Lippmann’s LibreMax Beats Peers With Bets on ‘Toxic’ Mortgages

LibreMax Capital LLC, co-founded by former Deutsche Bank AG trader Greg Lippmann, beat rivals last month with wagers on mortgage securities, including those backed by loans called “toxic” by a government commission.

LibreMax Partners LP gained 2.29 percent in January and has increased 6.55 percent since its inception in October, according to a monthly performance report to investors obtained by Bloomberg News. The gain for January was the fund’s biggest since its start, the report said. Hedge funds that focus on asset-backed securities globally climbed 1.97 percent in January, Bloomberg data show.

Lippmann, 42, who gained fame for his bets at Deutsche Bank against subprime mortgage securities before the housing market collapsed, is now profiting by buying subprime mortgage bonds that were created before housing prices peaked. Investments in option adjustable-rate mortgages, which allow borrowers to pay less interest than they owe by increasing principal, produced the biggest gains last month, the fund manager told investors.

“We believe securitized products are fundamentally cheap to broader markets,” Lippmann wrote in a letter discussing the fund’s fourth-quarter performance, also obtained by Bloomberg. Compared with high-yield corporate debt, “generally these bonds are 200 or more basis points higher in yield at our assumptions,” he said, adding that investments are made assuming housing prices drop 10 percent from current levels and that as many as twice the number of borrowers default as are currently delinquent.

‘Substantial Upside’

“To the extent that unemployment begins to decline or that home prices stabilize, there could be substantial upside beyond the expected return on our investments,” Lippmann, 42, wrote.

The trader left Deutsche Bank last year to start LibreMax with Fred Brettschneider, the German bank’s former head of global markets in the Americas. The firm has more than $500 million under management.

Lippmann’s team made almost $2 billion for Deutsche Bank in 2007 wagering against subprime debt through credit-default swaps as homeowner delinquencies soared, according to “The Greatest Trade Ever” (Broadway Books, 2009) by Greg Zuckerman.

Jonathan Gasthalter, a spokesman for LibreMax in New York, declined to comment.

Option ARMs

LibreMax had its biggest gains in January from senior securities backed by option adjustable-rate mortgages. The securities jumped about 6 cents to 64 cents on the dollar last month, according to Barclays Capital.

The Financial Crisis Inquiry Commission said the loans, which for some borrowers can more than double payments as interest is deferred and principal increased, were among the “toxic” debt at the center of the “corrosion of mortgage-lending standards.”

While the fund isn’t selling the securities after “a dramatic rally,” Lippmann wrote, it likely would only add to its holdings if prices dropped.

Gains on the mortgage debt were reduced by hedges the fund has bought against declines in high-yield bond and equity markets, according to the letter on January’s performance.

LibreMax’s biggest bet is on bonds backed by subprime loans, those made to borrowers with the worst credit, that were created in the first half of 2005 and earlier, before the peak in housing prices, according to the quarterly letter. The loans from that period typically have lower combined loan-to-value ratios that reduce the severity of losses and other risks that can diminish the value of the bonds while also increasing the borrowers’ incentives to pay, Lippmann said.

“These securitizations have consistently shown superior collateral performance versus those issued in the second half of 2005 and later,” he said.