Speaker 1: Hello, Welcome to The Credit Edge, a weekly markets podcast.
Speaker 1: My name is James Crombie. I'm a senior editor at Bloomberg.
Speaker 1: This week, we're very pleased to welcome Wayne Dahl from
Speaker 1: oak Tree. How are you Wayne, I'm great?
Speaker 2: How are you?
Speaker 3: James?
Speaker 1: Very good?
Speaker 3: Thank you.
Speaker 1: Wayne. It's co portfolio manager for oak Tree's global credit
Speaker 1: and investment grade solutions strategies.
Speaker 2: Thank you very much for having me.
Speaker 1: Thanks so much for joining us today. We're very excited
Speaker 1: to hear your views. Plus, we're also delighted to have
Speaker 1: back on the show Mike Holland with Bloomberg Intelligence. Hello, Mike, Hey, James.
Speaker 3: Great to be here. I'm Mike Colin.
Speaker 4: I'm a senior healthcare credit analyst here at Bloomberg, part
Speaker 4: of Bloomberg's research department of five hundred analysts and strategists.
Speaker 2: So great.
Speaker 1: So, just to set the scene a bit here, credit
Speaker 1: markets are struggling a bit, not really living up to
Speaker 1: their year of the bond bill. That's mostly because of
Speaker 1: rates which remain elevated, undermining total returns and also putting
Speaker 1: pressure on weak companies that have a lot of debt.
Speaker 1: Shorter duration assets like high yield and floating rate loans
Speaker 1: are doing okay, though nowhere near as good as equities.
Speaker 1: Debt spreads are very tight. You're not getting very much
Speaker 1: compensation for the risk of default or downgrade of corporate debt,
Speaker 1: and we've seen a ton of issuance. The ball case
Speaker 1: is supported by strength in the US economy, which is
Speaker 1: good for US companies, but credit markets in Europe and
Speaker 1: Asia are doing better than the US. There seems to
Speaker 1: be a fair amount of complacency. They're given all the
Speaker 1: risks debt defaults, bankruptcies, commercial real estate, stress, war, geopolitics, elections.
Speaker 1: Everybody's loaded up on US assets going into a very
Speaker 1: noisy presidential election. A recession cannot be ruled out, So
Speaker 1: I want to start there. When the first half of
Speaker 1: the year hasn't been that great for credit unless you
Speaker 1: are long Chinese junk bonds. There's a little bit of
Speaker 1: excess return though, but not really a stellar year. So
Speaker 1: what's your outlook for the second half? More of the
Speaker 1: same or maybe a big rally if we finally get
Speaker 1: those rates cuts. Everyone was home earlier this year.
Speaker 2: Yeah, James, I think you touched on a few things
Speaker 2: that are important to consider when looking at credit markets broadly.
Speaker 2: You mentioned the fixed versus floating. Floating has done better
Speaker 2: with rates. Higher fixed has done Okay, higher yielding fixed
Speaker 2: rate has done better just given the higher yields, where lower,
Speaker 2: higher quality fixed rate has has tended to underperform given
Speaker 2: its slightly longer duration and lower coupons. But I think
Speaker 2: the key is that you need to be diversified. There
Speaker 2: are trade offs across all these different markets. So if
Speaker 2: you can have the opportunity to have a portfolio that
Speaker 2: can you know, touch each of these areas and kind
Speaker 2: of balance out your exposure, you've done. You've done quite well.
Speaker 2: And you know you did. Mention equity markets, Yes, the
Speaker 2: S and P five hundred, Yes the NASDAC are both
Speaker 2: up very well. But if you look at small caps
Speaker 2: in general, they've largely underperformed high old bonds or broadly
Speaker 2: syndicated loans. Even the Dow Jones is, you know, maybe
Speaker 2: kind of in line with high old bonds through the
Speaker 2: first half of the year. So I don't think it's
Speaker 2: a stretch to you know, expect a similar outcome in
Speaker 2: the second half of the year. Income has been your
Speaker 2: friend for the last several months. I think that's going
Speaker 2: to continue to be the case. The one thing that
Speaker 2: we've seen with focusing on these income, high income generating
Speaker 2: assets is they do have a way of protecting you
Speaker 2: against some of the market volatility, which, as you alluded to,
Speaker 2: we could certainly see in the second half with US
Speaker 2: elections and other events that we're facing today.
Speaker 4: Hey, this is Mike Collins Wayne. Looking at the ag
Speaker 4: right now. We're about five percent, you know on ig
Speaker 4: credit and five point seven on triple b's if you're
Speaker 4: looking at the index on Bloomberg and six point six
Speaker 4: for double B seven point seven for single bees. You know,
Speaker 4: last year, two years ago, we're looking at Yould bond
Speaker 4: paper coming below four percent. As you look forward to
Speaker 4: the end of this year and next year, where do
Speaker 4: you see that vaul driving spreads and yields?
Speaker 2: Yeah, I mean I think you've you've definitely touched on
Speaker 2: some interesting things, Mike. I mean, and I think that's
Speaker 2: been the trade off for investors these days. Is is
Speaker 2: it fair to focus only on yield and ignore spread
Speaker 2: or should I solely focus on spread? I definitely see
Speaker 2: a situation where we could you know, kind of continue
Speaker 2: along these lines where spreads kind of stay where they
Speaker 2: are and you're kind of beholden to where to where
Speaker 2: rates go. I think you've seen a bit of a
Speaker 2: trade off there. Where As spreads have gone tighter in
Speaker 2: most cases, that has meant the interest rates have gone higher.
Speaker 2: So the yield, especially in high yield, has stayed relatively
Speaker 2: flat for the last couple of years, in a bit
Speaker 2: this year. So I think if you see a situation where,
Speaker 2: you know, what spreads wider at this point, it probably
Speaker 2: is some form of you know, negativity around the economy.
Speaker 2: And you know, I think most investors would anticipate that
Speaker 2: that could come with some rate cuts. So you know,
Speaker 2: do you get some sort of offset there where maybe
Speaker 2: a little bit of spread widening you know, is offset
Speaker 2: by some rate tightening and again kind of net net,
Speaker 2: the yield stays kind of similar and which which again
Speaker 2: would kind of benefit those who are in it for
Speaker 2: the for the carry and the long haul on.
