Video Transcript: The Alchemy of Capital Structure

Eric Schatzker - My name is Eric Schatzker of Bloomberg Television. I've been  looking forward to this panel for weeks. Many of you know there are few more  authoritative views on the use of credit than the people here with me on the  stage today. To my far left, John Sokolov of Leonard green and partners. To my  immediate left, we have Josh Harris of Apollo management to my right, Josh no  Carrie Lathrop of Citigroup and to my far right, Josh Friedman of Canyon  partners, gentlemen, thank you very much for doing this. The folks at the Milken  Institute are superb at giving panels intriguing names. And the alchemy of  capital structure is certainly no exception. Alchemy, of course, is the medieval art of turning lead into gold. So far as I'm aware, nobody ever succeeded in doing  that, but alchemy in credit is real, debt and leverage can make companies  better. So I'll begin today's conversation with a simple question for our panel,  why is capital structure so important? Josh Harris, well, I  

Josh Harris - mean, capital structure allows a company to have flexibility to  grow and prosper. So, yeah, I think if you set it up in a good way, it also is a  significant cost, so it's really, you know, kind of and then it allows for leverage,  which allows for greater returns if it's used properly. So I'd say that capital  structure, if you set up well, can be a real asset. It's the whole most companies  focus on the left side of the balance sheet, the asset side of the balance sheet.  But really, when you think about creating value for the equity or for securities,  you have to focus on both sides, the left and the right. And actually, Apollo, you  know, one of the things that we're known for is buying good companies with bad  balance sheets. And so there's definitely lots of great companies over the years  that have been really, really fantastic companies with great strategies, great  assets, great management, but they set up the right side of the balance sheet in  a way that wasn't appropriate for their volatility, and so they ended up getting in  trouble. And for that reason, really, the company itself was hurt, and in some  cases, the company itself can be destroyed if capital structure isn't handled.  Well, what are some good examples of bad capital structure, I  

Joshua Friedman - would say that one of the great undervalued assets in the  capital markets, generally, or mis valued assets historically, is the value of  optionality. And I think a lot of the panelists here, like John and Josh, for  example, understood long ago that if you leverage a balance sheet, the equity  has great optionality, as long as the debt is long enough and safe enough and  you can survive it, and you have a lot of opportunities to get get lucky. And when you have unbounded opportunity on the upside and bounded opportunity on the  downside, that's a great thing. And I remember one of the very first transactions  I worked on back at Drexel in 1984 or 85 with Mike was was a leveraged buyout  of Motel Six for KKR. And George Roberts said, if the capital structure is if the  debt is long left will follow. And I think that's a truism. And so part of the game is 

to try to look for situations where you might have a lot longer bet implicit than  what the securities imply. So the trick is to try to find balance sheets where  securities where that optionality is severely undervalued, debt security is  inherently negative optionality. So which is why we like to find distress things, or  things where there's much more, much more upside per unit of downside than  there is in par debt, where you basically, if you're lucky, or get your money back,  

Jonathan Sokoloff - John. Well, I think you know, three of us on the panel were  fortunate enough to learn our trade at the desk of Mike Milken, 30 years ago.  And we learned at a very I worked  

Josh Harris - for John and Josh, but I'd like to point out, right, so yeah,  

Jonathan Sokoloff - and we saw some great actors and some bad actors, but  we were taught very early that the balance sheet is your friend, and the balance  sheet as an issuer should be actively managed to enhance your equity returns  and and there's times to issue equity, there's times to buy in equity, there's times to issue debt, there's times to buy in debt. So a lot of folks view the balance  sheet as relatively static, but as Josh said, that side of the balance sheet  provides sometimes more opportunities to create value, and we saw so when  Drexel went down and the tide went out, it was a time of great Carnage and  great opportunity in the 89, 90, 91 and some fortunes were lost and some great  fortunes were made and firms were launched like three on this panel. So it was  a time of where active balance sheet management and using the tools we had  been taught by Mike and others, proved to be a real advantage and a  differentiator in the corporate world.  

Eric Schatzker - Carey, these guys come at it from either. The investor side, or  the issuer side, the sponsor side. You come at it from the trading side, if you will. Do you view it any differently? No,  

Carey Lathrop - I think it's, you know, it's the same view. I you know, you know,  to me, I think you know. I think Josh touched on it, or Josh Harris touched on it. I think one of the tensions is that, you know, is the cost of creating, you know, that duration or flexibility, and, you know, kind of, if you look back, probably, over our  careers, you know, I think companies that miscalculate, or I think, you know, you know, to me, I always, when I look a company, I try to think about, is there  

advantage on the asset side of the balance sheet or the liability side of the  balance sheet? And I think oftentimes, you know, when you get into, you know,  go through a cycle, people kind of stray and lose sight of that. And I think you  know whether it's, you know, ending up short funding or not when the markets  open, taking enough liquidity out of the market to maintain that optionality. So I 

don't, I don't think it's any different view from a, you know, a trading perspective.  Three  

Eric Schatzker - of you have pointed out that you worked for Michael Milken  Carey. You been doing this for decades as well. I can't resist the temptation to  turn this into a little bit of a history lesson, given that, as I say, three of you work  for Mike. We might consider him the godfather of modern capital structure,  revolutionized the industry and the implications of what he created at Drexel is  something that we're still that's still evolving. How has the thinking, John, maybe I'll come back to you to start this. How has the thinking about debt, leverage,  capital structure, generally speaking, evolved since your time at Drexel in the  1980s and then specifically, let's look at how things have changed in the post  crisis environment, with the move towards zero interest rates, the Reach for  yield, etc.  

