Speaker 1: This is Master's in Business with Barry Ridholds on Bloomberg Radio.
Speaker 2: This week on the podcast What Can I Say? Another
Speaker 2: extra extra special guest, Arman Panosian is head of Performing
Speaker 2: Credit at oak Tree Capital Management, where he works with
Speaker 2: the likes of Bruce Karsh and Howard Marx. He is
Speaker 2: also the incoming co CEO, a job he will take
Speaker 2: the reins at in the first quarter of twenty twenty four,
Speaker 2: helping to run oak Trees. I want to say it's
Speaker 2: about one hundred and seventy nine billion dollars in client assets.
Speaker 2: I found this to be just a masterclass in everything
Speaker 2: you need to know about distressed credit, investing, private credit,
Speaker 2: the role of the economy, the Fed interest rates, inflation
Speaker 2: bottoms up, credit picking, and how to manage a firm
Speaker 2: and a fund in light of just massive dislocations in
Speaker 2: your space as well as the overall economy. You've probably
Speaker 2: heard some aspects of this from the various interviews I've
Speaker 2: done with Howard Marx talking about the distressed asset fund
Speaker 2: they set up in two thousand and seven. That's very
Speaker 2: much a top down view from what Howard Marx was
Speaker 2: setting up. But here you have the guy who is
Speaker 2: part of the team running the funds day to day,
Speaker 2: right into the teeth of the collapse of the financial
Speaker 2: markets in the Great Financial Crisis. There were days when
Speaker 2: they were the only bidders for any type of fixed income,
Speaker 2: putting one hundred million dollars or more to work each day.
Speaker 2: It's really a fascinating discussion, a fascinating glimpse into history
Speaker 2: as to what was going on during the financial crisis. Hey,
Speaker 2: fast forward fifteen years, and now these guys are doing
Speaker 2: the same thing in twenty twenty two, when fixed income
Speaker 2: is down by double digits and there's a little bit
Speaker 2: of panic in that space. These are the guys that
Speaker 2: are on the other side of the trade looking to
Speaker 2: pick up dollars for fifty cents, and very often they're
Speaker 2: the only bidder when everybody else is kind of freaked
Speaker 2: out about what's going on. I found this conversation to
Speaker 2: be absolutely intriguing and fascinating, and I think you will
Speaker 2: as well. With no further ado, my interview of the
Speaker 2: incoming co CEO of oak Tree Capital Management, Arman Panosian.
Speaker 1: Yeah, thanks, Barry. So when I was in graduate school,
Speaker 1: I thought about all the different types of investing or
Speaker 1: advisory work I could do, and I, you know, really
Speaker 1: triangulated on distress debt being the most interesting part of
Speaker 1: the of the markets where I could participate in. Pequot
Speaker 1: Capital had a group based in Los Angeles that had
Speaker 1: a long and experienced team that was investing in distress
Speaker 1: debt and really kept separating apart from what the rest
Speaker 1: of the hedge fund at Peaquat was doing. But I
Speaker 1: did meet Art Samberg, really, I would say, a great
Speaker 1: person to work for. But I really learned a lot
Speaker 1: from the team doing the distressed debt investing, Rob Webster
Speaker 1: and Paul Mellinger in Los Angeles that really did a
Speaker 1: lot in the small and medium size distressed for control space.
Speaker 2: Yeah, Samberg is a fascinating guy. I had him on
Speaker 2: the show in twenty fifteen and the thing that was
Speaker 2: so astonishing seventeen point eight percent annual returns NETA fees
Speaker 2: and that's from nineteen eighty seven to the mid twenty tens.
Speaker 2: Just an incredible run. And he started I think his
Speaker 2: first year drodown was twenty five twenty six percent right
Speaker 2: into the eighty seven crash. Just an amazing track record.
Speaker 2: Was who like working with Art Sandberg? And and some
Speaker 2: of the other really you know, storied people who work there.
Speaker 1: Yeah, it was he had a very strong team around
Speaker 1: him on the equity side. You know, they were based
Speaker 1: in Connecticut and and doing uh, you know, I would
Speaker 1: say investing that was separate apart from the distress side.
Speaker 1: We were really focused on the distress side and small
Speaker 1: and medium sized businesses buying their debt, looking to restructure them,
Speaker 1: taking over control, making some you know, swift decisions around
Speaker 1: acquisitions or divestitures, and and then selling those businesses. So
Speaker 1: we were kind of kept in a little bit of
Speaker 1: a bubble on the distress side, and I think we
Speaker 1: were always kind of the the negative group within within
Speaker 1: an organization that was quite equity focused and always looking
Speaker 1: for the upside opportunity. So it's kind of an interesting
Speaker 1: dichotomy to be, uh, a distressed investor in the context
Speaker 1: of an equity manager that that was always looking for,
Speaker 1: you know, looking for the glass half full rather than
Speaker 1: the lass half empty.
Speaker 2: Well, well, you know, debt investors, they just want their
Speaker 2: money back. It's a very different philosophy. So now let's
Speaker 2: talk a little bit about oak Tree. Your timing was fortuitous.
Speaker 2: You join in two thousand and seven. Tell us a
Speaker 2: little bit about that era. What was it like between
Speaker 2: the time when housing had already rolled over, but before
Speaker 2: stocks peaked and crashed.
Speaker 1: Yeah, I remember when I bought my first house in
Speaker 1: two thousand and six. They all I was asked was
Speaker 1: if I intended to repay the debt, and I didn't
Speaker 1: have to show any materials about my income or my
Speaker 1: credit capacity. It was purely if I intended to repay,
Speaker 1: which you know, if I knew how to short it
Speaker 1: back then, I would have immediately, because I'm pretty sure
Speaker 1: I was not a good credit at that point in time.
Speaker 1: But fast forward to June of two thousand and seven.
Speaker 1: You know, oak Tree in the distress debt landscape is really,
Speaker 1: you know, second to none. And when Howard Marx and
Speaker 1: Bruce Karsh saw these cracks that that, you know, I
Speaker 1: think they were early to see it in the corporate
Speaker 1: credit markets, they decided to go raise a big fund
Speaker 1: and they had a lot of conviction to do that
Speaker 1: and stepped up with the clients to raise it. And
Speaker 1: I was fortunate to find a seat in that group
Speaker 1: and invested, you know, very steadily in two thousand and seven,
Speaker 1: not not terribly busy in two thousand and seven, to
Speaker 1: be honest, But in two thousand and eight, two thousand
Speaker 1: and nine, ten, it was by far the busiest time
Speaker 1: in my career in investing. I'm sure Howard mentioned this
Speaker 1: to you, but you know, after the collapse of Lehman,
Speaker 1: for many months, you know, we were buying hundreds of
Speaker 1: millions of dollars of publicly traded debt globally, and frankly,
Speaker 1: it took a lot of conviction to do so because
Speaker 1: everything we bought was down five points a week later,
Speaker 1: and so there were there were more than a couple
Speaker 1: of nights where I slept under my desk wondering if
Speaker 1: I had a job in the morning.
Speaker 2: And when you say you would buy hundreds of millions
Speaker 2: of dollars worth of publicly traded debt, that's every day. Yeah,
Speaker 2: every day. Isn't like one hundred million dollar purchase daily,
Speaker 2: You're going out. Because I recall Howard telling the story
Speaker 2: that they wanted to launch this fund in the beginning
Speaker 2: of seven and the target to raise assets was they
Speaker 2: wanted three billion. They ended up with fourteen billion. Sometimes
Speaker 2: size gets in the way of performance. Not in this case.
Speaker 2: It sounds like the timing was perfect, the sector was perfect.
Speaker 2: What was it like having to deal with all that
Speaker 2: capital when when you're watching the world fall apart?
Speaker 1: Yeah, it was interesting because with the way we structured
Speaker 1: that particular fund, it was a smaller A fund, and
Speaker 1: then we had a very very large B fund that
Speaker 1: was not it wasn't necessarily the case that it would
Speaker 1: be drawn. It was it will be drawn if the
Speaker 1: opportunity presents itself. So the A fund, if I recall correctly,
Speaker 1: was about three and a half billion. The B fund
Speaker 1: was over ten billion.
Speaker 2: Wow.
Speaker 1: And so when I started, we were investing the A fund.
Speaker 1: You know, the cracks were there, but they weren't wide.
Speaker 1: And then very soon after, you know, bear Stearns fails,
Speaker 1: Lehman Brothers fails. The cracks were massive. And there was
Speaker 1: so much FORES selling from the trading dusts at the banks.
Speaker 1: There was so much FORES selling from the something called SIVs,
Speaker 1: the special investment vehicles that had mismatched assets to liabilities.
