November 21, 2024 • 45 mins
Private credit to risky borrowers that need a lifeline is poised to boom as rates stay high, according to Oaktree Capital Management. “You’re going to see a lot of what they call rescue financing,” said David Rosenberg, head of liquid performing credit at Oaktree. “That’s going to be one of the greatest opportunities we’ve seen in a decade.” Loans to troubled companies will focus on sectors that have seen most leveraged buyout activity, like technology and health care, Rosenberg tells Bloomberg News’ James Crombie and Bloomberg Intelligence senior credit analyst Jean-Yves Coupin in the latest Credit Edge podcast. Rosenberg and Coupin also discuss liability management, creditor-on-creditor violence, private debt stress, the M&A outlook, European investment opportunities and geopolitical risks.
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Episode Transcript
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Speaker 1 (00:17):
Hello, and welcome to The Credit Edge, a weekly markets podcast.
My name is James Crumbie. I'm a senior editor at Bloomberg.
This week, we're very pleased to welcome David Rosenberg, head
of liquid performing credit at oak Tree Capital Management.
Speaker 2 (00:28):
How are you, David, I'm doing great, Thanks for having me.
Speaker 1 (00:31):
Thank you so much for coming on the show. We're
very excited to hear your views. Also delighted to see
co host Jehan Eve coupin from Bloomberg Intelligence. Hello, John Eve,
Good afternoon. Just to set the scene of it here,
Credit markets have rallied after the US election on hopes
of tax cuts, deregulation, and pro growth policies from the
next administration. At the same time, global bond yields have
(00:52):
risen on fears that inflation will rise. So on the
one hand, credit is getting a boost from the economic outlook,
but on the other there's a rag from higher for
longer interest rates, which will hurt weak borrowers With a
lot of debt coming due. There's a lot of uncertainty
about the next US government will do. Electoral campaign promises
aren't always kept, and politicians will have to adapt to
(01:13):
the world as it is. To get things done. Lack
of clarity could dampen business sentiment and delay investment. There
may also be a drag on economic growth because of it.
In addition, there's growing geopolitical risk. Quite a lot of
discord on display at this week's G twenty meetings that
may ramp up if the next US administration pursues very
aggressive tariff policy. Nonetheless, credit market participants still sound very bullish.
(01:36):
The expansion of private markets is helping to keep bond
spreads very tight. Most people don't expect there to be
a recession, so they don't fear a big surge in defaults.
Earnings are expected to be decent, underpinning company's ability to
repay all the debt that they keep raising. And there's
still the sense that the FED has your back if
you keep buying as long as you get the higher
quality stuff. So as credit spreads grind the tightest level
(01:59):
in decades, more people using the word complacency and bubble.
What's your view, David, This year has been kind to
credit investors, especially those who took on more risk. But
what do you expect for the next twelve months? What's
the outlook from here?
Speaker 3 (02:13):
You know, when you talk about credit. I think you
hit on it earlier that a lot of this comes
down to some of these Some of the things happening
in the world are good for credits, some not so good.
But I believe the ability to pick credits is going
to matter again. I think we're heading into a credit
pickers market. I also tell people take it with a
grain of salt because I'm a credit picker, so I'm
(02:34):
always looking for a credit pickers market.
Speaker 2 (02:36):
But in my.
Speaker 3 (02:36):
Opinion, the ability to pick good credits is going to
matter a lot more now than it has over the
past five or six years because the yield with rates
being higher for longer, it means that the yield you
earn is quite attractive if.
Speaker 2 (02:48):
You can earn it.
Speaker 3 (02:49):
And so if companies don't default, they can tra actually
have to pay. And if you pick the companies are
going to pay, you're coming out with an income that's
far higher than it's been for a very long time.
Speaker 2 (02:58):
So that makes me very excited about credit.
Speaker 4 (03:01):
Well, we've said that the environment is pretty benign right now,
with you know, strong growth in economy, you know, interest
rates coming down, low defaults. How sustainable do you think
this is?
Speaker 3 (03:16):
You know, so there's a few things in that, right.
I think the first one to talk about is rates
coming down, and I think that you know, as James
mentioned earlier, there are forces out there, not necessarily the
cause rates to go back up, but maybe kind of
slow down the pace of which rates will come down.
The market's starting to come around to that reality. I
think for a while the market was expecting this step
(03:38):
function drop in rates, and I think a smooth glide
path just always made a lot more sense because and
it's funny because all people have his history, right, that's
all we have, and so everyone will go back and say, well,
every time the FED cut, they would cut at least
three or four times in a row every time, and
I would tease that has saying always is dangerous and investing.
Speaker 2 (03:57):
But I did check. It is true.
Speaker 3 (03:59):
But if you if you look as to why, you
find that it was because there was a crisis. And
so whenever the FED was cutting over the last forty years,
generally because there was a crisis. And if there's a crisis,
one rate cut's not going to solve the crisis. You're
gonna have to do this multiple times.
Speaker 2 (04:13):
Well, today there's no crisis.
Speaker 3 (04:15):
As we were just talking about the economy is generally
doing okay. There's certainly always pockets a weakness we can
point to, but generally okay, And so cutting rates successively
and quickly doesn't really make.
Speaker 2 (04:26):
A ton of sense.
Speaker 3 (04:26):
So I think in that environment you have to think
about that. And if rates do stay directionally higher for longer,
that is good for the income side. You get to
earn more for longer, but that means companies have to
pay more for longer, and so if you pick a
credit that's a little bit more stretched, that's going to
be a challenge. I do think the economic situation, if
you look at earnings across most sectors, is pretty strong.
(04:49):
And so as we look around, i'd say that the
low end consumer is starting to show that it's getting
a little bit stretched. And so you look at the
low end consumer and you look at things like traffic
at fast food restaurants. So McDonald's traffic is down. Now,
the revenue dollars may be okay because they raise prices,
but the traffic is down. Starbucks traffic's down, Wendy's traffic
(05:11):
is down. My auto analyst told me the other day
that the percentage of car repossessions is above twenty nineteen
levels today, and I think about that. The last bill
you stop paying is your car because you need it
to get to work, and people are not being able
to pay that bill in the banks are taking the cars,
and so that shows you there is a cohort of
the consumer that is clearly stretched. But the middle end consumer,
(05:33):
high end consumer is still very strong. Travel, very strong,
leisure goods very strong, and so I don't think that
rolls over anytime soon. So I think that's an environment
that I think will go on for, you know, easily
another twelve months. You can also think about a Trump presidency. Right, So, Trump,
in pretty much every campaign speech mentioned the word terrace
terras is the definition of inflation. You have higher prices
(05:55):
the very next day, you're talking about lowering corporate taxes.
Speaker 2 (05:58):
That creates a deficit.
Speaker 3 (06:01):
Deficit requires selling debt that again puts upward pressure on rates.
And you're talking about border control that's also inflationary. So
there are forces out here that I think will potentially
slow down the path with which the market is hoping
and wanting rates to go down.
Speaker 1 (06:16):
As you say, though, it does mean that some companies,
well all companies are gonna have to pay more to
service that debt, that's right, and more than they're expecting.
And a lot of them are expecting rates to come
down significantly, which was you know, the rates of dubvish
expectation became in this year beginning with you know, the
rates would just drop. How much of the market is
in trouble if rates, you know, just glide and maybe
(06:39):
they stay where they are right now.
Speaker 3 (06:40):
Well that's a good question, right, And so the thing
about the market right now is the quality is very high.
So we had an interesting dynamic with COVID because usually
I always say that the recession is the cleansing event
of the market, but we had a cleansing event before
a potential recession with COVID. Right, So in high yield
default rates near seven percent and loans default rates or
four percent. And if you think about those companies that
(07:02):
defaulted during COVID would have stumbled along without COVID until
the next recession, then they would have defaulted. So whatever
recession comes, now you've pulled forward a lot of these
defaults and those week companies have left the market. The
other thing you have is you had this inflow of
money into credit and so you know, you kind of
think about twenty twenty three. You take the highield market
(07:24):
as an example. In January twenty twenty three, yields were
near nine percent and spreads were near six hundred, and
six hundred is an abnormally widespread and so I remember
going to a lot of people saying you should buy,
spreads are wide and never say no, I'm waiting for
one thousand, And I would joke that, you know, mathematically
you can't get to a thousand spread for the market,
and half the market's double b It doesn't make any sense.
But it was a debate, so not everybody agreed, and
(07:45):
that's fine. Then you fast forward to October of twenty three.
Spreads had gone down from six hundred down to four hundred,
but the yield is still nine turns out, spreads go down,
rates go up, you know, and all of a sudden,
I think there was a light bulb in the moment
for the market where they said, oh my gosh, I've
been waiting to tie my entry. Now I'm gonna buy
for the same nine percent I could have bought in January,
but I missed ten months of clipping nine percent, and
(08:07):
all this money came pouring into credit the fourth quarter
of twenty twenty three, first quarter twenty twenty four. Well,
that does a few things. When money comes in. I've
always learned that supply follows demand, not demand following supply.
If you show up with money, bankers will find something
to sell you.
Speaker 2 (08:22):
And so as.
Speaker 3 (08:22):
Money came pouring into credit, you saw all these companies refinance.
And so most people when they think about defaults and
when they think about stress in the market, they'll point
to the maturity wall. That's your hint of what could
be in trouble because the companies haven't fre financed yet.
And if you hit a weak patch in the market
and you can't refinance, you after restructure. But when all
this money came in, it pushed out the maturity wall.
(08:44):
So for twenty twenty five, less than five percent of
bonds and loans are maturing. It's deminimous the maturity wall,
and so that takes a lot of default risk off
the table that was in place before this money came in,
and so it kind of makes the market help there.
The other thing, you know, when you think about risk
in the market, you know, I'm.
Speaker 2 (09:03):
A liquid guy.
Speaker 3 (09:04):
Like to talk about liquid credits ever, and it's like, oh,
you must hate private credit, and I'm like, I love
private credit. They're buying all my risky stuff and taking
it out of the market. And so private credit has
had a bonanza, and you know, to be fair to
private credit, which I'm not always as a liquid guys,
there's some really amazing pockets of private credit and amazing
opportunities of deals to do, like rescue financing. But it's
(09:24):
a very big market and so there's also some places
where you know, you're seeing the discipline go down and
you're seeing risky deals that can't get done on the
liquid side get absorbed on the private side because it's
a way for them.
Speaker 2 (09:36):
To deploy capital.
Speaker 3 (09:38):
Well, again, that's an example of a deal that may
have defaulted but now won't because it got refinances. So
it's going to have at least five more years before
potentially defaults, and if it does, it'll be in another market.
So you've had a couple things that have made our
market healthier, you know, COVID taking defaults early, You've had
new money come in to refinance things, and you have
private debt start to absorb in that combination, in my opinion,
(10:02):
makes this a much more likely benign environment.
Speaker 4 (10:05):
I'd like to drail a little bit on the view
that the COVID that cleans the market and the you know,
weakest companies have been taken out of the market. Moody's
publishes their list of companies in B three negative and below,
and I think it's you know, currently they're seeing about
(10:27):
fifteen percent of high issuers are in that category, which
is kind of you know, in line with the long
term average, so that you know, points to definitely.
Speaker 2 (10:36):
Not a deterioration.
Speaker 4 (10:37):
However, in the past two quarters they've seen an improvement
and an increase in this UH in this ratio of
companies in that weeker past of part of the credit market.
And what I wonder is have companies for some of
them kick the can down the road by doing some
restructuring and and that you know, sort of buying some time.
(10:59):
It's officially into sort of you know weak single be
treple C category that we could see you know, maybe
in a year or two come back and you know,
having to you know, refinance or having facing some some
difficulties again.
