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Wall Street has found its next big short in the US credit market

Many mall complexes may soon buckle under their debts, much the way many homeowners did nearly a decade ago

Wall Street speculators are zeroing in on the next US credit crisis: the mall.

It’s no secret many mall complexes have been struggling for years as Americans do more of their shopping online. But now, they’re catching the eye of hedge-fund types who think some may soon buckle under their debts, much the way many homeowners did nearly a decade ago.

Like the run-up to the housing debacle, a small but growing group of firms are positioning to profit from a collapse that could spur a wave of defaults. Their target: securities backed not by subprime mortgages, but by loans taken out by beleaguered mall and shopping centre operators. With bad news piling up for anchor chains like Macy’s and JC Penney, bearish bets against commercial mortgage-backed securities (CMBS) are growing.

In recent weeks, firms such as Alder Hill Management—an outfit started by protégés of hedge-fund billionaire David Tepper—have ramped up wagers against the bonds, which have held up far better than the shares of beaten-down retailers. By one measure, short positions on two of the riskiest slices of CMBS surged to $5.3 billion last month—a 50% jump from a year ago. “Loss severities on mall loans have been meaningfully higher than other areas," said Michael Yannell, head of research at Gapstow Capital Partners, which invests in hedge funds that specialize in structured credit.

Nobody is suggesting there’s a bubble brewing in retail-backed mortgages that is anywhere as big as subprime home loans, or that the scope of the potential fallout is comparable. After all, the bearish bets are just a tiny fraction of the $365 billion CMBS market. And there’s also no guarantee the positions, which can be costly to maintain, will pay off any time soon. Many malls may continue to limp along, earning just enough from tenants to pay their loans. But more and more bears are convinced the inevitable death of retail will lead to big losses as defaults start piling up.

The trade itself is similar to those that Michael Burry and Steve Eisman made against the housing market before the financial crisis, made famous by the book and movie The Big Short. Often called credit protection, buyers of the contracts are paid for CMBS losses that occur when malls and shopping centers fall behind on their loans. In return, they pay monthly premiums to the seller (usually a bank) as long as they hold the position.

This year, traders bought a net $985 million contracts that target the two riskiest types of CMBS, according to the Depository Trust & Clearing Corp. That’s more than five times the purchases in the prior 3 months.

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