Credit markets & what to expect in the future with Christopher Swann founder & CEO of Cygnus Capital

Christopher Swann, CEO of Cygnus Capital, and Ryan Morfin discuss how the credit markets may be adversely impacted as a result of the COVID-19 pandemic.
Christopher Swann, CEO of Cygnus Capital, and Ryan Morfin discuss how the credit markets may be adversely impacted as a result of the COVID-19 pandemic. On March 23, 2020, there was a massive increase in selling resulting in a violent collapse followed by federal impositions which aimed to settle issues that arose from the prior three weeks. Unfortunately, the band-aid placed on the economy by the Fed is a short-term solution as our nations long term economic prosperity is contingent on overall public health and the duration of a demand slowing regulations.

Public Mortgage REIT’s have already imploded and liquidity crunching has already occurred. Now we are experiencing the destruction of demand. This is problematic due to the rapid increase in tenant forbearance in the real estate industry. Eventually, this congregation of forbearances will work its way up the economic ladder and the burden will land squarely on the Fed.

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Ryan:                                 Welcome to Non-Beta Alpha. I’m Ryan Morfin. On today’s episode, we have Christopher Schwann from Cygnus Capital, a real estate debt investment manager based in Atlanta, Georgia. Today, he’s going to share a little insight about what’s happening in the credit markets and what we can expect going forward during this pandemic. This is Non-Beta Alpha.

                                           Christopher, thank you for joining the show, and I appreciate you coming to talk to us about Cygnus Capital and the debt investments you guys are marking. Welcome to the show.

Christopher:                    Thanks for having us.

Ryan:                                 Well, you guys participate in acquiring debt or investing in distressed debt situations and recovering assets, which is, quite frankly, probably one of the more interesting conversations we’re having right now, because we think that the early innings of this credit crisis are just getting started. Maybe you can share a little bit about your firm’s background and your background, and then we can jump into where we are in the macro environment.

Christopher:                    Yeah, sure. Personally, I graduated from Duke University in 1992. I worked in industry for four years and then went to Wharton Business School. Prior to business school, for the four years, I was in Germany and Russia and saw the change that went on in those economies.

                                           After business school I worked for McKinsey and Company here in Atlanta for a number of years. And then I joined a local hedge fund here in town called GMT Capital. That fund, when I started, was about 200 million under management and then when I left it was about 3 billion. It was a global long-short value-focused strategy. For them I opened up their Asia office and was managing a portfolio in the U.S. and in Asia. I got hired away by that firm and worked for Steve Cohen at SAC Capital for five years after working for GMT for five as well. I did a similar exercise at SAC where I managed a global portfolio and had a team in Japan and Hong Kong as well as in the U.S.

                                           I left SAC largely because I wanted to go out on my own. It was also the depth of the financial crisis and there was a lot of opportunity in the distress debt and real estate world and wanted to do something on my own. And so I set up Cygnus Capital with Andy Cummings, who is my primary partner, and then also Tom Claugus, who was the founder of GMT Capital, is a silent partner too.

                                           So we raised a series of funds in the past 8-9 years primarily from friends and family, small institutions, etc. Started out with fund one and now we’re on fund five. These funds focused initially on buying debt and REO from banks that had failed in the southeast. So as you probably know, an FDIC takes over a failed bank, the acquiring bank inherits basically all of the loan portfolio and its loans they didn’t originate or assets that they don’t know much about. And typically the acquiring bank then sells off those assets. And so those are the types of portfolios and pools of debt and REO that we purchased. We also bought single assets as well as single mortgages, defaulted mortgages.

                                           And that really has been the bulk of the business. The first funds had a bit more multi-family focus. Some of the later funds were more credit-focused. But the main strategy has been the same in the sense of basically we’re working out or reworking defaulted or non-performing real estate or debt. And so we’ve been doing that really out of the financial crisis into the recovery period. We can get into it but there’s basically opportunity for a company like ours in both good times and bad. Interesting here in the most recent weeks with the coronavirus, we’ve actually been quite excited about the opportunities that we’re seeing in the marketplace, and I’m sure we’re going to talk about that some today.

                                           But that’s a quick history of the company and I’m happy to dig in more.

Ryan:                                 Yeah, no doubt, this is going to be the beginning stages of growth trajectory for you guys. I know it’s hard when you’re investing in debt and equity multiples keep going up and cap rates keep going down. But you’ve got to bide your time and now think you guys are hitting the stride perfectly, given the environment. Real estate debt is one of the asset classes we’re very excited about, so Cygnus has been one of the sponsors that we have on our platform. So I’m glad you’re on the show.