Speaker 1: Obviously the hedge funds had redemptions. It often felt like
Speaker 1: we were one of very few or maybe the only
Speaker 1: one buying in the market, which took a lot of fortitude,
Speaker 1: and I remember Howard especially said, you know, because everyone
Speaker 1: was scared that our client's capital was at risk and
Speaker 1: our jobs were at risk, and the future of the
Speaker 1: world as we know it was at risk. But Howard said,
Speaker 1: you know, we are paid to catch falling knives. That's
Speaker 1: our job. We need to do our work and make
Speaker 1: sure that we've done a very good amount of analysis
Speaker 1: to be comfortable with owning a business through a cycle
Speaker 1: at the creation value that we're investing at, and if
Speaker 1: we do our jobs right, that this will all turn
Speaker 1: out okay. And it did. I mean, I think we
Speaker 1: we did deliver a strong performance during that period of time.
Speaker 1: We returned a lot of capital. I think most importantly,
Speaker 1: our clients appreciated the return of capital. And we were
Speaker 1: on a footing that if we wanted to, we could
Speaker 1: have raised another fourteen billion dollars right afterwards if we
Speaker 1: wanted to, but you know, we decided not to. We
Speaker 1: decided that the opportunity set was less attractive coming out
Speaker 1: of the global financial crisis, and we raised a fund
Speaker 1: that was less than half the size of the prior
Speaker 1: fund because we thought that, you know, just because we
Speaker 1: could raise capital doesn't mean that we should raise capital.
Speaker 2: I recall reading and I know you can't say this,
Speaker 2: but I recall reading that fund return something like nineteen
Speaker 2: percent a year, some just astounding number. I'm curious, when
Speaker 2: you're in the thick of it and it feels like
Speaker 2: the world is going upside down, do clients start to
Speaker 2: get cold feet? To people who committed to the b
Speaker 2: fund say, Hey, you guys really want to be out
Speaker 2: here buying this as the world ends. What was the
Speaker 2: experience like in the midst of that.
Speaker 1: Yeah, I mean, I think oak Tree benefits from having
Speaker 1: really great clients and long history. And you know, Howard
Speaker 1: started investing in high healed bonds in the seventies. Howard
Speaker 1: and Bruce and Sheldonstone and their other partners began working
Speaker 1: together in nineteen eighty five and in nineteen eighty eight,
Speaker 1: and distressed that we had already delivered on promises that
Speaker 1: we had made to clients around the type of investing
Speaker 1: we would do and the responsibility that we would take
Speaker 1: in investing in their capital. So they knew that of
Speaker 1: all the things, of all the problems that they may
Speaker 1: have in their book, we were probably the least of
Speaker 1: their problems, and so they were happy that we had
Speaker 1: the We provided the countercyclical exposure that they needed at
Speaker 1: that time, So we really didn't have any clients that
Speaker 1: were fleeing. We certainly had clients that were nervous, and
Speaker 1: we're calling us and saying, look, I mean, what's going
Speaker 1: to happen in my private equity book. I mean, if
Speaker 1: you're having there, I mean, if you're by debt in
Speaker 1: you name it company at twenty cents to sixty cents
Speaker 1: and they're owned by you know, marquee private equity firms,
Speaker 1: what's going to happen with that? And we feeled a
Speaker 1: lot of phone calls. I think the most nervous we
Speaker 1: became was when the banks started failing, and when we
Speaker 1: were concerned, or we became concerned that client capital held
Speaker 1: in those banks, you know, prime brokerages and such. We
Speaker 1: were just worried at some point that that could become
Speaker 1: a general andsecured claim in the bankruptcies of a cascading
Speaker 1: set of banks. And that was probably the peak of
Speaker 1: when we became most nervous. But again, if that were
Speaker 1: to happen, If that had happened, we would have probably
Speaker 1: been the least of the worries of politicians, diplomats, investors.
Speaker 2: But even that you got so first, you guys are disciplined,
Speaker 2: you're structured, you're not cowboys. That had to make people
Speaker 2: feel pretty comfortable. In second, even those circumstances, that's a
Speaker 2: Custoonian relationship. But prime brokers, it's not an asset that
Speaker 2: other creditors can go after. So if that's the worst concern,
Speaker 2: you guys just had the courage of your conviction to
Speaker 2: be in the right place at the right time, with
Speaker 2: the right firepower. I had no idea that you were
Speaker 2: one of, if not the only ones as buyers throughout
Speaker 2: that I can't imagine what it would have been like
Speaker 2: if you guys weren't there. There would have been no bid.
Speaker 1: Yeah, it would There were times in certain companies that
Speaker 1: it really did feel like we were alone in a room.
Speaker 1: And and you know, the benefit of hindsight, It was
Speaker 1: a great time to invest, It was a great time
Speaker 1: to learn. I learned a lot about what it meant
Speaker 1: to have conviction when when others didn't, and also how
Speaker 1: to how to navigate or how to how to orchestrate
Speaker 1: your organization to withstand that type of pressure. And I
Speaker 1: think Howard and Bruce especially did a great job in
Speaker 1: navigating oak Tree to not lose itself and to not
Speaker 1: lose its stripes. When it was easy to do so,
Speaker 1: it was easy to become nervous and unhinged.
Speaker 2: To say the very least. So fast forward fifteen years later,
Speaker 2: you're now incoming CEO at oak Tree, and earlier this
Speaker 2: year you said something that caught my attention quote, it's
Speaker 2: a very exciting time to be in the credit markets.
Speaker 2: Tell us about what's going on today that makes it
Speaker 2: so interesting.
Speaker 1: Yeah, there's a lot of dislocation today which has been
Speaker 1: created by a rapid increase in rates, as well as
Speaker 1: some cracks in the economy, especially around borrowers that put
Speaker 1: together capital structures when money was easier to be had,
Speaker 1: when rates were lower, when liquidity was high, when valuation
Speaker 1: multiples were stable to rising, it was easy to make
Speaker 1: money and easy to deploy capital. And I think a
Speaker 1: lot of investors and lenders and really lost their way
Speaker 1: and agreed to terms and conditions that under today's market
Speaker 1: environment would not be acceptable. Levels of leverage that would
Speaker 1: not work. And as a result, there is a condition
Speaker 1: where there's risks and opportunities in the current market. And
Speaker 1: if you've done a good job of avoiding the risks.
Speaker 1: The opportunities are plentiful. What are those risks? The risks
Speaker 1: are older vintage transactions that put had just too much
Speaker 1: debt when rates were low. Now they're suffering from high
Speaker 1: rates because they have floating rate liabilities that they never hedged.
Speaker 1: And so there's a set of investors out there that
Speaker 1: have that exposure and are challenged. The opportunities are obvious.
Speaker 1: We're now lending on a private loan basis to very
Speaker 1: large companies that are being bought out by private equity firms,
Speaker 1: lending them at eleven to thirteen percent for first lean debt.
Speaker 1: It's been a long time since we've seen something like that,
Speaker 1: well over six seven eight years. And the equity checks
Speaker 1: being written by these private equity firms are larger than
Speaker 1: they've ever been as well, greater than fifty percent usually
Speaker 1: of the enterprise value of the transaction that they're taking on.
Speaker 2: That's big. So let's talk about some of those legacy
Speaker 2: portfolio issues. Obviously, when rates were near zero and money
Speaker 2: was cheap or free, a lot of people refinanced. Did
Speaker 2: they refinance on a floating rate as opposed to locking in?
Speaker 2: I know not everybody gets to do a billion dollar
Speaker 2: deal with a thirty year fixed mortgage. But when rates
Speaker 2: were low, you would have thought most companies would try
Speaker 2: and refi their debt at a fixed rate. You're suggesting
Speaker 2: a lot of that didn't happen.
Speaker 1: Yeah, the private equity owned businesses and private equity owns
Speaker 1: private equity sponsors prefer floating rate debt. The reason they
Speaker 1: preferred is generally speaking, floating rate debt does not have
Speaker 1: call protection, and so as the markets over the last
Speaker 1: ten years just continued to tighten every year or every
Speaker 1: other year, having non call debt was problematic. I mean
Speaker 1: if you had if you had call protection, then your
Speaker 1: cost of refinancing that debt would be onerous. So private
Speaker 1: equity firms we're taking advantage of the tightening market conditions
Speaker 1: by taking on floating rate debt, and they decided not
Speaker 1: to hedge with enough frequency. About a third of the debt,
Speaker 1: based on our estimation, about a third of the debt
Speaker 1: that's floating rate out there has been hedged in some
Speaker 1: form or fashion affixed. But that's hundreds of billions of
Speaker 1: dollars that is completely floating and livear has gone from
Speaker 1: twenty five basis points to now converted to SOFA at
Speaker 1: over five percent, So you have almost a doubling of
Speaker 1: the interest coupon paid by some of these businesses against
Speaker 1: the backdrop of COVID nineteen, inflation and some of the
Speaker 1: economic pressures that come with those factors.
