Derek Pilecki, CFA, Managing Member and Portfolio Manager, Gator Capital Management
Welcome everybody to another edition of the Asset Backed podcast. I'm your host, Andrei Sundate. I am excited to bring back a former client and, and also, an expert in financials, Derek Pilecki, the founder, CEO, and portfolio manager of Gator Capital Management based in Tampa, Florida, is my guest today on Asset Backed. Welcome, Derek, to the Asset Backed podcast.
Derek Pilecki:Thanks, Andres. Great to see you.
Andres Sandate:Yeah. It's great to see you. It was good to catch up offline. I'm glad to hear that, the kids are going gangbusters like mine. Today is the official start of summer for me here in Atlanta.
Andres Sandate:So, hopefully, nobody will jump up here, with a surprise and interrupt our show. But, I'm I'm glad to hear that that you and the family are doing well, and, I can't wait to hear, you know, more about what's going on at Gator. Before we, talk about financials and and I know we're gonna spend a lot of time today talking about banks and what's going on, in, you know, the boardrooms at banks with, respect to the interest rate environment. Tell us a little bit about your backstory.
Derek Pilecki:Yeah. So, I mean, I I've been running my firm for 16 years. It'll be 16 years next month. And, you know, prior to starting my firm, I worked at Fannie Mae, the the big mortgage giant, you know, the hated mortgage giant.
Andres Sandate:Yeah.
Derek Pilecki:You know, back in the nineties, it was one of the smart companies. I worked in their mortgage portfolio doing interest rate risk analysis. And so it was a great first job in finance. You know, they're long mortgage backed securities and CMOs and short agency debt, including a ton of structured notes. And so I got to learn about almost every type of fixed income instrument.
Derek Pilecki:And so that was great. And I went back to business school to make the transition to equity research and came out covering financial companies, worked for a couple small value oriented investment firms, and then was recruited to GSAM and work for their growth team. So I covered financials for Goldman's growth team for 5 years before launching my fund.
Andres Sandate:Yeah. And, you know, financials for many people, who are not in the financial world day in, day out, like like you and I, it's, like, you know, complicated. Why is it so complicated? So many acronyms. I wanna ask you some fundamental basic questions about what attracted you to financials with the complexity and with a lot of, you know, a lot of the things that attract people to the investment industry and asset management.
Andres Sandate:But then within that, financials could be even more complex. You just talked about agency, CMOs, etcetera, working at Fannie Mae and understanding all the fixed income products and strategies. What what what is it about, financials, that got you excited, you know, if you go all the way back to, you know, your days right out of Duke?
Derek Pilecki:Yeah. I mean, I I am just attracted to the the business models within financials. I think there's a variety of business models. You know, a capital markets firm versus an asset manager, an insurance company, banks, they all have different business models, different income statements, and I just find it's find it fascinating. You know, growing up, my dad would work for the Federal Reserve.
Derek Pilecki:He was a bank examiner for the Philly Fed, and they put him through law school. We moved to DC, and he worked as an attorney for the board of governors of the Federal Reserve. And so, you know, the dinner table conversation was always kinda around banking. So it was kind of a natural thing for me to, you know, not be scared away from banks. Right?
Derek Pilecki:You know, we talked about bank regulation and bank mergers. And and I remember when I was in college, we went through the SNL crisis. And by that time, he was in private practice and just the some of the stories of the of what was going on with banks and what made a good banker, you know, just really attracted me to the industry.
Andres Sandate:Yeah. So sort of like being being the coach's, son or daughter. Right? You just sort of grow up around the game and and you you you sort of are exposed to it. And and I I can completely think back to that first time we met in Nashville, Tennessee, at an industry event, and, you know, you stood up and talked about your strategy.
Andres Sandate:And at the time, I was coming out of working, in banking myself, at SunTrust and Regions for 4 or 5 years and was starting in the industry. And I thought that's somebody that I need to go meet and talk to. And then lo and behold, we worked together for a few years, and, I'm just excited to have you back, on the show or on the show to talk about this 15 plus year run you've had with your firm, Gator Capital Management. But but, you know, more selfishly with the asset backed podcast, I'd love to ask you, you know, about just the health of the overall financial sector. And I know banks is not the only thing that you do at your firm in terms of of research, but it certainly has has had, you know, bigger parts of the portfolio over time.
Andres Sandate:So let's start there. Let's let's talk about, let's talk about banks, because it is, you know, top of the news channel, makes the headlines. But there's 2 narratives. Yeah. There's 2 narratives.
Andres Sandate:There's there's the main street narrative of bad office loans and, you know, credit risk, and then there's maybe a second narrative that isn't often talked about. What is often missed when people think about banks?
Derek Pilecki:Yeah. I mean, I think banks are still recovering from the regional bank crisis of last year. Right? I mean, we we just had this huge shock to the system of, the the 3 big bank failures in last March. And what we're still dealing with is the interest rate risk that these banks still have.
Derek Pilecki:That, you know, there's they made a ton of fixed rate loans and bought a ton of low coupon securities during the 2021, 22 time frame, and those those loans and securities are sticking on the books for a long time. You know, we all know talk about people with low coupon mortgages. You know, they're not gonna leave their house. They're not gonna prepay that mortgage. Then you you have a 3% mortgage.
Derek Pilecki:You're not gonna leave your house. So the banks are stuck. A lot of banks are stuck holding that paper. And so I really think that, you know, when people talk about you know, bank stock investors are most focused on interest rate risk right now because we're all concerned about credit risk. Right?
Derek Pilecki:I mean, it's topical. It's obvious. We hear about the the office buildings that are vacant and that are going to foreclosure auction for 83% discount to the previous sale. That's all happening. Right?
Derek Pilecki:So a lot of those buildings are in commercial mortgage backed securities or owned by foreign or, you know, lent against by foreign banks. The the credit metrics for the regional banks aren't that bad right now. Like, they they've improved their disclosure. They show us what their office loans look like, what their multifamily loans look like. It's not a huge problem currently.
