😎Notice of Appearance: Daniel McNamara, Principal at MP Securitized Credit Partners😎
Today we welcome Daniel McNamara, a Principal at MP Securitized Credit Partners, where he’s worked since the summer of 2012. Prior to that he was a CMBS trader at Societe Generale, Braver Stern & Co., and UBS. He’s our first investor to make a Notice of Appearance with us and so we hope you enjoy this. It will be a bit longer than usual.
PETITION: Welcome Dan. Thanks for doing this. Let’s dive in. Back in January 2017, we, like seemingly everyone on Wall Street, got our hands on Eric Yip of Alder Hill Management’s 58-page treatise on CMBX 6 BBB- in what, months later, several mainstream media outlets would dub “the next big short.” Yip’s report had “DO NOT DISTRIBUTE” tagged on the bottom of it. Lol. For the uninitiated, in simple terms what is CMBX 6 and how does it work?
McNamara: Thanks for having me. CMBX 6 is an index that tracks the performance of 25 commercial mortgage-backed securities (CMBS) that originated in 2012. Each securitization is backed by loans on commercial real estate, and the underlying loans are diversified across geographic regions and property types, including multi-family, office, hotel, industrial, and finally, retail: CMBX 6 has a higher exposure to retail (over 40%)--and to regional malls, specifically (17%)--than any of the other indices (CMBX 1 thru 14). As for the terminal value of a tranche within the CMBX index, that can be derived by adding up the number of deals that an investor expects to pay off. Each of the 25 deals that payoff in full will contribute 4 points to the ultimate recovery of each tranche. (25 deals x 4 points = par)
PETITION: Your shop bought in almost immediately. But not literally: your team took its time and did its own research before putting money behind the concept-adoption; your colleague Katie McGee and others visited several malls and saw the dumpster fires up close. Eventually you pulled a Michael Burry and went in on credit default swaps against CMBX 6. Mr. Yip was much earlier than you. Why? What ultimately was the straw that broke the camel’s back and catalyzed your ultimate investment? If you can share, how big was your position? What percentage of your fund? We’d love to see what the level of conviction was!
McNamara: We started to visit a lot of malls in 2017 as the CMBX 6/Mall Short gained a great deal of attention in 2017 with the Alder Hill White Paper. It was a very well thought out paper that laid the foundation for all the fundamental reasons to be short the Regional Mall space using CMBX 6. Our only concern was timing: The negative carry on CMBX 6 was the main issue (3 points a year for BBB-6 and 5 points for BB.6), and we thought there might be better opportunities to add to the short trade as maturity approached in 2022 and the “short” became less expensive. It was our highest conviction trade and largest position in the Hedge Fund in 2019/20. In February 2020, we launched the “MP Opportunity Fund I,” which was created entirely to short CMBX 6 and to take advantage of the massive mis-pricing.
PETITION: What was it like, shortly after putting on the position, getting your face ripped off? Yip shut his fund. Other funds collapsed on the trade. You were up against AllianceBernstein and other large institutions and they were winning. Why? How?
McNamara: 2019 was a difficult year for MP. CMBX BB.6 rallied from $72 to $88.50 along with the negative carry of 500bp, even though we continued to see the fundamentals behind these properties deteriorating. The rally seemed to be driven by a perfect storm of a Goldilocksian economic backdrop, hedge fund short covering, and mutual funds adding to their long positions as they received inflows.
PETITION: Ultimately what changed? Did Carl Icahn’s involvement move the needle?
McNamara: Icahn’s involvement definitely improved the technicals of the short squeeze that took place in 2019. Icahn placed a large investment in shorting CMBX 6--and the publicity behind his involvement encouraged others to make similar investments.
PETITION: At this point, how has the trade worked out? What’s the return look like? What’s your go-forward view on CMBX 6? 🤑
McNamara: In May of 2020, we wound down the above-mentioned MP Opportunity Fund with an approximate return of 120% net to investors. Our focus now is solely on shorting CMBX BB.6: The asymmetric return available in CMBX BB.6 at this price ($53) is very attractive. After taking down our BB.6 and BBB-6 shorts post covid last year, CMBX BB.6 is now our largest position again in the hedge fund. We believe the ultimate terminal value for CMBX BB.6 is ~$28.