Speaker 2: And you mentioned some of the new debt Thatt's out there.
Speaker 2: If SOFUR is five plus percent, what do the private
Speaker 2: credit markets look like for a reasonable borrower, a reasonable
Speaker 2: corporate borrower, you.
Speaker 1: Know, for a private equity owned company or a private
Speaker 1: equity sponsor LBO. What we're seeing typically is fifty to
Speaker 1: seventy percent equity checks. We're seeing leverage between four and
Speaker 1: a half and as much as six times TIBITDA, which
Speaker 1: which is a little on the high side. But the
Speaker 1: multiples that the private equity firms are paying for some
Speaker 1: of the larger businesses are still quite high. It's still
Speaker 1: in the double digits. But the good news, though, is
Speaker 1: that with so much of the risks known, the economic risks,
Speaker 1: the high cost of borrowing, the private equity firms as
Speaker 1: well as lenders, are underwriting to a stress case scenario
Speaker 1: under which the company will continue to cash flow even
Speaker 1: if things deteriorate from here. So it's probably the most
Speaker 1: you know, well telegraphed recession in history. You know, if
Speaker 1: the recession does occur next year, I think everybody, nobody
Speaker 1: will be surprised if one does occur, and so everyone
Speaker 1: is underwriting as if that is a certainty. So credit
Speaker 1: quality as a result is quite high, the returns are
Speaker 1: quite high, and the loan to values are quite low,
Speaker 1: as evidenced by a very large equity check from these
Speaker 1: from these well healed private equity sponsors.
Speaker 2: So obviously not risk lists, but pretty low risk relative
Speaker 2: to the high yields and high returns that that sector
Speaker 2: is looking at.
Speaker 1: That's right, And you don't need to kind of bend
Speaker 1: and change your stripes and invest in cyclical businesses to
Speaker 1: get that additional return. You can invest in good companies
Speaker 1: that are you know, have very low cyclicality, could be
Speaker 1: very stable from a cash flow generation perspective through a cycle.
Speaker 2: Quite fascinating. Let's now talk about what's going on in
Speaker 2: the current credit markets. You describe what you said is
Speaker 2: a sea change in markets. Tell us about that.
Speaker 1: Yeah, it's a very different market environment today than just
Speaker 1: two years ago, you know, following the global financial crisis,
Speaker 1: we had economic stimulus. We had monetary policy that was
Speaker 1: quite accommodating easy access to capital liquidity to help bridge
Speaker 1: the problems of the global financial crisis to a new day,
Speaker 1: and that lasted until twenty nineteen until the COVID nineteen pandemic,
Speaker 1: and even after the pandemic. With this there was obviously
Speaker 1: considerable amount of stimulus that came in as well as
Speaker 1: quantitative easing, and with quantitative easing, there was a continued
Speaker 1: expansion of this easy money policy in the twenty twenty
Speaker 1: one time frame, specifically in the form of reserves being
Speaker 1: parked at and the bank balance sheets, and that those
Speaker 1: reserves being pretty readily deployed into the markets.
Speaker 2: Meaning the Federal Reserve parks reserves at all the major
Speaker 2: money center banks. They use that for fractional lending and
Speaker 2: out it goes into the system exactly.
Speaker 1: And one of the areas where the banks were very
Speaker 1: active with those reserves was buying triple A securities, and
Speaker 1: the widest spread triple A securities were clos so COLO
Speaker 1: formation was at an all time high in twenty twenty one,
Speaker 1: after the COVID nineteen pandemic actually had already occurred.
Speaker 2: So collateral loan obligation means that there's some underlying asset
Speaker 2: which is used as your collateral. You then break that
Speaker 2: up into different securities and different trenches, and out it goes,
Speaker 2: and it's a reasonable way to do financing, depending on
Speaker 2: what risk level the lenser wants to assume.
Speaker 1: Sure, So in a COLO, the asset side of the
Speaker 1: balance sheet are syndicated loans that are originated by Wall
Speaker 1: Street banks and really just distributed out to investment managers
Speaker 1: like oak Tree and others who put together diversified portfolios
Speaker 1: and then lever those portfolios with rated securities starting with
Speaker 1: triple A all the way down to double B or
Speaker 1: single B and then an equity tranch at the bottom.
Speaker 1: But the biggest part of that capital structure, about sixty
Speaker 1: percent of it, are the triple A securities. So when
Speaker 1: you do see a sudden and dramatic increase in the
Speaker 1: buying interest or the demand for triple A securities like
Speaker 1: what you saw in twenty twenty one, all of a sudden,
Speaker 1: the equity arbitrage available to the equity investor of a
Speaker 1: CLO becomes far more attractive because the cost of borrowing
Speaker 1: becomes meaningfully lower. And so a tremendous amount of CLO
Speaker 1: issuance occurred in twenty twenty one, larger, more active than
Speaker 1: any other year on record, And so the banks were
Speaker 1: originating debt to place into this COLO formation engine. What
Speaker 1: ended up happening, however, in twenty twenty two, I'm sure
Speaker 1: everybody recalls that the FED said, you know, this inflation
Speaker 1: thing might not be transitory. The FED decided that because
Speaker 1: inflation was not temporary, that he needed to move very
Speaker 1: swiftly and with a great magnitude. It needed to raise
Speaker 1: rates five hundred basis points in eighteen months. And that
Speaker 1: sudden increase in rates and the inflationary backdrop caused a
Speaker 1: significant pullback in the credit markets. By June thirtieth of
Speaker 1: twenty twenty two, you saw high yield bonds down sixteen percent,
Speaker 1: you saw senior loans down seven percent, huge price movements
Speaker 1: in these securities really based on the sudden increase in
Speaker 1: the yield curve.
Speaker 2: How significant was that big rush into triple A colos
Speaker 2: to what took place afterwards? What was the driver of
Speaker 2: that in twenty twenty one, and then how did that
Speaker 2: unfold into the mess in twenty two.
Speaker 1: So in twenty twenty one, there was about one hundred
Speaker 1: and seventy five billion dollars of COLO issuance that year,
Speaker 1: and again largely driven by this demand from the FED
Speaker 1: infusing reserves at the banks and the banks deploying that
Speaker 1: capital through COLO triple as it.
Speaker 2: Seems a little circular that the FED does QE, the
Speaker 2: FED parks all this cash at banks, the FED drives
Speaker 2: CLO appetite, and then subsequent, oh, you know, maybe we
Speaker 2: need to take rates higher. That they're on both sides
Speaker 2: of shaking everything up.
Speaker 1: They're on both sides of shaking it up. And you know,
Speaker 1: from a CLO investor standpoint, the clos have have floating
Speaker 1: rate features to them. So those investors said, wow, my
Speaker 1: return just went up magically, Thank you very much. Fed.
Speaker 1: But when quantitative easing turned into quantitative tightening, that's when
Speaker 1: the shift occurred. Because if you're a risk manager at
Speaker 1: a bank and all of a sudden, the reserve flow
Speaker 1: is not coming your direction anymore, you're the expectation that
Speaker 1: it will go the opposite direction. So then you turn
Speaker 1: to your investors and you say stop investing, and that's
Speaker 1: what happened. The banks then said I'm not a buyer
Speaker 1: of tripleas at all, at any price, and at that
Speaker 1: point the colo formation engine just halted.
Speaker 2: Is that a gradual process or is it like a
Speaker 2: switch gets flicked and that's it. No more bets.
Speaker 1: It felt like a switch, but that switch took about
Speaker 1: three to six months to get to really be felt.
Speaker 1: You know. The first quarter of twenty twenty two things
Speaker 1: felt a little choppy. Second quarter they felt like the
Speaker 1: floor was coming out. It was huge price declines. The
Speaker 1: investment banks were stuck with syndications that they had committed
Speaker 1: to a place in the markets with price caps on
Speaker 1: the coupons. They then had to move out hung loans
Speaker 1: at meaningful discounts. Resulted in big losses from the syndication
Speaker 1: of those loans. You know, historically you make fees when
Speaker 1: you syndicate. This time it was twenty twenty two is
Speaker 1: a massive loss year for the banks. But with that volatility,
Speaker 1: as the banks experienced these losses and stopped committing to
Speaker 1: syndication to earn these fees, the direct lenders had the
Speaker 1: opportunity to step in into that void and provide capital
Speaker 1: that was secure in terms of a certainty of execution,
Speaker 1: and so private equity sponsors and other borrowers that wanted
Speaker 1: to have that certainty of execution said you know, fine,
Speaker 1: I'll pay a little bit more in my spread, and
Speaker 1: I will have a single lender or maybe a small
Speaker 1: consortion of lenders give me the capital that I need
Speaker 1: to go buy this company. And I don't have to
Speaker 1: worry about going through a ratings process, doing a road
Speaker 1: show and pitching this to fifty or one hundred different
Speaker 1: management or investment managers. I could talk to three or
Speaker 1: four directly lenders and get this job done. And so
Speaker 1: it resulted in a massive expansion opportunity for direct lenders
Speaker 1: and a widening of pricing for the direct lending market.