Speaker 3 (11:15):
Yeah, no, I think you're referring to liability management exchanges
l E or as people like to say lender on
lender violence, and the short answer is yes. Right, So
if you look at quality of the market, what you'll
see as well, the double the weak single bee may
be growing, the triple C is lower. Right, So the
triple C is the lowest for high yield to triple
(11:36):
C is the lowest we've had in a decade. And uh,
and so I think overall you still have a better quality.
And the double b's the largest has been in a decade,
and so that's very strong. And on the loan side,
you were seeing the week single be grow and now
it's shrinking to some degree as it as.
Speaker 2 (11:52):
It goes public to private.
Speaker 3 (11:54):
But you still have some companies that are stressed. Right,
there's always some cohort of companies that are stressed. And
what you see these days is so you take a
company that got financed.
Speaker 2 (12:03):
To in LBO.
Speaker 3 (12:04):
Those are always the riskiest deals, right, leverage buyouts, private
equity sponsors and maximizing levers to drive an eternal rate
to return. And in twenty eighteen, twenty nineteen, when you
did an LBO, you know, and you know this will
show you my cynical nature, But I'm a bond investor.
So I like to say professional pessimist, not cynic. But still,
if you look at what happened, in my opinion, the
(12:25):
model was, it doesn't matter what I pay as a
private equity sponsor because I have free money to finance it.
I just need to pay enough to win the auction
against my competitors so I can deploy my capital. And
so if you look, multiples were just steadily creeping higher,
and they were doing it with floating rate debt. And
this is the part that's always fascinating to me because
I used to be a lender a couple decades ago.
(12:45):
When I was a lender, I was a junior lender,
and the credit deputy at the bank would not allow
me to make a loan unless the borrower hedged half
its baring costs. That was the rule of the bank
because back then, if you were a bank and you
wanted to syndicate the loan, you could not do so
unless you were willing to hold some on your balance sheet.
That was, no one would buy it from you if
you weren't going to own it yourself. And so that
(13:07):
was the rule because the bank's actually cared if you
could pay the loan back because they owned it. Now,
generally banks don't sit on the loans, they syndicate the
whole things. They don't care if you can pay back,
and so that requirement's gone away.
Speaker 2 (13:18):
And so a couple of years ago when.
Speaker 3 (13:20):
I had this epiphany, I remember going to our portfolio
manager of our loan strategy to say, okay, the loan
market's not required by the banks to hedge, but you
got private equity sponsors. They're financially savvy, record low rates,
surely a lot of them must to Hedge's not exactly
expensive or complicated to do. And so he checked and
it turned out about twenty five percent hedge.
Speaker 2 (13:40):
Twenty five percent.
Speaker 3 (13:41):
It's funny today you talk to people that said, no,
over half the market's hedge. I'm like, great, well, if
you hedge a five percent SOFA, I'm not really sure
what that means. But when SOFA was zero to one,
nobody was hedging, and they were all maximizing leverage with
these LBOs. And so those are the companies. Now the
barn costs is doubled, and some of them are now
going to have to struggle. Rates don't quickly go back
down to deal with paying for that interest, and so
(14:04):
that's where you see these lmes, which are equivalent to,
in my opinion, of an out of court structuring. You're
not going through bankruptcy, but people are memorializing a loss
and exchanging their debt into new It's effectively.
Speaker 2 (14:17):
The same thing.
Speaker 3 (14:18):
The big question is do you cure the problem? And
a lot of times I think the answer is no,
because the pain required to cure the problem. Nobody wants
to be the one to take the pain. They're like, yes,
pain needs to be taken, you should take it. I'll
be I'll keep my position intact. And when everyone's pointing
fingers at each other, you end up negotiating a deal
that often doesn't fix the problem. It kicks the can
(14:39):
to your point, which means a couple of years from now,
these companies are still.
Speaker 2 (14:42):
Going to be levered. And it's a symptom.
Speaker 3 (14:45):
Of you know, I remember, around the time of COVID,
before rates start going higher, I was having a conversation
with a strategist where I said, I'm starting to worry
that leverage is creeping higher, and the strategy said.
Speaker 2 (14:55):
Why are you looking at leverage? Look at interest coverage.
Speaker 3 (14:57):
You know you can have high leverage because it's it's
free money and you can just support it. And I'm like,
that's fine on a day to day basis, but eventually
you got to pay the money back.
Speaker 2 (15:04):
How is nobody thinking about that?
Speaker 3 (15:06):
And now that day is here, and so I think
that's what you're starting to see. So again, this is
why I think we're in a credit pickers market, because
the yield's already high. I tell people all the time,
we don't need to be a hero. The yield is
already high.
Speaker 2 (15:18):
We just have to keep it.
Speaker 3 (15:19):
And if you're better at keeping the yield than other people,
you're going to do quite well because the companies that
can pay have to pay. So, you know, everyone says, well,
the covenants.
Speaker 2 (15:28):
Are really weak cross credit. Very true.
Speaker 3 (15:30):
That's why we have this l ME because the covenants
allow it. And everyone's like, well, how do you know?
Speaker 2 (15:36):
You know which you know?
Speaker 3 (15:36):
Do you go through the covenants, which of course we
do to kind of protect yourself from l ME and
a sad Well, the truth is most companies can do
an l ME today. The covenants are what they are,
you can't change them, and they're generally weak. The reality is,
if you have a healthy credit and you try to
do an LME. The covenants may allow it, but you know,
you take high yield. Again for an example, the average
leverage in a high credits four times if you're four
(15:59):
times levered. And so when comest and says, hey, I
want to do an LME and I want you to
exchange in this new deal at fifty cents on the dollar,
you say, well, no, I don't want to do that.
And by the way, you have the right to just
sit on what you own and when it matures, they
have to pay you back. If they're solvent, and most
companies are four times lever it'll be solvent. If you're
ten times levered, then you get to go and say, hey,
(16:19):
I want you to do this exchange. If you don't,
we're going into bankruptcy. And you actually have a stick.
And so the weaker credits are the ones that can
get this down. The rest of them, the market will
just say no.
Speaker 4 (16:28):
And talking about those weakest credits, he's it a part
of the market that you're interested to invest in because
when they are when it comes restructuring time, and you know,
sometimes misity gets capital from outside. I mean, is that
an area of the market that could be of interest
where arguably could be you know, outsize earning.
Speaker 3 (16:47):
For sure, I always like to buy what people don't
want to buy, and so you know, I always caution
this with you know, my job and clients come to
me to get buy things that will pay. So I'm
not looking to take equity in companies and takeover companies
is a whole different strategy. It's distressed or people are
very good at that, but it's a different skill set.
My skill set is to find companies that can pay
(17:09):
or structure securities within companies that are struggled where I
know I'm going to get paid back and so if
and when that area starts to heat up, yeah, we'll
be looking at that. I expect we'll get a lot
of competition from private debt because that's one area where
probably can more efficiently structure, and so you're going to
see a lot of what they call rescue financing. I
think of the private debt market. I think that's going
(17:29):
to be one of the greatest opportunities we've seen in
a decade. And it'll be for these companies that need money,
and so you'll have people come from both angles. But
it's always great to be a liquidity provider and people
are desperate for liquidity, you tend to be able to
get very good terms that way. It tends not to
last for a huge, huge amount of time, so you
have to be ready. But it feels like that part
of the cycle is coming.
Speaker 1 (17:50):
But to be clear, that means that companies that are
struggling and they would otherwise doing that, lem me, the
private detmarkt is just going to go directly to them
and do it by natural loan to help them out.
Speaker 2 (18:00):
Yeah, so think about it.
Speaker 3 (18:01):
Think about the options a company has. So you're looking
at a near term maturity and you have a balance
sheet that's two levered, so you can go to existing
creditors and say, hey, I want you to exchange into
a new loan or new bond, and now I've extended
my maturity, so I deal with a short term maturity,
and I want you to do it at fifty cents
on the dollars so I can delever and there will
be a negotiation. Or you go to a private lender
(18:24):
and the private lender says, okay, because the covenants are
so weak, I want you to take some of these
assets away from creditors. Give it to me, I'll give
you new money, and now you take that new money
and pay off the short maturity and go in the
market and buy stuff back at a discount and try
and get your debt discount that way. And so it
becomes the negotiation between between the two parties as far
as which way you're going to do. Most companies lately,
(18:45):
I've observed prefer as to go They'll use the private
side as a negotiating stick, but they'll prefer to go
with existing lenders.
Speaker 2 (18:52):
Is much more efficient.
Speaker 3 (18:53):
You know, you get an exchange versus having to go
buy everything in the market, and so that generally is
how it goes so far, does it? I mean, that's
how it'll go going forward. But those are the two
types simplistically types of deals.
Speaker 1 (19:04):
But the private lend is the way of talking to
about that kind of business. You know, they're talking about
high double digits correct twenty percent, you know, which is
great for the investment, but hell sustainable full of the bloo.
Speaker 3 (19:15):
Well, so it depends on how much debt discount they're
capturing at the same time, and so you know the
other again back to my cynical nature. You think about
a rescue financing if a company is truly run out
of money, you know the balance sheet is stretched and
they're going into bankruptcy. You look at the private equity
sponsor who probably owns this company. You say, here's the deal.
(19:37):
I will give you five years a runway to try and.
Speaker 2 (19:39):
Figure this out.
Speaker 3 (19:40):
It's going to cost you, but what do you care.
Your option is to throw away the keys and get
wiped out.
Speaker 2 (19:44):
So you're going to pay.
Speaker 3 (19:45):
And I'm only going to do this if i can
layer everybody else. I'm in the very safest part of
the balance sheet. So if you work it out, then
I get a good return. But if you don't, I
still have a debt claim that's going to be protected
because everyone below me is going to take the loss.
So that's your simplistic rescue Finnis. So it's very expensive,
but it's pure optionality. And so if the cycle turns
and if rates go down, or a company or industries grow,
(20:08):
whatever it may be, the company grows into its balance sheet.
But that's why, to Johnny's point, before a lot of these,
you'll take on this new debt. It'll give you a
couple of years a runway, and then you'll be right
back where you started, if you haven't done something to
grow with the new money, and then you're still you're
still going to be struggling, and.
Speaker 1 (20:24):
It dons the opportunity that you see. You're talking about
a big opportunity over the next ten years. I mean,
is it the sectors? Is it particular types of companies
that you're looking at in this regards?
Speaker 3 (20:33):
You know, for for this type of stuff, it'll be
the sectors that were more LBO heavy, and so, you know,
you think about technology, healthcare, you know, sectors where you've
seen more LBOs.
Speaker 2 (20:45):
That's where what my sense would be.
Speaker 1 (20:48):
And it's an opportunity right now that you see for
oak Tree.
Speaker 3 (20:52):
I think, so it won't be for all parts of
oak Tree, but I think that you know, we have
a big private debt business and distress business, and I
imagine those guys can be very act.
Speaker 4 (21:01):
Moving on to maybe the impact of the recent election
could have on some of the industries that we imagine
you invest in. And going back to that statistic, which
I think is quite interesting. On this Moodys B three
negative list, the subsector that has the highest representation is
earl and gas I think of twenty one percent, and
(21:21):
I wonder is there an opportunity there considering potential changes
to regulatory environment to you know, invest in that part
of the market, as those companies are currently stressed but
might actually benefit from an improvement in the our parting environment. Going.
Speaker 3 (21:38):
Yeah, so think of the thing about oil and gas.
You got to think about volume and price, right, and
a lot of these regulatory changes people are expecting. Is
two big things people are expecting from the Trump presidency.
Speaker 2 (21:51):
In the oil business.
