Stewart: Welcome to another edition of the InsuranceAUM.com Podcast. We're thrilled to have you back and this is a good one today. We are talking about private credit with Bill Bohnsack, President of Oak Hill Advisors. Bill, welcome.
Bill: Hey, thank you, Stewart. It's great to be here today and I'm really looking forward to the conversation.
Stewart: Me too. This is your first podcast. I'm thrilled, I can't tell you. So, just to start it off, we did a survey, an informal survey of about a dozen CIOs and they ranked private credit top of the list for relative value as they go into 2023. Private credit was the number one topic on our site year-to-date. So, there's a lot of good stuff to talk about and I want to get to all of it. But before we go too much further, let me just start it off with this, what's your hometown, your first job, and a fun fact?
Bill: All right. So, hometown, Evanston, Illinois. It's a suburb outside of Chicago, not too far away, I think, from where you spent some of your teaching career. I had a whole string of jobs growing up, and the first job was actually bagging groceries at the local Jewel grocery store in Wilmette, Illinois.
Stewart: I know that Jewel in Plaza del Lago, that thing's still there.
Bill: Absolutely. Absolutely. So, before I went on to then work as an assistant butcher, which is a whole ‘nother story. Fun fact, I was asked an icebreaker question with the group the other day and it was, "What was the first concert I ever saw live?" And I realized that it was actually 40 years ago that I saw Mick Jagger, Keith Richards, and The Rolling Stones. It was awesome. And what was extraordinary is that they'd been playing together for 20 years before I had seen them.
Stewart: Isn't that crazy?
Bill: And they're still going strong. A second fun fact, just to throw in a second one, because I know that your audience here is primarily insurance company investors, as I understand it, is that I'm very proud to say that I started my career post-business school, working with Prudential Insurance, financing buyouts, and other private market financings, going all the way back to the early '90s working in Newark, New Jersey.
Stewart: Wow, there you go. That is a fun fact. My first concert wasn't nearly as prestigious as that. I saw Billy Squier and Pat Benatar. So, that's not nearly as good as The Rolling Stones, Bill. So, can you give us a little background on Oak Hill Advisors, just if someone's not as familiar with the firm?
Bill: I'm happy to. So, this is now my 30th year with Oak Hill Advisors and the firm's evolved a lot over three decades. Today, we are known primarily as a specialist in credit market investing. We manage nearly $60 billion of capital across private credit, distressed and special situations, structured and real asset-focused lending, as well as a meaningful footprint in the liquid leverage loan and high-yield bond market.
We grew initially from one multi-strategy fund backed by Robert Bass in the late '80s to now a business where we're partnering with large insurance companies, sovereign wealth funds, pensions, endowments, foundations, other types of investors. But throughout the history of the firm with our founder Glenn August, we've had a real focus on fundamental credit investing being driven by an understanding, a deep understanding of companies and the industries that they operate in, the cash flow and value that they generate. And then being, I would say more flexible in the capital that we bring to bear, to move across credit markets to where we see best risk-adjusted returns across liquid and illiquid markets.
Very large and growing part of our business is in private credit, but everything we do is really focused on trying to understand where we can find the best absolute and relative value, actively managing our risk, and being a good partner to the companies and private equity sponsors that we are working with, in many cases where we're structuring a customized financing or solutions based capital for them.
And so, we've been doing this for more than 30 years and feel like it's the type of business where your knowledge of companies and relationships that you're developing, get better and stronger over time. And we're always learning and it's a business that is, as we'll talk about, is evolving rapidly given the markets that we're in. And we feel like we're really well-positioned today with a platform that has scale, with flexible capital, with great partner relationships in terms of those who provide us capital, and really extraordinary, deep, repetitive relationships with the companies, the borrowers, the financial sponsors who are tapping credit markets increasingly as a source of financing.
So, I feel very fortunate to be in a great industry and have been there for a long time and now a year in as a partner to an awesome organization, T.Rowe Price, we have access to even more scale and opportunity given that relationship.