Speaker 1: In addition to the floating rate going up, you know,
Speaker 1: four hundred bases points five hundred bases.
Speaker 2: So let's talk about that before we get to private credit.
Speaker 2: First time in decades, treasuries and investment grade corporates. It's
Speaker 2: an attractive yield at five five and a half percent.
Speaker 2: What does this mean for what's going on in the
Speaker 2: world of privates? If if you can very relatively safely
Speaker 2: get in the fives, what does it mean for private
Speaker 2: credit for colos, for direct lending compared to that. I
Speaker 2: don't want to say risk free. Course, Tripolic corporates aren't,
Speaker 2: but you know the two year, the ten year, you're
Speaker 2: not that far off.
Speaker 1: Yeah, it's from an absolute return standpoint, treasuries, IG corporates
Speaker 1: are high yeal bonds are more attractive than they've been
Speaker 1: in very long time. They are as long as an
Speaker 1: investor has the willingness to own a longer duration asset,
Speaker 1: they are very attractive investment opportunities, and we would recommend investors,
Speaker 1: you know, buy a basket of those types of securities. Now,
Speaker 1: in the case of private credit, you do pick up
Speaker 1: a lot more return for in exchange for the complexity
Speaker 1: of the situation as well as the illiquidity. You know,
Speaker 1: in the case of private credit to large businesses, you know,
Speaker 1: these are companies that have one hundred million of EBIT
Speaker 1: DOT or more, or have an enterprise value of a
Speaker 1: billion dollars or more, and they're being bought out by
Speaker 1: private equity firms. The pricing we're seeing on first lean
Speaker 1: debt and those types of situations is about twelve percent.
Speaker 1: But from a relative value perspective and a risk adjusted
Speaker 1: return perspective, getting twelve percent to lend to that size
Speaker 1: of a business with that type of backing from a
Speaker 1: household name type private equity firm, it's a very attractive
Speaker 1: risk adjusted return and I would say it's be part
Speaker 1: of an investor's credit appetite. And frankly, I think it
Speaker 1: it favors credit or the topic we're discussing about favors
Speaker 1: credit over equities actually over the over the next few years,
Speaker 1: because if you think about the size of the corporate pie,
Speaker 1: you know, with COVID nineteen and with inflation, the size
Speaker 1: of that corporate pie generally hasn't changed too much over
Speaker 1: the last few years, but with a sudden increase in rates,
Speaker 1: essentially the FED has said, well, I'm going to slice
Speaker 1: off more of that pie for creditors than i am
Speaker 1: for equity. And that was the opposite in this easy
Speaker 1: money period following the global financial crisis and ending, you know,
Speaker 1: in the twenty twenty one timeframe when QE was was
Speaker 1: then reversed with inflation.
Speaker 2: And that twelve percent you mentioned so for earlier the
Speaker 2: replacement for libor that sounds like sofur plus six six
Speaker 2: and a half percent.
Speaker 1: Is exactly the typical loan today's priced that so for
Speaker 1: plus six to six and a half percent with about
Speaker 1: two or three points of discount and origination. And again
Speaker 1: the equity checks being written by the private equity firms
Speaker 1: generally speaking, or over fifty percent of the capital needed
Speaker 1: to buy the business.
Speaker 2: So let's talk a little bit about the spread back
Speaker 2: when rates were zero and the ten year was two
Speaker 2: percent or under. It seemed like you weren't getting paid
Speaker 2: for duration risk, you weren't getting paid for credit risk.
Speaker 2: Even I know we don't use the term junk anymore,
Speaker 2: but even high yield was barely above investment grade corporates.
Speaker 2: How has that spread changed now that the floor is
Speaker 2: five five and a half percent for FED rates.
Speaker 1: Yeah, so the spread back then, when in the easier times,
Speaker 1: the spreads were generally four seventy five to five point
Speaker 1: fifty over sofur for the equivalent risk today that is
Speaker 1: being priced at six twenty five six fifty over. So
Speaker 1: it's about one hundred and fifty bases points wider in
Speaker 1: just eighteen months. And that's in addition to SOFA rising
Speaker 1: as much as it is.
Speaker 2: So what does that tell us when the spread's won
Speaker 2: like that.
Speaker 1: When spreads widened, it either means that there's risk of
Speaker 1: default that's higher, which I don't think is the case
Speaker 1: in this new vintage. I think it's more a technical
Speaker 1: imbalance between the demand for private credit versus the supply
Speaker 1: of private credit, and that's what's caused that meaningful widening.
Speaker 1: And there just is less competition from the banks. The
Speaker 1: banks were the alternative financing tool for private equity sponsors
Speaker 1: wanting to do an LBO, and with those banks taking
Speaker 1: a step back because of their syndication losses in twenty
Speaker 1: twenty two, it created a attractive pricing opportunity for the
Speaker 1: private credit lenders to step in where the banks were
Speaker 1: stepping away and expand those spreads pretty meaningfully.
Speaker 2: H really quite interesting. Let's talk a little bit about
Speaker 2: that role that kind of unusual. You don't have a
Speaker 2: whole lot of co CEOs. Tell us a little bit
Speaker 2: about what the process has been like getting ready for
Speaker 2: this new transition.
Speaker 1: Yeah, it's been you know, I've been at the firm
Speaker 1: for over sixteen years, and the firm was founded by
Speaker 1: Howard Marx and Bruce Karsh to investors, and so the
Speaker 1: model for oak Tree, you know, has been that we
Speaker 1: would have investors overseeing the firm overall. You know, we
Speaker 1: went public in twenty twelve, and that entrepreneurial history of
Speaker 1: oak Tree since its founding required a little bit more
Speaker 1: institutional framework, and so we did have a dedicated CEO,
Speaker 1: Jay Win Troub. We did a great job of institutionalizing
Speaker 1: oak Tree further and all of our business processes away
Speaker 1: from the investment side that Howard and Bruce continue to
Speaker 1: focus on. And so today we benefit from the efforts
Speaker 1: taken by Jay to have a very professional organization. That
Speaker 1: non investment side of our business will be managed by
Speaker 1: Todd Moltz, who is a veteran of oak Tree, Chief
Speaker 1: Administrative Officer of oak Tree and former general counsel of
Speaker 1: the firm, so he will be taking on a lot
Speaker 1: of those institutional non investment areas of the firm, and
Speaker 1: Bob O'Leary and I, who run the opportunistic credit business
Speaker 1: in Bob's case and the performing credit business in my case,
Speaker 1: will take the mantle in terms of strategic leadership of
Speaker 1: the firm as co CEOs.
Speaker 2: You're still both going to be pms. You're still going
Speaker 2: to be running funds and overseeing the investment.
Speaker 1: Absolutely, I think to do a good job running oak Tree,
Speaker 1: we want to be as close to our clients as possible,
Speaker 1: and to be as close to our clients as possible
Speaker 1: would mean that we need to be as close to
Speaker 1: the markets and actual investments as possible. When I sit
Speaker 1: down with clients, I think if I bring any value
Speaker 1: to the table, it's giving them really on the ground
Speaker 1: knowledge about what we're seeing in the markets from a
Speaker 1: risk and return standpoint, and I think it's important as
Speaker 1: the CEO to also to have that framework.
Speaker 2: And sixteen years is unusual these days. Staying at the
Speaker 2: same firm for that long. Tell us what makes oak
Speaker 2: Tree special? What's kept you there for you know quite
Speaker 2: a while, compared to most of the industry seems seems
Speaker 2: to see people job hop from place to place.
