The State of the Credit Markets







In the first episode of the Dallas on Download series, we interview credit market veteran Josh Friedman, Co-Founder, Co-Chairman, and Co-CEO of Canyon Partners, LLC.

Listen in as Greg Dowling, CIO and Head of Research at FEG, guides the discussion with Josh around:

  • How the global pandemic impacted the markets and overall business
  • Comparison of the current crisis to those we have seen before
  • Impact of inflows and outflows on liquidity
  • The three main goals of the Fed's response
  • Outlook across structured credit, including residential and commercial mortgages
  • The positive side of the pandemic


Joshua Friedman

Co-Founder, Co-Chairman and Co-Chief Executive Officer | Canyon Partners, LLC

Josh is Co-Founder, Co-Chairman, and Co-CEO of Canyon Partners, LLC, a leading global alternative asset management firm headquartered in Los Angeles, California. Canyon Partners’ funds received awards for Institutional Investor’s “Credit-Focused Hedge Fund Manager of the Year” and “Hybrid Hedge Fund of the Year." Josh also received Institutional Investor’s “Lifetime Achievement” Award. Prior to forming Canyon, he was Director of Capital Markets for High Yield and Private Placements at Drexel Burnham Lambert.


Greg Dowling

Chief Investment Officer, Head of Research | FEG

Greg Dowling is Chief Investment Officer and Head of Research at FEG. Greg joined FEG in 2004 and focuses on managing the day-to-day activities of the Research department. Greg chairs the Firm’s Investment Policy Committee, which approves all manager recommendations and provides oversight on strategic asset allocations and capital market assumptions. He also is a member of the firm’s Leadership Team and Risk Committee.

Podcast Transcript

Greg Dowling (00:06):

Welcome to the FEG Insight Bridge. This is Greg Dowling, head of research and CIO at FEG. This show spans global markets and institutional investments through conversations with some of the world's leading investment, economic and philanthropic minds to provide insight on how institutional investors can survive and even thrive in the world of markets and finance. As we all stay home to do our part to flatten the curve, our current series, Dallas on Download, highlights speakers who were originally going to be featured at our Dallas Investment Symposium that was canceled due to the coronavirus. This limited series will offer insights across a variety of asset classes and styles, including energy markets, credit markets, value investing and biotech. Today's episode is titled the state of the credit markets.

Greg Dowling (00:57):

While financial media has spent much of its time discussing the carnage in the equity markets during the pandemic, there has been as much damage or more in the credit markets and besides being more diverse and multiples of the size, there have been a lot more technical pressures going on behind the scenes. Thankfully we have a credit market veteran to help us sort this all out. Joining us today is Josh Friedman, co-founder of Canyon Capital. Josh, would you mind kicking us off with a brief introduction of both yourself and Canyon?

Josh Friedman (01:30):

Happy to do that, Greg. Thank you very much and thank you all for listening to this podcast. I grew up outside of outside of Boston in the suburbs. My mom was a school teacher, my dad was an engineer and I was a physics major. I thought I'd end up working in a startup and being in the sciences. There were all those companies around route 128 back then and somehow after law school and business school, I got waylaid by wall street and worked at Goldman Sachs and then at Drexel in the high yield debt business, and then started Canyon. I met my business partner, Mitch Julis because we were roommates back in business school and law school. He was from a somewhat similar background. Both his parents were school teachers in the Bronx and he became a bankruptcy lawyer.

Josh Friedman (02:14):

When we left graduate school, we eventually reunited as partners at Drexel. He was in the bankruptcy investing side of the business. I was responsible for structuring leveraged buyouts and sponsor led transactions, which at the time, believe it or not was sort of a new thing in the, in the early to mid eighties. In 1990, we started Canyon. Canyon today is a large investor both through hedge fund type structures and through draw down type structures that are more private equity type structures, but they do more distressed debt. We do the whole gamut of debt investing from core credit oriented investing. Think of it that way with both through multi-strategy funds as well as through these dedicated types of that strictly do less liquid distressed as well as through things like CLOs that buy bank debt. So we have a range of vehicles.

Josh Friedman (03:06):

We have about 200 employees plus, maybe 240, I guess at this point. We invest in all parts of the debt structure of balance sheets as well as occasionally in the equities and leveraged structures. We're very focused on the bankruptcy world, we have been big investors in everything from Lehman to charter communications to Enron to more recently Caesars. We were probably the largest and probably the most successful hedge fund oriented investor, or distressed oriented investor, buying distressed securitized paper RMBS particularly when the Fed was out there when the federal agencies were out there selling all of the paper that they had taken in as a result of the last financial crisis. So that's kind of a summary of the firm. We run an un-levered shop. Generally, we try to maintain very good alignment of our own interests with those of our investors by investing in everything we do. And we try to be a values oriented firm. In other words we generally keep a low profile for a firm of our size and we try to act in a way that we would like others to act toward us as well. So we have a very high very identifiable culture as a firm. It's almost like an anti-hedge fund culture in the sense that there are not a lot of big egos within Canyon in general as a firm.

