Stewart: Welcome, Alfred. Can you start off by giving us some background about yourself and MetLife Investment Management? You’ve been at this for a good long while, and I want folks to understand the depth of your background and also that of MetLife Investment Management.
Alfred: Thank you, Stewart. Happy to be here. I won't say when I started in the industry so I won’t age myself, but as you said, I have been doing this for a very long time. I've been in residential credit all my life. I started in the mortgage lending side of the business, so I really got involved in learning how loans were made. I made my way through many different areas within the mortgage company and spent most of my time in the sales and trading side of the business — selling to other mortgage companies, dealers, hedge funds, private equity, etc. As a result, I built a lot of relationships from being on the sell side for a number of years.
Once I joined MetLife, I brought many of those relationships over to the buy side. I've been with MetLife for 15 years — the first four years at the mortgage company within MetLife Bank, and the last eleven years within MetLife Investment Management where I am responsible for the acquisition and management of the residential hold loan book.
Just to give a little bit of background on MIM — the insurance asset management business — we've invested on behalf of the MetLife general account since 1875 and on behalf of third parties since 2009. Our clients are supported by the expertise of long-tenured insurance investment professionals, including portfolio managers, advisory and solution specialists, and relationship managers who've worked together through multiple market cycles, powered by the experience in integrating an ESG approach into our investment process, as appropriate.
We understand insurers’ capital constraints and other constraints, and we seek to implement practical and sustainable portfolio solutions designed to help meet their unique needs and objectives. As to the residential whole loan space, we've been in the market since 2011 and have been a very, very active participant in that market. We've purchased over $40 billion residential loans, over those eleven years, with more than 420 trades.
Stewart: Most of our audience is familiar with residential mortgage collateral as a core fixed-income holding for an insurance company. Nothing new there, but it would be helpful, I think, to have youexplain a little bit — just what is the residential whole loan market — and what made you get into this market originally, back in 2011?
Alfred: Sure. As you said, I think most people are familiar with residential collateral. The way to access the residential whole loan market that is most familiar to everyone — is through agency securities, the Fannie and Freddie eligible loans, or via some level of private residential mortgage-backed securities (RMBS) transactions. However, what we do, at MIM, within the residential whole loan space, is this: We're actually investing on the loan level. So, we're not buying anything that has any type of structure or rating. We're buying the individual loans, and each of our clients have a 100% ownership. We see that as a benefit.
Looking back, this is what got us into the residential loan market. We all lived through the 2008 −2009 Great Financial Crisis (GFC). The aftermath from that prompted us to get involved with the residential whole loan space. We saw the residential whole loan space as a risk-mitigation investment strategy to access residential credit. We learned two main things from the GFC — the lack of control and transparency regarding residential loans was commonplace. But we found we could gain control and transparency throughout the residential whole loan process.
As many know, when you're buying a public agency security or RMBS, you buy it and you're done. Everything's already made. The structure's already there. You just decide what part of the capital structure you want to invest in. For us, we gained control and transparency across the entire residential whole loan investment process, starting from determining who we wanted to buy from, what loans we wanted to buy, the ability to conduct confirmatory due diligence on the loans that we're buying, negotiating legal contracts that we felt were suitable for that specific loan collateral, determining who we wanted to service the loans for us, and then being able to manage the portfolio really down to the loan level, and being able to have lots of control in understanding what's going on with each of these loans — instead of being beholden to information that we were getting from trustees and such.
Stewart: You mentioned GFC. Unfortunately, I'm aging at a rate where it seems like it wasn't that long ago, but it actually was. This housing market feels very different to me compared to the housing market we had at that time. Can you talk a little bit about how you see things now versus then?
Alfred: Yes, you're exactly right. Just as you said, today's housing market is very different from the GFC — in a good way. For example, the supply picture is just very, very different. The amount of homes that are out there for sale is very different. It's multiples and multiples below what we saw in 2008. That keeps home prices stable. In addition, there aren't any factors that are forcing people to sell. I think one of the things that many of us heard about during 2008 was the number of adjustable-rate mortgages that were going to force borrowers to make a decision about whether or not they needed to refinance or sell their home.