Jonathan Sokoloff - Well, I think it's, it's, you know, we're a private equity firm,  so we're a net issuer of debt securities, equity securities, etc. But I think  generally, in the C suite, in the boardroom 30 years ago, and to some extent  today, even debt is a bad word. And see, many CEOs do not, do not like debt. It  has a negative connotation. I don't need debt. I'm debt free. People say with  great pride. And we were kind of taught that debt can be your friend and a great  tool to use in your in your C suite and in your balance sheet. But you know, in  the 80s, when we learned our trade, there was some tricky debt out there, and  some debt was your friend, and some was really your enemy. That ate you alive, because we were issuing securities sometimes at 12, 14, 15% and they had  amortization and they had covenants and they had all kinds of bad triggers, and  bank debt was high single digit to 10% so it was a tricky time. We would kind of  carefully manipulate the LBO model in the 80s to try to get an EBITDA interest  coverage ratio of one and a half times. This is on lotus, 1 2 3, and if you got  there, you felt, whoa. This is a safe credit now. Well, none of us would ever do a  deal today at one and a half times EBITDA to interest coverage. So, so the  technology in our world has has evolved dramatically, and for those of us that  learned our trade with double digit interest rates, the interest rates we have  today are somewhat of a fantasy. It's almost like alchemy. You've turned high  rates into low rates, where we used to borrow money at 15% now we're  borrowing money at 5% we just have a comfort level today that is so  dramatically different than we did 25 and 30 years ago. So when we pitch debt  today to companies, we try to tell them, Hey, you don't understand. You're living  in this unbelievable golden time of issuing debt with rates where it's very hard to  get into trouble. And I think there's more receptivity today to to making proposals to executives 20 30, years ago was was much tougher. So 

Josh Harris - what Mike and Drexel did was they before Mike and Drexel, there  was bank debt, and there was an aggressive investment grade bond. So if you  were one of the biggest companies in the world, you could issue bonds, and  there was equity. And what Mike noticed was that there was this whole middle  part of the capital structure that was not being utilized, and many, many  emerging companies, smaller issuers, couldn't, couldn't find leverage other than  from the banks. And so the high yield market, which, as John mentioned, was  used to be called the junk bond market, because that was a derogatory term,  was born. And you know, from probably the late 70s to 1990 Drexel had, you  know, the largest market share in that market. In 1990 the government decided  that junk bonds were bad, and so they legis made it very difficult for savings and loans and insurance companies to hold junk bonds, and so the entire market fell apart. And Drexel itself went bankrupt in 1990 and then, you know, Apollo, at  that point was born to, in essence, facilitate the refinancing of and some other  firms. By the way, oak tree, Josh's firm, was born to facilitate the deleveraging of of the companies that that had been financed by the high yield market. And so  distress for control today is a kind of a nomenclature that everyone knows. You  go out instead of, you know, kind of putting up equity and borrowing from the  markets. You buy a company that's a very good company. In our case, probably  the best example was lying down chemical, which now is a 50 60, $70 billion  market cap company where the debt had traded down to very distressed levels.  And so you buy debt and you deleverage it instead of leveraging instead of  raising it, but you end up in the same place with a good company and a well  structured capital structure. And so Apollo, in those early days, as well as a few  others, we made our name buying a lot of great companies. You know whether,  whether it be lane, Boyle, Thomasville, furniture, Samsonite, luggage, Culligan,  water system, Converse shoes, and Vale ski resorts and that, and hence, like  that, that market was born. And so that's a bit of the history lesson today. At zero rates, the temptation for everyone is to borrow too much, because at zero rates.  Doesn't cost very much, and those EBITDA interest, you know, kind of ratios  look really good, but the problem is, when rates go up, you got to pay it back.  And so it's, it's a it's real problem. And you need to be very conservative about  how you think about terminal value, how you think about the ability of a  company not just to pay its interest, but also to pay its principal at the end of the  day. The other thing is, today, what you should be doing as a sponsor or an  issuer is you should be refinancing and pushing out maturities and, you know,  really being intelligent about setting up a capital structure that creates that long,  dated option that that John talked about.  

Carey Lathrop - I mean, one of the things you touched on was negative rates,  or even if you think about zero rates, and what's that done? I mean, you know,  you can think about, you know, Europe, for example, where you have the if you 

look at the investment grade market, the investment grade market in Europe  yields, 130 you know, the high yield market. I don't even know if you can call it a  high yield markets, a high spread market. It's about 435 so what's happened,  and I think with flexibility that borrowers or sponsors have gotten, is that people  have gotten squeezed into high yield. So I think it's created an incredible  environment for companies, too, if they want to lengthen out maturities. And  probably up until the last six or nine months, the market's been kind of wide  open and very, very accessible and willing to provide rescue financing. Again, I  think there's been some changes recently, but I think overall, and again, I think  that Windows probably closed for some companies, but I think for the vast  majority, there's still access and ability to, you know, kind of protect, you know,  or fortify your balance sheet as you get kind of later in in the cycle. I just  

Joshua Friedman - wanted to jump in with a couple of things there. You don't  always have to pay it back. You can figure out something else to do, which is,  we all know that we can talk about that later, much later. But we'll start with you  asked Eric earlier, what makes a bad balance sheet. Government policy has a  unique ability to create bad balance sheets. If you look at the housing crisis, it's  not like governments out there with clean hands and didn't have a role in  creating really bad balance sheets across an enormous asset class. And it's a  it's a bit of what's happening again today. And we're talking about the history of  the high yield market. And Josh and John were talking about how in the old  days, you had bank debt and you had equity, and maybe there was some  subordinated debt that some insurance company negotiated privately, then you  had a more liquid market, and so forth. Well now you've got a situation with  negative interest rates where some guy is working for a living and he says,  geez, stock market multiples are really high. I'm scared about that. Well, maybe  that's driven by low rates. I think I'll buy bonds and the most attractive market in  the world right now in terms of just yields, you look at European rates, you look  at Treasury rates, you look at IG rates, all of a sudden, high yield looks pretty  good at 740 or whatever the yield is this morning on the high yield index, and of  course, that masks a lot of significant issues that create really bad balance  sheets. So now you have an explosion of ETFs and mutual funds that are  buying high yield bonds because everybody wants that yield so desperately. The only problem is, government policy has also created a situation where  commercial banks and investment banks, guys like my friend Carey here, no  longer can devote a significant portion of their capital to making markets, and so liquidity is basically pretty terrible if you really need to sell something overnight,  so someone doesn't think he's taking a lot of risk because he's earning a nice  yield, and then all of a sudden, there's a few. Redemptions at the fund, or maybe they have to reshuffle their index because some high grade bonds got  downgraded, and now they're part of the investment grade index, and all of a 

