How Insurers Can Unlock Alpha Through Residential Whole Loans

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Stewart: Hey, welcome back. It's great to have you and I appreciate you very much. I mean, just to the housekeeping: this is the InsuranceAUM.com podcast, home of the world's smartest money, and my name's Stewart Foley. I'm excited because I am getting ready to take off for Martinsville in the morning for the second of the last NASCAR race this year. It is super. I love, love racing. I've always said I would watch two people race lawnmowers in a Walmart parking lot as long as it was competitive. So, I'm a car and bike guy and love motor sports, so super excited to be getting out, going down there. I think Martinville is the smallest track NASCAR has, and it's also one that you can, kind of like a football game, you can watch the whole thing at once, which isn't possible when some of the tracks are too big. And the folks in Martinsville are super, super nice.

The food is awesome , I think it's made by the people who work at the track, and it's a very homey atmosphere. So, I'm thrilled to be doing that. Hopefully somebody else is going down, and hopefully we'll see you there soon. But the topic of today's podcast, we're talking about how insurers can unlock alpha through residential loans and asset-based finance. And my guest today is someone who has shaped how the insurance industry approaches structured and private credit over the past two decades. Nancy Mueller Handal, Chief Investment Officer of Insurance Asset Management at Bayview Asset Management. Nancy is a friend. We've known each other for a long time. Nancy, I'm just thrilled to have you on the show.

Nancy: Thank you so much, Stewart. It is my pleasure to be here.

Stewart: We always start the same way, and I know people get sick of it. I'm sorry, but other people tell me they like this part the best. So, where did you grow up, and I'll just ask you the one that we used to ask, what was your first job, not the fancy one.

Nancy: Sure, absolutely. So I grew up in upstate New York, way up in a little town called Fairport, outside of Rochester, New York, right on the Erie Canal, and I loved it. It was a great way to grow up, very simple and easy. My first job was working at a bagel shop, which I loved, and I was kind of running the shop myself. It was a tiny place. My friends would come in and sit down, chat, and have bagels, and it was a really good, fun first job to have.

Stewart: If you were a friend of Nancy, you got an extra smear on the bagel.

Nancy: Oh, you know it. And you might get a chocolate chip cookie for free, too.

Stewart: There you go. I love that. I was wondering about that the other day. That's so cool. We were just in New York, and we managed to get a slice of pizza and a bagel because there's something about it. I mean, everybody says it's the water, but there's something about it that's really cool. If we can, I think it would be nice to be able to set the stage a little bit, talk about Bayview for those who may not be familiar, and then I want to talk about your career a little bit.

Nancy: That'd be great. And Bayview is sort of the asset manager that many have never heard of because we've been quiet and behind the scenes for a very long time. It's a 32-year-old company and at its roots started in mortgage servicing rights, advising on that; grew a proprietary capital book and investing in mortgage credit. So from the start, Bayview was, I'd call it, kind of an ecosystem of mortgages. But I came on two years ago to start up insurance asset management after being an LP in Bayview in my former career, where I was running all of structured products and alts and all of privates and alts and was a big partner of Bayview's over time, buying mortgage loans from the Firm and really got to see the evolution, I'd say from 2009 to when I joined in 2023

We have a C-PACE platform that has been off and running and then really started digging into consumer loans over a decade ago, including auto, student loans, unsecured, you name it. We have over 40 data scientists, including eight PhDs on the platform.. So, really a unique platform that's incredibly data-driven. Our goal and what the owner, founder, and CEO, David Ertel, had always said, he's not an asset gatherer, he's only doing things that make sense. So kind of very much kept the Firm manageably small for a long time, although we have over 2,000 employees. So that's at the core of Bayview and what we do.

Stewart: That's super helpful. Nancy, you are professor for a day today, so I know what CRE is. It's commercial real estate. I know that resi is home mortgages, right on homes that people live in. You mentioned MSR, can you tell me what MSR is?

Nancy: Yeah, absolutely happy to. So those are mortgage servicing rights, and essentially, when you think about any time you see residential mortgage-backed securities, there's a strip in there for mortgage servicing. And what we do is we buy up a lot of mortgage servicing rights, and then we have them sub-serviced. So we have a platform and an MSR fund that's fully hedged, where we're buying those mortgage servicing right strips, and we can do 'em one at a time by bidding on loans, agency mortgages, these are all agency mortgage-backed and then delivering the actual loan to the GSEs and keeping the servicing strip. So we do it that way, and we'll also bid on pools of mortgage servicing rights and essentially Fannie, Freddie and Ginnie want to make sure that every security out in the market has enough of a servicing strip in the event that we reach a downturn so that there's enough leeway left in a deal that can afford to cover the cost of servicing.