Speaker 1: Yeah, oak Tree culturally is a very stable organization. You've
Speaker 1: met Howard several times. You know that Howard is not
Speaker 1: somebody that changes his stripes, and therefore oak Tree is
Speaker 1: not a place that changes its stripes, which is which
Speaker 1: is great from a career standpoint, because as a firm,
Speaker 1: you know that they're not going to take wild risks
Speaker 1: just because everybody else is taking wild risks and then
Speaker 1: jeopardize the firm's existence as a result of those risks
Speaker 1: not panning out. We see that all too often in
Speaker 1: the hedge fund space, and another with other investment managers
Speaker 1: really going a little bit too far out on the
Speaker 1: risk spectrum in their in their investment style and therefore
Speaker 1: blowing themselves up and creating volatility in the lives of
Speaker 1: people that work at those firms. Oak Tree has not
Speaker 1: been one of those places, and I think personally, you know,
Speaker 1: working directly for Bruce Karsh has been part of the
Speaker 1: reason why, a main, a main part of the reason
Speaker 1: why I've decided to stay at the firm as long
Speaker 1: as I have, because he is the type of person
Speaker 1: that I think think any investor would like to be,
Speaker 1: you know, calm, cool, collected very very strong instincts about
Speaker 1: people and businesses and behavior, and the willingness to have
Speaker 1: a tremendous amount of conviction, especially when others don't have
Speaker 1: the conviction. I think Bruce has shown that time and
Speaker 1: again in his career, and so having the opportunity to
Speaker 1: learn from a guy like Bruce Karsh has kept the
Speaker 1: job really interesting. And I haven't felt that sixteen years
Speaker 1: has gone by slowly at all. I think it's gone
Speaker 1: by very very quickly.
Speaker 2: So I would imagine if you specialize in distressed debt investing,
Speaker 2: you're not going to be an emotional, flighty cowboy. Those
Speaker 2: guys don't survive. You have to be calm, cool, and collected.
Speaker 2: It's like a surgeon, a neurosurgeon. You have to be
Speaker 2: very precise and very measured and recognize how the crowd
Speaker 2: has lost its mind and you're going to take advantage
Speaker 2: of it. I get that sense from both Bruce and
Speaker 2: Howard a little bit contrarian and not given to overreactions.
Speaker 1: Absolutely, you have to be patient, you have to be unemotional,
Speaker 1: and you have to know that there will be times
Speaker 1: where you're unpopular and that's okay.
Speaker 2: Oh really, why do you say that?
Speaker 1: Because you know when you are investing, the rest of
Speaker 1: the world is fleeing, and so you are calling capital
Speaker 1: when the when your clients are hearing from the rest
Speaker 1: of their investment managers that it's an absolute bloodbath out there,
Speaker 1: and so answering those questions takes some fortitude. But the
Speaker 1: good news is at this point oak Tree is so
Speaker 1: well known for taking that type of contrarian bet that
Speaker 1: we're not we're not suffering from that as much. But
Speaker 1: but it certainly is a It certainly is an important
Speaker 1: feature of being a distressed that investor.
Speaker 2: And you mentioned you know, at times you're unpopular. But
Speaker 2: like we talked about earlier in eight oh nine, o seven,
Speaker 2: if you're the only bid, I would think people would
Speaker 2: be grateful that, Hey, at least somebody's on the other
Speaker 2: side of the trade. But for you guys, there's no bid.
Speaker 1: Yeah, they were grateful at the time, but then when
Speaker 1: they saw our returns, they you know, they were pretty
Speaker 1: upset about it because, you know, selling, selling to.
Speaker 2: Make them sell, that was their decision.
Speaker 1: Oh yeah, just there, Yeah, it was. It was the
Speaker 1: structures that were put in place prior to the GFC, unfortunately,
Speaker 1: were not conducive to that type of you know, someon
Speaker 1: would call it a six sigma event. I don't know
Speaker 1: that it was, but that type of an extreme reaction
Speaker 1: in the markets and and withdrawal from investors out of
Speaker 1: the market so rapidly, these structures just weren't set up
Speaker 1: for it.
Speaker 2: Human nature is what human nature is going to be. Right,
Speaker 2: If if someone is selling one hundred dollars bills for
Speaker 2: fifty dollars, they can't blame you. If you're a buyer
Speaker 2: who told them to sell. Absolutely, that's quite fascinating. So
Speaker 2: you mentioned you want to stay close to what's going
Speaker 2: on in the investing world to fulfill this new role
Speaker 2: as incoming co CEO. When you look at this present environment,
Speaker 2: do you think of yourselves more as bottom up credit
Speaker 2: pickers or do you look at the macro environment and say, hey,
Speaker 2: we have to figure out what's going on there.
Speaker 1: Also, we're bottoms up credit pickers. We are not macro forecasters,
Speaker 1: but we are macro aware understanding what's happening in the
Speaker 1: economy with technicals in the markets, those influence or can
Speaker 1: influence the performance of certain sectors. For example, interest rate
Speaker 1: sensitive sectors that may be impacted in a more violent
Speaker 1: way because of the rapid rate increase.
Speaker 2: As an example, so any long duration you have to
Speaker 2: be aware.
Speaker 1: Real estate that values itself based on cap rates, which
Speaker 1: is a derivative of the tenure treasury. That's an example.
Speaker 1: Another floating rate Another interst rate sensitive asset class or
Speaker 1: LBOs highly levered leverage buyouts supported by floating rate liabilities.
Speaker 1: That's an interest rate sensitive asset class. So you know
Speaker 1: we are macro aware that definitely. I think tips the
Speaker 1: scale in some ways in terms of, you know, is
Speaker 1: there a bigger investment opportunity coming or a smaller investment
Speaker 1: opportunity coming. But at the end of the day, the
Speaker 1: companies we invest in are bottoms up or based on
Speaker 1: bottoms up credit analytics that we have the conviction and
Speaker 1: will return power plus accrued through a cycle, and if
Speaker 1: they don't, we're happy to own them at the valuation
Speaker 1: that we are creating that company at.
Speaker 2: Huh. That's really quite intriguing. So I like that concept
Speaker 2: of macro aware. How do you deal with the macro
Speaker 2: environment that has been forecasting recession for I don't know,
Speaker 2: it feels like three years now, and for most of
Speaker 2: that time there's been a fairly inverted yield curve, especially
Speaker 2: once the FED started really hiking rates in early twenty
Speaker 2: twenty two.
Speaker 1: Yeah, the indicators are sending mixed messages. Obviously, in inflation
Speaker 1: or control of inflation is heading in the right direction,
Speaker 1: but still not the level that it needs to be
Speaker 1: at for the FED to pause raising rates. The employment picture,
Speaker 1: or the unemployment picture is actually quite stable. Consumer spending
Speaker 1: is stable, although credit card defaults another consumer starting to
Speaker 1: take up. So we might be at the inflection point now,
Speaker 1: and it's always confusing when you're at the inflection point
Speaker 1: where when you look at historical data, backward looking data,
Speaker 1: it shows a different picture than what the forward would
Speaker 1: would indicate. I think it's hard to avoid a recession
Speaker 1: with such high rates and with the inverted yield curve. Eventually,
Speaker 1: what that says to me is the FED is going
Speaker 1: to keep rates as high as possible for as long
Speaker 1: as possible until something breaks in the economy.
Speaker 2: When you say something breaks, we're not talking Silicon Valley
Speaker 2: Bank or those specific regionals you're talking.
Speaker 1: I'm talking. I'm talking with something about in the actual
Speaker 1: economy itself. Growth slows down, investment in certain types of
Speaker 1: capital expenditures slows down, the availability of capital becomes more challenged,
Speaker 1: and there is an increase in residential foreclosures, something that
Speaker 1: means more than just a bank failing here or there
Speaker 1: because of a duration mismatch. That's really what Silicon Valley
Speaker 1: Bank was. Silicon Valley banks failure is not enough for
Speaker 1: the FED to do anything, and we saw that. I mean,
Speaker 1: they really did not pause at all. And so I
Speaker 1: think that as we look forward, I don't know how
Speaker 1: we actually avoid a recession because I don't think that
Speaker 1: we will. I don't think that the FED will have
Speaker 1: enough data to support a decline in rates or reducing
Speaker 1: rates without a recession. And so if rates stay higher
Speaker 1: for an extended period of time, higher for longer, then
Speaker 1: that in itself could cause a decline and availability of
Speaker 1: capital of lending and therefore recession. And that's why you know,
Speaker 1: an inverted yield curve has historically been highly correlated or
Speaker 1: nder percent correlated with a recession because the cost of
Speaker 1: borrowing in the short term is higher than the long term,
Speaker 1: and that doesn't work for banks because they borrow short
Speaker 1: and lend long. So it just means that the FED
Speaker 1: is telling banks stop lending and to corporate borrowers, stop
Speaker 1: borrowing for the purpose of investing in your business. That
Speaker 1: will impact the economy. That will, and that will that
Speaker 1: should create a recession. I think the reason I say
Speaker 1: should and not would is because we also have stimulation
Speaker 1: by the Biden administration in the form of infrastructure bills,
Speaker 1: in the form of green manufacturing capabilities, reonsoring of certain
Speaker 1: types of manufacturing, and that's stimulative.