sudden you have really significant capital losses. And I worry that that the  structure of the market today is one with a lot of very mismatched capital  structures. And if you have a mismatched capital structure in the corporate  sense, the assets don't work out so well. The liabilities are coming due.  Something bad is happening. There's a there's a pattern for how you renegotiate that that works pretty well, and the company can have another life if the  business is okay. That doesn't work as well in other contexts. But  

Carey Lathrop - I would argue that's what creates an opportunity, if you have  the right kind of liability structure as an investor. And that is one thing, you know, we're seeing more. And it'd be interesting to hear the three of you, you know, if  you're kind of, kind of moving down this path also, but just having more, longer  term locked up money, because, you know, if you think about what happened  even in the CLO market earlier this year, you had, you know, triple A buyers who had bought product on leverage that were for sellers. You had Junior meds,  buyers who had terrible 2015s. And when 2016 started out poorly, there was  fear of forced liquidations. So yeah, there was some fundamental reasons why  liabilities got beaten down. But there was a large technical element. And if you  have the right balance sheet, and you know, who do you typically see stepping  in, you know, could be insurance companies, pensions, endowments, someone  who could live with the mark to market volatility, it gives you an ability to be a  buyer when, you know, there are four sellers. A perfect  

Josh Harris - example, what Josh was talking about is the energy markets. So  the energy markets drove the development of the shell, if you look at it, energy  used to be 5% of the high yield market. Sort of Fast forward five or seven years,  and it's 18% of the high yield market. And really, the risk that people were taking  got lost in the wash a bit. People really didn't understand how volatile the  companies were, and they were looking for yield. And so should that have been  equity financing? It, you know, in retrospect, of course, it should have. They're  the you know, it's a very capital intensive business. The assets are very hard to  understand from a financial statement. You need real geologic and engineering  talent to understand them. And yet the high yield market was indiscriminately  financing all these companies. And ultimately, price of oil fell, and it's a  commodity, right? The price of oil goes up, it goes down. It's unpredictable. And  now you know, the the the country and the economy and the energy markets  have a problem. And so that's, that's an example of a mismatch, mismatched  capital structure. And I think for a long time from here, we're going to be working  out a number of companies  

Jonathan Sokoloff - that raises a I think, I think a lot of companies, CEOs CFOs, sometimes focus on the wrong thing when issuing debt securities. And it's 

almost, you know, they just want to know what's the rate. And it's a macho thing  if they get a lower rate than their friend, or the spread over this. And what we  were taught early is the rate is sometimes, you know, not that important. You  know, what's the maturity? Buy more time. Have optionality. Some of the firms  have made it through the tough times in 1990 in 2002 2008 or when they didn't  have maturity. So if it's an extra 50 or 100 basis points for another couple three  years of maturity with no covenants, you know, we pay that every day, and other people get upset about eighths and quarters. I mean, you're there a lot of these  strange converts that have been issued the past few years where there's no  coupon, 50% premium, it's kind of on. That's really alchemy. That's kind of  unintelligible, and companies issue them all day, but a lot of them are five year  maturities, and they do mature, and if your stock is down when they mature, it's  a real time bomb. So So you know, buy flexibility, pay a little bit extra, and make  sure whatever storm comes you can live through. The storm is something that  we employ. And I think we were all taught at a young age.  

Eric Schatzker - I think the sense we're getting in the room here is that the  storm is coming when, right, where are we? I don't know how you prefer to, you  know, characterize it, whether it's innings of a baseball game or hands on a  clock. What does it look like? You've  

Joshua Friedman - had a pretty monstrous bounce in the high yield market in  the last call, it eight to 12 weeks from a point where the indices looked really  wide to where they looked quite a bit tighter. What that masks is a bunch of  danger, which is why you have to really look it's more of a security pickers  market right now, and the dangers are at both end of the high yield market. The  average yield may be in the low sevens, but almost nothing lives in the low  sevens. If you look at it, there's a whole bunch of stuff yielding four to 6% you've  got interest rate risk, you've got spread risk, and you. Got the odd piece of credit risk, and when you add them together, it can be a really dangerous  neighborhood to live in if you own that subset of the market. At the other end,  you have a whole slew of stuff that's trading at 15 to 25% yield, some of which  the yield is illusory, because it's clear you're not getting paid back, and other  which is quite interesting, but it's very it's very bifurcated. Some we've seen how  extreme the downside can be if you get it wrong on some of those more junior,  very low dollar price pieces of paper. So So I think that the idea that, ah, this  index is yielding 400 basis points more than all these other ones, therefore this  is really safe. No worries. Maybe I'll hedge a little bit of it with with rates is  probably not a good, not a good way to play. There are a lot of things that can  cause that can be catalysts, but I'll, I've used enough time. I'll let others talk  about them. But I think oil, you'll see what happens at the end of the year when  went to the transmission companies and some of those balance sheets. You'll 

see what happens to some of these companies that are almost IG type rates  that they're paying, but that have really leveraged to points that that give them  the lowest interest coverages that we've seen in five or six or seven years. And  the macro economy is clearly showing slower growth, clearly in many, many  areas. And yet, leverages is really, really rather high and interest coverage is  rather low. So it seems inevitable that there's going to be some correction in  those broad indices.  

