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The Journal Gazette

Saturday, March 18, 2017 10:00 pm

Hedge funds bet on shopping malls failing

Rachel Evans and Matt Scully | Bloomberg

Wall Street speculators are zeroing in on the next U.S. credit crisis: the mall.

It’s no secret many mall complexes have been struggling for years as Americans do more of their shopping online. Now they’re catching the eye of hedge-fund types who think some may soon buckle under their debts, much as many homeowners did nearly a decade ago.

Like the run-up to the housing debacle, a small but growing group of firms are positioning to profit from a collapse that could spur a wave of defaults. Their target: securities backed not by subprime mortgages but by loans taken out by beleaguered mall and shopping center operators. With bad news piling up for anchor chains like Macy’s and J.C. Penney, bearish bets against commercial mortgage-backed securities are growing.

In recent weeks, firms such as Alder Hill Management – an outfit started by protégés of hedge-fund billionaire David Tepper – have ramped up wagers against the bonds, which have held up far better than the shares of beaten-down retailers. By one measure, short positions on two of the riskiest slices of commercial mortgage-backed securities surged to $5.3 billion last month – a 50 percent jump from a year ago.

"Loss severities on mall loans have been meaningfully higher than other areas," said Michael Yannell, the head of research at Gapstow Capital Partners, which invests in hedge funds that specialize in structured credit.

Nobody is suggesting there’s a bubble brewing in retail-backed mortgages that is anywhere as big as subprime home loans, or that the scope of the potential fallout is comparable. The bearish bets are just a tiny fraction of the $365 billion commercial mortgage-backed securities market and there’s no guarantee the positions, which can be costly to maintain, will pay off any time soon. Many malls may continue to limp along, earning just enough from tenants to pay their loans.

But more and more, bears are convinced the inevitable death of retail will lead to big losses as defaults start piling up.

This year, traders bought a net $985 million contracts that target the two riskiest types of commercial mortgage-backed securities, according to the Depository Trust & Clearing Corp. That’s more than five times the purchases in the prior three months.

Sold in 2012, the mortgage bonds have a higher concentration of loans to regional malls and shopping centers than similar securities issued since the financial crisis. And because of the way commercial mortgage-backed securities are structured, the BBB- and BB-rated notes are the first to suffer losses when underlying loans go belly up.

"These malls are dying, and we see very limited prospect of a turnaround in performance," according to a January report from Alder Hill, which began shorting the securities. "We expect 2017 to be a tipping point."

Cracks have started to appear. Prices on the BBB- pool of commercial mortgage-backed securities have slumped from roughly 96 cents on the dollar in late January to 87.08 cents last week, index data compiled by Markit show.

That’s still far too high, according to Alder Hill. Many of the malls are anchored by the same struggling tenants – Sears, J.C. Penney and Macy’s – and large-scale closures could be "disastrous" for the mortgage-backed securities. In the worst-case scenario, the BBB- tranche could incur losses of as much as 50 percent, while the BB portion might lose 70 percent.