Big Short Tied to Dying Malls Threatens to Be a Big Bust
(Bloomberg Gadfly) -- It's easy to say American malls are dying. It's much harder to profit from their death.
That isn't stopping a growing number of hedge fund traders from trying. One group in particular is making bearish bets on derivatives tied to commercial mortgages originated in 2012, namely, the Markit CMBX Series 6. Fund manager Eric Yip has led the charge, going public with his "Big Short" idea as documented here, here and, most recently, this week in the Wall Street Journal.
Yip has wagered about half of the $200 million in assets under management by Alder Hill Management LP on this anti-mall wager, according to the Journal. The idea is that as retailers stumble they won't be able to pay their rents, eventually causing their landlords to default on their loans and, if it gets bad enough, triggering a big payout to the short-sellers.
The wager seems to be going well, at least during the first two months after Jan. 30, when Yip publicly presented his bet to a group of investment firms at a Manhattan lunch.
From that day through May 23, the indexes he's targeting dropped by almost 10 percent. The drop coincided so exactly with the timing of Yip's roadshow that it's hard to believe that he (and all the press) didn't have something to do with it.
But some investors are starting to push back, including behemoths such as Pimco and AllianceBernstein. Their argument is that American malls are in trouble, and some will close. But those that are going to die will do so in a long, drawn-out process. (Consider how long it's taken RadioShack to die. Ditto, Sears). Not only that, but this particular derivatives index is backed by less vulnerable debt than, say, mortgages of vacant strip malls.
Meanwhile, bearish traders have to fork over a substantial sum of money up front to initiate the trade and make regular payments to maintain it. In other words, being bearish on American retailers may be the right trade, but this index is likely wrong vehicle. It's too soon. And it's incredibly expensive.
To just break even, short-sellers on the CMBX series 6 BB index would probably need at least an 8 percent realized loss on five of the underlying 25 deals within the next year, according to Brian Phillips, director of commercial real estate credit research at AllianceBernstein. That's because short-sellers must pay upfront fees plus a 5 percent annual coupon.
Retail assets account for about 39 percent of the debt referenced by these CMBX 6 indexes, but only 8 percent are in the riskiest class "B" and "C" regional mall category, Phillips noted. For the trade to yield a reasonable return, Phillips estimates pretty much all of these second-tier malls in the index will have to liquidate in the next 12 to 24 months, which is unlikely given that none of these mall loans are in special servicing.
It's also important to note that real-estate investment trusts and insurance companies are big owners of these mortgages and have a vested interest in not allowing them to all fail at once. They have shown they're not willing to let them default so quickly. Insurance companies have been extending these mortgages and making other allowances, sometimes extending the life of a property in default for years. If REITs run out of cash to cover interest or principal shortfalls, they have plenty of ways to borrow more money, including unsecured debt and equity markets.
Meanwhile, the amount of uninsured commercial-mortgage debt has generally been shrinking, meaning that some of it is being paid off and there's less of it to default.This also supports loan values.
Enough investors are growing skeptical of this particular "big short" that the derivatives are starting to reflect a bit more optimism, implying a price that's higher today than it was on March 23.
Yip and his mall-hating peers may have started strong, but's it's looking less like a winner as the days go by. Even if these traders are ultimately correct, the timing matters a great deal. If the debt tied to these specific commercial properties manages to avoid default in the next year, Yip and others may find their Big Short turn into the Big Bust.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.
Shelly Banjo is a Bloomberg Gadfly columnist covering retail and consumer goods. She previously was a reporter at Quartz and the Wall Street Journal.
To contact the authors of this story: Lisa Abramowicz in New York at labramowicz@bloomberg.net, Shelly Banjo in New York at sbanjo@bloomberg.net.
To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net.