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‘The Big Short 2.0’: How Hedge Funds Profited Off the Pain of Malls

Catie McKee was nervous. It was last October, and the 31-year-old hedge fund analyst, who had been scrutinizing the mortgages on the nation’s malls, was convinced that some of those malls would default on their loans. She and her colleagues had even bet a substantial amount of money on that likelihood.

Ms. McKee was about to make her case to Carl Icahn, one of the country’s best-known investors, who had made a similar wager and invited her team to discuss the trade. Nothing would bolster her confidence — and the prospects for her trade — more than if the billionaire and onetime corporate raider backed her up.

She needn’t have worried. As Ms. McKee sat in Mr. Icahn’s wood-paneled boardroom with a sweeping view of Manhattan’s Central Park, discussing her thesis with the 83-year-old investor, she realized they shared the same outlook. Both agreed that e-commerce, changing consumer habits and evolving demographics had pummeled all malls to some degree in recent years, but some were far worse off than others. So by betting on their demise, both could profit handsomely — which they did.

Mr. Icahn, whose hostile takeover of TWA in the 1980s established him as a major dealmaker, has made $1.3 billion on the trade since that meeting. And the investors that made the trade within Ms. McKee’s firm, MP Securitized Credit Partners, more than doubled their money. They are among a handful of investors who have, collectively, made hundreds of millions of dollars on similar trades this year.

There is something discomfiting about the idea of getting fantastically rich off someone else’s misfortune, which is what happens when a “short” trade — or bet against a stock or industry — succeeds. The contrast is even more startling given that the pandemic, which has devastated the economy and hurt the livelihoods of millions, has turbocharged the bets that Mr. Icahn, Ms. McKee and others placed on the downfall of malls.

But on Wall Street, such brazenness is celebrated. Investors love little more than a contrarian bet that pays off, a combination of math and seeming magic that allows them to find a market disruption before everyone else and score a big win.

The trade Mr. Icahn and Ms. McKee met to discuss, known as the “mall short” in financial circles, is the latest in a longstanding Wall Street tradition that some criticize as bottom-feeding because it preys on failure and can push a business over the edge while contributing little to the economy. Most investors buy stocks and bonds with the expectation that they will rise in value. A short is the opposite, and their defenders say they can help expose corporate fraud or deflate a dangerously overvalued asset, which can aid the smooth functioning of markets. More than a decade ago, some investors famously profited off the collapse of the housing market, even as the United States plunged into a financial crisis. Their trade came to be known as “the Big Short,” inspiring a book and a movie.

“We periodically do shorts, and this is one of the best that I’ve ever seen,” Mr. Icahn said in an interview last week, echoing what he had told Ms. McKee. The two, who were introduced by a former colleague of Mr. Icahn’s, have stayed in touch.

Daniel McNamara, a colleague of Ms. McKee’s, called it “the Big Short 2.0.”

Brick-and-mortar retail has been in distress for years. Trapped between the growth of online shopping and the popularity of discount chains, many retailers have struggled to find a foothold in the changing firmament. The nation’s roughly 1,000 shopping malls (excluding strip and outlet malls) have borne the brunt of the problems, with hundreds of them fighting low occupancy and the loss of major stores, known as anchors.

The coronavirus pandemic, which prompted stay-at-home orders, increased the financial strain on malls by choking off much-needed foot traffic and cash flow.

Credit…Michelle V. Agins/The New York Times

“The pandemic sped up the rate of demise for CMBX 6 malls by being the final straw for a lot of struggling retailers and mall owners,” Ms. McKee said, referring to the obscure real estate index that she bet against because of its exposure to troubled malls.

The private equity fund Apollo Global Management, which runs an internal hedge fund that focuses on credit investing, made more than $100 million shorting the CMBX 6 and other commercial real estate securities — one of the fund’s most successful trades of the year. Jason Mudrick, whose New York hedge fund, Mudrick Capital, focuses on distressed investments, estimated that he had made the same amount. So did Scott Burg, chief investment officer at Deer Park Road, a fund in Steamboat Springs, Colo.