Stewart: Yeah, they're a really good relationship for us as well and we're happy to have them on our platform. And one of the things that I get the real advantage is, I get to talk to guys like you, that have a very good perspective and viewpoint on markets in general. We were just talking about you were seeing some insurers up in the Hartford area. At 20 to 30,000 feet off the ground, how do you see the current market environment and what are the key questions that you're hearing from insurers right now?
Bill: Well, here we are, and it's February 3rd, so we're basically one month into 2023, and it's been just an extraordinary period of time since we rolled the calendars over onto the new year. I mean, 2022 was all about investing through an inflation spike and the huge volatility that was created. And it was, I guess, the fifth time in 94 years of the recorded history for the S&P 500 and the 10-Year Treasury that both experienced negative returns.
And so, at the very beginning of this year, I mentioned at a firm-wide kickoff meeting for the new year, that we faced enormous kinetic energy in the markets last year. And that, that left us as investors facing what we saw was an enormous amount of potential energy built up in the markets, going into 2023, that could lead to volatility as well as lead to some really exciting returns.
And that's what we've seen in January. I mean, it was truly one of the most extraordinary starts to a year or month that we've ever seen. I mean S&P is up nearly 9% year-to-date, Nasdaq up 16.5%. European stocks have been very, very strong. And we've seen across the Treasury curve 50 basis points, a spread tightening through last night, although I guess we've given back some of that tightening this morning, and that's led within credit to some pretty extraordinary year-to-date returns.
Again, just through the first couple of days here in February, high-yield markets have generated 5.5% returns. Loans for the CS Loan Index up 280. Lower-quality credit has led the way, but even investment grade credit, it's up 4.5% to 5% year-to-date. So, it's been, from a market reaction standpoint thus far, I think a harbinger of an exciting year to come. And this market reaction is, I think, a reflection of the fact that inflation fears may be waning, that the prospect of a longer, deeper recession may be receding. There was a jobs print this morning of 517,000 new jobs. Hard to think about how deep and long recession is going to be when you keep on adding an exceptional level of jobs into the economy. But following eight Fed interest rate hikes, I think there's a lot of focus right now on the Fed tightening may be abating, and the focus is, for how long will the Fed hold its resolved in terms of keeping rates higher? And that is, I think, a pretty interesting backdrop to think about your portfolio, to think about really all aspects of risk, duration, spreads.
And while we entered the year with, I think, some very attractive yields, some very attractive spreads, this move thus far is pretty startling. And for example, BB High Yield spreads come in 58 basis points, and single B in 100 basis points. So, you really have to then think about, where is their excess return, where is both absolute and relative value evolving in such a fast-paced market?
And the key point I would say from a fundamental standpoint is, while inflation appears to be waning, we don't feel like we're out of the inflation risk picture. We believe that through the first six months of this year, we're going to see some weak earnings in particular sectors and companies. We think there's real idiosyncratic trends in terms of how companies are dealing with inflation, are seeing changes in demand for their products and services. Certainly, as we'll talk about later, what higher interest rates means to valuations, access to capital, free cash flow, are all really important issues that equities investors are going to be thinking about this year.
Stewart: Yeah. And I mean, I think, as you know, we do a number of podcasts with insurance CIOs and with the backup in rates in 2022, there was a lot of discussion of, "You know what? I could even buy the 2 Year Treasury note and raise my book yield." And it seemed like there was a tailwind to public markets after the shakeout. And, I don't have data to support that other than the anecdotes told by the CIOs themselves. So, when you look at public versus private market relative value, what do you see?
Bill: So, this is a great topic of conversation with a lot of our investors, not just insurance companies. Yields have moved pretty dramatically over the last year, despite the rally that we've talked about year-to-date. And that does give investors a lot of choices. You can sit in cash in a money market fund today and earn 4.5%. And for all markets the choices of where do you want to access yield and return, have changed dramatically.
Public versus private in credit, we have to think about the rate component. We have to think about the spread component. When you move into privates, you think about liquidity premium or complexity premium. And I'd say that the industry over the last several years, and I'll say the industry, global investor portfolio shifts over the last several years because we've been in a low interest rate environment, there was just a need for yield and return, and that pushed a lot of investors to embrace private markets. And we've seen a very, very significant growth in areas like private credit over that period of time.
