

LT (04:27)
Yeah, so those arrangements tend to be used quite a lot in either third-party originator or more commonly now, particularly since the sole purpose test clarification, we'll call it, came through. We're seeing a lot of movement towards manager originator structures. Certainly that's something you and I work a lot on together and have had lots of folks getting into this space with manager originator structures or altering their original third-party originator structures now to be more of the series limited partnership structures. So, I guess sort of in that vein, what are you seeing with regard to managers and their thoughts on using those third-party origination structures or the manager originators to help them to comply with risk retention?

JA (05:17)
Yeah, so I mean, even before the guidance over the summer, the more commonly used structure, as you all know, is the manager originator. There are a handful of participants in the market that use, at least in the U.S., third-party originator, but it's definitely the minority approach. And I think it's going to continue to be that way. So we're seeing new managers start to launch platforms. Many times they'll seek to comply with EU risk retention.

It's been said for several years now that having the ability to market to European investors does impact pricing. I think there's a split view as to whether or not that's actually true, whether or not there's any evidence to that. That said, anecdotally, we're seeing a lot of managers who have the capacity to comply with EU risk retention are comfortable taking on the incremental risks and costs associated with it because of the perceived or actual better execution costs.

LT (06:17)
I certainly think in this context, you know, from the funds lawyer side of the world, having that ability makes the fund more marketable as well. If you have a captive equity fund, certainly it allows a broader base of investors to come into the structure because then you can either have every deal be compliant or structure in a way that would allow exposure for those who require compliance into those. I think it also just opens up the market even beyond European investors and funds or European note holders in the CLOs, also to Japanese investors who I believe also prefer to have the EU stamp of approval on the risk retention side as well. So I think there's lots of opportunities there.

Last question for you on the sole purpose test: What have you been seeing with regards to folks both dealing with taking vertical strips, possibly financing those strips, and some of the considerations around holding a vertical? Does that give you more freed-up, unencumbered equity, we'll call it for the sole purpose test that can count towards the good assets? Is that something that people are making more use of these days?

JA (07:35)
Yeah, actually, we're seeing a lot of instances where a manager will take a vertical slice, get retention financing, and also take a majority of the equity, with the result being you have increased cash flows that are, quote unquote, good income for purposes of the sole purpose test. We also, as you know, are seeing structures where they have a catch-all bucket in the manager originator structure where they could deploy capital for non-EU risk retention, interests, loans, bonds, whatever to produce income that is again going to be used for the sole purpose test.

LT (08:17)
Yeah, absolutely. Seeing an increase in the size of those buckets as well, market was generally 20%, but certainly seeing some of those creep up a little bit to allow some extra bits and pieces to go in there. I think also just the flexibility of these structures, when they're using a series limited partnership structure, you can add additional series. So, if you have someone who just wants to take equity, you know, in, let's say, U.S. compliant only CLOs or other assets, you can have a series that doesn't really relate to the risk retention purposes, but having that additional income coming into the structure overall can help with meeting the sole purpose test. So, I think that flexibility has driven a lot of managers into this space and having one of these structures in place. So, you know, keeping us busy for sure.

JA (09:09)
Yeah, for sure. And it could be quite meaningful. You know, when the U.S. banks dropped out of the market in the spring of '22, all the way through, November of '23, beginning of '24, you could only really market to Japanese banks and European investors, and those who were equipped and positioned to be able to market to those investors were able to keep printing their deals. Those who couldn't sort of sat on the sidelines for two years.

LT (09:36)
Yeah, absolutely. Well, thank you very much for joining us. Wanted to just give folks a little bit of a flavor overall of what we're seeing in the equity market for CLOs right now. And thank you for joining us. We are very happy to help if you have any questions on CLOs, captive equity funds, or manager originator structures. And we will see you in our next episode.

LT (00:11)
Good afternoon, everybody, and welcome to the Kirkland ABSolute Credit vlog. I am Lindsay Trapp. I'm a partner in the New York office, and I am joined today by Kate Luarasi, my co-head of the Structured Capital & Insurance Solutions team here at Kirkland.

Hi, Kate.

KL (00:25)
Hey, so great to have you on board. I'm thrilled that you finally decided to join us and really excited about putting our heads together and creating some new structures and adding to the market in this space.

LT (00:39)
Absolutely. I am delighted to have taken up my post here at Kirkland and it has certainly been a whirlwind journey for the first few weeks and it's been wonderful. So really excited to be here and working with the whole team. It's been fantastic. [crosstalk]

KL (00:54)
[crosstalk]
We specialize in the whirlwind! Welcome.

LT (00:57)
We do, we do, absolutely. I thought it'd be great to just give some updates to folks in the market and maybe for those of you who are joining us for the first time and aren't familiar with the Rated Note structures and kind of just a little bit of background about why we use them and what our practice is all about. So I think in their first nascent stage when you and I first started doing these, like in the last 10 years, [laughter] ⁓ they started obviously, sorry, last month or week.

So, you know, when we first started doing these, these were largely a designation to restructure slightly an investment into a private fund to deal with the fact that insurance companies, particularly in the U.S., get treated as having an equity investment in a private investment fund, regardless of what that fund actually invests in. So you'd have an equity capital charge for risk-based capital, even if you were investing into a credit fund. So I don't know about you, but certainly in the first versions of these, they basically looked like a fund with a couple of tweaks that said, you know, and part of this is debt. But that is certainly not where we are now. So I thought today maybe we could talk a little bit about what we're seeing in the vertical space. For those of you who are unfamiliar with that term, vertical basically just means that it's an expectation that the same legal entity or economic group is going to take both the debt and the equity in the structure. So a vertical strip of all of the securities that are being offered and horizontal structures, which we have seen growth in massively ⁓ for the last little while. And that term essentially just means that we're placing the equity with separate parties from the debt tranches within the structure. So.