Speaker 1: The economy way and that do you expect a recession
Speaker 1: and do you expect a deep recession? What it's your
Speaker 1: vial on that and also interested in your rates outlook,
Speaker 1: when do we expect to see cuts?
Speaker 2: Yeah, I mean, I think the recession backdrop is is
Speaker 2: an interesting one, and I think it's one that has
Speaker 2: I don't know if i'd say confused the market, but
Speaker 2: is maybe you know, colored the market view over the
Speaker 2: last couple of years, there's been so much talk about
Speaker 2: a recession and one hasn't materialized. And I think that
Speaker 2: that is why you hear a lot of the talk
Speaker 2: of spreads are too tight, spreads are too tight. If
Speaker 2: if we never had this conversation about a recession, would
Speaker 2: we feel the same way about spreads? I mean, going
Speaker 2: forward from here, it's it's difficult to see, you know,
Speaker 2: where where a recession would come from, the economy seems
Speaker 2: to be doing well, consumers seem to be doing well.
Speaker 2: Things are definitely slowing, but are they slowing enough for
Speaker 2: a recession. I think it's very, very hard to predict.
Speaker 2: And if you invest with you know, a very very
Speaker 2: you know, strongly defined base case of a recession will
Speaker 2: happen in three months or six months or nine months.
Speaker 2: I think that's led to, you know, a path of
Speaker 2: disappointment over the last uh, you know, several months.
Speaker 4: You know, I listened to your lots of podcasts back
Speaker 4: in I believe it was September, and you talked about
Speaker 4: you know, we're both risk focused, you know, folks that
Speaker 4: have looking for downside versus upside on you know, be
Speaker 4: given that we're in credit and I wonder, you know,
Speaker 4: do we even need a recession when you have all this.
Speaker 3: Uncertainty that keeps ramping up?
Speaker 4: I mean I looked to last week and the Chevron
Speaker 4: doctrine the Supreme Court coming out talking about that. There's
Speaker 4: there's so many moving parts to this broader economic story
Speaker 4: and stuff that's happening around the edges. I wonder have
Speaker 4: you guys even focused on this Chevron doctrine.
Speaker 3: I mean, that was something that came out yesterday or
Speaker 3: on Friday.
Speaker 4: And as it relates to healthcare, I mean, we're thinking
Speaker 4: about legislative and regulatory uncertainty ramping up, and we clearly
Speaker 4: just had this conversation.
Speaker 3: It's just in early stages.
Speaker 4: But you know, how do you think about uncertainty on
Speaker 4: the edges versus you know, does it have to be
Speaker 4: you know, a binary recession or not? And how does
Speaker 4: that affect credit spreads and yields going forward?
Speaker 3: Yeah?
Speaker 2: No, I think you make a great point, Mike. And
Speaker 2: I think the one thing too, you know, kind of
Speaker 2: look at there is you're right, do you need a
Speaker 2: recession to have stress in certain parts of the market
Speaker 2: you mentioned healthcare. Health Care has been an area, especially
Speaker 2: in the leverage finance space where you have a lot
Speaker 2: of private equity involvement there, levered balance sheets. They have
Speaker 2: come under pressure, they've seen default rates tick higher as
Speaker 2: you've as you've seen some you know, whether it's regulation
Speaker 2: kind of shifting and changing on the state and federal level,
Speaker 2: where you've had some labor stress given you know the
Speaker 2: results of COVID and and you know wage pressures in
Speaker 2: in the healthcare space. So I think you're absolutely right
Speaker 2: that on a sector bi sector basis, you're you're going
Speaker 2: to see and continue to see. I think some pressure
Speaker 2: build in certain parts of the the credit markets. Now
Speaker 2: that doesn't mean that you should avoid the credit markets completely.
Speaker 2: I think it means that to have a kind of
Speaker 2: bottom up, fundamental approach to how you're thinking about investments
Speaker 2: and not just trying to own the entire index is
Speaker 2: the right approach. I mean, many people refer to that
Speaker 2: this period as a credit pickers market, and I think
Speaker 2: what they mean by that is exactly what you alluded to.
Speaker 2: You can avoid some of these broader challenges and take
Speaker 2: advantage of these very attractive yields, which again, if you
Speaker 2: can avoid those defaults in areas of stress, I think
Speaker 2: they serve a very good need for portfolios today.
Speaker 1: Just the point earlier on spreads, when you know, we've
Speaker 1: talked about them being very very tight, and then when
Speaker 1: we talk about that and people just say, well, look
Speaker 1: at the yield, it's so big that it doesn't really matter.
Speaker 1: But the textbook would tell us that we should worry
Speaker 1: about the spread, and it seems that would only take
Speaker 1: a little bit of volatility to come back to actually
Speaker 1: push those a lot wider than where they are right now,
Speaker 1: which would presumably mean losses. I mean, are we just
Speaker 1: focusing on the wrong thing here? Should should we just
Speaker 1: not be looking at the index and we should be
Speaker 1: looking at as a dispersion, We should be looking at
Speaker 1: individual bonds much more closely instead of the index.
Speaker 2: I do think there is an argument to be made
Speaker 2: to to look a little more closely at at individual
Speaker 2: bonds rather than just trying to take a take a
Speaker 2: market approach. I mean, and you can see this so
Speaker 2: far in in some of the performance data. If you
Speaker 2: look at the you know what, I would call the
Speaker 2: non tradable high yield indices that are out there relative
Speaker 2: to say ETFs in the first half of the year,
Speaker 2: you know, especially in this in this most recent quarter,
Speaker 2: you've seen some underperformance in UH in those ETFs relative
Speaker 2: to to the index. So again, I think just trying
Speaker 2: to you know, own that kind of most liquid, higher
Speaker 2: quality part of the market has has proven a little
Speaker 2: more challenging from a from a return perspective. But you know,
Speaker 2: the other thing to consider as well, and I think
Speaker 2: it's it's something to think about for high yield is
Speaker 2: we like to look at spreads and we like to
Speaker 2: look at them across time and compare them. Well, the
Speaker 2: index was you know, three hundred and fifty basis points today,
Speaker 2: it was three hundred and fifty basis points back in
Speaker 2: twenty eighteen. But you know, at the same time, for
Speaker 2: those who want to maybe get a little bit more
Speaker 2: what i'll call nerdy in the high yield space, you've
Speaker 2: seen a pretty significant drop in duration. And duration is
Speaker 2: that kind of measure of sensitivity to interest rates or
Speaker 2: credit spread. So with that number a lot shorter, then
Speaker 2: you know, I think you do have an easier time
Speaker 2: kind of looking at that market today, where again, your
Speaker 2: your sensitivity against those moves in rates or credit spreads
Speaker 2: give you give you a little bit you know, better
Speaker 2: return when it comes to thinking about how much can
Speaker 2: I lose and then most importantly how long does it
Speaker 2: take me to earn that back through the current yield?