So there's an amount of excess in those servicing rights in the event that it doesn't cost as much. So we end up earning money on the servicing rights. Now, it's an incredibly, as you can imagine, negatively convex asset. It's the strip, so it's basically like an IO. So we have to manage it very carefully with hedging. And over time, we've had a portfolio and a platform out there that we've been doing this for a very, very long time. As I said, Bayview at its start was an MSR advisory firm where we were advising banks and others on valuations on MSRs. So that's where we started.

Stewart: That's super helpful. Alright, so we'll talk a little bit about how and why you started investing in residential loans. And so you've been involved in residential credit for a long time and this is a multi-part question. So starting from the beginning, how'd you get involved in resi investing and then also from those early days, what are some of the foundational lessons that shaped your approach to credit and capital allocation?

Nancy: Yeah, great question. So I've been involved in resi for a very long time. I actually started as an ABS analyst right out of business school and quickly worked my way out of a job because I was analyzing subprime mortgages and looking at buying pools and essentially nothing passed on, which was a good thing for MetLife at the time. I ended up then being an agency CMO trader. So with agency CMOs, obviously negative convexity is the biggest issue there. So I had spent a lot of time working on spec pools and constructing CMOs, buying CMOs. So that was a really fun job. And then that evolved to running all of RMBS, including a very big non-agency portfolio. So my evolution, it started with subprime, then to agency, then to prime all day. And at the height of the crisis running that portfolio, I was spending a lot of time on investor rights, especially with what was going on with all the programs, including ham, harp, and ag settlements, where the investors were paying for what the banks had done with loans.

And at the same time, I was working with a firm called Gibbs and Bruns on the big putback settlements. So if you think about it, these were the eight and a half billion with Bank of America, numerous ones of these, and I was on the steering committee with someone from PIMCO and someone from BlackRock. So we had all of the details on what was actually in those files, and I did a lot of the work in modeling and seeing what the prime mortgages were supposed to be and what we thought they were versus what was really in those securitizations. So what drove that was, well, first of all, I was still buying non-agency, but buying it at a very deep discount, working on Resi 2.0, trying to get alignment of interest between the issuers, banks, servicers, and investors, and really having a hard time with that because of reps and warrants.

So I said, “I'm going to go out and start buying just residential loans.” So I started in 2010. I bought my first pool of loans in 2012. It took me two years to figure out the right cap, the platform, all the stuff to start buying resi loans for MetLife at the time, and very thoughtfully put together a platform. At the time, my thesis as well was that there were over a trillion dollars of re-performing loans on bank balance sheets on Fannie and Freddie that were modified. So the banks couldn't hold them because they were TDR, they'd have a very high capital charge, but insurance company capital, they were super clean, they were low coupon, they'd been fixed good duration and very little convexity given the rates on them because they were all at discounts. So my idea was to go out and buy all of these for MetLife and very carefully pick through credit, and it worked. I built up over time a 20 billion platform at its height and just with alignment to obviously managing money for insurance companies, figuring out what liabilities it fit and having as flat a convexity profile as possible over time. And with that, then I went on to not just RPLs, but new issue resi whole loans both in bulk and flow, and building out over time. So I spent a really long time working on resi mortgages throughout my lifetime.

Stewart: So what's TDR?

Nancy: TDR is restructured. So essentially anytime a loan is restructured, the bank balance sheet, it's considered defective. Going forward, it gets a bad capital treatment. Even if it, say it goes delinquent, it comes back, everything's perfect, and it pays for the next 20 years straight. It's still TDR.

Stewart: And what's RPL?

Nancy: RPL is a re-performing loan.

Stewart: Got it. Okay. Super helpful.

Nancy: Usually, a modified loan that the interest rates cut, then whatever's owed or balance is cut and kept at the end. Some forgiveness on some of 'em. Fixed, I'd say they're fixed loans.

Stewart: And it's interesting because residential home loans, and this is based on my understanding, but they have a very favorable capital charge, and there's something like 80% pledge to FHLB. So if done properly, it's a really good asset class for insurance companies to consider. Right? So for a lot of reasons. Talk to us about the evolution of resi. You've seen residential credit evolve from the post-crisis rebuilding to today's more institutionalized market. How would you describe that evolution? Where did it start? Where is it now and where in your mind do you think it's going?