Give me what you got, Kate, on the verticals lately. What's the biggest kind of thing that you've been seeing in that space?

KL (02:52)
So I guess I'll start with it's increasingly complex. It increasingly attracts different kinds of insurance companies, not just life insurance, but others as well, maybe lesser check sizes. But the investor pool has grown, the complexity that comes with it has grown, the investor requirements to come into the structure has also grown. And this is before we even get to the horizontal. You know, now we're more likely to see at least two tranches of debt rather than when we started a month ago, [laughter], all there was essentially like one strip of debt, one strip of equity. And now that has evolved. But, ~ I guess the overarching note here is that we're seeing increased sophistication and growth. And, that is inherently leading to the complexity of these structures and also to the value add from our perspective, certainly as attorneys, and also from a client investor and intermediary perspective. We'll talk about horizontals in a bit, but we are seeing, ⁓ even in the vertical context, we're actually seeing the size of the RNF feeders grow. So what started with maybe $50 million here and there has now, like a lot of them are $250 million plus.

There's still some idiosyncratic requirements here and they tend to be fed by an anchor investor or seed investor. Some of them come in and they want a single commitment, others want multiple commitments. they can, even if they're buying the entire vertical, like Lindsay was saying, they want the ability to kind of parcel on the backend and place ⁓ maybe the equity or parts of the debt on their platform, still held by one affiliated complex, but they want to kind of slice and dice on the back-end. So there's that piece as well. We're also increasingly seeing investors that come in, they want the entire vertical because the return profile blended makes sense to them. But they want some features that they are seeing in the horizontals. So they want a security interest, they want perfection, they want opinions, ⁓ attendant opinions that kind of go along with that. But overall, I think it's a sign of depth, increase in size and increase in sophistication.

LT (05:10)
Yeah, absolutely. I definitely think certainly seeing quite a few very large placements in the vertical feeders. And I think some of that has to do with the fact that they are decoupled interests from and, you know, from a legal perspective, we have to draft them and make them structured in a way that the equity can be sold separately or at least transferred and held separately from the debt, which ultimately what makes it vertical, I guess, for folks to think this through is just there's a different commercial position when a single economic group is holding both the debt and the equity because it kind of ultimately is all going to the same pot. And so that sort of inherent difference between what debt investors are expecting and what equity investors are expecting is not as present. That's not to say that there are certainly not considerations around both of those, but it's very different to what we're seeing in horizontals, which is certainly important. But I think for insurance companies and as they're thinking about it, that ability to be able to hold the debt and the equity in separate entities within their group or separate parts of their book is quite helpful because with the NAIC's increase in the capital charge on equity for these structures to 45%, I think that's driving a lot of this sort of desire to have separate entities hold. And sometimes we will see people hold a mix. So one entity holds the senior notes, another entity holds the junior or mezz notes, and someone holds the equity or holds those lower tranches as a package. There's certainly a lot of chopping and changing. And it's very important as a manager to kind of think through how that's going to be structured within your wider fund structure. And from our perspective, from a legal perspective, we do have to think about it very much as, you know, this is debt, this is how this operates is debt. It's how that mechanic flows through the wider fund structure and kind of dealing with the master fund in that context.

Horizontals seem to be, I won't say the flavor of the month, but, you know, certainly I would say probably three years ago, it was every now and then you'd see somebody with a horizontal. Now, I'd certainly say we're seeing probably 50% or more at this point in horizontal sales, which certainly has increased a massive amount of the size of these vehicles. We just worked together on a big deal that brought in $2.3 billion in a structure. And so that's all insurance capital. And I think that that just goes to show how much this industry has evolved, and so horizontals are a very big part of that. So I guess in that particular space, you know, what are you seeing as the biggest issues between the tranches in as far as the investors are negotiating?

KL (08:00)
It's a very exciting space. I definitely agree with you. I think we're probably up to like 50% inbounds on horizontal structures. Some of them have a little bit more acute pressure points and some discomforts and reconciliation between a true horizontal structure in a feeder and the underlying fund. Not to say any of them can't be resolved, and we'll highlight some of them here, but there is a little bit of incongruity between the feeder that's being offered as a horizontal and the main fund. To your point on what investors are kind of looking for, I guess from a structural perspective, one of the key differences that you can optically determine just by looking at it is in a horizontal, you're much more likely to see a minimum two, but usually three or four tranches of debt. And sometimes we also see tranching of the equity. So, you know, you might have an actual pref before the residual or the residual itself might have like a “class one” and ⁓ “class two”. And that's [not] just for payment priority purposes.

When it comes to negotiating, as you mentioned earlier, like the investors are coming in and it's no longer a singular entity negotiating on behalf of all of the entities in the backend, like all of the affiliated entities that will hold the vertical. It's every man for himself. If it's a senior note holder, they are counting each penny before a payment is made on their debt coverage. That includes interest. And if it's a residual holder, they're actually kind of doing the same because they want to prevent leakage outside of the box. And they also want to kind of tinker with, one, the ability to receive some distributions either for tax purposes or plainly just to maintain that LTV ratio during the investment period. So they're looking to receive some distributions while the structure is in play. But overall, they're also looking to see and they're more motivated to cap org expenses, or in this case, you know, the transaction expenses. Everybody's very much focused on the priority of payments and making sure, you know, who gets paid what, when. Administrative expenses are much more likely, if not always capped. There's a catch-all of course, at the end before the equity, but the equity sometimes even tries to cap that to make sure that, you know, [cross-talk] Exactly, that they're getting some cents on the dollar if things go astray.

