Friday, 27 March 2015
Last updated 11 min ago
May 8 2013 | 9:19am ET
Millenium Partners vet Michael Craig-Scheckman founded Deer Park Road Corp. in Steamboat Springs, Colorado in 2003. The firm, which focuses exclusively on distressed asset-backed securities, recently closed its flagship STS Partners Fund to new investors at $750 million and launched a new vehicle—the Burgess Creek Fund.
FINalternatives Senior Reporter Mary Campbell spoke to Deer Park Managing Director Will Bashan and Portfolio Manager Scott Burg about the “phenomenal” opportunity they see in asset-backed securities and the return of investor interest in the asset class.
I'm curious about your fund names. What are the origins of STS and Burgess Creek?
Bashan: We tend to be pretty uncreative with our names [laughs]. STS really stands for Ski Time Square, which is our address, and Burgess Creek is a creek that is right outside our office.
Burg: It's a chairlift outside our office, too.
How is the new fund structured?
Bashan: It's going to be very similar: a master-feeder structure, onshore/offshore.
What is your approach to risk management and has it evolved since the financial crisis?
Burg: Risk management's a pretty broad word—portfolio risk, operational risk, compliance risk—we basically have done a lot more as we've grown. In terms of the portfolio, we've expanded some of our capabilities of understanding how certain positions affect our sensitivity to future interest rates, for example. We've tried to alleviate some of the interest-rate risk through our structure of our portfolio—we don't use any external hedges, we're actually trying to sterilize that interest-rate risk. Or, if we've decided in a specific environment that we want to take a certain position on interest rates, we can attempt to do that within the bonds and the structure of our portfolio, whereas other firms use some external hedges or they do stuff with Treasuries. We're able to, in this environment, respond to the interest-rate risk and strive to get what we consider both beta and alpha returns.
You don't use leverage in the STS fund and you won't in the new fund. Why?
Burg: A lot of these structures have embedded leverage within them, and I think that a lot of people didn't understand the amount of leverage that was in a lot of these instruments, such as collateralized debt obligations and CDOs-squared, that really helped intensify the crisis and the crash. In such a low-yield-environment, where structures already have leverage, it could be considered a little reckless to continue to add leverage. And we feel that we can get the returns without utilizing leverage.
Was this fund difficult to market post-financial crisis?
Bashan: When we launched STS in May of '08, we really didn't start marketing it until mid- to late-2009, post-mortgage crash, and there were numerous occasions where you would talk to investors and they would say, "I've been in mortgages, I don't do mortgages anymore, I got burned in mortgages." Now, it's actually kind of gone full circle; that issue has really dissipated and I haven't heard that in years. Now, people say, "Mortgages have been doing so well, they've been out-performing every other asset class, I guess there's no juice left." We wholly dispute the notion that there's no opportunity left; we're seeing phenomenal opportunity in our markets. But that's the investor sentiment that sometimes we see.
Where, exactly, do you see opportunity these days?
Burg: We're seeing opportunities still where we think a lot of people are not looking. We're lower down in the capital structure, and we're also looking in different asset classes—I mentioned one earlier, CDOs. We've been buying commercial mortgage-backed securities, we've been selectively buying things in sub-prime, Alt-A and prime. We just bought an Alt-A RSC deal where there's all this settlement optionality within the deal— it's like the Countrywide settlement: There's so many good things that could happen. We own $400 million of Countrywide bonds that are part of the settlement, so these are all lower capital structure, credit interest onlys, single-digit bonds. When you start to price in that settlement, it's a pretty amazing opportunity.
What criteria do you use in evaluating an investment?
Burg: The interesting thing is, they're all like the Rorschach Test: It's really in the eye of the beholder. We obviously have our statistics and all our systems, and you look at different types of trend analysis, but at the end of the day, you're really making a judgment call.
I just did a bid list, and we owned just over $15 million original face on one of the bonds. We sold it in the very high 30s, but we had a bid from someone of 1 and 24, we had a bid of 6, we had a bid of 12, we had bids of 20, 25, 28, 29, and then a cluster of 30s and a couple of mid-30s. And you're sitting here going, how is this possible? The 1 and 24, it's, in any of my scenarios, a 300% yield, which just doesn't make any sense.
I think it's pretty fascinating that, even though things have been going up, even though prices have been increasing, transparency's been increasing, with some of these bonds that have a lot of embedded leverage—this bond has a lot of embedded leverage—you can have a significant variation of valuations.
What is your outlook for the housing sector?
Burg: You always hate to be with the crowd and we try to stay away from them. The way we're running bonds, and our future expectation is anywhere from 0% for 2013 up to, let's say, 4%. Now, our personal belief is probably along the lines of what you saw from JPMorgan Chase, Morgan Stanley and even Bank of America: They just all raised their expectations for the year up to a high single-digit, very low double-digit home price appreciation for 2013. In that sort of environment, once again, it makes these assets look very attractive.
Who is your target investor for the Burgess Creek fund?
Bashan: We think that it will have a great amount of appeal to endowments, foundations, universities, pension funds and larger family offices. What makes this fund relatively unique is the focus on cash flow and yield. In the foundation, endowment, university market, these institutions have operating budgets that they have to cover, so in essence, they need absolute return. We have a fair number of these kind of clients in our current fund, and that's one of the things that has attracted them to us.
How is the current fundraising environment?
Bashan: Well, the current fundraising environment for STS is very, very good for us. At the beginning of 2012, we had an AUM of just below $150 million and we just closed the fund in March, a little bit over a year later, at $750 million.
We've had very good interest in terms of the new fund that we're about to roll out, we just released the market materials and just announced that we were coming out with a new fund, the first subscription is June 1, so we have indications of interest and indications of investment but obviously, until June 1 comes, you don't know for certain.
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