Now there's, I think, more opportunity to be thinking about public market for how you layer and yield in your portfolio. It's a great point in time for investors to be asking the question about relative value. We've seen periods, and I would say just from 2020 on, we've seen volatility induced by the pandemic, induced by the closing and opening of markets. Now this inflation surge, where the relative value has shifted pretty dramatically between public and private markets. You saw that just with the March time period in 2020, the selloff in the public markets, where for what was then a very short period of time, public market loans and high-yield just got very, very cheap as markets panicked and investors dumped risk.
And that was an opportunity you could really only capture in the public markets, because the private markets had basically closed down for a month or two until borrowers were able to then come back to the private market. And we saw that actually similarly in 2022, in the first half, where public markets got very cheap as the markets sold off and private markets hadn't really reacted. So, there's an opportunity to be nimble and move among these markets on a real-time basis.
For a lot of our investors though, they tend to think more strategically in terms of asset allocation. And I think that's actually a good idea. And for a whole variety of reasons for investors who can take on illiquidity and complexity premium, we think that there is a really good case to be made for meaningful allocation to private markets, credit, broadly defined.
But let's talk about the relationship right now, which is I think really where your question's focused, today, what are we seeing? So, we often start with the building blocks of relative value thinking about where BB loan risk in the liquid market is pricing. And today, that's call it on the high 6% yields, low 300 spreads on a floating rate. You can also look at BB High Yield bonds yielding about 6.3%. Spreads today at 250 over, which interestingly came in from about 300 over just at the beginning of the year. So, a lot of tightening in the public markets.
In privates today and just bellwether, corporate, larger cap unitranche risk. We've seen that pricing at SOFR plus 650 to 700. We haven't seen much tightening there despite the fact that these are spreads that have widened out quite a bit. In fact, OIDs have also been attractive. This is the points of discount that an investor receives on purchase of the loan. And those have been in the 96 to 98 range in terms of entry cost.
And so, that's implying some yields through a whole period of low double digit unlevered gross returns. So, you compare that to what you can get in the public markets and we think there's meaningful premium there today. We think that that is offering really attractive relative risk-adjusted return. And then of course, there are all sorts of different submarkets across private credit, different pricing. But I think that that would be a benchmark public versus private in corporate space, where we think that there's compelling value today. We've seen a lot of movement in the markets over the last month. It could be that you could see, it wouldn't surprise me to see private markets react to that over the next couple of months, but there's some interesting technicals in the private market where we could certainly see spreads remain pretty wide.
Stewart: So, Bill, at the top of the show, I mentioned the survey that we did that said insurers see private assets as the number one ranked in terms of relative value. So, specifically in the private credit markets, where do you see opportunities and where do you see opportunities in the non-corporate private sector?
Bill: Well, sure. So, our business has evolved over the years to now a fairly broad private credit platform where we're financing a variety of different types of companies and against a variety of different types of assets. And really across the spectrum we're seeing interesting opportunities.
In corporate private credit, our historical bias has been on larger cap companies and for a variety of different reasons we think that that, to us, offers more compelling risk-adjusted return. Bigger companies, from our perspective, have typically more proven businesses, more diversification, better management teams, more pricing power to pass along things like inflation-related input costs to their clients, et cetera.
And so in that area today, we're focusing on companies with $75 million of EBITDA and above. Typically in our portfolios will have average EBITDA of, call it $150 million. So, these are bigger types of businesses, market-leading businesses, and that's an area where owners of companies, private equity sponsors, have increasingly been moving to private market financing solutions. And we think it's good risk-adjusted return. I'd say that last year we did 62 transactions across 30 sponsors. Over the last couple years we've invested, I think between '21 and '22, $17 billion in capital. A lot of it was in unitranche. And as I said a few minutes ago, that risk, first dollar secured risk in a capital structure, 40% to 50% loan to value, zero to 40%, zero to 50% loan to value, that that's, we believe, an extraordinary opportunity in the current market where you can pick and choose the types of companies, the types of industries you want exposure to.
