Episode 27

NOVEMBER 10, 2021

Three securitized questions for D.J.

Steve sits down with D.J. Lucey, Managing Director, Senior Portfolio Manager, Fixed Income at SLC Management, to discuss the securitized sector and the impact the 2008 global financial crisis had on preparing securitized credit markets to weather the COVID-19 storm.

Steve Peacher: Hi everybody thanks for dialing to this episode of “Three in Five,” this is Steve Peacher head of SLC Management and today I’ve got D.J. Lucey with me, D.J. is a managing director and senior portfolio manager on the fixed income side and D.J. spends a lot of his time on the securitized sector, so D.J. thanks for taking a few minutes.

D.J. Lucey: Thanks Steve.

Steve Peacher: So, as we lead up to COVID, the front of the curve was starting to see a rise in rates. You know which was after a long period of declining rates and then of course COVID hit and you fast forward a year and a half later we're back to zero overnight rates, very low short duration nominal rates. So, what are you doing on the short end of the curve that you think is attractive and trying to find yield?

D.J. Lucey: Yeah thanks for the question. You know the interesting thing, there is, we are still finding lots of interesting relative value stories. Obviously, yields are not at their all-time highs or anywhere close to you know to looking attractive on an absolute standpoint. But there's all sorts of things that you know that we can do to add that incremental return and focus on value, you know for our investors and our strategies. And I spend a lot of my time researching and managing the securitized products and credit sectors, and that was a really hard-hit area by COVID. You know, obviously, that was a really tough time in the capital markets, as well as, obviously in society, but at the same time, all sorts of values arose coming out of that, and you had really, an unprecedented Federal Reserve response to what was going on in the credit markets, and particularly in ABS and CMBS and the mortgage credit markets. So we're still finding some values there and the interesting thing about the securitized credit areas there's just so many diverse businesses and sub sectors within that space so you know whether it's the CMBS market which is backed by various forms of commercial real estate or asset backed space, which is not just autos and cards, but now you have things like consumer loans and everything from that to whole business ABS with franchises, you're really seeing a diverse set of opportunities for us to invest in and we're still here we're still finding interesting stories that have a very attractive carry and breakeven versus very low yielding two and three year treasury yields and corporates.

Steve Peacher: D.J., if you look back to the financial crisis in 2008-2009, to some extent it was centered on the securitized markets’ problems and the subprime market, commercial real estate markets. What are some of the misconceptions about securitized assets that you think came out of the financial crisis, and how is COVID different from the financial crisis in ’08 and ’09?

D.J. Lucey: Sure, so yeah that's a great question that's one we talk about internally on our desk with our analysts and PM’s all the time. And one interesting discussion that I’ll just relate here, because it will happen in real time while we're you know looking across sectors, whether to investing corporates are or securitized assets, as you know, if it hadn't been for 2008, which was obviously devastating for the capital markets, you really would have seen a much worse outcome we believe in COVID. So in a very weird way 2008 was actually almost essential for the securitized credit markets’ performance overall, to act so resilient coming out of COVID. And what I mean by that is I think securitization obviously was it wasn't a huge factor in the ‘09 crisis, but it wasn't really the structure of a securitized bond themselves that many of them are very straightforward sequential pay, senior, subordinated bonds. I think a lot of the problems were too much leverage and not enough credit protection, known as credit enhancement in the bond. So fast forward you know, over a decade later and COVID really hit the securitized credit markets very hard, commercial real estate assets like offices or malls abruptly closed for months, at a time, I mean no one can underwrite that or does usually underwrite that. You had you know immense pressure on consumers backing autos and car loans and personal loans and small business loans. So you had many parts of the securitized market that really had incredible fundamental pressure from almost natural disaster type event. And yet, by and large the structures held up extremely well from a principal protection standpoint, you fast forward a year and a half later and most of those investment grade asset classes, not just the AAA classes, but all the way down to BBB, it was very rare for us to see any principal losses, so you know what I mean by that is price volatility, obviously was you know, was very punitive and very tough to go through, but these structures were much more robust coming out of the 2008 financial in 2009 global financial crisis and we thought they held up very, very well through COVID and remained quite resilient in terms of protecting our investments.

Steve Peacher: You know, as you mentioned in the commercial real estate sector you've had very different experience through the crisis, retail, office, industrial have all performed very differently, and I’m not sure it's fully played out yet. So if you think about the CMBS sector how worried, are you about the decline in retail, the decline and activity and the values of malls. You've talked about the structures being resilient, you know, does this play out. How concerned are you about the underlying holdings in real estate in these structures and also in office you know the return to work is still kind of a big experiment, how do you think about the office sector in the CMBS world?

D.J. Lucey: Sure, so yeah, a couple things in there, one I would say worried isn't the right word definitely analyzing various outcomes across those asset class that you're talking about. But for a you know, an asset class such as retail, for example, we think that's unlocked tremendous opportunity for us as bond pickers because we spend hours, if not days, researching individual assets and the loans beneath those bonds and retail is very heterogeneous where yeah there's class B or B minus malls that you know we don't think are likely survivors in the next 10 years. But there's also fantastic recent retail assets out there that you know we feel like the bonds can still be bought at quite a discount just because of those overarching retail headwinds that you're speaking about. And in terms of office, similar to fundamental trends, where we still feel like the office is going to be the home base for most of your services professionals in the United States. Maybe you don't go as much, and maybe that model is a lot more flexible, kind of reminds us, you know of our discussion internally about what we're doing here in SLC, but I still do believe you're going to see a home base survive for most professional service services workers in the US, and that will still support trophy asset properties which can be again, we had at a discount that you know I don't think we would otherwise ever see if we didn't go through the last 24 months.

Steve Peacher: Okay well that's a great look at a complicated sector. So on the personal note, D.J. I know, our listeners may not know, but I know that you were a pitcher in college, as a pitcher and as a baseball player. First is there's a bit of a scandal earlier this year in Major League Baseball and the use of Spider Tack by pitchers, so the world wants to know when you were pitching in college were you using Spider Tack?

D.J. Lucey: I did not use Spider Tack, I will admit I did scuff some baseballs with the spikes of our cleats. In those days that was more sophisticated, but nothing short of that and the resin was allowed on the mound. I don't I had not heard of Spider Tack I don’t know if that just makes me old, I’m sensitive to that now entering my 40s. But yeah so, some scuffing of the seams, build up the seams to get a good grip on that curveball, but no Spider Tack. I didn't like how they did it midseason, you can't be breaking the rules, but I would have let them have the offseason to adjust.

Steve Peacher: Yeah, I’m with you on that, D.J. thanks a lot for taking some time this afternoon, and thanks everyone for listening in to this episode of “Three in Five.”


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