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Bargains in mortgage land


It looks to be a busy and interesting week for initial public offerings with a Chinese educator, Mexican phone company and an American builder of server farms on tap. But the most interesting of all is probably the most overlooked: Cypress Sharpridge Investments, a hedge fund-like investment company disguised as a real estate investment trust. Bear Stearns and Friedman Billings Ramsey are lead underwriters and the trust’s symbol will be “CYS.”

Massive market dislocations, like the current subprime mess, generate an awful lot of bad press and fear on the street. Investors want out and dump all kinds of things to get there. At the end of past bubble eras, the good got thrown out with the bad and there were plenty of bargains to be had.

This time around, not surprisingly, some of the best bargains are in mortgage land. I’m not talking about securities backed by shaky subprime mortgages other bond market exotica. Rather, I’m referring to straight forward mortgage-backed securities, those made out of regular mortgages, and carrying the imprimatur of Fannie Mae or one of it’s sister government-sponsored entities. These types of vanilla securities are the baby that’s been thrown out with the bath water this time around.

Cypress Sharpridge is essentially a pool of a couple of hundred million dollars managed by former star Fidelity bond manager Kevin Grant that plans to go hunting in this exact space. Grant left Fidelity in 2005 and raised private capital to start his own investment firm, Sharpridge Capital Management.

Grant is one smart guy and has put his decades of experience to work in designing the investing strategy for the fund. And he’s got a great track record. The 1994 derivatives meltdown, when most bond funds got creamed by a surprise string of interest rate hikes, was Grant’s best year as a Fidelity manager. When the corporate debt default crisis hit in 2002, Grant’s funds were devoid of loser like Worldcom and Enron. So when it came time to design Cypress Sharpridge, he didn’t just run his portfolio through the usual computer-generated stress tests. He also tested using the once-in-a-blue-moon market conditions seen after the 1998 demise of Long-term Capital Management and the wacky, unprecedented interest rate gyrations of the mid to late 1970s.

Grant has been telling potential investors that the current mortgage market is so cheap, running the fund is like shooting fish in a barrel. The kinds of high quality debt they’ve bought yield close to 6% thanks to beaten down prices from the selling stampede. They use interest rate swaps to lock in a profitable spread without taking much risk from rate movements. Even after fees and a conservative estimate of where the market is headed, they’re forecasting a 13% return with minimal volatility.

Unlike a closed-end fund IPO, Cypress Sharpridge has assets beyond what’s it’s raising in the IPO, including a 19% stake in Grant’s management firm. So I’m not too worried about the dilutive effect of underwriitng fees that hurts closed-end fund IPOs out of the gate.

And those other IPOs to watch this week? DuPont Fabros Technology, which builds giant data centers, will start trading under the symbol “DFT” in a deal expected to raise as much as $640 million. Noah Education Holdings, which teaches English to Chinese folks, will trade under “NED” after its $115 million debut. And Mexican phone carrier Maxcom Telecommunications is looking for up to $212 million when it hits the tape under the symbol “MXT.” Any thoughts in the peanut gallery on these fine fellahs?


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