Greg Dowling (04:33):

For those of you listening, I think you get the sense that Josh has been doing this for a very long time. I guess that's a kind way of saying that you're old, Josh. You're very experienced and you've seen a lot of these crises happen. How is this one different from what you've seen and how is it the same?

Josh Friedman (04:54):

I think we have to recognize a certain number of truisms about all crises that makes them all in some ways the same. I think Rich Handler, who I used to be partners with at Drexel--in fact we hired him once he was out of business school and he's now running Jefferies--he had a very good piece that he put out where he said, basically, you know, you have to have a little perspective. And he listed all the crises during his career from the '87 stock market crash through the bankruptcy of Drexel with the SNL implosion that followed in the Russian financial crisis and the internet bubble and 2008 and so on and so forth. And he said basically each time it felt like the end of the world and things would never get better. Each time there was a huge surge in unemployment.

Josh Friedman (05:39):

Each time it felt like this was different and it was the big one. And after a little bit of passage of time, eventually the financial markets recovered to reach new highs, unemployment went to new lows and the world learned something productive and improved the ways that they conducted through these crises and great innovations emerged. And I think that this crisis will be no different when we look back in a few years. And you have to have a little bit of age and perspective to understand that. That being said, this is a very, very, very different crises from any crisis, from any of those prior ones. Number one, it started with a human toll, a personal toll that is, you know, unspeakably awful. My sister works in a geriatric facility in Massachusetts. She's a social worker and the number of people they've lost in a relatively small center is extraordinary and all without the presence of loved ones, et cetera.

Josh Friedman (06:39):

So the personal toll is extraordinary and it comes at a time when the media highlights that too. And that dictates to some extent our responses both political and business. It shouldn't be a political issue, but it's become one. So the personal toll is enormous. Second of all, the reaction to that, to that fear and the fact that you have a virus that can be contagious when it's non-symptomatic has been essentially an instantaneous stoppage of most businesses. And the toll that that adds on top of the illness toll is really large. You have restaurants, retailers, nail salon, sports, facilities, concerts. You've taken the whole trend that we've had prior to this. The whole, the number one dominant social trend in, in the pre-COVID era was toward people spending their time and their money on experiences and social interaction as opposed to spending it buying things.

Josh Friedman (07:41):

The suburbs were dying, the cities were booming. This just caused a complete rethink of that and an instantaneous stoppage and literally putting out a business, tons and tons of businesses and with the related massive escalation in unemployment, part of that also driven a bit by policy that encourages that but also in and of itself. So this is very, very different. Prior to the global financial crisis, you had commercial banks and investment banks that were way over leveraged and, and and now you have banks that are not over leveraged, but you have alternative lending institutions that have gotten very robust in their lending. And I think, so if you look at the personal toll, then you look at small businesses getting instantaneously wiped out. This is very different from prior crises. Then you look at larger companies and we have a totally different context than we had in '07. Levels of corporate debt to GDP are higher, covenants are worse, debt to EBITDA is higher.

Josh Friedman (08:44):

And this is all driven because we've had monetary easing that got us out of the last crisis. So everyone has been in this global desperate search for yield and has led them be far too forgiving in terms of the financial covenants and in terms of the permissible leverage and in terms of believing adjusted EBITDA with all sorts of, you know, fantastical assumptions into what the adjustments were. So, you come into this with high levels of debt to EBITDA and you come into it on a crest of private equity where private equity has raised so much money, has leveraged so many companies across so many industries that suddenly you have balance sheets that were not constructed for this kind of scenario. And the last thing I would say that makes it just kind of a headline of what's different is the government response and the programs that we've seen take place.

Josh Friedman (09:40):

Both the spending things from the treasury and the lending things from the Fed are unprecedented in their, in their forcefulness and their speed. And we don't really know the effect of those. So the long and short of that I think is the patience is going to be required as we invest in this because it produces, each one of these phenomena produces rolling opportunities. We'll get to that later on I'm sure. But this is a very different set of circumstances from any of the prior crises. First and foremost because of the personal toll. Second, because the context is a pervasive media that shapes opinions, how we should respond. Third of all because the public response is so different from the public response. And I don't mean the public response in terms of government programs, I mean the public response in terms of thoroughly shutting down businesses, many of which will never be restored or will be a very good long time before the restored and then finally the government program. So I think it's a very, very different context and very different type of crisis than the ones we've experienced in the past.

Greg Dowling (10:49):

Josh, maybe you could elaborate a little bit more, kind of give the inside baseball view of what's different structurally from 2008 whether it's broker inventory that private debt funds that are now supporting private equity ETFs, CLOs. How does that impact what's going on in the credit markets?