So those are all normal course, but it's just everybody has their own interests in mind when negotiating the terms. They're inherently far more complex as a result. And it also has much longer timeline in terms of coordinating some of the cats and herding some of the cats here. So we have intermediaries of the structured agents, placement agents. You know, we have certainly we have the rating agencies on the horizontals, you're much more likely to see two sometimes. And the verticals you never see two. And then obviously, you know, it's the attorneys, if you have investors counsel, they can actually be really helpful in herding some of those cats for you. So that instead of, you know, kind of having to address each individual lender or each individual equity comment memo. They can kind of help aggregate those, consolidate to the material positions and kind of present it in whole, keeping fees, timeline, everything else down. And we like to help our clients with that as well because we think it's a key component of making sure that these are, Lindsay and I have talked about this, I don't think they'll ever be truly commoditized. But I think there is a lot that we can do as service providers to help kind of cement some of those guardrails and usher everybody towards the closing gate.

LT (11:54)
Yeah, absolutely. I think, you know, it's important for people to kind of think through and realize, like, obviously in a vertical, it's the same structure. You have a fixed return to debt. They are only going to get the interest coupons and the principal. The equity is going to get all of the residual upside of that, but they are also bearing all of the fees. But when you have that as your sole piece that you are just getting the residual and you are bearing all the fees on a levered amount, you are not getting what the debt gets. And equally for the debt folks, they are solely getting principal and whatever interest coupon is coming with their particular tranche. It certainly creates a lot more kind of thought process and complexities in negotiation between people, rights in things like an enforcement ⁓ issue, that type of thing. Verticals still, notwithstanding the fact that, yes, on occasion we do get someone who wants to secure them, oftentimes verticals just remain unsecured, whereas horizontals are pretty much universally secured debt. So you then are looking at what is the collateral package? If you have a wider fund structure as well, what would happen in enforcement? Is this structure that sits below this particular issuer capable of having investors come directly into it? Sometimes we have fund structures where the master fund is solely designed to have feeders. And so then you kind of have to work on what that enforcement actually would look like and sort of deal with that and how your collateral trustee is going to kind of handle that. So there's quite a lot of things to think about in that type of thing. But I also do wanna talk a little bit about the features that might make these a little bit more operationally, not necessarily cumbersome, but things that people in the manager-side space should be thinking about that investors as they're looking at these are going to focus on.

Certainly one of the things that I think we've both come across is verticals oftentimes were revolving debt. Horizontals are not. And so you end up with debt that needs to be drawn. And then that cash is generally never going to go back out during the investment period. So if you have something like, you know, we return capital during the investment period and it's subject to redrawing, that cash is going to sit inside of this feeder vehicle. And so there needs to be other thoughts about, well, what can we do then in that context for the equity returns so we don't have a bunch of cash drag? So we oftentimes will see fairly broad other assets, types of investments that folks can make, definitely traditional cash management, liquid paper, that type of thing, but certainly have seen somewhere there are more things like ETFs or the managers’ '40 Act funds or other types of liquid strategies that folks are seeing in there. And then I know you and I have certainly talked quite a bit about our favorite, which is conditions to funding. Maybe run down a little bit on, you know, where that can cause some issues.

KL (14:45)
Absolutely. So I think, overwhelmingly, these horizontal structures tend to pair better when you have what we would refer to as like a CFO or a fund-backed note, where it's a standalone vehicle and it's actually feeding into a pool, whether it exists at closing or not, but it will feed into multiple fund interests and maybe they're staggered or maybe there's a lot of diversification. By virtue of that pool, at any given moment, it presents different needs, right? So you're not gonna have the need to draw down all of the capital at once, but maybe over a shorter period of time than you would with a true normal-course single fund investment. In the latter, you're much more likely to have like a 12 months drawdown period, 18 months, sometimes, dare I say, 24 months and, you know, with extensions to boot. If we're all putting our lender hats on, nobody wants a commitment outstanding for that long. Like the ideal for a true lender is, you know, they're coming into this, but nobody wants to provide a revolver. But even with a delayed draw, they're looking at it as, you know, what am I getting while this money is committed? And to your point on CPs, while we have this prolonged period of time, there's CPs in the credit documents. So you can't have a lender fund into, I don't know, let's say things have gone all the way back. They can't fund into an event of default, and you can't force them. Whereas when you have an equity investor or an investor that's taking that entire vertical, the motivations are completely different, and they know that they would have to fund in any event, but for a lender, they don't have to fund. So there's this period where the CPs are in effect, you have pressure from the lender group because they want to fund and they want to fund ASAP. They don't want to draw it out. The sub-line lender is much less likely to give you credit. So there's a little bit less cash management or like tooling options downstairs. And we can talk about that as well.

But yeah, there's these friction points that kind of form an amalgam, and it's a little bit uncomfortable when you're, when you have a single fund investment and you want to maintain the same flexibility as you would otherwise have with a vertical where you can have the revolver or you don't necessarily have the CPs, or if you do have them, everybody's still motivated to fund because they have to fund anyway. Honestly, it's essentially like having your cake and eating it too. And we understand like, everybody's kind of coming to the table and negotiating for their cake and they want to eat it as well. But ⁓ from a sponsor-side perspective, that is one of the key components where, you know, we understand the motivation to lean towards a horizontal. It might have a bigger market or they might have an equity investor lined up and now they just need to sell the debt or they might even be able to hold the equity themselves. So there's a lot of, favorable aspects to it, but there is also a lot of key considerations that, you know, you and I work with our clients a lot to put into play and make sure that everybody's well-advised of what those guardrails need to be and has a plan on a go-forward basis. And certainly CPs and that mismatch between the commitments at the feeder level that are subject to CPs and the issuers' actual hard, unconditional commitment to the main fund, that's a big component there.