So far this year, 16 percent of all retail industry loans are delinquent, according to statistics tracked by the data firm Trepp. Major retailers, including J.C. Penney, Neiman Marcus and Modell’s Sporting Goods, have filed for bankruptcy, and new tenant demand for mall space has never been weaker, according to an analysis of national malls by the advisory firm Green Street. The closure of anchor stores only exacerbated the financial duress, given that, as Green Street noted in a recent mall survey, their departure can allow other tenants to reduce the rent they pay. Some landlords have opted to hand ownership of their struggling malls back to their lenders, making distressed sales of those investments very likely.

“The malls were way overbuilt to begin with,” Mr. Icahn said, “but additionally, the real problem was that malls and physical retail were constantly losing ground to online shopping.” He has kept his trade, believing that certain shopping malls could be in far worse trouble.

The CMBX 6 index is intended to track a basket of bond products, each of which contains bundles of individual mortgages to commercial borrowers, more than 2,000 in total. Those products are then sliced into brackets, known as tranches, and assigned credit ratings ranging from AAA to BB, according to their perceived level of risk.

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The CMBX 6, which tracks the performance of mortgages issued in 2012, has been a target for short-sellers because of its relatively strong exposure to malls. According to an analysis by Trepp, 40 percent of the property loans tracked by the CMBX 6 are in the retail sector, giving it the highest exposure to retailers of any CMBX index. (The balance of the mortgages are in lodging, residential and office, and industrial sectors.) Of the retail mortgages the CMBX 6 tracks, 39 are in American malls, many of which have 10-year mortgages coming due in 2022.

Deer Park Road’s Mr. Burg, who specializes in complicated bond investments and said his firm had done well by betting heavily on risky home borrowers in the aftermath of the 2008 financial crisis, adopted the mall short before the virus hit. His research suggested similarities between the lax way that home loans were signed in the run-up to the last crisis and the underwriting of many retail mortgages. He also thought there were too many malls.

By the middle of May, the portion of the CMBX 6 with a BBB– rating, which had begun the year trading strongly but was especially popular with short-sellers, had fallen more than 30 points. It has recovered only a few points since then.

“It’s an absolute perfect storm, unfortunately, for the commercial real estate market,” Mr. Burg said. “We see very little that the Fed or government can possibly do to prop this up when there’s so much excess supply.”


Credit…Caleb Santiago Alvarado for The New York Times

To short any CMBX index — there are 13, each tied to a different origination year for commercial mortgages — investors pay various fees, including an annual amount to hold what is essentially an insurance policy that pays out if the mortgages the index tracks default. Those fees might be $300,000 to $500,000 a year for every $10 million of insurance the investor wants to hold.

Before making their bets, some investors who shorted the CMBX indexes engaged in labor-intensive research. Mr. Mudrick and his analysts walked all 39 malls in the CMBX 6 index, from the Northridge Fashion Center in Los Angeles to the Town Center at Cobb in Kennesaw, Ga. Wearing casual clothes, his group paced the perimeters and food courts, snapping photographs and taking notes.

A slide deck on the Crystal Mall in Waterford, Conn., that Mudrick Capital prepared in 2017, when the firm first did the trade, contains maps of the two floors, facts and figures on competing shopping centers and a summary of the tenants classified into categories like “distressed” (Gymboree, Claire’s), “local/non-national” (Lord’s & Lady’s Hair Salons, FroyoWorld) and “notable” (Hollister, Aéropostale). A caption above one picture that prominently displays a J.C. Penney store and few shoppers in the atrium reads: “Interior physical product ok, but tired. Vendor renting ride-able stuffed animals for kids in middle of photo.”

Mr. Mudrick said security workers in the malls sometimes hassled him or his employees. “When we took photos, we tried to do it sort of in a clandestine way,” he recalled.

When Ms. McKee, who this year became a portfolio manager at MP, and Mr. McNamara, her colleague, met Mr. Icahn, their main fund had already invested more than $100 million in the short trade. They were hoping to do more, but some of the investors they were pitching were uncertain, which was why Ms. McKee was hoping for Mr. Icahn’s endorsement.