                                           Looking at the last crisis versus this crisis, I know we’re just getting in the early stages of the downturn here. How are you seeing the credit market being impacted by the demand destruction from the shutdown?

Christopher:                    Yeah, so maybe I’ll talk a little bit about what I’ve seen in the last four weeks in the credit markets and then maybe specifically to that question, because that’s kind of the key issue. The credit markets had a heart attack four weeks ago, is the best way to describe it. Everything was being sold, I think it was on March 23rd. Gold, stocks, bonds, equities, everything. Everybody was trying to raise cash. And there was a violent collapse in the credit markets. And I think worse than many people know that aren’t market participants. There was just real stress. We’re close to the mortgage and debt and real estate world, so we saw it particularly acute in the mortgage business, but also you saw it in just normal corporate debt as well.

                                           But basically anybody that had paper that had to roll over or any kind of short-term repo, any kind of debt product that had a short turnover in those couple of weeks there, the market was frozen for a few days. So luckily… the policy reaction was… luckily is maybe too strong a word. The policy reaction was the feds stepped in in a huge way, bigger than they ever had before and the market unglued itself. The last 3-4 weeks have been a settling and calming of the markets. And the market-to-market problems that were causing the liquidity problems and the repo problems have largely worked themselves out.

                                           To answer your question though, what’s the impact long term, that’s the huge question. It’s, I think, a little hard to answer without answering the health question, because if people don’t go back to work, all of the liquidity and fed money in the world doesn’t matter. An extreme example, you can’t just keep propping up the economy by keeping people at home and giving them checks. That’s just not going to work. So ultimately people have to go back to hotels, go back to rental car companies, start flying around the world again to create the demand.

                                           We actually look at it through that lens. We’re not epidemiologists, but we are trying to be as smart as we can about what we think the base worst and maybe a best case will be in terms of how the health situation unfolds, and therefore back in a little bit too, what does it mean for demand and what does it mean, then, for credit?

                                           So I could stop there, but that’s how we look at it and how we’re looking at the opportunity. And I think, layered into that too is what do you think the… at least you need to have some theory around what you think the duration of the problem’s going to be, because that also impacts the math.

Ryan:                                 Well I totally agree with you. And I’m not an immunologist, but I play one on TV. I agree, you’ve got to keep pulse on what’s going on. What are your thoughts about where we are in this pandemic response?

Christopher:                    Yeah, so again, I am not an epidemiologist, but like you say, I’ll play one on TV for a little bit. I’ll give you my perspective. I have lived in a number of places in the world and traveled in different places and seen how different cultures have reacted from a policy standpoint to this. I’ve used it as a way to think about it from an investment process standpoint as well, too. So as you think about how this has unfolded, we started out with really only Korea and China being… where you could look to examples of countries that have found their way through it. And they did it through really strong authoritarian mechanisms. And so as we started looking at Italy and Germany and Spain, I think that was the next data points where you could say, “Okay hey, we need a western country that’s more of a free democracy. If they can find a way through this, what’s the chance that we’re not going to end up in an apocalypse?”

                                           And that was the moment when the credit markets were totally freezing was, I think, partially trying to answer that question, is there actually a window here where we can see that it’s not apocalyptic? And then now you’re seeing the breaking of the curves in Europe and then also breaking of the curves in the U.S. And actually, really interestingly, you’re starting to see these new studies on the antibodies that suggest that the infection rate is a whole lot higher. And again, I’m not an epidemiologist, but really do believe in data; our company’s very data-driven. And think the weight of the data, if you look at the Swedish data and the German data and Heineberg, some of the data that came out the Diamond Princess boat and then the Santa Clara studies that have come out in LA’s data and there were some out of New York earlier this week. You really are seeing a bit of the weight of the data that says infection rates are a lot higher than they have been. Which is bad news, but also good news in the sense that the mortality is going to be, potentially, a lot lower.

                                           So that then, if you think about that from an investment standpoint, what does that mean? Well it probably means that this could look not 10 times or 20 times as worse as the flu. Maybe it’s only one times worse than the flu, or maybe it’s only as bad as the flu, in a really best case scenario. But nonetheless, there’s been a huge confidence destruction here. So it is going to take a second for people to go back to eating at restaurants and bars and all of that. But again, if you look at different places around the world, we’re trying to keep as close to the ground as we can into the patterns in China or in Sweden or in these other places that have opened up a little bit more to try to get a handle on some of those curves.

