Stewart: Welcome to another edition of the InsuranceAUM.com Podcast. My name’s Stewart Foley and I’ll be your host. We’re talking about ABS, mortgages, and specialty finance with TJ Durkin of Angelo Gordon. TJ, welcome. Thanks for being on, man.

TJ: Thanks for having me, Stewart.

Stewart: It’s great to have you. Angelo Gordon is new to us. We’re thrilled to have you on, and we want to start this one off we start them all. What’s your hometown? What’s your first job, not the fancy one, and a fun fact?

TJ: Sure. I was born in Brooklyn, New York, but moved quickly thereafter to a small town in New Jersey called Flanders.

Stewart: Wow, there you go. That must have been… That little culture shock, right? From there-

TJ: Very exciting, yeah.

Stewart: Yeah, absolutely. First job?

TJ: First job, I was basically a filer in my mom’s office, probably age 14, 15.

Stewart: There you go.

TJ: Like old school, taking faxes and putting them in file cabinets.

Stewart: Well, I’ve done a version of that. We’re dating ourselves a little bit on that one. And what’s a fun fact?

TJ: Well, professionally, I’ve been at this for about 20 years, and I’ve had my whole career in about a one-block radius here in Manhattan, so I haven’t experienced too much of the city. But on a personal note, I have no idea how to drive a boat, but I’m a fairly well-versed jet skier.

Stewart: There you go. Jet skis, those things are really fun. They’re really cool. I was amazed with the first time I ever rode one and how responsive they are. They’re incredibly, incredibly cool.

TJ: Just have to remember there’s no breaks.

Stewart: That’s a very, very good point. Tell me about Angelo Gordon. Very well-known firm, very capable firm, maybe not a household word to our insurance investor audience. So, what asset classes do you manage? How long has the firm been around? How big is it? Just give us a little background.

TJ: Yeah, absolutely. We are a $50+ billion alternative asset manager. We were founded in 1988. We’re still privately owned, and there’s about 600+ employees of us globally. We’re really focused exclusively on credit and real estate. And so, real estate makes up about a third of our AUM in private equity format, and it’s broken down mostly into regions, but we’ll have US, Europe, and Asia. And then, we run a net lease strategy as well.

When you move into credit, that makes up the other two-thirds, and there’s really three pillar businesses within that, and it’s corporate distress and special situations. We have a large middle market direct lending business, doing business under the brand Twin Brook. And then lastly is the structured credit vertical, which I run.

Stewart: At the top of the show, I mentioned ABS, mortgages, specialty finance on the structured credit platform. Can you walk me through the history and current state of play for your business at Angelo Gordon?

TJ: Yeah, absolutely. I mean, we’re running just over about $6 billion of equity capital within the strategy, across both publics and privates. I joined the firm back in 2008 to really help Angelo Gordon take advantage of, I would say, the distress securities opportunities that were being created by the GFC across all those acronym food groups that we just talked about. A year later, we were selected as one of the nine managers by US Treasury for their PPIP program, the public-private partnership. That, I would say, quickly put us on the map with institutional investors.

While we started in the securities market, by 2010, just being opportunistic and getting to know management teams, we did our first private financing or warehouse transaction to a subprime auto company that had made it through the GFC. They didn’t file for bankruptcy, but their traditional bank lenders hadn’t turned them back on yet for new origination. That was something the management team really wanted to do, to get back to business.

And so, having known them from owning their securities and just doing regular-way surveillance, we were very comfortable with how they thought about risk. And so, we gave them that initial fresh financing lines so they could get back to the business of originating. Fast forward 12, almost 13 years, we’ve been doing it ever since, living in both the public and private markets within our specific sectors of expertise.

Stewart: When we talk about private credit opportunities, and I mentioned the term specialty finance, I think that means different things to different people. Can you define specialty finance and how you see the overall opportunity set in private specialty credit right now?

TJ: Yeah. We like to joke that private credit is the most loosely defined thing in our world. When we think about it in my space, I think when we think about specialty finance, it’s really non-bank financial companies that are doing lending but not on an EBITDA basis. So, we think of things on an EBITDA, traditional, corporate lending lens, and then everything else which is more asset based. There’s different forms and flavors of asset based once you kind of dig into the different food groups, but that’s kind of a high level what we think of as specialty finance.

Stewart: What differentiates your platform in this space? I know that in my background running money, size, if you’re too big, you can’t take advantage of certain opportunities that exist in certain market segments. Can you talk a little bit about where you think your competitive advantages lie?