Derek Pilecki:It could become a problem later this year or next year. I think the the central issue right now is interest rate risk. There's a bunch of banks that have too many mortgage backed securities, too many fixed rate loans. And with the competitive deposit environment, they're really getting squeezed. And they're just sitting there waiting for these loans and securities mature, and it's gonna take a long time.
Derek Pilecki:And so I think that's the real issue when we we look at these net interest margins that have compressed, how long will it take to rebound? I think it's gonna be a while. So I think that's the thing that, you know, investors generalist investors aren't really as focused on or compared to the credit risk.
Andres Sandate:Yeah. So when when you when you talk about a a bank investor versus, maybe just a general equity investor,
Derek Pilecki:If you
Andres Sandate:look at the bank sector, you talked about how there is a really competitive environment for deposits, and that net interest margin is compressed. And so where are banks that you are looking at and saying there's a constructive, set of activities happening at these institutions versus maybe another subset. What are you seeing? What are the things that, I I don't wanna call them growth banks, but more attractive from the standpoint of, their balance sheet, their fundamentals.
Derek Pilecki:Yeah. I mean, I think there are some bankers who wisely did not load up their balance sheet with mortgage backed securities during the pandemic. So right during the pandemic, there was huge deposit flows. You know, quantitative easing just flooded the system with liquidity. The bank saw a huge deposit growth, like way above trend deposit growth.
Derek Pilecki:And it was a question of what did the bankers do with all that excess liquidity. A lot of them just invested in mortgage rec securities like Silicon Valley. But, you know, other solid banks did too. Like Glacier Bancorp in in Montana, great franchise. They saw a flood of liquidity, and they bought mortgage backed securities.
Derek Pilecki:They're not the only bank like that. There's a lot of banks who just took that exit excess liquidity and invested it out the yield curve. And but there are some bankers who didn't do that. And those bankers who didn't do it are in the catbird's seat. There's the spreads of widened on loans.
Derek Pilecki:They can can continue to grow at these wider spreads at these higher rates, and they can continue growing. And so it's a small subset of these banks that you wisely sub sidestep the the low interest rates, and now they're in a very good position to continue lending. What they need is a little bit more loan growth or loan demand. You know, loan growth demand is really down because obviously, real estate investors aren't buying new buildings now or new properties because the the numbers don't pencil with high interest rates. But there are there is some loan demand out there.
Derek Pilecki:And these these bankers who sub side stepped low interest rates are able to take advantage of it.
Andres Sandate:Yeah. I there's a lot of, themes that I wanna sort of talk about. 1 one, selfishly because of the show, the asset backed show, you know, we are, we are constantly, trying to sort of understand this narrative around the growing asset backed finance market. Right? It should be everything from student loans, aircraft loans, all the way to mortgages and auto.
Andres Sandate:And, and I wanna talk about, that. But before we do that, I wanna ask you back back to banks for a second. When when you look back at the career you've had of of looking at banks and and getting to know bank management teams and understanding, you know, the the characteristics and the qualities as a as a you know, I don't wanna say you're a value investor, but certainly trained at Chicago and trained at some of these organizations, that you that you, that you came up in. When you look at banks and you say, okay. Finding loan growth, competing for deposits, what are some of the different levers?
Andres Sandate:Because when you look at 5, 6000 banks, how many do we have in the US? It is such a different just playing field than, say, Europe, right, where there just aren't as many banks. And I always ask the question to bank investors, do we have too many banks? But but what are the levers that these management teams can pull in this type of an environment? And as a growth invest you know, as an investor that's looking for for growth and looking for those sort of proverbial diamonds in the rough, what are the what are the things in those management teams that really stand out?
Derek Pilecki:Yeah. I mean, I would say one thing that really stands out is, like, not being distracted. Right? So organic growth is the most valuable growth the bank can have. So and the way you get organic growth is from your existing teams making more loans, hiring, bankers, you know, you can steal bankers from the the bigger the bigger banks or, you know, some of these failed institutions had great client facing bankers.
Derek Pilecki:You hire them. And if you're not distracted, you can make those additions to the team. Where you get distracted is if you have problems in credit, or if you do an m and a transaction. So m and a, although it seems pretty attractive, like, put 2 banks together, cut out a bunch of costs, returns go up, it's a huge management distraction for a 2 year time frame. And then you can't really grow organically while you're in that integration period.
Derek Pilecki:And so you're internally focused, you're not externally focused. So, you know, I think that's why when you see deals, even though the accretion on deals is very seems very high, the the stocks don't react because I think investors just are like, that management team is gonna be distracted for the next 2 years. Like and we you know, it's gonna be hard to to value the bank. And so I think that distraction, you know, avoiding the the companies that are going through m and a that are potentially distracted is is one thing to to look for.
Andres Sandate:Yeah. Let's let's, I wanna ask you about, about CRE as well. I know that the popular narrative is, yes, post COVID, you have all these empty office buildings, and, you know, you you you a lot of these, you know, a lot of these mortgages, are are either upside down or you have leases that you've restructured. All the leases you can restructure, there's just less demand, etcetera. What do you see, at the banks that you are following when it comes to CRE?
Derek Pilecki:Yeah. I mean, we're seeing some some stress on the on the office portfolios. But what what we're seeing generally across the industry, office is about 4% of bank loan portfolios. So not a huge number, like but, you know, significant. And then generally, in a generic bank, of that 4%, about half is somehow related to medical.
Derek Pilecki:So, you know, doctor's offices are in better use than a typical office building. Right? And then Yep. And then you break it down further to then there's suburban office and then owner occupied office. And so there's categories you can kinda cleave off to say, okay.
