Dearth of Opportunity

A number of privately offered distressed mortgage opportunity funds are shutting down these days, years before they were supposed to return money to their investors.

Like investing in financial stocks last March, the funds that were lucky enough to begin their purchase programs at the right time have produced spectacular results, albeit for less than two years rather than the five years the marketing materials supposed.

Of course, there were a few that came to the party too early (check Chimera, symbol CIM) and its performance in its first year after IPO.

You have to ask yourself why, in a world where the hardest thing is to raise money for speculative investments, would the managers choose to return the cash to their investors?

The answers are several:

  1. The low-hanging fruit has been picked.
  2. The Fed is gradually getting out of the business of providing financing to every Tom, Dick and Harry willing to buy securitized debt.
  3. The fee structures pay a performance fee based on holding period returns, sometimes expressed as excess returns above a threshold, so holding the money longer is almost sure to cut the manager’s paycheck.

As a good friend summarized it, we’ve gone from a market where “no experience needed” was the mantra to a market where Russian Roulette is the business model.

There are still mortgage bonds that trade at substantial discounts to par.

The reality is that those bonds usually deserve a discount, because the credit losses that were only predicted in the past are now visible, and headed this way.  This applies to both residential and commercial real estate deals.

Also, with a number of commercial data services now offering to update the status of loans and underlying property values every month, there is no longer any meaningful informational advantage for a manager to claim.

So who can survive this kind of investment environment?  Where might there be an advantage for one manager over another?

One way is for the manager to have their own property management team with the appropriate national “footprint” and decades of experience.  Another might be an ‘in the family” source for leverage to increase returns.  A third might be a lock on sourcing new distressed product without competing on price with other managers.

The first advantage is shared by a handful of asset managers with associated “bricks and mortar” commercial real estate management divisions, or, in the case of residential MBS, captive special servicing companies and/or rental housing management arms.

The second is usually not visible, though CIM does enjoy $400 million in financing from its larger amREIT cousin (NLY) that owns the manager, FIDAC, which manages both REITs.  You would have to know the ins and outs at a couple of major banks, insurance companies or fund managers to find other examples, and even then, there are no guarantees that repo financing will always be there.

The final method (non-competitive distressed asset sourcing) is likely to be found at a couple of recent funds set up to acquire failed banks from the FDIC, where distressed pricing is the norm during the valuation process.

That leaves the broad swath of asset managers who set up opportunity funds in ’08 and ’09 with the chance to get out of Dodge with most of their performance loot intact.

The smart ones are choosing not to spin the cylinder and pull the trigger too many more times.

hh

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2 Responses to Dearth of Opportunity

  1. Jay Litman says:

    HH: I’m trying to figure out what your blog means to ME and my portfolio! Do you like mortgage Reits? Do you still like the agency Reits? Or not? My REIT’s have held up OK the past couple days. What’s killing me more is my MLP’s.

    • hhill51 says:

      Jay —

      I can’t give advice, especially when I don’t know about your portfolio and your needs. I do try to say why I am doing what I do, and how I look at things.

      It’s no surprise that your amREITs have held up, given how well they perform when the Fed is still holding rates short rates down. Today some additional strength may be due to the fact that prepayments on fixed rate MBS have declined.

      If you check my post called “sold too soon,” you’ll see where I sold my Annaly. Wish I had bought it back yesterday, but still only want to re-load when it gets back into the $17 zip code. ANH, on the other hand, continues to sell for less than book value with a very low risk profile from the portfolio and hedge viewpoint, so I haven’t sold that one.

      I have a selection of the others, but nothing major. I hold them for income, and don’t worry about the price. I expect the income stream to be just fine on all of them for another year, but will be looking for the exit if the market gets reallyo convinced that the Fed will tighten, because the principal hit can more than cost what the dividend payments will be.

      hope this helps
      hh

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