LT (18:11)
Yeah, absolutely. You know, that's not the only thing we certainly think about. Another thing in these is that because we tranche them out so deeply, that often means that there's a relatively small, comparatively, you know, piece of equity in those structures. So one other thing for folks to think about if their fund, you know, typically more commonly closed-end master funds, but sometimes in evergreen master funds, depending on the structure, if there is a give back, ⁓ or LP clawback situation, you don't get to get money back from debt. So oftentimes, you need to think through, how much of a mismatch is there between how much we have in the equity, which in general, we typically require all distributions made to the equity throughout the life to be recallable into the issuer, just in case there is this type of issue. So kind of balancing out what the feeder's obligation is to the master and any limitations on that total amount and how much equity you truly would have.

And so for everybody that's kind of thinking of investing in a whole sort of fund complex and whether they become the investors coming into the master fund or investors going into another feeder or investors coming into the rated feeder, there's certainly things that occur with rated feeders and how they operate, particularly in the horizontal space, ⁓ that certainly should be discussed with your council ⁓ or if you're coming to us, we will happily take you through all of those different things and the various experiences we have had. Certainly, there's new ones every day, but we've definitely been through quite a lot. So very happy to walk through those. I guess the other thing that we see a lot or certainly a question I think you and I get asked on every single call we do is: where do we find equity for these structures? It certainly started out, I think, largely that the managers oftentimes would take down the full equity tranche or the vast majority of it. Certainly have seen a lot of interest lately in third parties coming in. From my side, of seeing family offices, hedge funds, other types of fund investments. But have you been seeing similar things in your funds?

KL (20:21)
Yeah, absolutely. I think strategic partnerships have become a very large, critical and significant component of this market. A lot of times our sponsor clients will actually come to the table and say, I've lined up a hundred million of equity. you know, like …

LT (20:39)
We need the debt.

KL (20:46)
Exactly, it's essentially like the inverse of what the historical problem was that you already highlighted, you know, where are the equity investors? I think overall, it's still a little bit more tough to place that equity, especially where you have a single fund underneath and that fund, you know, it kind of cuts both ways. It's easier to get a rating on a credit fund. And, you know, the easier part is just on the getting a good rating on the notes. It's harder, however, to get the type of return profile net for the equity that's actually going to incentivize equity or, you know, typical equity investors to come in and hold that residual. They're looking for a very specific return profile and it tends to be harder to generate that when the underlying fund is like senior direct lending or something along those lines. It needs to be a little bit spicier to actually draw third-party equity interest.

LT (21:39)
Yeah, particularly the unlevered master funds. I've certainly seen it as an option for providing a levered version of a fund as opposed to having a separate sleeve that's doing ABL. But it is something certainly that investors that are coming into the equity should think through what their profile desires are and what they would like to do and kind of taking into account things like the fees are being paid on the levered amount and that type of thing and how they would generally do that. I guess the last thing in horizontal world that you and I have both been facing recently that we love to chat through is MFNs and kind of generally, you know, there's a lot to think about in the context of a horizontal. In a vertical, an MFN, the whole total amount is generally coming from one investor. So it makes sense that it's a relatively straightforward process comparable to MFNs in the wider fund.

But in a horizontal, there's very different considerations within that structure. And so certainly, I think managers and investors alike should be thinking through how that should ultimately compare or should it even be included in the context of the MFN of the wider fund because it is such a different position. And really, I guess in horizontals, we're thinking more through MFLs because it isn't really just most favored investors, kind of wider, it's really most favored lender type of clauses and they don't bear economics generally. And we have reading considerations so you can't really change their interest rate or anything like that in side letters, but ... certainly have seen a rise in asks for MFNs from lenders in my side. So what have you been seeing in that space?

KL (23:22)
Definitely a rise in requests where I think for years and years ... I mean, take a step back, Lindsay and I like to geek out together. So this is what we're, we don't just talk about MFNs. We talk about any and everything.

LT (23:34)
We talk about all things. We are nerds, yes, actually, yeah, we are.

KL (23:38)
But yeah, MFNs have been coming up a lot, and you don't really see MFNs in the debt space. But, I guess, you know, when we've been putting our heads together, one way to rationalize it is the investors that are coming into the space have very specific needs. So it's almost like addressing the difference in a direct lending facility. It's almost like addressing the difference between a BDC and, you know, a private credit fund, unregistered of course. So they're going to have different reporting pressures and confidentiality and similar restrictions. And it's kind of incumbent on whoever is drafting the documents and whoever's negotiating on behalf of all of the parties to reflect something in the documents that everybody can kind of live with. There are certainly bespoke circumstances and nobody's not like the equity world where there might be different economic arrangements. This is class by class, and as among the lender group, the terms are in the actual credit documents.

But yeah, definitely seeing a lot more inbounds on reporting, disclosures, and more recently, our favorite that we've been putting our heads on, these pledges, because insurance companies fall into that very bespoke lender bucket. And a lot of them are either subject to or they have reinsurance agreements in place. So in addition to wanting to kind of turn around and parcel these investments among their own affiliates, in many cases, they actually want it to count as eligible collateral for a reinsurance arrangement. So then, you know, we put our heads together with the sponsor and kind of see what the transfer provisions can and should look like. But that's the colorful array here. And I guess for our clients, these are the types of issues to keep in your back pocket and in back of mind as we negotiate the MFN provisions and the underlying fund as well.