Carey Lathrop - I think I was going to say, I think a lot of the known unknowns,  you know, whether it's coming up, you have things like Brexit, Greece is still not  resolved. China has kind of been, probably, you know, somewhat, you know,  pushed to the side. But again, you still have the risk, if Fed looks like they're  going to increase rates China comes back into play. Plus keep an eye you're  seeing an increase in defaults in the local market there to see how that spills to,  you know, to potentially external markets. There are a number of factors you  have, the US election. And I think what was interesting, if you look at kind of the  correction that we had last August, the first time that China encountered  volatility, you know, when you looked at kind of how assets rallied at the end of  last year, you had equities rally. You had the high end of credit, you know, call it  investment grade rally. But I thought was really notable was that the low end of  credit, you know, stressed, you know, high yield or distressed, continued selling  off. And I think that was probably the first time since the financial crisis that you  didn't have this risk on, risk off movement. And I think credits really been the  bear market since July 2014 and I think what credit markets have been doing is  really coming to the realization that we're going to be in a low growth, low  inflation environment for a prolonged period of time, and what companies are  not gonna be able to grow into their balance sheet or delever. And that's why I  think you've seen this real dispersion that Josh was talking about, where  whatever 20 or 30% of the market trades below five and a quarter, and close to  20% trades above 11 and a quarter. And I think the like I said, the challenges  even with the recent rally in the last couple of months, it's not like every  company has access. Again. If you looked at really what kind of issuance you've seen, it's been very much double B dominated. You know, it's clearly moving  down the credit spectrum. But not every company has access. And I don't think  not every company will regain access. I think, you know, as investors have kind  of gotten burned and are working through, you know, the problems in their  portfolio. I think there's a psychological impact that that they deal with, and  they're just much more defensive. You know, equity investors, you know, can  have a few things go to zero and then find that thing that goes up five or 10  times and make up for it. Debt investors don't have that benefit. So I think it is a  we are late cycle, whether you want to use it the clock, you know, I think you're  getting close to nine o'clock or, you know, late in the innings of the game. And 

this is the time that, while markets are still open, you know, I would, I think it's a  great time, you know, to term out that. And, you know, fortify your balance sheet, 

Josh Harris - know, I will say, like it all, you have to start with the macro. It all  starts with the fact that 70 to 75% of the world has negative real rates. And so  that kind of, that kind of sets the backdrop for everything else. And so you know,  whether it be the equity markets, whether it be the high yield market, whether it  be, you know, all the fixed income markets, even the private equity market,  which the average multiple paid for company now is over 11 times even. That's  the absolute peak in the private equity market ever. So all this stuff stems from  the fact that people, like big institutions, individuals, no one has any place to put  their money, so people are chasing yield. And what you saw between November and February was really nothing. I mean, China certainly you know, maybe  made some policy mistakes. The price of oil was down, but the chain, there was  no, no real change in the fundamentals, and yet, the market just sold off big  time, because people's view, because everyone, all of us, know that, that all  these markets are overvalued stemming from, you know, really, government  policy. And so the minute that there is even the slightest hint that things might go wrong. People like shoot first and ask questions later, they drive the markets  down. And what you saw in February, in March and April was, you know, the wall of money came back in. You know, QE kept going, and it overwhelmed the risk.  So what you really have, it's a very treacherous time to invest. Risk is being  missed. There is no real risk is being mispriced by, you know, a lot of stemming  from the government policies and the easy money. And as an investor, you know it's very, very treacherous as an issue, or obviously it's time to take advantage of it. But you know, the bar is open. That doesn't mean you should have five drinks. You know, you need to have one drink and go home and take an aspirin and go  to sleep, and so, you know, we all have to be very careful right now. And I will  say even triple C is a rallying I mean, you say that, yeah, for a month or two, the  markets got tough, but you're now seeing, you know, distressed and triple C's  and energy credit and everything is kind of coming back. So, you know, you  again, you know the market is vacillating. You know, between, you know, huge  risk on and huge risk off. And it's really a battle between the fundamentals,  which are somewhat late, late cycle and treacherous, and the technicals, which  is massive amounts of money with no place to go.  

Eric Schatzker - John, you having one drink or five? What's that you're having  one drink or five? I didn't hear you. Are you having one drink or five?  

Jonathan Sokoloff - Well, look, I think I'm not a big drinker anyway, but maybe  should be. But you know, whenever you're six or seven years into an economic  expansion, all of our alarms are going off, and we're watching, and we've had 

these wonderfully receptive both equity and debt markets to issuers. And so  whenever you do a new transaction today, as far as your balance sheet, you  have to plan that during the next five or 10 years you're going to be going  through some type of type of downturn. You have to build that into your models.  Now, generally, we don't think it will be as rough as the downturn of 2008 and  2009 because that was an 80 year storm and and, but you know, we look at  we've been waiting for rates to go up for a long time. We have spent 10s and  10s of millions of dollars and caps and swaps and everything planning for rates  going up, and we could have held a bonfire with the money, because it's all been wasted, but we still do it out of a sense of caution and but look at we have a  heavy consumer focused portfolio in the United States. We keep looking for  signs of slowdown, because the press is so negative, and by the way, our view  is things are okay out there. We're not really exposed to energy, but retail  services, healthcare, actually doing okay, but we're still worried, you know, we're still cautious. And our view today is, again, borrow. You know, again, the debt  today is not our father's debt. If we can borrow six to seven times EBITDA at six  to 7% interest rates with no covenants, no amortizations, borrow every nickel  you can, as long as you believe you have a fundamentally strong underlying  performance at the issuer and that when maturities come, your EBITDA will be  higher than it is today. So that, in our view, is almost like shorting the credit  market by issuing all this debt. And, by the way, if, if the debt comes down, and  your performance is doing well, you buy in the debt. So, so the the crunch that  came into leverage credit markets in January, February, was was swift. It was  dramatic. And there was tremendous carnage, you know, caused, as they say,  by energy and supply. It wasn't really as credit driven. So we're like, oh my gosh, but you have to respond. So what did we do? Well, we turned from being an  investor in equities to an investor in debt. So we're a private equity fund, but we  found equity like returns in credit instruments. So in January and February, we  invested only in debt of other companies, as well as for our own companies. We  bought in a bunch of debt because the market overreacts, because the  leveraged credit markets are kind of fickle, emotional, dramatic in their reactions on the upside and downside, all of which creates opportunity. So we're cautious. But you know, the markets are your friend, and right now, if you know, for some  of our companies, we're doing new deals, credit still abundant, we're issuing all  we can. I think  