Nancy: Yeah, I'm happy to. I mean, I think about the evolution from first start with non-agency and the fact that the non-agency market got to about 2.7 trillion at its height and it was about 50% of production in the go-go years, call it 2006, 2007, which was a level that it probably never belonged at because we know the excesses in the market and you had products like subprime and Alt-A and then it just completely shut down. As we all know, throughout sort of the dark years. And then, there was all of the regulation and the cleanup. It went from where even agency eligible collateral, the difference between what it was pre-crisis and post-crisis is remarkable. And Bayview was actually a huge investor in credit risk transfer doing bilateral deals with Fannie and Freddie because very early on we used our modeling and research to say these loans, there's something different about these loans than pre-crisis Fannie and Freddie.

They're very, very, very clean and it had to do with limitations on DTI, just the way that they were underwritten checks and balances and that remains true today. So agency eligible loans are incredibly clean. And then throughout time you didn't see much and you went through and we had the non-QM and that's evolved over time. Qualified mortgage versus non-qualified mortgage and what that means. And more recently we've seen another kind of what I'd call mini explosion in non-QM. So you went from what was subprime and Alt-A to just sort of agency eligible and some securitization of reperforming loans and non-performing loans to very sort of slowly getting into non QM and now a lot of non-QM deals and insurers buying non-QM loans on their balance sheet. We do that for insurance companies. So I'd say there's a lot of different flavors of non-QM.

We'll talk first about loans we buy. Typically we buy a lot of agency eligible loans. We bid on them one at a time, and agency eligible means Fannie and Freddie will buy that loan. They will put a guarantee on it. And typically, any loan that's owner occupied, with the exceptions of things like condos and other, they're usually the best bid for when it comes to second homes and investor properties. And with Fannie and Freddy agency eligible investor properties are underwritten to the borrower, not to the properties. So they're not a business purpose loan, it's actually the debt to income of the borrower. So it's not prospective saying, I will earn this rent on the property, it’s this is how much money I earn myself and fully loaded across any property they own. Their debt to income has to reflect that. So a little bit of a different product and then we all know what a second home is.

So that's agency eligible and we do a lot of that. Then in the non-QM space, you have your DSCR loans or debt service coverage ratios, which are investor properties, but they're underwritten to the property itself. So the borrower could be an LLC, it could be an individual, it could be cross collateralized. There's lots and lots and lots of properties that people could have, a thousand properties, and all put into the non QM market as a DSCR. Then there are bank statement, which are typically self-employed borrowers. So either 12 months, 24 months, we've actually done the work to show that there's not a huge amount of difference between the two programs. And then you have things like asset depletion, so people who have a lot of stocks, bonds, money that are underwritten to sort of that piece of it. Then there are sort of it. So those are borrowers that don't have social security numbers essentially than for a non-resident. So there's all these different programs that are all under the non-QM platform and all different makes and models within that. And that's how we've evolved over time. And I would say non-QM is closest to what Alt-A used to be prior to the crisis with some differences in nuances, not blanket statement, but very much.

Stewart: So, DTI, you mentioned is debt to income, right? So what are you cautious about when you look out, there's a lot of interest in ABF right now. There's a lot of interest in residential mortgages, at least based on my vantage point, but every opportunity comes with risks. So what are the key risks you're watching in resi and in asset-based finance today?

Nancy: Absolutely, and the key risks in resi are really the potential for overvaluation on properties. We've seen some issues in Baltimore that most resi borrowers buyers are aware of where people buying up lots of properties, sometimes, not necessarily, some could be fraudulent, non-arms-length transactions that are masked throughout the process. So we shut down buying in Baltimore and we've also shut down in some other areas where it's just more difficult to get a proper valuation or there could be some little mini fraud ranks. So we're really, really careful when it comes to underwriting documentation, valuation check, fraud check. But that's an area that I think has been a little bit, you've seen some articles in Bloomberg and elsewhere, but there is potential there if you're not really scrubbing your loans and you're just buying and sort of not paying as much attention to some of the red flags, there could be issues there.