Josh Friedman (11:10):

There's a great deal of buying and selling that's driven much more by flows than by substance. There are many companies today that have leveraged balance sheets where the debt has gone down and it hasn't popped back up. In many cases it probably should, but it's not in those liquid parts of the market that the government is supporting and the government has obviously chosen certain areas as a way of restoring confidence. In the functionality of the markets because if you have no liquidity on top of everything else and everything goes straight down, you know, markets are psychological and recessions are psychological, you, you, you need to try to restore the animal spirits somehow. So the, if you look at the SMCCF, the secondary market corporate credit facility, which was finally activated this week, there was a lot of activity of people basically front running. What security is those programs would be purchasing.

Josh Friedman (12:00):

And by the way, that's what the government wants you to do. They want people out there buying things. But the structure of the market is different. Clos for example, are holders of many, many, many securities that have been downgraded to triple C as they hit the limits of what they're allowed to own, you will see, and we have seen, for sales essentially of some of that paper, you have high yield funds that have had whipsawed flows. First they had record outflows, then record inflows. That causes for selling and then forced buying also, but only of particular types of securities. So you have liquidity in certain places, lack of liquidity in other places and a lot of buying that has not to do really with fundamentals, but it has more to do with where is there going to be liquidity injected by the Fed, or where is there not going to be a forced seller like a CLO or a mutual fund?

Josh Friedman (12:54):

So I think you have to look at the market today and realize that with the emergence of passive investing and index types of products they buy when they have inflows, they sell when they have outflows, they're not really deep credit analysts. If you looked at the liquid ETF, you know, it was trading at a discount of six points to NAV in March because of outflows. But then when the Fed stepped in and said, Oh my God, we're going to support these ETFs. Even before they actually started doing it, capital rushed back in and had trading at a premium to NAV because frankly the ETFs were more liquid than the underlying securities. You couldn't really get any volume in the underlying securities. So the structure of the market because of this massive amount of passive capital is quite different and a bit more fragile and a bit more volatile than any time in the past. So I think you have to be aware, not just of fundamentals, but very much of these sort of what I call technicals of the market if you're going to be involved in these types of securities.

Greg Dowling (13:59):

The other point that I wanted to hit on is liquidity or lack thereof. And a lot of this is based on big financial centers like New York, Singapore, Chicago, all of them, Boston, all of them are facing their own issues. You used to have a trading desk full of both young and old veterans alike who could exchange information real time. Now everybody's working from home. Did that have any impact on our overall credit market liquidity? And then, maybe after you comment on that, you could also comment on how Canyon is dealing with that.

Josh Friedman (14:43):

Sure, happy to. I don't really think the working from home per se has affected the liquidity. I think what's affected liquidity is the outflows and the inflows. And you know, in March they had record outflows from, high yield mutual funds that monitor by AMG. So that was like $19 billion that caused us to NAMI of selling until the fed said it was going to support ETFs. And then you had a tsunami of inflows $43 billion through May 8th, which is like 12% of the assets of all those funds and a big number. So that produced sort of robo purchasing, if you will. So there's a lot of robo buying and robo selling. And it doesn't matter if the people are home or not, they start out by buying what's in the index. And then if they can't buy that, they have an algorithm that says, well, this bond's going to trade like this bond, so I'll buy that.

Josh Friedman (15:33):

Or they buy the index itself or an ETF. So I think that the liquidity itself, truthfully hasn't been that effective. People are pretty effective at working from home. We've, we've had a skeleton crew here in the office, which is where I am right now. And I mean literally it was very, very small, handful of us, very spaced out and so forth. But we've really functioned quite well. It's a real toll on our employees. I mean, it's difficult to work from home when your kids are home from school and your dog is there and you know, there's people tripping over each other and it's, it's not easy to do it and it's really unprecedented. But I think it has caused people to rethink commercial real estate. How much do I really need of all this space? Do people really have to be here as much?

Josh Friedman (16:15):

We certainly rethink those issues. And I'm sure if we rethinking it, there are many, many others who are as well. So I don't think that's been the issue. I think it's more a question of things related to flows and also to leverage. And when I say leverage, there are a lot of securities that are in passive instruments that are flow driven, right? Mutual fund gets an inflow. They have to look like the index. They pretty much have to buy that day. They get an outflow, they have to pretty much sell that day. Even if there's no liquidity. That's mutual fund world or 40 act world. The other side is if you look at structured securitized product in the desperate search for yield of the last 10 years, more and more products of more and more types have been leveraged up. People have leveraged up non-performing foreign loans.

Josh Friedman (17:02):

They've, you know, to real estate deals in Spain and Italy and God knows where else they've leveraged up small business loans. They leveraged up a lot of things. Some of those don't really get marked to market accurately, but some people have leveraged up in a way that involves a mismatch. And one thing that is common to all financial crises, virtually everyone, is that there's usually something somewhere buried in that crisis that involves a mismatch of assets and liabilities that produces volatile prices when it unwinds. You know, in the savings and loan crisis, you had depositors and the money was being put in construction loans. And when there were outflows, you had a huge crisis in the early nineties. If you look at long-term capital management, it was massively with somewhat illiquid securities on the other side of the balance sheet. If you look at 2008, 2009, you had banks leveraged up to their eyeballs and when they pulled in their repo lines that they had offered to people, those institutions were mismatched.