We just don't see that now. We see lots and lots of loans that are fixed-rate collateral instead of adjustable rate, because rates have been so low for fixed-rate mortgages. So, borrowers are locked into low fixed rates. Lastly, we believe that the consumer is stronger entering into what we're hearing about an impending recession. Lots of savings were built up during the pandemic, and that's contributing to an overall stronger consumer, in our opinion.
Stewart: Having said that, what are your concerns about the housing market today?
Alfred: I think one concern is obviously that rates are higher. Refinances have slowed a lot. With elevated rates, affordability is going to be a concern. One way we can mitigate that concern goes back to control and transparency — we can control the guidelines under which we want to buy — directly with the originators. We can craft with them what we want to buy and what we won't buy. And the confirmatory due diligence I mentioned allows us to confirm that those guidelines are met. As a result, we believe we can really control the credit that we're buying throughout the process.
Stewart: When you look at residential whole loans, are you buying every loan type? You mentioned floating, you mentioned fixed. Are you able to be selective there as well? Are there types of loans that you're avoiding right now?
Alfred: The short answer is no. We're not buying all the loan types out there, and I think there are two main drivers of which loans we'll consider buying. One is relative value. There's going to be a spectrum of loan types that are available to us out there. You have the highest credit-quality loans that are the prime-jumbo loans, and then you have lower credit-quality loans that are going to involve lower balances, lower property values. There is a spectrum. When I say relative value, it's a mix of both credit risk and also prepayment risk. We have several models that we run these loans through to determine their risk. It would be very easy to say, "Well, prime jumbo is the lowest credit-risk loan, so let's go buy a whole lot of them."
However, if we think about direction — where rates are potentially going to go from here — the prepayment risk for those loans is going to be what's driving the risk for that loan. So, the loan may not default, but the loan may prepay very quickly. That might not be suitable from a relative value perspective. The other aspect of what we believe we can control is driven by the fact that we have very strong, long-standing relationships with the sellers we've been buying from over the last eleven years.
We have plenty of partners that we can seek to align with. If there are loans that we don’t want from a credit perspective — or if there are loans, simply from a regulatory perspective, that our clients can’t hold, it could help us to exclude those loans. An important reason why we've been able to build the business to source the loans that we want — are the relationships that we've built over the last eleven years.
Stewart: I am happy to report that we have some questions that have come in on the Q&A. Here is the first one. How has competition changed over the years for residential whole loans as more investors have entered the market? What are the keys to be successful in this market with the higher levels of competition?
Alfred: In short, the competition has increased a lot, specifically from other insurance companies. I think, going back to some of the things that I mentioned about why today's housing market is very different than during the GFC, the expectation of many people has been to think — what if we go into another credit downturn — housing is going to look just like 2008. But as I said earlier, it actually looks very, very different. Because of that, I think we've seen more competition. We've seen the residential whole loan market as more of a safe haven where you can invest across all of the investments that you have. As to the question about how to be successful in this market. It goes back to what I was saying earlier on the relationship side.
We've built a significant portfolio across all our clients. Our success is in large part because of those relationships. We're confident that we’re one of the first to be called when people have loans to sell, when there are opportunities out there for us to partner on these pools. They understand our credit box because they've worked with us for a very, very long time. It's those relationships that make a bigdifference. I’ve briefly walked through our entire residential whole loan investment process. It's a lengthy process, and there are a lot of areas where new entrants can get tripped up on the processes because it is a multiple-step process. The relationships that we have, and that we've fostered over these past eleven years, really give sellers the confidence to engage with us, rather than with some of the newer entrants, because they know we've done this, and we've done this a lot.
