First came the big short. Then, for Milan Patel, came the big long.
With the financial crisis raging in January 2009, Patel and a handful of colleagues hit upon the trade of their life: They would put up their own money to buy the complex securities that everyone else was dumping.
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Anatomy of a Scene: The Big Short
Director and co-writer Adam McKay narrates a sequence from his film The Big Short featuring Ryan Gosling and Steve Carell.
By the time they sold, they'd racked up returns of as much as 800 per cent, turning bonds trading at pennies into millions of pounds. The twist is that much of what they were buying -- toxic asset-backed debt -- was the kind of paper they'd loaded onto the books of their employer, HBOS, which helped sink the institution.
If investors like Michael Burry shot to fame and fortune for their bets against the crowd -- now celebrated in the movie "The Big Short" -- Patel's tale is a timely reminder of keeping your nerve when all around you are losing theirs.
"After subprime blew up, everyone said asset-backed securities have to go," said Patrick Janssen, a money manager at Prudential Plc's M&G unit, which oversees about £250 billion ($503 billion). "Those that were able to tune out that advice and make their own decisions did very well."
The early days of 2009 were a strange time for Patel, who was still collecting a paycheck but prevented by his employer from trading. It had been less than a decade since HBOS was formed by the merger of Halifax, Britain's biggest mortgage lender, and Bank of Scotland, which was established in 1695. By now, it had received a secret central bank cash infusion, a £20.5 billion taxpayer bailout and a state-brokered takeover by what became Lloyds Banking Group. The company counted 22 million customers, more than a third of the UK population.
From his perch on the credit-trading desk with a view of Deutsche Bank's limestone-clad office across the street, Patel, along with his boss Richard Paddle, were stuck in a trader's purgatory.
Emerging from trader's purgatory
"I would think what am I doing? I'm regressing," said Patel, 42, who was born in the UK to Indian parents and spent much of his childhood in Kenya.
They spent their days calculating the performance of the asset-backed portfolio, forecasting how deep the losses could be and preparing reports for management. As they dug through spreadsheets and bond documents, they discovered securities at prices totally out of whack with their underlying assets -- much as the famous short sellers did just a few years earlier.
The pair bet the UK housing market would avoid the mass defaults that hammered the US. There was money to be made, they figured. But Patel and Paddle wouldn't be buying for the bank.
Investing as much as £50,000 a time, they bought separately, together and in small groups with two or three other HBOS colleagues. They bought distressed asset-backed securities, typically secured by UK mortgages, as well as bank bonds.
The most profitable trade involved notes secured by mortgages made by Northern Rock, which in 2007 needed a UK government rescue after succumbing to the first bank run in the country in 140 years -- a harbinger of what was to come. The securities, known as Granite, collapsed after the bank was nationalised.
"Granite traded lowest and gave the best returns by far," said Paddle, 44, a mild-mannered Englishman who has worked in the City of London for his almost 23-year career. "There was a concern in the market that the UK government would rip it up."
They bought the riskiest Granite bonds, which put them first in line for losses, for 8 pence on the pound, or less than 10 per cent of their original sale price.
The pair invested about £8000 each and pocketed about £70,000 about two years later when they sold at about 70 pence, a return of almost 800 per cent. Granite bonds were redeemed in December and January after the government sold the underlying mortgages to Cerberus Capital Management.
Paddle, who joined HBOS in 1998, was responsible for managing the majority of assets that could be sold quickly for cash. Patel arrived at the Scottish lender from Chase Manhattan Bank a year later.
The duo was instrumental in the growth of Grampian Funding, an HBOS vehicle that issued short-term notes to buy longer-dated asset-backed securities. The unit became the largest seller of asset-backed commercial paper in Europe with £19 billion of assets in 2007, from £9 billion in 2002.
Grampian ran into trouble in August 2007 when the subprime mortgage rout in the US spread to European banks and shut off the credit tap.
The rapid growth of Grampian, and the larger asset-backed debt portfolio managed by Paddle and Patel, mirrored the aggressive expansion of HBOS. In the seven years since the merger creating the lender, its assets more than doubled to £630.9 billion.
That proved to be the bank's undoing as lending outpaced deposits, a UK parliamentary commission concluded in 2013. Last year UK regulators said HBOS failed when it was unable to fund itself after investors questioned its solvency.
"People knew that there was massive liquidity risk," said Paul Moore, HBOS's former head of risk who says he was fired in 2004 after warning about inappropriate sales of insurance and bond products. The bank "just carried on towards disaster."
In January 2009, the month Paddle and Patel officially became employees of Lloyds, they sought permission from the compliance department to buy asset-backed bonds -- a standard procedure for money managers wanting to invest their own cash -- the first of many hurdles on their way to making a fortune.
Ewan McCulloch, a spokesman for Lloyds, declined to comment on the trades Paddle and Patel made while employed by the bank.
The asset-backed market is nearly impenetrable for individual investors, with many bonds featuring minimum denominations of £100,000 and requiring specialist knowledge.
When the market collapsed, access became easier. At 10 pence on the pound, the minimum threshold for investment dropped to £10,000. The next obstacle was execution.
It took as long as two hours for Patel to explain to the anonymous call-centre operative in Glasgow what he wanted to buy and how to find it.
"Ninety five per cent of the stuff I wanted to buy they had not heard of," Patel said. "It was very painful."
It was worth it.
Paddle invested about £300,000 in subordinated bank debt and asset-backed securities, averaging returns of about 150 per cent, while Patel put in about £350,000 and achieved an average of 350 per cent, they said.
Paddle made about £450,000, while Patel made about £1.2 million, according to Bloomberg calculations. Both men made the majority of their investments using their pension funds, meaning most of their gains can't be accessed until they retire. Paddle says his profits partially offset losses on his HBOS share holdings, while Patel's gains exceeded losses on his stock position.
Having been unable to find another senior banking role in the asset-backed market after leaving HBOS in September 2009, Paddle later became a financial adviser, offering expertise on pensions and investments to wealthy individuals in London. Patel, who also left HBOS in 2009, went on to co-invest with a friend in an Indian startup that makes precision components for mining. He's now seeking to return to the market.
"Something big happens every decade," said Paddle. "This was happening in my market in something I knew in intricate detail. That's a once in a lifetime opportunity."