Speaker 2: So higher current yield, lower duration, I think overall it
Speaker 2: is less sensitive. So again, if you can kind of
Speaker 2: pick those good credits, I think you're you're again going
Speaker 2: to benefit from what is a great opportunity to earn
Speaker 2: a higher yield.
Speaker 1: We tilked about twenty eighteen and I had a chance
Speaker 1: to check the spreads on that, and the spreads did
Speaker 1: actually blow out at the end of twenty eighteen on
Speaker 1: how yield. Maybe that was completely you know, for the
Speaker 1: reasons that you know will not happen again. But it
Speaker 1: just seems to me that things too priced to perfection,
Speaker 1: that all of the risks that we see just being
Speaker 1: underpriced at the moment. Do you not feel the same way.
Speaker 2: Look, I mean there's no doubt that you know spreads
Speaker 2: are tighter, and that you know people are kind of
Speaker 2: pricing things for perfection, as you say, and you're right,
Speaker 2: I mean, spreads did blow out at the end of
Speaker 2: twenty eighteen. Remember twenty eighteen was was a hiking cycle.
Speaker 2: The hiking cycle ended in December twenty eighteen, and that
Speaker 2: fourth quarter where spreads went wider. I mean, in a way,
Speaker 2: you could relate that fourth quarter move of twenty eighteen
Speaker 2: to something more like what we saw in twenty twenty two,
Speaker 2: where spreads definitely moved wider as rates went higher. But
Speaker 2: you know, today in the US, we've we've passed that
Speaker 2: period and I think everyone would agree, although there is
Speaker 2: probably a you know, a tail risk out there that
Speaker 2: rates could go higher again, that we're most likely going
Speaker 2: to see the next move in rates being lower. So again,
Speaker 2: as a high yield investor, if I think, well, you
Speaker 2: know what's going to cause those spreads to go higher,
Speaker 2: A lot of those scenarios are also most likely going
Speaker 2: to drive interest rates to come tighter. So there is
Speaker 2: a bit of an offsetting effect. And again, when I
Speaker 2: don't know the timing of that, what I want to
Speaker 2: do is make sure I'm in good companies that will
Speaker 2: accrue that yield in my favor while i'm you know,
Speaker 2: call it waiting for that for that event to hit.
Speaker 4: Wan One of the sectors. Of the very subsectors in
Speaker 4: healthcare that I cover, obviously payers and if you look
Speaker 4: at where payer spreads are now today, you know, look
Speaker 4: United and SIGNA and out of vants ECBs kind of
Speaker 4: wider on the margin.
Speaker 3: Price to perfection.
Speaker 4: Meanwhile, Congress is talking about, you know, regulating PBMs and
Speaker 4: you know, maybe causing some changes to the way the
Speaker 4: payers operate. You see that spreads haven't gapped out at all.
Speaker 4: And I wonder, I mean, do you have do you
Speaker 4: have to have an incident to happen.
Speaker 3: First before spreads widen?
Speaker 4: And I'm talking regulatory pushback against payers and making acquisitions
Speaker 4: outside of their normal payer side regulated revenue. I wonder
Speaker 4: you know that that's something that I see as a risk.
Speaker 4: And I wonder you know across sectors. You know, obviously
Speaker 4: healthcare is very regulated. Are there any other sectors that
Speaker 4: you're interested in right now from a long or short
Speaker 4: perspective where you see trends favorable or unfavorable?
Speaker 2: Yeah, I mean, you're you're right for sure, Mike, that
Speaker 2: you know, I think you will probably you know, people
Speaker 2: will try and hold on maybe for as long as
Speaker 2: they can. And again, I think that does speak to
Speaker 2: the power of you know, kind of active management versus
Speaker 2: passive management. And that's one thing that we have focused
Speaker 2: on over the last you know, call it year plus,
Speaker 2: is you know, looking across the market and looking at
Speaker 2: opportunities in various sectors where you have a chance to
Speaker 2: rotate into something that you may view as a little
Speaker 2: bit more defensive at you know, similar spreads and yields,
Speaker 2: which again, I mean you have to make those moves early.
Speaker 2: You can't. You can't wait and kind of after the
Speaker 2: fact is as you said in your example, you know,
Speaker 2: maybe a regulation does change spreads, move at that point
Speaker 2: it's too late. So you know, there certainly are are
Speaker 2: some parts of the market where there there's maybe things
Speaker 2: a little bit more attractive i mean food and beverage,
Speaker 2: you know, certainly a bit more on the staple front.
Speaker 2: You know, things like that are are good. I mean
Speaker 2: power is an area that that in certain parts of
Speaker 2: the market you've seen an increased demand for There's a
Speaker 2: lot of talk around you know, data centers and AI
Speaker 2: and their kind of demand for more power and maybe
Speaker 2: we're kind of underappreciating or underpricing the need for that
Speaker 2: to grow. You've also seen some pretty good strength in
Speaker 2: the various insurance sectors. So you know, there are parts
Speaker 2: of the market that I think when you kind of
Speaker 2: look at the landscape and think, you know, do I
Speaker 2: want to maybe give up a few basis points of
Speaker 2: yield or spread and lock into something which, again I
Speaker 2: think to your point has maybe less of that tail
Speaker 2: risk in it.
Speaker 3: Yeah, that's helpful.
