Intriguing Bond Finds

Lawrence Jones: Hi, I am Lawrence Jones. I am a fixed-income fund analyst here at Morningstar and today, I have the privilege of having Tad Rivelle, the CIO of Metropolitan West Asset Management visiting us today in Chicago.

Tad Rivelle: Thanks for having me.

Lawrence Jones: Thank you for being here Tad.

Tad Rivelle: Yeah.

Lawrence Jones: One thing we have been speaking a little bit today in earlier meetings and I think it would be interesting for our viewers to hear about is, some of the areas of opportunity that you have been finding in the fixed-income landscape right now. Obviously, we have seen a tremendous dislocation, part technical, part fundamental, over the past 12 to 18 months or so and it has created some compelling opportunities that you have identified. Can you talk a little bit about some of those?

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Tad Rivelle: Sure. There has been obviously a massive repricing of large segments of the fixed-income marketplace over the course of the last six to nine months particularly. And we would suggest that some of the more intriguing places to look are in the investment grade corporate sector, in particular those companies that have the strongest balance sheets and the most experienced and talented management teams.

Most recently, just as a for instance, we found the debt securities of GECC, of Berkshire Hathaway, of a variety of different utility businesses that have their business models well protected and limited from a standpoint of how much leverage can be applied to that.

We also think that there are very intriguing opportunities in other portions of the fixed-income marketplace, but with a similar theme: The theme being that in our view it is imperative to focus on those securities, those models so to speak, that have the highest degree of protection from the standpoint of being able to withstand changes in the fundamental valuation of underlying securities.

So, as a for instance, that would include some of the AAA rated commercial mortgage-backed securities out there. And we are not talking about the typical AAA commercial mortgage-backed security; the typical one would have perhaps 10 to 12 percent of subordination, of credit enhancement to attain its rating. What we are talking about are some of the super-senior structures, the ones that are 30 percent enhanced.

We also think that the AAA jumbo-prime mortgage marketplace is also of interest and there are some other areas as well that if you would like we can elaborate on.

Lawrence Jones: What do you think about...Obviously we have yield spreads in the part of the market such as high yield bond market gap out tremendously. Is it, do you think, still too early to venture into high yield? Do you think there is name by name opportunities that exist there? How bad of a minefield do you think high yield is going to be going forward with uncertainly over where the default rates will be and where they will strike?

Tad Rivelle: Yeah, the high-yield market has been a very interesting place as well. Traditionally, when spreads to Treasuries have exceeded 1000 basis points, 10 percentage points over Treasuries, that was generally viewed as a strong purchase signal on the part of the investor community.

In this particular cycle, we went well through that very rapidly. Sometime last fall, we were looking at spreads that were not 1000 over, but closer to 2000 or even 2300; 20 to 23 percent additional yield over a comparable Treasury issue.

Our sense is that there has been a significant elevation obviously in the loss experience in the high-yield marketplace. In fact, I think the one year trailing rate has elevated to something like seven percent. And with the current cycle of deleveraging and travails of the economy, there will be a significant increase in corporate restructurings and bankruptcies and so forth.

Having said that, we do think that it is somewhat name by name. We would suggest that the CCC rated portion, this is perhaps an overly broad statement, but that the CCC portion of the high-yield universe maybe at significant risk over the course of 2009 and maybe into next year for restructurings and it maybe a dangerous place for investors to go.

We should remember that it was only a couple of years ago that so many businesses leveraged themselves up to the hilt. Nine or 12 times debt-to-EBITDA ratios versus their peak earnings and obviously earnings are well below their peak. But, in the B, the BBB, and the bank loans, some very good go forward opportunities.

Lawrence Jones: OK. Tad, thank you very much for joining us today. It was very very useful and helpful to hear from you.

Tad Rivelle: Well, thank you. We appreciate it. Thank you.

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