Josh Harris - there's a limit to what QE can do. And you know, right now, you  know, QE is driving the market, and QE outside the US, and what the Fed does  or doesn't do is going to have a big impact on the market. And what you're  seeing in Japan, and what you're seeing Japan, for the first time, went negative  rates and did and sort of announced big programs, and the yen strengthened  and the stock market fell. Europe, the effectiveness of QE is is waning. You 

know, just statistically, it's not working as well. As it did. And the real question is,  when the efficacy of QE runs out, and people are staring at, you know, kind of a  stock market with really high valuation, fixed income, credit markets with really  low rates, and QE that's no longer working and very slow fundamentals, what  happens to terminal value if you borrow six to seven times EBITDA, it better be  the case that you can sell it 10 times EBITDA, if you bought it 10 times EBITDA.  So you know, the other implicit bet that you're making is that you can sell at a  very high price if you if you buy it 10 times EBITDA, and you borrow at 6% and  you sell at eight times EBITDA, and you grow at 5% you've lost money for your  investors. And so, you know, it's the other bet that you're making, is that terminal valuations are appropriate in a really slow growth environment. And I really, you  know, I question, or we question whether that's the case, and what really  happens when the efficacy of QE goes away, and it's really starting to look like  you're heading in that direction.  

Eric Schatzker - So Josh Friedman, if investors are becoming more disciplined,  what is doable? Let's go back to the capital structure question. What is doable?  What you're an investor, what are you willing to buy into? What kind of structure  is feasible today?  

Joshua Friedman - Well, first of all, I think you have to be, as an investor,  acutely sensitive to what's going on around you. Who's buying, who's selling.  Why are they buying? Why are they selling? If you looked at the beginning of  this year, the end of last year, you know, I think the first four months, first three  months of this year, two and a half months through February 11, there were  about 4 billion of outflows in high yield mutual funds. And not surprisingly, prices  got killed. They had almost nothing to do with fundamentals. Following February  11, everyone decided that oil was going up, and 15 billion of capital came into  those funds. So everybody was buying. And you go, why is this debt trading  here at this time? And is trading here at this time is, are things that different at  you pick the company, not really. So fundamentals aren't always being attached  to the pricing of securities. And the reason is that when you get the kind of flows  that those things imply in an illiquid market, and you're in a much less liquid  market. A, you better make sure you have the right capital structure to handle it.  And B, you want to know who is selling and who is buying, why and is that  creating a price opportunity that is way out of whack with the risk return. So  today, that means that you have to be relatively quick to react to things. You  have to be able to move into fairly specialized markets when they get thrown out with the bathwater, whether that's the CLO tranche market, or whether that's,  you know, non performing loans, or whether that's some other type of  specialized paper that all of a sudden got got battered around by this paper. I  also think the regulatory structure has created a situation where there are many, 

many places in the markets where banks used to be more active and the capital  costs associated with those banks have now gotten to be really, really punitive.  You take commercial real estate lending is a good example. Banks are more  than happy to lend to you at three or three and a half percent if you fit into the  box of what the bank does, but if there's one check mark you can't check off,  even though it's a great loan, they simply say, no, they don't say, well, we'll do  the loan, but we'll charge you 5% or six or seven or even eight or nine or 10. So  you try to find things that have complexity to it, that don't fit into one of the  capital markets are very segmented people. High yield index funds can only buy what's in the high yield index, you know, oil and gas funds can only buy what's in oil and gas. So you try to find things where, where people's mandate forces  them to be buyers or sellers, or not to be buyers or sellers, because those are  the places where you can get way overcompensated for the fundamental risks  and then wait it out. I think  

Josh Harris - it's very hard to find places to put your money in the opportunistic  world. So if you're a distress player, or, you know, to a certain extent, private  equity, you know, you have to look at really specific areas where there's  carnage. And so the energy market certainly is an area that and by the way, it's  not for the faint of heart, it's, it's treacherous. You have to have special  expertise. But there's, you know, there's some value to be had there. I think  prices have rallied way too much. But you know, they're volatile. They go up and down. And you know, you need to play across the capital stack and look very  specifically for opportunities, I think financial services in Europe, where, you  know, the regulatory climate, and in the US, to a lesser extent, is just, you know,  banging on the banks. There's just lots of businesses kind of coming out that  due to, you know, all the regulatory changes that are going on are, are better  being in non bank structures. And so there's, there's opportunities there. And  then I think the biggest opportunity, truthfully, is, you know, also relates to the  banks just getting out of more investment, investment grade credit, whether it  be, you know, CLOs, structured credit, illiquid investment, a great credit  insurance link liabilities. So which is really not the 10 to 15% business, it's really  the five to 10% business. And so to me, you know, you can, intelligently, today,  make two to three to 400 base points excess return, you know, in the sort of  double B, triple B, you know, kind of area that crossover area, the opportunity  business, the distress business, really hard, other than specific, specific  situations. And truthfully, when the markets pulled back, I mean, all of us that do  this for a living, it was hard to buy anything. The markets were incredibly illiquid.  Yeah, we tried to buy a lot. We bought some. And so we would have needed,  and I think all of us would have needed, a more sustained downturn. It was just  getting interesting. It was led down by energy. And then you were just getting to  the point where, on a broad based situation, industrials were getting cheap, and 

we were starting to buy a lot, and then boop wall of money hit it and went right  back. And so we put some money out, but really ended up doing a lot of private  equity transactions because sellers got a little more realistic in the financing  markets that collapse. But that's what I would say.  

