Episode 276: Navigating the Evolution of Asset Finance and Opportunistic Credit with Centerbridge

 

Stewart: Welcome to another edition of the InsuranceAUM.com Podcast. My name's Stewart Foley, I'll be your host. Welcome back to the home of the world's smartest money. We just trademarked that phrase and we love it. Today's topic is the evolution of asset finance and opportunistic credit, and we're joined by Aaron Fink, Senior Managing Director at Centerbridge. Aaron, welcome. Thanks for taking the time. I look forward to our terrific podcast here today.

Aaron: Stewart, thanks a lot for having me on. Likewise, I'm excited to be here to chat today.

Stewart: And we want to start this one off the way we always do, which is where did you grow up and what was your first job, not the fancy one?

Aaron: Well, I love talking about where I grew up. I grew up in a town called Newton, Massachusetts, just outside of Boston, about eight miles outside of Boston. I moved to New York 25 years ago but never left as a diehard Boston sports fan, Red Sox, Patriots. Hopefully, that doesn't alienate some of your listeners, Bruins, Celtics, and the like. And my first job really was not a very glamorous one. I worked in the fish market at Legal Sea Foods, think it was their first or second Legal Sea Foods in the Boston area, and it was a pretty interesting job. It was very unglamorous. We had the live quarter lobsters, devein shrimp, serve clam chowder. Really early starts, long hours on my feet. It smelled pretty bad by the end of the day, but it was a pretty valuable, I think, lesson about working hard, doing unglamorous work, and in high school it paid pretty well and notwithstanding the tough setup, it was a pretty good experience for me.

Stewart: That's super cool. I've had a number of unglamorous jobs. So you're a graduate of the University of Vermont with honors and Phi Beta Kappa. How did you get from the University of Vermont to being the senior managing director at Centerbridge? And tell us a little bit about Centerbridge just in case. Centerbridge is relatively new to our platform, joined last year and thrilled to have you, but just in case somebody's... It's not a household name for someone, just give us a little background on you and the firm.

Aaron: Great. Well, I went to University of Vermont, no banks recruited at Vermont or very few did. I fought my way to some interviews spring of my senior year and was able to land a job at Credit Suisse doing commercial real estate, large loan origination. About a year into my career I moved into asset finance trading and was on the trading desk from 2001 trading and structuring from 2001 to 2006, at which point I moved to Bear Stearns in the mortgage business had a couple of exciting years over there. When Bear ultimately was sold to JP, I moved to the buy side, went to a large multi-strat called Perry Capital where I led the asset finance business, and then joined Centerbridge in 2017. So I lead our asset finance effort here. As I mentioned, I spent my whole 25-year career in the asset finance space between the buy side and the sell side.

And the asset finance team at Centerbridge is a business team that's embedded inside of our broader financials effort, and I'll touch on the firm in a second, but the firm has an approach where we invest across the continuum from control, private equity through public credit and everything in between. Centerbridge is coming into its 20th year and we'll set up with this mentality that we will approach the world with one investment team with majors and minors. I'm a credit major, my peers are private equity majors and we have funds today focused in credit, control private equity and real estate, and are able to really dynamically face the world and face counterparties and sponsors with a mentality and perspective that understands really all of the markets with an opportunistic approach to the world.

Stewart: That's super helpful. It's my understanding that Centerbridge is built to be what's known as cycle agnostic, so that being defined as the flexibility to generate returns throughout market cycles. Can you talk a little bit about why an investor would want to be able to pivot across private equity credit and real estate? How is that advantageous to me as an investor?

Aaron: So the way we talk about our approach is that we are opportunistic and in our interpretation that is really having the flexibility to pivot not only between public and private markets but like you mentioned across different investment types and private equity and credit, which is broadly defined, includes our efforts in the reinsurance space and the direct lending space and the opportunistic credit space and then in real estate. So we really take where we are in the market cycle to help dictate our focus. For instance, when spreads are at long-term averages or tighter, we tend to focus more on the private markets, particularly in the credit business, but then we pivot very quickly when public opportunities present themselves. And for us, being able to move back and forth between public and private markets is really a real competitive advantage. And public opportunities, as you know, can be very short-lived and so you need to be very quick to react in COVID for instance, or other points when those opportunities present themselves.