And I think in general, the way that we model, we model to an OAS on each loan. Because the valuations when you're buying a mortgage can vary greatly. It could be the same dollar price for the mortgage, but whoever the asset manager is, who's modeling it, you could go anywhere from call it a two 50 spread to a 300 spread on that same exact loan based on the payment, but also your default probability and your severity. So I caution to look at the dollar price, look at the WAC, and then understand the modeling and what goes into it and the thoughtfulness that goes into each. And is it an honest model or is it sort of light on expected losses? I'd also say layered risk, I know I'm going on here, but this is sort of my layered risk in non-QM is it can be atrocious. There was a recent KBRA study on default, so everybody has been very go, go, go on mortgages and non-QM has been hot and great because there have been no losses, right? But there have been no losses because home price appreciation has been phenomenal since COVID. So what that's done is masked what has actually turned out to be a pretty significant number of defaults.

And if you look at this study, there's a high correlation to certain factors for those defaults. And a lot of it is really unlayered risk too. So meaning you could have a pretty, say you have an 80 LTV, but you have a 650 FICO and on top of that you have a, I dunno, just certain other a lower DSCR, everything else layered on top of layered you just have to watch out for, I think in resi loans and creating a buy box is essential. That figures out making sure you don't have layered risk and everything is pretty right down the fairway is incredibly important when constructing a portfolio and avoiding those risks.

Stewart: So I'm going to go back and dig out all the structured securities things I've learned in my life and I'm going to try to unpack the alphabet soup that was just there. So OAS is option adjusted spread. CPR is constant prepayment rate.

Nancy: Correct.

Stewart: So for those who don't know, home mortgages are refinanceable and whether they are has to do with a couple of things, but one is the market level of interest rates. So if the market level of interest rates was high and I had a home mortgage and the market level of interest rates are now low, I can refinance that. But as a holder of that mortgage, I get my money back when I don't want it.

Nancy: That's right.

Stewart: Which is negative convexity, which is a term that if you can define, you get free coffee at Dunkin Donuts. And you also mentioned DSCR, which is debt service coverage ratio, just so that everybody knows, you mentioned another one in there and I can't remember, I can't pull it out, but I thought it started with an H. But regardless, HPI.

Stewart: Okay. Good deal. Okay, fine. So you mentioned that you were working with Bayview since 2009 and you were with one of the largest insurance investment platforms anywhere at MetLife. And full disclosure, MetLife Investment Management is a client of ours as well. So why make that transition? You are obviously exceptionally well-versed in this market, so what makes that move happen for you?

Nancy: Yeah, sure. And I think it's exactly because of that. So I was a senior managing director and I was running all of privates and alts, so that was private corporates infrastructure debt, actually index alternatives, which was obviously the portfolio of LP interests. Then I started up a private ABS platform and I started up this resi loan platform. What I found over time is, and I had a big team, I had about 150 people and about $150 billion in AUM and I wasn't looking to go anywhere, but my boss at Bayview came to me and we had worked together. I actually had a fund of one on behalf of MetLife. I invested as an LP on behalf of MetLife and I had known Bayview and bought over $10 billion of loans from Bayview while managing the platform at MetLife. And I knew just how nuanced and intricate and how deep into mortgage credit and convexity Bayview got and I was always enthralled with it.

So I wasn't planning on going anywhere, but my next move would've been at Met running other areas, all of MIM in theory, and job offered but not accepted to take this. I think it was exactly that. I love mortgages, I love, I ran structured products, I started in ABS, I've done ABS, CMBS, CLOs, resi, and that's what I truly enjoy. I was starting to be more of a sort of an executive, let's just say we're not as into the details, not investing dollars, but really just managing people and pitching on behalf of MetLife, traveling the world, telling the MetLife story as the poster child. And I loved MetLife it’s a wonderful company and I can't say enough about it, it was my career starting. I was there for over 20 years and I had some incredible mentors and sponsors throughout that time and great leadership from the CEO on down.

So it was just more of a career switch to start up my own unique strategy within Bayview, which is insurance asset management, build the platform to be aligned with insurance companies, which we have a platform where we do everything at our cost directly to the insurer. So with no gain on sale. So every time I bought mortgages, I was paying a gain on sale and then putting in my portfolio. Here it goes directly into the client's portfolio, no gain on sale just at our scale and cost, which is massive. We also buy from 625 different originators and we bid at a loan level day in, day out. So all of that was very, I know it's nerdy, but it was exciting to me to do that.

Stewart: That's interesting though, because that takes a lot of infrastructure. That is hard to do. I mean that's a lot loans.