LT (25:31)
Yes, absolutely. It's very important, I think, in general, you know, when this first started and when we were both children, clearly, you know, we used to kind of get called up and asked if we could do a rated feeder into a fund that was coming up to its final close, or it was kind of already in there. But as the market has shifted, a lot of funds start out with a rated feeder. Sometimes they are the actual seed vehicle. So it is important if you aren't planning for a rated feeder or if you're just thinking about it in the beginning of a fund kind of setup and structuring that you reach out, let us kind of walk you through some of the things that might be important in your master fund documents to kind of think through and how might that work with having a rated feeder, having multiple rated feeders, evergreen structures in particular as well. We do a lot with that and we are going to do a whole separate episode for you all since we've been asked so many times about different things for evergreen funds. So we'll be joined by our other partner, David Miller, soon on an upcoming episode where we will talk all about our extreme geek nature of loving evergreen structures with rated note feeders ⁓ or our favorite lately, ⁓ evergreen rated note feeders. ⁓ So, you know, we'll cover that, but I think it's important to think through if you do have an idea that you might want to put a rated fund onto your master fund or even side-by-side with it, just sort of thinking through, understanding that stuff from the beginning. It does not have to come in at the first close. It can come in at various points, but there are certainly a lot of things that it's important to sort of think through in advance before you have things to bait because you don't want to have to go to investors and ask them for accommodations for another feeder.

So jumping away from our friends rated funds into slightly different versions of them because today's discussion is a lot about evolution, I certainly have seen over the past year or so since the end of 2024 when the UK regulators adjusted the ⁓ matching adjustment positions to having self-certification and highly predictable cash flow positions, certainly seen a huge sort of rise in doing these structures in the UK or for UK insurers more accurately. And so I think that that's something, you know, people are often asking, where are you seeing, you know, new things, new appetites, that kind of thing. Certainly from my perspective, we're seeing a lot from the UK. There's a lot to consider there, and we will do kind of a separate episode on this, but I do want to just get it out there because we are getting so many calls about this that oftentimes the matching adjustment structures do not suit well to being a feeder fund. It is not impossible, but they simply don't fit quite right with the way that funds typically operate. There are requirements on how you can stage drawdowns. There are requirements that you have a scheduled amortization. There's no deferral for longer than 364 days on interest coupons. And so those types of things just don't tend to lend themselves well to the way that funds operate. So just if you're thinking about doing that, of bear that in mind, bear in mind that each insurer will have its own views on what will satisfy matching adjustment and what will not satisfy matching adjustment. So it's going to be unlike sort of a typical rated feeder raise where you can build it and they will come, in often cases, you know, or you have kind of one investor and if you build it for them, it'll be, you know, pretty close to what other people want. These ones tend to be a little bit more in the, you need to find people that have similar alignment on what they think in order to kind of get them across the line. So. I did want to just kind of highlight that.

But the other thing that you and I have been doing quite a lot of, and we're lucky we've been having a conference here over the last few days, so a lot of our colleagues from rating agencies and other places have been in town, CFOs are everywhere, everything. We see them constantly getting asked about them. We do quite a lot of them. So just kind of high level, we will do an episode on that as well. ⁓ But high level, know, kind of anything that you see as a particular difference between rated note funds and CFOs and kind of if someone's thinking maybe one way or the other, you know, what features would you say of their underlying pool might be important to consider in the context of a CFO?

KL (30:10)
Absolutely. So yes, lots of inbounds on CFOs and lots of them getting done faster and faster lately. But I tend to think of them as setting up a horizontal structure, but the most complex one that you could possibly have. Just to take a step back for our audience, ~ if you don't know what a CFO or a collateralized bond obligation is, sometimes they're also referred to as private equity-backed notes, fund-backed notes and you might've seen some of them in the headlines lately ~ but essentially what it is, is a pool of interest in various funds and the more diverse, the better the, you know, the more like different vintages, the better. I guess from an NAIC perspective, the key focus would stick, which is true for verticals and horizontals, into one fund as well. The key across all of these structures will always be how much cash is coming up from the underlying assets. Are they self-liquidating? Is there a general onus on the issuer to otherwise, you know, generate a liquid bucket somewhere else? Like, you know, very important to make sure that you have a stream of cash coming up to support the debt coverage. And that's principal, interest and that gray area in between, which is deferred. So what do we mean by more complex? Everything is being negotiated. So we've mentioned some key components throughout this vlog. Some of them will include amortization. Some of them include a drawdown schedule. All of them will include a ticking fee if there is a delayed draw component. There is a very short availability period, if there is one… All of the intermediaries, so the structuring agents, the rating agencies, everybody, and certainly the investors, everybody's kind of aligned in thinking about it from the perspective of if you have one closing and it's fully funded, that's the ideal. That's the Rolls-Royce. That's the easiest to underwrite, easiest to sell, easiest to get a good rating on and then everything else, like the more components, the more flexibility you need as a sponsor, everything else kind of notches and eats into that. Is it doable? Absolutely. A lot of, you know, I would say like premium sponsors, global sponsors, really niche type strategies are also getting done these days and they're getting done quite successfully. It's become more and more innovative and how the structures are kind of put together. And again, diversity and cash flows are going to be at the very top of the list. And setting that LTV as well is going to be a key component. But are you going to face a lot more time on that runway versus a vertical or even a horizontal into a fund? Absolutely. They tend to take maybe up to six months, whereas a normal-course rated note fund might take you, I don't know, four to six weeks sometimes if it's a vertical. And then anything horizontal will probably be in the middle there. But lots of innovation in this space and frenetic energy. It's kind of an exciting time to be practicing here.

LT (33:18)
It absolutely is. It's, yeah, this is one of those things where, you know, I'm sure that there are loads of people who would love to snooze through this, but this is what gets me and Kate out of bed in the morning and constantly chatting with each other about what we're seeing, what we're thinking, just coming up with different things and ideas. You know, we love what we do and we would love to talk to you about it as well. ⁓ We will continue, obviously, as we have promised, doing new episodes with different things that we're seeing, different products. We are looking forward to having some guests on soon as well, some third-party guests. And our next episode that you will be seeing is another component of our SCIS practice, which is ⁓ captive CLO equity structures and dealing with European risk retention requirements with Jared Axelrod. We look forward to seeing you all. Give us a follow. And if you have any questions, please reach out to us, and we will be happy to speak with you. Thanks, Kate.