I think the other feature of our model that's interesting is because we have the ability to think about applications or investments across private equity, credit, and real estate, we really start with situations or opportunities to understand what is interesting, do we like a specific asset or asset class? Do we like a sector? And then we can work through the waterfall to identify where the best place to make an investment is. Every year we do a pretty large theme project where the whole investment team comes together and articulates by sector the places where we see the most exciting long-term investment themes. We present them to our investment team, we distill them down to the action level and then we go out and act on them. And it just gives the whole team perspective to be able to say, "Hey, where do we want to point our efforts, and where do we think the best absolute and relative value is available?"

Stewart: That's helpful, thank you so much. When we talk about opportunistic investing and the ability to move between private and public markets, you've touched on it, but do you find the relative value changes in maturity buckets or does it change across the market? I mean how do you make the decision of when you think privates are attractive and when you think publics are attractive?

Aaron: It's an interesting question. It's one we talk about pretty often in here because sometimes the markets all move in the same direction. More often there are parts of the markets, whether it's, as you mentioned, different points in the tenor, different points on the duration curve, or different asset classes that are more or less interesting. So it comes back to how we think about sourcing. We are thematic with an opportunistic orientation, with an opportunistic bend.

And what that causes is that there are certain points, and we'll talk about them I think a little bit later on in the cycle, that we are really excited about particular subsets housing for instance, or consumer finance and credit today. And there are other markets that we'll look at at the same time and we'll say "We think those are priced to perfection," or, "For whatever reason those aren't compelling to us." And so our focus is to try to be in the places that offer the best absolute and relative value at any point and pay attention to where there could be froth or distress to make sure that we're either steering clear or focusing opportunistically on sectors that we aren't currently actively investing in.

Stewart: You mentioned market cycles kind of dictate your focus. Given where we are right now and we are today 11 days into a new administration, where do you think there are compelling opportunities right now and, if anywhere, are you cautious?

Aaron: So coming into 2025 and I think we're a month into 2025 and the markets expect there to be pretty meaningful changes from a new administration, potentially friendlier regulatory environment, which has broad implications, the potential for tariffs, which could be inflationary, even more nuanced questions like potential for GSE privatization, which could have pretty broad implications for housing. But coming into the year, our core view is that rates are going to be higher for longer. That's going to have pretty important impact in the housing space. We see the consumer as in a pretty good place, the consumer environment, the current environment feels okay. Inflation, though still high, it has been moderating, unemployment is still very low and the consumer balance sheets are in reasonable shape. Consumers have had real wage growth over the last year or two, but certainly, for the consumer unemployment risks, meaningful upticks in inflation or upticks in rates could have really negative effects.

So we come into the year focused on some opportunities in the housing space that we think will be interesting. Persistent high rates have locked consumers into their homes with no real ability to access what's been a pretty meaningful buildup in home equity over the last 5 to 10 years. We still think there's exciting opportunities to originate to the consumer. At Centerbridge we've owned or invested in consumer finance for instance, since the beginning of the firm. And one core lesson that we've carried through over all those years is the best time to be an originator of consumer credit for instance, is after the market has repriced, after there's been blowups and you have that phenomena very much in play today leading into COVID, you had a really strong consumer environment, a lot of origination. Originators really leaned in and now 2021, 2022 vintage consumer origination will be some of the worst on record.

The result of that is that investors pulled back and originators pulled back, and that's created really attractive opportunities for us to step in and provide capital in different forms to originate different types of consumer risks. So we're excited about that in 2025 and then we're spending time on other more earlier stage type of opportunities. I saw an interesting stat the other day about ChatGPT. ChatGPT took 2 months to get to a hundred million users. The telephone took 75 years, the TV took 13 years and Instagram took 2.5 years. And so before the DeepSeek news earlier this week or earlier this month, you had a world where there were going to be dramatic capital needs for data, for digital infra, for GPUs, and that's a place that we're trying to understand where there could be investment opportunities. So those are three areas of potential focus in '25.

Stewart: And you had mentioned that '21 and '22 will be some of the worst consumer ABF on record. Why do you think that is?

