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