Speaker 3 (21:52):
You have the drill, baby drill, so a lot more
supply and as they release restrictions and allow more companies
to drill. And you have the claim that the rush
of Ukraine, you know, whole crisis will be ended very
very swiftly and shortly. Well, both of those add supply
to the market, which bring prices down. So you have
(22:12):
to think about that, which is, you know, oil prices
and theory should come down. Gas prices should come down
if there's more supply without and you know a you know,
increasing demand at the same time. And so I'm a
little more cautious. You know, it goes back to kind
of you know, I like to be controller and I
like to buy energy when everyone hates energy and I
like to sell energy when everyone loves energy. The thing
about energy, you know, it's an above average risk sector
(22:35):
because you have this unknowable which is what's the price
of the commodity going to be tomorrow, which is so
important to the profitability of every company in the sector.
And so for me, I'm okay to buy above average
risk things. So I invest in blow investment grade for
a living. But I always say, if you're going to
go into something that's above average risk, you should get
above average reward. Most people don't fight me on that,
And so to me, when you have periods like COVID
(22:58):
and oil goes negative for a period of time and
everyone's convinced you'll never use fossil fuels ever, again, we're
aggressively buying higher quality energy names that are a creative
to our portfolios. And you have today days like today
where oil is hovering around seventy and everyone's convinced no,
nothing will ever go wrong and energy again, and it's
dilutive to the portfolio. I'm a better seller because if
(23:20):
I can sell an energy name and buy anything else
that doesn't have that kind of volatility but has the
same yield, I should do that. And so that to
me is kind of how I treat the sector. And
so if I'm right and energy prices start to weaken
because of these policy changes, then we'll probably start looking
to where we can buy some higher quality stuff.
Speaker 4 (23:41):
Away from energy. I mean, do you have any sectors
or subsectors industries that you like and don't like from
any investments than born right now? Yeah.
Speaker 2 (23:49):
So it's funny.
Speaker 3 (23:50):
I'm a credit guy, so I was like to talk
about what I don't like versus what I do like.
I mean, the reality is, in the end of the day,
you buy credit for their contractual income, and so there's
nothing is going to double and triple and value.
Speaker 2 (24:01):
It's all about picking what can pay.
Speaker 3 (24:03):
And so we talked about energy where I'm shying away,
you know, the other sectors where I'm really cautious these days,
or anything that's consumer discretionary spending dependent. Because we talked
about the weakening and the low end consumer and the
potential for that to spread, and the reality that rates
do stay a little higher for longer that does start
to stretch a consumer. You know, it's funny people talk
(24:24):
about inflation. They say, well, inflations come down, and ours
remind people. Inflation is a rate of growth. The rate
of growth has come down from nine percent to two
to three percent, but that's still growth, which means that
prices people are paying are a good twenty percent higher
than they were pre COVID, and that really stretches a consumer.
And it's not coming down, it's just going up slower.
And so in that type of environment, I start to
(24:46):
worry about sectors that are dependent on consumers continuing to
spend discretion on discretionary at an item. So specialty, retail, automotive,
things that people can buy but don't need to buy,
is an area that I'm very cautious on.
Speaker 1 (25:01):
I just want to go back to something you said
about credits from credit of violence. Yeah, it's an interesting topic.
We've talked about it a lot on this show. We've
ranged from opinion that it's just the law of the land.
It's part of capitalism at work too. It's terrible and
you know, the only winners of the lawyers. Do you
see an opportunity there? I mean, how do you like
factor it into your investment decisions? You know, given that
(25:22):
you think that it also leads the company in worse shape.
Speaker 3 (25:25):
It can you know, some of these will work, and
a lot of them I think won't. I think the
reality is, you know, we spend a lot of time
on covenants. Not everybody does, and so to me, it's
always you know, you should never you know, come in
you know the covenants when you when you read them,
you know generally you go into an indenture. There's generally
a standard package in the market. It changes from day
(25:48):
to day, but if you read enough of them, you
know what standard. And if a company strays from the standard.
They don't do it for sport. They have to pay
lawyers a lot of money to do it. They do
it for a reason, which means that there is literally
a roadmap of exactly what the company is going to
do if things go wrong, if you're willing to read it.
And the problem is a lot of people don't because
you could have a sentence, it goes a whole page
and it's boring, and so that's a bit of an
(26:10):
efficiency in the market in my opinion. So we spend
time on this, and I do that on purpose because
I want to know if things go wrong. You know,
a how likely is it the things are going to
go wrong?
Speaker 2 (26:20):
And be if they do?
Speaker 3 (26:21):
Am I okay with it because I have all the
time when something will go wrong and people be like,
I can't believe the sponsor did equiz and I'm like,
how could you not believe they told you before you
bought it that this was exactly what they're going to do,
and so you need to know. And so I do
think it creates an opportunity, but maybe not in the
way you're thinking, which is to me as a credit investor,
if I can avoid problems and everyone else has to
(26:42):
own them, that's generally the best way to outperform. And
so I love having things in the market that can
blow up that I can choose not to own.
Speaker 2 (26:49):
And this is a big area of that.
Speaker 3 (26:52):
Had a client ask me not too long ago, like
how do you protect yourself against all this l ME?
Speaker 2 (26:56):
What do you do?
Speaker 3 (26:57):
And it's an interesting question because covenants are what they are.
You cannot change them. You can't amend covenants. You know,
in the middle of the life of a security, nobody's
going to do that. And so if the covenants allow
for an lme's that's it. There's nothing you can do.
And so and you can do like people form co
ops and it's it's an effective strategy is basically what
(27:18):
they'll do is it's like a non aggression pack. So
in the original form of lm ME, you would have
a company that would go to the creditors say, hey,
it was kind of a prisoner's dilemma. I want you
to exchange at fifty cents on the dollar to this
new first line. If you don't do it, I'm gonna
cram you into a third Liane. And you have twenty
four hours to tell me if you're in or out,
and there's this big panic, what am I going to do?
And everyone just rush in and so to avoid that
(27:40):
credit what creditors or creditors are now doing, which I
think is smart, is locking arms early before an LME
is formed. They'll or announced, they'll go to the company
and say we've formed a co op. We're all voting together.
So this whole twenty four hours trying to cram that's
all over. They can still do the LME, by the way,
they just have to actually be an adult and have
a conversation about it, and then they can do it,
(28:02):
but it doesn't change the end outcome tremendously. And so
to me, the biggest protection of this is doing your
credit work, which is like we talked about before, if
you have a performing credit and you own it and
you know it's going to perform, they can announce whatever
LM they want. I don't care because I know that
I can sit on my security and it's going to
payback on maturity. That's really the only defense you have.
(28:24):
And you know, when it's funny because I talk to people,
they are like, you're right, I'm going to focus on
credit now.
Speaker 2 (28:28):
I'm like, well, it's too late now, Like you have
to have done this a.
Speaker 3 (28:30):
Couple of years ago to make sure you have a
portfolio that's in a good place today. Otherwise, when you
go to sell the risky name, it'll be priced in
that everyone knows the lem risk is there.
Speaker 2 (28:38):
But that's the key.
Speaker 3 (28:40):
If you're good at credit, you're going to have less
of these and that should show in your performance.
Speaker 4 (28:45):
Peeking up on the topic of red flag such as
we Covenant package, we've seen, you know, more of the
kind of alternity financing solution being put in place recently,
such as payment in kind. Is it a red flag
for you?
Speaker 2 (29:00):
I think it is.
Speaker 3 (29:01):
And so you know, when you think about the whole
construct of a pick is because the company can't afford
to pay, and that should tell you something, right, And
so now there's two ways to do it. There is
the payment in kind at the onset. So, hey, this
company's a little bit too levered, I'm going to do
fifty percent cash pay, fifty percent pick or a lot
of It'll do like a pick toggle. I'm not going
(29:22):
to pick now, but I have the option to pick
if things get really tight. That's still to me a
flag of stress. But it's different than when you have
a company that you know, quite frankly, you look at
like the private debt market. I had this conversation with
our CIO recently where I said, you know, I'm worried that, uh,
there's a lot of stress building in the private markets
(29:43):
because you're seeing all these risky deals in public markets
get out. In the private markets, you're going to see
the faults. And the comment that came back I thought
was really interesting where he said, well, you never see
a default in private debt. You just pick the interest
and extend the maturity. And I'm like, well, what's the difference.
You're not getting paid and the difference is you don't.
Speaker 2 (29:58):
Have to call it a default.
Speaker 3 (30:00):
That's actually become pretty important. And so I tell people
all the time, if you want to look at the
health of the private market, just look at BDCs.
Speaker 2 (30:09):
And you know, I believe it.
Speaker 3 (30:11):
Was Barkley as It did a study of this recently
where they said, if you go back to twenty eleven,
the average across all BDCs, the average pick was about
two percent, and if you fast forward to today, the
average pick is over ten ten percent. Pick that is
ten percent in trouble. I haven't seen a level of
stress like that since the global financial crisis is shockingly high.
(30:32):
But the other thing he pointed out to me is
you think about what that actually means is, if you're
a BDC, you have to distribute ninety percent of your income.
Speaker 2 (30:39):
How do you do that?
Speaker 3 (30:39):
If you're picking in the hypothetically eleven that becomes a challenge.
Speaker 2 (30:44):
And I asked a BDC expert about that. So what
do you do? And you saw it's easy.
Speaker 3 (30:48):
We borrow, Oh my god, because that never goes wrong.
You just borrow to pay a distribution. And I'm like, okay,
but barring capacity is not infinite. What happens when that
runs out? They said, oh, we take our best assets
and sell them at a discount to another private life.
So I'm like, okay, so now you've got a shrinking
fund with that verse election and growing leverage.
Speaker 2 (31:04):
What could go wrong?
Speaker 4 (31:05):
Now?
Speaker 3 (31:05):
The answer is, you know, I got all excited. It
is going to be the next ground of opportunity. But
it'll take years because you know, it's all locked up
money without marked to market, so you're not going to
see it until the fund actually ends.
Speaker 2 (31:16):
But again it goes back.
Speaker 3 (31:17):
To not all private credits the same, not all public
credits is the same. If you're good at picking credit
in private credit, there's gonna be some great things to
do and you're.
Speaker 2 (31:25):
Going to have a great return.
Speaker 3 (31:26):
If you're just buying the market because of the explosion
of supply then or explosion of demand, sorry, then you
may find that you're going to have a lot more
deals that you have to turn to pick and so
you'll be able to see the good and the bad
just by looking at that statistic, in my opinion.
Speaker 1 (31:40):
And you do expect that to get worked.
Speaker 3 (31:42):
I do, yeah, I think that. Again, it's a credit
pickers market, not just for publics. It's very much a
credit pickers market for privates. If you're a good credit picker.
Then you get paid extra for going into the private market.
It's a great deal, but you'll see a divergence of
that market of the haves and the have nots.
Speaker 1 (31:58):
Yeah, what about rates coming down? The economy booming and.
Speaker 3 (32:01):
The trees grow into the sky and rainbows and everything amazing,
you know, I think it's it's not as I'm a cynic,
So I guess you got to take this with a
grain of salt. But no, I think that the economy
is already in good shape, and I think, so you've
got to have to start with that baseline. But you know,
I think the rate picture coming down is going to
(32:22):
be slower than the market hopes. And because it's just
the economy doesn't need it. You know, everyone's like, well
what happens if you know, if you don't stimulate the economy,
and you're like, where's where's the economy screaming for stimulus?
And so I think that's going to be slower. But
I don't think that creates a huge crisis because generally
the economy is okay and generally credit is high quality.
(32:43):
There'll be pockets of credit that will stress be stressed
if but they're small as a percentage. You know, the
dollars there may be large because the markets are you know,
trillion dollar markets.
Speaker 2 (32:52):
But uh, but I think you're in.
Speaker 3 (32:54):
A baseline of a pretty stable economy. But I don't
expect massive growth from here. I think you know, it's
gonna you know, the growth rate has to slow.
Speaker 1 (33:04):
Okay, but there will be stressed in the private credit market,
which is growing and if you correct in what people
are calling, you know, the asset based finance boom, which
according to a polo takes it's forty trillion, and it's.
