Don Mullen, founder and chief executive officer of Pretium Partners, says that corporate debt could underperform mortgages this year, with fewer defaults likely for real estate loans and higher recoveries for mortgage-backed instruments.
Mullen, whose firm manages $20 billion of investments in corporate debt, real estate and mortgage finance, spoke with Adam Tempkin in a series of interviews ending March 15. Comments have been edited and condensed.
What’s your outlook for corporate credit now?
While the overall corporate credit market has fared far better than many expected throughout Covid thanks to rapid and comprehensive government support, there will continue to be a divergence between winners and losers, even within sectors. That will continue to create opportunities. But it will likely be the relatively smaller capital structures, for example between about $500 million and $3 billion, that offer the most fertile area for nimble managers who are at the right size to pursue them.
As investors remain concerned about inflation and rising rates we expect robust demand for floating-rate products such as CLOs and funds that invest in loan-related instruments to continue.
How are you thinking about mortgages compared with corporate credit?
Mortgage credit is far more attractive than corporate credit. With corporates, we expect about a 4% default rate, and you’ll see lower recoveries. In mortgage credit, we expect high recoveries with a lower incident of defaults as well. Mortgage debt also gives portfolios the ability to have lower correlation.
What is your outlook for mortgage-related debt investments this year?
We think it’s one of the more extraordinary moments for residential mortgage credit, maybe more extraordinary than the Great Financial Crisis. With the GFC, you had a major shock to the system, a dramatic decline in GDP, which usually causes less home price appreciation, and an increase in foreclosure and default.
When we got the pandemic, the beginning was as expected -- the volume of house sales first declined and home prices froze, many Americans applied for forbearance. But as we worked through Covid, the combination of fiscal and monetary stimulus created a completely different outcome. Last year we had more home sales than we did in the previous year, and almost a record increase in home prices.
Many borrowers are still in forbearance. How does that affect your view of the market?
There is a large volume of sub-performing mortgage loans. Forbearance loans will move out of financial institutions and move to investment managers in a large way this year. Financial institutions are not particularly well designed to service these loans.
They will have to deal with the fact that there may be 6 or 9 months of non-payment of mortgages. How are they going to resolve that issue? Many Americans have reduced income. You need the hands of specialists to ameliorate these challenges.
There will be a big opportunity to figure out how to move assets off the books of Fannie Mae and Freddie Mac and put them in a place where investors can help borrowers realize the equity in their house, and in doing so, earn a fair return.
And we’ll probably see people who can’t stay in their homes decide to sell instead, because the prices are so much higher, versus in the GFC. The rational behavior back then was to stay in the house until evicted, because you probably didn’t have any equity. We live in a really different time now.
Do you think urban centers like New York will make a strong comeback from the pandemic?
It’s not the vaccine that makes people want to come back to cities. It’s the vitality of the city. For example, senior citizens move to NYC, go out to museums. Young people seek other forms of nightlife. We need for cities to be restored to a state of excitement.
There is so much pent-up demand that as soon as a lot of people have the vaccine, the restaurants will be so busy that they won’t know what hit them.
But it will be a slow rebuilding process. The question is, how much capacity gets restored to the system? What will the cost of living be? This will be a challenging era for NYC. Perhaps the city becomes a little more edgy or fun. But it will be painful for a cohort of people.