Speaker 2: I'm so glad you brought that up, because people seem
Speaker 2: to be waiting for the care Zac stimulus, waiting for
Speaker 2: the pig to go through the python. But between the Semiconductor,
Speaker 2: the Infrastructure Bill, the Inflation Reduction Act, these are decade
Speaker 2: long fiscal stimulus that are going to get spent over time,
Speaker 2: and they're not just going to go away. Although clearly
Speaker 2: they're nothing like Carezac one was like ten percent of GDP,
Speaker 2: but still that's an ongoing tailwind for the economy.
Speaker 1: It is, and we are in an election cycle now too,
Speaker 1: with an incumbent running for reelection, I would expect that
Speaker 1: if there's any pressure on more stimulus, if there is
Speaker 1: pressure on stimulus, it'll it's to the upside, not to
Speaker 1: the downside at this point.
Speaker 2: So let's bring back this recession risk back to your
Speaker 2: clients and the impact on private credit if we do
Speaker 2: tumble into a recession somewhere in twenty twenty four, I
Speaker 2: think is the latest consensus. What does this mean for
Speaker 2: private credit?
Speaker 1: Well, for private credit in older vintage deals, especially those
Speaker 1: that were backing private equity sponsors in transactions, I think
Speaker 1: there will be elevated defaults and risk, especially in the
Speaker 1: weakest you know, maybe twenty or thirty percent of private
Speaker 1: credit portfolio. We see this because we are a public
Speaker 1: we own up, we manage a publicly traded BDC, and
Speaker 1: so do a lot of our peers, and so we
Speaker 1: watch the UH pressure building up in some of the
Speaker 1: publicly traded BDCs the way they announce non apcruals or
Speaker 1: amendment activity of underlying borrowers. And my expectation is that
Speaker 1: generally speaking, if you if if investors were to watch
Speaker 1: the publicly traded BDC market, they will see an escalation
Speaker 1: in those types of those types of risks UH that
Speaker 1: are reported by the BDCs. Now oak Tree in particular,
Speaker 1: you know, we have a lot of capabilities in terms
Speaker 1: of private credit, so we have not had to rely on,
Speaker 1: you know, just lending the private equity sponsors to generate returns.
Speaker 1: We have opportunistic credit capabilities, We have non sponsored credit
Speaker 1: capabilities lending the companies that are publicly traded that that
Speaker 1: need capital not for a buyout but for some strategic
Speaker 1: growth initiative. So our particular book is quite balanced and
Speaker 1: is quite clean relative to where we think the pressures
Speaker 1: will reside over the course of the next twelve months.
Speaker 1: So we feel good about our ability to kind of
Speaker 1: lean into the market, and we also manage our private
Speaker 1: credit book far less levered than what is ordinarily the
Speaker 1: case in the market. So we are cautiously optimistic that
Speaker 1: the cracks that we are seeing in the older vintage
Speaker 1: private credit, the older vintage broadly syndicated loans, will create
Speaker 1: opportunities for oak Tree in our sort of brand or
Speaker 1: style of private credit. It's not the case for everybody,
Speaker 1: but certainly oak Tree, as a countercyclical bent manager, will
Speaker 1: benefit from the.
Speaker 2: And your clients are primarily large institutions.
Speaker 1: Our clients are primarily large institutions global. We do have
Speaker 1: a retail client base as well in the form of
Speaker 1: our publicly traded BDC, but the overwhelming majority of oak
Speaker 1: Tree's clients are very large institutions that have invested across
Speaker 1: a variety of oak Tree strategy, not just a single one.
Speaker 2: Really quite interesting. So we're talking about rates, we're talking
Speaker 2: about debt. We really haven't spent a whole lot of
Speaker 2: time talking about the Federal Reserve. Are you an obsessive
Speaker 2: Fed watcher? Does all of Jay Powell's comments each month
Speaker 2: affect you or is it just kind of background noise
Speaker 2: and you're watching what the market's doing.
Speaker 1: Yeah, we're really watching what the market and the economy
Speaker 1: are doing rather than hinging on every word that the
Speaker 1: chairman has or says. Obviously, the information that the FED
Speaker 1: has is very important in term that is, in terms
Speaker 1: of digesting what's happening with the economy and the likelihood
Speaker 1: that they pivot or not. So I would say it
Speaker 1: goes into the same theme as being macro aware rather
Speaker 1: than you know, really making key decisions based on every
Speaker 1: word that the FED has.
Speaker 2: And you know, I have to give as much as
Speaker 2: people criticize this FED, I have to give Ja Pal
Speaker 2: credit for being transparent saying this is what we're going
Speaker 2: to do and then going out and doing it. The
Speaker 2: market seems to constantly be doubting him. This is going
Speaker 2: on for a couple of years. Hey, we're going to
Speaker 2: do this, and they go out and do it. What
Speaker 2: is it that keeps people second guessing? When the FED
Speaker 2: says the sky is blue, they don't seem to believe them.
Speaker 1: Yeah, it's it's odd to me too, to be honest
Speaker 1: with you, because you know, coming out of the financial crisis,
Speaker 1: there was a mantra that don't fight the FED, and
Speaker 1: that nobody wanted to fight the Fed when the FED
Speaker 1: was reducing rates. I don't understand why people want to
Speaker 1: fight the FED when they're increasing rates.
Speaker 2: I mean, it's well, you know, because they don't want
Speaker 2: to pay higher rates.
Speaker 1: Yeah, But when you don't fight the FED, just don't
Speaker 1: fight them in both directions, is what I think I mean.
Speaker 1: And I think you're right. Powell has been very clear,
Speaker 1: and I think that the FED, for those for those
Speaker 1: in the market that are economists, you know, there is
Speaker 1: an academic need for having the right level of rates.
Speaker 1: The reason is is because in the future, when you
Speaker 1: do have a shock and you do need monetary policy
Speaker 1: to correct for that shock, you need high rates to
Speaker 1: be able to reduce those rates and correct for that shock.
Speaker 1: And for the last ten twelve years, the FED has
Speaker 1: not had that lever and it finally has the opportunity
Speaker 1: to build that lever in and retain it if it's
Speaker 1: careful about or precise about, you know, when it decides
Speaker 1: to pivot or what it says around a pivot. So
Speaker 1: I think that the FED is predisposed to leaving rates
Speaker 1: high longer because of this academic need and because the
Speaker 1: data supports it too. It's not like it's not like
Speaker 1: the data supports a quick pivot or a significant decline
Speaker 1: in rates at this point in time, and I would
Speaker 1: argue that this is consistent with Howard Marx's see change memo,
Speaker 1: that we are in a period of time where rates
Speaker 1: should be expected to stay high for long, not longer,
Speaker 1: but long, and in the context of the last forty years,
Speaker 1: where rates are today are not meaningfully out of whack.
Speaker 2: I'm so glad you brought that up, because when people
Speaker 2: talk about, oh my god, seven percent mortgages, Hey, you
Speaker 2: know that's about average for the past half century. Yeah.
Speaker 1: The only time that it's not been average is the
Speaker 1: last ten years. I mean, you could have gotten a
Speaker 1: thirty year mortgage at three three and a quarter percent
Speaker 1: at its lows, but that was unprecedented and I don't
Speaker 1: think we will see that anytime soon.
Speaker 2: I just read an interesting analysis from a mortgage research
Speaker 2: shop that that surveys home buyers, and they said, five
Speaker 2: point five percent is where all these golden handcuffs come
Speaker 2: free again. All right, we're stuck in our house. We
Speaker 2: have a four percent mortgage. We're not paying seven percent, Hey,
Speaker 2: five and a half percent. We can think about moving.
Speaker 2: What are the indications that you'll notice that this higher
Speaker 2: Fed funds rate, the seven percent mortgage rate is starting
Speaker 2: to stress the economy.
Speaker 1: Yeah, it's a great question, and I don't have the
Speaker 1: the ball, but I would tell you right now. Even
Speaker 1: though the rates have been high now for twelve eighteen months,
Speaker 1: and the mortgage rates have been out of the money
Speaker 1: in terms of a refine now for the better part
Speaker 1: of at least a year, we are still continuing to
Speaker 1: see home builders sell new homes. We're not seeing as
Speaker 1: much velocity in the sale of the secondary sale of homes,
Speaker 1: but homebuilders are still selling homes, and that's because there
Speaker 1: is a shortage of housing stock. There is a shortage
Speaker 1: of multi family and single family housing, and the homebuilders
Speaker 1: are able to charge a high enough price that they're
Speaker 1: able to buy down the rate for their buyers. So
Speaker 1: for now, at least, because of that shortage, it is
Speaker 1: cushioning what would otherwise be probably a challenging picture economically
Speaker 1: for the home building industry and just housing overall. Now,
Speaker 1: there will come a point where the homebuilders will exhaust
Speaker 1: their low cost basis. In Land, the cost of constructing
Speaker 1: home is higher today than it was three years ago,
Speaker 1: so there is real inflation and cost of construction, and
Speaker 1: so those margins will shrink in home building. And I
Speaker 1: think when you combine new home sales declining and new
Speaker 1: home construction and multi family construction declining, that's when I
Speaker 1: think the bite will be felt. But that's probably not
Speaker 1: in the next twelve months, is my best guess. I
Speaker 1: can't really point to a reason why, other than I
Speaker 1: do think that there is this real shortage, and there
Speaker 1: is that shortage is causing a material increase in the
Speaker 1: in the rental rates for multi family.
