Ben Shoval, Managing Director of Ambit Funding, answered a few questions for us about the firm he and his partners run and how they are enabling hedge fund investors to generate returns by taking an unusual approach to investing in the asset-based space.

Your hedge fund has an atypical strategy. How do you describe your firm and what it does?
Ambit Funding is an asset-based lender that makes short-term, real estate-backed loans to commercial real estate developers. We neither buy nor sell our loans. We underwrite, originate, and service them to maturity.

Ambit offers hedge fund investors the opportunity to earn returns in the range of 10% to 13% on a very consistent basis, from loans backed by commercial real estate with low loan-to-value ratios. Our internal due diligence processes are similar to those at commercial banks. Our staff of over 20 people includes an in-house lawyer, a compliance officer, a chief operating officer, a three-person accounting department, and an underwriting group. Many of our employees have experience with real estate and/or commercial banking.

Since Ambit’s strategy doesn’t fit into a standard product style box category how are investors seeing using your fund?
We’re finding interest from investors who are looking for one of four things:

• An alternative fixed income investment.
• An alternative to investing in traditional mortgage pass-through securities, since they are more sensitive to interest rate changes and prepayment risk.
• Adding total return to the more market-like returns generated by their core equity allocation.
• A buffer against the downside risk exposure from a core equity allocation.

Also, there are a growing number of asset-based funds-of-funds. Some of them allocate to us alongside premium finance, life insurance settlements, credit card receivables and similar strategies.

What is your investment process with regard to capturing investment inefficiencies?
Real estate projects can fail for many reasons. One of the most common is that in the first phase of the project banks can not or will not provide financing, usually for regulatory reasons. This is the most common reason real estate developers borrow from us. We are the bridge between the start of their projects and the time when banks will lend to them.

The market for these types of loans is fragmented.  Information is very opaque. So, there is much less capital than there is demand. These are the primary sources of the inefficiencies that we capture.

What is your risk management process for protecting your clients from downside risk?
We’re conservative asset based lenders. So, risk management is the most important consideration in our comprehensive due diligence process for vetting bridge loan financing opportunities. Our vetting process analyzes a number of factors, including the character and history of the borrower, the value of the collateral, the area fundamentals where the property is located, the market liquidity of the borrower’s collateral and the soundness of the borrower’s repayment strategy.

To provide additional downside risk protection, our portfolio construction includes three additional forms of diversification:

• Geographic diversification of the real estate bridge loans in the portfolio;
• Sub-asset class diversification in which various types of real estate are collateral for the loans; and
• Staggered expected payoff dates for the loans.

We also generally get personal guarantees from borrowers.

How much capacity does your strategy have?
Our strategy depends in part upon having a sufficient number of loans to underwrite and originate.

We receive most of our lending opportunities from commercial mortgage brokers. They come to us because we can bridge the gap until their clients get their longer term bank financing.

To expand our sources of bridge loan in-flow, we recently hired someone whose full time job is to recruit and manage our firm’s relationships with mortgage brokers. In addition to steering brokers who have with experience with bridge loans to us, he will be educating many other mortgage brokers about how we originate and service short-term real estate-backed bridge loans. As brokers come to learn what we do, they quickly appreciate that they now have an outlet to source deal opportunities to that they previously had to turn away.

We expect our assets under management to grow to $500 million or so within two years. There is tremendous demand for asset-based funds such as ours.

How will your investment returns be affected by varying interest rate regimes?
Since our loans are short-term bridge loans, they’re generally not correlated with interest rates. The marked change in prevailing market rates during the last few months has not hurt our pricing. Also, in conducting our due diligence we focus on the price that each borrower’s project can reasonably support, not the interest rate environment.

Can you discuss an adverse investment event, quantify its investment impact, how you dealt with it, and measures you have taken, if any, to mitigate or prevent any recurrence of that event?
Some projects may have setbacks. That’s the nature of lending to real estate developers, whether by commercial banks or by other lenders. I’ll give you an example.

We had a borrower with a quality project that depended upon a future tenant signing a lease before the bank would lend. When examining the project, we recognized that the collateral was very strong and that the borrower only wanted us to lend a modest portion of its value. So, we made the loan. Everything proceeded according to plan until the future tenant began dragging his heels when it came to signing the lease. It became clear that even if the lease was signed on time, the bank would have insufficient time to lend, replacing our bridge loan.

To resolve the problem amicably, we worked with the developer to find a new equity partner. This person bought the current partner’s equity piece. The new partner had a significant relationship with a major commercial bank and was able to secure long-term financing quickly. We were repaid – with default rate interest. And the tenant signed the next month. So, we ended up making even more off of this transaction that we would have if there hadn’t been a project setback.

Are there any factors particular to your strategy that affect raising and deploying more assets?
We are seeing strong investor demand for our funds, both in the U.S. and internationally. Because we need to balance our inflows with loan originations, we work with our investors to ensure that money flows into our funds at appropriate intervals. It’s our preference not to have to sit with too much cash on hand, just awaiting loan investment opportunities. So we aim for getting investor commitments that, ideally, permit us to have “just in time” funding as we originate new real estate-backed short-term bridge loans. As our loan deal flow continues to grow, we expect to be able to increasingly add investor dollars into our funds.

Switching gears, what is the current state of the CRE CDOs?
If the question is “What is the state of CRE CDOs this quarter,” my answer is, “things have been better.” But I don’t think the problem has all that much to do with CRE CDOs per se. Risk simply got repriced across virtually all debt in the last few months. Compared to residential CDO pricing over the past few years, CRE CDO repricing looks pretty benign.

However, issuance is down for two reasons. Issuance is down for almost all debt. Even triple-A municipal bonds aren’t selling. Specific to CRE CDOs is that the banks that put them together have to decide what is going to go in them going forward. Investors are likely to expect stronger rent rolls and leases.

How do CRE CDOs compare with bridge loans?
There’s not much overlap. CRE CDOs offer the nice feature of allowing everyone to participate -- from investors seeking high credit ratings to those willing to take a good amount of risk in pursuit of higher returns.

With bridge loans, everyone is typically in the same boat, with the potential for significantly higher returns compared to the equally risky parts of CRE CDOs.

Are CRE CDOs a viable financing vehicle?
They’re a terrific financing vehicle, assuming the underlying assets and cash flows fit.

Why would someone use CRE CDOs for financing real estate?
The cost of capital tends to be quite low, there are typically minimal restrictive covenants and the money is locked up for several years.

Why are they so popular?
There are four key reasons CRE CDOs have been popular:

1. They offer a low cost of capital.
2. They tend to have minimal restrictive covenants.
3. They have a long lockup.
4. At least in the past, they’ve been easily raised.