Speaker 2 (33:16):
A very interesting area.
Speaker 3 (33:18):
Honestly, you know, when whenever banks step away from an
area usually creates a huge opportunity. But you are right,
there's a lot of money. Howard Marx taught me many
years ago. When markets grow this fast, you buy what
you can, not what you want to, because deploying capital
becomes the chore, and so you do have to be
very picky. But I always caution people because I've seen
this so many times in the public markets too. It
(33:39):
doesn't mean the whole market is bad. It just means
there are gonna be a lot of players. If you
just hung a shingle a week ago, and said I'm
going to start a private credit fund, You're probably gonna
have a lot of trouble in your portfolio. You've been
doing this for ten or twenty years, you'd probably be okay.
Speaker 4 (33:52):
Ibe moving on from from the credits that are a
little stressed into the better part of the market. The
double b's, I mean double b's, you know, currently generate
some tractive yields. Do you think it's a credit trade.
Speaker 3 (34:08):
I've been underweighting double b's, and so you know, the
thing is that right now it became less of a
credit trade and more of a duration trade. Is that
the double b's tend to be longer duration, and everyone's
convince rates we're going to go down, so they're all
going heavy on double b's. But the other thing is,
you know, we've been in a massive risk on rally,
massive risk on rally, and so a lot of people
(34:29):
saying the only way you can hope to keep up
is to buy triple c's. You have to buy triple c's.
And I never like them when anyone tells me I
have to do anything but buying triple c's for the
sake of buying triple c's never made a ton of
sense to me, and so we looked at it and saying, well,
triple c's is a bet on growth. We've seen a
lot of growth. But if money's going to stay expensive
higher for longer, directionally, that means you're it's going to
(34:51):
be harder to finance growth, so you should see less growth.
I think that formula is pretty straightforward, So I'm not
really excited about making a big bet on growth from here.
I don't think the economy falls apart, but I also
don't think it's going to grow from here in a
dramatic way in this environment, and so I'm not rushing
into triple c's.
Speaker 2 (35:07):
But if you think.
Speaker 3 (35:08):
About designing a portfolio and you want to bring the
average yield up, there's two ways to do it. You
can chase really risky stuff or own a lot.
Speaker 2 (35:16):
Less of the safe stuff.
Speaker 3 (35:17):
I prefer prefer to do the latter, because if I
believe we're very good at credit, and I think, you know,
oak Tree's got the best credit team in the world,
then I think we can go to that credit team
and say, hey, go from double B to single B.
You're gonna bring your yield up without increasing your default risk.
Because not every single Bee company is on the verge
of default, whereas you go to Triple c's a it's
(35:37):
a lot of default risk and so it's been to
me a better trade lately.
Speaker 2 (35:42):
So that's kind of how I view it.
Speaker 4 (35:44):
And what about investment great, I mean we're seeing credit
spread is coming tighter and tighter. Yes, I mean it's
totally a different logic there. But I mean you see Pucket,
so opportunity tis there as well.
Speaker 3 (35:55):
Yeah, I mean, you know, look, the yield is attractive
right relative to the risk you're willing to take. So
I think our chairman wrote a memo recently where I
think it came to asset allocation, and it starts with
how much risk are you comfortable with? What can you tolerate?
And I think that's always the right place to start.
You start with the risk and then say, you know,
you don't force the yield, and then say this is
(36:15):
the yield I need, and then force the risk. That's
when you get into trouble. You start with this is
the risk I can take, this is what I can tolerate,
and know that I'm not going to sell at the
wrong time, and then what yield does that deliver? Well,
it turns out that across credit that yields a lot
higher than it was four or five years ago. And so,
you know, investment grade yielding five six percent pretty attractive
for people in some of their needs. I think, you know,
(36:37):
I yield at seven eight, even more attractive, but more
with more risk, you know, a multi strategy eight or nine.
But again, you know, you continue to say how comfortable
with your risk? You know, private debt you can get
double digit and so a lot of this depends on
the risk. So for people that need a bucket of
low risk capital, turns out that low risk capital can
deliver a pretty reasonable income.
Speaker 2 (36:58):
I think that is attractive.
Speaker 1 (37:00):
Another thing that people are very excited about from you,
attentially from the next administration in this country is merges
and acquisitions.
Speaker 2 (37:07):
I love new supply thankers.
Speaker 1 (37:09):
I always talk about it is if it's you know,
it hasn't really transplied, it hasn't really ploted through. But yes,
new supply on the one hand, but then risk in
the tons of LBOs on the other. True, what do
you what do you expect from the M and A lens?
Speaker 3 (37:20):
I expected to pick up and you know, I've been
hearing the same thing from bankers. I think the reality
is that we had a pause in LBO activity because
of the election. A lot of companies saying, well, I
want to do deal, but I'm not doing it till
I know what regulatory environment I'm stepping into, and so.
Speaker 2 (37:38):
I'm going to wait.
Speaker 3 (37:39):
Well, now we know, and we know that the environment
should be less regulation, not more. That seems to be
pretty well accepted view, and so you would expect M
and A to pick up from here. But you also
have to remember there's a seasonal aspect of this. Thanksgiving
comes around, the market tends to get very quiet. Christmas
break comes around, the market comes gets very quiet. Bankers
(37:59):
and pretyarticular of a regulatory requirement to take a two
week holiday, and a lot of them do it during
the Christmas holiday, so that slows everything down. So we're
seeing a bit of a pickup of activity this week
because people trying to get it in before Thanksgiving. And
then you might see one more week of activity after
Thanksgiving and I think it gets dead. But January comes around,
(38:19):
I think you're gonna have all this pent up demand
that now is going to come to the market. So
we should see a pickup in M and A. And
the thing about M and A it does add risk
for certain deals. Not every deal is a bad deal,
but absolutely will be some. But it's net new supply.
So it's one thing to refinance. But when you're refinancing,
you're taking oftentimes you're taking a bond you already own
or a loan you already own and exchanging it for
(38:41):
a new one. So it's net neutral. M and A
is usually new supply, so it creates a little bit
more of a demand, it takes more cash out of
the market. That makes pricing a lot more efficient, and
so it's usually generally a healthy thing.
Speaker 1 (38:55):
We are international audience. You're sitting to Europeans here, what
yea out there in the world of Pelton the US
are you're looking at in terms of investment opportunities?
Speaker 3 (39:04):
Yeah, so, well you look across the globe and right
now you kind of you when you think about credit globally,
what I would say US versus Europe, it's generally from
size kind of seventy five to twenty five US Europe.
And that's true for loans and bonds, which means so
Europe is a smaller market, is a little less liquid,
and so you should get paid a premium for that.
(39:27):
Anytime you sacrifice liquidity, you should get paid a little
And so you know, I've been doing global portfolios for
about a decade and you know, the rough rule of
thumb is you get paid fifty seventy five basis points
additional yield you go from US to Europe, and it's
it's a good trade. And so there are periods like
you know, a couple of years ago when Russia is
(39:47):
going to turn off natural gas to Europe and natural
gas goes into electricity, electricity goes and everything, and it
was going to be armygedin and you were getting paid
over two hundred basis points to go to US from
the US to Europe, which is last time I saw
that was gregsitt Or the global finance crisis, and that
didn't feel that bad, and that was an opportunity and
we were buying. Today the pickup is very low. It's
(40:08):
almost a parody because there's debates of who's going to
have rates go down faster, US or Europe. And so
I've been leaning more towards the US if I don't
get that pickup. I've found that, you know, the European
loan market seems to have a little more pickup than
the US loan market because clos are a big buyer
in the loan market. They tend to buy about seventy
percent of the market in the US. And there's more
(40:28):
aggressive COLO creation in the US than Europe, so that
creates more demand. And there's a bigger etf retail presence
in the US market, so that creates more demands. So
the lack of demand has a little bit better pricing,
so on the marginal like that you know we do
when we look at things like em EM, we go
back to again being credit pickers. I don't come in
saying I want exposure Russia or I want exposure to China.
(40:50):
We go in looking for credits that you know, frankly,
are good good houses on a bad block. Right So
it's a company that if it were in any other
country would be investment grade, but because it's in X
y Z country, it's high yield and we'll look at those.
But right now we're not aggressively pushing into em because
you can get such a good yield and develop markets
(41:11):
that you don't need to be a hero.
Speaker 2 (41:12):
So we're being pickier right now.
Speaker 1 (41:15):
And when you look at everything across the board. Where's
the best relative value, where's the best opportunity for you
right now?
Speaker 2 (41:21):
Right now?
Speaker 3 (41:21):
Across the board, We're really like structure credit, colo debt.
I think w B clos are very attractive, and you know,
I also kind of you know, I like say, boring
is beautiful for bonds, and so you know, we like,
you know, just regular way loans and bonds where you
can just clip a good income, right you know, that's
really the key right now is just where can I
lock in a good income? Because you know, everyone's convinced
(41:44):
that everything's going to go amazing, Well, it's going to
be all this growth equities until today we're on fire.
And you know, in those kind of periods that I
kind of look around, like there's lots of things that
could cause the market to hiccup, you know, whether it
be rates that we've talked a lot about, whether it
be you know, the ultimate outcome of policy from from
the new from the recent election in the US, whether
(42:04):
it be ge politics.
Speaker 2 (42:05):
There's lots of things you can point to.
Speaker 3 (42:07):
You only need one of them, but there's plenty of
things that you could point to. And so in those
environments where nobody's worried. I tend to worry, and so
I like to kind of lean towards locking in my
income and waiting for a little more volatility.
Speaker 1 (42:18):
You mentioned rescue finance is a huge opportunity as well. Yeah,
you know, is that everything in rescue finance.
Speaker 2 (42:25):
I think, you know again, it's gonna be.
Speaker 3 (42:26):
It's gonna be like anything. There's gonna be some really
good rescue finance and really bad rescue finance, and you're
gonna have to be good at picking. And if you're
good at picking, I think there's gonna be some really
good risk adjusted opportunity. It's gonna have to be patient.
It's not gonna just come flooding in. You're gonna have
to wait because companies are gonna have to be desperate,
and it will be market dependent because if money keeps
(42:47):
flooding into the market and companies keep finding ways to refinance,
and they won't need rescue financing. So it's gonna, you know,
take some time to evolve. But I do think they'll
be good and bad.
Speaker 4 (42:57):
Strong created skills, a bottom up of approach, and a
lot of setic tvts that seems a recp for success.
Speaker 3 (43:04):
I agree, and being contraran that that is key.
Speaker 1 (43:08):
But what's the one thing that worries you?
Speaker 3 (43:11):
Ah, I'm a professional worrier, So what worries me the
most right now? I mean we kind of talked about before.
I worry the most that nobody's worried and that, you know,
everyone's convinced trees are going to grow to the sky
and everything's going to be perfect and we're going to
see all this growth. I am bearish on growth because
I think money's going to stay expensive a little bit longer,
(43:32):
and so I do think that cuts into growth. I
do think geopolitics is a little bit underplayed. We'll have
a flare up for a day or so, and then
everyone will convince themselves that it's it's all fine. I
kind of say, it's like violence on TV. Everyone's getting
desensitized the volatility in the markets, and so used to
be if you saw a ten or twenty basis point
move in the ten year and a day, you would panic,
And now that's just another day. And so I do
(43:54):
think that's where I focus most of my attention these days.
Speaker 1 (43:58):
Great stuff. David Rosenberg, head of liquid performing credit at
oak Tree. It's been a pleasure having you on the
Credit Edge money. Thanks, thank you, and of course we're
very grateful to John eve Coupan from Bloomberg Intelligence. Thank
you so much for joining us today.
Speaker 4 (44:09):
Thank you all for a pleasure for more.