Aaron: So leading into COVID, the consumer was really strong. Rates were very low. There was an environment where originators were chasing volume and credit boxes were too permissive and COVID hit consumers got a lot more excess savings, they got stimulus, and that really supercharged what was already a really positive consumer profile. And I think in some ways that validated the decisions originators and investors had made to really lean into the space. And when the punch bowl got taken away, the models weren't calibrated to the impact that the stimulus had had and performance really fell out of bed for a variety of reasons. In retrospect, it seems obvious there was just too much capital thrown at the space. There was too much investor demand. Banks were active, originators were active. Now post-COVID banks had been in balance sheet reduction mode. Originators that had some missteps tightened in their credit boxes dramatically. Investors as well pulled back from the space. And that created we think really compelling opportunities to originate credit to better borrowers at better returns that you could achieve before 2023, 2024.

Stewart: Thank you. Private credit has seen, and this is a result of the phenomenon that you just described which is banks pulling back and so private credit has seen explosive growth over the last decade. Can you talk a little bit about your collaboration across private equity and credit, how it's evolved over time and how does that or does that create a competitive advantage or unique sourcing opportunities for you?

Aaron: So our effort in asset finance at Centerbridge is born out of a footprint in financials that has been established since the firm really was founded. We talk about it as a one-team approach to investing and because we've owned all flavors of consumer originators, we've invested in banks, we've invested in and alongside of insurance companies and specialty finance companies. When we go and sit down and when I go and sit down with my peers in our private equity business with the management teams of originators of assets or insurance companies or banks, we do so not only as investors but as owners of those businesses. And that gives us pretty unique perspective on the challenges that they face. For instance, especially finance company, how do you create the credit box? How do you finance the business? How do you think about the time to scale in origination and the ramp costs?

And so as a result of that, we can really relate to and help to solve all of the different challenges that those counterparties are facing. And it gives us a real differentiated partnership with those folks that allows us to offer them solutions that are really valuable and that they might not otherwise be able to achieve. We can be responsive to their needs, we can be a single point of contact. And so that helps us create really sustainable and long-term relationships where we can provide a variety of capital to these companies. And importantly we can get to know them, get to know performance, and build comfort with the investments that we're making so that over time we can really scale those investments and deliver more attractive returns and well-understood and underwritten returns to our investors.

Stewart: And one of the things it's my understanding that you also have a strong background in distressed. We've had other guests on talking about distressed and I think there's some thinking that says that this distressed class is going to be the result of higher interest rates as opposed to business challenges or operational challenges. Can you talk a little bit about distressed investing and how you see that opportunity right now?

Aaron: I don't know that we see a ton of distress in the asset finance space specifically. I think I mentioned performance in 2021, 2022 vintages across asset classes was poor and is now starting to burn off. But our background in distress really that goes back to the founding of the firm, gives us I think, important perspective on what can go wrong, whether it's at the business level as you mentioned, whether it's a borrowing question or a cost of borrowing question or just understanding the impact that certain types of covenants for a given business can have on its ability to refinance its debt or operate in the coming years.

So we take that bottom-up approach to investing that distressed mindset in really everything we do, whether we're making an IG asset finance credit investment or some of our insurance investors or we're making a controlled private equity investment, our orientation to underwrite bottom-up to focus on what can go wrong really comes from this mindset as a distressed credit investor that you want to make sure you're not stepping into any issues and you really understand the risks in a situation that in distressed investing can often be quite hairy.

So there's not a ton of active distress in the market today. I think some of the stats on the corporate side are that corporate defaults have gotten to elevated levels, but you're not seeing broad distress. The borrowing environment is still pretty wide open even at these levels. And I think that's in part because of covenant flexibility companies have gotten in the last couple of years. It's in part a function of just the sheer quanta of capital available in the private credit markets. And so I'd say what does it mean for us? We try to be cautious in markets like this so that we're underwriting investments with the right amount of downside protection, that we're focused on sticking to our knitting, not chasing other opportunities or investments, and making sure that if the world does wobble, we've set things up to really have positively asymmetric outcomes.

Stewart: And it's a compelling approach. I mean the cycle-agnostic, opportunistic thematic approach, I always feel like that in my experience that every strategy has some inherent blind spot or some inherent... So when you think about the risks or structural limitations to this approach, is there anything that comes up that you're trying to avoid or is there a way to mitigate that risk that might have investors be able to get a little different perspective on the opportunity?

