Author / Date: Joshua Peach — October 16, 2023
Source (URL):https://www.afr.com/markets/equity-markets/how-this-hedge-fund-pulled-off-2023-s-big-short-20231012-p5ebrm
Republished By:Sohn Hearts & Minds
Echoes of the GFC in Azora’s ‘big short’
Joshua Peach
Monday Fundie | Ravi Chopra, Founder and Chief Investment Officer, Azora Capital
The hedge fund successfully shorted all four of the US banks that failed in March and sent financial markets reeling.
Last year, Ravi Chopra was travelling through Europe to help explain his team’s investment thesis to external fund investors. Azora, Chopra’s hedge fund based in New York, was building short positions in a range of US banks as bond values tumbled and a select class of lenders with huge holdings of fixed-rate assets began to show cracks.
“We were looking for these that, from our view, were clearly capital impaired and would rather be repriced or liquidated than deserve to survive as a going concern,” Chopra said.
By the time the regional-banking crisis hit in March this year, Azora had shorts in all four of the US banks that would later fail — Silicon Valley Bank, Signature Bank, Silvergate and First Republic.
“History was rhyming — things were looking pretty similar, but the drivers were different,” Chopra says.
One decade on from the worst crash in a century, the differences were real. “Now we weren’t dealing with a credit meltdown and there was no highly leveraged, sophisticated credit instrument blowing up,” he says. “This was interest-rate exposure and asset-liability mismatch that had been building for years and had gone largely unnoticed.”
Chopra explains that while credit losses dominated 2008, the more recent problem was duration and liquidity risk from mismatched bank balance sheets.
“In the US, interest rates were at zero for so long that banks kept buying long-dated fixed-rate securities. When rates rose fast, those assets plunged in value — but liabilities (deposits) re-priced instantly.”
Looking around, Chopra says that some banks, much like American citizens stuck at home during the pandemic, had gone on stimulus-led shopping sprees. “They were buying Treasuries and agency securities with 10-year maturities, financed by short-term deposits. When depositors ran, it was over.”
“Banks that touched growth tech lenders, like Silvergate or Signature, were especially hit because those deposits were hot money — non-insured, non-sticky.”
Chopra describes his firm’s research as “very weeds-down” and heavily quantitative. “Financials are all numbers and modelling — it’s not macro bets, it’s spread-sheet bets,” he says.
“We built our own models for unrealised losses and deposit composition using regulatory data filed quarterly by US banks. By mid-2022, bond portfolios of some banks had unrealised losses equal to half of their tangible capital.”
“When rates rose, banks suddenly had to fund at higher cost but could not sell those securities without realising massive losses — it was a liquidity death spiral.”
Azora Capital built the shorts in the back half of 2022 and early 2023, amid rising Fed tightening bets. “By January we were ready,” Chopra recalls. “By March we had a basket of 15 names on the short side.”
When the crisis hit, Azora was up more than 20 per cent year to date and its flagship financials fund had its best month ever. “Still, we knew we needed to cover fast and redeploy capital to better-risk-adjusted ideas,” he adds.
Chopra has since rotated into select financials he believes will outperform as rates stabilise and deposits normalise — including Webster Financial, highlighted as his top pick for the 2023 Sohn Hearts & Minds Conference.
“We’re in a very different phase now. But the lesson is the same — you must understand duration and liquidity risk from first principles,” he says.
— Reproduced courtesy of The Australian Financial Review (16 Oct 2023 p.27).