Nancy: And that's why I told you we have over 2000 people. So the engine underneath me is phenomenal. And it takes not only the ability to settle every day, not in pools, it's day in, day out, be able to settle one loan, two loans, but also to be able to bid those loans and understand exactly where we should be pricing for the best value. But also we have a whole team that's a FIG team that is out talking to banks and others about Reg Cap, how we can be helpful in helping them with their balance sheet needs. And then also a whole other group that goes out to a mortgage originators to get them on our platform. So again, we have 625 mortgage originators, we put them on one by one, starting with one up to 625, and we cut some for performance or other reasons. So we're constantly on top of that too, the performance of those originators. So it's just the platform is so robust when it comes to mortgages. And that was really sort of my decision to go from what I really did love from a big management position and lots of people and lots of credibility to what do I really love to do. 

Stewart: Nancy, it has been an unbelievably good education on this market. I've learned a lot today and I really appreciate that. Can you give us a couple of key takeaways from the podcast that you want our audience to take away with you? And then I've got a couple of fun ones for you in the way out the door.

Nancy: Sure, absolutely. So what I'd say is resi loans in particular a great asset for insurance companies. Like you said, pledge usually and the agency eligible are absolutely pleasurable to the FHLBs. If done right, you can manage convexity either in DSCR with a five-year prepayment penalty, agency eligible because they're just naturally less negatively convex. They're really great diversifying assets to have on the books versus a book of corporate credit in commercial real estate. And especially because if you think about a portfolio of resi, whole loans across the country have every type of industry and borrower and location within it. So it's naturally diverse in very many ways If you're very good at underwriting, you're careful and you don't just kind of go with the flow, but really take a look at everything within a loan file and re-underwriting, a great asset class to have on your books.

Stewart: That's super. Alright, so I really appreciate the education, it's been very good today and thank you so much. I got a couple other ones for you. One is, one attempts to get to the culture of your firm and also benefit from your experience. And the question is, what characteristics do you look for when you're hiring members of your team?

Nancy: Great question. I would say I like to hire people who are can-do attitude, optimistic, the kind of people who aren't going to put up hurdles but are going to jump over hurdles. So I'll look for that in an interview. And I also like to hire someone who's a little more scrappy, who's got a lot more fight in. It's never about to me, although everyone on the team has great pedigrees and they're well versed. It's people who truly like to roll up their sleeves, who have checked their egos at the door or do not have egos, scrappy and just hardworking and quite frankly, a little bit geeky like myself and really loving to dig into the data and think things through. And also, I like to hire people who kind of check me and question me as well. My team, I'm always up for, okay, tell me where I'm wrong here. And I like the people who are going to say, this is where you're wrong and not be afraid to, because that's the only way you learn in life.

Stewart: I think it's so true. Alright. Who would you most like to have dinner with? Alive or dead? You can choose one, two or three guests dinners on us, by the way.

Nancy: Oh, I like that a lot.

Stewart: Yeah. Thank you. Well, I mean now we're now owned by The Institutes, so it's not my money anymore.

Nancy: Even better. I'm kidding. Even better.

Stewart: No, I'm kidding. Pete Miller's like, what? Okay, so you can have one, two, or three dinner guests. Who's it going to be?

Nancy: First of all would be my dad who passed away in 2012, literally right as I was building my career in many ways and was just a phenomenal person and influence on me, a renaissance man. So I'd love to have one chance at that. And then I'd say across the board, Madeline Albright, I would love to absolutely have dinner with, I think it's, and actually kind of Condoleezza Rice as well. I saw her speak one time and an amazing fact that I hadn't been aware of was that Condoleezza Rice and Madeline Albright had the same mentor and sponsor, and that was Madeline Albright's dad, who was Condoleezza Rice's professor.

Stewart: Wow.

Nancy: And mentor and sponsor. Yeah.

Stewart: That's interesting.

Nancy: Crazy. Right? And those are both two women that I think were incredible leaders, incredibly thoughtful and broke the mold, and clearly across both sides of the spectrum. I just thank two phenomenal people that I'd really love to learn from and hear from.

Stewart: Great podcast, Nancy, thanks for being on. We really appreciate you taking the time.

Nancy: Thank you. It was my pleasure.

Stewart: We've been joined today by Nancy Mueller Handal, Chief Investment Officer for Insurance Asset Management at Bayview Asset Management. If you like what we're doing, please rate us, like us, and review us on Apple Podcast, Spotify, or wherever you're listening to your favorite shows. You can also catch us on our new YouTube channel at Insurance AUM community. If you have ideas for podcasts, please shoot us a note at podcast@insuranceaum.com. My name is Stewart Foley. This is the Home of the world's smartest money on the InsuranceAUM.com podcast.

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