In February, Ms. McKee and Mr. McNamara started a fund with $30 million in investor capital that was dedicated solely to the mall short. Within a month, they had more than doubled that money, so they closed out the fund in May and distributed the proceeds to investors. MP still retains a short position in its main fund.

“I’m definitely bearish on malls,” Ms. McKee said. “But I think it’s a very case-by-case basis. I don’t think all malls are dying.”

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Hertz, Car Rental Pioneer, Files for Bankruptcy Protection

Hertz, which started with a fleet of a dozen Ford Model T’s a century ago and became one of the world’s largest car rental companies, filed for bankruptcy protection on Friday after falling victim to its mountain of debt.

The coronavirus pandemic has devastated Hertz by grounding business travelers and tourists, making it impossible for the company to continue paying its lenders. A sharp drop in used car prices has also decreased the value of its fleet.

“They were doing quite well, but when you turn off the revenues and you own all these cars and all of a sudden the cars are worth less it’s a very tough business,” said John Healy, an analyst and managing director with Northcoast Research in Cleveland.

Hertz said late Friday that it would use more than $1 billion in cash on hand to keep its business running while it proceeds with the bankruptcy process.

“Today’s action will protect the value of our business, allow us to continue our operations and serve our customers, and provide the time to put in place a new, stronger financial foundation to move successfully through this pandemic and to better position us for the future,” Paul E. Stone, its chief executive, said in a statement.

The bankruptcy filing excludes operations in Australia, Europe and New Zealand as well as the company’s franchisee locations. Hertz also said that it had sought aid from the federal government, but that funding for its industry “did not become available.”

Though it had piled up $17 billion in debt, Hertz, which also owns the Dollar and Thrifty brands, was reporting healthy sales at the start 2020. The company’s revenue rose 6 percent in January and February.

But the pandemic dealt what the company has described as “a rapid, sudden and dramatic” blow. Sales dried up in March as much of the world started to shelter at home. Airports, where Hertz and its competitor Avis Budget Group earn most of their revenue, turned into ghost towns.

By late March, the company started to cut back on spending, sold some of its cars, furloughed workers and combined nearby outposts. Hertz management suggested that they had some room to maneuver, including access to $1 billion in cash.

“Hertz is a resilient company, with resilient brands and resilient people,” its chief executive, Kathryn Marinello, said in a statement at the time.

But Ms. Marinello resigned last week, and Hertz has since laid off or furloughed 20,000 employees, half of its work force. The company had cut pay for senior leaders in March, too, but reversed that decision recently.

The company’s march to bankruptcy began in late April when it missed a payment on a lease for some of its fleet, which includes about 667,000 cars, sport utility vehicles and other vehicles worldwide. It persuaded lenders to give it until midnight on Friday to put together a financial plan that they could accept. But in a filing this month, Hertz acknowledged the enormity of the task.

“If our business does not recover quickly and we are unable to successfully restructure our substantial indebtedness, obtain further waivers or forbearance or raise additional capital, there is substantial doubt that we will be able to continue as a going concern,” the company said.

Hertz had struggled in the years after the financial crisis of 2008 but had begun to turn around recently. Under Ms. Marinello, the company had improved operations, cut costs and reduced its debt, analysts said.

“I have no doubt that had the coronavirus not happened that Hertz would have eventually achieved its turnaround,” said Ryan Brinkman, an automotive industry analyst with J.P. Morgan.

The company’s shares closed on Friday at $2.84, down from around $20 in late February. Carl Icahn, the billionaire investor, owned about 39 percent of the company’s shares as of mid-March.

Its peers were better suited for the moment. Avis Budget Group, which has less debt, said last month that it had access to enough cash to survive the year. Avis, which also raised $500 million in a bond sale this month, acted more quickly to cut costs, analysts said. Enterprise, a private company, is better diversified and not nearly as reliant on rentals at airports as either Avis or Hertz.

When Ms. Marinello took the helm of Hertz in early 2017, she inherited a troubled company.

