The Big Long: Faith in Underwater Mortgages Nets Hedge Fund $2.6 Billion Payday
The film “The Big Short” is about how Michael Burry’s Scion Capital and others famously uncovered the housing bubble and sought to profit from it.
Fir Tree Capital Management was part of this story as well, except they were on the other side of the table. They noticed the crash taking place in sub-prime mortgages and associated derivative products because they found them at abnormal discounts from panicking investors. While the story of Burry, Scion, and the rest is one of finding banks to essentially place one of the largest wagers of all time against mortgages the banks allegedly believed in and their overall value, the story of Fir Tree is of picking up discount bags and carefully selling them. They had also bet against some of the credit default swaps on offer, but not in the extremes that others had.
Betting On American Dream
The fundamental underpinning of their $2.6 billion (to date) success story is human nature. While the movie “The Big Short” shows people abandoning their properties instead of paying mortgages that made no sense, the reality is what you might expect: people don’t get into homes with the intention of not paying for them, by and large. Many of the stories depicted in the Big Short are those of people who had bought “investment” properties and, when the properties inevitably corrected in value, gave up on. The part of this story that the movie and its associated book did not focus closely enough on was the legally deficient methodology these loans were given under.
After ridding themselves of garbage mortgages, banks were still liable for their shady practices – and this is how Fir Tree has recouped up to half of its $2.6 billion in proceeds from the sub-prime mortgages it picked up dirt cheap during that period of time. According to the Wall Street Journal:
Clinton Biondo, one of Fir Tree’s managing partners, said the firm figured the securities selling for cents on the dollar were so cheap, it could still break even if most of the loans defaulted. […] By 2013 Fir Tree, at a cost of about $1 billion, had acquired second-lien bonds with a face value of roughly $9 billion, according to people familiar with the matter.
The rest of the money came exactly as Fir Tree expected it to: through homeowners paying their mortgages regardless of the “value” of their homes.
On paper, it may not make sense to continue paying a price that’s higher than what you could ever realize from a property. But if you bought such a place with the intention of housing your family for life, and not merely as a place to become some sort of slum lord, as depicted in the Big Short’s Florida scenes, then the cost of walking away is much greater than “lost value.” Home ownership is a right of passage in the American ethos. And even though it was relatively easy to secure a mortgage in the early 2000s, few would have been naive enough to believe that simply walking out on one would lead to better pastures down the road.
Fir Tree understood all of this then, and now they are reported to be finishing up the deals they started back then. They “favor” deals which may ultimately require a judge’s oversight.
Fir Tree’s Understated Success Model
Fir Tree is reported to currently manage around $8 billion in assets, and the firm is rather opaque in public facing information.
We in the blockchain world are used to loud venture capitalists and personalities. But Fir Tree’s top tiers don’t have much floating around the open internet about them, and even their pictures are hard to see.
In a rare move of publicity, they published an open letter earlier this year as regards a firm they are deeply invested in, Halcón Resources Corporation, a publicly traded outfit, and their demand that it make certain moves to secure a large cash reserve.
The way Fir Tree sees it, Halcón shares are undervalued at present time. Halcón should, therefore, sell assets that Fir Tree believes are a long-term waste of time and use some of the proceeds to repurchase outstanding stocks that are currently on discount.
Halcón is fortunate to have two terrific acreage positions in Pecos and Ward County. While Pecos provides extremely high quality Permian acreage, it’s not the Company’s crown jewel. Rather, the Company has two decades of higher ROIC inventory to drill in Ward County. The Company does not have excess capital or scale to drill both counties simultaneously. […] Pecos is more valuable in the hands of a larger producer who can use its operational scale and strong balance sheet to drill more efficiently. […] Having a significant net cash position (instead of net debt) will allow the Company to buy back a large portion of its market cap, and still have enough dry powder to continue its growth in Ward County.
The demands, as it were, come from Fir Tree’s stance as a collective manager of around 7.2% of Halcón’s overall stock. Given the fund’s performance on long-term positions like “underwater” mortgages, at time of purchase deemed to be garbage by the sellers, it would seem that HRC would be wise to heed their advice.
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