TJ: Yeah, I think that’s right. I think when you think about public markets and securitization, if you think about those household name money managers, they’re so big that they’re getting a lot of that beta or almost synthetic index exposure. I think when you think about private credit, I think there’s a lot of different ways to express it even within specialty finance. I would say what our platform brings is a one-stop shop to LPs in the sense of that we live in both public markets in terms of having more liquid open-ended products that are geared towards securities and almost a fixed income alternative for investors. And then, we are very active in the private markets, which is lending or owning the raw receivables, not insecurity forms. So, the illiquid versions of those same asset classes.

There’s not many of us in the alternative asset management space that I say have core businesses in both. There’s a lot of people that maybe specialize in just private or specialize in just the public markets, the QSIP business. And that I think there’s very few of us that are, on a day-to-day basis, managing a large sum of money in both those spaces.

I think what we’re seeing, particularly in a year like 2022, there’s a lot of overlap in opportunities, or I would say opportunities and situations will change mid-process where you thought you were working on something in the public markets, but now a private market solution is better or vice versa. And so, having that expertise and the proper pockets of capital to address those opportunities, I think is what sets us apart from many others in the space.

Stewart: That’s really helpful. Let’s talk a little bit about tactical opportunities today, both illiquid and liquid. A lot has gone on in 2022. Can you talk a little bit about 2022 events, and how are you thinking about the macro risks and opportunities as we move into 2023 here?

TJ: Yeah. I think let’s start with the public markets and I would say just technicals. There’s a lot that’s gone on this year, whether it’s inflation, SPACs, Ukraine, et cetera. We sit here in December, and if you take a step back and you look at high yield spreads just to center everybody, they’re in the low 500s, which if you look at a historical basis isn’t that interesting. If you look at dollar prices, they’re a lot lower and that’s just simply interest rate direction. So, the index is down a lot in the mid-teens, but spreads from a credit perspective, I would say not that compelling on a historic basis despite all the uncertainties in the world.

That really has to do with, if you think about the last 18 months leading into 2022, I would say most high-yield CFOs did their job. There was low nominal interest rates, tight credit spreads, and the extended duration. And so, I would say barring any M&A, there was no need to issue this year. Everyone can sit on the sidelines. You’ve seen I would say limited activity in the secondary market and spreads are, I would almost say, artificially tight.

When you do see supply, i.e. Twitter, the Citrix deal from a couple months ago, you see the banks taking some pretty material losses when that debt actually has to clear the market. It looks like high yield volumes will be down roughly 75% year over year. So, that is the primary calendar technical environment. If you switch to specialty finance CFOs versus traditional corporates, they just don’t have that same luxury. Their business model is predicated on being able to hit the securitization markets.

And so, I like to give an analogy of an auto finance company and that CFO has a budget of doing $4 billion a year of origination, and they’re going to do a billion dollar securitization every quarter. They’ve got $800 million of financing from an investment bank. They’ve got $200 million of equity below it, an 80% advance rate, and they’re going to just turn that over four times in a calendar year. What we saw happen in the beginning of this year is rates started to leak out in Q1, credit spread started drifting wider, and that CFO was supposed to do their first quarter deal in February. They said it doesn’t feel that great, let’s kick the can 30 days, let’s do the deal in March.

And then, March didn’t feel as good as February. Let’s wait until April. As we now have 12-month hindsight, every month’s effectively got worse and worse. And so, what we saw happen is by May, June, a lot of these companies that kicked the can were forced to capitulate and issue, not because they had margin call issues. A lot of these financings are non-market-to-market. It’s that working capital that is sitting below their warehouse is their oxygen. And so, if it’s all tied up in these old loans sitting on a line, they don’t have the capital to make new loans. And so, what’s the point of having a marketing budget of Salesforce, you can’t make the product, you’re out of business.

And so, they were forced to come to market and effectively take what was given to them, and those were materially wider spreads than where we started the year. On top of that, I would say a lot of mutual funds are a huge consumer of structured credit bonds. Given, I would say, the performance that they’ve seen year to date, they’ve been on a buyer strike. I think they’re bracing for redemptions, and so while they haven’t really been selling from what we can see in large size, they’re certainly not buying the way they usually are.

That kind of double whammy of supply still coming and there not being that natural source of demand has pushed spreads in our market to 300% higher than where we started the year. And so, that’s very, very different than what you’re seeing in the corporate space, and it’s predicated on that fact that, for these companies to continue being in business if you will, they’ve got to originate and sort of distribute. That’s happening on the public side. Obviously, I would say that volatility and the cost of funds expanding dramatically leads to a lot more opportunities on the private side as those CFOs are looking for alternative sources of liquidity and financing. And so, we’re really busy on both fronts because of that.

