Bloomberg News

Funds Cite CMBS Top Bet After Subprime Gains: Mortgages

February 12, 2013

Saba to Kempner Call CMBS Top Bet After Subprime Gain

Firms are mainly investing in the $550 billion commercial mortgage backed securities market after the hedge-fund industry reaped its biggest gains last year on bets tied to subprime-home loans. Photographer: Scott Eells/Bloomberg

Hedge funds seeking the hottest trade of 2013 are turning to skyscrapers, shopping malls and hotels after last year’s rebound in residential real-estate drove the industry’s best gains.

Boaz Weinstein, founder of Saba Capital Management LP, and Tom Kempner of Davidson Kempner Capital Management LLC cited commercial property bonds as their best investment idea last week at the EnTrust Investment Summit in New York, according to a person who attended and asked not to be named because it was a private event. Jamie Dinan, founder of York Capital Management LP, also speaking at the conference in the Waldorf Astoria Hotel, said his top pick is commercial property and stocks.

The managers, who can buy everything from corporate loans to stocks and derivatives, are joining mortgage-bond investors including Seer Capital Management LP and LibreMax Capital LLC touting commercial real-estate after property values recovered 45 percent since bottoming in December 2009. Firms are mainly investing in the $550 billion commercial mortgage backed securities market after the hedge-fund industry reaped its biggest gains last year on bets tied to subprime-home loans.

“The fundamentals in CMBS have very slowly been repairing itself over the past three to four years, yet residential real estate received so much focus last year because finally after six years the housing market bottomed out,” Philip Weingord, chief executive officer of Seer, said last week in a Bloomberg Television interview. “CMBS underperformed many of the other sectors last year from a price perspective, but actually performed quite well from a fundamental credit perspective.”

Significant Upside

Home-loan bonds without government backing returned an average of about 21 percent last year, according to Amherst Securities Group LP, with some notes tied to subprime borrowers rising more than 40 percent. That compares with gains of 10 percent to 12 percent for commercial debt, suggesting “CMBS still has significant upside,” Seer wrote in a letter to investors last month.

The $1.7 billion New York-based fund, started in 2009, increased its holdings of commercial-mortgage bonds to 23.8 percent as of Dec. 31, from less than 15 percent in September, according to the letter.

Weinstein, the former co-head of global credit trading at Deutsche Bank AG, started Saba in 2009 to profit on price discrepancies between loans, bonds and derivatives and now manages $5.3 billion. Last year he wagered against the JPMorgan Chase & Co. trader who earned the nickname the London Whale because his outsized trades were distorting prices in a credit- derivative index.

Long-Short

He said last week at the EnTrust meeting that investors should buy commercial-mortgage securities and equities, while shorting, or betting on price declines, in a high-yield index. Saba rose 3.9 percent last month, according to a person familiar with the matter.

Jonathan Gasthalter, a spokesman for the New York-based fund, and Robert Siegfried, for $19 billion Davidson Kempner, declined to comment on the event. Mary Beth Grover, a spokeswoman for $14.8 billion York, also based in New York, declined to comment.

Investors are buying CMBS and commercial property as buildings in large cities such as New York and San Francisco lead gains in the U.S., according to Moody’s Investors Service. Norway’s sovereign-wealth fund, the world’s largest, said yesterday it agreed to purchase a 49.9 percent stake in five U.S. office properties from TIAA-CREF, its first real estate investment in the world’s largest economy.

Delinquency Rate

Landlords are also finding it easier to stay current on mortgage payments. The delinquency rate on commercial mortgages packaged into securities fell 10 basis points to about 9 percent in December, according to Barclays Plc. The rate has been falling since reaching a record 9.7 percent in July when borrowers struggled to refinance maturing debt taken out during the market’s 2007 peak.

That’s helped drive new bond sales, which is a boon for borrowers with loans coming due as landlords are able to access financing to pay off debt on everything from Manhattan skyscrapers to strip malls in Texas. Issuance is forecast to increase by more than 50 percent from last year to as much as $70 billion in 2013, according to Credit Suisse Group AG. Banks arranged about $8.3 billion in new CMBS deals in January, the highest monthly volume since 2007, according to JPMorgan.