And there's a technical in terms of demand for capital relative to supply, that's pretty attractive. And actually, very few larger platforms and partners like OHA that have the scale to be able to provide a solution. So, we like that opportunity. Before we move off of corporate, let me also say that while we prefer senior secured, there are also opportunities to provide second lien and more junior capital, and get paid really handsomely for taking on more risk.
If you think about what's happened where companies are, in some cases, facing higher cost structures, more interest expense, and maybe finding it more challenging to access capital. The opportunity we're finding right now in terms of what we call junior capital solutions or maybe a sponsor's looking to do an add-on acquisition and the markets have shifted, we're going to ask them maybe to put in some more equity capital. We'll provide some junior capital to maybe de-lever the capital structure a bit and help them finance an acquisition and get some really attractive terms and structure to go with it. So, we're seeing opportunity, I'd say, across the spectrum in corporate credit and as we maybe talk a little bit more about distressed in a few minutes, there's opportunity. We think, as you see, liquidity needs becoming even more acute, opportunities from a capital solution standpoint.
When you think about non-corporate risk, there are a range of markets where the banks continue to be pulling back from very capital-intensive industries, where those industries themselves are growing. Maybe it's just not the banks, you also see securitization markets pulling back. And so, at OHA, we have a focus on a range of different end markets across digital infrastructure, which would include cell towers, data centers, fiber assets, aircraft finance, energy finance, particularly energy transition, shipping and containers, different types of real estate assets. In fact, real estate is another sector that we could have a whole podcast on. But there are enormous opportunities and challenges across the commercial real estate world today, as access to capital and re-rating of cap rates and valuation, we think are going to have profound implications across real estate.
And so, there's a lot of opportunity there and an emerging area for us and the market as a whole is in an area that we call, broadly, GP solutions and NAV lending, where access to capital for private equity sponsors who have portfolio company needs that they can't finance on a portfolio company basis, or portfolio needs where maybe a fund is out of capital but has a need to do an add-on acquisition or wants to buy back bonds, or wants to facilitate another solution for the private equity fund or the sponsor. That we see really attractive opportunities to lean in with flexible capital and use our relationships to create opportunities.
And so across the spectrum, I'd say that there's opportunity, but it's really picking and choosing the types of risk that you may have to carry through a recession. There's uncertainty in the markets, for sure, and you need to lend against assets where, while the underlying credit may not be tied to EBITDA, there's typically some sort of sensitivity to the underlying businesses and need to really understand the asset and structure appropriately, that you're protected in just about all scenarios, so that your capital's protected and you're going to get your return. So, I'd say there's a lot of opportunity in private credit. We covered a lot there, so maybe there's a follow-up question or two to take on.
Stewart: Yeah. And I mean, I think the one that is something you touched on just briefly earlier is, what's your market outlook on distressed?
Bill: So, it's interesting, I think that the distressed business is one that's been core to us for a very long period of time. We've invested more than $20 billion in distressed opportunities and it's been our highest returning strategy. So, we love distressed investing and we do it across trading opportunities, influence opportunities, where we can get in and really help restructure a business or control where we end up owning a company, coming through a reorganization process.
And yet, we've also been of the view that there are times to lean into distress and there are times to, perhaps, lean out of it, because we have found that distressed returns are often best paired when you've got real forced sellers in the markets and you're able to source opportunities at very significant discounts relative to the intrinsic value that we're investing against.
And I would say in this environment, default rates have been remaining very low, access to financing over the last many years and the cost of that financing has made for very few defaults. And I would say, looseness of capital structures has also changed the game meaningfully, because companies have not only found an ability to access additional capital when they otherwise might have been forced to restructure, but it's just changed the type of investing that we and other distressed investors are finding as attractive.
Well, as we look at this year, you see default rate estimates by the big banks in the 3% to 4% range over the next few years. If you take those numbers and you apply that against a high-yield bond leverage loan in private credit universe, that totals over $4 trillion here in the United States. You can think about over the next, let's say 3 years, 10%-ish of the market defaulting. Now, you're talking about, and leaving aside real estate, which is a huge market where we think there's going to be a lot of distress. Europe, which is a softer economy or set of economies that we think there's going to be more stress and distress.