Stewart: Another question came in, and I don't know if this is more than you want to cover right now or not, but I'm just going to throw it out there. Any comments on the proposed changes to S&P's capital model and potential material changes for the treatment of residential mortgage loans for insurers?
Alfred: I can speak to more on the residential mortgage loan side. I think the S&P capital model changes are probably better for a separate, longer conversation. For now, we haven't heard of any changes for the treatment of residential mortgage loans from a capital perspective. On the question of capital for life insurance companies, it can be a very capital-efficient investment — residential whole loans. For P&C companies, I think there are other aspects, such as liquidity, duration, and credit quality, along with the control and transparency that I mentioned regarding the residential whole loan space — to be considered as to what we can choose to buy, and what we can target. It's very important to try to get to the right capital treatment for P&C companies.
Stewart: When you look at residential whole loans, why do you think residential whole loans are attractive for an insurer today? I don't know if I've got this right, but if I'm buying a residential mortgage-backed security, there's a considerable difference between the coupon that the homeowner is paying and what I'm receiving as the holder of that security. Am I able to capture that, more of that haircut, by buying residential whole loans?
Alfred: Correct. You are able to capture basically the full coupon that the borrower is paying, minus any servicing fee that we pay to our servicers. The servicing fee that we would pay to our servicers will vary, but they typically are somewhere around 10 to 20 basis points. So, you're still capturing a material portion of the coupon that the borrower is paying. As far as the “why today?” question, our biggest competitor in the residential whole loan space is the public RMBS market. A lot of the loans that we are able to buy are loans that are being securitized into the public markets as well.
What we've seen in 2020, 2022, and even so far this year, is that the public RMBS markets have had uncertainty around pricing and deal volume, etc. Those types of factors provide good opportunities for the residential whole loan market. At the end of the day, there's been a big increase in the number of non-bank originators in the country. What that really means is that they need to find liquidity. Liquidity can either be done through the public RMBS market or by going to the whole loan market. Today, because of that uncertainty, we're able to see wider spread levels that we've seen in the past.
For that reason, today seems like a very good opportunity to get into the residential whole loan space. Additionally, there are many reasons why we like the residential whole loan space, as a whole, for our clients. As I mentioned earlier, it can be capital efficient. Loans can be pledgeable to Federal Home Loan Banks (FHLBs). We're also able to pick up — to your point — a spread over public investments within residential credit. Then lastly, I've said this a couple of times, the control and transparency that got us into this to begin with, I think, is a great risk-mitigation tool to access residential credit.
Stewart: A couple of more questions have come in, and I don't know how specific you can get here from a compliance perspective, but one question is — what are the net yields available across the residentialmortgage loan space today? Do you want to comment on what market yields are, or is that something that we can't go to?
Alfred: It's probably best to have separate conversations about that. What I would say is that yields and spreads are wider than they have been, just because of uncertainty around public markets. It would probably be best to have a separate, one-off conversation when we can give more detail about that topic. It also really depends on the type of residential whole loans that you want to buy. There are differentiations across the spectrum, depending on the type of credit that you want to take on, the type of prepayment risk you want to take on. There are different yield and spread aspects to that. So, probably best suited for more of a one-off discussion.
Stewart: Next question, what is your percentage allocation in the MIM General Account? How would you manage the illiquidity of this sector in a total return mandate?
Alfred: As to the allocation percentage, I think it varies. We've seen peer studies where it's varied depending on the type of insurance company — and really, upon what other investments they have within residential credit. I mean, we can work with any potential clients to discuss what that percentage might be, depending on what they're doing today. We've had clients where they have had allocations to public markets within residential credit, and that's been reduced or even eliminated because of the residential whole loan space.
We trust we can really work with whatever it is that people are looking for. From an illiquidity perspective, we believe that in illiquid times, everything is illiquid, and we saw this in 2020. Public-rated bonds were illiquid in 2020. There was an active residential whole loan market at that time, much as in the public space, as well. I don't think that I saw a material difference between investing in residential whole loans versus the public space in a pretty illiquid time like 2020.