                                           So long story short, to answer the question, we think it’s going to take this summer, at least, to build some confidence back. We actually are pretty optimistic that the baseline economy will come back in a reasonable way and that the economy’s going to get unglued here. So we think there’s actually a short term setback even further, further rebound in credit, if you will, from some of these really distress levels.

                                           But that being said, the way we think about it is the economy’s definitely going to be impacted. It’s not going to be the economy that was… at least the stock market was pricing in the third week in February. This is an economy that’s definitely… has taken a hit, a body blow. And so demand’s going to be down. My base case is that demand, though, actually is going to come back to a more sustainable, reasonable level.

                                           People are going to social distance, but they’re still going to go out to eat, they’re still going to participate in the economy, but it’s going to be at a lower level, whether that’s 2% down or 5% down or 10% down, that’s a little bit what we’re still trying to model ourselves and figure out. But I think some of the worst case scenarios, personally, are off the table from the demand destruction standpoint. And it’s a bit more of a muddle through.

                                           And then the last point I’ll make before I turn it back over is I think the bad businesses are the businesses that have negative trends going into this. All that got amplified. If you were having trouble making your rent payment or if your same-store sales growth, if your retailer was declining before the pandemic, well guess what? All of that got accelerated. So there’s still going to be a lot of distress. I’m not saying in the least that there’s not going to be a lot of distress on the debt side and the real estate side. But some of the better business models, I think, actually will rebound quite nicely. So it’s going to be really bifurcated. I think you’re going to have some companies that probably needed to be killed maybe two years ago are going to die quickly here and need to be restructured. And then there’s going to be some businesses that are going to do just fine. And so I think that’s the investment opportunity.

Ryan:                                 I’ve been taking some lexicon from biology, it’s the comorbidity of some of these business models has been accelerated and we agree with you. They should have been put out to pasture a while ago. Well, it’s refreshing to hear another group looking at it similar to the way we do it.

                                           So in your base case model, the markets are going to start to stabilize, we’ll get back to a sustainable growth level over a period of time as we muddle through it. We agree. How does that then turn into a distress cycle to start buying some of these assets? Will we see a forced clearing of the market on distressed credit from a real estate asset standpoint? Or is this going to be a lot of special-situation cherry picking because the banking sector seems to have given the regulatory pressures of the last crisis… the banking sector, I don’t think, is in a similar situation where banks are flooded with bad mortgages right now. And maybe I’m wrong but I’m curious to hear your thoughts.

Christopher:                    Yeah. You’ve got good questions, because those are key ones. Don’t know for sure, but my thesis is this, and I’ll compare it to the financial crisis. So the financial crisis we just had tremendous leverage in the system, just way too much money and relatively very thinly capitalized financial institutions. Not only did you have too much leverage in the system, then you had too much leverage in the guys that can actually provide liquidity. So the banks collapsed. In Georgia alone I think we had 40 banks collapse. When that happens there’s a giant flush that happens on the credit side, on the real estate side.

                                           I don’t think that’s as likely to happen. At least not that severe, for a couple reasons. One, the overall leverage in the economy, at least in real estate, it’s high, it’s elevated, but it’s not what it was. And also the credit that’s been extended, by and large has been to more or less credit-worthy buyers. We don’t have the no doc loans, the stated income. There’s been at least a little bit, if not a lot, more rigor around giving loans out. You can still argue that maybe the LTVs are too high and maybe there was some lending that was done to companies that probably shouldn’t have been extended as much credit. But there wasn’t as much ridiculous lending behavior that was going on.

                                           And then the banks themselves are much more capitalized and able to withstand and absorb more of the shocks and the write downs. But they will have to absorb. So I think it’s going to be a bit more of a, like you say, a special situation kind of cherry picking. I think the overall default levels could be pretty high. And then I think within the slow grind down there’s going to also be some violent situations, like we were just talking about. I think there’s some business models out there that this is just going to serve as a little bit of the last nail in the coffin. They really clearly should have done a restructuring or maybe they got an extended pretend loan. I think there’s going to be some credit officers now that just aren’t going to extend credit, and they’re going to say, “Okay look, you need to either just go bankruptcy or restructure.”

