The Mall Short

In today's Finshots, we provide a simplified guide on how to bet against a mall.

The Story

It’s no secret that coronavirus has hit retailers hard. Multiplex theatres are empty. Window shopping is a thing of the past. And sweeping changes in multiple industries might just spell the doom for malls and shopping complexes. However, for a certain class of investors, this is actually good news.

These people have been betting on a retail apocalypse for a while now. In fact, they’ve been banking on it even before the pandemic reared its ugly head.

You see, brick and mortar retail outlets have been on shaky ground for the past few years. Property prices have increased, online shopping is more popular than ever, and fewer people are visiting the malls. Last year, over 9100 stores across America shut down — the highest number in any year until then. This year is probably going to be much worse, thanks to the coronavirus and all that. According to Coresight Research, around 25,000 U.S. stores could close permanently in 2020.

And the closure of these stores will eventually translate to a sharp decrease in rental income (for mall owners). And since mall owners primarily depend on these rentals to repay their debt burden, you can see why they are in trouble.

So how exactly does an investor bet against malls?

For starters, you need to know exactly what you are betting against. I mean, what does it really mean to bet against a mall? Does it mean you’re betting that all malls will go bankrupt? Or are you betting that some malls will go bankrupt? And if you are making such a bet, who’s going to accept this wager?

Well, let’s start with the basics.

Mortgage-backed securities: Think of a commercial real estate loan. You have the bank and you have the prospective customer. In this case, a mall owner. Usually, the mall owner borrows money from the bank and the bank assumes all risk associated with repayment. But what if they wanted de-risk a bit?

Well, in that case, they’ll sell the loan to somebody else and claim a commission for facilitating the transfer. Why are they entitled to a commission, you ask? Because, if the mall owner pays up in full, the individual who owns the loan can walk away with a lot of money.

Imagine they sold the loan to you. If you had the kind of firepower to buy this thing, you could make some serious cash. The only problem — Very few individuals have millions of dollars in spare cash lying around. However, if there was some way for the bank to slice and dice this loan and sell small parts to multiple individuals at a modest price. That would be stellar!!!

Except…

It isn’t.

What happens if the borrower defaults? I mean, it’s almost certain then that these individuals will have to walk away with nothing. Meaning, it’s a bad idea to slice up a single loan. Instead, you might want to pool many such loans together. That way, even if some borrowers default, investors can always walk away with something. Once you have the pool, you start slicing it up into tiny pieces and sell it to prospective investors. Whenever repayments are made, cashflows will be apportioned to you based on the number of pieces you own. Each piece is called a Mortgage Backed Security (MBS) and with that, your little crash course on securitization is complete.

Now obviously this pool will have many loans mixed together. So if you want to bet against shopping malls, you’d have to find an MBS that has a lot of “mall loans” mixed in it. Enter CMBX 6. It’s got everything you’re looking for. It’s got mortgage-backed securities with a lot of shopping mall loans. Most of the loans originated in 2012, 2013 — at a time when the “death of shopping malls” wasn’t exactly a principal concern. And if you were looking for borrowers who are likely to default right now, CMBX 6 ticks all the boxes.

But how do you bet against this thing?

Well, believe it or not. You buy insurance. The idea is simple. You pay a small premium to cover any potential downside that could accrue if borrowers in the CMBX-6 index start defaulting on their obligation. Theoretically, if the final payout is higher than the sum of all premiums combined, you could walk away with a profit. Investment bankers call these special insurance notes — Credit Default Swaps (CDS). And a few brave investors that bought CDSs in the past few years are finally resting easy knowing their wager is paying off in a big way.

Billionaire Carl Icahn walked away with a $1.3 billion gain during the first half of the year. Private equity fund Apollo Global Management made over $100 million, and fund managers like Jason Mudrick of Mudrick Capital and Scott Burg of Deer Park Road are believed to have made similar amounts.

More importantly, some of these investors haven’t closed their bet. At least, not yet. Meaning as more malls go bankrupt some of these investors could claim even higher payouts. And considering the latest surveys indicate that only one-third of Americans feel safe about shopping in a mall right now, that payout might be right around the corner.

Also, if you want a visual explainer on mortgage backed securities, credit default swaps, short sellers and a global financial crisis, do check out the award winning American comedy-drama Big Short. The movie will not disappoint you.

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The growth numbers are out

In other news, we just found out our GDP contracted in the first quarter of 2020 (compared to the quarter last year) and it’s worse than most people expected.

Until next time...