Josh Friedman (18:02):

And this time you're seeing some things like that as well. So in structured products we've seen a lot of liquidity mismatch where people have bought all sorts of exotic structured products, but they bought them with overnight repo lines. And when the prices get down, it produces for selling in an illiquid type of a situation, because it's not a security that's in the target zone of the fed. So I think liquidity is important. I think market structure is important. I think you have to look at who has a mismatch if you're going to look for sellers and irrational pricing, but I don't really think it's been driven by the fact that the new Yorkers are, are working from home or the people in Chicago are working from home where the people in Los Angeles were working from home. I think they've adapted reasonably well to that reality.

Greg Dowling (18:55):

Gotcha. Well maybe we can hit on the Fed's response. It seems that the Fed has brought order into those areas that it is targeted, but it's still pretty bifurcated where there are still areas that aren't as liquid as others. So maybe you could kind of talk about, so what are the winners and losers of the Fed's response?

Josh Friedman (19:16):

The Fed has been very forceful in his and very quick and very sizeable both in its announcements and in reality in terms of monetary policy steps that it's taken to achieve certain goals. And one of, let's start with what those goals are, right? Number one is to try to avoid a complete breakdown in market confidence because if you have a complete breakdown in market confidence together with a situation where companies all of a sudden encountered zero revenues and every airline's got issues and Boeing's got issues and Ford motor company has issues and everything else, then even if there are basically very good companies that will ultimately make it through, they might not have an easy path to getting from here to the other side of the crisis. So you need to be able to open up the debt markets in a way that those companies can access capital and the equity markets for that matter.

Josh Friedman (20:13):

So you need to, you need to avoid a complete breakdown in market confidence. That's sort of goal number one. Number two is you have to focus that goal, I think on markets and companies that are key to restoring confidence. And that means some of the larger investment grade (IG) companies, including the ones that have been recently downgraded. And that's where the fed focused. So that's secondary market corporate credit facility program, which was just activated part of it. Part of that capital and the capital can be leveraged up to 10 times depending on whether it's being used to buy ETFs, whether it's buying high yield corporates, whether it's buying fallen angels or whether it's buying ETFs high yield ETFs, different as opposed to IG ETFs. They can do IG and IG ETFs at ten to one leverage. So, you know $25 billion of capital, can be $250 billion in purchases in a universe that if you look at the short duration part of the IG world is only really $350 billion.

Josh Friedman (21:13):

So it's a significant, significant potential effect on that market. So, so the first focus was to try to focus on that, those markets that employ a lot of people that are key to restoring confidence. They're big visible companies. You need the Fords and the Boeings of the world to have some strength and to be able to address the capital markets. So that was really the first, the first step of that sort. Actually, it wasn't the first step because the first step was probably the money market funds because that has a way of affecting, you know, everyone's view of the world. So the, the money market fund, liquidity facilities were right up there in the beginning. They also had to have programs, and this was more the treasuries domain, to deal in a humane way with the, with the crisis that's affecting workers everywhere. So whether it was the PPIP or other aspects of the cares act, you know, those things were quite important.

Josh Friedman (22:06):

And again, just to calm everyone's nerves so you have, you don't have the kind of crisis in confidence that feeds on itself. Do I think the idea, and then they move on to high yield through the ETFs. But even in the corporates, they're focused on things that are less than five year duration. Things that were IG before March 23rd when the real spike down occurred. And this creates liquidity and creates levels where the market can then do the work. So when you see certain traders, and this is more trading than investing, when you see traders kind of front running the Fed programs by rushing in to buy these securities, that's a good thing. The fed wants that to happen because it takes the burden off of them to be the ones buying. And it has a way of then creating enough confidence to create a primary market where new securities can be sold.

Josh Friedman (23:01):

And the result has been record issuance. I mean an absolute tsunami of IG deals. And it's really because the fed calmed everyone's nerves. So in March you had literally something like $250 billion of new IG transactions take place. The money raised in the IG market and another $300 and April. And I think last week was $90 billion. And we're looking at $300 for May. So you see a quick spring back in the indices, you see a lot of financings taking place. There are high yield deals being done now. So the private markets are taking over the task of doing things that may be in a crisis of confidence they wouldn't have done. You've seen financings in the last few days. I think there's one today for carnival. There was one for biking. There's one there for a number of the cruise lines. You saw, I mean AMC, which was on the death list and maybe still is, so the junior bonds trade terribly and that's on traded down, managed to do a financing in the public markets. So without directly buying those types of securities, by putting enough of a safety blanket around the markets, they've restored enough confidence to try to keep the financing markets alive.

Greg Dowling (24:16):

It's certainly left out other parts of the market. Right. That's great if you're a former IG company issuing debt, what about if you're a non-agency RMBS? So what are the areas that are been not yet targeted by the Fed that still have very low or zero liquidity, Josh?