                                           So I think we’re going to have a little bit of both. I think we’re going to have some companies that are just going to flat out go to bankruptcy and we will see, perhaps, pretty big borrowing opportunities or at least more of a credit flush type situation. And then I think we’re going to have also a longer period where we’re going to have a pretty high volume of debt out there that’s going to need somebody to at least babysit if not do workouts on and be able to absorb while it gets either repackaged or restructured. Because the demand destruction could be significant that it’ll impact their ability to pay or pay off their debt.

                                           So it’s a long answer, but that’s what we see.

Ryan:                                 Yeah. My big concern in 2019, we went on the record with a bunch of our clients, is the private debt markets at corporate lending for SMEs, small tenants, we think that’s where the distress is because there’s been a lot of capital raised and multiples on private equity have been enormous. And so I think it’s a derivative effect for the real estate market, where you’re going to see a lot of tenants that maybe… the small balance tenants or the larger tenants that have been funded by private debt that’s expensive, is going to start to really weigh in on the lack of earnings growth.

                                           So I wonder how long of a… how much duration is going to be needed before we start to really see the distress in the real estate market? Because it’s going to take some of these companies 6-12 months to go through restructuring or bankruptcy. And while we’re waiting in that period, you’re going to see these leases have to go through the bankruptcy process. So it’s not really the… at least what I’m seeing, it’s not really the cap structure of the real estate assets that’s impaired, it’s the underlining credit on the cash flow streams.

                                           Do you agree with that sentiment or are you seeing some over-leverage in certain property types?

Christopher:                    Let me talk about both of those. There’s certain vehicles where we’ve seen real interesting opportunities even here in the immediate credit crisis. If you looked at what happened… I don’t know if you follow the public mortgage reads, but those are business models that are highly levered and highly geared. A lot of them imploded. They had very large book value destructions. That had more to do with their individual leverage than the overnight repo that they need for their investments. That was phase one. I think the liquidity crunch is probably over. And because the fed has come in in such a massive way. So the real problem in the overnight markets and that part of the debt market, I think, has been fixed. And so now we’re to the demand destruction side. And again, I think it does go back a little bit to the health question and how long the confidence takes for this consumer-driven economy to get its footing under itself.

                                           And then I think each situation’s going to be a little specific. Ultimately the problem is is everybody’s talking about the deferral or the forbearance. Somebody has to be ultimately the guy that has the pool of money that allows the forbearance to back up to. You can let your tenants forbear and then you can go to your lender and say, “Can you forbear?” Is the fed supposed to be the pool liquidity that provides the forbearance for the entire United States? So it doesn’t work at some point, and I think that’s the key to your question. If we only have to do this for 30 days, 45 days, then I think a lot of this could have a lot lower impact than maybe what the markets are pricing in right now. But if we start moving into 90, 120, 180, a year of really low demand, absolutely you’re going to see the smaller companies that have too much leverage go out of business and then that’s going to back up into the real estate that they’re using and then ultimately for the mortgages, back that real estate, are going to get backed up. So yes, this could extend and have a very lingering impact.

                                           I don’t have the exact answer to that. Again, I think it’s going to be asset-specific. I think actually here in the near term is where we could see a reasonable amount of opportunity on the things that really were very levered here and could snap back from… think about it this way. If there’s something… the worst part of the demand cycle is right now. Now it’s very intense and very deep. The question is if we can come back to an 80% of where we… well, 80% of 0. But if we’re at 0 right now and we go back to 80% then a lot of business models can do fine at 80%. They can cover their… they can at least service their debt. They may not be able to have much cash flow on the equity side, but at least they can service their debt.

                                           If we go back to 90% then things are kind of normal. If things go back to 50% then there’s going to be a lot of defaults. So a little bit hard to say. That’s why I think the credit markets can heal more from here. And what I mean by that is if you look at the high-yield market right now it’s still showing a lot of distress in it. But I think that comes down. But then the next question is, “Okay what does the long term demand look like?” Again, long answer but I think there’s some opportunities in high yield right now, as an example, and prefers. And we have been buying some of that. And I think that actually comes back pretty quickly. But then you have this second wave that kicks in of the more normal mortgages and debt levels and all the work outs that are going to need to be done over time.