Derek Pilecki:Those loans are probably fine. Like, if, you know, a company owns their office building and they have a loan against it, they're less likely to default rather than an investor owned property. And so we are seeing some issues especially in Chicago. Right? I mean, the there's Chicago downtown core is really problematic, and we're seeing across all the gateway cities with long commutes.
Derek Pilecki:You know, New York, San Francisco, LA, people just don't wanna get spend an hour and 15 minutes commuting to an office downtown. To counter that, we're seeing return to work. Right? I mean, so people companies are saying mandate people's showing up in the office.
Andres Sandate:Mhmm.
Derek Pilecki:What they when they do return to work, say, it's 3 days a week, it's Tuesday, Wednesday, Thursday. You have everybody there Tuesday, Wednesday, Thursday. You still need the same amount of office space. You it's not like you can do a hoteling arrangement. Some people show up on Monday Friday if you have everybody there the same day.
Derek Pilecki:Now certainly, some back office operations, you won't mandate to come back to the office. So, like, I think that the natural demand for office has to be lower going forward. New supply is also close to 0, so we have that offsetting a little bit. But, you know, certainly, there's gonna be problematic issues within the office portfolios. But I don't at this point, I don't think it's gonna be, you know it's it's certainly not a capital issue.
Derek Pilecki:It might be an earnings issue for 1 or 2 banks occasionally, but we're coming from such a low level of credit losses in 20, 21, 22 that we're kinda just normalizing here. So it's what we're not clear on is will we got come back to a normalized credit loss ratio and that'll it'll stop there, or will it keep going to, a more problem a higher problem level? I would say these things take a long time to play out, and they're not it's not going rapidly. So we're not seeing, like, a sudden surge in in credit losses in the bank portfolios as of right now, but that doesn't mean we can't see it as we get in back half of this year or next year.
Andres Sandate:Yeah. And and, you know, the the the conversation started with interest rate risk and that being, you know, probably more of a prominent, part of your underwriting and certainly the discussion amongst management teams and boards. I wanna ask you about as as as a as a bank investor, again, it's not the only thing that you do at Gator. You look at all different parts of the financials from insurance and capital markets and asset managers, etcetera, and even Fintechs. And I wanna talk about some of those other areas.
Andres Sandate:But on on on the subject of banks, a couple more questions. You you made the comment in our preshow about this is the first cycle with private credit really having a a seat at the table. And, you know, for the longest time, banks were the only game in town largely. Now you have private credit, asset backed, the podcast. We interview a lot of private credit investors, and you hear different things from different investors.
Andres Sandate:You know? Some work a lot with banks, and bank partnerships are really big part depending on the size of the the private credit firm and franchise. But when you think about banks and private credit in the same conversation, what are some of the initial thoughts that come to mind, as you think about where we are in the cycle?
Derek Pilecki:Yeah. I mean, I think that whole aspect of having private credit involved this time is is really interesting, especially from a, even a more macroeconomic view. Like, the the worst recessions, like, say, take 9091. That recession was terrible because we had a liquidity crisis amongst the banks, and there was no alternative. The banks just stopped lending.
Derek Pilecki:There was nowhere else to get loans. Kinda same thing in the great financial crisis. Right? I mean, it was liquidity crisis. Lack of lending makes a very deep recession as opposed to 0102 where the banks were in pretty good shape.
Derek Pilecki:They continued lending through that recession, and it was a pretty shallow recession. So, like, to the extent that banks are pulling back and not making new office loans or CRE loans, and but we have credit private credit stepping in, you know, at a higher price, but still you can still get credit. Will this make, any potential recession we face more shallow? Right? It's not like you can't get a loan at all.
Derek Pilecki:You can get a loan at the right price. Yeah. And so I see banks working with private credit. I mean, the the regulatory environment, the regulators want the banks to take less risk. Right?
Derek Pilecki:And the bankers would rather provide leverage to private credit than make a direct loan themselves. So to the extent that private credit can make the make the commercial, mortgage and then get some financing from a large regional bank. I mean, I think that makes the banking system safer. The private credits taking the first loss risk. They're, you know, they're experts taking credit risk, and they're not beholden to the same regulatory issues that the bankers are.
Derek Pilecki:I think that's a a pretty elegant way for the system the banking system to take on less risk while still funding these projects.
Andres Sandate:Yeah. So you you raised, the the the the notion of the regulatory environment, and the regulators want the banks to to to take less risk, which does, if you will, play into the hand, if you will, of of the growing private credit, asset class, and and industry. You've seen some gigantic funds raised, and you seem to be, you know, able to pick up almost any paper these days and read about the golden age of private credit, and there's a insatiable demand for yield. With that said, what you know, you you have a little bit of a regulatory background. Right?
Andres Sandate:You you mentioned, you know, your your your dad worked at the Federal Reserve, and I would love to get your perspective on the regulatory environment as it relates to banks. And what is this looking like for them over the next, you know, 3, 4, 5 years? Because I've heard from numerous private credit firms that have said, you can't walk into a bank and get a loan anymore. Now, you know, I I don't know how much of that's conjecture, how much of that's reality. You said, you know, regulators are saying they want banks to take less risk.
Andres Sandate:What is what does the reality look like on the ground?
Derek Pilecki:Yeah. I mean, I think it's hard to get loans these days. Like, I think it's, you know, I think there's a lot of bankers who are just taking care of their core customers that they're not looking to expand into new relationships. They're certainly not looking to add on credit without any deposit relationship, which a lot of real estate investors don't have deposits. Right?
Derek Pilecki:I mean, they're they just they're asset rich and cash core. So, you know, I don't think that bankers are looking to really ramp up their commercial real estate lending at all. And so I think that's you know, I think there's a when you think about the banking industry, like, 30 years ago, 30, 40 years ago, every bank looked like JPMorgan. Right? I mean, a commercial mortgage, commercial bank, you know, a little bit investment bank, trust bank, credit card, mortgage, and now regional banks have been shrunk down to they do small business lending and they do CRE.
