The Exchanges

Q Was the seminal insight when you were figuring that out, why don't you walk through that value of the asset, value of the structure, value of the option?

A It's kind of a circular argument because it starts with the value of the option and goes back to the value of the option. The value of the option is if I'm buying a bond and it's in trouble, so it could go into an event of default. If it goes into an event of default, what happens? And if it goes into an event of default and the senior most class can vote to liquidate Well, that option tells me if I'm buying a junior bond, that bond can go away. Now, if it's a deal where there's five tranches, and every single tranche needs to vote, and needs to vote 66 and two-thirds, no one's going to ever vote to get zero. And if I buy that bond, which is worth zero, and now I have a blocking vote, So understanding that option and what can happen, because most of the times I'm buying things that look messy. The next thing is, is when you move over to the assets, and you're looking at the assets, it doesn't matter what it's worth today. It matters what it's going to be worth in the future. And one of the interesting things about if you have a deal and the value of the option is very, very strong, you can have assets that trade down to zero, trade back up. As long as that option can't be exercised, then you're okay. So it's not looking at The amount of loss that's going to occur right now, or what is this pool telling you? It's what will these assets eventually pay off? And you then look at th…

AI assessment note: “starts with the value of the option... move over to the assets... look at the structure”

Q Throughout that thread, there were a couple of things you mentioned I just wanted to ask you about. One is this question of mentors and models. Your father was out at sea and you had a couple of coaches that recruited you. You had the father at DePauw. What did you learn from those key teaching mentors and as you said, male role models?

A It was kind of interesting because I grew up in a household where I had two sisters, my mom, my dad was away for six months a year because that was the job he decided. Both my parents were only children, so I didn't even have uncles or cousins or anything like that. When I got to Avon, there was a gentleman there who eventually became the headmaster. His name was Ken Marock. Ken just understood people well, and really had the ability to get the most out of people. He wouldn't quit on people. Coach Simmons at Syracuse is one of the most unique individuals probably ever. I mean, he's a fine artist. That is what he does besides coaching. So he's not your typical coach. He takes what he has and doesn't try and force his system on them, but allows the players to really play in the way they want. And something which no other coach I think ever does is he encouraged you to take risks. And our practices weren't like other practices when they were very regimented. We would just play. And he would want you to take risks. And he would tell you, okay, if you took that risk and it didn't work out, do you understand why it didn't work out? And if you think you can do it the next time, you should do it.

AI assessment note: “he encouraged you to take risks... And he would tell you, okay”

Q When you started buying these trucks, you really found an inefficient area and owned it. Obviously it played out really well. At some point in time, when did you decide to sort of move on into other areas of credit within Hildean?

A So Trumps are still going on. It's eventually going to end one day. It's still inefficient. We're still finding interesting things. We're doing different things to create alpha. So that is it. But in 2011, we started to branch out into other things. We started to get more involved in the CLO market. We became heavily involved in the tarp auctions, which people talk about free government money, but really the tarp auctions. And I'm talking about JP Morgan. I'm talking about Little banks that got five million dollars of tarp. This was like free money. They made it where the rules of it were so overbearing that any compliance officer that read this would say, there's no way you're going into this. And every sentence I did with, and if you violate this, you become A bank, which is the last thing you ever want to be. So the rules were onerous. There were a few players. We didn't have one default. We didn't take a loss on any of them. Pretty much they're all gone. Most of them were cumulative perpetual preference that paid five percent, stepped up to nine percent, and you're buying them at 50 cents on the dollar. They worked out very well. We do some other ABS stuff, mortgage stuff, but I think the firm as a whole really changed a lot in 2016. In 2015, we had a great year. We sold a billion dollars of trucks. And a lot of that was because I looked at what we owned. I said, you know, …

AI assessment note: “But in 2011, we started to branch out into other things.”

Q Well, let's turn to the markets today, because certainly your area, people are thinking about distressed credit, and what you're doing is sort of that next level of complexity. So we're sitting here, it's the end of April. What are you seeing, and what do you think the next couple of years look like?

A I think the elephant in the room, which is the CLO market, I think that a lot of people got into this market. You know, if you look at it over the last few years, there's been two places and structured products that insurance companies could put their money to. That's CMBS, and that's the CLO market. And the CLO market, this is going to be different than the one that happened at Marathon. This is going to be different than, oh, wait, I call this, this one being my third tour duty, and I don't know if I got a fourth one, because this one's been a tough one. But, that being said, The last time in 2008 with all the mortgages, the rating agencies really got rid of the riot act because they didn't act. Rating agencies are active, and within these securitizations, you basically have different covenants where if you're a triple C basket, because you're buying double B and single B, mostly single B, when that gets breached, your triple C basket breaches, and you start to breach certain covenants and bonds pick, and then the underlying bonds get downgraded. So we will see Massive amounts of downgrading. What I think we will see is, is you will see certain names default, but you have to remember that all of these companies that are in the CLOs, most of them come from private equity sponsors, and the amount of private equity capital in these names today is much higher than it's ever been.…

AI assessment note: “So we will see Massive amounts of downgrading. What I think we will see is”

Q thread you mentioned is this desire to prove yourself. So you went from sports and then you wanted to get Syracuse or you want to play a national championship team and you did that. And then later on, when you're starting in your career, you decide, hey, I should go see if I can, as you said, prove yourself that you could be a student. Where does that come from?