Ryan:                                 And you bring this up and it’s the most valid point is the fed has done some unprecedented actions. And that’s partially in part because we have a strong treasury secretary who was on the front lines during the last crisis. But you seem to be a quantitative investor that looks at the details here. How much runway has the fed bought the markets in terms of confidence? Let’s just say they spent 10 trillion, globally. We’ve bought ourselves, in your opinion, how many months to continue this posture?

Christopher:                    Interesting question. I would say… again, this is qualitative, not a quantitative answer. But I would say that we’re kind of in this 60-90 days. There seems to be an appetite and even almost a social willingness that’s a little hard to explain. I think there’s a certain amount of, “Hey we’re all in this together,” to an extent. I think tenants and landlords, if they have a little breathing room themselves I think people get it a little bit. This is horrible.

                                           But it’s sort of based on the belief that it’s not going to get much worse. If it gets a lot worse then it just is a normal bankruptcy and credit rebuilding cycle where it’s sort of like, “Sorry, but if you can’t pay your rent then I’m kicking you out.” Or whatever. So I think there’s a… as we think about this month and then into May, there’s a little bit of a pause that is happening, both because of the fed’s action and a little bit of social goodwill. But if we get into the summer where shops are closed and the demand’s not there and the unemployment rate stays where it is, you’re going to see a lot of defaults, and we could end up in a situation again like the financial crisis.

                                           I still don’t think it’s going to be that bad, though, just because the amount of overall leverage relative to… and the strength of the banks, is still relatively strong. So when I say it’s not that bad, the default rates could be as high, but I think the banks may hold on… perhaps they may offer more credit. And again, the other thing that’s at play here is the interest rates are so low. So it’s quite possible that more debt will be given to companies that are already indebted because, in effect, they’re refinancing lower.

                                           So I hate to say it, but there could be a little bit of this also… while I do think some companies are going to get washed out, there could be a little bit of a zombie business happening too where some companies are allowed to raise capital again that maybe shouldn’t have. So again, it’s really complicated, but I think we’re going to have a mix of both. I think we’re definitely going to have a lot of buying opportunities, but it’s going to be selective and we’re going to have to be a little bit careful.

Ryan:                                 You mentioned zombie companies and you look at what happened in Japan over the last 20 years. Do you think we’re at risk of going into a negative rate environment? You’ve worked in Asia. Are we at risk of reverting to something like that?

Christopher:                    I think the next crisis is a collapse of a major currency. And my bet would be on either the yen or the sovereign debt in Italy, to pick on two countries. And the reason for that is… but when that happens, that could happen soon or that could happen 40 years from now. And I think there’s some really interesting data and analysis that makes the point on both sides. The debt to GDP levels in both those countries is astounding, and yet it’s really a psychological will, more or less, in the belief in the currency in those countries that’s keeping things afloat. And there’s some other technical aspects.

                                           But again, if you ask me where the next big crisis comes from, at least financially-driven if it’s not a health issue, is just that we’ve really really accelerated the debt burden in a lot of countries here. And so yes, I do think because of that distortion in the market, you run the risk of having too much sovereign debt out there and these Japan-like situations. Now I do think the U.S. is just culturally a little different than Japan, and there are some reasons why the Japanese market is the way it is. But there’s a chance, yeah, there is a chance that over the next decade or so that we see these same things in the U.S. that have happened in Japan and in Europe.

                                           I think the major reason why you might not is just we do have reasonable population growth in the U.S. and immigration, still. And so whereas one of the major problems in Japan and large parts of Europe is there’s really just not much population growth. And so that’s hard. It’s another reason big contributing factor, demographically, why some of the debt levels I believe trade the way they do, just because there really isn’t anything… there’s no growth at a population level, so it’s almost hard to have productivity growth that outweighs not having population growth.

                                           Anyway, but that’s my thought. It can happen, but I think it’s more likely than not we don’t see those, at least in the near term, those negative rates in the U.S. But we certainly are risking our future growth by distorting the market so much with all the liquidity and debt levels that the fed’s pumping out right now.

Ryan:                                 Well and it’s an interesting question, because I think a lot of our viewers were mainly U.S.-focused. And you’ve tactically deployed capitals and investment professional in Asia where rates have been almost negative to non-existent. If we do go into that environment, how would that change for the average retail investor or the financial advisor? How does that environment distort ASA prices, in your mind?

                                           Yep, I can hear you.

                                           No, no problem. You’ve deployed capital in Asia. How do negative interest rates distort capital prices? Is it you have to take a much longer term to have lower expectations towards realizing a return? How does the deflationary environment really change ASA prices?