PETITION: The pandemic has claimed CBL and PREIT. WPG is teetering and Macerich looks wobbly. A lot of people think David Simon is full of sh*t. Thoughts?
McNamara: The Mall REIT space is fascinating. We have always believed that higher quality malls will survive; lower quality regional malls is where the pain lies. CMBX 6 malls most resemble the CBL, WPG, and PREIT portfolios. SPG and Brookfield have focused their efforts on the Class A malls and have continued to give back the keys on their lower quality malls.
PETITION: What do you make of SPG’s strategy to buy up distressed retailers and function as both landlord and equityholder? They’ve clearly been busy in bankruptcy court.
McNamara: SPG is trying their best to hang onto as many tenants as possible, and buying these bankrupt companies in order to stem the exodus from their enclosed malls isn’t without risk. That said, these aren’t large investments relative to the size of SPG: If the approach grants some of their malls more time, they might not be throwing good money after bad. TBD.
PETITION: What do you make of Amazon Inc ($AMZN) reportedly gobbling up dead malls and converting them into distribution points?
McNamara: Amazon is taking advantage of some redevelopment opportunities in areas where they need more space. As it relates to CMBS, Amazon will not be the savior that some are hoping for: The cost to redevelop these malls is very large. The Amazon bid for these malls is ground value minus demolition costs. I don’t believe that any of the malls left in CMBX 6 will be paying off their debt because Amazon purchased them.
PETITION: Let’s move away from malls. There’s a lot of fear out there among commercial real estate lenders that offices won’t come back. That work-from-home isn’t going away. What do you think? What are your thoughts about co-working spaces like WeWork going forward?
McNamara: Work from home is here to stay. How much that will affect offices going forward is difficult to quantify at this point, but we do think that it will put pressure on office valuations and create more opportunities down the road for mortgage credit investors like us.
PETITION: The delinquency rates are falling across the board but hospitality remains stubbornly high. What do you expect to happen in that sector now that the economy is re-opening? How would one play continued pain in the sector?
McNamara: Headline delinquency rates are falling primarily due to forbearance agreements. This is just a short-term band-aid. Post 2008, it took 3 years for CMBS delinquencies to reach their peak. CRE is a slow moving product, and it takes time for these properties to sort their way through the system. We are expecting CRE to be the epicenter of distressed investing in the next few years. Costar currently predicts that about $320b in distressed assets will come to market over the next five years — a remarkable 60% increase over the $192b in distressed assets that came to market between 2010 and 2014, following the last recession.
PETITION: Why hasn’t there been a flurry of distressed real estate activity in NYC?
McNamara: Forbearance agreements have provided a lot of borrowers with a "free option." While many realize their property is under water, they will hold on until the forbearance period is over in hopes of a speedy CRE recovery. Also, we have seen foreclosures being delayed and a large bid/ask spread between sellers and buyers which all contribute to a "kicking of the can". None of these things are long term solutions though and we are confident that a long period of "distress" will be coming to the CMBS/CRE markets.
PETITION: Which recovers first? NYC or SF? Do you buy into the idea that, long-term, those cities will lose out to places like Austin and Miami?
McNamara: Pre covid, NYC & SF were losing residents for Miami & Austin just based on taxes and I don't see that migration slowing anytime soon. Some cities (like SF and NYC) were bulletproof post 2008, due to capital fleeing to safety; I believe they will struggle more post covid relative to the gateway cities. Also, NYC & SF were priced to perfection pre covid and it’s difficult to see that pricing returning anytime soon. This is especially true as people feel more comfortable living/working further away from these larger cities.
PETITION: What is the best piece of professional advice that you’ve ever gotten and why?
McNamara: “Work hard and play nice in the sandbox.” The former part is obvious but what people don’t realize is the CMBS market is a small place relative to the size of the entire CRE market--if you don’t act with integrity, it can very quickly impact your reputation. And in general, I like the sandbox analogy because it’s good to remember that we can have fun here--if you love what you do, work can feel more like play.
PETITION: What are some books or podcasts that have helped you get to where you are today?
McNamara: The best podcast I listen to right now on the topic of CMBS/CRE is the weekly Trepp Podcast. They do a great job of boiling down the latest relevant topics in my space. For books, I’m a Michael Lewis fan, of course--my favorites are Liar’s Poker and The Big Short.