A I'm not the type of person that you should go and tell you can't do something to. If I think I can do it, I'm going to do it. I haven't always won. I realized what it means to lose. I remember getting to business school, and everyone had been perfect at everything they'd ever done, and I was like, wow, I tried to be a floor trader. It didn't work out. I wanted to be a starting goalie at Syracuse. I was a backup. You know, that's a great achievement, but I think it's just this, maybe it was when I was young, and I had to work a little bit harder to be a student, and to kind of overcome some obstacles there, but I don't know. Maybe I'm hard-headed. I mean, I haven't won everything in this world, but when I go after things, I really get to a point where it's like, I'm not going to fail at this.

AI assessment note: “maybe it was when I was young, and I had to work a little bit harder”

Q your investment management tech, request a demo at ridgeline.ai. And now, back to the show. How did you think about who to trust? Because you're coming at this with a big information advantage, and you said in some instances you're sharing that information with people and almost giving them your edge in that particular trade. So how did you decide Who are the people that you wanted to deal with?

A I knew there were certain dealers that I wanted to deal with. I had known them from the past. I had known them and did trust them. On the regional broker side, it was, you just wanted to be their first call, and there wasn't that sharing of information as much, and a lot of times you got the information from them, because you could just always ask them, can you see, that original holder who has that, can you see what information he might have, because I don't really understand this, and you would get there from that. But it's really interesting that you say this about the whole information. So, We did something that I will guarantee you nobody else would ever do. And it happened when our largest investor at the time said to me and said, Brett, what are you going to do if everybody wants to get out of this product? You've convinced me that you're right. You've convinced other people that you're right, but you have this information. I said, look, if everybody wanted to get out, I would take all this information and I would put it on the internet. I'd let everybody see it and I'd let everybody understand it. So we closed our fund. Add about three or fifty million dollars. And we were sort of just going along and trying to get more people involved. So what we did was we created a product called Trump's Info. And it was free because we looked at the Wikipedia model because Wikipedia…

AI assessment note: “I had known them from the past. I had known them and did trust them.”

Q How did you think about what that opportunity was?

A It was a very primitive market. There were a few dealers who actually would look at these products in the secondary market. All of these securitizations were sold, and they never really traded. There was also this problem in the high yield market and the telecom sector, and about 40% of all CBOs or CLOs had telecom bonds, and that was just the largest issuer there. A lot of folks looked at them as to what they were worth today. So if you think about what a securitization is, you take, let's just say, 50 high-yield bonds, and they're paying you seven percent, and then you can go out and finance 90% of it because you have a 10% equity tranche, and you can finance that at five percent. So now you have this arbitrage, and that's, the equity gets the balance. But what was happening is, is as you have defaults, you start breaching certain covenants. And most people looked at these transactions as, what are they worth today? So they would do it on an NAV basis, and I remember looking at some offerings that they were getting, and I was, when I first came in, I would run just certain scenarios, and of course, I would be questioned, like, why are you running that scenario? Why not run a different one? And I didn't really have an answer, and I knew that there was no way that I was ever going to get anywhere unless I could get the two principles of the firm To understand exactly what was g…

AI assessment note: “everyone was looking at this product on an NAV basis... The problem was”

Q And what did that do to the efficiency of pricing when you started releasing the information?

A This is still an inefficient asset class, and it's still inefficient for a lot of reasons. One is, it doesn't trade a lot. It's a small asset class. I always say to people, this was the same size as the non-agency market, which I think trades to perfection. You know, it's trading at two and a half percent type returns. People who go through and understand banks would look at this and say, like, this should be trading a lot higher. What it is right now today, it's really high quality assets trading at really high yield Spreads. And I get it. If you talk to other folks in the market, especially today, and you ask them when you think there's going to be another banking crisis, no one's saying there's going to be. So it made it more efficient. Are we talking about efficient asset class? No, I'm not a big believer in the efficient market theory. When you buy a bond three times for a buck and a half and it ends up paying you a 140 points, that's not efficient markets.

AI assessment note: “So it made it more efficient. Are we talking about efficient asset class? No”

Q And so how did it play out when you started buying this stuff?