Christopher:                    Yeah, well basically it inflates them, is what you’d expect. It’s interesting, in Japan, if you look at the real estate market in Japan as an example. A lot of investors get excited over a 2% return. The option is 2% is better than negative 50 basis points. So it’s all relative. But when you think about a developer building a building that needs financing and their hurdle is a 2% cap rate, you get very strange behavior. And I think you can get overbuilding and things like that. I think what it just does from an allocation standpoint, and particularly in an economy like that, you get infrastructure built or buildings built that really maybe aren’t as financially viable as if the cost of debt was higher, the cost of equity was higher.

                                           That’s what I worry about, a little bit. And you’ve seen it, to some extent, in the U.S. So for example, a more near term example, we’re pretty negative on all the luxury apartments that have been built over the last five years. It’s too much volume. But it was because there’s just a very crowded market. There’s one area in the U.S. where I think there’s been extreme overbuilding. There’s one other one, but particularly in the U.S. there’s just too much multi-family construction going on, and our belief is that relative to the people that can afford that level of quality.

                                           But there was a willingness and investor appetite for that product type, as a category, because it was just believed, “Oh it’s safe.” Well it’s safe to a point. Just imagine now, all of those rents in urban quarters where people are supposed to pay $3000-4000 a month, there’s just not a big enough market. There’s just not that many people that can afford those types of rents. And so all the business models that were based on building that type of product and then financing it, that’s a great example of where I think there’s going to be an interesting pocket of real pain. Because some of the business models that financed all that stuff aren’t going to look really good here. Because are going to trade down, they’re going to find cheaper places to stay.

                                           So I think multi-family lending is an area that potentially had some over leverage going into this and could see some extended pain. And that’s because there was a credit distortion there, there’s too much money going into that sector, and people chasing cap rates.

Ryan:                                 How do you see the construction loan market playing out in the next 12-24 months?

Christopher:                    Well I think for multi-family, I think the rent growth that was happening has slowed. That was happening pre-corona, there was clearly a rent growth problem that was starting to show itself. So I think a lot of those projects that were on the drawing board aren’t going to get funded. They’re probably going to get absorbed, just like it did last time. I don’t think there’s going to be huge amounts of default, but I think there’ll be some.

                                           In terms of new construction for single family, I think actually that’s going to be fine. We participate, actually, in that market some. We have another part of our business that actually does some construction single family. And the reason for that is I think the demand, the underlying family creation and the demand for home and housing is still strong. Again, continually people having jobs, which is my base case. And then affordability levels are generally there and interest rates are low.

                                           And so I think residential construction does okay, I think multi-family will slow down. And then office really never came back in a huge way, so it’s probably going to be about the same. So I think good projects will get funded. I think leverage [inaudible 00:34:57] will come in. Maybe they were starting to get a little bit credit-light in terms of the terms. But again, rates are down. So projects that maybe weren’t finance-able at a 6% or 7% interest rate might be finance-able at a 3% or 4% interest rate, if that’s where credit levels are. So there’s a little bit of give and take on both sides. I think banks are going to be tighter, projects are going to have to be higher quality. But at least for a little bit of period of time you might be able to borrow at cheaper rates for good quality credit. So again, overall, things might muddle through there and not be too horrible.

Ryan:                                 What are you hearing from the market? I know CMBS has slowed way down. What’s the origination market like today? Is it non-existent? And is it starting to come back?

Christopher:                    No, it’s frozen right now. Zero. And that probably will be a bit. So if you were a mortgage read or anybody that originated paper that was in the market of collateralizing it and selling it, at least right now, to my knowledge, there’s been no new same-day-as-issuance sold. And everybody who has deals that were about to get packaged or sold off they’re stuck. Now how quickly might that unfreeze itself? It actually could loosen up relatively soon. If we look at some of the high yield deals that are being done as a proxy for the repair of that market, Carnival being able to raise debt or some of these other troubled travel companies being able to raise capital, I think that’s a decent barometer that you’ll see some of these collateralized deals, particularly ones that were originated before come loose.

                                           The the problem’s going to be pricing. So if there’s an institution that had originated a lot of commercial loans and the expectation was to do a collateralized deal and to sell it off at a certain price, then those prices are way way down, particularly for non-agency, non-Fannie or Freddie backed type products. So where you’ll see it first is just regular standard agency product, that basically just your standard conforming home loan rolled up into an RMBS product. That actually, I could… I don’t have the data at my fingertips. My guess is that that stuff is actually probably coming off okay and we’re not having any big issues. But again, because that’s federally-backed stuff.