Speaker 4: I think, you know, our food and beverage team on
Speaker 4: the credit side do have some interesting views.
Speaker 3: For sure.
Speaker 4: They've been talking a lot about GLP ones and potential
Speaker 4: impacts there, which we think will be a longer term trend.
Speaker 4: But I think stepping back, I mean, Bloomberg is Bloomberg
Speaker 4: Intelligence here has put out twenty years or twenty I'm sorry,
Speaker 4: twenty years twenty editions of our bi credit medians, and
Speaker 4: we're looking at trends recently for the last several quarters.
Speaker 3: You know, Joe Lovington's the head of.
Speaker 4: Our team, and he put this out last week basically
Speaker 4: showing you know, the sequential uptick and leverage across ratings classes,
Speaker 4: you know, from A to triple BB and you know
Speaker 4: approaching you know, higher levels that we've seen since you know,
Speaker 4: post COVID. What what are your views on broad sector
Speaker 4: trends and how that could and leverage trends and coverage
Speaker 4: trends which are clearly getting more coverage is declining, leverages rising.
Speaker 4: Do you think that we're on a glide path towards
Speaker 4: something you know, more negative or on the corporate side,
Speaker 4: or what signals are you seeing over at oak Tree,
Speaker 4: across the across the spectrum in terms of leverage and
Speaker 4: should that be a concern.
Speaker 2: Yeah, I mean, I think you're right. I mean, leverage
Speaker 2: has certainly ticked up from from those lows. But if
Speaker 2: you kind of take a step back and look and
Speaker 2: go back a little bit further into the into the
Speaker 2: pre COVID days, you'll see that, you know, leverage for
Speaker 2: the most part, whether it's loans, whether it's bonds, it's
Speaker 2: you know, kind of at the median or below the median,
Speaker 2: below the average in many cases. So you know, it
Speaker 2: certainly shows you that companies have not been what I
Speaker 2: would call irresponsible over this most recent time period. They've
Speaker 2: been pretty measured in their cases for increasing leverage, whether
Speaker 2: that's through acquisitions or you know, large capital expenditures which
Speaker 2: would require the issuance of new debt packing on leverage.
Speaker 2: I mean, I think I think companies have been pretty
Speaker 2: responsible and I think overall from a credit perspective, that
Speaker 2: should be good for investors. On the coverage front, it's
Speaker 2: it's interesting, I think over the last few months you're
Speaker 2: seeing coverage almost go in the opposite direction if you
Speaker 2: look at the high yield market versus the loan market,
Speaker 2: where high yield borrowers, because they've been fixed rate, they've
Speaker 2: been able to kind of live out this term of
Speaker 2: higher rates for longer than floating rate products where they've
Speaker 2: immediately felt that impact. High yeld bonds are now just
Speaker 2: starting to refinance and have started to refinance into higher rates.
Speaker 2: So yep, you're seeing coverage tickdown, but again tick down
Speaker 2: from very very high levels into areas that are still
Speaker 2: very very reasonable. And on the loan side, in this
Speaker 2: year of pretty significant refinancings, you've actually seen loan borrowers
Speaker 2: be able to improve their coverage metrics because that loan
Speaker 2: that they issued two years ago or eighteen months ago
Speaker 2: is now being refinanced at a fifty basis points spread
Speaker 2: roughly lower. So you are seeing a little bit of
Speaker 2: relief there, but it's certainly an area that you still
Speaker 2: have to watch out for in companies with excessive leverage
Speaker 2: are going to be the ones that continue to struggle. Again,
Speaker 2: kind of making that case for active management over just
Speaker 2: purely trying to own the market.
Speaker 1: A Now that really struggling end when there is increased
Speaker 1: incidence of liability management, which is coercive, it's violent, it's
Speaker 1: inflicting losses and a little of pain on investors. How
Speaker 1: much are you engaged in those sorts of transactions and
Speaker 1: what are you doing to fight back?
Speaker 2: I mean, you certainly have to pay very close attention
Speaker 2: to the capital structures that you know seem most likely
Speaker 2: to go through that kind of activity. And again, as
Speaker 2: I mentioned with the idea of you know, kind of
Speaker 2: rotating away from trouble sectors, you have to be prepared
Speaker 2: for that. You have to do that in advance. It's
Speaker 2: very similar here. You don't want to be you don't
Speaker 2: want to be surprised by one of these activities, and
Speaker 2: that might mean you know, speaking to other lenders, talking
Speaker 2: to other parties, and again kind of preparing it. And
Speaker 2: in some cases it might mean you know, leaving leaving
Speaker 2: a bit of return on the table and switching out
Speaker 2: from a name or a sector rather than kind of
Speaker 2: trying to squeeze out those last few basis points.
Speaker 4: In healthcare, there's been a couple of instances when where
Speaker 4: we've had just you know, discounted buybacks, but the agencies
Speaker 4: turned them opportunistic versus distressed.
Speaker 3: And I wonder is that something you guys have looked into?
Speaker 4: Meaning there are instances where liability management exercises are reducing
Speaker 4: PAR basically or haircut and par, but they're not getting
Speaker 4: you know, they're not being assessed as a distressed exchange.
Speaker 4: The company comes to mind as multiplan that I've been
Speaker 4: working on for many years, and they were they did
Speaker 4: it sell par buy back, And I wonder do you
Speaker 4: see much of that? I mean, are there instances where
Speaker 4: companies are doing are basically defaulting on their part payment
Speaker 4: and getting almost getting away with it. Maybe that's just
Speaker 4: a something that I'm keying in on here. It seems
Speaker 4: strange to me.
Speaker 2: Yeah, I mean, look, I think one thing that you know,
Speaker 2: periods of I would call Marcus stress certainly seem to
Speaker 2: bring out, you know, creative solutions to problems that we
Speaker 2: haven't seen historically. And and there's no doubt that those
Speaker 2: are going to grow for those balance shees that have
Speaker 2: the most leverage. I mean, the other area that you've
Speaker 2: probably looked at in detail as well is just you know,
Speaker 2: what's going on in the private credit markets. We don't
Speaker 2: see those headlines as much, but we know that there
Speaker 2: are being you know, there are situations where companies are
Speaker 2: choosing to pay their interesting kind or a portion of
Speaker 2: their interesting kind, rather than pay it in cash. And again,
Speaker 2: you know, is that a default? Is that not a default?