Speaker 1 (44:11):
Credit market analysis and insight reader all of John eve
Coupan's great work on the Bloomberg Terminal. Bloomberg Intelligence is
part of our research department, with five hundred analysts and
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(44:32):
We're on Apple, Spotify and all other good podcast providers,
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at Bloomberg dot net. I'm James Cromby. It's been a
pleasure having you join us again next week on the
Credit Edge.
Hello, and welcome to The Credit Edge, a weekly markets podcast.
My name is James Crumbie. I'm a senior editor at Bloomberg.
This week, we're very pleased to welcome David Rosenberg, head
of liquid performing credit at oak Tree Capital Management.
Speaker 2 (00:28):
How are you, David, I'm doing great, Thanks for having me.
Speaker 1 (00:31):
Thank you so much for coming on the show. We're
very excited to hear your views. Also delighted to see
co host Jehan Eve coupin from Bloomberg Intelligence. Hello, John Eve,
Good afternoon. Just to set the scene of it here,
Credit markets have rallied after the US election on hopes
of tax cuts, deregulation, and pro growth policies from the
next administration. At the same time, global bond yields have
(00:52):
risen on fears that inflation will rise. So on the
one hand, credit is getting a boost from the economic outlook,
but on the other there's a rag from higher for
longer interest rates, which will hurt weak borrowers With a
lot of debt coming due. There's a lot of uncertainty
about the next US government will do. Electoral campaign promises
aren't always kept, and politicians will have to adapt to
(01:13):
the world as it is. To get things done. Lack
of clarity could dampen business sentiment and delay investment. There
may also be a drag on economic growth because of it.
In addition, there's growing geopolitical risk. Quite a lot of
discord on display at this week's G twenty meetings that
may ramp up if the next US administration pursues very
aggressive tariff policy. Nonetheless, credit market participants still sound very bullish.
(01:36):
The expansion of private markets is helping to keep bond
spreads very tight. Most people don't expect there to be
a recession, so they don't fear a big surge in defaults.
Earnings are expected to be decent, underpinning company's ability to
repay all the debt that they keep raising. And there's
still the sense that the FED has your back if
you keep buying as long as you get the higher
quality stuff. So as credit spreads grind the tightest level
(01:59):
in decades, more people using the word complacency and bubble.
What's your view, David, This year has been kind to
credit investors, especially those who took on more risk. But
what do you expect for the next twelve months? What's
the outlook from here?
Speaker 3 (02:13):
You know, when you talk about credit. I think you
hit on it earlier that a lot of this comes
down to some of these Some of the things happening
in the world are good for credits, some not so good.
But I believe the ability to pick credits is going
to matter again. I think we're heading into a credit
pickers market. I also tell people take it with a
grain of salt because I'm a credit picker, so I'm
(02:34):
always looking for a credit pickers market.
Speaker 2 (02:36):
But in my.
Speaker 3 (02:36):
Opinion, the ability to pick good credits is going to
matter a lot more now than it has over the
past five or six years because the yield with rates
being higher for longer, it means that the yield you
earn is quite attractive if.
Speaker 2 (02:48):
You can earn it.
Speaker 3 (02:49):
And so if companies don't default, they can tra actually
have to pay. And if you pick the companies are
going to pay, you're coming out with an income that's
far higher than it's been for a very long time.
Speaker 2 (02:58):
So that makes me very excited about credit.
Speaker 4 (03:01):
Well, we've said that the environment is pretty benign right now,
with you know, strong growth in economy, you know, interest
rates coming down, low defaults. How sustainable do you think
this is?
Speaker 3 (03:16):
You know, so there's a few things in that, right.
I think the first one to talk about is rates
coming down, and I think that you know, as James
mentioned earlier, there are forces out there, not necessarily the
cause rates to go back up, but maybe kind of
slow down the pace of which rates will come down.
The market's starting to come around to that reality. I
think for a while the market was expecting this step
(03:38):
function drop in rates, and I think a smooth glide
path just always made a lot more sense because and
it's funny because all people have his history, right, that's
all we have, and so everyone will go back and say, well,
every time the FED cut, they would cut at least
three or four times in a row every time, and
I would tease that has saying always is dangerous and investing.
Speaker 2 (03:57):
But I did check. It is true.
Speaker 3 (03:59):
But if you if you look as to why, you
find that it was because there was a crisis. And
so whenever the FED was cutting over the last forty years,
generally because there was a crisis. And if there's a crisis,
one rate cut's not going to solve the crisis. You're
gonna have to do this multiple times.
Speaker 2 (04:13):
Well, today there's no crisis.
Speaker 3 (04:15):
As we were just talking about the economy is generally
doing okay. There's certainly always pockets a weakness we can
point to, but generally okay, And so cutting rates successively
and quickly doesn't really make.
Speaker 2 (04:26):
A ton of sense.
Speaker 3 (04:26):
So I think in that environment you have to think
about that. And if rates do stay directionally higher for longer,
that is good for the income side. You get to
earn more for longer, but that means companies have to
pay more for longer, and so if you pick a
credit that's a little bit more stretched, that's going to
be a challenge. I do think the economic situation, if
you look at earnings across most sectors, is pretty strong.
(04:49):
And so as we look around, i'd say that the
low end consumer is starting to show that it's getting
a little bit stretched. And so you look at the
low end consumer and you look at things like traffic
at fast food restaurants. So McDonald's traffic is down. Now,
the revenue dollars may be okay because they raise prices,
but the traffic is down. Starbucks traffic's down, Wendy's traffic
(05:11):
is down. My auto analyst told me the other day
that the percentage of car repossessions is above twenty nineteen
levels today, and I think about that. The last bill
you stop paying is your car because you need it
to get to work, and people are not being able
to pay that bill in the banks are taking the cars,
and so that shows you there is a cohort of
the consumer that is clearly stretched. But the middle end consumer,
(05:33):
high end consumer is still very strong. Travel, very strong,
leisure goods very strong, and so I don't think that
rolls over anytime soon. So I think that's an environment
that I think will go on for, you know, easily
another twelve months. You can also think about a Trump presidency. Right, So, Trump,
in pretty much every campaign speech mentioned the word terrace
terras is the definition of inflation. You have higher prices
(05:55):
the very next day, you're talking about lowering corporate taxes.
Speaker 2 (05:58):
That creates a deficit.
Speaker 3 (06:01):
Deficit requires selling debt that again puts upward pressure on rates.
And you're talking about border control that's also inflationary. So
there are forces out here that I think will potentially
slow down the path with which the market is hoping
and wanting rates to go down.
Speaker 1 (06:16):
As you say, though, it does mean that some companies,
well all companies are gonna have to pay more to
service that debt, that's right, and more than they're expecting.
And a lot of them are expecting rates to come
down significantly, which was you know, the rates of dubvish
expectation became in this year beginning with you know, the
rates would just drop. How much of the market is
in trouble if rates, you know, just glide and maybe
(06:39):
they stay where they are right now.
Speaker 3 (06:40):
Well that's a good question, right, And so the thing
about the market right now is the quality is very high.
So we had an interesting dynamic with COVID because usually
I always say that the recession is the cleansing event
of the market, but we had a cleansing event before
a potential recession with COVID. Right, So in high yield
default rates near seven percent and loans default rates or
four percent. And if you think about those companies that
(07:02):
defaulted during COVID would have stumbled along without COVID until
the next recession, then they would have defaulted. So whatever
recession comes, now you've pulled forward a lot of these
defaults and those week companies have left the market. The
other thing you have is you had this inflow of
money into credit and so you know, you kind of
think about twenty twenty three. You take the highield market
(07:24):
as an example. In January twenty twenty three, yields were
near nine percent and spreads were near six hundred, and
six hundred is an abnormally widespread and so I remember
going to a lot of people saying you should buy,
spreads are wide and never say no, I'm waiting for
one thousand, And I would joke that, you know, mathematically
you can't get to a thousand spread for the market,
and half the market's double b It doesn't make any sense.
But it was a debate, so not everybody agreed, and
(07:45):
that's fine. Then you fast forward to October of twenty three.
Spreads had gone down from six hundred down to four hundred,
but the yield is still nine turns out, spreads go down,
rates go up, you know, and all of a sudden,
I think there was a light bulb in the moment
for the market where they said, oh my gosh, I've
been waiting to tie my entry. Now I'm gonna buy
for the same nine percent I could have bought in January,
but I missed ten months of clipping nine percent, and
(08:07):
all this money came pouring into credit the fourth quarter
of twenty twenty three, first quarter twenty twenty four. Well,
that does a few things. When money comes in. I've
always learned that supply follows demand, not demand following supply.
If you show up with money, bankers will find something
to sell you.
Speaker 2 (08:22):
And so as.
Speaker 3 (08:22):
Money came pouring into credit, you saw all these companies refinance.
And so most people when they think about defaults and
when they think about stress in the market, they'll point
to the maturity wall. That's your hint of what could
be in trouble because the companies haven't fre financed yet.
And if you hit a weak patch in the market
and you can't refinance, you after restructure. But when all
this money came in, it pushed out the maturity wall.
(08:44):
So for twenty twenty five, less than five percent of
bonds and loans are maturing. It's deminimous the maturity wall,
and so that takes a lot of default risk off
the table that was in place before this money came in,
and so it kind of makes the market help there.
The other thing, you know, when you think about risk
in the market, you know, I'm.
Speaker 2 (09:03):
A liquid guy.
Speaker 3 (09:04):
Like to talk about liquid credits ever, and it's like, oh,
you must hate private credit, and I'm like, I love
private credit. They're buying all my risky stuff and taking
it out of the market. And so private credit has
had a bonanza, and you know, to be fair to
private credit, which I'm not always as a liquid guys,
there's some really amazing pockets of private credit and amazing
opportunities of deals to do, like rescue financing. But it's
(09:24):
a very big market and so there's also some places
where you know, you're seeing the discipline go down and
you're seeing risky deals that can't get done on the
liquid side get absorbed on the private side because it's
a way for them.
Speaker 2 (09:36):
To deploy capital.
Speaker 3 (09:38):
Well, again, that's an example of a deal that may
have defaulted but now won't because it got refinances. So
it's going to have at least five more years before
potentially defaults, and if it does, it'll be in another market.
So you've had a couple things that have made our
market healthier, you know, COVID taking defaults early, You've had
new money come in to refinance things, and you have
private debt start to absorb in that combination, in my opinion,
(10:02):
makes this a much more likely benign environment.
Speaker 4 (10:05):
I'd like to drail a little bit on the view
that the COVID that cleans the market and the you know,
weakest companies have been taken out of the market. Moody's
publishes their list of companies in B three negative and below,
and I think it's you know, currently they're seeing about
(10:27):
fifteen percent of high issuers are in that category, which
is kind of you know, in line with the long
term average, so that you know, points to definitely.
Speaker 2 (10:36):
Not a deterioration.
Speaker 4 (10:37):
However, in the past two quarters they've seen an improvement
and an increase in this UH in this ratio of
companies in that weeker past of part of the credit market.
And what I wonder is have companies for some of
them kick the can down the road by doing some
restructuring and and that you know, sort of buying some time.
(10:59):
It's officially into sort of you know weak single be
treple C category that we could see you know, maybe
in a year or two come back and you know,
having to you know, refinance or having facing some some
difficulties again.
Speaker 3 (11:15):
Yeah, no, I think you're referring to liability management exchanges
l E or as people like to say lender on
lender violence, and the short answer is yes. Right, So
if you look at quality of the market, what you'll
see as well, the double the weak single bee may
be growing, the triple C is lower. Right, So the
triple C is the lowest for high yield to triple
(11:36):
C is the lowest we've had in a decade. And uh,
and so I think overall you still have a better quality.
And the double b's the largest has been in a decade,
and so that's very strong. And on the loan side,
you were seeing the week single be grow and now
it's shrinking to some degree as it as.
Speaker 2 (11:52):
It goes public to private.