Stewart: It’s really interesting to understand the nuances of that market and the kicking the can down the road and the market just being in their face month after month. I mean, it makes total sense, and it’s really helpful to hear you lay it out. I always say to people, I learn the most on these podcasts of anybody because I get a chance to talk to somebody like you that’s very close to these markets, and I learn a lot and it’s really helpful.

Angelo Gordon hired Matt Heintz, who’s a good friend and I’ve known Matt for years, clearly focusing your efforts in the insurance segment, which is our only market. Our listeners are insurance investors all over the place. Can you talk a little bit about the relationship you have with Insurers? Private credit has been a big allocation from insurers, it has been a place that they can find good yields, good value. How has this strategy resonated with the US insurance community?

TJ: Yeah. I would say within our credit business here, more broadly speaking, I mean, we’ve experienced significant growth over the last five years with insurance partners into all the three credit strategies, both as I would say a traditional LP maybe coming into our special situations fund, as well as lenders to us, say in the direct lending business. Specifically within structured credit, we have, I would say, seen real interest pick up, I would say, in two parts of it. I think what we find is that a lot of insurance companies have internal teams that invest directly in structured credit in some format. And so, they’ve got a lot of knowledge on the space from a capital perspective, typically investing in the IG part of the capital structure. But they know the asset classes that my team is looking at, pretty cold, way more sophisticated than an average, say, pension fund.

But what we bring to the table for them is that we’ve got a much larger team, almost 30 investment professionals, where we’re able to, I would say, source, underwrite, and asset manage a lot of the private opportunities within those same core asset classes that they know, and be able to effectively deploy capital at much higher returns for that same amount of nominal risk by doing it in private format versus buying it publicly off the syndicate desks from the investment banks. And so, we’ve been able to create a structure within our private funds, a rated feeder fund that gets insurance companies very efficient capital treatment for the risk, and get that exposure that, I would say, they’re just from a personnel perspective, capacity constrained, to really go out and originate an asset management. But again, at the end of the day, our conversations with them are very, I would say, quick and fluent and in-depth.

A lot of insurance companies have been really impressed with our, I would say, our homegrown technology when we’re doing due diligence calls. A lot of them say, “Wow, I wish we had that.” That’s how we’re able to manage this risk efficiently. Secondly I think, really a function of 2022 with the moving higher end rates, and I would say the widening in spreads, it’s fair to say the securitization markets at some points this year have been broken and at best times have been struggling. And so, it’s created an opportunity for us to work with some of our insurance clients and strategic partners to give them a turnkey solution for residential mortgage exposure. Just unsecuritized residential mortgages get really great capital treatment, I think really interesting yields right now and credit spreads given the dynamic of the securitization markets being clogged, but it’s a cumbersome process with hundreds, if not thousands, of underlying loans.

And so, we are a major securitizer in the market. We’ve been able to offer some of our insurance clients a turnkey solution where we’re effectively originating and sourcing to their own credit boxes, we can customize that. We’re doing all the low-level due diligence and asset management functions, and then delivering them, whether it be on a monthly or quarterly basis, that kind of custom reporting package that their accountants need, and structuring it in a capital efficient way that it’s a Schedule B asset. And so, that’s seen a huge uptick in interest this year in particular.

Stewart: Yeah, that makes sense. I mean, obviously, you’re seeing a lot of deal flow and that’s very important in those markets as well. TJ, let’s talk a little bit about, at the top of the show, I mentioned mortgages and we haven’t really talked too much about that. Where do you see value in residential mortgages, for example, right now?

TJ: Yeah. I think we’re obviously looking at higher interest rates, we’re seeing home prices go down, and I think the natural caution is that, are we in 2007, ’08 again? It’s a fair question, and I think there’s been a lot of, I would say, belts and suspenders put around mortgage lending since the crisis. You got Dodd-Frank, you’ve got the ability-to-repay rule, et cetera, et cetera, which if anyone listening has actually tried to get a mortgage in the last 10 years, you know it’s not a fun process. It is delivering a lot of documents in a very cumbersome manner. So, where we sit today is that we fully expect home prices to go down in 2023, we expect them to go down. We’re modeling them at a 10% decline nationally. It’ll vary by region and MSA, but what you’re looking at still coming into this was, in general, if you look in the non-qualified mortgage space, which we have a lot of experience in, average LTVs are around 70.