Speaker 2: Housing, so you're going right to a fascinating area. Some
Speaker 2: of the pushback for higher for long, not even longer,
Speaker 2: is hey, none of this stuff is rate based. There's
Speaker 2: a shortage of single family and multi family houses because
Speaker 2: of the post financial crisis underbuilding and moving to other
Speaker 2: commercial areas. There's a shortage of labor that's keeping wages high.
Speaker 2: We just don't have enough bodies. Arguably, the semiconductor shortage
Speaker 2: is why car prices, both new and used have gone
Speaker 2: up and have stayed fairly high. They just can't get
Speaker 2: enough chips for this. What do high rates do for that?
Speaker 2: And maybe higher for long gets resolved once all the
Speaker 2: supply comes back online.
Speaker 1: Yeah, I don't think higher rates help the bottleneck these
Speaker 1: these issues that you that you pointed out, In fact,
Speaker 1: they definitely hurt. And that's why I do think that
Speaker 1: there is a reasonable chance of a recession, because I
Speaker 1: think that the FED will all else being equal, keep
Speaker 1: rates higher and tell that and tell something material breaks.
Speaker 1: So I don't think that we're going to see the
Speaker 1: de bottlenecking. I do think that, you know, if I
Speaker 1: only had a dollar to bed on a recession or
Speaker 1: not a recession, it would be for a recession really
Speaker 1: next year. But again we're not macro forecasters here. It's
Speaker 1: more about you know, it's more based on the conviction
Speaker 1: that with or without a recession, we're going to see
Speaker 1: elevated defaults. With or without a recession, we're going to
Speaker 1: see a tightening of the availability of capital. And those
Speaker 1: two factors, defaults and tightening availability of capital should at
Speaker 1: some point cause a recession.
Speaker 2: All right, I only have you for a limited amount
Speaker 2: of time. Before I get to my favorite question, I
Speaker 2: have to throw a couple of curve balls at you.
Speaker 2: Starting with you mentioned grad school, and I wanted to
Speaker 2: ask which grad school. So, in addition to a BA
Speaker 2: in economics from Stanford. You have an MS in health
Speaker 2: services from Stanford Medical School, a jd from Harvard Law School,
Speaker 2: and an NBA from Harvard Business School. A what led
Speaker 2: to so much school and b Stanford Medical School, Harvard
Speaker 2: Law School. How does that apply to what you do
Speaker 2: in the world of credit?
Speaker 1: Yeah, well, I wish there I could say that it
Speaker 1: was all intentional, and it's absolutely not. You know, I
Speaker 1: entered college not knowing what I wanted to do. My
Speaker 1: older brothers were surgeons or our surgeons, so I thought,
Speaker 1: naturally I should be a surgeon. And then when I
Speaker 1: was a freshman in college and taking pre med courses,
Speaker 1: I visited my brother at the emergency room at USC
Speaker 1: and Los Angeles doing trauma surgery, and I passed out
Speaker 1: seeing him treat a bullet wound. And when I came to,
Speaker 1: he said, You're not cut out for this, and he
Speaker 1: was right. I am not cut out for being a doctor.
Speaker 1: But I still valued healthcare, life sciences, biotechnology as important
Speaker 1: areas of the economy and things I've just found naturally
Speaker 1: interesting and curious, and so I kind of pivoted and
Speaker 1: became effectively a health economics major. And so I was
Speaker 1: an econ major, but my advisor was Mark McClellan, who
Speaker 1: headed the FDA as well as the Centers of Medicare
Speaker 1: and Medicaid at different points in his career, and so
Speaker 1: he straddled being a professor at Stanford Medical School as
Speaker 1: well as a professor in Stanford Economics Department. And I
Speaker 1: thought that multidisciplinary approach to his career was interesting and
Speaker 1: could be of interest in my career. So when I
Speaker 1: decided to.
Speaker 2: Go to.
Speaker 1: Morgan Stanley and work in the M and A department
Speaker 1: there in the late nineties, a good portion of the
Speaker 1: deal floy I did or worked on was healthcare related, biotech,
Speaker 1: pharma related, and I find that to continue to be
Speaker 1: an area of interest for me. I'll get to the
Speaker 1: law and law and business in the moment to.
Speaker 2: Do them at the same time. The JDMBA, the JD
Speaker 2: in the NBA I did.
Speaker 1: After I worked at Morgan Stanley, I started at the
Speaker 1: law school. But then that's around the time or right
Speaker 1: after the time that the dot com bubble burst, and
Speaker 1: so I thought, you know, now I was about as
Speaker 1: good a time as any to stay in school, and
Speaker 1: so I applied to the Business school to Harvard Business
Speaker 1: School when I was a first year in the law
Speaker 1: school and was lucky enough to get in, and that
Speaker 1: was a fantastic opportunity to learn from a lot of
Speaker 1: great class made, some great professors, a lot of guest
Speaker 1: lectures that came in that were you captains and in
Speaker 1: their particular industries. And learned a lot there. But when
Speaker 1: I emerged from the j D M b A, you know,
Speaker 1: I thought about what did I what did I enjoy
Speaker 1: in school the most, And frankly, it was bankruptcy and reorganization.
Speaker 1: And interesting tidbit. My bankruptcy professor in law school was
Speaker 1: Elizabeth Warren, and you know, the same penetrating questions that
Speaker 1: she asked to people, you know, in senate hearings is
Speaker 1: the way I felt every day in bankruptcy class. And
Speaker 1: and I learned a lot and and uh but and
Speaker 1: that kind of left a mark. And and that's I
Speaker 1: would say, you know, that experience was one of the
Speaker 1: reasons why I gravitated towards distress debt as early in
Speaker 1: my career when I joined Pequad in the Distress Group.
Speaker 2: And you also serve on the advisory board of Stanford
Speaker 2: Institute's Economic Policy Research group tell us a little bit
Speaker 2: about what that group does.
Speaker 1: So that group is an advisory group attached to the
Speaker 1: Economics Department at Stanford and supports graduate research and undergraduate
Speaker 1: research in economics for a variety of different types of studies.
Speaker 1: It allows me to stay close to the university and
Speaker 1: talk with you know, economists and academicians that you know
Speaker 1: look at the world differently, and I think, you know,
Speaker 1: it helped to give me a different lens. It also
Speaker 1: helps me kind of stay in touch with some of
Speaker 1: the other members of that advisory board that are in
Speaker 1: the investment management industry and other industries that also help
Speaker 1: kind of expand my universe. I think in investment management
Speaker 1: it's a it's a negative if you become to my
Speaker 1: opic and have too many blinders on. It's kind of
Speaker 1: good to look to your left and to your right
Speaker 1: and think about what other people are seeing.
Speaker 2: And that's the latest and greatest economic research coming up.
Speaker 2: So I'm sure there's there's some benefit from that, absolutely
Speaker 2: all right, So in the last ten minutes I have
Speaker 2: let's let's jump to our speed round and run through
Speaker 2: our favorite questions we ask all of our guests, starting
Speaker 2: with what have you been streaming during the lockdown and afterwards,
Speaker 2: what are you either listening to or watching?
Speaker 1: Well, I'm absolutely listening to your podcast for sure, so
Speaker 1: thank you. But in terms of streaming now, I really
Speaker 1: like the more documentary oriented streaming content. For example, the
Speaker 1: Formula One, you know, Drive to Survive, looking forward to
Speaker 1: the next to the next series there.
Speaker 2: It's it's been really absolutely fascinating and it's caused all
Speaker 2: of America or half of America to become Half one fans.
Speaker 1: Absolutely well, and they're they're bringing a Formula One race
Speaker 1: to Las Vegas for the first time in November. And
Speaker 1: so from a just a business standpoint, seeing the impact
Speaker 1: that media can have on on a brand like Formula
Speaker 1: One that was under penetrated in the US, I think
Speaker 1: there there are there are lessons to be learned from
Speaker 1: a business standpoint by by focusing on content that is
Speaker 1: unrelated to finance. I mean, I know there are folks
Speaker 1: that love to watch billions or love to watch you know,
Speaker 1: or love to read about finance or invest in investing.
Speaker 1: I tend to not like watching shows or reading books
Speaker 1: about investing. I like kind of going the opposite direction
Speaker 1: and spending time with content that is completely unrelated to
Speaker 1: my life, right.
