Big Short Against Shopping Malls Is Still on Back Order

(Bloomberg Gadfly) -- A little more than a year ago, a relatively small hedge fund, Alder Hill, went public with its relatively big bet -- reportedly half of its $200 million fund -- against retailers and malls. It was dubbed the new Big Short -- a reference to the bet against housing in the run-up to the financial crisis that netted a few hedge funds tens of billions of dollars. A few other hedge funds came out and said that they, too, were short the CMBX 6, an index of subprime commercial real estate debt that has about the most significant mall exposure that you can find, and a few Wall Street analysts recommended the same. Some quickly declared the trade too crowded.

How's the bet playing out? Based on the news, you would think exceptionally well. Last week, Toys "R" Us Inc., already bankrupt, said it was closing all of its stores. Mall jewelry chain Claire's Stores Inc. filed for bankruptcy on Monday. Department chain Bon-Ton Stores Inc. decided to close more locations than expected. And while not exactly mall news, though indicative of Amazon. com Inc.'s march through retail, Southeastern Grocers LLC, the owner of Winn-Dixie, filed for bankruptcy on Thursday, the second of two supermarket chains to do so in less than a month. And that was just in the past week.

Based on the CMBX 6, though, you would hardly know it. The index has rallied since early February, to 85 cents on the dollar, not far below the 86 cents it was a year ago, and barely budged on the Toys "R" Us news. Factor in premium payments on CMBX credit-default swaps -- investors can't invest directly in or bet against the index -- and during the past year any short was surely a losing bet, even as the mall Big Shorters look more and more correct. The outlook for malls and the likelihood that their owners will be able to continue to make their loan payments has worsened. The price of the CMBX 6, though, has improved.

One simple explanation is mechanics. Toys "R" Us stores are typically not in malls. More often they are next to them. Two years ago, Toys "R" Us did a private-placement loan tied to about 125 of its stores. That deal, though, is not in the CMBX 6. Of the $23.7 billion in debt tied to the CMBX 6, just $351 million in loans, or 15 percent of the index, according to Kroll Bond Rating Agency, are exposed to properties where Toys "R" Us is a tenant. Moreover, the index has just 40 percent exposure to retail and limited exposure to the riskiest malls. 

More generally, what made residential mortgages such a great short in the run-up to the financial crisis was how quickly the loans were going bad. Some borrowers didn't even make their first mortgage payment. Retailers, on the other hand, are proving more resilient than expected. Sears is still kicking. And it wasn't just homeowners, and flippers, who were over-leveraged. The banks were as well, which forced the refinance machine to come to a grinding halt. Banks are in much better financial shape then they were a decade ago. Another big difference is there is little else you can do with a house, other than live in it. Malls have restaurants. They can be converted into indoor experience centers. The trend has it limits -- not every mall can be turned into an indoor water park -- but, unlike homeowners, mall operators have options. To be right on Wall Street, you have to be not only correct about your trade but the mechanics of it as well.

Ever since the financial crisis, hedge funds have been on the hunt for the next Big Short. And after nearly a decade, the success rate is nearly zero. Betting against low-volatility exchange-traded vehicles would have generated some returns in early February, but not a lot, and the VIX quickly reversed itself. The same is true of short bets against energy high-yield bonds in late 2015, the euro in late 2011 and Greek banks before that. The CMBX 6 may seem even more like the financial crisis Big Short than those before it, but it's not the first to disappoint.

And yet the fact that the CMBX 6 barely budged in the past week is worrisome. Even if the index itself has relatively little exposure to Toys "R" Us, the closing of the biggest chain of toy superstores is most definitely a negative for the retail industry and a signal that things could get worse for the brick-and-mortar crowd. Sentiment alone should have dragged down the CMBX 6. The fact that it didn't could be another sign of an asset bubble fueled by low interest rates and markets divorced from fundamentals. That should worry investors, not just in retailers or banks, but everywhere.

The counterargument is that it's a good sign that the CMBX 6 is the best way for hedge funds to bet on the death of traditional retailers. No bank (so far) is willing to create synthetic derivatives tied to the debt of America's worst malls or retailers. That doesn't mean that investors shouldn't be worried about the recent financial regulatory rollback. But Toys "R" Us can fail, and the index most tied to the health of retailers only slightly wiggles. Ten years after the financial crisis, that's probably as good a sign as any that markets are a lot more shockproof than they used to be.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Stephen Gandel is a Bloomberg Gadfly columnist covering equity markets. He was previously a deputy digital editor for Fortune and an economics blogger at Time. He has also covered finance and the housing market.

©2018 Bloomberg L.P.

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