If you think about 2007 and to pick on, say countrywide, if you’re looking at subprime there, it was 90, 95 LTV product, on much smaller balances, I think $200, $250,000. So from a down payment perspective or skin in the game, you could buy a house with a 95 LTV and write a $10,000 check. Right now, if you look at non-QM, we’re probably averaging $600,000, $700,000 average mortgage balance with a 70 LTV. So, it’s a million dollar house. Think about the interest rate environment today, it’s 75% plus purchase. There’s no refinancing, really, activity going on. What that means is even going into an environment where we know home prices are going to decline, someone just wrote a $300,000 down payment check. There’s no real second-lien market out there. That’s an immaterial piece of equity that I just don’t think you’re anywhere near having that kind of walkaway effect that you’ve had in 2007, ’08 when home prices started to decline.

I think a lot of the regulatory actions post-GFC have made the mortgage finance market, I would say, much more robust and, honestly, safe from a credit perspective as an investor. Now, again, I think what we would emphasize too is just away from what the regulatory aspect is, I mean, we’ve just built a tremendous amount of infrastructure to understand what credit box we want to be able to… We’re still doing 100% re-underwriting or low-level due diligence before we settle the transactions to make sure the debt-to-income ratios are what is being advertised. We’re agreeing with the loan to values that are being advertised with reappraisals, et cetera.

We think it’s an interesting market in the sense of the credit’s still really good. I think the risk-adjusted spread is attractive. And on a forward-looking basis, there’s just going to be a lot less supply of it at these interest rates. We’ll probably have the lowest origination volumes holistically speaking for 2023 that we’ve seen in probably over 15 years. There’ll be less of it available. I mean, we think it’s a good time to be buying those assets now because there’s still demand for this product, and I think that will cause price tension or spread compression, whichever term you want, 12 months forward.

Stewart: That’s extremely helpful and really interesting. I mean, I live through… I was running money in the 0678 timeframe, and it’s one of the reasons I’m so gray, but it’s a very good point you’re making about the differences between now and then. Just kind of a wrap question for you, what risks or phenomenon do you think is not properly priced in the market right now as we go into 2023? Either over or underpriced, either way.

TJ: Well, I think the risk around housing is overpriced. I think there’s a lot of scars still left over from, call it 15 years ago. Again, I would say rightfully so. I think whether you talk about what the government’s done, I would say the rating agencies have course corrected a lot of their mistakes since then, and I would say that market’s much more stable. Where you’ve seen, I would say, the irrational exuberance in the last two to five years has been the emergence of this consumer unsecured space. So, the FinTech lenders where at two in the morning you can go online and apply for a $12,000 loan and you’ll find out instantaneously. We’re seeing the performance or fundamentals, I would say, start to really rapidly deteriorate over the last six to nine months as a lot of that stimulus tax credit money has burned off, particularly at the lower income levels within the demographics.

You’re starting to see that really, I think it’s not a secret, but I think you don’t want to catch a falling knife there either. And so, we’re still looking at that space fairly actively. I would say a lot of tourists that got into that looking for yield, chasing yield in 2021, that didn’t really know what they bought. And so, it’s not to say we’re afraid of it, but it needs to be at the right price. That’s where we probably spent a lot of time, honestly in the last 90 days, looking at different pools coming out of different types of sellers that are just saying, “You know what? We’re hanging up the towel. We should’ve never bought this. We have no idea where this is going.” And so, that’s the place where I would say the risk was definitely mispriced, and now it’s coming back to bite some of those buyers from 12, 18 months ago.

Stewart: That’s great, I appreciate it. I was a professor for a few years, and I got a soft spot in my heart for young people and people who are early in their careers. You mentioned at the top of the show that you’ve been 20 years in this business and it’s all within about a one-block radius in Manhattan. If you could go back and talk to TJ Durkin walking off the stage right after they handed you your diploma, what advice would you give your 21-year-old self today?

TJ: I mean, it’s really just ask a lot of questions. I think most people are positively inclined to teach and help younger people, particularly if they see you’re putting the effort in on the other side and just be a sponge of those answers. You can’t really expect people to go out of their way to just deliver it to you. But if you’re proactively asking people questions, very rarely do I see those questions being ignored.

Stewart: That’s great advice, man. I wish I would ask more questions along the way too. One of the great things is I love doing podcasts, especially with guys like you that I get in the weeds on markets that I’m not as close to. So, thanks for taking the time for being on and spending some time with me this morning.

TJ: I’m happy to be here, Stewart. Thanks for having us. Look forward to doing it again.

Stewart: Absolutely. TJ Durkin, managing director, portfolio manager, and head of structured credit at Angelo Gordon. Thanks for listening. Please follow us on Apple Podcast, Spotify, Amazon, Google Play, or wherever you get your podcast. Please rate us, review us, and we appreciate it. Thanks for listening. My name’s Stewart Foley, and this is the InsuranceAUM.com Podcast.