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Landmann: Lower Risk in Subprime Today

Miriam Sjoblom, CFA

Miriam Sjoblom: MetWest and TCW are both known for their expertise with non-agency mortgages. That's another area we've heard some data about housing. Where are you seeing value in fundamentals and the prices on some of these bonds?

Laird Landmann: It's quite converse to conventional wisdom. What we're seeing out there right now is that, really the bottom of the housing market has been pretty fully decimated. When you look at prices in Florida, when you look at housing prices in Phoenix, when you look at housing prices in Sacramento, you're really seeing housing prices that are down 60%, 70% in some cases. We look at it versus the 2000 benchmark level "before the bubble" really began, and we're seeing housing prices in some of those markets down 40%, 45% from that point in time. And that's how it represents a pretty attractive value.

So, people think of subprime as being the worst quality that's out there; right now we kind of look at that as the best quality that's out there. The houses have fallen the most. It's factored into the prices of those securities. There's actually appreciation going on in many of those marketplaces. So we think some of the lowest risks exist in some of those subprime bonds as compared to, say, some of the prime bonds that are out there, where maybe those housing prices are only down 15%, 20% in some of those markets and they could really be at risk for a further fall, particularly if we continue to see slow growth in the U.S. economy.

Sjoblom: How does this compare to your view on commercial real estate?

Landmann: We recently turned slightly negative on our view on commercial real estate. We'd had an overweight in that sector of our portfolio for the last year and a half, and it had done very, very well. Commercial real estate bonds at the highest level of credit quality had bounced back from having prices in the high 60s to having prices close to 100 cents on the dollar. So quite a huge move has occurred in that market.

But when we look at really the quality of those securities, when we look at the types of defaults that are in the pipeline using our own models, what we're seeing now is higher losses than were expected. And we think the market may take that quite negatively, and we may see some price erosion in that marketplace. So, we've moved to being a little bit below neutral in that market at this point.

Sjoblom: Then you mentioned high yield. Maybe you could talk more specifically about where you are spotting value or what you don't like in both investment-grade corporates and high yield?

Landmann: In investment-grade corporates, we still think the systemically critical financial institutions are one of the best places to be invested right now. Particularly at the top of the capital structure, we think there is very low risk rate there at this point in time. Conversely, some of the cyclical industrials are, we believe, one of the best places to avoid in the market. We think this slow growth, higher savings rate economy will not necessarily be to their benefit and those companies may incrementally be increasing leverage over time. They also may be candidates for LBOs and takeovers, which obviously increases leverage, usually drops them into the high-yield space and makes them much riskier credit. So we've been avoiding those areas of the marketplace.

On the high-yield side, the triple-C area of the market, that is the lowest credit quality area of the market, has had the largest run. Many of those bonds were, the triple-C market, I should mention, is the area where the vast majority of defaults actually take place. Those prices are up more than the double-B and the single-B area of the market. We certainly think the higher quality areas are the places to be right now, are right in the breadbasket of the high-yield market. We've really been emphasizing bonds with a lot of asset quality associated with them: utilities, energy company, secured airline financings, those tend to be the best values out there for the risk level in that market right now.