Jonathan Sokoloff - Okay, in our it's always challenging to invest. We've been in a low GDP, very low, single digit growth environment, low rate, zero inflation for  many years. How do you invest in that market? So we kind of have have two  strategies. I mean, generally, we try to find companies that are just going to  dramatically outgrow the GDP, and that's our fundamental philosophy in  investing. And we'll pay up for them, and we'll pay 1011, times EBITDA. A lot of  people don't like to hear that, but we do pay them now, if you're right on the  growth that within two or three years, all of a sudden, you own it at six or seven  times EBITDA, and you feel much better if you pay a big price, and you're wrong on the growth, you're kind of dead. You'll have refinancing risk, you'll have  terminal value risk, and it doesn't end well, you know, we wish we were better at  buying stuff cheap. We try to buy stuff at lower multiples. We're not that good at  it. Occasionally, the public markets or the high yield markets will have irrational  dislocations and give us time to pounce, which kind of Mike Milken taught us. So in 2008 we made a huge investment in Whole Foods. At that time, couple three  years ago, we made a large investment in Activision, where we just felt the stock was so fundamentally undervalued. And the stock has we benefited in those  situations from both growth and multiple expansion. So those are kind of  outliers, exceptions you have to pounce on but But fundamentally, for us to  invest our capital in this tough environment is to just look hard and find the  growth. And there are sectors in the services area, food, experiential, health  care, that are growing 10 15% today and and that's where we're putting our  money and borrowing every nickel we can along the way. Josh, 

 Eric Schatzker - you mentioned that, I guess valuations became attractive  enough that you did some private equity, but you also became an issuer right in  the process of doing the ADT transaction. Did regional care Capella and fresh  market. What was your experience like in these credit markets as an issuer?  Yeah,  

Josh Harris - so, I mean, one of the things that we did, and we did, we  completed a number of transactions, and a couple others as well a hospital  company and, you know, hopefully, an education company, we'll see, is we, we  had to redo the capital structures to get the deals done. You know, we went to  Koch industry, you know, the ADT transaction, which was a $15 billion deal with  10 billion of refinancing. We we made an investment grade. We rolled the  bonds. We went to Koch Industries, a big LP of ours, stepped up and bought a 

lot of the debt. So when you we paired the debt down to we were only selling  really two or 3 billion of debt by the time we got done with all of those things and private placements, we only and that was enough that the banks were willing to  to bridge it, even though it was a difficult time, they felt very, very comfortable  with that credit. And so, you know, and in all these cases, we're announcing a  deal today, actually, in the industrial space, we had to lower the leverage  multiples. But when you do that, in many cases, you're able to also renegotiate  price. And in some cases, we did that in those transactions. And so there was,  there's a sharing of. Of the pain. And the reality is, when you put more equity in,  returns go down. It's a safer company. But ultimately we, we in private equity,  are all slaves to that 20% plus return hurdle. And so I think the way it worked out for us in the latest dip was was good in the sense that we got safer, more  deleveraged companies at, you know, at sort of lower prices, and maybe held  the returns close to the same. And, you know, interestingly, when the other thing  that happens is, when you finance into those types of markets, the the terms the banks are willing to bridge the deal on are very onerous, and you take risk. If  things go the wrong way, you can be forced into the market. You can have  onerous covenants. You can end up with all the non optionality things that John  talked about, that you can have short term capital structures. They can move  around the debt in different ways, and I think so far, we've been lucky enough to  have bridged the transactions going into a difficult climate. But then the  financings themselves have gone quite well. ADT itself was wildly  oversubscribed, and the rates that we ended up getting were several 100 basis  points below our base case model. Not that you know that sometimes you know  luck isn't you know it was luck. We the week that we were in the market was,  was a good week. And so in some cases, a lot of people say, well, when rates  go up, what happens to private equity? It's bad. Things dry up. And that is true to a certain extent. But longer run and medium term, it's better because at the end  of the day, it drives pricing down. And pricing ultimately is permanent. Capital  structure is temporary, like you can get a great capital structure, but ultimately it  matures. So really it's about reconciling the price you pay with the cost of debt  and the amount of leverage you get. And for us, in this case, it turned out okay,  

Eric Schatzker - Carey is what Josh describes about the deals Apollo's been  involved with recently, broadly representative of what you've seen. Yeah,  

Carey Lathrop - as I was saying, I think, you know, the market, you know, has  had a dramatic change in the last couple months, and you know, has clearly, you know, been open to, you know, like I said, is moving down to the risk spectrum.  But I think, as Josh said, is you have to be flexible, you know, to either delever  or accommodate what you know the sentiment of investors are. And as what  about 

Eric Schatzker - the flexibility of terms? You know, one of the dominant features  of sort of the past decade, right, is the erosion of covenants once, maybe once  upon a time, sacrosanct. Not so much any longer. You stand on that, you  

Carey Lathrop - know, I think again, that speaks to, I think, just the technicals.  And, you know, it's probably if there's anything that probably investors complain  about the most is the lack of ability to, you know, impose, or, you know,  covenants. And the hard thing is, you know, when the deal is five times  oversubscribed, you can be okay, I'm gonna drop because I don't like the terms.  And, you know, there's, you know, five other people who are waiting for your  bond. So I think it's, again, it's great for borrowers. It pushes off, you know, the  likelihood or the timing of defaults, you know, probably means recoveries are  lower, ultimately, when there are defaults. But again, I think that's just a function  of, you know, kind of the environment where we've been in somewhat driven by,  as we've touched on QE, but I think it's just natural when you're late in the cycle  to see, you know, an erosion of of investor protection, because the leverage is  clearly, you know, like I said, it's shifting a little, but Still with, with the borrowers,  rather than investors.  