UBS AG and Barclays may sell a $1.5 billion deal later this week and Morgan Stanley is planning a $193 million offering backed by an office building in Los Angeles that houses Oprah Winfrey’s network.

“All signs point to continued expansion in the commercial real estate market,” JPMorgan analysts led by Ed Reardon said in a Feb. 8 report. “Financing conditions continue to drive the commercial real estate recovery.”

Fund Involvement

Prices on a Markit Group Ltd. CMBX index linked to bonds rated AAA during the boom, many of which have been cut to junk, reached a 12-month high of 70.6 cents on the dollar on Jan. 9, up from 54 cents on May 17. The index has since dropped to 67.9, with some analysts speculating the rally may have run its course.

“We are still seeing hedge funds involved, but there was quite a bit of profit-taking by hedge funds in January,” said Stephen Schwartz, who trades the debt at RBC Capital Markets in New York.

Chasing Yields

Managers chasing higher yields in the CMBS market may struggle to find bonds that meet their return hurdles after the recent rally, said Harris Trifon, a commercial-mortgage debt analyst at Deutsche Bank.

“For the sector to be an attractive trade over the remainder of 2013, there would have to be a meaningful retracement,” Trifon said in a telephone interview. “It’s increasingly difficult to believe the magnitude of future price appreciation will be in line” with previous performance, he said.

The pace that property values are increasing has also slowed in recent months, with prices climbing 0.4 percent in November, according to a Jan. 10 report. Commercial real-estate values will probably be unchanged or down in some markets in 2013, according to the New York-based rating company.

“With many investors’ expectations becoming overly optimistic, we think the recent market pause is not only healthy, but also gives investors a chance to reassess their expectations,” Bank of America Corp. analysts led by Alan Todd said in a Feb. 8 report.

Relative Value

Still, as the Federal Reserve keeps benchmark borrowing costs near zero for a fifth year, investors are being pushed into riskier debt. Yields on a record 38 percent of the $1.1 trillion of notes sold by junk-rated U.S. corporate borrowers were trading below the 10-year average rate for investment-grade debentures last month, Barclays data show. Investors poured a record $1.3 billion into U.S. leveraged loan funds last week as covenants on the debt weaken the most ever.

With prices being pushed up across credit markets, money managers are viewing commercial property debt as a better relative investment than securities tied to residential.

“Even with continued improvement in the housing market, it is not clear that much upside remains at current prices,” Paul Singer’s Elliott Management Corp. wrote in a fourth quarter letter to investors on Jan. 28.

The $21 billion New York-based manager said it’s reduced a “significant portion” of RMBS holdings and will continue to sell this year. The firm is “optimistic” about commercial mortgage-backed securities.

“The parts of the capital structure that will be the ‘winners’ and ‘losers’ have become increasingly clear, and prices are making large moves towards either par or zero,” Elliott wrote in the letter.

LibreMax Switch

Greg Lippmann’s LibreMax began wagering on commercial- mortgage securities in 2012, according to a November letter to investors. The $2.4 billion New York-based hedge fund also reduced bullish wagers on subprime mortgage bonds and shifted more toward commercial-mortgage bonds, collateralized loan obligations and consumer-tied securities in the third quarter of 2012, Lippmann wrote.

The share of commercial-mortgage bonds among bullish bets at LibreMax rose to 15 percent on Sept. 30 from 9 percent at the end of the first quarter, the period in which it started trading those bonds, according to the letter. Lippmann is the former Deutsche Bank trader who bet against home-loan debt before the housing slump.

There are pockets of value to be found, particularly for funds that can boost returns by financing their purchases, according to Trifon of Deutsche Bank.

“While future gains might not match those from the recent past, the sector continues to be an attractive place to invest on a relative basis to other fixed-income markets,” he said.

To contact the reporters on this story: Kelly Bit in New York at kbit@bloomberg.net; Sarah Mulholland in New York at smulholland3@bloomberg.net

To contact the editors responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.net; Rob Urban at robprag@bloomberg.net


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