Derek Pilecki:And so when you look at some of the metrics of CRE as a percentage of loans or percentage of capital, there's a lot of banks that are over their skis on having too much CRE. And I think the regulators wanna bring that down. And, you know, CRE is a risky a risky business. You know, we've had pretty clear sailing for a number of years here, and I think regulators I think that they get back to your original question of what's the regulatory environment. Like, I think the regulators are under a lot of stress.
Derek Pilecki:Like, I think those bank failures last year embarrassed the regulators.
Andres Sandate:Yeah.
Derek Pilecki:And I I think that environment's gonna persist. Like, the regulators are, they're, you know, they're defensive. Right? Like, bank failures are no good. And the way those bank failures went down where it was a pretty obvious risk of interest rate risk, you know, it's unacceptable.
Derek Pilecki:And so I think the bank regulators are under a lot of stress, and I think in turn, the bankers are under a lot of stress because the regulators are not, you know, they're trying to protect themselves by making sure the banks don't take any unnecessary risk. So
Andres Sandate:Yeah. We can't we can't have another SVB or another weekend where a Sunday night rescue has to happen. Right? Not at all. Because it just keeps spooking the markets.
Andres Sandate:Yeah. Yeah.
Derek Pilecki:For sure.
Andres Sandate:Just when you think you're on solid footing.
Derek Pilecki:I I would say that, like I mean, I know this is asset backed for podcast, but, like, the deposit insurance system is still vulnerable. Right? I mean, we still have there haven't been enough changes to the deposit insurance system since SED that, like, there could still be a massive run on the banks because we have everybody has a app on their phone, and you can zap all your money to your Schwab account if you're worried about your bank. And so you could have a run on the bank still. And so, like, I think we you know, regulators and legislators really need to take a look at deposit insurance.
Derek Pilecki:And, I mean, I'm in favor of unlimited deposit insurance, like or massively increasing the deposit insurance level. There's
Andres Sandate:plenty 250,000 just isn't, yeah, isn't sufficient for even consumers on some cases.
Derek Pilecki:I mean, exactly. Like, there's plenty of 75 year old or 80 year old people who have more than 200 $50,000 who can evaluate their bank. Like, look at SVP. It had $16,000,000,000 market cap to 48 hours before it failed. Any depositor would look at that and say, they're fine.
Derek Pilecki:You know? And so, like, I I just think it's unreasonable to have such a low deposit insurance limit.
Andres Sandate:Yeah. No. It's a great point and something that hopefully, you know, when the, when the regulators, can get back to focusing on, regulation, it's, it's something that I think is gonna be important, particularly, you know, given that we're in an election year. Let's let me ask you about, you know, when you think about the the overall investment landscape of financials, one thing that, I I recall about your approach and strategies, you look for the inefficiency. You look for the you look for the areas that are harder for the maybe the generalist analyst, who who dabbles in banks or dabbles in financials to to really uncover.
Andres Sandate:Is it fair to say that that complexity and that, inefficiency and just the the the large number of publicly traded banks creates a pretty attractive playing field in which to look for ideas. Is that is that fair?
Derek Pilecki:Yeah. I think that's exactly true. Like, in the small mid cap financial area, there's a lot of unique business models that, you know, you need some specialized study to understand. You know, take student lending for instance. There's 3 publicly traded student lenders.
Derek Pilecki:You you have to invest some time to understand student lending, and and and you the benefit is you only get to cover 3 companies. And so but I've done that, and, I just I don't see a lot of more people, you know, dusting off the the playbook to see, like, oh, let let me dive into student lending and see if there's an opportunity there. But, you know, especially with the given the the headlines of, you know, free college or Sure. Or giving student loans, like, why would you even bother? And but, you know, there's some pretty interesting companies in this.
Derek Pilecki:You know, those 3 companies are pretty interesting, and there's, you know, pretty, inexpensive valuations amongst those 3 companies. But that that's just an example of, like, within financials, there's a lot of nooks and crannies of small to mid cap financials. You know, one of my favorite ones is a couple years ago, you know, Genworth we purchased shares in Genworth. And, you know, Genworth's a life insurance company, they wrote a lot of long term care policies and long term care is just a terrible business because you're writing policies for 60 year olds for when they might go in a nursing home at 85. And so everybody underestimated the cost.
Derek Pilecki:And so Genworth has been really struggling with these policies. They also have a mortgage insurance subsidiary. And so they went through a long transition where they are trying to raise rates on their long term care policies and moving the, mortgage insurance subsidiary out from under the life insurance company into its own subsidiary under the holding company. They finally made progress, IPO'd 20% of the mortgage insurance subsidiary and it's publicly traded. It's called EnAct.
Derek Pilecki:And so when I bought the shares a couple years ago, if you valued Genworth's life insurance subsidiary and all their long term care policies at 0. Saying that, hey that's ring fenced. And then their the value of their publicly traded mortgage insurance subsidiary, you're buying Genworth at a discount, like 20% discount to the value of its mortgage insurance holdings. And that mortgage insurance companies continue to grow. They had some tax assets that reduced their cash taxes and, you know, that stock had worked.
Derek Pilecki:But it's the complexity of, like, okay. This long term care business is terrible, but there's this mortgage insurance subsidiary. Should this trade at a discount? And, you know, when they started they announced they're gonna start buying back stock, that's when I I took my position in Genworth. But that's an example of the complexity that's out there within financials that, you know, Genworth is not a a highly trafficked name amongst investors.
Andres Sandate:Yeah. When when you think about the, the the additional, nooks and crannies, to use your term, of of the financial sector, there's some there's some areas I'd love to ask you about. One of those is fintechs and and just how we saw you know, before 2021, 20 yeah. I would say 21, you saw a lot of Fintechs, getting a lot of VC, and they were gonna disrupt banks. And they were gonna, you know, claim to be a better version, and a and a more efficient version of a bank.
