00:00Joining us now is Danielle Pauly Managing Director and co-portfolio manager of Global Credit at Oak Tree Capital Management.
00:06Danielle so wonderful to have you in New York and here. Great to be here. Thank you for having me.
00:10You all and especially now as part of the
00:12you know the book the mothership that is the bet on AI are doing so much in AI infrastructure. To
00:21what degree is this kind of the
00:22only game in town. Well AI is transforming the credit markets. And with Brookfield you know they've been investing in
00:31the
00:31backbone of our global economy for 40 years. That looked different back then. That was building pipeline and water lines
00:39and
00:39telecom. Today it's building data centers and AI factories. So the backbone has shifted and we see tremendous opportunity in
00:48building where we get cautious. It's just the amount of debt that's coming to the market and the need for
00:55selectivity is there
00:56which placed our strength at Oak Tree as an active credit manager focused on risk control. I we've been talking
01:02a lot about how
01:03much liquidity there is. And basically there's enough cash out there to buy every bond you sell. But what does
01:09what do longer
01:11term rates mean to you. We've seen the 10 year tick up to 465. Right. We've seen the 30 year
01:18tick up to the highest level
01:19since before the great financial crisis. How does that affect your business. Well I think there is a case for
01:26rates to stay
01:27higher for longer. When you think about what's happening not only with commodity prices higher oil prices but the fiscal
01:33deficit. Right. And also to like let's just back up the last six months and take stock of everything that's
01:39happened.
01:40All the geopolitical activity. Venezuela. We were potentially going to invade Greenland. We have the war in Iran and
01:48we have to ask apocalypse private credit concerns. There's been so much that could have shaken the market. And I
01:54think
01:55finally you're seeing some rational behavior from investors saying if I'm going to lend for longer I want to be
02:02compensated for that. And so I think it's natural that we're seeing rates rise. I mean for us any volatility
02:08in the rate
02:08markets is an attractive entry point for buying. We're an opportunistic credit manager. So we look at this as an
02:15opportunity to enter from a position of strength especially because a lot of what we do is short duration. So
02:21we're
02:21positioned pretty short on the curve today giving us just ample opportunity to go longer if we see value in
02:27rates
02:27higher. Where are those opportunities. I know Howard Marks and Armin have been warning against you know not software doesn't
02:34seem like the
02:34opportunity right now. Where are there things on sale. There's things on sale across the board. You know you'd be
02:40surprised today a diversified
02:43multi strategy portfolio in liquid credit only can get you a yield of around eight percent. That's invested across high
02:50yield bonds
02:50senior loans incorporating things like CLOs real estate. We're also seeing pockets of value in private credit. We've been big
02:58buyers of asset
02:59backed finance. We like the recurring cash flow tied to specific assets again in sectors that underpin the backbone of
03:07the global
03:07economy. So we're doing things in equipment finance. Of course AI is a big theme. So I think there are
03:13opportunities to get a high
03:15kind of single digit yield in today's market and then await maybe more volatility to step in to get those
03:22double digit yields when you're doing
03:24rescue financing or other things that may come. I know we want to dig deeper into AI and data centers
03:30and that's the sexy part of
03:31real estate. But how is the housing market looking to you and where is there opportunity in that. I'm glad
03:39you said that because
03:39boring is beautiful. So a lot of what we're doing is unsexy today because it's providing attractive income. I think
03:46the housing market's pretty
03:48strong right now. You have the majority of Americans with long term mortgages at very low rates. You don't have
03:56a lot of
03:56refinancing risk there. We're not seeing huge pickup in delinquencies. So the housing market's really strong and bigger picture banks
04:04are pretty
04:05well capitalized. There's not a lot of things that would create systemic risk in this market right now. You talk
04:11about one of the risks that you
04:12kind of hinted at in just this idea of supply that deficits are going governments are issuing more bonds. And
04:17at the same time just looking
04:19at what the big tech giants they've issued issued. They issued 121 billion dollars in debt last year. They're on
04:25track to blow past that
04:26with 175 billion at least in 2026. Can the market keep absorbing all of this. Well a lot of the
04:33debt issue and so far has been in the
04:35corporate IG market and it's leading to a large concentration for AI debt. I think it's surpassed now financials at
04:42around 15 percent of
04:43the market. And that's interesting right because banks are in the business of lending. AI hyperscalers are not. They're building.
04:51So they do
04:52need to monetize AI to pay back. So the risk profile is very different. Again selectivity required. We're starting to
04:59see the issuance go into
05:01different markets just because the need is so big. So what gives us a little caution is the off balance
05:07sheet
05:07financing the circularity of some of these deals. And so I think like any industry that sees a lot of
05:14growth. We were just
05:15talking about private credit and the growth it's seen and maybe cockroaches that emerge. There's going to be issues in
05:20the
05:20future. So right now is the warning to be selective to focus on underwriting you know to not get ahead
05:27of yourselves and
05:28caught up in a fad or momentum and throw fundamentals out the window. Speaking of cockroaches we talked with Jamie
05:35Dimon yesterday in
05:37Shanghai. Listen to what he said. The notion that somehow people said they'll never go up is the wrong notion.
05:43And so companies like us
05:44prepare for higher rates lower rates and you know figure those things can happen. The thing is they're at the
05:49highest level in decades. I mean that is
05:52where the surprise could be. I mean they could be much higher they are today. So he's talking about rates
05:59could be higher. Obviously they could
06:00be lower. And what is your intelligence point to in terms of where we'll see rates go from here. I
06:09mean how do you prepare for that and what do you
06:11forecast. Well we're not macro forecasters at Oak Tree. You know this. So take my view with a grain of
06:17salt. I feel like Howard always has a pretty good
06:18view. Yeah. We try and be macro aware. Right. And so I think what we're seeing now is a fiscal
06:26deficit that has grown
06:27significantly. And it's not that number that's so concerning. It's the one trillion dollars of debt service for the U
06:33.S.
06:33government. And as you know there's not enough to cover that. And so it continues to grow as more debt
06:41is issued to fund that.
06:42And hopefully you know the debt that is issued the money is going back in a productive way and increasing
06:48GDP. But we think
06:49there's a lot of reason that there's going to be pressure on the long end of the curve. And we
06:54could see rates go
06:55potentially higher from where they are. But we do need rates ultimately lower at some point because the debt is
07:01unsustainable. What happens in that scenario pressure on the long end for direct lending when you're already in this world
07:07of
07:08PIC picking up more payments in kind. There was a Fitch study that bankruptcies. I mean they're still at a
07:14relatively low
07:14level but they are climbing. And especially for companies that have done that have introduced PIC. So there's already been
07:22can kicking. What happens if rates stay high for these companies that are borrowing at floating rates. Yeah. It creates
07:29a very
07:29challenging environment and you're already starting to see it like it looks calm on the surface and credit. But the
07:35real
07:35stories the dispersion happening underneath. So looking at the leveraged loan market where there's a bit more
07:40transparency you're seeing triple C borrowers with 20 percent yields. And whereas spreads have generally
07:47tightened for the rest of the market that triple C cohort has seen 300 basis points of spread widening. So
07:53I feel like the
07:53market's waking up to higher rates being a problem for over leveraged borrowers. And you're going to need rescue
08:00financing and solutions. And the issue will even be more pronounced in private credit.
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