Speaker 3 (11:54):
But you still have some companies that are stressed. Right,
there's always some cohort of companies that are stressed. And
what you see these days is so you take a
company that got financed.
Speaker 2 (12:03):
To in LBO.
Speaker 3 (12:04):
Those are always the riskiest deals, right, leverage buyouts, private
equity sponsors and maximizing levers to drive an eternal rate
to return. And in twenty eighteen, twenty nineteen, when you
did an LBO, you know, and you know this will
show you my cynical nature, But I'm a bond investor.
So I like to say professional pessimist, not cynic. But still,
if you look at what happened, in my opinion, the
(12:25):
model was, it doesn't matter what I pay as a
private equity sponsor because I have free money to finance it.
I just need to pay enough to win the auction
against my competitors so I can deploy my capital. And
so if you look, multiples were just steadily creeping higher,
and they were doing it with floating rate debt. And
this is the part that's always fascinating to me because
I used to be a lender a couple decades ago.
(12:45):
When I was a lender, I was a junior lender,
and the credit deputy at the bank would not allow
me to make a loan unless the borrower hedged half
its baring costs. That was the rule of the bank
because back then, if you were a bank and you
wanted to syndicate the loan, you could not do so
unless you were willing to hold some on your balance sheet.
That was, no one would buy it from you if
you weren't going to own it yourself. And so that
(13:07):
was the rule because the bank's actually cared if you
could pay the loan back because they owned it. Now,
generally banks don't sit on the loans, they syndicate the
whole things. They don't care if you can pay back,
and so that requirement's gone away.
Speaker 2 (13:18):
And so a couple of years ago when.
Speaker 3 (13:20):
I had this epiphany, I remember going to our portfolio
manager of our loan strategy to say, okay, the loan
market's not required by the banks to hedge, but you
got private equity sponsors. They're financially savvy, record low rates,
surely a lot of them must to Hedge's not exactly
expensive or complicated to do. And so he checked and
it turned out about twenty five percent hedge.
Speaker 2 (13:40):
Twenty five percent.
Speaker 3 (13:41):
It's funny today you talk to people that said, no,
over half the market's hedge. I'm like, great, well, if
you hedge a five percent SOFA, I'm not really sure
what that means. But when SOFA was zero to one,
nobody was hedging, and they were all maximizing leverage with
these LBOs. And so those are the companies. Now the
barn costs is doubled, and some of them are now
going to have to struggle. Rates don't quickly go back
down to deal with paying for that interest, and so
(14:04):
that's where you see these lmes, which are equivalent to,
in my opinion, of an out of court structuring. You're
not going through bankruptcy, but people are memorializing a loss
and exchanging their debt into new It's effectively.
Speaker 2 (14:17):
The same thing.
Speaker 3 (14:18):
The big question is do you cure the problem? And
a lot of times I think the answer is no,
because the pain required to cure the problem. Nobody wants
to be the one to take the pain. They're like, yes,
pain needs to be taken, you should take it. I'll
be I'll keep my position intact. And when everyone's pointing
fingers at each other, you end up negotiating a deal
that often doesn't fix the problem. It kicks the can
(14:39):
to your point, which means a couple of years from now,
these companies are still.
Speaker 2 (14:42):
Going to be levered. And it's a symptom.
Speaker 3 (14:45):
Of you know, I remember, around the time of COVID,
before rates start going higher, I was having a conversation
with a strategist where I said, I'm starting to worry
that leverage is creeping higher, and the strategy said.
Speaker 2 (14:55):
Why are you looking at leverage? Look at interest coverage.
Speaker 3 (14:57):
You know you can have high leverage because it's it's
free money and you can just support it. And I'm like,
that's fine on a day to day basis, but eventually
you got to pay the money back.
Speaker 2 (15:04):
How is nobody thinking about that?
Speaker 3 (15:06):
And now that day is here, and so I think
that's what you're starting to see. So again, this is
why I think we're in a credit pickers market, because
the yield's already high. I tell people all the time,
we don't need to be a hero. The yield is
already high.
Speaker 2 (15:18):
We just have to keep it.
Speaker 3 (15:19):
And if you're better at keeping the yield than other people,
you're going to do quite well because the companies that
can pay have to pay. So, you know, everyone says, well,
the covenants.
Speaker 2 (15:28):
Are really weak cross credit. Very true.
Speaker 3 (15:30):
That's why we have this l ME because the covenants
allow it. And everyone's like, well, how do you know?
Speaker 2 (15:36):
You know which you know?
Speaker 3 (15:36):
Do you go through the covenants, which of course we
do to kind of protect yourself from l ME and
a sad Well, the truth is most companies can do
an l ME today. The covenants are what they are,
you can't change them, and they're generally weak. The reality is,
if you have a healthy credit and you try to
do an LME. The covenants may allow it, but you know,
you take high yield. Again for an example, the average
leverage in a high credits four times if you're four
(15:59):
times levered. And so when comest and says, hey, I
want to do an LME and I want you to
exchange in this new deal at fifty cents on the dollar,
you say, well, no, I don't want to do that.
And by the way, you have the right to just
sit on what you own and when it matures, they
have to pay you back. If they're solvent, and most
companies are four times lever it'll be solvent. If you're
ten times levered, then you get to go and say, hey,
(16:19):
I want you to do this exchange. If you don't,
we're going into bankruptcy. And you actually have a stick.
And so the weaker credits are the ones that can
get this down. The rest of them, the market will
just say no.
Speaker 4 (16:28):
And talking about those weakest credits, he's it a part
of the market that you're interested to invest in because
when they are when it comes restructuring time, and you know,
sometimes misity gets capital from outside. I mean, is that
an area of the market that could be of interest
where arguably could be you know, outsize earning.
Speaker 3 (16:47):
For sure, I always like to buy what people don't
want to buy, and so you know, I always caution
this with you know, my job and clients come to
me to get buy things that will pay. So I'm
not looking to take equity in companies and takeover companies
is a whole different strategy. It's distressed or people are
very good at that, but it's a different skill set.
My skill set is to find companies that can pay
(17:09):
or structure securities within companies that are struggled where I
know I'm going to get paid back and so if
and when that area starts to heat up, yeah, we'll
be looking at that. I expect we'll get a lot
of competition from private debt because that's one area where
probably can more efficiently structure, and so you're going to
see a lot of what they call rescue financing. I
think of the private debt market. I think that's going
(17:29):
to be one of the greatest opportunities we've seen in
a decade. And it'll be for these companies that need money,
and so you'll have people come from both angles. But
it's always great to be a liquidity provider and people
are desperate for liquidity, you tend to be able to
get very good terms that way. It tends not to
last for a huge, huge amount of time, so you
have to be ready. But it feels like that part
of the cycle is coming.
Speaker 1 (17:50):
But to be clear, that means that companies that are
struggling and they would otherwise doing that, lem me, the
private detmarkt is just going to go directly to them
and do it by natural loan to help them out.
Speaker 2 (18:00):
Yeah, so think about it.
Speaker 3 (18:01):
Think about the options a company has. So you're looking
at a near term maturity and you have a balance
sheet that's two levered, so you can go to existing
creditors and say, hey, I want you to exchange into
a new loan or new bond, and now I've extended
my maturity, so I deal with a short term maturity,
and I want you to do it at fifty cents
on the dollars so I can delever and there will
be a negotiation. Or you go to a private lender
(18:24):
and the private lender says, okay, because the covenants are
so weak, I want you to take some of these
assets away from creditors. Give it to me, I'll give
you new money, and now you take that new money
and pay off the short maturity and go in the
market and buy stuff back at a discount and try
and get your debt discount that way. And so it
becomes the negotiation between between the two parties as far
as which way you're going to do. Most companies lately,
(18:45):
I've observed prefer as to go They'll use the private
side as a negotiating stick, but they'll prefer to go
with existing lenders.
Speaker 2 (18:52):
Is much more efficient.
Speaker 3 (18:53):
You know, you get an exchange versus having to go
buy everything in the market, and so that generally is
how it goes so far, does it? I mean, that's
how it'll go going forward. But those are the two
types simplistically types of deals.
Speaker 1 (19:04):
But the private lend is the way of talking to
about that kind of business. You know, they're talking about
high double digits correct twenty percent, you know, which is
great for the investment, but hell sustainable full of the bloo.
Speaker 3 (19:15):
Well, so it depends on how much debt discount they're
capturing at the same time, and so you know the
other again back to my cynical nature. You think about
a rescue financing if a company is truly run out
of money, you know the balance sheet is stretched and
they're going into bankruptcy. You look at the private equity
sponsor who probably owns this company. You say, here's the deal.
(19:37):
I will give you five years a runway to try and.
Speaker 2 (19:39):
Figure this out.
Speaker 3 (19:40):
It's going to cost you, but what do you care.
Your option is to throw away the keys and get
wiped out.
Speaker 2 (19:44):
So you're going to pay.
Speaker 3 (19:45):
And I'm only going to do this if i can
layer everybody else. I'm in the very safest part of
the balance sheet. So if you work it out, then
I get a good return. But if you don't, I
still have a debt claim that's going to be protected
because everyone below me is going to take the loss.
So that's your simplistic rescue Finnis. So it's very expensive,
but it's pure optionality. And so if the cycle turns
and if rates go down, or a company or industries grow,
(20:08):
whatever it may be, the company grows into its balance sheet.
But that's why, to Johnny's point, before a lot of these,
you'll take on this new debt. It'll give you a
couple of years a runway, and then you'll be right
back where you started, if you haven't done something to
grow with the new money, and then you're still you're
still going to be struggling, and.
Speaker 1 (20:24):
It dons the opportunity that you see. You're talking about
a big opportunity over the next ten years. I mean,
is it the sectors? Is it particular types of companies
that you're looking at in this regards?
Speaker 3 (20:33):
You know, for for this type of stuff, it'll be
the sectors that were more LBO heavy, and so, you know,
you think about technology, healthcare, you know, sectors where you've
seen more LBOs.
Speaker 2 (20:45):
That's where what my sense would be.
Speaker 1 (20:48):
And it's an opportunity right now that you see for
oak Tree.
Speaker 3 (20:52):
I think, so it won't be for all parts of
oak Tree, but I think that you know, we have
a big private debt business and distress business, and I
imagine those guys can be very act.
Speaker 4 (21:01):
Moving on to maybe the impact of the recent election
could have on some of the industries that we imagine
you invest in. And going back to that statistic, which
I think is quite interesting. On this Moodys B three
negative list, the subsector that has the highest representation is
earl and gas I think of twenty one percent, and
(21:21):
I wonder is there an opportunity there considering potential changes
to regulatory environment to you know, invest in that part
of the market, as those companies are currently stressed but
might actually benefit from an improvement in the our parting environment. Going.
Speaker 3 (21:38):
Yeah, so think of the thing about oil and gas.
You got to think about volume and price, right, and
a lot of these regulatory changes people are expecting. Is
two big things people are expecting from the Trump presidency.
Speaker 2 (21:51):
In the oil business.
Speaker 3 (21:52):
You have the drill, baby drill, so a lot more
supply and as they release restrictions and allow more companies
to drill. And you have the claim that the rush
of Ukraine, you know, whole crisis will be ended very
very swiftly and shortly. Well, both of those add supply
to the market, which bring prices down. So you have
(22:12):
to think about that, which is, you know, oil prices
and theory should come down. Gas prices should come down
if there's more supply without and you know a you know,
increasing demand at the same time. And so I'm a
little more cautious. You know, it goes back to kind
of you know, I like to be controller and I
like to buy energy when everyone hates energy and I
like to sell energy when everyone loves energy. The thing
about energy, you know, it's an above average risk sector
(22:35):
because you have this unknowable which is what's the price
of the commodity going to be tomorrow, which is so
important to the profitability of every company in the sector.