Aaron: The way we source puts us in a position with counterparties that is a differentiator in the sense that when we show up with a specialty finance company, we have the ability to provide them a pretty broad range of solutions from control private equity deal to a corporate loan to a whole loan sale in the asset finance space to doing public or private ABS. That's not appealing to everybody. So if I think about the limitations of our approach, there are a lot of investors out there who do one thing and in the effort to do that one thing, they will be maybe at a tighter price, a lower price for the borrower.

And the way we think about our competitive advantage and the limitations of the approach is that we're not necessarily going to be the cheapest cost of capital, but we want to win on being the most dynamic cost of capital, being able to be flexible to the counterparties and really provide them a broad range of solutions. And those solutions can really evolve over time for a given counterparty or for us in an industry as opposed to somebody who has a very specific outcome that they want to be able to achieve with a given counterparty. And they can pay a very high price to do that, but that is a single outcome we try to be a one-stop shop. For the counterparties who value that it's a really powerful tool for us. But certainly when we're out there just competing on price, sometimes that can get in the way.

Stewart: Yeah, I mean it always reminds me of the old line, would you rather have price or terms, and usually you'd rather have terms. So with regard to 2025, and you touched on this a little bit, Aaron, but you've highlighted consumer housing, specialty finances, market themed for 2025. Is that where you see the opportunities? At this point what's driving those trends? And is there anything that you're cautious on right now?

Aaron: Yeah, just let me spend another minute on the housing front, give you a little bit more detail there. There's been 16 trillion of home equity created since 2019, $25 trillion-plus since 2012. If you look at the world today, less than 10% of mortgages outstanding have any ReFi incentive in excess of 50 basis points. The average coupon is around 4%. Existing home sales are 25-year lows. There's been underbuilding in the US I've seen some folks recently call for really positive technicals for home builders. As a result, there's real supply issues. Those factors have kept housing turnover down, have kept home prices up. And what you have today is a situation where homeowners are locked in their homes, they have low mortgage rates and there's not a lot of inventory and that creates a couple different types of opportunities. There's also some risks which I can come back to, but the ability to tap that trapped equity is pretty interesting for consumers.

And when you think about the evolution of retirement funding in the US, if you go back many years, the house was an asset viewed as something you monetized later in your retirement journey. And the world is evolving today where consumers appreciate their ability to tap some of that equity to consolidate debt, to do home improvement projects, or otherwise as something that is a more valuable resource to really target and tap today. And so we've spent quite a bit of time focused on those types of opportunities. I think that will persist this year. Certainly, if mortgage rates get too high, rates continue to... Inflation continues to run at some point that could put pressure on home prices.

There's other derivatives of that. There are products that we think will benefit because of affordability issues and housing. Manufactured housing has been a space that we've invested in over the last 15 years at Centerbridge and we think there's really compelling options for borrowers to look at manufactured homes versus what we call stick-built homes because stick-built homes are just highly unaffordable and manufactured homes, the build quality has improved dramatically and they're a lot cheaper and a compelling option in comparison. So we're excited about some options and opportunities in the manufactured housing space as well.

Stewart: So one of the things that has always been a curiosity for me, Aaron, is there's new asset classes being created, particularly in ABF that are different collateral types that don't have a history, and oftentimes when that happens, there's an outsized opportunity for a short period of time before everybody else shows up, but there's inherent risk in not having much history. So how do you think about new asset classes or new types of assets in private space in particular?

Aaron: We're always looking for new ways to invest and deploy the IP we've developed over the last 20 years. One of the benefits to having been in business as long as we have is we've modeled and have data and have thought about a lot of well-established and new asset classes over that time. So the first thing that we think about any time we see a new opportunity is first is there data? Can we do what you touched on? Which is think about historical performance. Can we really understand how the assets originated, what the criteria are to originate it?

We ask ourselves what sectors or data do we have that might provide a good proxy to help us think about how this asset class could perform. And we want to balance the absence of data, which often creates above-market return opportunities as you mentioned with stepping into sectors that we just don't understand or don't know. I'd say we tend to want to be second than first because while we want to optimize outcomes, our goal is to make smart investments to not lose money and having performance history, having a bit more established of a track record in new asset classes is really the best determinant of success.