This is a big opportunity over the next several years that we're excited about, but it falls short of a wholesale opportunity unless we see some sort of exogenous shock, policy mistake by the Fed or just a deeper, more prolonged recession than is expected. And when you get those wholesale opportunities, then you see default rates go up into the high single digits. We look at a measure of opportunity in the markets.
You should look at the distressed ratio. It's a statistic produced by Bank of America on a monthly basis that measures the amount of stress in the high-yield market, where the percentage of high-yield bonds are trading in excess of 1,000 basis points is measured. And at the end of January, that number was, as I recall, less than 8%, or the last reading is less than 8%. By the end of January, given the rally that we've had, I think it's going to be even lower.
And so, the distressed ratio is telling you that there's not necessarily today, a wholesale opportunity, but we're believing that, A, there's a fairly reasonable expectation on base level of distressed activity over the next few years that's going to make the regular way distressed opportunity pretty attractive. And think that there's certainly an opportunity as we've typically found in these markets every couple years, for some sort of market volatility, some sort of shock, some sort of stress to the system that creates more of a wholesale distressed investment environment.
So, that's what we're thinking about on the distress side. In certain industries, we're starting to see the impact of higher interest rates or inflation or labor market issues. So, you can see it in healthcare, you can see it in certain technology and software companies. And so, our pipeline of distressed opportunities has actually been building over the last couple months.
Stewart: Very good. And I want to thank you, because I get a chance to learn so much from you and our audience does as well, and I appreciate you being on. I'd wrap with this, you mentioned at the top of the show that you've been at Oak Hill Advisors for 30 years. And I want to take you back to that first day that you walked through the door and you might have just gotten a coffee or whatever and you're fired up and ready to walk through the office. And if you could catch that guy today, right before he walked through the door, what advice would you give him?
Bill: Well, so I actually get an opportunity to talk to our young people when they're ... We hire typically 10 or 12 people right out of college every year, as part of a training program. So, I get an opportunity to talk to them about their careers and what might make them successful, and I also get a chance to talk to my three kids and their friends who are, two of them are in college.
And so, you know what's interesting right now? I'll tell you what I told my son the other day and a couple of his buddies is, and this is unrelated to finance, is that, beware the work from home. Embrace an opportunity to go into an office and learn from people far more experienced than you are. So much of what I've learned in my career is through mentoring and working with some of the most extraordinarily talented people I've ever had the pleasure of knowing. And that is done through working in an office.
And so, I really think that to the extent that you're starting off in your career, find an opportunity to work in an office around really good people, where you're going to learn as much as you possibly can, because that will help you dramatically over the course of your career. So, that's something I think particularly relevant to the here and now.
I'd say more generally, and this is something that we look for in our young people because it's so core to who we are as a firm and as a culture, is that we look for people who really want to be on a team and who value and lean into teamwork. And there's so much focus on the hard skills and the smarts and the technical capabilities of young people, and we're so fortunate to have some absolutely wonderful young people join us each year.
But the intangible, I think that leads to success, comes from young people who embrace the opportunity to work on a team, who go and help out their colleagues, who stay late and help another junior analyst build a model or analyze a particular aspect of a covenant or capital structure. And that teamwork pays itself back so much in terms of, developing better relationships, friendships, I think you learn more. I think your organizations will value it, recognize it, and ultimately just lead to a more fulfilling, happy experience. Just some thoughts to share with our young people.
Stewart: That's great advice, Bill, thanks very much for being on. I really appreciate it.
Bill: You bet. Thanks, Stewart, and congratulations to you and the community you've been so successful in developing. Thanks for having me on today.
Stewart: I really appreciate it. Thank you. We're fortunate to have you on. So, we've been joined today by Bill Bohnsack, President of Oak Hill Advisors. Thanks for being on. Thanks for listening. If you have ideas for podcasts, please send us a note at podcast@insuranceaum.com. Please rate us, like us, and review us at Apple Podcast. My name's Stewart Foley and this is the InsuranceAUM.com Podcast.
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