Andres Sandate:And you saw a lot of VC give a lot of capital to to these these tech, startups. And then sort of like they woke up and realized, wait. This is a different business, you know, than this is a lending business, not necessarily about just grow, grow, grow it at at, you know, at at any price. And I don't know that they're gonna keep funding these these businesses, and I think we've seen a lot of pressure on some of these fintechs, and some of them will probably go away or have gone away. What did that whole, maybe you're not investing.
Andres Sandate:You're clearly not investing, in in in IP pre IPOs and and VC. But what did what did that tell you about the tech community? I'm just curious when you saw sort of that happening, because I'm sure there are, lots of examples over your long career of, you know, we're gonna go disrupt banks, and we're gonna do this better and cheaper. But what what what comes to mind when you think about that episode?
Derek Pilecki:Yeah. I mean, I think there was a lot of innovation to come from that episode. Like, there there's a lot of, you know, outside the box thinking. And so, specifically, when I think about Venmo and Cash App. Right?
Derek Pilecki:I mean, those are pretty interesting businesses, and they were able to take a lot of share, and they were able to get a lot of consumers to participate in those those platforms and it forced the banks to come up with Zelle. And Zelle has been growing. It has very high payments, but, you know, Cash App and Venmo are gonna stick around for a while. I guess, so I think those are there's interesting businesses that come out of that and they're, you know, good customer innovation. You know, I think we have all benefited from having money, you know, peer to peer money transfer.
Andres Sandate:It's
Derek Pilecki:easier to to live life to Yeah. You know, share expenses with friends, whatever. I think, you know, I I guess the area where I was most skeptical, you you mentioned the the personal lending. I guess the area I was most skeptical about disruption was on insurance. So auto insurance.
Derek Pilecki:I mean, I I think that the big auto insurers like State Farm, GEICO, Progressive, Allstate are are very very good companies and, you know, they spend a ton of money on advertising. So to think that, like, they're lazy companies that you could disrupt, I I I thought that was a stretch. So, like, these these, personal auto insurers that were gonna come and take over the insurance comp insurance world, I thought was was a little bit of a stretch. And you those companies have had a harder time. You know, personal loan companies, I mean, I I think it's I think they've done a good job and have served to, fill the need there.
Derek Pilecki:But, you know, personal lending, it's a low multiple business. Like, look at Discover and Capital 1, they trade it, you know, best case, they trade it 8 times earnings. You know, 1.2 times book or 1.4 times book. Like, it's, you know, for a Fintech to get a higher valuation on personal lending, I mean, it's just not a high multiple business. Like and, you know, getting this is a little tangential, but, like, Goldman entered personal lending too, and they've exited it.
Derek Pilecki:But it was like, why is Goldman getting into purse consumer lending? They could just buy Discover at 8 times earnings and, you know, you have the you have the greatest investment banking franchise of all time, which is a high multiple business. Why dilute it with personal lending? So, you know, I agree with you. Like, these fintechs who are trying to use their balance sheet to to grow, it's it just lowers their valuation.
Derek Pilecki:What you really want is a a Fintech that had some asset light business model which, you know, Square and and PayPal have done. Yeah. You know, they're for asset based businesses that are payment oriented.
Andres Sandate:Yeah. Yeah. And they they scoop up transactions. I wanna ask you about some other areas that, that that I that I think, you know, are quite interesting. The first one is property and casualty.
Andres Sandate:You know, it just seems like every time you turn around, there's another major natural disaster, there's a major, you know, storm or fire, and it just seems like rates, not that there's as much home buying. We saw the numbers come out yesterday. I think the April numbers for for home buying, it were down again for the 3rd consecutive month, but but a big part of this, reset is insurance. In Florida in particular, you live in the state of Florida. I can only imagine how much premiums are going up in the state of Florida.
Andres Sandate:But overall, property casualty, maybe you have exposure to it today, maybe you don't, but just curious about your take on that sector.
Derek Pilecki:I mean, I I think, climate change is real and their insurers are pricing for it. Right? And so I think pricing has been going up. You know, I think on property, reinsurance prices didn't go up as much this year as they had in previous years. Certainly on casualty reinsurance prices are going up.
Derek Pilecki:And I think there's there's a lot of underpriced casualty business from the 2015 to 2020 time frame that, you know, people need to raise prices going forward. They generally the industry generally underpriced casualty business. So I'm and I think it's an interesting area. You know, we're not involved in a ton of insurance companies right now. We we own one homeowners insurance company that's focused on the state of New York that, you know, is kind of benefiting from the big companies exiting Long Island.
Derek Pilecki:And so that coastal exposure on Long Island is, you know, there's a lack of capacity there. And so that's the the really the only insurance company that we're we're involved with at the moment.
Andres Sandate:The 2 areas, that, you know, I know you've you've you've, been involved in these areas for a long time, and you are one of the first ones, one of the the first financial specialists that that got, real constructive on the publicly traded asset managers, particularly alternative asset managers. So I'd love to spend a little bit of time talking about, asset management in general. So you have a deep background, as as as do I in asset management. And then I wanna talk for a minute about capital markets. So let's start with asset management.
Andres Sandate:When you think about the the the universe of asset managers, you you have this notion of traditional versus, alternative. You also have passive versus active. I'll let you pick where you would like to start, passive versus active or traditional versus alternative or maybe both. Yeah. But when you think about asset management, these are gigantic forces that are disrupting this industry, changing this industry.
Andres Sandate:And we even saw yesterday, I think, KKR announced, a partnership with Capital Group, you know, the the, you know, the sponsor of the American Funds. Long a bastion of portfolios for financial advisors announcing that they're gonna partner up on a couple of of offerings, which is just fascinating. So what comes to mind when you when you think about asset management?
Derek Pilecki:Yeah. I mean, I think private equity managers are a great business model. For a long time, I've told investors, you don't invest in Blackstone or KKR's fund. Just buy their their GP. You know, just own KKR KKR stock.