A We bought a lot of it. We bought a lot of them. I would be sourcing them. Probably top producer of Marathon for the years, 2003 to 2005. I did very well. I was a guy who never made much money in his life. I didn't make money. It was unfortunate. In 2006, I departed. I love to say we hugged it out at the end, but we didn't. I look back at Marathon right now and Bruce gave me an opportunity. If I hadn't had that opportunity, I don't know where I would be. He has a way of pushing and motivating, which sometimes can be a lot, but he did give me an opportunity. I'm thankful for him for that. I left in oh six and didn't really know what I wanted to do. The world had changed a lot, and this is when the advent of everybody writing derivatives on everything, which maybe I wasn't Smart enough to understand that, but I just didn't get it. I also looked at the value of the option in a CDO, and I said, if I short this, whatever it might be, mortgage bond, ABS bond, into this structure, And the structure never liquidates. I can't get out. And I kind of came to this conclusion that the only way this is ever going to work is if the entire world blows up. It almost did. But I took the summer off. I had made a couple bucks. I had a house down at the Jersey Shore, which was a big house, and I had a bunch of buddies. I rented rooms, too, and I had just started dating the woman, and that was my wif…

AI assessment note: “We bought a lot of it. We bought a lot of them. I would be sourcing them.”

Q What do you see as the biggest risks in the market going forward?

A There's always risks in the market. I think one of the biggest risks right now is that this is going to continue on for a longer period of time. We have too many people who, like I said, we're just taking money and Doing stuff on repo. You're going to have defaults. There's no doubt about it, but it's not going to be as bad as the rating agencies are saying in their downgrades. And that actually is a benefit because it's, it will force paper out. Insurance companies' capital charges are going to go through the roof when that triple B bond goes down to single B, and that's going to cause it. So you may have Need some changes. I mean, look, after the OA crisis, we went in and we fixed a lot of things. We made banks very, very conservative, which was a great, great thing for me. I don't know if there's a place that they can point to with the exception of some of the dumb things they've done in retail recently, which these ETFs, which seeing oil go negative because they create a product because they want to sell it to retail. And there's probably been Five other ETFs which have just evaporated. This is wrong when they're selling these products. I'm not talking about the ones that mimic the S&P or the Dow. I'm talking about the triple levered short triple Q NASDAQ or the oil one. There was a great article written in the FT and the title says everything. The Muppets versus the Sharks…

AI assessment note: “I think one of the biggest risks right now is that this is going to continue”

Q As you thought about the business and the advantages you've seized over the years, what have been the most important principles that you've used to kind of drive the business forward?

A Somebody asked me once, what does it take to be successful as a hedge fund manager? And I kind of look at this, what does it really take to be successful in business? And I think there are four things. I think you need to be smart. You need to work hard. You need to be innovative. You need to understand risk. And if you were to ask me, what are your strengths? I get risk. I am innovative. I work hard. And I'm smarter than the average bearer. Understanding risk and valuing that component of it is really, really important, but structured products is really a place where there's not a lot of creativity. There's not a lot of people who can get out of looking at things on a statistical basis and trying to quantify credit is something which has never worked and I don't think ever will, because you're basically saying, okay, these guys at the rating agencies, they did it right, or I'm missing the motivations of the underlying leverage. So Really, those components are important, but I think we have a couple principles at the firm. The first one is, is we manage scale well. And we deal with asset classes where there's a finite amount of, I don't go into the CMBS market. It's a very big market. There's a lot of smart people in there. It's just not a place I'm going to go to. But we do it in a different way where we may buy certain securities that are securitization that have CMBS. But ma…

AI assessment note: “I think we have a couple principles at the firm. The first one is, is we manage scale well.”

Q When you made mistakes in the process of doing this, where did the underwriting matter more than say structure?

A So I'll be really honest with you. There was a time for a while where we did not have a hundred percent of the actual banks. And I'm going to tell you that there's a lot of first national banks in this country. There's a lot of first Cherokees. There's a lot of bank ones. I mean, there's 8000 banks in the country and they're all over the place and you think you've got it right. And then all of a sudden you're like, we actually had the wrong bank. So We weren't perfect. I think there was enough wiggle room, and we were being compensated so well for the risk that it was okay. I can remember one investor early on, this investor who's been with me for a long time, done a lot of things, and he showed me a bond. I showed him a bond. I think we had paid 15 for it. He said, what do you think you're going to get for it? And I'm saying, well, I think you're probably going to get about 50. He said, why 50? I said, well, and he said, Brett, I don't think you're being honest with me. What do you really think you're going to get for now? And I said, I think you're going to get all your money back, get all your back to interest. He said, well, why didn't you tell me that? I said, because she would have thought I was crazy. I just paid 15 for it, and I could lose 15. I knew that was my downside. That was easy. So, yeah, there was a lot of wiggle. There was a lot of inefficiencies in this asset…

AI assessment note: “we actually had the wrong bank. So We weren't perfect.”