                                           But it’s the loans to the guy who’s doing a remodel of a B apartment or a C apartment and he borrowed $8 million at 7-8% or 9% and then that loan’s getting packaged into some sort of CMBS product. It’s those loans that are… they may not be bad loans, but the appetite for buying that in a collateralized instrument right now is very low. Now again, that may change in 60 days, 90 days. But maybe 6 months too. But my guess is it’s more like a 60, 90, 120 days type of thing. It’s not months and months and months.

Ryan:                                 So real quick, just changing gears, more personal. So you guys are in Georgia. You guys are, I think, the first state opening back up. What are your thoughts about that and do you think it’s the right call?

Christopher:                    Yeah, can we make some jokes about tattoo parlors and mani-pedis and haircuts and everything? Look, I personally think it’s too early. But I’m also a realist in the sense that there has to be the first penguin that falls off the iceberg into the ocean with the walruses below. And once that guy survives everybody else jumps in the water. So we’re a little bit of the test case.

                                           As I look around the world though, honestly to answer it in a broader way, if I look at Sweden… I’ve got two Chinese nationals that work in our office and look to them for little anecdotal data points, I think there are actually some reasonable data points around the world where you can say, “Hey things will get back to some level of normal. And we need to move forward.” I think that combined with data that suggests the amount of infection is a lot higher and therefore the fatality rates, as a general disease across the populous, is way lower. Still, really bad for, if you’re elderly, there’s a 15% mortality rate, it’s terrible. But if you’re 20 to… call it mid 60s, it’s maybe not that worse than the flu, maybe one or two times worse than the flu or maybe as bad as the flu.

                                           And so, if that’s true, and the data seems to be weighing in on that, then this is something that will be prevalent in the economy and will be treated more like the risk level that it is. That it’s, “Hey we need to socially distance, we need to wash our hands. But we can get back to work. We can start flying around the country again, we can start going to hotels. We can start playing golf, etc.”

                                           As I look around Georgia, just as a data point, even today, I just came in from going for a run, there’s more people out on the street today than there were two weeks ago. And I think that’s just going to keep going and going. And so, again, tying that back into the demand discussion, my base expectation is that confidence does come back and it comes back to a reasonable level. But still, a lot of damage has been done in the economy and there’s a lot of business models that are going to be impacted by that. And so we’re going to have to sort through those winners and losers here, and it’s going to be a process. But by and large things will get back to some solid footing here, and that the worst is behind us, in my opinion, in terms of the panic stage and the freezing of credit. And now we’re in a, “Okay what’s the impact?” And “What’s the long term damage?” If you will. The patient’s been taken off life support, but he’s still not recovered. And that’s sort of where we’re at.

Ryan:                                 Not to drag you back into the pit of despair, but do you worry about mutations in a second wave?

Christopher:                    That… so everything I say about what I think is based on the data I see today. Again, I’m not astute enough to understand all the things that could go wrong that I don’t see today or don’t understand. So we are very data-driven in our company, and we’re always trying to be smart and look at the things that might suggest that we could be wrong or something could go wrong. And we try to buy at a margin of safety that if there’s something that happens that we can absorb it. So our investments are typically un-levered, we do them with cash, we want to have a level of protection to ride out something that comes out of left field.

                                           And so, yeah, I worry about everything. I worry that I’m wrong. I’m hypersensitive on things that we don’t know. At the same time, I do try to put as much information together to act. If you worry about everything and you couldn’t come to some conclusion or you didn’t constantly test your models you just stay in cash. And so yeah, I think the things that could go wrong, yeah, mutations are one. Some of this data about the infection rates are different, that there’s some other spike here that happens. But I’m not seeing it in the data today. But we’re keeping our ears close to the ground and trying to use our collective knowledge in the team or my personal experience in looking around the world for analogs and trying to understand what does that mean for us here and our investment process and how should we think about risk? So yeah, definitely trying to have a margin of safety in everything we do and everything that we invest in.

Ryan:                                 That’s great advice. Last question: What are you reading right now given that you have a little more time? What’s interesting to you from either books or journalists and articles?