Stewart: You've touched a little bit about on this, but are there other differences about buying residential mortgage collateral in the public markets? I mean, are there accounting things that I need to be concerned about, or can you help me walk through that? Investment-type conversations tend to lend themselves to some accounting conversations.
Alfred: Sure. I think the one aspect that we see within the residential whole loan space is pretty consistent volume. If I look at some of the public markets, they can be inconsistent. If you want a consistent investment within residential credit, we've been able to see consistent volume and access to residential whole loans. From an accounting or reporting side, this will be different. I think what we can help with — as we do with our clients — is the fact that we get millions and millions of lines of data.
So, whatever reporting requirements our existing clients or potential clients need, we have access to it. We can provide different data to the extent that it's needed, from either an accounting or reporting perspective. We started from zero, eleven years ago, and so have our unaffiliated third clients. We have helped people build the infrastructure needed to do all the reporting and the accounting needed for these loans.
Stewart: That was my point. I wanted to make sure that people knew that you had the infrastructure to help them with this asset class, because I think sometimes, people want to know that you've got the necessary data. It’s clear that you've got that well in hand. When you look at the opportunity today, do you see a sufficient capacity as you go forward here? You've been able to build a $40 billion portfolio ofresidential whole loans since 2011, and you've said that this asset class is consistently available. Do you see anything that would change any of that or anything that would change the supply side of things?
Alfred: Just to clarify, Stewart, over $40 billion is what we've purchased over time. Collectively. The loans are prepaid over time and run off from the portfolio. From a supply perspective, I see the trend being tilted more toward private markets like ours. I think, specifically in 2020 and 2022 when public markets really went away, sellers of residential whole loans have started to focus more on what they refer to as permanent capital. And that gives us the advantage because we have a consistent appetite for residential whole loans. That's what the sellers like to hear. For us, I see a consistent supply coming our way going forward.
Stewart: We have another question that just came in. Have regional banks or other banks pulled back materially from this sector? If so, do you think that is a risk or an opportunity?
Alfred: The regional banks have been somewhat involved in the residential whole loan space — the same space that we’ve been in. Our clients' focus has been more on the longer-duration assets. We see that regional banks and banks, as a whole, tend to be more focused on the shorter-duration assets. So, we don't really run into each other all that much. I see it as more of an opportunity. Some of our clients have had smaller pockets of demand for shorter duration. However, because of some of the bank pullback on shorter-duration, residential whole loans, we see they have come at more attractive levels. But we'll continue to monitor this pullback. Currently, right now, I'm not seeing a lot of effect from it.
Stewart: We would love to have a couple of more questions. We've had a number of them, and we really appreciate your engagement and involvement and participation. I'm just trying to see if we're going to be on the backside of things here, Alfred, what is the one or two things that you want our audience to take away when they think about using residential whole loans as an asset class? Either they already own them or I don't have any allocation to this asset class. What should I be thinking about? If I have a modest allocation here, how should I be thinking about it?
Alfred: Sure. I think the main things are spread pickup. We're able to pick up spread on top of public investment opportunities within residential credit. At the end of the day, I think everybody's in search of yield. The pledging aspect of it has been a very strong aspect that our clients have really liked. A driver of that is because at the end of the day, what the federal home loan banks will take as acceptable collateral is limited. So, if you can open up a new asset class that is pledgable, the fact that you can substitute residential whole loans for things that are pledged today that you might want to use or sell or what have you for other purposes, has been a big driver.
Then it's just really that this is a risk mitigation strategy that we've seen. So, our ability throughout the whole process to help weed out different things that we don't want to buy from the beginning and find things in the diligence process. So, I think those are aspects which control transparency, we got to spread pick up here. Then on top of that, pledgeability. I would say those are the main takeaways for the audience.