Derek Pilecki:Now that being said, we're at a interesting point where there's a lot of big institutional firms that are are institutional investors who are over their skis on their allocations to private equity. Distributions aren't coming as quickly as they expect, especially in VC, and so they don't wanna make new allocations because there there's a little bit of liquidity crunch there. So, like, are we at a temporary place where fundraising is gonna be harder for the big private equity firms? Not really clear to me what which way to go there, but I I know generally, I think those firms are gonna continue to grow and, you know, have very good business models. The one that I'm really involved with at the moment is Carlyle Group.
Derek Pilecki:I really like the new CEO. I think, you know, the previous CEO transition had been botched by the firm.
Andres Sandate:Yep.
Derek Pilecki:I think that I think the new CEO has a a huge canvas to work on. Like, there is a there's a huge expense cutting opportunity at Carlyle. Carlyle It's Harvey Schwartz,
Andres Sandate:the new CEO?
Derek Pilecki:Exactly. So, you know, You know, Carlyle would always run their business of, you know, we're gonna run the business on the management fee and pay ourselves on the carry. And, you know, the when the other publicly traded managers came out, Carlyle and I mean, Blackstone and KKR, all of a sudden they were earning 20 or 30% margins on their management fee and Carlyle has, like, how we we're breakeven on our management fee. So, like, there was an just a a heavy spending culture at Carlyle that I think Schwartz is gonna, you know, not clamp down on, but just, like, make intelligent choices about Yeah. Improving the margins there and reducing some of the spending.
Derek Pilecki:And then there's a lot of opportunity on the, investment capability side of Carlyle and great brand name and, you know, great at raising money. They they just have some some gaps in their, investment arsenal that he can fill and grow the firm. So I think and, you know, the valuation's way cheaper than the its peers even with those opportunities. So Yeah. And when you
Andres Sandate:yeah. When you think about them, you think, you know, private equity, defense, government. I mean, the that's a a a sort of a gold plated franchise. But when you think about them, you necessarily don't think credit. You don't think, secondaries, you know, in some of these other areas.
Andres Sandate:And I think all of them, and I'd love to get your take, seem to really, from a from a capital flows perspective, really are eyeing not only foreign markets, as a source of growth, but also the retail investor as as a source of growth. And when I say retail, I mean, you know, trying to go after that high net worth, retail investor that's being served by a financial adviser. It seems like all of the more successful ones that are growing, number 1, have product, and they have a way to distribute that product to retail, both globally, but also importantly in the US where that average investor is woof not woefully, but they're under allocated to alts relative to, you know, their their family office or institutional peers.
Derek Pilecki:I mean, we've had a bull market for the past 14 years. Right? So the there's a ton of investors who have historically not invested in alts that have a lot of money now. And they're, you know, they're people with, you know, 5 to $25,000,000 or even more that historically have not invested in alts. So the, like, the access that the private equity managers are trying to get to those people are coming through investment advisers or financial advisers.
Andres Sandate:Yeah. Let's talk about capital markets. When when you talk, capital markets in the context of of Gator Capital Management, what what does that universe look like? I'm curious.
Derek Pilecki:Yeah. I mean, it's the investment banks. Right? So it's the Okay. Goldman's and Morgan Stanley's, Barclays, you know, UBS.
Derek Pilecki:The, you know, the capital markets really hit hit the cover off the ball in 2021, you know, with the SPAC craze and the IPO boom. You know, those businesses really were busy and had a lot to do. And then there was, you know, the pullback in 2022 really, you know, capital markets revenue is really at a cyclical low. And we're just starting to see, like, that's coming back a little bit, late 23, early 24. And, you know, 24 has been a good year for capital markets growth.
Derek Pilecki:You know, the a lot more trading, a lot more business being done. I think, you know, when rates were going up so much in 2022, there's a lot of on the debt capital market side, things were pretty quiet. So now we're, you know, I think the stable rates, you know, 10 years staying here around 4.50 makes a a better environment for issuance, and people are like, okay. This is, you know, there's not as much volatility. We have business to do.
Derek Pilecki:Let's let's raise some debt and, you know, lock in some funding. And so I think capital markets businesses are in a a nice recovery mode from the the cyclical lows of, you know, 12 to 24 months ago.
Andres Sandate:I wanna ask you about securitization. You know, it it it up until 2008, you know, a lot of folks didn't know what a CDO was, didn't know, maybe they don't know, but, you know, you saw so much innovation, in the asset backed securitization markets. And then it was I would say largely, you know, the veil was lifted with the GFC, and we saw a lot of banks suffer. And there was just it it it exposed just how interconnected the global capital markets really were. I had a guest on last week who talked about there's there's somewhat been a loss of innovation in the securitization markets because you saw this talent leave, and you saw some of these securitization markets sort of seize up.
Andres Sandate:And you have private ABS. You have public ABS. But, obviously, and some of the bigger, areas like auto, student loans, mortgages, etcetera? I mean, are origination volumes just generally down, and that's why we don't hear as much about securitization? Why has there been, for example, such a a more and more chatter and talk about private ABS?
Andres Sandate:I'm curious, like, do you traffic in in these in these, universes, or does it touch the capital markets names that you follow?
Derek Pilecki:Yeah. I mean, it's it's very my exposure to that is pretty small. So, like, the
Andres Sandate:Okay.
Derek Pilecki:I I think there has not been a lot of innovation because there's been some regulatory changes and about what risk retention is. And so I I I think that there's not been you know, people haven't been paid to take more and more risk or come up with more innovative structures. And so there's just been lack of innovation there, and it's been more it's it's boring because it's like this the structures are tried and true, and there's not much innovation there. And so it's Yeah. You're just basic business.