Josh Harris - It's unclear whether having covenants, you know, in big issuers  with broad based Syndicate, it used to be that the banks, it was a club of of  banks. And, you know, it was relationship banks. They knew these companies  well. And certainly from an issuer standpoint, not having covenants is a good  thing from an investor standpoint. I think it's unclear whether, certainly having  come there's a great debate, you know, investors, some investors will argue that they want a seat at the table. But now these are broadly syndicated institutional  markets with, you know, sometimes hundreds of players. And so, you know, if a  company's not doing well, if it's a good company that happens to trip a  covenant, largely, these things end up being ways of getting concessions on rate fees and other things. I don't necessarily believe there was a study done by S &  P that it necessarily is better for investors to have covenants. It creates early  distress in many cases, in situations where the company might have worked  through it. I think it's, think it's a debatable point, and you can I've heard lots of  different people come out on different sides. It's unclear to me that it's valuable  to either investors or issuers, certainly in certain situations. It's valuable to have  an early warning system, but in other situations, you might have a covenant that  goes into bankruptcy and is really distressed and racks up lots of legal costs and is forced to do things it might not otherwise do because of the covenants.  

Joshua Friedman - Look, covenants count. I mean, there's no question in my  mind that covenants count and we get into all sorts of situations every day of the

week on the distress situation that we have in our portfolio at Canyon, where we have to look at covenants. Sometimes the issuer has a different interpretation of  the covenants, and it becomes an interesting contest, but there's no question  that if you didn't have a covenant there, you'd be in substantially worse shape.  Sometimes that's actually okay, because we get to enter something at a really  low price because the last guy wasn't thinking about the covenants. Or we're  stuck with something where we say, Geez, I wish we had had this covenant,  because we expected the issuer to behave in a way that they didn't behave in.  But the covenant thing is very much driven by supply and demand in the market. There's no no question. What's kind of interesting is, even with this big run up  over the last eight weeks, we found that in a number of the new issues, there's  actually been a significant ability to negotiate, if we're willing to take a big block  in an issue, significant covenant protection that seems inconsistent with the  pricing that's existing in the market right now. Maybe that's a little bit of a lag  phenomenon from the first quarter. I'm not sure, but it's definitely the case. And  so it's look it's an issue that that people have to worry about bank debt. You  know, you see covenant light transactions, and owning lots of covenant light  transactions just puts you in a position where you have negative optionality  period, you There's nothing good that can happen to you other than you get paid back. So you need to have protections that make awfully sure you're going to  get paid back, and maybe that you're even going to get paid back early with a  premium, because there's something valuable in that to the issuer. So  covenants are part of that whole package of maturity, and call protection and  everything else is quite important.  

Eric Schatzker - John is the guy who's willing to pay more, and maybe,  

Jonathan Sokoloff - I think covenants are one thing, indenture language and  layering of securities and dead end moving stuff around is a whole other issue. I  think it's very unclear. If covenants helped the lender. I think as was described,  we used to want to have relationship lenders. We knew our lenders. They'd loan  us money. They'd hold the money. If you had a problem, call us up. We'll work it  out. Well, that was never a lot of fun, by the way, to call now you have to call  work it out. But now you know there's hundreds of holders. You don't know who  to call. It's chaos. If you ever have to get them together, they have advisors, they have CLOs. It's difficult. So the beauty of covenant light is there's really two  major points, two obligations in your contract with your lender over the life of the  loan, which is to pay them their interest on time and to pay them their money  back when it matures. So that's really your only two requirements. And if you  can pull those off, there's really no reason to even speak with them over the  entire length of the loan. And if you have to speak with them because something goes really bad and you can't pay your interest. It's tough because you don't 

know who your lenders are, and it probably bears no relation to who your  lenders were when you first you know, borrow the money. So I think covenant  light, well, it's been a boom to issuers. I think in some ways, it's been a self  correcting structure that has addressed the vast proliferation and syndication of  loans out there. And if we had covenant in a lot of these loans, you would see  exponentially more bankruptcies which area which are expensive, difficult,  protracted and usually value destroying. So  

Joshua Friedman - that's my view. You've had a slew of companies, and I won't  suggest whose portfolios have these, but where they've done leverage recaps,  because there's no covenants protecting against restricted payments, and the  inevitable result of not having a covenant that prohibits those kinds of restricted  payments is a massive re leveraging of the balance sheet, followed by  somebody loses a ton of money. And so I don't know, I think they're pretty  valuable, but  

Jonathan Sokoloff - just remember, the leverage recaps of five or 10 years ago? Were hold, co zeros, 12, 14% they were  

Joshua Friedman - equity. They were two years ago, huh?  

Jonathan Sokoloff - And if you guys alone, us leverage recap money at 7% we'll take it every day. I understand that. Thank you,  

Eric Schatzker - Carey, you were talking about the the leverage door, the credit  door closing for certain companies, right? Lower grade credits, right? Now, what  happens when that window is no longer open to higher grade companies? I  

Carey Lathrop - mean, again. And I think you're just, you're facing the inevitable restructuring. I think that's what the markets kind of moving towards. Yes,  

Eric Schatzker - that's on the that's on the existing issuer side. What about  somebody who's going to try and finance something? I mean, we don't know  when this is going to happen, whether we're at nine o'clock on the clock, or later, at some point where we're going to pass midnight and lots of companies are  going to hit this refinancing wall. How then do you create a capital structure?  What's it going to be akin to? What would you take it back to again?  

