Eric Jacobson: Hi, I’m Eric Jacobson, Director of Fixed Income Research at Morningstar.
I’m here with Bryan Whalen. Bryan is the co-head of the mortgage group
at Metropolitan and West Asset Management and now as a result of a
recent deal, co-head of the mortgage group for TCW’s high grade bond
operation as well. Bryan thanks very much for joining us.

Bryan Whale: Thanks for having me.

Eric Jacobson: So Bryan sort of trial by fire here now with the recent transaction and
given the style that TCW run money especially in the TCW total return
fund, lots of questions about Metropolitan West Mortgage capabilities. I
know your specialty is non agency mortgages. Maybe you could sort of
dial back and tell us a little bit about your history in the business and how
you came to go into non-agency side of the business in particular.

Bryan Whalen: Sure, well first half of my career in Wall Street I joined Metropolitan West
in 2004 and I realize there was an opportunity to expand the platform into
the credit side of the business. I was taken some of the experience I had on
Wall Street and bringing it over to the by side. That experience in the
platform that we built out really lend itself to an opportunity to take
advantage of the dislocation in the mortgage market that really started to
occur in the middle of 2008. We took our flagship fund MWTRX
Metropolitan West total rates return fund and really start to log into that
sector, stop post to Lehman Brothers downfall in September of 2008.

It has always started to Dow Industrial Average our way into the sector
throughout the end of 2008 and the beginning of 2009 and the run of turn
of the yearn in the first quarter of 09, our performance was suffering
versus the bench mark but we definitely recognize just the fundamental
long term value of this cash flows and that it was purely due to a market
dislocation. We pit as a percentage of the fund in non agency credit around
35% back in the spring of this year in 2009 and the performance obviously
over the last year and even looking back further has benefited
tremendously from that type of exposure.

We’ve taken the opportunity and the rally this fall to trim those holdings.
Still a significant portion of the overall fund at about 20% to 25% but like
any rally, I have to give dollar cost average away in as prices are dropping.
We also think we should dollar cost average our way out as prices are
rising.

Eric Jacobson: Let me take you back a little further than that. I want to say perhaps and
you can correct me. Sometime not too long after you join Met West and
started building out the platform. My recollection from that period of time
is that the team was very aware right even then that there were a lot of
differences in the way that underwriting standards are being applied,
differences in the way refies were occurring lots of things in terms of the
servicing and that was something you guys were focusing on the building
and that platform. Talk to me and our readers a little bit about, our viewers
if you will about when the signs started to appear and how that evolves in
terms of the strains in the market and what the signals were that you were
saying.

Bryan Whalen: Well, you know, the first signs were on the subprime market to us. We
were seeing these transactions get issued by Wall Street in greater and
greater volumes and the first big sign to me was the use of hybrid arms in
that market place, 228 to 327 which mean the rates is fixed for two to
three years and then start to adjust. Other sees the risk there that if rates
rise, the index raises that your mortgage payments going to rise as well.
Within three to six months, they start including interest only components
to those mortgages.

Eric Jacobson: And this—

Bryan Whalen: This is 03 or 04 and then they started losing the documentation
requirements so no longer did you have to approve your income, how you
could effectively just stay it. And that was really the first signs to us that it
looks like this is getting out of control and we definitely saw it
predominantly in a small group of originators but as the party went on,
more and more originators started to use that type of underwriting. And
really if you wanted to stay afloat unless you were a large national or
multi-national bank with other sources of revenue, if you were a US
domicile and mortgage only company, you know your choices were to
either go out of business or kind of match that kind of lax underwriting
just as you can do allowance.

So that was the big sign and it expanded. It got even worst in subprime. It
definitely expanded to the alternative A market and then even in the prime
market as defined by vital scores underwriting there definitely started to
deteriorate as well.

Eric Jacobson: And so what was it going on in terms of the way you guys were allocating
mortgages back in that point. Were your friends investing in non agency
mortgages at that time and if so how are you sort of having to play that?

Bryan Whalen: I mean the funds been investing and the firm that spot less have been
investing in non agency mortgages through its inception back in 1996. The
founding partners, Tad Rivelle, Laird Landmann, Steve Kane they were
investing mortgages all the way back to PIMCO over 20 years ago. So the
firms founders come with mortgage expertise, the firm is always had a
heavy focus in mortgages, obviously increasing, reducing that percentages
base upon market opportunities.

Even throughout the course of when we saw that lending, the underwriting
terms really start to get to loosen up, we still thought there was value at the
senior part of the capital structure and typically in the shorter duration
cash flows such that one day if things did get bad, you would be first in
line to get paid out. And of course those securities, they did drop in value
when we really hit the credit crisis in the fall of 08 but our conviction was
that this are solid fundamental sound cash flows where you will get paid
back at par and now looking back with over 12 months of up high insight,
now we are absolutely right. And so it’s just a short term dislocation in
pricing. Not an actual fundamental hit to the value of those box.

Eric Jacobson: That kind of brings us all the way back to sort of today now. We’ve have
this huge rally sort of a retracement or rebound and a lot of cases where
things were just beaten down horribly last year for all kinds of reason.
What can you tell us about you and the team in terms of the thinking about
where we are today in terms of the securities market for a lot of the non-
agency stuff. Is there a lot of value left out there, what can people expect?

Bryan Whalen: Sure. You know I think I’ve describe it as basically rounding second right
now. There's a baseball analogy in terms of where we are in this rally
approximately half way through or I think eventually will end up and the
prices will stabilize. I think a big part of the first half of this rally has a lot
more to do with basically the removal of panic from the system, no more
fear that we’re entering the next depression and secondly leverage coming
back into the system. There is leverage through the government programs
like PPIP. There's leverage just from the broker community. You can now
take a non-agency bond and get reverse reform on putting up a haircut,
paying a financing rate but you still can get leverage.

So that is when we price it. It’s lifted the whole sector up but we’re not at
the point yet really where the market is running a particular bond and
expecting fewer defaults on the borrower pull then it did just 6 months
ago. That hasn’t happened yet. I think the market is going to need to see
the economy stabilize, housing truly stabilized at it’s on own two feet not
from government programs.

Once that happens and people start getting more comfortable that the
faults are actually not going to be as bad as we thought right now and the
severities on every loan that defaults isn’t going to be as high as the
markets fearing right now. That will really be the second leg of this rally
when prices rise even further. It will be rising base upon fundamentals not
just upon leverage.

Eric Jacobson: Well that’s a good place to stop. Thank you very much for your time
Bryan, we appreciate it.

Bryan Whalen: You’re welcome.

Eric Jacobson: Thank you for joining us. I’m Eric Jacobson with Morningstar.