KL (34:14)
Thank you.

LT (00:10)
Good afternoon, and welcome to the Kirkland & Ellis Absolute Credit Series. I’m Lindsay Trapp. I’m a partner in the Kirkland New York office, and I am joined today by my partner and co-head of the Structured Capital & Insurance Solutions team, Jared Axelrod. Hi Jared, how are you?

JA (00:26)
Hey Lindsay, I’m great, how are you?

LT (00:28)
Excellent. So today we’re taking our viewers through the introduction into collateralized fund obligations, or CFOs. And I think we’re just gonna have a little chat about some of the things we’re seeing in the market, give a little bit of background to these products. So, really excited that you could join me today.

JA (00:47)
Yeah, happy to be here. I think we could just jump right in then.

LT (00:51)
Absolutely. So, I guess, from a lot of people’s perspective, what a CFO is tends to get a little bit blurred in the market, right? There’s a lot of names, words, fund-backed notes, PBNs, all sorts of different things. So, I think just to level set: For us, when we say CFO, or collateralized fund obligation, we are talking about an issuing vehicle that’s going to issue both debt and equity, and the underlying collateral of that vehicle is a number of underlying fund interests. So instead of a rated note feeder, which generally has just a singular fund interest as its underlying, here you’re looking at a number of underlying fund interests or, on occasion, we also see these in a structure where there may be a single underlying fund interest, but that fund itself is actually a fund of funds and so holds that diversity element in its portfolio. So that’s just kind of our little bit of background. But I guess Jared, these products actually have been around since before the GFC. So historically, I think they were traditionally led by limited partners that were aiming for a financing perspective. Is that kind of what you’ve typically seen in kind of years past for these structures?

JA (02:14)
Yeah, I think that’s right. So historically, it was more of a portfolio finance trade. You’ve got LPs who have interest in a variety of different GP funds. They have it on their balance sheet, and they utilize the CFO as a means to either move the assets off balance sheet entirely or just to put efficient financing in place. And so what they do is they’ll move the LP interests from their balance sheet into an SPV. They will issue several classes of debt. So, usually single A, triple B, double B and then issue an equity tranche. And historically the equity was retained by the sponsor effecting the transaction.

As of late though, the past year, 18 months, there’s been several transactions where some, or in some cases, all of the equity has been sold to third parties, which is really an interesting development in the market, and I think speaks to sort of the market coming to terms with how useful and how interesting of a trade this technology can be.

LT (03:28)
Absolutely. And so I guess from both of our perspectives, we’ve certainly been chatting a lot about how the market has shifted quite a bit toward more of a GP-led solution. So that comes in a few different varieties that we’ve seen. Sometimes it’s a GP balance sheet transaction. Sometimes it’s a capital raising goal, but other times there’s more of a liquidity solutions for some of their LPs and allowing them to transfer interests in, and you just completed a very big transaction kind of in that vein as well. So how did those different types of structures come to the fore?

JA (04:08)
Yeah. So like you said, on one side there is the sort of portfolio finance trade, on the other side is the fundraising exercise. One is sort of freeing up capital. The other is getting access to new capital, right? Getting access to new investors, whether it’s insurance companies, pension funds, different LPs that they don’t necessarily have a relationship with, whatever the case may be. And so those are the two basic types, but we also see combinations, right? So where you’ll do: move some assets off balance sheet and then at the same time open up a couple of new funds. So do both a fundraising and a portfolio finance trade.

LT (04:53)
Interesting, okay. And I think that, from my perspective as well, as a funds lawyer, I also find it very interesting sort of how these were used traditionally and what we’ve seen as a development here. For most of you, you all know I started my life as a private credit funds lawyer, but CFOs were traditionally a means of providing rated financing or rated collateral based on private equity. And so, mainly they tended to be private equity funds, but we’ve seen a pretty big jump in that as well over the last little while. So what kind of asset mixes are we seeing these days?

JA (05:30)
Yeah, so I think that’s right. I mean, we see private equity, private equity and credit, the credit being either private credit or public. So like BSL loans, usually it’s a combination of the two. And then you’ll also see pure credit CFOs. So that’s just a handful of private credit funds that have the CFO financing put in place. Which many people sort of ask, why not just do a CLO, right? When you think of putting these securitizations in place with, whether it’s a BSL portfolio, private credit or both, I mean, CLOs have been around for decades. It’s a very well-worn path. There’s a vibrant investor base, very efficient financing is able to be put in place. You know, you’re getting 10 turns of leverage on a BSL, CLO, depending on the strategy, you know, three, four, five, six turns of leverage for private credit. Why not just do that? And I don’t know what you’re seeing on your side, Lindsay, as far as sort of the calculus, but the people I’ve talked to sort of see them as two different, not necessarily mutually exclusive options, they’re tools that can be used depending on what the needs of that particular sponsor are. So what I mean by that is, with the funds option, so the CFO option, you get a lot more flexibility, right? Less concern with concentration, requirements, less restrictions with the types of assets you could buy. You just have a lot more flexibility, the trade-off being that you get lower leverage and potentially higher cost of capital. CLOs on the other hand, right, much more strict criteria set, eligibility criteria set, concentration limits, but you’re getting tighter pricing and better leverage.

LT (07:27)
Yeah, and I think you’re also giving up a bit on the rating side as well. That flexibility comes at a cost in a rating. So we don’t get all the way up to AAAs in CFOs. So that’s something that folks need to think about as well. But I think that really is the genesis of a lot of this kind of new mix of asset classes. We’ve certainly seen there’s obviously a lot of private credit in there. There’s also infrastructure debt, real estate debt. So there’s a number of different asset classes that are going into these. I think, I’ve been hearing some stuff about ABF as well, maybe as an underlying, there’s a lot in there.