Speaker 2: How do we treat that going forward? I think you
Speaker 2: know these periods where or again times are going to
Speaker 2: get tough for certain balance shees. I think you have
Speaker 2: to expect more and more creative solutions. And again, the companies,
Speaker 2: as you mentioned, tend to be ahead of how the
Speaker 2: rating agencies think about this. So you know, again, I
Speaker 2: think it's going to be one of those situations that
Speaker 2: we look back on in a few years and you know,
Speaker 2: everyone will try and kind of take the lessons forward,
Speaker 2: as typically happens, we always fight problems in reverse. But
Speaker 2: you know, again, it's it shows that there is just
Speaker 2: no replacement for a focus on kind of bottom up
Speaker 2: fundamental credit work, especially at times like this where you
Speaker 2: can and will probably continue to be surprised by some
Speaker 2: companies actions.
Speaker 1: Can we talk a bit about securitize credit. A lot
Speaker 1: of guests on this show really excited about it. They
Speaker 1: see a ton of opportunity, they see more relative value
Speaker 1: that compared to you know, playing vanilla bunds. Where where's
Speaker 1: the where's the excitement when you even to securitize credit.
Speaker 2: Yeah, I think securitized credit has been a great addition
Speaker 2: to UH to fixed income portfolios. I know some of
Speaker 2: your prior guests have spoken about the CLO market, and
Speaker 2: and rightfully so. I mean the CLO market has offered
Speaker 2: some pretty big premiums relative to other fixed income spreads
Speaker 2: that that we've seen in a while. And I think
Speaker 2: there's a there's a couple of reasons for that. Number One,
Speaker 2: if you look at a CLO, the spread for that
Speaker 2: will come, you know, as a result of the quality
Speaker 2: of the underlying collateral, and we know that that has
Speaker 2: you know, gone through periods of widening and tightening over
Speaker 2: the last year. But there's another element within securitized which
Speaker 2: is the financing piece of that, and that is where
Speaker 2: I think you saw a bigger premium come in, primarily
Speaker 2: in the form of of you know, US banks that
Speaker 2: were very very big participants in triple A securitizations following COVID,
Speaker 2: their reserves, you know, spiked dramatically once quantitative tightening came in.
Speaker 2: Everyone expected, well, if reserves went up during quantitative easing,
Speaker 2: the natural reaction would be reserves would decline. So in
Speaker 2: a way, you saw a pullback in anticipation of that,
Speaker 2: and that push spreads wider and created a great opportunity
Speaker 2: to invest. Reserves did not fall, So you've seen some
Speaker 2: of that normalized. But securities, I think is definitely an
Speaker 2: area that has been that has been great for fixed
Speaker 2: income portfolios.
Speaker 1: Is it just sal were you also into consumer abs
Speaker 1: or even real estate? What's what's what are the assets
Speaker 1: are you looking at?
Speaker 2: Yeah, I think all parts of securities have been good.
Speaker 2: I mean residential real estate I think has been very
Speaker 2: attractive over the last couple of years. You know a
Speaker 2: lot of people still you know, think back to problems
Speaker 2: in the mortgage market that happened in two thousand and eight,
Speaker 2: and this market is very very different. If you think
Speaker 2: back in kind of two thousand and six and seven,
Speaker 2: loan to values were very high, FIGHTO scores were low,
Speaker 2: in the non agency space today, you see the exact opposite.
Speaker 2: You see FIGHTO scores, you know, above seven hundred, you
Speaker 2: see loan to values near seventy percent, in some cases lower,
Speaker 2: just given the boost in real estate prices. So you
Speaker 2: could probably argue that, you know, mortgage or real estate prices,
Speaker 2: you know, should maybe be a little bit lower. We
Speaker 2: saw such a spike in mortgage rates, well, we had
Speaker 2: to simultaneously rise in in house prices. But there's so
Speaker 2: much cushion in the securities that you're very, very very
Speaker 2: well protected. And the one thing I like about residential
Speaker 2: mortgage backed securities, and I would say the same for
Speaker 2: commercial and some others, is that, unlike a CLO that
Speaker 2: when alone refinances in the collateral, the CLO reinvests, when
Speaker 2: an R and B S security has a loan refinance,
Speaker 2: the security de leverages and you actually kind of move
Speaker 2: up in quality. So you have some double B issued,
Speaker 2: you know, residential mortgage backed securities that look on a
Speaker 2: kind of credit enhancement or risk basis more like a
Speaker 2: triple B. So again it kind of goes to that
Speaker 2: point of spreading out your sources of risk and diversifying
Speaker 2: across I think a lot of pretty attractive areas in
Speaker 2: the markets.
Speaker 1: What about the commercial stuff that the offices, so you
Speaker 1: taking into that, so a lot of our guests are
Speaker 1: getting excited about that given how cheap it became.
Speaker 2: I mean, look, I think office is an area that's
Speaker 2: going to be you know, under stress or or under
Speaker 2: some sort of repricing for you know, it could be
Speaker 2: a number of years into the future. There's just not
Speaker 2: a lot of transactions happening. You do see them one
Speaker 2: off pop up here and there. Some are worse, some
Speaker 2: are better. So it is an area I think in
Speaker 2: a kind of performing or liquid credit strategy. It's it's
Speaker 2: maybe difficult to to get too excited about right now
Speaker 2: with the uncertainty. But that doesn't mean that there aren't
Speaker 2: very attractive areas of commercial mortgage backed securities right now.
Speaker 2: Commercial real estate clos again look quite attractive with good yields,
Speaker 2: good levels of protection. You even have new kind of
Speaker 2: areas into the market, data centers, for example. I mean,
Speaker 2: I think data centers are very interesting. The AI kind
Speaker 2: of boom from a from a credit perspective, it's you
Speaker 2: you get so many different areas that that touch. As
Speaker 2: we mentioned the power space, whether that's in a loan
Speaker 2: or whether that's in a bond. You have CMBs for
Speaker 2: the data center itself. You have fiber issued ABS which
Speaker 2: is coming into those data centers. So you know, kind
Speaker 2: of secular shifts like that can give you a lot
Speaker 2: of opportunity in many different markets.