But we're lucky in that we've owned a lot of different businesses, whether it's in insurance commission or whole business securitization or we touched on earlier, some of the potential investing opportunities in the digital infrastructure space and some of the derivatives that'll create. We've owned a lot of businesses and derivatives or comparable businesses that we hope can help us triangulate to the right outcomes. But I'd say first and foremost, do no wrong. If we can't get fully comfortable with the direction of an asset class, we'll wait and let that asset class develop.

Stewart: That's super helpful. I've really enjoyed the education today. It's been good to have you on. I've got a couple of fun ones for you on the way out the door. Maybe the first one's not super fun. But the last one is if you'll indulge me, and we always ask a question right here about what advice would you give your earlier self, and I want to change that question just a little bit because I think this question is more helpful, which is when you're hiring an analyst, what are the things that you're looking for or said differently what has proven to be characteristics that result in a strong member of the team?

Aaron: I've found that the most valuable quality in successful investors, in successful analysts we've hired is the ability to figure out how to answer questions they don't know the answer to. So how do they take initiative to go out and understand a request or a topic that they might not have a background in and are they able to deliver? Ultimately, we're in a business where we've got to progress an idea, we've got to progress an investment.

So I find the analysts, there's a lot of analysts today that show up with a lot of background in corporate finance or in different flavors of underwriting, but the folks who have thrived with me are people that are able to get stuff done and if they don't know an answer to a question, they know how to figure out how to find that answer. And that process of learning is something that I've found to be incredibly valuable, be a bit of advice, I guess I would share with your younger listeners to say, figure out how to figure things out because ultimately that is a real utility man style skill that's incredibly valuable on a lean investment team and an organization that's running very quickly.

Stewart: That's super helpful. And this is an aside and I'll embarrass her, but Jennifer Myers is listening right now and she is the queen of figuring it out, and it is such a great aspect of someone who's like... I think I actually heard Obama say this too. It's like what I value the most is somebody who doesn't just bring me a problem. They go, I'll figure it out. Don't worry about it-

Aaron: I'll figure it out.

Stewart: I'll figure it out. Don't worry about it. I got it.

Aaron: And in our business, there's rarely just one answer for a given problem. So people who can help us at least brainstorm, whiteboard, a couple of different solution, moves the discussion forward and helps to get us to the right outcome, that's incredibly valuable because ultimately we need to make decisions and make progress.

Stewart: That's awesome. Okay, last one. Fun. Lunch or dinner table of four, you're one, you can invite up to three guests alive or dead, who you having dinner with?

Aaron: That's a great one. I think the first guess would be David Chang, Momofuku. I'm a chef. I like to cook in my spare time. He's a pretty exciting innovator. Cooking is a fascinating discipline because it's a combination of real established techniques like investing, but also those who are the best are exciting innovators and he's been a really fascinating voice for the industry but also has really pushed the discipline of cooking forward. I would probably also have Marcus Aurelius. I'm fascinated by the concepts of stoicism. A lot of what we do is about staying level-headed, not reacting to stimulus. We have an expression in my house living between the stimulus and the reaction, and it'd be fascinating to understand how to implement that. Marcus Aurelius having led through crisis and really trying to articulate and understand how leaders navigate uncertainty, I think they would be two pretty cool guests. I think David Chang will probably be more fun than Marcus Aurelius, but I would invite the two of those guys.

Stewart: Wow, very cool. It's been great to have you on, Aaron, thanks so much for a great podcast, very educational and really a lot of fun. So thanks for being on.

Aaron: Thanks so much for having me. I appreciate it. We're really excited about the opportunities in the asset finance space today. We're excited about managing money for our insurance clients. We think there's a lot of compelling opportunities, and I'm excited that I got the chance to chat with you about it today. So thanks so much.

Stewart: My pleasure. We've been joined today by Aaron Fink, senior managing director at Centerbridge. Thanks for listening. If you have ideas for a podcast, please shoot me a note. It's Stewart@insuranceAUM.com. Please rate us, like us, and review us on Apple, Spotify, Amazon, or wherever you listen to your favorite shows. My name's Stewart Foley. We are the home of the world's smartest money. We'll see you next time on the InsuranceAUM.com Podcast.