Stewart: Alfred, we've had a last-minute flurry of questions. From a pledging perspective, does the Federal Home Loan Bank (FHLB) have a preference about the types of residential loans? Which types get the most favorable collateral treatment?
Alfred: From the FHLB's perspective, it basically requires the credit underwriting files on the loans. This goes back to the amount of transparency. When we go through the due diligence process, we get those credit files. So, because there's a credit file required, the newly originated loans are favored by FHLBs. Those loans make up much of the large percentage of what we're looking to buy. On the seasonal loan side, we do have access to that, but they don't come out regularly. On the new-origination side, obviously, there's just normal production on a monthly basis that we see.
Stewart: Are there certain sectors you like more than agency-eligible, prime-jumbo, non-qualified mortgages (QM)? As someone who's not steeped in the residential whole loan market, I'm not familiar with some of the terminology. So, can you unpack those? Also, what about second lien mortgages? Is that an area you're investing in?
Alfred: Sure. As I was mentioning earlier, we see loans across many different product types, and what we invest in is going to be driven from a relative value perspective — both credit and prepayment risk. Today, given where the opportunities are, non-QM has been the most attractive segment in our view. They have been securitized into the public RMBS markets. Because of the uncertainty, most of those loans are originated by non-bank originators, as I was mentioning earlier as well. Those loans have to find a home. When there's not a public RMBS market for them, then residential whole loans are the next place for them to go, given the lack of a balance sheet.
That's what we've liked the most from a relative value perspective, when I consider the prepayment risk and the credit risk associated with them. This product has been available since 2017. We didn't get involved in the non-QM space until 2020, because we believed it didn't make sense from a relative value perspective. However, once we saw softening in those prices in 2020, that's when it became attractive for us to get involved, and that's what we were doing across all the loan types. I think you asked about second liens as well. There's a lot of talk about second liens.
If you go to any residential credit or fixed-income or securitized products conference, that's all everybody talks about. That for us is a “wait and see.” I think there are some opportunities for us to do those types and buy those types of mortgages. But much like the non-QM, it's going to have to make sense from a relative value perspective, first, before we get involved. It's not going to be something that we feel we should get involved in just because everybody else is, because it may not be the suitable product for our clients.
Stewart: Alfred, what are one or two things that you want our audience to take away when they think about using residential whole loans as an asset class? Such as — I don't have any allocation to this asset class. What should I be thinking about? If I have a modest allocation here, how should I be thinking about it?
Alfred: Sure. I think the main things are spread pickup. We're able to pick up spread on top of public investment opportunities within residential credit. At the end of the day, I think everybody's in search of yield. The pledging aspect of it has been a very strong aspect that our clients have really liked. At the end of the day, what the Federal Home Loan Banks will take as acceptable collateral is limited. So, if you can open up a new asset class that is pledgeable, the fact that you can substitute residential whole loansfor things that are pledged today — that you might want to use or sell or what have you for other purposes — that's been a big driver.
Then it's the fact that this is a risk-mitigation strategy. Our ability, throughout the whole process, to help weed out different loans that we don't want to buy from the beginning — or find other issues in the due diligence process. Those are aspects of control and transparency. That, on top of the pledgeability, I think are the main takeaways for the audience.
Alfred: I think it's the three aspects that I mentioned when thinking about residential whole loans — the spread pickup, the pledgeability of these loans, and also the control and transparency that we're able to get. We see this as a risk-mitigation strategy. So, likewise, thanks everyone for attending and thanks again, Stewart, for hosting. This was great.
Stewart: That's tremendous. I really appreciate your taking the time to walk through this with me. I've learned a lot. I always say it on my podcast, but I learned a lot today, Alfred, and I really appreciate it. Is there anything you want to leave us with, before we go?
Stewart: My pleasure. You've been listening to Alfred Chang, MetLife Investment Management's Head of Residential Loan Trading. Alfred, thanks for being on. My name is Stewart Foley, I'm the managing partner of insuranceaum.com. Thanks for joining us.