And so for me, I'm okay to buy above average
risk things. So I invest in blow investment grade for
a living. But I always say, if you're going to
go into something that's above average risk, you should get
above average reward. Most people don't fight me on that,
And so to me, when you have periods like COVID
(22:58):
and oil goes negative for a period of time and
everyone's convinced you'll never use fossil fuels ever, again, we're
aggressively buying higher quality energy names that are a creative
to our portfolios. And you have today days like today
where oil is hovering around seventy and everyone's convinced no,
nothing will ever go wrong and energy again, and it's
dilutive to the portfolio. I'm a better seller because if
(23:20):
I can sell an energy name and buy anything else
that doesn't have that kind of volatility but has the
same yield, I should do that. And so that to
me is kind of how I treat the sector. And
so if I'm right and energy prices start to weaken
because of these policy changes, then we'll probably start looking
to where we can buy some higher quality stuff.
Speaker 4 (23:41):
Away from energy. I mean, do you have any sectors
or subsectors industries that you like and don't like from
any investments than born right now? Yeah.
Speaker 2 (23:49):
So it's funny.
Speaker 3 (23:50):
I'm a credit guy, so I was like to talk
about what I don't like versus what I do like.
I mean, the reality is, in the end of the day,
you buy credit for their contractual income, and so there's
nothing is going to double and triple and value.
Speaker 2 (24:01):
It's all about picking what can pay.
Speaker 3 (24:03):
And so we talked about energy where I'm shying away,
you know, the other sectors where I'm really cautious these days,
or anything that's consumer discretionary spending dependent. Because we talked
about the weakening and the low end consumer and the
potential for that to spread, and the reality that rates
do stay a little higher for longer that does start
to stretch a consumer. You know, it's funny people talk
(24:24):
about inflation. They say, well, inflations come down, and ours
remind people. Inflation is a rate of growth. The rate
of growth has come down from nine percent to two
to three percent, but that's still growth, which means that
prices people are paying are a good twenty percent higher
than they were pre COVID, and that really stretches a consumer.
And it's not coming down, it's just going up slower.
And so in that type of environment, I start to
(24:46):
worry about sectors that are dependent on consumers continuing to
spend discretion on discretionary at an item. So specialty, retail, automotive,
things that people can buy but don't need to buy,
is an area that I'm very cautious on.
Speaker 1 (25:01):
I just want to go back to something you said
about credits from credit of violence. Yeah, it's an interesting topic.
We've talked about it a lot on this show. We've
ranged from opinion that it's just the law of the land.
It's part of capitalism at work too. It's terrible and
you know, the only winners of the lawyers. Do you
see an opportunity there? I mean, how do you like
factor it into your investment decisions? You know, given that
(25:22):
you think that it also leads the company in worse shape.
Speaker 3 (25:25):
It can you know, some of these will work, and
a lot of them I think won't. I think the
reality is, you know, we spend a lot of time
on covenants. Not everybody does, and so to me, it's
always you know, you should never you know, come in
you know the covenants when you when you read them,
you know generally you go into an indenture. There's generally
a standard package in the market. It changes from day
(25:48):
to day, but if you read enough of them, you
know what standard. And if a company strays from the standard.
They don't do it for sport. They have to pay
lawyers a lot of money to do it. They do
it for a reason, which means that there is literally
a roadmap of exactly what the company is going to
do if things go wrong, if you're willing to read it.
And the problem is a lot of people don't because
you could have a sentence, it goes a whole page
and it's boring, and so that's a bit of an
(26:10):
efficiency in the market in my opinion. So we spend
time on this, and I do that on purpose because
I want to know if things go wrong. You know,
a how likely is it the things are going to
go wrong?
Speaker 2 (26:20):
And be if they do?
Speaker 3 (26:21):
Am I okay with it because I have all the
time when something will go wrong and people be like,
I can't believe the sponsor did equiz and I'm like,
how could you not believe they told you before you
bought it that this was exactly what they're going to do,
and so you need to know. And so I do
think it creates an opportunity, but maybe not in the
way you're thinking, which is to me as a credit investor,
if I can avoid problems and everyone else has to
(26:42):
own them, that's generally the best way to outperform. And
so I love having things in the market that can
blow up that I can choose not to own.
Speaker 2 (26:49):
And this is a big area of that.
Speaker 3 (26:52):
Had a client ask me not too long ago, like
how do you protect yourself against all this l ME?
Speaker 2 (26:56):
What do you do?
Speaker 3 (26:57):
And it's an interesting question because covenants are what they are.
You cannot change them. You can't amend covenants. You know,
in the middle of the life of a security, nobody's
going to do that. And so if the covenants allow
for an lme's that's it. There's nothing you can do.
And so and you can do like people form co
ops and it's it's an effective strategy is basically what
(27:18):
they'll do is it's like a non aggression pack. So
in the original form of lm ME, you would have
a company that would go to the creditors say, hey,
it was kind of a prisoner's dilemma. I want you
to exchange at fifty cents on the dollar to this
new first line. If you don't do it, I'm gonna
cram you into a third Liane. And you have twenty
four hours to tell me if you're in or out,
and there's this big panic, what am I going to do?
And everyone just rush in and so to avoid that
(27:40):
credit what creditors or creditors are now doing, which I
think is smart, is locking arms early before an LME
is formed. They'll or announced, they'll go to the company
and say we've formed a co op. We're all voting together.
So this whole twenty four hours trying to cram that's
all over. They can still do the LME, by the way,
they just have to actually be an adult and have
a conversation about it, and then they can do it,
(28:02):
but it doesn't change the end outcome tremendously. And so
to me, the biggest protection of this is doing your
credit work, which is like we talked about before, if
you have a performing credit and you own it and
you know it's going to perform, they can announce whatever
LM they want. I don't care because I know that
I can sit on my security and it's going to
payback on maturity. That's really the only defense you have.
(28:24):
And you know, when it's funny because I talk to people,
they are like, you're right, I'm going to focus on
credit now.
Speaker 2 (28:28):
I'm like, well, it's too late now, Like you have
to have done this a.
Speaker 3 (28:30):
Couple of years ago to make sure you have a
portfolio that's in a good place today. Otherwise, when you
go to sell the risky name, it'll be priced in
that everyone knows the lem risk is there.
Speaker 2 (28:38):
But that's the key.
Speaker 3 (28:40):
If you're good at credit, you're going to have less
of these and that should show in your performance.
Speaker 4 (28:45):
Peeking up on the topic of red flag such as
we Covenant package, we've seen, you know, more of the
kind of alternity financing solution being put in place recently,
such as payment in kind. Is it a red flag
for you?
Speaker 2 (29:00):
I think it is.
Speaker 3 (29:01):
And so you know, when you think about the whole
construct of a pick is because the company can't afford
to pay, and that should tell you something, right, And
so now there's two ways to do it. There is
the payment in kind at the onset. So, hey, this
company's a little bit too levered, I'm going to do
fifty percent cash pay, fifty percent pick or a lot
of It'll do like a pick toggle. I'm not going
(29:22):
to pick now, but I have the option to pick
if things get really tight. That's still to me a
flag of stress. But it's different than when you have
a company that you know, quite frankly, you look at
like the private debt market. I had this conversation with
our CIO recently where I said, you know, I'm worried that, uh,
there's a lot of stress building in the private markets
(29:43):
because you're seeing all these risky deals in public markets
get out. In the private markets, you're going to see
the faults. And the comment that came back I thought
was really interesting where he said, well, you never see
a default in private debt. You just pick the interest
and extend the maturity. And I'm like, well, what's the difference.
You're not getting paid and the difference is you don't.
Speaker 2 (29:58):
Have to call it a default.
Speaker 3 (30:00):
That's actually become pretty important. And so I tell people
all the time, if you want to look at the
health of the private market, just look at BDCs.
Speaker 2 (30:09):
And you know, I believe it.
Speaker 3 (30:11):
Was Barkley as It did a study of this recently
where they said, if you go back to twenty eleven,
the average across all BDCs, the average pick was about
two percent, and if you fast forward to today, the
average pick is over ten ten percent. Pick that is
ten percent in trouble. I haven't seen a level of
stress like that since the global financial crisis is shockingly high.
(30:32):
But the other thing he pointed out to me is
you think about what that actually means is, if you're
a BDC, you have to distribute ninety percent of your income.
Speaker 2 (30:39):
How do you do that?
Speaker 3 (30:39):
If you're picking in the hypothetically eleven that becomes a challenge.
Speaker 2 (30:44):
And I asked a BDC expert about that. So what
do you do? And you saw it's easy.
Speaker 3 (30:48):
We borrow, Oh my god, because that never goes wrong.
You just borrow to pay a distribution. And I'm like, okay,
but barring capacity is not infinite. What happens when that
runs out? They said, oh, we take our best assets
and sell them at a discount to another private life.
So I'm like, okay, so now you've got a shrinking
fund with that verse election and growing leverage.
Speaker 2 (31:04):
What could go wrong?
Speaker 4 (31:05):
Now?
Speaker 3 (31:05):
The answer is, you know, I got all excited. It
is going to be the next ground of opportunity. But
it'll take years because you know, it's all locked up
money without marked to market, so you're not going to
see it until the fund actually ends.
Speaker 2 (31:16):
But again it goes back.
Speaker 3 (31:17):
To not all private credits the same, not all public
credits is the same. If you're good at picking credit
in private credit, there's gonna be some great things to
do and you're.
Speaker 2 (31:25):
Going to have a great return.
Speaker 3 (31:26):
If you're just buying the market because of the explosion
of supply then or explosion of demand, sorry, then you
may find that you're going to have a lot more
deals that you have to turn to pick and so
you'll be able to see the good and the bad
just by looking at that statistic, in my opinion.
Speaker 1 (31:40):
And you do expect that to get worked.
Speaker 3 (31:42):
I do, yeah, I think that. Again, it's a credit
pickers market, not just for publics. It's very much a
credit pickers market for privates. If you're a good credit picker.
Then you get paid extra for going into the private market.
It's a great deal, but you'll see a divergence of
that market of the haves and the have nots.
Speaker 1 (31:58):
Yeah, what about rates coming down? The economy booming and.
Speaker 3 (32:01):
The trees grow into the sky and rainbows and everything amazing,
you know, I think it's it's not as I'm a cynic,
So I guess you got to take this with a
grain of salt. But no, I think that the economy
is already in good shape, and I think, so you've
got to have to start with that baseline. But you know,
I think the rate picture coming down is going to
(32:22):
be slower than the market hopes. And because it's just
the economy doesn't need it. You know, everyone's like, well
what happens if you know, if you don't stimulate the economy,
and you're like, where's where's the economy screaming for stimulus?
And so I think that's going to be slower. But
I don't think that creates a huge crisis because generally
the economy is okay and generally credit is high quality.
(32:43):
There'll be pockets of credit that will stress be stressed
if but they're small as a percentage. You know, the
dollars there may be large because the markets are you know,
trillion dollar markets.
Speaker 2 (32:52):
But uh, but I think you're in.
Speaker 3 (32:54):
A baseline of a pretty stable economy. But I don't
expect massive growth from here. I think you know, it's
gonna you know, the growth rate has to slow.
Speaker 1 (33:04):
Okay, but there will be stressed in the private credit market,
which is growing and if you correct in what people
are calling, you know, the asset based finance boom, which
according to a polo takes it's forty trillion, and it's.
Speaker 2 (33:16):
A very interesting area.
Speaker 3 (33:18):
Honestly, you know, when whenever banks step away from an
area usually creates a huge opportunity. But you are right,
there's a lot of money. Howard Marx taught me many
years ago. When markets grow this fast, you buy what
you can, not what you want to, because deploying capital
becomes the chore, and so you do have to be
very picky. But I always caution people because I've seen
this so many times in the public markets too. It
(33:39):
doesn't mean the whole market is bad. It just means
there are gonna be a lot of players. If you
just hung a shingle a week ago, and said I'm
going to start a private credit fund, You're probably gonna
have a lot of trouble in your portfolio. You've been
doing this for ten or twenty years, you'd probably be okay.