Josh Friedman (24:35):

Well, liquidity is around, but it's spotty. I think in general in these short term financeABS types of entities we've seen--we've done work on three or four of them, we're about to do a rescue financing on one I hope that we'll come together and finish today--repo finance, short term financing against very complicated securities that probably shouldn't have been leveraged for that degree in the first place, a lot of de-leveraging and value creation by de-leveraging, the Fed's doing nothing about that. More importantly, the Fed is solving for liquidity in the securities markets. They're not solving for solvency. When when the private equity firms raised a lot of money and bought a lot of companies, some of them not even looking super leveraged, but the prices were high. So maybe they were leveraged seven times on something that they bought for 14 times. Seven times is a lot of leverage.

Josh Friedman (25:30):

And no one did a spreadsheet. I guarantee you at those firms or any place else that involved a revenue stoppage for three or four months, followed by a slow economy afterwards, much slower than they expected. So there are many, many, many balance sheets that have serious solvency issues. They're just trying to figure out how to get through the summer right now and what a reopen might look like before they figure out how to fix the balance sheet so that the Fed has done really nothing to help those companies. And it really can't. You've seen some of the private equity firms be somewhat vocal and saying, Hey, we're feeling left out of the party here. And the way the rules work is there are two sort of technical barriers to direct federal aid to those types of businesses.

Josh Friedman (26:18):

One is they tend to aggregate all the companies that the PE firm and so therefore the, the size triggers get to be too large for the ones that the fed is interested in or that the federal government is interested in bailing out. And second of all, a lot of those funds have offshore feeders and therefore they don't qualify as U.S.-only and so forth. But the basic point is that I think the markets and the sort of private enterprise system will have to restructure those balance sheets. It's not something simply buying securities doesn't, doesn't help with those with those situations at all. You know, there are very different dynamics in different businesses. Some businesses. What's interesting now is that the inappropriate balance sheet phenomenon spans all industries, including very good companies and very good industries that just have too much leverage for this reality.

Josh Friedman (27:14):

Prior to this COVID situation, the restructurings that you saw out there were all in either energy, you know, oil and gas, metals and mining, retailing. They were in industries that had fundamentally been displaced. And then with covert, it was the last nail in the coffin. So you immediately saw J Crew, Neiman Marcus filing, you saw, you know, Macy's has issues. But it's very different, because the stress is across all industries now and the government is not going to bail out all of these companies. It can provide liquidity, can provide confidence in the financing markets. It can provide confidence that if you do restructure the balance sheet in a way that's sensible and appropriate given the realities of demand and of the business competitiveness, those securities can trade very well.

Greg Dowling (28:07):

I think that's a great comment and an important piece there that it's not the Fed's job or role to guarantee, you know, solvency for all. And I think that was well-made Josh. More on the general side, how do you game plan because in any type of credit you have to have some sense of what cash flow is, and therefore have to have some sense on what a recovery might look like. As you're taking a view of the landscape, are you having to be a lot more focused on collateral and cap structure, margin of safety versus what is the principal appreciation I could potentially have? How do you even make any sort of fundamental assessment of what you're buying?

Josh Friedman (28:57):

I think it's a really good question. I think the honest answer is no one really has visibility about the exit path and at what point in the future do we have what looks like the life that we had at a fixed point in the past. I don't think people know the answer to that. So I think that there's two things. Number one, you have to be cautious and patient because over time we'll get a lot more data on that. Second of all, I think the opportunities tend to be this kind of rolling opportunity set. The first opportunities are really trades. They're not really investments. It's the Fed's going to restore confidence in this market, or I'll buy it, or it's not going to do this, I'll stay away from that. That's more of a fast, funny kind of game, but it's okay. The second steps are securities that have back leverage that's literally they have a balance sheet that has repo type leverage and the facility's being pulled because all of a sudden everyone's retracted.

Josh Friedman (30:00):

You know, we saw a package of real estate loans that was leveraged literally 80% with repo debt. And these are long duration construction loans. I mean that can survive. We've seen a sequence of these things and our securitized asset group, which performed so well in 2012 and forward, and our real estate lending group, you know, all of a sudden are working nights and weekends after, you know, being a little bit in hibernation because we were in a strong bull market. Now all of a sudden there are these situations, some of which have very good assets, some have not so good assets, and we're working very hard in that area. And I think that's a very near term and very compelling opportunity. And that's generally speaking, structured products and vehicles that are leveraged. The next area is, there are certain things in the call it, the high yield market and the stress market that are getting a little bit left behind.

Josh Friedman (31:02):

Just because the way the markets function because so much buying is mechanical and so much selling is mechanical. That's more around the edges. There's not enough liquidity to put on huge size, but those can be some excellent risk return situations and then come the big ones that I think are really going to be interesting. The big restructurings, the good companies with the overly leveraged balance sheet. In some of those situations there'll be traditional distressed and you'll have to go in and fight with the sponsor. As always happens in these distressed situations. Others I think will be different because the sponsors have capital too and they sort of want to rescue their own situations, but they can't be the one necessarily pricing the securities because they're, they already own the equity and if they're going to put some coercive security above the debt, they need a third party to be the one leading that.

