Beyond 2023: Bonds, rates and real estate

[00:00:00] All right, here we go. Hey, Skylar, how are you? Great. How are you, sir? I'm doing terrific. We're here in New Jersey. We haven't caught up in many years. Yeah, long time. Over five plus years. So by way of background, I was an investor in Skylar's hedge fund, Regan Capital. And at the time, this is back in like 2011, Skylar, your fund was making markets.

I wouldn't say you were making money by making markets through your hedge fund and trading in non agency And we're going to talk about the Fed, rate outlook, Bill Ackman's comments, thoughts on the housing market, the multiple components to that part, where's their risk reward in bonds, where's their value.

And if you have any other questions you want me to ask Skylar just making note in the thread and I'll be able to see it here. So Skylar, [00:01:00] your background has been in the bond market. I've got your bio here. You were at Cantor Fitzgerald from 2007 to 2011, trading consumer asset backed securities with the heads of, you're the head of residential consumer asset backed securities.

And you were at a number of firms and you managed P& Ls and, we're generating tens of millions of dollars. In P& L before you decide to go out and create your own hedge fund. That's right. Yeah, I've been doing this my entire career. I started in 01 at one of the largest mortgage originators in the country GMACRFC.

It was a General Motors company. That eventually became ResCap that eventually went defunct. But we were the biggest, but one of the biggest buyers of what's now called non performing and re performing loans back then, they were called scratch and dent. So I got hired as a loan level programmer, modeler to model defaults and prepayments.

And, we were buying these at 70 cents [00:02:00] on the dollar and getting them re performing and then securitizing them into deals at. 96, 97 cents. So that was 22 years ago now in the market, the markets come full circle and here we are again and opportunities abound. Exactly. So do you want to walk us through the post 2008 crisis briefly?

And obviously we had the banks pulling back substantially, capital requirements and the loss of ratings forced the banks to expunge their balance sheets. So I like to think of all of that as a repetition of what happened recently with Biden. And the fourth element of that cycle of banks is the growth of net fiat.

So people want to know where are the banks at 10 million of equity, You can then go borrow vis a vis deposits or CDs a hundred million dollars, and you can [00:03:00] use that hundred million dollars to go buy securities and or to lend money traditional mortgage loans, CNI loans, et cetera. So between 05 and 07, there was a tremendous amount of securities that were created that were AAA rated to satisfy.

The regulators and so that banks could put them on their balance sheet and insurance companies like AIG. So you do the math and back then you only had about, if you lost 10 cents on your 100 million, 10%, your equity's gone. And that's really what happened to Silicon Valley Bank recently. And we can go through that.

But the aftermath really was banks had to de lever. For the banks who really didn't have a lot of this on their balance sheet or were able to get rid of it quickly, including their the liabilities in warehouse lines, et cetera, that they had with [00:04:00] their customers, whoever moved quickest was fine.

And or whoever didn't put a lot of leverage instruments on their balance sheet were fine. So in the aftermath, you had about an 18 month time period where there was really no bid. Yeah. And I remember I was going over to Pine River, going to Soros, going to Paulson, educating them on these mortgage bonds of, hey, you probably made a good amount of money shorting these.

Now you can buy these. They're legitimately, could be 5Xers or 20Xers in terms of return on investment. The first mover at that point was really global macro. Third point, SROs, Paulson, Pine Tree Pine River. Then 2011 to 2013, a lot of managers, Left the street to go form their own shops that specifically were looking at going long this trade, and the trade [00:05:00] still exists.

Exxonic, the rise of structured credit hedge funds. Exactly. To help create these products on the sell side. Blow up the babies and stuff, and then they move to the buy side, create a fund, and they were benefiting from the non economic selling of the babies. They knew where the bodies were buried, they knew where value was.

Yeah, and going into the crisis, there were only a couple of RMBS, ABS hedge funds. There was the Bear Stearns Fund, Halcyon, there were only a couple. That, that were, this is all that they really did. You had Meta Capital and SPM on the rate side, but not on the credit. Exactly. Then your firm saw this opportunity to create liquidity in the market.

So the banks, when they weren't able to make markets, they lost their ratings and capital requirements had forced them out of the system. And that's when we met, I think it was 2011 ish, plus or minus a year. And Regan, at least at that point in time, I The way I would describe it is you are making market in these securities because there were, it was an [00:06:00] orphaned niche capacity constrained after class.

So you're buying low, selling high, and doing that in a lot of turnover, which is what a market maker does. Yep. And capital bid ask spread. Yeah. Moral of the story was that banks still had a lot of this on their balance sheet. Very similar to where banks are today, where they own a lot of paper, they know it's distressed, they actually don't really even want to make markets in these, and or, You had desks that went from a headcount of 20 to a headcount of maybe four, a balance sheet of two to three billion to a balance sheet of maybe a hundred million.

There was a lot of money to be made being The pseudo middleman. Okay. And the mechanics of the bond market are so much different than, especially in our market, which is primarily over the [00:07:00] counter, hardly any of it's electronic trading. So there is no like marketplace where you're going to actually sell bonds.

