“The young, youngish and seasoned principals of Bienville Capital Management, New York and Mobile, Alabama, hold informed opinions on China, Europe, gold and the world’s monetary affairs. They travel, think, read and consult. And then, all at once, it came to them. The opportunity they were searching for is the one they are virtually sitting on.”
– Grant’s Interest Rate Observer
The always articulate and exceptionally brilliant James Grant recently highlighted the work of our good friends at Bienville in his most recent letter. We are no strangers to the Redneck Riviera ourselves, having studied the hundreds of thousands of acres owned by The St Joe Company after a devastating oil spill in 2010, and more recently, personally “vacationing” in Apalachicola during Tropical Storm Debbie! Despite the occasional hurricane winds, Northwest Florida is home to some of the most beautiful beaches in the country. And some of the best values in real estate today.
More broadly speaking, it appears the US housing market is in a bottoming process, as valuations have returned to normalized levels (chart above). Several years of underbuilding since the crash, coupled with ongoing population growth, should ultimately result in pent-up demand for homes. By no means are we calling for a return to the glory days and it is easy to make the case for additional downside given increasing risk of recession. But we think the worst is behind us, with US home prices down over a third in seven years, consistent with the average duration and magnitude of historical housing busts across the developed world. We are working on a much more thorough report on housing and related opportunities shortly, but in the interim, an excerpt from a recent investors letter follows:
“We aim to allocate an increasing portion of our assets to income generating investments with current cash flow. In a world chock full of largely inflated asset prices, we prefer a bird in hand (income) to one in the bush (capital appreciation). In a world void of yield, collateralized credits with attractive yields are particularly appealing given that short term rates are pegged at the zero bound for the foreseeable future. Mortgage backed securities are roughly 25% of the US bond market today, an opportunity set even larger than the corporate bond market. As shown below, loss-adjusted yields in the non-agency portion of the market remain far higher than income available from other fixed income markets. We believe this opportunity exists due to several technical dislocations in the market which are likely to diminish over time. First, non-agency credit is excluded from the Barclays Aggregate Index, precluding many fixed income managers, particularly those of the benchmark-hugging variety, from holding the bonds, at least in any meaningful size. Second, many of those institutions that did invest in the space are forced sellers today. Banks are largely absent due to changing regulations which mandate greater capital requirements for “risk assets” – meaning these bonds are being sold by (European) banks forced to deleverage their balance sheets. Ironically, debt issued by the same governments making these rules is still considered “risk free” in terms of capital requirements. Insurance industry participation is also limited due to changes in credit ratings. Finally, we believe there is a general misconception amongst investors that mortgage backed securities are a bad investment because housing is a bad investment. Importantly, correlation does not imply causation between two variables (i.e. housing and mortgage backed securities), particularly in the presence of a third variable – price. Put simply, once everyone believes something is risky, price is usually compressed to the point where it’s not risky at all. The price you pay determines the risk you take. Given the loss-rates already baked into the non-agency market, we see little risk at today’s price, and the potential for handsome gains if that much-lamented housing recovery ever comes around.”
Most managers in the mortgage space we speak to are not at all optimistic on housing. Some are even preparing for something closer to a “depression case,” despite signs of improvement in the market. But given the prices on offer in segments of this market today, many are resolutely bullish. As are we. For a closer inspection of the housing market and the constructive case for mortgage securities, or just for a good time, take a look at Bienville’s U.S. Housing Investment Theme, embedded below.