Josh Friedman (31:54):

And interestingly, private equity firms don't like to look to other private equity firms necessarily to solve their problems. So being a bit of a neutral third party and having good relations I think will be an asset in that kind of environment. Those, those, those more long-term, you know what I call the higher return, longer duration type investments. I think we have to wait a little while to see those unfold as people emerge from the work from home situations and as revenue start to kick up and people are disappointed and maybe there's a relapse, maybe there isn't in the fall. I think that'll be one of those balance sheets start to get really addressed. I think we're too early in the cycle to see a lot of that yet what we're seeing right now is balance sheet repair in these repoed situations and we're seeing a lot of technical dislocation across the spectrum in high yield and distressed.

Greg Dowling (32:51):

I know it's probably talking to your own book here, but as you talk about having patience and having flexibility, it seems to me that a structure like Canyon that has locked up capital both in their hedge fund and their drawdown vehicles and being multi-strategy multi discipline, you could take advantage of that. How important is that in this environment as we kind of think through what happens next?

Josh Friedman (33:23):

I think it's a huge asset and you know, we'll see. You know, you never, every, every quarter you get a new view on what redemptions you have and what inflows we have. Last quarter, thankfully we had mark at the margin, slight inflows, but relatively flat in capital and inflows into the distressed, drawdown less liquid funds, which I think is probably quite appropriate for this environment. Very appropriate for this environment. It's A huge asset. You can't do this in a mutual fund. Some of these things are you need to own enough security, have influence in a process. You don't want to be whipsawed around in terms of now you're buying, now you're forced to sell. Our redemption schedules and our hedge funds are generally spread out over four quarters, which is pretty good. And we have good visibility and that we don't have a lot of backlog or redemptions.

Josh Friedman (34:09):

So that's a good, strong position to be in. And we also don't have leverage. And the other thing that's helpful I think is that some of the large positions that we have and we have cash balances already, which let us go out and be aggressive in these, in the securitized area for example now. Some of the six big positions that we have are in some what I think are the most attractive existing distressed situations out there like PG&E which is going to emerge from summer. And the securities you'll get are exactly the kind of securities that the federal government wants you to buy. You're going to get investment grade debt. So in some respects your recovery with a world where Powell says rates are staying really low, close to zero for a long time here, and there's talk of negative rates, although, you know, God knows what that'll mean.

Josh Friedman (34:56):

The bottom line is when you have a security you're getting that has a good rate of return, that's investment grade in our totally restructured balance sheet where you solve the fire problem that is designed to give you more upside than you had before the crisis. Because of the tailwind behind those types of IG securities. So I think in our balance sheet, the way we look at it is we have a certain amount of cash, we don't have leverage, we have other things that we can turn into cash if we want to, and there are certain things that will turn to cash without us necessarily even having to sell. We call that endogenous liquidity and the end of some of these restructuring processes like PG&E and like Puerto Rico, which is more next spring's finale those types of situations will give us more capital to recycle as well, which I think will synchronize well with the anticipated schedule of restructurings. But we'll see.

Greg Dowling (35:54):

I wanted to move to the asset-backed securities (ABS side). So in 2008, the consumer was over-levered coming into this crisis. You can see where it doesn't have that same level of leverage, but more and more their securities are embedded in structured vehicles. And the same time we have more plumbing issues. We have this whole concept of forbearance, and servicers are in the middle. So how much as you look at whether it's the mortgage side or something a little bit more esoteric, more about the plumbing than the underwriting, how do you sort of figure out what happens to that whole area of the market?

Josh Friedman (36:45):

Well, both are quite important. Both are very important. What's interesting is when, you know, one of the, sort of a new provisions that the agency just came up with was that special servicers are not required to advance more than four months of payments in the event of nonpayment of the payments that are due. And after that, the federal government will make those payments. So if you're a mortgage servicer, you're not worried about the security of your advances cause they go to the top of the waterfall, but you are worried about, Oh my God, what if I have to make tons of additional advances because everybody's not paying their mortgage. What do I do? Do I keep advancing it even though I know I'm going to get it back from the federal government because as sort of from the proceeds, because at the very top of the waterfall, or do I have enough leverage facilities in place to keep making those? Well when they all of a sudden cap that at four months, that's a much, much different situation and it creates a lot more balance sheets, stability for those mortgage servicers.

Greg Dowling (37:55):

Josh, if you can compare and contrast residential mortgages versus commercial mortgages.

Josh Friedman (38:01):

I think if you're very careful in the commercial mortgage world. We don't really know what rents will be. Everyone's just adapted with remarkable speed and smoothness to this stay at home business and a lot of people are going to rethink exactly how much commercial real estate they need and we'll see what that does to the commercial real estate business. We have some calls scheduled for later this week with some of the major commercial real estate developers, but I would expect that that will be a bit of a challenged asset class going forward, just because of people's space requirements will shrink somewhat. The nature of the spaces they need will also change. You've gone from a trend toward decreasing square foot per employee to a situation where with social distancing people won't tolerate 75 feet per employee or whatever tiny spaces per employee you get in a WeWork facility and then you might have a bunch of WeWork office space on the market in New York.