Speaker 2: You don't want to be a foot wide and a
Speaker 2: mile deep. It's going wide. It's always interesting. Tell us
Speaker 2: about your mentors who helped shape your career.
Speaker 1: Well, absolutely, Bruce Karsh is at the top of that list.
Speaker 1: You know, I've had great mentors over my life. And
Speaker 1: Mark McClellan was a mentor for me in college and
Speaker 1: again the multi disciplinary approach to his life opened my
Speaker 1: eyes to also being multidisciplinary and between law, business, medicine.
Speaker 1: And you know, we as a result of that multi
Speaker 1: disciplinary approach. You know, a year or so ago, we
Speaker 1: launched a very large life sciences lending fund, which I
Speaker 1: found personally gratifying because it gave me a conduit and
Speaker 1: it gave Oak Treocon to it to use our skills,
Speaker 1: our hard work in investing in a very difficult space
Speaker 1: in biotech and pharma to change the lives of people,
Speaker 1: to save the people's lives. And I think that's I
Speaker 1: think the pinnacle of how investing can be positive in
Speaker 1: impacting the community and society. So I'm very grateful for
Speaker 1: having done that. But I think I look back on
Speaker 1: my mentors and I think Mark for sure was one
Speaker 1: of them. And then you know one of my mentors,
Speaker 1: he was one of the first employees of Providence Equity Partners.
Speaker 1: His name is al Dobron. He was my associate at
Speaker 1: Morgan Stanley. He was the one that actually convinced me
Speaker 1: to delay going to law school and work in Morgan
Speaker 1: Stanley for two years and work one hundred hours a week.
Speaker 1: But it exposed me to an industry, a career path,
Speaker 1: the possibility of investing as a career path that I
Speaker 1: otherwise would not have seen. And so I think that
Speaker 1: when you look at your mentors, even though you know
Speaker 1: maybe time with them has been short, the impact can
Speaker 1: be material if you interacted with them at a point
Speaker 1: where their critical decision had to be made in your life,
Speaker 1: either personal life or career life.
Speaker 2: Really interesting. Tell us about what you're reading. What are
Speaker 2: some of your favorite books. What are you reading right now?
Speaker 1: Yeah, I'm reading Genghis Khan and the Making of the
Speaker 1: Modern World. I know that's not a new book, but
Speaker 1: I really like the books about periods in history and
Speaker 1: people in history that have made an impact that you
Speaker 1: can actually with withdraw or you can garner some lessons
Speaker 1: in life out of In the case of Genghis Khan.
Speaker 1: You know, there were some obviously some tremendous accomplishments that
Speaker 1: he made, but you know, I think that he probably
Speaker 1: did too much too fast, and it was not a
Speaker 1: lasting empire as a result of its as a result
Speaker 1: of its reach. So there are some takeaways for business
Speaker 1: that you get from there. And you know, I also
Speaker 1: enjoy kind of Soviet history as someone as an Armenian.
Speaker 1: The part of their, i Meanian history that was under
Speaker 1: the Soviet Union is interesting to me. So I've read
Speaker 1: Mikhail Gorbachev's I enjoyed reading Mikhail Gorbachev's autobiography as well,
Speaker 1: and you know that sort of thing. I'm not I'm
Speaker 1: not really into fiction or entertaining reading. It's more about nonfiction.
Speaker 2: I'm trying to remember who was the author of the
Speaker 2: Genghis Strickland con book. I read Strickland.
Speaker 1: Strickland is the one that I'm reading, but there could
Speaker 1: be another one. Jack Weatherford, Oh Weatherford, sorry Weatherford.
Speaker 2: So maybe it was the same.
Speaker 1: Maybe it was weather Yeah, Strickland was enemy at the Gates.
Speaker 2: What's astonishing about the whole Genghis con story is he
Speaker 2: like conquers most of Asian half of Europe by the
Speaker 2: time he's twenty five, some some crazy number just steamrolled everybody.
Speaker 1: He controlled more of the world in thirty years than
Speaker 1: the Roman Empire did in its entire history.
Speaker 2: It's astonished.
Speaker 1: Yeah, but I think that the stretch was probably too much.
Speaker 1: And eventually, you know, his children and descendants became cons
Speaker 1: as well, and they fought with each other, and there
Speaker 1: was therein was the creation of other countries. The takeaway
Speaker 1: for businesses, you know, if you want to build a
Speaker 1: sustained empire, you have to do it more carefully and
Speaker 1: maybe over a shorter period of time.
Speaker 2: Makes a lot of sense. Let's jump to our last
Speaker 2: two questions. What sort of advice would you give to
Speaker 2: a recent college grad interested in a career in distress, assets, finance, credit,
Speaker 2: whatever you would like to tell them.
Speaker 1: Yeah, I think it's a couple of things. And I
Speaker 1: know others have said this on your show before, but
Speaker 1: it's be patient. I think that that's very important because
Speaker 1: I always took the early part of my career as
Speaker 1: education or an opportunity for education, as much as it
Speaker 1: was employment. And I think my employers appreciated it because
Speaker 1: I wasn't trying to be a portfolio manager before my time.
Speaker 1: So I think that's that's the advice number one. Advice
Speaker 1: number two is remember that you have good If you
Speaker 1: have a job as a young person in finance, whether
Speaker 1: it's an investment, banking, or consulting or buyside sell side,
Speaker 1: you have it really good. You have it good in
Speaker 1: that you're learning a lot, you have the opportunity to
Speaker 1: learn from good people, smart people, and you're not there's
Speaker 1: a lot worse of a job that you could have, like,
Speaker 1: for example, medical residency. You could have gone to eight
Speaker 1: years of school, then make a fraction of what you're
Speaker 1: making after doing eight years of school, learning the same
Speaker 1: surgery over and over and over again, to be able
Speaker 1: to repeat it over and over and over again as
Speaker 1: a professional and not really innovating as much as you
Speaker 1: thought you would, whereas in finance you got you actually
Speaker 1: do have the opportunity to innovate, even in a place
Speaker 1: like medicine. And I think that that's an important way
Speaker 1: to kind of contextualize finance as a career versus other
Speaker 1: things where you have the opportunity to be flexible and
Speaker 1: you have the ability to make a change if you
Speaker 1: so desire.
Speaker 2: Huh. Quite interesting and our final question, what do you
Speaker 2: know about the world of distressed investing, credit debt today?
Speaker 2: You wish you knew twenty plus years or so ago
Speaker 2: when you were first ramping up your career.
Speaker 1: Yeah, you know, thirty or twenty years ago, of twenty
Speaker 1: five years ago. When I thought about a career, I
Speaker 1: thought that investing was monolithic. I thought that it was
Speaker 1: you know, you just kind of invest in stocks and
Speaker 1: that's about it, and you have to think about, you know,
Speaker 1: brands that do well and growth. But I think that
Speaker 1: what I know now is that And again this is
Speaker 1: consistent with some of my other comments today has been
Speaker 1: that if you do take a multidisciplinary approach, if you
Speaker 1: do marry investing and finance with knowledge of an industry,
Speaker 1: then you are able to generate or or or drive change.
Speaker 1: Change that it can be quite meaningful and positive change
Speaker 1: that could save lives or change lives. I never expected
Speaker 1: that I would feel that way about investing. I thought
Speaker 1: investing was just a means to an end. It was
Speaker 1: a means to just generate an income and live a
Speaker 1: live a comfortable life. I remember my father as a
Speaker 1: blue collar worker. He's a contractor, and he would always
Speaker 1: kind of tell me when I when I first told
Speaker 1: him I wanted to go into either law or business.
Speaker 1: He said, you know, you're not really building anything. You're
Speaker 1: not You're you're What good is that if you're not
Speaker 1: really building anything? And I think that I've realized that
Speaker 1: I am building something or I can be building something
Speaker 1: in finance. I didn't appreciate that before. I certainly appreciate
Speaker 1: it now. I do think it's a fantastic industry for
Speaker 1: those who want to do well by by doing good
Speaker 1: as well. I think that that is the I think
Speaker 1: there's an opportunity there for people if they have if
Speaker 1: they choose to go down that path.
Speaker 2: HM really quite interesting, Arman. Thank you for being so
Speaker 2: us with your time. We have been speaking with Arman Panosian,
Speaker 2: head of Performing Credit and incoming co CEO at oak
Speaker 2: Tree Capital Management. If you enjoy this conversation, well, be
Speaker 2: sure and check out any of our previous five hundred
Speaker 2: discussions we've done over the past nine years. You can
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Speaker 2: Sean Russo is my researcher. I'm Barry Ridults. You've been
Speaker 2: listening to Master's bit, Isn't This on Bloomberg Radio.