Christopher:                    I’ve become a student of all these studies, honestly. I do speak a little German, because I lived in Germany for a while. So I’ve been actually reading the German newspapers and trying to see what they’re doing and what they’re pulse is. And I’ve actually also been trying to read the South China Morning Post, which is online, it’s an English language paper in Hong Kong. And also the Australian newspapers. Really just to be a student of what’s going on globally. Because I think one interesting thing here is that I don’t see… whether it’s Fox, CNN, whatever, I don’t see enough people studying what other countries have been doing and what they’ve been doing well or wrong. Because again, there’s not a whole lot of reason, necessarily, why what we’re experiencing here in the U.S. we can’t learn from what happened in Italy or Spain or Germany or Korea or China. Leaving all the politics aside and all of the accusatory things. If you just look at the death rates, infection rates, the recovery rates, the demand levels, you can learn a lot, I think, about what to expect in the U.S. and then also what that might mean for an investment process.

                                           So that’s the kind of stuff I’ve been reading here, recently. I haven’t had time for really much stuff that’s for fun. But I kind of like this puzzle. Because frankly, this is a bit of a puzzle right now. It’s sort of like what data can you glean and what conclusions can you draw? And so that’s kind of an intellectual process that I’ve used here. Most of my free time I’ve been trying to figure that question out.

Ryan:                                 Do you buy into the data quality from China?

Christopher:                    Not really. In the sense that… I’ve very much a centrist, politically. So just to get that on the table. But China, it’s a controlled command economy. I’m not going to call them Communists. I mean, yes, the Communist party runs the country over there. But it’s a controlled economy. So everything [inaudible 00:46:19] mandated and if you’re not in the political goodwill [inaudible 00:46:27] free market system there. So I think definitely there’s some data distortion that happened there. I think that they controlled the data [inaudible 00:46:34]. You see that just in their own data releasing. They had a bunch of data that came out and then a week ago they said, “Oh yeah, sorry. We forgot to tell you, double the people died.”

Ryan:                                 Whoops.

Christopher:                    Yeah, right. So it’s like is even that believable? Was it triple the people? We don’t know. And that was one of the problems three or four weeks ago when I was looking for analogs. I said, “Okay well where around the globe can we look at what happened here?” And you saw a pathway in China that looked like it was okay. They got it figured out, they locked everybody up and everything worked out. Well, no, it was a lot worse. But then you had Korea and you had Singapore and you had Hong Kong where you could maybe trust what was going on there a little bit. And then as that worked its way into Italy, into Spain, into Germany, you started getting even more data where you could say, “Okay look, this is reliable.” You can at least say what’s happening in Germany ought to be something that’s an analog for the U.S.

                                           I don’t think China was trying to sabotage the global economy or anything like that. I think that’s too… I’ve been to China. There are good people in China. But do they have a controlled economy? Absolutely. Does the government control everything? Absolutely. But there’s plenty of hard-working, smart folks there that are getting up every day and living normal lives too. So anyway, that’s my two cents on that.

Ryan:                                 Well I really enjoyed the conversation. Thank you for joining us. We’d love to have you back in a few weeks’, few months’ time and we’d like to keep in touch. Thank you so much.

Christopher:                    Yeah, no great questions and good luck with the podcast and product. I’d be happy to come back on and it’ll be really interesting to come back in four weeks and revisit what we said and see if we were on the right. So we’ll see.

Ryan:                                 Sounds good, will do. Thank you, have a great day.

                                           Thank you for watching Non-Beta Alpha. Once again, before we go, please remember to subscribe and leave us a review on Apple Podcast or YouTube channel. This is Non-Beta Alpha. And now, you know.

Speaker 3:                        All price references and market forecast correspond to the date of this recording. This podcast should not be copied, distributed, published or reproduced in whole or in part. The information contained in this podcast does not constitute research or recommendation from Non-Beta Alpha Inc., Wentworth Management Services LLC, or any of their affiliates to the listener. Neither Non-Beta Alpha Inc., Wentworth Management Services LLC, nor any of their affiliates make any representation or warranty as to the accuracy or completeness of the statements or any information contained in this podcast, and any liability therefore including in respect of direct, indirect, or consequential loss or damage is expressly disclaimed. The views expressed in this podcast are not necessarily those of Non-Beta Alpha Inc. or Wentworth Management Services LLC, and Non-Beta Alpha Inc. and Wentworth Management Services LLC are not providing any financial, economic, legal, accounting, or tax advice or recommendations in this podcast.

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