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May 29, 2020  

Popular CMBS Swap Trade Comes Up Short

Commercial MBS traders are abuzz over the recent performance of derivatives that hedge funds and others have long used to short the shopping-mall sector.

The swaps in question are tracked by IHS Markit’s CMBX.6 series, which offers synthetic exposure to a basket of 2012-vintage CMBS that’s underpinned by a heavy concentration of retail loans. Not surprisingly, long positions on the CMBX.6 have fallen sharply in value since the pandemic forced the nationwide closures of malls and many other retail properties. That, in turn, has generated handsome profits for those on the short side.

But compared to other vintages in the CMBX series, the payout for the retail bears has been disappointing. Traders have been struck by the relative underperformance of CMBX.6 shorts, given the heavy damage the crisis has inflicted on the retail sector.

“The 6 has been pretty much average,” one investor said. “You could have been short any of these and been in the zone.”

Since January, investors who are long the double-B-rated tranche of the CMBX.6 had lost 47% as of May 22. But those with the same position on the 2014-vintage CMBX.8 had lost 58% — translating to bigger profits for investors on the short side of the trade. Short-sellers of the CMBX.6 also were outperformed by those taking similar bets via swaps tracked by the CMBX.7 (2013), CMBX.9 (2015) and CMBX.10 (2016).

Market pros said the lackluster performance of CMBX.6 shorts is all the more glaring because it has long been an expensive trade to carry. Prior to the pandemic, a short-seller of the double-B tranche had to pay around 5% annually. After racking up losses for several years, some investors threw in the towel just before the outbreak hammered the retail sector.

“We are closer to the outcome, so the carry is less painful,” said one CMBS investor. “I’m still not sure if it will work, but at least you are going to find out sooner.”

Pros said one reason the CMBX.6 has underperformed is that it’s so widely traded, and thus offered more liquidity when the market seized up. It didn’t “overshoot the marks on the way down,” a source noted. The CMBX.8 may have fallen hardest because it has the highest exposure to properties with oil-industry tenants, one investor said.

While some investors have sold their short positions at a profit in the past couple of months, most have remained invested, convinced the values of their contracts will continue to rise as the economic picture worsens. Among the big-name traders with hefty stakes is Carl Icahn, who according to one source has seen the value of his CMBX.6 short increase from $400 million to $1 billion. Another source said structured-product shop MP Securitized Credit Partners of New York could make a killing after doubling down on its CMBX.6 short last year.

At the same time, sources said, two of the biggest players with long positions, AllianceBernstein and Putnam Investments, are staying the course. Their strategies include shorting other vintages of the CMBX index.

“The long players were hedged with later series, so they got very lucky,” said another CMBS investor. “They could have lost a lot of money, but their hedges paid off big and saved them. Now it depends how heavy the outflows are, but if they aren’t big I’m confident they go back and add to this [long] trade.”

Investors with long positions in the CMBX.6 maintain it’s the wrong vehicle for shorting the mall sector. AllianceBernstein laid out its position last year in a lengthy report that argued short-sellers are overly pessimistic about near-term defaults. The report also noted the willingness of the stronger mall owners to continue investing in their properties to maintain value, as well as the tendency of CMBS servicers to be patient.

“If the virus is relatively short-lived and we have a quick and mild recession, it’s a great long bet,” another investor said. “On the other hand, if we have a severe recession and two or three waves of virus lockdowns, it’s a great short.”