Carey Lathrop - I think it's hard to kind of generalize, because I think in that type of environment, it becomes very creditor situation specific. And I think what Josh Harris was saying is, can you negotiate, bring in, you know, other investors to  kind of help delever, you know, in a sense, the transaction, at least, that you go 

into the public markets with. But again, at the end of the day, I think it has to be  a viable and sellable story. And that's where, like I said, I you know, from where  we sit there, definitely the market has discriminated and differentiated, and there are definitely companies that are moving down that path of having to restructure. Is that healthy? I think it is healthy. I think, you know, the, you know, the kicking  

the can down the road, you know, the market is again, getting to that point  where just saying, kind of, we just don't see kind of, you know, late cycle, you  know, you know, who's going to take us out, you know, if the company's not  going to be able to grow, you know, or delever, you know, it's the greater fool  theory, who's going to show up, you know, when there is a maturity. So I think, I  think that's healthy, that it's just a normal cleansing, you know, that occurs in the  market. And again, that greater discipline, I think, is healthy, you know, for, you  know, for the market. So I think it's inevitability,  

Josh Harris - yeah. I mean, the wall maturities has largely been dealt with, and  so the companies that are left with lots of debt that kind of, they haven't paid  back, that have kicked the can and kick the can and kick the can. And there's a  number of, you know, big names in the distress and high yield market, you  know, there's a day of reckoning in some of these companies, and the markets  are now saying, you know, we kind of own this company. You know, we don't like what's going on necessarily. And you know, we're not going to do that amend an  extent. We're not going to refinance that maturity. And you know, each situation  is different.  

Eric Schatzker - Well, Josh Creedon raised the point about catalysts. It's not  going to be the same for every company. But on a broader basis, what do you  see me the catalyst for a turn?  

Josh Harris - Well, I think in terms of just the macro environment, or Yeah. I  mean, the macro environment, you know, sort of no one knows, but there are  just a lot of things out there that could, you know, create issues. You know, I'd  say certainly people are very focused on China. But, I mean, like, throw Japan in that mix. Like Japan, it's, it's, it's a difficult situation in Japan where there's a lot  of debt, and a company the country is, you know, not really doing well. I'd say  certainly geo there are geopolitical events that could happen. And you know, the one that people don't talk about is, you know, the US could get inflationary. If the US starts to get wage inflation, and the Fed really has to raise rates, I think you'll see the dollar respond, you know, by strengthening a lot. And so you could see  a lot of pressure on the US economy. And right now, the Fed kind of has a free  lunch, they can go very slowly about how they raise rates. And when you look at what happened between November and February, certainly oil was going down  in China, but the Fed raised, raised rates. They got off a zero and I think that 

had, you know, a relatively significant effect on the market. So if the Fed starts to get into a situation where we start to see some inflation, wages are moving up,  that's slow, I think you could then see, you know, them being forced into raising  rates and really slowing our economy, which has been kind of the thing that's  pushed the world forward a bit. And so slow growth could become no growth,  and at that point, you know, you could have, you know, real terminal value  issues on these capital structures. Let's  

Eric Schatzker - end on this point, you're a capital provider. Jonathan, you can  be a capital provider opportunistically. Josh, you're a capital provider. You see  lots of capital providers. Is now the time to keep your powder dry.  

Joshua Friedman - I think it's a time for caution. As I said, I think exposure to  beta in the in the high yield market is scary, because beta really isn't it's two  different bets. It's the super leveraged things that look like a bit of a disaster, on  the Triple C side, that have run a lot in the last quarter. And it's the things that  trade between four and 6% that are vulnerable to interest rates and spreads and credit deterioration. And when you take an environment of decreasing growth,  and I'm not saying the economy is going to be a disaster by any means, but it's  clearly an economy where, if you look at growth revisions in almost every  country, by the way that where these are tracked, they've all dropped. They've  all dropped and continue to drop. So you have declining growth, you have  technological innovation that's displacing companies, whether it's software  companies, where there's the cloud, or whether it's reach. Retailers that are  getting displaced. Or whether it's any one of a variety of industries, I think it's  one where caution is merited. But that being said, there's, there's been just  enough disruption and roiling around that there seemed to be a lot of different  things trading at 10% or north to choose from much, larger universe than there  was four or five years ago. I think there's 1300 credits, as opposed to 400  credits trading at 10% or greater. That's a really different environment. So I think  it's one where you should keep some powder dry. You should be very selective  about what you should buy. And I'm not a lover of the index. Anybody else want  a word before  

Josh Harris - we wrap up, there's no, there's very little alpha in the market  today. It's all been, you know, kind of pushed out by zero rates. There's, you  know, of the credits that Josh is talking about, like 80 something. Like 80% of  them are natural resources and energy credits. So I think that you know, you're  fishing in a pond. You might be a very skilled fishermen. But you're, we're all  fishing in ponds that don't have a lot of fish in them right now. So I think it is time to be cautious. And, you know, go senior, go, go lower, return. You know, go for  that extra two to 300 basis points, and then be very selective in the opportunistic

markets. And really, where you have a big edge.  

Jonathan Sokoloff - Look at, from our view, the world is a frightening place. If  you go around the world, in the Middle East and Russia and China and Asia,  one country is more frightening than the other, and the least frightening is the  

United States. And we're doing the best here than anybody, which is we're  concentrating our investments. I think it's always a time for caution, but we're all  in the business of investing. The beauty of the private equity model is we tend to we have a fun structure, so we have dry powder when there's opportunity. If  you're in a redemption type product, whatever, you may not have the capital  when there's opportunity. So we're always investing. But our view continues to  be, if we find the growth, it will work out over time. But be cautious, you know,  and take advantage of whatever opportunities Mr. Market is giving you in the  credit markets to to reduce your risks.  

Carey Lathrop - And very quick last word, yes, you know, I think what Josh had  mentioned, I think it's, it's a market of credits, not a credit market. And probably  the market wasn't as bad, with the benefit of hindsight, when high yield was at  10% and I'm probably in the camp, it's probably not as good as you know it is,  you know, closer to seven to quarter. And I think with just, you know, the  expectations we talked about, just what are the impact of regulation, market  structure, there's going to be more volatility, and I think there will be more  attractive entry points over, over the course of the year. Ladies and  

Eric Schatzker - gentlemen, I hope you've learned something about how to turn  lead into gold. Please join me in thanking Josh Friedman, Carey Lathrop, Josh  Harris and Jonathan Sokoloff,