Derek Pilecki:And and
Andres Sandate:that would that would explain why some of it's maybe moved to to the private markets. Let's talk about, we we touched on this earlier, but I wanna ask you. When you when you talk about nonbank lending, in that universe, you know, you talked about Stripe and Venmo and Cash App. And the I look at those as more transactional, like, processing and the technology. When you talk about nonbank lending, a source, you know, 10, 15 years ago, it was Prosper, and it was all these peer to peer type of lendings.
Andres Sandate:I'm not thinking that's what you're you're talking about when you say nonbank lending. So I'd be curious, like, how big is this market? Who are the players, and who seems to be doing a decent job at it?
Derek Pilecki:Yeah. So I mean, non bank lenders on the consumer side are, you know, OneMain Financial. It's a subprime lender. It's the old Citi Financial, AIG, American General Business, you know, or I mentioned Sallie Mae, the Mhmm. The student lender.
Derek Pilecki:You know, I I think it's lenders like that, like LendingClub, Upstart, or currently non bank lenders SoFi. And so those are the companies that are non bank lenders. On on on the commercial side, there's some commercial mortgage rates. There's some commercial finance companies that are are non bank lenders.
Andres Sandate:See? It wasn't my kids today. It was my dog.
Derek Pilecki:I was hoping to get to see one of your kids today. I'm I'm bummed I'm not showing
Andres Sandate:up yet. You you might you might see one jump in. I mean, that's that's the nature of it. So so there's a number of nonbank lenders across mortgages, across student loans, and these other areas.
Derek Pilecki:Yeah. I like I like nonbank lenders. They tend to be monoline. They they tend to Yeah. Have higher returns on equity than banks.
Derek Pilecki:They tend to grow a little bit faster, but they don't have as much stability, right, because they don't have the deposit franchise. So they, you know, a lot of times they're funded in the capital markets and it it, you know, they can run into problems with the the balance sheet if they're not more stable on their funding side. But they're interesting businesses and they're innovative and and they they can grow faster than a typical bank. And so I think they're interesting businesses from time to time.
Andres Sandate:But like you said, earlier in our conversation, the complexity, the inefficiency, they can run into problems just because they don't have the deposit base. All the more reason why, you know, only specialists probably are really starting, you know, to really be constructive on doing the underwriting, doing the work, and the research.
Derek Pilecki:That's right. I mean, I think it's, you know, a specialized area that, you know, it's trafficked in by a lot of financial sector specialists, not necessarily generalist investors.
Andres Sandate:Yeah. How much, you know, when when you look back, at the time that you have been running Gator Capital Management, and and you're doing that away from, you know, call it Wall Street in New York. You're doing that in Florida. And and I know you used to get this question from investors, and I'd love to get your take on it now, you know, years removed. How much does being outside of kind of the trading of ideas amongst other funds, other PMs, like, how much has that benefited you?
Andres Sandate:I'd I'm curious, where you can really, you know, sort of burrow in and concentrate and not be caught up in the noise and the hype. How much has that impacted, your business and your approach? I think I
Derek Pilecki:I think it's an interesting question. Like, I definitely talk to other investors some, but not to the my network amongst my peers is not extensive. Like, I'm not, you know, I'm not in touch with other investors on a daily basis. So, you know, I I see them at conferences a couple times a year and we're we're cordial. But, you know, I just kinda march to my own beat and, you know, do my own research.
Derek Pilecki:There's a few few people that I talk to that, you know, to share ideas, but really it's, you know, a lot of my own research and, you know, just doing my own independent thinking away from what's fashionable amongst, you know, bounce amongst the financials crowd. So
Andres Sandate:I think that's
Derek Pilecki:a huge benefit.
Andres Sandate:Yeah. It sounds like it is a benefit. And, you know, without talking about your book and and and the strategy, you've always, operated the beat of your own drum. Right? You you tend to not hold the names that the sector or the index is hold.
Andres Sandate:You tend to do a lot of your own idea generation and research independent, and and successfully, relative to, you know, your index and your peers. I wanna ask you, you know, kind of couple of final questions. As you think about, you know, financials, we're we are in an election year. It seems like you can pick up any newspaper, turn on any news channel these days, and get an opinion one way or the other depending on what you're looking to hear. But, you know, financials and you talked about this at the beginning of the conversation.
Andres Sandate:A lot of the things that get talked about in the media that make headlines aren't necessarily the things that you're paying attention to, and one of those things you talked about was interest rate risk. So I'd love to ask you in an in an election year with the Fed attempting that soft landing, what's your, you know, what what's your outlook, for the sector? You know? Yeah.
Derek Pilecki:How
Andres Sandate:do you sort of assess how Powell and the Federal Reserve have done given, you know, a a quite tricky hand to play? And, clearly, this is gonna have a big impact on on the names that you follow.
Derek Pilecki:Yeah. So I guess one thing that I'm trying to reconcile is the, you know, my portfolio when I look at my portfolio now, not by design, but just when I try to be objective and say, would my my portfolio benefit from a Biden victory or a Trump victory? I think it would benefit from a Trump victory. The problem is I think Biden's gonna win, which and I know that's not a consensus view. Like, I think especially amongst financial people, everybody clearly thinks Trump's gonna win.
Derek Pilecki:But, you know, I guess my reasons for why I think Biden's gonna win is I think the polls are wrong. I think, you know, people with landlines who get called for polls are 10 skew older and Republicans. So I think overstates Trump's support. I think, number 2, I think there's gonna be a turnout issue for Trump. You know, just we saw it in, you know, that primary in Indiana where Nikki Haley dropped the race months ago, and she still got 20% of Republican vote.
Derek Pilecki:Like, I just think Republicans, there's enough Brian O' Republicans that they just won't show up to vote for Trump. They just won't vote at all. And then, you know, I I think there's some social issues, I mean, namely abortion that are gonna really swing towards Biden's favor. So, like, when I look at the election objectively, I think Biden's gonna win. My portfolio is set up for a Trump win, not because I said Trump's gonna win and I'm gonna buy there just naturally banks will be do much better under a bank, a Trump regulatory view.