Also on the phone, they have to know you. They have to give you access. Yes. You're a retail investor or even a family office. You can't get in this market. You have to know people at specific dealer desks. Yeah. So it's, it creates e liquidity, but it creates advantages by, Oh, if you're in the know, if you have those relationships, you can actually buy and sell.

But to this day, you can't walk into a JP Morgan or a Fidelity or a Schwab and say, I want to buy a mortgage bond. They'll look like, they'll look at you like you have, two heads. The best is ETFs. Then you mentioned Pine River. They had two harbors, which is their ETF. But obviously you pay fees on that and you can't do security selection and find that value.

So the banking sector, there are a couple of difference between then and now. So then it was a credit risk store. You had an impairment on the securities and that ripped a hole in the [00:08:00] bank balance sheet, so the banks were levered between 10 if you're an investment bank, 10X if you were a consumer bank.

Here, of course, with SVB, that was more of an interest rate risk story. The regulators post 08, they said, all right, let's clamp down on credit risk. Let's encourage banks to own high quality liquid assets, HQLA, give them favorable regulatory capital treatment for that. Then SVB and a few other banks loaded up on those securities, which are treasury bonds and mortgage backed securities, which are RAAA, made to carbon value.

A couple of banks went down. Obviously, banks today still have around 600 billion plus in unrealized full to maturity losses. The Fed's created a facility. For those securities, so they can fund at par value, which is above the market value of the bond, help replace the bank balance, help them hold to maturity.

So that, brings us to today, covered 12 years and 12 minutes, not bad. Yeah, where we are today, we've got this housing market. [00:09:00] Which is really quite a dynamic story. We've had the fastest pace of rate increases since 1982, and home builder stocks have been on a tear and they're creating new supply of homes, but there's a capacity constraint around that, meaning, but on the other side, you've got a locked housing market.

People aren't moving. I told my wife, we got a 2020 COVID mortgage in June, so we're not moving until that bond pays off in 30, I guess we're 27 more years to go, whatever it is. You walk us through what you're seeing in the housing market, the impact of rates and what do you think the outlook is?

Yeah, there were a couple interesting charts popping around just this past week about new home values, i. e. like builder, new home builder Home values that were down, I think, something like 18%, whereas existing homes were up year over year, three handle three to 4%. And so it really shows this bifurcation between those folks that [00:10:00] don't really have to move, i.

e., if you're in your home and you have a low I think something like 80 percent of mortgages out there are less than a 5 percent coupon. Morgan Stanley has a metric out there the share of. Loans out there that are in the money to refinance, and it's 0. 3%. Okay, so if you're in an existing home and an existing mortgage, yes, there's very little incentive for you to move.

But builders are in a different spot. Okay, builders are on it. A shot clock of between 6 and 18 months, where they have a construction loan, then maybe they have a perm loan, they have, and those are usually expensive loans, okay, so they're building in, obviously, a profit margin, but that profit margin is quickly going away.

And so they're they're in the moving business literally, not the storage business. And so they have to move as quickly as possible to be able to move on to [00:11:00] the next build. So that metric of, you're looking at Boise, Austin some hot cities out there that are down 10 to 20%.

It's, it was the froth. It was the cities that were up, 50 to 70 that are now down 15 to 20. And it looks cool. These got, housing falling everywhere. But in reality, It's not. It's going to be a very, we're all kind of lobsters in a pot right now, and the water is getting warmer.

You're referring there to single family residential, in terms of those price drops across those markets. And, We see some stress in multifamily and obviously commercial real estate as well, which is a different sector of the market. So the homebuilders are benefiting from the fact that existing homeowners with a low rate mortgage don't want to sell because they can't refinance without paying more.

And therefore that's created a bid for homebuilders to create new products, so homebuilders have done well. On the other hand, developers Yeah. Commercial real estate multifamily that took out these short [00:12:00] term construction loans are in a world of hurt, obviously, because rates have increased 500 basis points.

And then they got the work from home issues on top of that. So there are a lot of cross cutting facts and players that are benefiting and hurting the real estate sector. And I think. If you want to create a timeline for it, if rates do stay high who's going to be hurt the worst in the first, it's look to those folks, A, that have the most amount of leverage, or those companies that have the most amount of leverage.

And that's why it's started with banks, because banks are 10X levered. Okay? That's a caveat there. They were 10x levered going into the last two years. Now, they're potentially 20 times levered. Okay. So if you had 100 million in [00:13:00] assets backed by 10 million in equity, and those assets fell by, five or call it 10% you're in a world of hurt right now.

So you're seeing some of these banks that are like 20x levered. Now, okay. And so a lot of these banks, you can do the math, about a third of their portfolio was in fixed income. That fixed income is down 10 to 20%. Okay. So if you had 33 million, and it's down 20%, okay, you're down 6. 6 million. So now, You have only basically 3.

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