Speaker 4: So stepping back a little bit from the securitization, you know,
Speaker 4: talking about risk management. You know, we talk about the
Speaker 4: growth and private credit and you know, I'm not sure
Speaker 4: if we're still in the golden age this week, but
Speaker 4: you know, you think about risk management there versus the
Speaker 4: clo market, versus the bond market. I mean, having grown
Speaker 4: up in Loanland, I know what a you know, a
Speaker 4: matrix colo matrix is and wharf and weight to average
Speaker 4: spread and managing to the matrix and there's robust, you know,
Speaker 4: strictures in place to keep in underwriting standards in line.
Speaker 4: I wonder as the banks are no longer agenting so
Speaker 4: many deals and you're looking at some of these bigger
Speaker 4: private credit shops actually deals and the blurring of syndicated
Speaker 4: loans with private credit, you know, how does that affect
Speaker 4: risk risk management going forward? You know, do you see
Speaker 4: I mean I'm sure not all private credit operators out
Speaker 4: there are as rigorous as oak Tree has been for
Speaker 4: decades and underwriting, and I wonder do you see risks
Speaker 4: on the horizon there and how does that how would
Speaker 4: potential fall out if there were to be some you know,
Speaker 4: how do you see that sort of materializing if we
Speaker 4: play along with my hypothetical here.
Speaker 2: Yeah, no, you're right, Mike, And I would just quickly
Speaker 2: touch on something you you know, kind of alluded to
Speaker 2: in your your breakdown of securitizations and and you know,
Speaker 2: clos in particular. I mean, those are the reasons that
Speaker 2: I think also kind of make clos relatively attractive and
Speaker 2: securitizations and those those are the reasons why I think
Speaker 2: ultimately default rates in those various tranches of various ratings
Speaker 2: has remained quite low because there are those kind of
Speaker 2: you know, stand or it's almost that you could call
Speaker 2: them that the market does adhere to. And you're right,
Speaker 2: private credit certainly doesn't have those, and it's a growing
Speaker 2: market and and you know, I think one of the
Speaker 2: keys for private credit is is flexibility. You know, you
Speaker 2: need to be able to you know, kind of pick
Speaker 2: your spots and where you want to invest. At one moment,
Speaker 2: you know, a large cap you know, sponsor back private
Speaker 2: credit deal might be the most attractive area in the market.
Speaker 2: At the next moment, maybe the better parts of the
Speaker 2: private credit market could be something in the non sponsor space,
Speaker 2: something where you have a little bit more control and
Speaker 2: negotiating leverage within those structures. I think there's just a
Speaker 2: lot of uncertainty that we're going to see in the
Speaker 2: private credit market. And again as I as I said before,
Speaker 2: it's difficult to always kind of get that full picture
Speaker 2: of exactly what's going on in that market. So yes,
Speaker 2: I think focusing on risk management, focusing on underwriting, and
Speaker 2: you know, to the best you can, you know, trying
Speaker 2: to make sure that the positions you're investing in are
Speaker 2: built to you know, work through a period that is
Speaker 2: that could be facing us with again higher rates for
Speaker 2: longer probably being one of the big ones. And then
Speaker 2: also being you know, kind of thinking ahead to what
Speaker 2: does some of the workout plans look like in these
Speaker 2: kind of deals, Where where can new capital potentially come
Speaker 2: in to you know, fix some of these broken problems
Speaker 2: and are we in a position to be able to
Speaker 2: take advantage of that.
Speaker 1: So most stress when in private credit. I mean, people
Speaker 1: are quite right about how quickly it grew. And some
Speaker 1: people say that the tourist money coming in may may
Speaker 1: result in some blow ups, But do you expect more
Speaker 1: even if we can see them defaults, more sort of
Speaker 1: general stress in that market.
Speaker 2: I think there will be you know, some some general stress. Again,
Speaker 2: I think part of it depends on, you know, again
Speaker 2: the path of interest rates. A lot of markets that
Speaker 2: are undergoing stress where certainly, you know, very excited at
Speaker 2: the beginning of the year when the market anticipated some
Speaker 2: very quick cuts and interest rates that that didn't that
Speaker 2: didn't emerge. But you know, I think those are just
Speaker 2: some of the some of the things that that investors
Speaker 2: need to think about when they're making these kind of
Speaker 2: investments where their capital is locked up and and you
Speaker 2: do mention tourists. I mean, you can only have so
Speaker 2: many tourists in that kind of market because the majority
Speaker 2: of the capital is still in a place where you're
Speaker 2: going to be locked up, You're going to be committed,
Speaker 2: and so you know, as as end investors, you don't
Speaker 2: have that same fear of your capital walking away as
Speaker 2: soon as you have to. You know, kind of think
Speaker 2: about think about or restructuring so that that will definitely,
Speaker 2: I think, kind of ease some of the pressure or
Speaker 2: at least kind of help this market get through. The
Speaker 2: bigger challenge with with private credit is probably probably that
Speaker 2: you know, in some of these kind of non traded
Speaker 2: products which have some form of semi liquidity, but I
Speaker 2: would primarily consider them relatively a liquid you don't always
Speaker 2: align those inflows with the opportunity. So when people get excited,
Speaker 2: they put money in the end investor has no choice
Speaker 2: but to invest that, and therefore you'll, you know, maybe
Speaker 2: see spreads compress a little bit more then then would
Speaker 2: otherwise be warranted if you didn't have that kind of
Speaker 2: surge in demand.
Speaker 1: To what extent if there are problems in private credit,
Speaker 1: do they spill over to other markets?