Derek Pilecki:And and so I don't have that reconciled. Like, how am I gonna approach the election here with, who's gonna win? I'm kinda waiting to see we have to get more into the need of the race before Yeah. I guess the one thing I would say about the election year, like, usually, election year, the market doesn't do much until the election happens. Right?
Derek Pilecki:And so, like
Andres Sandate:That's right.
Derek Pilecki:We we've actually had a pretty strong market for an election year so far. Like, S and P is up 10%. We're at sitting here at close to all time highs. That's a little bit surprising. So, like, is the mark and how how do I interpret that?
Derek Pilecki:Is the market looking through the election? Does the market already know who's gonna win and it's comfortable? Or is it just a a fed phenomena where we're expecting interest rate cuts and the economy is stronger than everybody expected and and, you know, so the market can power through an election year because so it's not clear and just trying to sift through that and, you know, you ask me tomorrow, I'll have a different answer for you. Right? Yeah.
Derek Pilecki:Yeah. Like, I'm trying to figure it out. Like, it's it's an open question in my mind. They're like, why why has the market been so strong in the face of an election year?
Andres Sandate:Yeah. That that that makes a lot of sense. I mean, you have to keep your your head on a swivel. Last question. You know, when you think about, the Federal Reserve and you think about Jerome Powell, you know, chairman of the Federal Reserve and trying to, trying to determine, you know, are we gonna see a rate cut this year?
Andres Sandate:Are we gonna not see a rate cut at all? Are we gonna see a rate cut a a a rate rise? What what is your overall grade that you'd give, the Fed? You know? I'm I'm just curious because I would imagine, you know, you're paying attention to this as much, if not more so than most of the people that I talk to.
Andres Sandate:Certainly, the people that I have on our show, are paying a lot of attention to what's going on in the macro economy, what's going on in their portfolio. So I'm just curious what what kind of grade and assessment you would give him because it's an incredibly difficult job.
Derek Pilecki:Yeah. It's a very hard job. Like, it's, you know, in and I'm also looking at it with hindsight here. Right? I mean,
Andres Sandate:it Yeah.
Derek Pilecki:There's some things like did qt or q quantity of easing have to continue? Did they have to continue to buy all those mortgage backed securities and treasuries Yeah. Into 2021 when the the market was red hot and that we had this back craze. Like, I don't there's some things that, in hindsight, I wish I bet they wish they could have a redo on. Right?
Derek Pilecki:So it's a very hard job. I guess I didn't agree with the last couple rate increases. Like, I felt like, going to 4 and a half percent on the Fed funds was enough. Like, I didn't think I didn't think that they needed to do the last three rate increases. So, like, could they cut 3 times and go back to where I thought they should be in the first place?
Derek Pilecki:Yeah. I think this inverted yield curve is really hard for the banks. I think it's, you know, but I I think the Fed also wants the 10 year higher. I mean, I think the the Fed would like I guess the other thing about the where where interest rates are is I kinda agree with some of the people who are saying the higher rates are causing inflation because, you know, if you think about housing supply, we're short housing. We need more housing.
Derek Pilecki:Higher rates does not promote more housing. Right?
Andres Sandate:That's right.
Derek Pilecki:So, like, rents are gonna go up because there's not enough housing. And so what are we doing here? Like, let's and every time I see a solution from the administration, it's let's create more housing demand. Let's lower the cost of mortgages. Well, that doesn't create more supply.
Derek Pilecki:We need to address housing supply. That's the issue. And more housing supply will lower, prices, lower rents, and so and lower inflation. So, like, we have to figure out housing supply, and I don't know that higher rates is fixing housing supply. Yeah.
Andres Sandate:So that yeah. Interesting. This has been a really great, you know, tour through the financial markets. I you know, we've talked about so many sectors within financials, you know, including banks, insurance, asset management, capital markets. I wanna give you the last word, though.
Andres Sandate:You know, we we've known each other for, you know, a a number of years. You've been running Gator now for 16 years. Congratulations. When when you think about, you know, where, the next 15 or 20 years with with Gatorgo, and where you wanna take your platform and financials, You've built your team up, and, and you're in Florida and you're doing this. What what are the things that come to mind?
Andres Sandate:Like, as far as, you know, these are the challenges I wanna tackle. These are the areas that are most exciting. You know, these these are the things as a as a CEO, as a portfolio manager that get me excited to get up and focus on this really highly complex area every day.
Derek Pilecki:Yeah. I mean, I'm just excited about compounding my investors capital over the next 16 years. Like, you know, I've been doing it for 16 years. In 16 years, I'll be 70. I think that's a, you know, a nice career and, you know, I'm excited.
Derek Pilecki:The firm's at a decent size now. We compound investors capital for another 16 years. We'll be, you know, bigger than I ever thought we would be. And so, like, that's just the focus of, like, continue to put up good investment performance, find the opportunities in these small and mid cap financials where we can put up excess returns for our investors. And and, you know, I think with the I think it's a very dynamic industry, and I think there'll continue to be opportunities, for our investors there.
Andres Sandate:That's great. Well, Derek Pilecki, portfolio manager of Gator Capital Management, headquartered in Tampa, Florida. Thank you for joining me today on the Asset Backed podcast. Tell us how people can learn more about you, where can they, get in touch with you, and, hear more of of your views on financials.
Derek Pilecki:Yeah. So our website's gatorcapital.com, and you can send me an email. My email address and phone number are listed on the website. And, You'll you can also follow me on Twitter under the handle Gator Capital. Fantastic.
Derek Pilecki:For having me, Andres.
Andres Sandate:Yeah. Derek, it was a pleasure, and, I look forward to having you back on to get an update on what's happening in financials. Thanks for joining me today on the Asset Back podcast.
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