But I think all of this kind of goes back to the fact that in the historical CFOs where you had these huge portfolios of like a hundred and plus private equity interests, the cash flows that came from that were largely created through the diversity of the life cycle of those underlying funds. So you had some in investment period, some like just in that transition and others that were in full harvest. And so there was a mix that allowed the distributions to be reliable enough to support the credit. But as the portfolios have become far more concentrated, the GP-led side, I think, generally we’re seeing anywhere between maybe five and 20 LP interests as the underlying. That certainly has necessitated either having a diversity in the actual underlying portfolio funds, or you might also in some instances see direct loans held or other cash producing instruments held within the CFO itself outside of fund interests, which is, particularly a development and an interest, but led by the fact that you have to have cash flows, right? We still have to service this debt. And of course, if we have insurance company investors out there, we’re talking about debt that needs to meet the long-term bond definition. So you are going to have to have those consistent cash flows to get in there.

I think that’s been a very interesting development as this market continues to grow and certainly grow it has. I think we’ve seen more issuance this year in the CFO space than any year prior. And we had the wonderful Bill Cox on from KBRA recently as well, who talked a lot about how that’s been working and the number of deals that they’re seeing in the market based on some of their publications. So very interesting kind of movements there.

From the funds perspective as well, I think it’s important to remind folks that you are dealing with funds. And so your underlying is a little bit different than how you have to deal with collateral from, for instance, the takeout of a warehouse for a CLO, right? Here, we have a lot of different things going on, and depending on which type of CFO you’re doing, it’s going to end up with its own kind of nuances that you have to deal with. In an LP-led CFO, you’ve got a whole team of funds lawyers that are gonna have to kind of get in there, deal with all of the GPs that you have, talk to them about their transfer cycles. You know, sometimes they’re off cycle. So we might be in a situation where we need to have everything ready to go for the transfer, but it won’t actually transfer in at the closing, making sure any side letters or those kinds of things work. And particularly the consent for the fact that this is going to be a transfer into a vehicle that is then going to offer security over that LP interest. So it is a lot in that perspective, but from the GP side, we’ve certainly been dealing a lot recently with folks who are moving their own GP interests into some of these. And in doing that, you do have to be at least conscious of the fact that if you hold that GP interest in your GP itself, you will probably need to get that converted into an LP interest. There are going to be consents in that regard. And kind of going back to your question about third-party equity or the discussion thereof, do you have an issue if you’re moving your own GP stakes in and you have other folks there if we can’t qualify that vehicle as an affiliate of the GP for the purposes of that transfer? So there’s a number of things that go along from the fund side. And so it is important to kind of speak to your attorneys in advance and kind of think through all of those different issues that can come there.

JA (12:07)
Yeah, I mean, it’s certainly way more complicated than just simply moving a portfolio of loans, right? These LP interests are not liquid. They’re not tradable. There’s so many requirements associated with what needs to be done, what you need to do in order to move these assets — well beyond my area of expertise. So definitely happy to have you and others on the funds team to sort of take that aspect of the trade off my plate because it’s a lot and to stay coordinated, you have all these different moving pieces, negotiating steps, you’re dealing with rating agencies. And then on the other side, right, have we done all the diligence for purposes of moving the assets? Did we get the consents? What’s required? Can we even move these assets? It’s lot going on for sure.

LT (12:55)
Absolutely, and one of the things that we tend to do in this industry is implement a holding vehicle underneath the issuer. So I think you had a wonderful slide that we were chatting about earlier. So maybe if we put up the structure chart to kind of help folks get a visual of what this often will look like in the context of those transfers.

JA (13:19)
Yeah, the slides always help when talking about something like this for sure. So here, we have just a sample CFO structure. You have the CFO issuer in the middle. So that’s the entity special purpose vehicle issuing the debt. We have the rated senior debt, Class A, Class B, Class C and then the equity. The equity can take different forms. Could be subordinated notes, subordinated loans, LP interests, but the main idea being that the economic first loss is represented by that interest in the CFO issuer. Below that, sitting directly below the CFO issuers, what’s commonly referred to as “Asset Co.” So this is where all the assets sit, right. So all the LP interests that are being transferred into the CFO are held by Asset Co. That entity, the Asset Co, all of its interests are pledged by the CFO, typically, and there’s some variety in the market, but typically, we do not pledge the actual LP interest, usually because there are some sort of restrictions on the underlying fund documents that preclude the ability to pledge those. So the way you deal with it is, have Asset Co’s interests that are held again by the issuer as part of the collateral package.

LT (14:49)
Yeah, absolutely, certainly something that can be very helpful there. Obviously, things to think about as you’re going through, right? If there were an enforcement scenario, even though it comes in one big package, that ultimately may mean that somebody else is holding those interests in the fund. So lots of things to keep in the back of your mind, particularly if you’re transferring in your own GP interests into that from the GP side. And then from the LP side, certainly taking a look at, or I should say note holders, taking a look at that package, how that would ultimately operate and what you would end up with in the context of an enforcement. It’s certainly something to think through and can be very helpful. And of course, we’re happy to provide this slide if you want to reach out and have a chat about this.