Speaker 2: Yeah, I mean, I think the one thing is that
Speaker 2: you know, you do have that kind of nature of
Speaker 2: locked up capital in there. So if you have you
Speaker 2: know a lot of capital that's kind of trapped in
Speaker 2: a certain area, then you do kind of see challenges
Speaker 2: in other markets. We did experience that, I think a
Speaker 2: little bit after twenty twenty two, where you know a
Speaker 2: lot of investors in in various kind of private markets
Speaker 2: that were used to some level of distribution and using
Speaker 2: those distributions to redeploy into other areas. You definitely saw
Speaker 2: those decrease. So, you know, I think yields in high
Speaker 2: yield loans and some of these public markets did stay
Speaker 2: a little bit higher for longer than maybe people expected
Speaker 2: because I think some of the capital that probably would have,
Speaker 2: you know, kind of come into those markets for that
Speaker 2: opportunity were constrained somewhat just given the kind of locked
Speaker 2: up nature of more and more capital today.
Speaker 4: I think you bring up and it makes me think
Speaker 4: about an interesting point. As you know, we talk about
Speaker 4: risk kind of getting diffused across more shops basically instead
Speaker 4: of being held on balance sheet at banks, you know,
Speaker 4: does that I mean a lot of folks in the
Speaker 4: media and regulatory agencies look at that as you know,
Speaker 4: increasing systemic risk. But if the banks that are providing
Speaker 4: commercial lending and you know, are doing everything else that
Speaker 4: they're doing cash management are no longer holding I mean,
Speaker 4: I think back to two thousand and seven when there
Speaker 4: were a lot of deals like Leman but you know Archstones,
Speaker 4: the Archstone Archstone was a Tishman spare deal. A lot
Speaker 4: of these hung deals that got hung back then actually
Speaker 4: impacted the banks more broadly because the corporate credit was
Speaker 4: dragging capital and whatever impacts ahead and ultimately defaults. But
Speaker 4: were we safer now if Blue Owl or you know,
Speaker 4: oak Trees agenting a deal, is it a safer environment
Speaker 4: for the economy?
Speaker 2: Well? Yeah, I mean, I think I think you bring
Speaker 2: up a good point as it relates to the kind
Speaker 2: of broader economy and really for banks to be able
Speaker 2: to you know, kind of cover the wide remit that
Speaker 2: they have, which is a lot it is, you know,
Speaker 2: providing financing to companies, but it's also providing financing to consumers,
Speaker 2: whether that's through mortgages and other forms of borrowing. And
Speaker 2: and yes, I think it's a you know, it's a
Speaker 2: good point that you know, you won't see that kind
Speaker 2: of same risk of kind of locking up the entire
Speaker 2: system in a situation where more and more of this
Speaker 2: these kind of let's call them almost riskier activities have
Speaker 2: been you know, pushed off into into people who have
Speaker 2: maybe the right you know, asset liability mix. Again, it's
Speaker 2: one thing if people can walk away from these kind
Speaker 2: of private credit deals in the middle. If they can't
Speaker 2: they're locked in, they will have to kind of work
Speaker 2: them out. A bank doesn't have to worry about capital
Speaker 2: tied up in those areas. Again, as I mentioned, at
Speaker 2: periods where you could see reserves start to decline in
Speaker 2: ratios adjust. So yes, I think you're right that, you know,
Speaker 2: from a broader kind of economic standpoint, banks should be
Speaker 2: able to continue to provide the servicing that they need
Speaker 2: to for the broader economy.
Speaker 3: Yeah.
Speaker 4: I spent a lot of time in a loan group
Speaker 4: at Credit Swiss, and we you know, we had exposure
Speaker 4: from IG to high yield and distressed and we did
Speaker 4: a lot of hedging, you know, single name ultimately single
Speaker 4: name CDs hedging there was uh became two cost prohibitive
Speaker 4: and we started you know, payers and put options on
Speaker 4: the index and hedging that way. And you know, the
Speaker 4: hedging strategy always evolved. And I wonder for private credit,
Speaker 4: how do you hedge that?
Speaker 2: Yeah, I mean that you're right. I mean everything you
Speaker 2: just mentioned about hedging, you know, whether it's whether it's
Speaker 2: an index or whether it's an option. You know, there
Speaker 2: is an element of well, my hedge is going to
Speaker 2: benefit because I have some pick up in volatility, whether
Speaker 2: that impacts just purely volatility, the price of the option
Speaker 2: or volatility drives that kind of widening in credit spread.
Speaker 2: So I think when you look at that private credit market,
Speaker 2: and as you know, I mean from those days of
Speaker 2: credit Swiss and anyone out there who's you know, tried
Speaker 2: to hedge even a high yo bond or loan or
Speaker 2: CLO credit portfolio with credit derivatives, that there is a
Speaker 2: pretty significant basis risk one can move without the other,
Speaker 2: and you know, private credit obviously just kind of draws
Speaker 2: that basis risk even even greater. So I would almost
Speaker 2: look at, you know, adding a hedge like that is
Speaker 2: as almost like a second bet. It's difficult to kind
Speaker 2: of put that in the category of a hedge when
Speaker 2: one might move and one and one might not. But
Speaker 2: but I understand where you're trying to get at. Maybe
Speaker 2: you're willing to, you know, spend a little bit of
Speaker 2: that excess you know, spread and put that in some
Speaker 2: form of protection. But it's hard to say that your
Speaker 2: hedge will definitely make money when your you know, your
Speaker 2: other asset that you're hedging is losing money. I think
Speaker 2: that's that's one of the risks and things that I'm
Speaker 2: sure risk managers everywhere are struggling with right now, I want.
Speaker 1: To flip to another risk that we mentioned at the
Speaker 1: beginning of the show, when politics. Obviously we've seen a
Speaker 1: lot of volatility around Mexico, around India, We're now going
Speaker 1: into very volatility in France and and obviously the US
Speaker 1: and you know even even Canada politics they were getting choppy.
Speaker 1: What do you how do you position for that? And
Speaker 1: you know, I mean again, Hedges, I mean, can you
Speaker 1: can you Hedge? Can you can you position for any
Speaker 1: of these things? I mean, that's that's just focus on
Speaker 1: the US. The significant change is implied by a Trump
Speaker 1: presidency for example.
Speaker 2: Yeah, I mean obviously again for US, the focus is
Speaker 2: always going to be on on credit. I mean, our
Speaker 2: our cio Bruce Karsh always says, if you get the
Speaker 2: credit right, nothing else matters, and he's right. It's another
Speaker 2: way of saying, you know what, what our chairman Howard
Speaker 2: Mark said in his December twenty twenty two memo on
Speaker 2: the sea change. He spoke about these higher yields and
Speaker 2: your ability to earn them only if you can avoid defaults.
