IOs – an alternative play on mortgages
WHAT DO SANDY Weill, Lloyd Blankfein and Dan Loeb have in common with a Nascar driver, Sting and a cartoonist? There is a joke in there somewhere, for sure, but the less humorous answer is: they all bought apartments in 15 Central Park West, Manhattan. Known locally as 15 CPW, it is a "place to live graciously in New York".
With 210 apartments with views of Central Park, a 14,000 square-foot gym with lap pool, 20-seat cinema, a library, 30 climate-controlled wine rooms, suites for domestic employees, a club floor with a games room, terrace and meeting room, 15 CPW is the most prestigious apartment building in Manhattan, and in the spring the building was finally ready to be lived in. With all sales completed in March last year, 15 of the condos have reportedly already been sold on to second buyers. Some of the building’s most prestigious residents paid as much as $45 million for an apartment.
If there are concerns about the worst residential real estate slump in US history, they are not to be seen at 15 CPW. Nor in the rest of Manhattan. "We are not seeing the 20% increases in property value we have experienced the last several years and it is taking longer to shift property, but it’s not a downturn yet," says a Manhattan real estate broker. She says the prices of condominiums in New York City are rising at about 5%. But nor are declines visible in the prices of single-family homes prices in the surrounding suburbs.
Denial of a housing crisis on Wall Street is less common than it was five months ago but there are still those who appear oblivious. "Oh yes, the real estate market in the US has really tanked but it’s not as serious as it’s being portrayed," says a Wall Street banker. Maybe he should hop on the ferry and take the 15-minute trip across the Hudson River to Jersey City. There, a foreclosure adviser says: "There are so many for sale signs, it’s like a supermarket for houses."
One shouldn’t just target New Yorkers – the US’s other metropolitan cities have also seen house prices rise.
But take a car to the outer suburbs and it is quite a different story. Detroit, says a hedge fund manager, "is ground zero". In Nevada, one in every two properties is in some state of foreclosure. But there are pockets of distressed assets, loans and securities that are ripe for investment now. Funds have been frantically raising cash ready to deploy when a bottoming of the market is signalled. Market sources estimate as much as $100 billion has been raised so far.
Where does this leave the securities markets that tanked as US sub-prime real estate collapsed?
For those funds waiting for the mortgage-backed securities market to bottom out, that time has just arrived. BlackRock’s purchase of $15 billion of UBS’s sub-prime and Alt-A mortgage debt in May was indicator enough.
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"You have to sift a lot of gravel before you find gold"
Tony Lembke, MKP Capital Management |
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That could be good news for the likes of MKP Capital Management, an alternative asset management firm with $5 billion under management. The firm has been investing in mortgage assets for 12 years. Tony Lembke, a principal of MKP Capital Management and, with Patrick McMahon, co-head of investing and risk management, says the market reached its low with Peloton Partners’ asset liquidation in March. The London-based hedge fund manager was forced to liquidate its roughly $15 billion portfolio of sub-prime and Alt-A mortgage securities after mortgage credit bets turned against them. "That liquidation was the bottom of the market for highly rated RMBS," says Lembke. "And shortly after, the Fed stepped in to support Bear Stearns, effectively saying that no large financial institution would fail. That removed the systemic risk premium." Since then, long bets on mortgage-backed securities have outperformed shorts on the ABX.
But it is not a strategy suited to all managers. "Interestingly, the guys who made the sub-prime call last year were hedge funds with little mortgage market expertise or infrastructure," says Lembke. "It was a macro call. Most of the mortgage experts actually got it wrong. The opportunities now available though do require infrastructure. There are millions of cash securities, and you have to sift a lot of gravel before you find gold." MKP has spent years building a system that could monitor and analyse securities. "You need to be able to analyse between 50 and 100 securities every day, and each is backed by thousands of loans. Some managers will just not be able to do that."
In addition to some funds lacking the infrastructure, one manager says lack of skill alone will prevent them from investing in distressed RMBS. "Several distressed and special situations funds are looking for opportunities in distressed RMBS assets but it requires a different type of analysis and skill," says a hedge fund manager that toyed with the idea. "These assets are extremely untransparent. Who is the mortgage owner for every mortgage? Are they going to meet their payments? It’s too hard to know what these assets are really worth for a small fund without the adequate resources. It is not at all similar to analysing a distressed corporate."
Don Brownstein, CEO and CIO of Structured Portfolio Management (SPM), a Connecticut-based hedge fund, agrees that the true value of mortgage-backed securities is still too vague. His firm made successful bets on the sub-prime market last year by shorting the ABX. "When we did our trades on sub-prime, triple-B minuses were in the mid 90s; now they are between 5 and 8," he says. "Someone bought those. Triple-As were about in the high 90s, and that was considered the real value. Now they are in the 50s and 60s. So what is the value? Is it 50? Is it 90? Or is it 10? The problem with buying distressed mortgage-backed securities is simply that the information is too limited to tell what the real value is. The risks still appear to be too great for sizeable investments in distressed MBS."