Speaker 4 (33:52):
Ibe moving on from from the credits that are a
little stressed into the better part of the market. The
double b's, I mean double b's, you know, currently generate
some tractive yields. Do you think it's a credit trade.
Speaker 3 (34:08):
I've been underweighting double b's, and so you know, the
thing is that right now it became less of a
credit trade and more of a duration trade. Is that
the double b's tend to be longer duration, and everyone's
convince rates we're going to go down, so they're all
going heavy on double b's. But the other thing is,
you know, we've been in a massive risk on rally,
massive risk on rally, and so a lot of people
(34:29):
saying the only way you can hope to keep up
is to buy triple c's. You have to buy triple c's.
And I never like them when anyone tells me I
have to do anything but buying triple c's for the
sake of buying triple c's never made a ton of
sense to me, and so we looked at it and saying, well,
triple c's is a bet on growth. We've seen a
lot of growth. But if money's going to stay expensive
higher for longer, directionally, that means you're it's going to
(34:51):
be harder to finance growth, so you should see less growth.
I think that formula is pretty straightforward, So I'm not
really excited about making a big bet on growth from here.
I don't think the economy falls apart, but I also
don't think it's going to grow from here in a
dramatic way in this environment, and so I'm not rushing
into triple c's.
Speaker 2 (35:07):
But if you think.
Speaker 3 (35:08):
About designing a portfolio and you want to bring the
average yield up, there's two ways to do it. You
can chase really risky stuff or own a lot.
Speaker 2 (35:16):
Less of the safe stuff.
Speaker 3 (35:17):
I prefer prefer to do the latter, because if I
believe we're very good at credit, and I think, you know,
oak Tree's got the best credit team in the world,
then I think we can go to that credit team
and say, hey, go from double B to single B.
You're gonna bring your yield up without increasing your default risk.
Because not every single Bee company is on the verge
of default, whereas you go to Triple c's a it's
(35:37):
a lot of default risk and so it's been to
me a better trade lately.
Speaker 2 (35:42):
So that's kind of how I view it.
Speaker 4 (35:44):
And what about investment great, I mean we're seeing credit
spread is coming tighter and tighter. Yes, I mean it's
totally a different logic there. But I mean you see Pucket,
so opportunity tis there as well.
Speaker 3 (35:55):
Yeah, I mean, you know, look, the yield is attractive
right relative to the risk you're willing to take. So
I think our chairman wrote a memo recently where I
think it came to asset allocation, and it starts with
how much risk are you comfortable with? What can you tolerate?
And I think that's always the right place to start.
You start with the risk and then say, you know,
you don't force the yield, and then say this is
(36:15):
the yield I need, and then force the risk. That's
when you get into trouble. You start with this is
the risk I can take, this is what I can tolerate,
and know that I'm not going to sell at the
wrong time, and then what yield does that deliver? Well,
it turns out that across credit that yields a lot
higher than it was four or five years ago. And so,
you know, investment grade yielding five six percent pretty attractive
for people in some of their needs. I think, you know,
(36:37):
I yield at seven eight, even more attractive, but more
with more risk, you know, a multi strategy eight or nine.
But again, you know, you continue to say how comfortable
with your risk? You know, private debt you can get
double digit and so a lot of this depends on
the risk. So for people that need a bucket of
low risk capital, turns out that low risk capital can
deliver a pretty reasonable income.
Speaker 2 (36:58):
I think that is attractive.
Speaker 1 (37:00):
Another thing that people are very excited about from you,
attentially from the next administration in this country is merges
and acquisitions.
Speaker 2 (37:07):
I love new supply thankers.
Speaker 1 (37:09):
I always talk about it is if it's you know,
it hasn't really transplied, it hasn't really ploted through. But yes,
new supply on the one hand, but then risk in
the tons of LBOs on the other. True, what do
you what do you expect from the M and A lens?
Speaker 3 (37:20):
I expected to pick up and you know, I've been
hearing the same thing from bankers. I think the reality
is that we had a pause in LBO activity because
of the election. A lot of companies saying, well, I
want to do deal, but I'm not doing it till
I know what regulatory environment I'm stepping into, and so.
Speaker 2 (37:38):
I'm going to wait.
Speaker 3 (37:39):
Well, now we know, and we know that the environment
should be less regulation, not more. That seems to be
pretty well accepted view, and so you would expect M
and A to pick up from here. But you also
have to remember there's a seasonal aspect of this. Thanksgiving
comes around, the market tends to get very quiet. Christmas
break comes around, the market comes gets very quiet. Bankers
(37:59):
and pretyarticular of a regulatory requirement to take a two
week holiday, and a lot of them do it during
the Christmas holiday, so that slows everything down. So we're
seeing a bit of a pickup of activity this week
because people trying to get it in before Thanksgiving. And
then you might see one more week of activity after
Thanksgiving and I think it gets dead. But January comes around,
(38:19):
I think you're gonna have all this pent up demand
that now is going to come to the market. So
we should see a pickup in M and A. And
the thing about M and A it does add risk
for certain deals. Not every deal is a bad deal,
but absolutely will be some. But it's net new supply.
So it's one thing to refinance. But when you're refinancing,
you're taking oftentimes you're taking a bond you already own
or a loan you already own and exchanging it for
(38:41):
a new one. So it's net neutral. M and A
is usually new supply, so it creates a little bit
more of a demand, it takes more cash out of
the market. That makes pricing a lot more efficient, and
so it's usually generally a healthy thing.
Speaker 1 (38:55):
We are international audience. You're sitting to Europeans here, what
yea out there in the world of Pelton the US
are you're looking at in terms of investment opportunities?
Speaker 3 (39:04):
Yeah, so, well you look across the globe and right
now you kind of you when you think about credit globally,
what I would say US versus Europe, it's generally from
size kind of seventy five to twenty five US Europe.
And that's true for loans and bonds, which means so
Europe is a smaller market, is a little less liquid,
and so you should get paid a premium for that.
(39:27):
Anytime you sacrifice liquidity, you should get paid a little
And so you know, I've been doing global portfolios for
about a decade and you know, the rough rule of
thumb is you get paid fifty seventy five basis points
additional yield you go from US to Europe, and it's
it's a good trade. And so there are periods like
you know, a couple of years ago when Russia is
(39:47):
going to turn off natural gas to Europe and natural
gas goes into electricity, electricity goes and everything, and it
was going to be armygedin and you were getting paid
over two hundred basis points to go to US from
the US to Europe, which is last time I saw
that was gregsitt Or the global finance crisis, and that
didn't feel that bad, and that was an opportunity and
we were buying. Today the pickup is very low. It's
(40:08):
almost a parody because there's debates of who's going to
have rates go down faster, US or Europe. And so
I've been leaning more towards the US if I don't
get that pickup. I've found that, you know, the European
loan market seems to have a little more pickup than
the US loan market because clos are a big buyer
in the loan market. They tend to buy about seventy
percent of the market in the US. And there's more
(40:28):
aggressive COLO creation in the US than Europe, so that
creates more demand. And there's a bigger etf retail presence
in the US market, so that creates more demands. So
the lack of demand has a little bit better pricing,
so on the marginal like that you know we do
when we look at things like em EM, we go
back to again being credit pickers. I don't come in
saying I want exposure Russia or I want exposure to China.
(40:50):
We go in looking for credits that you know, frankly,
are good good houses on a bad block. Right So
it's a company that if it were in any other
country would be investment grade, but because it's in X
y Z country, it's high yield and we'll look at those.
But right now we're not aggressively pushing into em because
you can get such a good yield and develop markets
(41:11):
that you don't need to be a hero.
Speaker 2 (41:12):
So we're being pickier right now.
Speaker 1 (41:15):
And when you look at everything across the board. Where's
the best relative value, where's the best opportunity for you
right now?
Speaker 2 (41:21):
Right now?
Speaker 3 (41:21):
Across the board, We're really like structure credit, colo debt.
I think w B clos are very attractive, and you know,
I also kind of you know, I like say, boring
is beautiful for bonds, and so you know, we like,
you know, just regular way loans and bonds where you
can just clip a good income, right you know, that's
really the key right now is just where can I
lock in a good income? Because you know, everyone's convinced
(41:44):
that everything's going to go amazing, Well, it's going to
be all this growth equities until today we're on fire.
And you know, in those kind of periods that I
kind of look around, like there's lots of things that
could cause the market to hiccup, you know, whether it
be rates that we've talked a lot about, whether it
be you know, the ultimate outcome of policy from from
the new from the recent election in the US, whether
(42:04):
it be ge politics.
Speaker 2 (42:05):
There's lots of things you can point to.
Speaker 3 (42:07):
You only need one of them, but there's plenty of
things that you could point to. And so in those
environments where nobody's worried. I tend to worry, and so
I like to kind of lean towards locking in my
income and waiting for a little more volatility.
Speaker 1 (42:18):
You mentioned rescue finance is a huge opportunity as well. Yeah,
you know, is that everything in rescue finance.
Speaker 2 (42:25):
I think, you know again, it's gonna be.
Speaker 3 (42:26):
It's gonna be like anything. There's gonna be some really
good rescue finance and really bad rescue finance, and you're
gonna have to be good at picking. And if you're
good at picking, I think there's gonna be some really
good risk adjusted opportunity. It's gonna have to be patient.
It's not gonna just come flooding in. You're gonna have
to wait because companies are gonna have to be desperate,
and it will be market dependent because if money keeps
(42:47):
flooding into the market and companies keep finding ways to refinance,
and they won't need rescue financing. So it's gonna, you know,
take some time to evolve. But I do think they'll
be good and bad.
Speaker 4 (42:57):
Strong created skills, a bottom up of approach, and a
lot of setic tvts that seems a recp for success.
Speaker 3 (43:04):
I agree, and being contraran that that is key.
Speaker 1 (43:08):
But what's the one thing that worries you?
Speaker 3 (43:11):
Ah, I'm a professional worrier, So what worries me the
most right now? I mean we kind of talked about before.
I worry the most that nobody's worried and that, you know,
everyone's convinced trees are going to grow to the sky
and everything's going to be perfect and we're going to
see all this growth. I am bearish on growth because
I think money's going to stay expensive a little bit longer,
(43:32):
and so I do think that cuts into growth. I
do think geopolitics is a little bit underplayed. We'll have
a flare up for a day or so, and then
everyone will convince themselves that it's it's all fine. I
kind of say, it's like violence on TV. Everyone's getting
desensitized the volatility in the markets, and so used to
be if you saw a ten or twenty basis point
move in the ten year and a day, you would panic,
And now that's just another day. And so I do
(43:54):
think that's where I focus most of my attention these days.
Speaker 1 (43:58):
Great stuff. David Rosenberg, head of liquid performing credit at
oak Tree. It's been a pleasure having you on the
Credit Edge money. Thanks, thank you, and of course we're
very grateful to John eve Coupan from Bloomberg Intelligence. Thank
you so much for joining us today.
Speaker 4 (44:09):
Thank you all for a pleasure for more.
Speaker 1 (44:11):
Credit market analysis and insight reader all of John eve
Coupan's great work on the Bloomberg Terminal. Bloomberg Intelligence is
part of our research department, with five hundred analysts and
strategists working across all markets. Coverage includes over two thousand
equities and credits and outlooks on more than ninety industries
and one hundred market indices, currencies and commodities. Please do
subscribe to the Credit Edge wherever you get your podcasts.
(44:32):
We're on Apple, Spotify and all other good podcast providers,
including the Bloomberg Terminal at bpod Go. Give us a review,
tell your friends, or email Meet directly at jcromb eight
at Bloomberg dot net. I'm James Cromby. It's been a
pleasure having you join us again next week on the
Credit Edge.
Host
James Crombie
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