Speaker 2: So that really is kind of the first and foremost
Speaker 2: is thinking about, you know, how do these various regimes
Speaker 2: ultimately impact you know, our underlying barrowers' ability to pay.
Speaker 2: And I think Trump versus Biden and the is an
Speaker 2: interesting one. I mean, there are certainly some similarities. I
Speaker 2: think both will have you know, a higher deficit, a
Speaker 2: higher or you know, continued high deficits. That means that
Speaker 2: you know, there's going to continue to be a lot
Speaker 2: of issuance in the treasury market. Does that keep rates
Speaker 2: higher for longer? Do the threat of you know, increased
Speaker 2: tariffs maybe under a Trump presidency keep rates higher? I mean,
Speaker 2: it does make you again kind of think about how
Speaker 2: you position yourself and kind of maintaining that, you know,
Speaker 2: kind of mix, not not putting all of your eggs
Speaker 2: in one basket, which again I think a lot of
Speaker 2: investors have made the mistake of in the last couple
Speaker 2: of years getting a little too excited about the potential
Speaker 2: for interest rates to fall, leaning very very hard into
Speaker 2: duration assets, long duration assets, only to be disappointed. So
Speaker 2: I think the best kind of hedge you can have
Speaker 2: almost is to have a good diversified, you know, portfolio
Speaker 2: of these various exposures, two bonds, two loans, two securities
Speaker 2: that we talked about and making sure that you're not
Speaker 2: you know, leaning into just one sole factor that that
Speaker 2: you could easily get wrong. And I think nobody can
Speaker 2: really predict.
Speaker 1: But Trump risk, higher inflation, FED independence potentially undermined, lower taxes,
Speaker 1: you know, demographic changes around immigration. How does that all
Speaker 1: shake out in credit markets if let's say the FED
Speaker 1: actually has to hike the next move.
Speaker 2: Yeah, I mean a hike would definitely be a challenge
Speaker 2: for credit markets. You know, I think a lot of
Speaker 2: people are resigned to the fact that, you know, rates
Speaker 2: have peaked and they might stay high for longer, but
Speaker 2: at least we know the the next move is down.
Speaker 2: And I think again you need to really look at
Speaker 2: kind of where balance sheets are positioned today in which
Speaker 2: areas you know are most at risk. Again, you know,
Speaker 2: many of the things we've talked about today, and the
Speaker 2: answer to a lot of your questions has been that
Speaker 2: they're just there is no substitute for you know, digging
Speaker 2: in doing your credit work. And we're probably going to
Speaker 2: live in this kind of credit pickers market where we
Speaker 2: have you know, idiosyncratic defaults, whether it's you know, maybe
Speaker 2: idiosyncratic to a sector or an industry. As Mike mentioned,
Speaker 2: that could be driven by by policy, but you you
Speaker 2: really just have to be ready for for anything.
Speaker 1: Other than that. The way and specifically in terms of
Speaker 1: like one opportunity, what's your edge? How do you How
Speaker 1: does oak Tree come out on top this year?
Speaker 2: Well, I think the you know, one of the one
Speaker 2: of the things for oak Tree is that we've been
Speaker 2: a long time specialist in sub investment grade markets, and
Speaker 2: sub investment grade markets do tend to have higher yields,
Speaker 2: and I think, you know, being able to earn you know,
Speaker 2: a high amount of income has been a big benefit.
Speaker 2: The way I look at kind of higher yielding markets
Speaker 2: right now, that sub investment grade market is it has
Speaker 2: almost been a substitution for for equities. And you know,
Speaker 2: at times we've mentioned the ability to earn equity like returns.
Speaker 2: Others have said the same thing, and I think people
Speaker 2: confuse that sometimes by you know, implying that these these
Speaker 2: fixed income investments are going to equal their return of
Speaker 2: the S and P five hundred or the Nasdaq or
Speaker 2: other equity markets. But really what it means is, you know,
Speaker 2: where do these where do these investments have a place
Speaker 2: in your portfolio? And four or five years ago, many
Speaker 2: people were looking at equities to earn that kind of
Speaker 2: high single low double digit type return, and that is
Speaker 2: what you're getting today from these kind of higher yielding
Speaker 2: sub investment grade assets. That that income. That inability to
Speaker 2: time markets is really key in being able to kind
Speaker 2: of maximize your income over that period while avoiding the
Speaker 2: defaults and avoiding some of the trouble spots that we've
Speaker 2: discussed today. I think really is a key, and I
Speaker 2: think really is kind of where oak Tree has has
Speaker 2: maintained and gained its reputation over the last thirty years.
Speaker 1: Does that mean buying triple C bonds?
Speaker 2: It doesn't necessarily mean buying triple C bonds. I mean,
Speaker 2: if you look at the high yield market today, a
Speaker 2: little over seventy percent of that market trades with a
Speaker 2: spread below three hundred. Yeah, the index average is three
Speaker 2: point fifty. So you know, there are certainly, you know
Speaker 2: a number of single B rated bonds out there, single
Speaker 2: B rated loans, other structured credit securitized assets that we
Speaker 2: mentioned that can you know, kind of get you that
Speaker 2: yield maybe a little bit below where a triple C.
Speaker 2: But I don't think it's an environment where you do
Speaker 2: have to kind of lean into the riskiest parts of
Speaker 2: the market to earn that excess yield.
Speaker 1: Great stuff, Wayne Doll, It's been a pleasure having you
Speaker 1: on the Credit Edge, Manny.
Speaker 2: Thanks, thank you very much.
Speaker 1: Wayne is co portfolio manager for oak Tree Capital Managements
Speaker 1: Global credit and investment grade solutions strategies. And of course
Speaker 1: we're very grateful to Mike Hollin from Bloomberg Intelligence. Thank
Speaker 1: you for joining us today.
Speaker 3: Mike, great to be here.
Speaker 1: For more credit analysis read all of Mike Hollins's work
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Speaker 1: I'm James Cromby, it's been a pleasure having you join
Speaker 1: us again next week on the Credit edge.