Josh Friedman (39:01):

Who knows? So I think commercial real estate is going to be complex. It is definitely not, none of this is good news for commercial real estate, commercial real estate retailing, which is often at the ground floor of residential buildings and at the ground floor of office buildings will be very challenged. A lot of the local shops as well as the national brands will be contracting and continue to contract any retailer who wasn't fully taking the internet seriously as a major initiative is now laser focused on it. So I think that real estate will be, it'll be an interesting time, especially for commercial, you know, offices et cetera. Warehouse is another issue there. They're obviously benefiting from the massive change in logistics and shipping and Amazon and that whole phenomenon, and I don't think that will change terribly. Residential is a different story. We'll see what happens with forbearance. We'll see what happens with how many people skipped payments for how long. We didn't have the overbuilding that we had prior to '08. It's a very, very different situation. I mean pre-'08, you had, you know, jet fuel in the form of the financing that was being offered through all the various programs, and through the securitization of non-agency as well, so that, you know, pay option arms and subprime and all day and all these other things and half part doc, no doc, different loans. These were getting securitized at this crazy rate where the volume of new homes being constructed far exceeded the real demand for new homes. That's now sort of filtered through the system. And multifamily has probably not suffered from over overbuilding either, although we'll see what happens on the cities versus the suburbs. So I think it will be different. I think that the most cautionary area will be in office.

Greg Dowling (41:10):

Gotcha. Those are some great comments. I liked your example of WeWorks and that was where everybody was going. Now I hear more and more just on the manager side, people looking to open up satellite offices because nobody wants to get out of mass transit to go into the city. So I think you're spot on in that. Josh, the other unique thing about Canyon is that you're a global firm and so you have the ability to invest wherever you want. How should we think about what the opportunity set looks like for the U.S. Versus the rest of the world, and specifically Europe? I mean, boy, Europe, it was a mess prior to this and even more a mess. Does that make it a better opportunity?

Josh Friedman (42:03):

You also have to realize we don't have unlimited capital, so we try to prioritize where we're going to invest. I think that my own personal view is while we have investments in Europe and we've continued to make some incremental investments in distressed, it's such a different market. There's so little liquidity. The high yield market is not active. The U.S. Programs are not out there doing the same things there that they're doing here. I think that you're seeing some of the stresses within the EU that you saw with the recent court case on quantitative easing. You have zero or negative rates, which means that you don't always have high enough yields on other securities. I think it's more challenging to invest in Europe, myself. I think a lot of people wanted to tell a story about buying nonperforming loans in Europe and then leveraging them a lot with back leverage. And we never liked that business before a drop in liquidity and we like it even less today. So it's not that there won't be opportunities. I am sure there will be, but it'll require a lot of caution. Governance is always an issue even in Europe. Generally speaking, governance is poor in certain countries and better in others. You know the closer they are to the UK, generally speaking, the better the governance. France can be very difficult because certain things you can do to actually fix an operation you simply can't do in France because they won't lay people off or close a facility or whatever. Italy has all sorts of hometown rules and I just, you know, that doesn't mean we've never done a deal in Italy, but I think that the U.S. Is the most predictable.

Josh Friedman (43:50):

I think the UK is sort of the second most predictable and I think you just have to be cautious and given all the other things to do in the world right now, I don't feel like we have to rush into areas that maybe people were stretching to rush into in the last cycle. And I think not all of that will have a great ending. I also think the liquidity on the exit will never be as good if you own PG&E and you're going to get IG securities, you know, that are a strong rating, and a good issuer, you know, and the Fed wants you to buy that security. That's a great place to be. If you buy something in, you know, even in the UK you might get into a security that's not so easy to sell or certainly at the right price.

Greg Dowling (44:36):

Great point. Josh, with the last couple of questions here, and one question and is for your point on patience and having different vehicles. What's the right vehicle for the different strategies? So you have a private equity distressed drawdown and you have a hedge fund. So if an allocator has $1 of marginal capital to invest, where should they put their money? In the hedge fund or the drawdown vehicle?

Josh Friedman (45:10):

I think it depends a lot on the person's liquidity needs. The nice thing with a hedge fund is you buy an incumbent portfolio of assets. Granted it's only maybe 80 something percent invested and then a bunch of that stuff will turn to cash and then we'll find new investments and so forth. But you're buying a lot of securities that I think are in the best situations that are in the market today where you couldn't accumulate those positions today without moving the market quite materially. And I think there's a lot of snapback potential in a lot of securities that are already on the balance sheet, et cetera. And you have more liquidity because you can take your money out over four quarters, et cetera. And maybe we'll have lower return targets in some respects in that vehicle than we would in the drawdown vehicle.

