“The overconfidence, in caution, and inattentiveness that lead to unwise investments in good times also present the perfect conditions for fraudulent schemes. Risk tolerance, FOMO, fear of missing out, inadequate due diligence, and fevered buying provide fertile soil for financial scams. In heady times, rather than say, that's too good to be true, people are more likely to ask, how can I get in on that? The markets aren't crooked per se, but they're full of money, and, thus, they tend to attract crooks.”
Redemption gates are critical for protecting fund stability
“I think they're critical actually in the, retail channel because you're protecting both sets of investors. It's not the asset side of the equation. It's not the loans that they're making that are the problem. It's the other side.”
Scale lets investors spread research costs across positions
“Importantly, Oaktree's span and scale provided multiple points of contact with first brands through a number of our strategies, helping us to assemble the necessary mosaic. Further, a thorough job of credit research costs the same whether you're considering investing 50,000,000 or $500,000,000. Greater scale allows an investor to spread the cost of in-depth research over larger holdings. In investing, size has both pros and cons, but here, we're talking about one of the former.”
First Brands showed multiple red flags before bankruptcy
“But even in advance of First Brand's bankruptcy filing in late September, Oaktree's research turned up the following red flags, only six years of operating history, but already $5,000,000,000 of annual sales, controlled by an individual with almost no media references or online profile, a significant litigation history, including allegations of misconduct, reported profit margins above the industry average, a large number of m and a transactions creating a web of corporate entities, other aspects of weak controls.”
“So I think that all these things filter into more and more pressure on these companies, which could lead us to a spot where we do get to 15% of loans. I'm not saying that probability is very, very high, but if it happened, I wouldn't be shocked.”
High-yield markets are now higher quality than before
“The high yield market is substantially higher quality now than it was before. The double b portion of the market is approaching 60% that used to be about 35%. And the riskiest segment, the triple c's is now about 9% that used to be over 20%.”
Private credit filled the post-2008 bank lending vacuum
“Then after the financial crisis, the bank regulators really did not want banks lending to highly levered and or risky entities, both corporations and individuals. So you saw pretty strict capital requirements. There is an explicit prevention from banks lending to companies with greater than six times leverage. That created this need for lending outside of the bank market.”
Recent credit failures signal carelessness, not systemic collapse
“I don't think today's issues are systemic in the sense that there's something wrong with the lending system or that they will trigger other defaults and lead to a breakdown of the system. In simpler words, there's nothing wrong with the plumbing. But imprudent loans and business frauds often occur in clusters for the simple reason that people who make investments and loans are highly prone to error in good times. Investors and lenders are supposed to be risk averse and thus exercise discipline and vigilance, but sometimes they fail in this regard. This isn't part of the plumbing of the financial system, but rather a regularly recurring behavioral phenomenon. So it isn't systemic, but it is systematic.”
“This is summed up most concisely in a great banking adage. The worst of loans are made in the best of times. A good bezel. Charlie Munger and I used to enjoy talking about the economist, John Kenneth Galbraith. Galbraith was the source of many of my favorite expressions with regard to the financial markets.”
Software companies created new challenges for credit security
“Historically, people have in the the LBO space, they were coming to the high yield market saying we'll put 20% down, finance the other 80%. If they go to the private credit guys and say, well, we'll put 40% down if you'll lend to us on the balance. We we love this business at 16 times. And I think they potentially persuaded a lot of these lenders to get a little bit too far out over their skis in terms of the amount of leverage that they were willing to extend.”
“I also think that we've been talking about private credit as it stands today, but it started so much earlier. And it started in an area that I think most people will tend to forget about, which is GE Capital was one of the largest providers of private credit under the GE umbrella for many, many, many years.”
“In detecting credit defects, the big payoff is for being early. If you reach a negative conclusion at the same time as everyone else, the price you'll get for your holdings is likely to be marked down to fully reflect the negatives. That's market efficiency.”
Markets swing between flawless and hopeless perceptions
“As I pointed out in my memo, what does the market know in 2016, in real life, things fluctuate between pretty good and not so hot. But in investors' minds, they go from flawless to hopeless. We saw a very strong reaction in this case, Notably, the stock prices of some prominent alternative asset managers were down five to 7% on October 16, close on the heels of the regional bank's disclosures.”
Public debt offers exit flexibility private credit lacks
“It's important to note that whereas private credit has been the rage of late, all else being equal, it's great to hold public debt that can be exited more readily if you sour on the credit. We've lived through generally good times in the last sixteen years. The coming period is likely to be more interesting as errors that were made in those good times come to light.”
Retail BDCs face unique liquidity and underwriting risks
“In order to raise the money, they've needed to offer some concessions on the liquidity. Right? Because it makes it easier to raise money if you're gonna allow people or you tell them that you're gonna allow them to redeem at least somewhat periodically. That has allowed them to raise money really fast. It's a little bit piggy because they've just said, okay. We can raise a lot of money. Let's just raise the money when we can.”
Managers face pressure to invest subscription cash quickly
“The difference is when those dollars come in, they come into the fund on a subscription basis and need to be invested quickly. And that's what's really created a lot of the problems and what's really led to the degradation of credit underwriting. Because if you don't invest those dollars quickly, it creates the lag on performance in the fund.”