I think another thing maybe just to chat on a little bit is from the ratings perspective, you and I certainly have seen recently a, let’s say influx of evergreen structures as the underlying funds. Not usually all of them, but certainly having a few in there. And I think it’s important for folks to remember, there are going to be similar analyses as we have in the context of rated funds that go into an evergreen fund. And there will be a question, how do we get out of this fund? So if you have something like a BDC or a liquid fund that operates on a NAV pay basis for redemption, you will need to think through and there will be rating agency considerations around that market risk that continues to exist while you’re going through the redemption process. You have questions about gating and sort of how long is it going to take us to get out? So certainly, think through those things. If you have more than one evergreen fund in there, you’re going to have to consider that in kind of all of their various forms. Obviously, if there’s a slow pay mechanic, that’s fairly straightforward because we just need to select a date on which the CFO will redeem from that fund. But, you know, lots of things from the fund side in these, which is, you know, just true to their nature of being a very hybrid approach between the securitization side and the fund formation side, which is, I think, probably why I like them the most.

JA (17:24)
It’s definitely an interesting puzzle, right? It’s like with most things in this structure, you really just need to make sure you’re matching up the assets with liabilities, right? The maturity of the assets with the maturity of the liabilities. And it’s really an interesting development for sure.

LT (17:40)
Absolutely. One of the questions we get a lot is around liquidity. So you do have a bunch of underlying funds, which may have capital calls still do coming out to them. So what have you been seeing in the context of how we solve for that?

JA (17:57)
Right, so you need to have cash, right? There have to be cash flows in the securitization. It’s pretty obvious. Not only to service the debt, but also to the extent you get a capital call and there’s not enough time to fund for one reason or another. You can’t call it from the note holders. What do you do, right? And so there’s a couple tools out there, right? So you have liquidity facilities. So that’s really just a revolving credit facility being provided by a third-party financing source. Oftentimes, frankly, we’ll see the party that provides the liquidity facility to also invest in the deal. So they’ll come into the class A notes, and they will also be the liquidity facility provider. Another alternative is to have an interest reserve account. So that’s a spot in the waterfall that you re-up every time the amount of cash drops below a certain threshold. And the threshold is three months, six months, nine months, whatever the number is, whatever has been modeled into the deal of cash to pay interest and expenses of the deal. And so it’s a deal that sort of acknowledges that there may be a shortfall or there may be a timing mismatch from what the underlying interests are producing from a cashflow perspective versus when the interest and expenses are due. Another option is to have something like a credit SMA as one of your fund interests, right? So you create a fund-of-one, which is the only LP is the CFO issuer, and you just set aside a certain amount of commitments to invest in liquid and illiquid credit assets, right? So whether it’s private credit loans or CLO bonds or BSL loans, whatever it may be, the point is you’re deploying the capital from the investors in order to produce cash flows for purposes of servicing the debt of the CFO.

LT (20:10)
Yeah, those are certainly the credit SMAs get very interesting. I’ve done have done several of those on the formation side. And I think that they provide an interesting solution. Certainly, when you’re doing something with an external lending provider, that’s a cost to the equity returns in the deal. So it’s something to think through. Obviously there can be impacts to the equity returns through doing underlying investments and things other than the main focus of the issuer. But certainly something that I think there are so many good options out there, and it really is just something that managers need to think through what’s going to fit best and then model out for this particular deal and see how we can get there to provide that coverage and to make sure that we always have enough capital somewhere to make sure that we’re keeping ourselves from becoming a defaulting LP and those underlying funds, but also paying our note holders, which is great.

Excellent. So I guess to bring ourselves full circle on this discussion, let’s talk through some of the additional regulatory considerations that we see from particularly the securitization side. Definitely our good old friend risk retention on both sides of the pond can come into these now that we’re seeing a number of non-U.S. investors interested in taking down positions in these CFOs.

So what are the thoughts that we need to have in the context of both EU and, well, EU-UK and U.S. risk retention?

JA (21:50)
Yeah, so just starting with the U.S. side of things. So this is a securitization, right? We have underlying assets being put into an SPV. We’re issuing debt, whether you call it securities or not. You need to think about whether or not U.S. risk retention applies. So simply put, the underlying interests are limited partnership interests. Limited partnership interests are not self-liquidating assets. That is a key component of U.S. risk retention. If there are not self-liquidating assets, then U.S. risk retention does not apply. There are certain circumstances where you need to sort of do a little bit more analysis, and there’s myriad fact patterns where you would need to sort of do more than just say, are there LP interests? But the bottom line is that these securitizations are generally not subject to U.S. risk retention. On the other side, European, UK risk retention, it’s not as simple as that. The fact that there are LP interests doesn’t end the inquiry. And typically, you need to look through to see what are the underlying assets. So if we’re talking about a pure private equity CFO, then the answer is no. EU risk retention does not apply. If we’re talking about pure credit CFO, then the answer is probably yes. And then as you know, there are different CFOs that are private equity and credit, the infrastructure, real estate, it really varies. The important point is that it depends, and you really need to look at what the underlying assets are.

LT (23:43)
Yeah, absolutely, and you know, certainly speak to those regulatory folks early on in the process. You know, it can definitely jump up to get you, you know, the other consideration …

JA (23:58)
… the last thing you want is right before you price, you go to your regulatory folks and say, does U.S. risk retention apply? Does EU risk retention apply? We’re pricing tomorrow. That is not where you want to be.

LT (24:10)
Exactly. That is not the place that you want to be when you’re coming up to the ends of these. And I think just for the wider grouping of audience, these are complex vehicles. They involve a lot of considerations, and they are truly a hybrid, so you will have funds considerations and you will have securities and securitization considerations. So it’s important to gather a team that has kind of an understanding of all of these things, both from the external service provider and from your internal teams as well, I think would generally be our experience. But they are really wonderful products and have been quite successful and are continuing to grow in use and popularity and investor familiarity as well. So certainly we are here, and we are happy to discuss with you if you have a desire to know more or to begin a project. And we are very thankful today for Jared coming on to help give this introduction. And we look forward to seeing you guys in the next episode.

JA (25:17)
Glad to be here. Thanks, Lindsay.