Josh Friedman (45:53):

In the drawdown vehicle, it will be more concentrated, there'll be more pure distressed. There is a collection of existing distressed securities in there already. They share the same characteristics of that smaller bit that's in the hedge funds. So you do get good exposure to existing distressed situations that what I believe are attractive prices, but you also read that money will recycle during the investment period and it's a longer lockup type of vehicle. I do think that generally the longer lock up vehicles should be giving you a higher return in exchange for that longer lockup. That is what they should do. Absolutely.

Josh Friedman (46:32):

I think the entry points are, it's a good entry point in terms of timing in both, because I think we're, we no longer feel like we have to stretch and look at companies that are in unattractive displaced industries in order to find these types of distressed or stressed opportunities.

Greg Dowling (46:51):

Hey, Josh, last question, and a lot of these podcasts, just given the timing of when they're recorded, we're talking a lot of doom and gloom. Give me one silver lining. One good thing that's come out of this, either on a personal or a professional level, and you can't say the lack of traffic in LA, although I'm sure that's somewhat of a benefit.

Josh Friedman (47:13):

Oh, it's fantastic. It takes me no time to drive out to you know, to Malibu or other places outside of LA. There's no traffic. Look, I think it accelerates certain transitions of businesses that are good for society and that are efficient for society, including people learning different ways to work, different ways to communicate. I think it's been fantastic for having people take a step back and take a breath and spend time with their families. Everybody was running too fast and I would put myself on that list. Traveling when you didn't really need to travel, rushing out and having a meeting that you really didn't need to have. And I think some of the basic values of focusing on a smaller group of loved ones in a more serious way. I think some of that is forced by this. Who are your real friends? Who's your family and how do you communicate with them? For all the difficulties, I think it's reminded us a little bit of our values in a way that I think is quite important.

Josh Friedman (48:21):

I don't think we're going quite back to that world that we had right before the crisis. And maybe that means the economy will be softer for longer. But I also don't believe, look today is a rough day in the market. Why is it a rough day in the market? We'll, you've had five pessimists say things in the market. Right? You had the LA health person say, Oh, we're going to stay closed through July. You've had similar announcement from New York. You now have the LA mayor backpedaling a little bit, but you had LA, you had New York, they're going to stay closed forever. You have Powell come in and say we're going to just keep rates low forever because you know, this could really be difficult. You had Stan Druckenmiller make his comments. You had David Tepper make his comments about equity pricing and valuation. On the other hand, the fact is Europe's reopening. It actually really is, except for the UK, and it will too. The U.S. Is slowly reopening. We may get a resurgence. I'd be surprised if science didn't come up with something quite effective faster than the market expects because of the amount of resources and creativity of being dedicated to that. And we talked to a lot of hospital systems that are very involved. So I think you have to take those, kind of gets back to how we started the interview, and you were saying what's the same and what's different, what's the same as we will get through it and eventually we'll come through it stronger and markets will recover and employment will recover and everybody will be okay. There's a lot of pain between where we started and there, but I think that having a little reminder about values not being terrified, by what everybody says on TV every day. And having the patience to act out in a sound manner in this type of environment. I think those were all positives.

Greg Dowling (50:15):

Definitely some words of wisdom there. Hey Josh, that's great stuff, and as always, we love your insights and we appreciate your time today. So thank you very much.

Josh Friedman (50:26):

Thank very much. We really appreciate all of our friends at FEG and thank you for having me.

Greg Dowling (50:34):

If you are interested in more information on the topic, please go to our website where we will have a list of relevant FEG publications. And don't forget to subscribe to our event communications at so you don't miss the next episode.

Greg Dowling (50:53):

Please keep in mind that this information is intended to be general education that needs to be framed within the unique risk and return objectives of each client. Therefore, nobody should consider these FEG recommendations. This podcast was prepared by FEG. Neither the information nor any opinion expressed in this podcast constitutes an offer or an invitation to make an offer to buy or sell any securities. The views or opinions expressed by guest speakers are solely their own and do not necessarily represent the views or opinions of FEG.


This was prepared by FEG (also known as Fund Evaluation Group, LLC), a federally registered investment adviser under the Investment Advisers Act of 1940, as amended, providing non-discretionary and discretionary investment advice to its clients on an individual basis. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Fund Evaluation Group, LLC, Form ADV Part 2A & 2B can be obtained by written request directly to: Fund Evaluation Group, LLC, 201 East Fifth Street, Suite 1600, Cincinnati, OH 45202, Attention: Compliance Department. Neither the information nor any opinion expressed constitutes an offer, or an invitation to make an offer, to buy or sell any securities. The information herein was obtained from various sources. FEG does not guarantee the accuracy or completeness of such information provided by third parties. The information is given as of the date indicated and believed to be reliable. FEG assumes no obligation to update this information, or to advise on further developments relating to it. Past performance is not an indicator or guarantee of future results. Diversification or Asset Allocation does not assure or guarantee better performance and cannot eliminate the risk of investment loss. The views or opinions expressed by guest speakers are solely their own and do not represent the views or opinions of Fund Evaluation Group, LLC.

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