In addition to amassing a lot of debt, Hertz had recently purchased too many compact cars, which have been falling out of favor with American drivers for years, and failed to meet corporate cost-cutting goals. Her predecessor spun off the company’s equipment rental business. Earlier, Hertz decided to move its headquarters from New Jersey to Florida, which led many seasoned executives to leave the company.

“The company lost a lot of momentum during that time,” Ms. Marinello told investors soon after taking over. She was the company’s fourth boss in three years. And Hertz had been poorly served by “incredibly optimistic demand forecasts” and misguided car purchases, she said.

By some accounts, the company’s modern difficulties date to 2012. That year, Hertz, under the leadership of Mark Frissora, bought Dollar Thrifty in a deal valued at $2.3 billion, a price that some investors and analysts believed was too rich.

“That was the beginning of their troubles,” said Betsy Snyder, a credit analyst at S&P Global Ratings.

In mid-2014, Hertz said it would need to correct its financial results going back three years because of a string of accounting errors. A few months later, Mr. Frissora stepped down.

  • Frequently Asked Questions and Advice

    Updated May 20, 2020

    • What are the symptoms of coronavirus?

      Common symptoms include fever, a dry cough, fatigue and difficulty breathing or shortness of breath. Some of these symptoms overlap with those of the flu, making detection difficult, but runny noses and stuffy sinuses are less common. The C.D.C. has also added chills, muscle pain, sore throat, headache and a new loss of the sense of taste or smell as symptoms to look out for. Most people fall ill five to seven days after exposure, but symptoms may appear in as few as two days or as many as 14 days.

    • How many people have lost their jobs due to coronavirus in the U.S.?

      Over 38 million people have filed for unemployment since March. One in five who were working in February reported losing a job or being furloughed in March or the beginning of April, data from a Federal Reserve survey released on May 14 showed, and that pain was highly concentrated among low earners. Fully 39 percent of former workers living in a household earning $40,000 or less lost work, compared with 13 percent in those making more than $100,000, a Fed official said.

    • How can I protect myself while flying?

      If air travel is unavoidable, there are some steps you can take to protect yourself. Most important: Wash your hands often, and stop touching your face. If possible, choose a window seat. A study from Emory University found that during flu season, the safest place to sit on a plane is by a window, as people sitting in window seats had less contact with potentially sick people. Disinfect hard surfaces. When you get to your seat and your hands are clean, use disinfecting wipes to clean the hard surfaces at your seat like the head and arm rest, the seatbelt buckle, the remote, screen, seat back pocket and the tray table. If the seat is hard and nonporous or leather or pleather, you can wipe that down, too. (Using wipes on upholstered seats could lead to a wet seat and spreading of germs rather than killing them.)

    • Is ‘Covid toe’ a symptom of the disease?

      There is an uptick in people reporting symptoms of chilblains, which are painful red or purple lesions that typically appear in the winter on fingers or toes. The lesions are emerging as yet another symptom of infection with the new coronavirus. Chilblains are caused by inflammation in small blood vessels in reaction to cold or damp conditions, but they are usually common in the coldest winter months. Federal health officials do not include toe lesions in the list of coronavirus symptoms, but some dermatologists are pushing for a change, saying so-called Covid toe should be sufficient grounds for testing.

    • Should I wear a mask?

      The C.D.C. has recommended that all Americans wear cloth masks if they go out in public. This is a shift in federal guidance reflecting new concerns that the coronavirus is being spread by infected people who have no symptoms. Until now, the C.D.C., like the W.H.O., has advised that ordinary people don’t need to wear masks unless they are sick and coughing. Part of the reason was to preserve medical-grade masks for health care workers who desperately need them at a time when they are in continuously short supply. Masks don’t replace hand washing and social distancing.

    • What should I do if I feel sick?

      If you’ve been exposed to the coronavirus or think you have, and have a fever or symptoms like a cough or difficulty breathing, call a doctor. They should give you advice on whether you should be tested, how to get tested, and how to seek medical treatment without potentially infecting or exposing others.

    • How can I help?

      Charity Navigator, which evaluates charities using a numbers-based system, has a running list of nonprofits working in communities affected by the outbreak. You can give blood through the American Red Cross, and World Central Kitchen has stepped in to distribute meals in major cities.