4 March 2008

Ebola of the Financial kind

March 3 (Bloomberg) -- The extra yields investors demand on bonds backed by assets from commercial mortgages to credit cards rose to records last week, as the debt-market slump prompted banks, hedge funds and other investors to shun the securities.

The extra yields, or spreads, over benchmarks have surged since mid-2007 as a weakening U.S. economy erodes confidence in the bonds' credit quality and as losses on debt investments lead to forced sales and reduced demand. The spread widening may herald more losses for the world's largest banks, which have reported more than $180 billion in mortgage-related losses.

``People are calling it financial Ebola,'' Ed Steffelin, a senior managing director at GSC Group in New York, said in a telephone interview last week, referring to the deadly, contagious virus named after the Ebola River Valley in the Democratic Republic of the Congo.

Yields on three-year, AAA rated credit-card bonds with floating rates rose to 75 basis points over the London interbank offered rate, up from 40 basis points at the start of the year, according to Deutsche Bank AG data. Spreads over three-year swap rates for three-year, AAA rated fixed-rate auto-loan securities rose to 140 basis points, up from 75 basis points. The average spread over U.S. Treasuries on AAA rated commercial-mortgage securities climbed to 364 basis points, from 167 basis points on Dec. 31, according to Lehman Brothers Holdings Inc. index data.

A basis point is 0.01 percentage point.

Subprime Bonds

Deerfield Capital Corp., a Chicago-based investor in mortgage- and asset-backed bonds, last week said it's sold ``substantially all,'' or $1.3 billion, of its residential bonds that lack guarantees from government-linked entities such as Washington-based Fannie Mae this year through Feb. 15.

The company needed to ``increase our liquidity position'' at a faster pace than originally planned as prices fell for the securities, which Deerfield used as collateral for loans, Chief Executive Officer Jonathan Trutter said in a Feb. 29 statement. Deerfield reported a $110 million fourth-quarter loss and sold the securities this quarter at a loss of about $152 million.

Spreads for three-year AAA bonds backed by U.S. subprime or home-equity loans rose to 380 basis points, up from 250 basis points, according to Deutsche Bank, Germany's biggest bank. Default rates on subprime mortgages, sold to borrowers with poor credit or high debt, have surged to records.

Commercial Mortgages

Such securities lost 5.9 percent last month, when price drops and interest payments are considered, according to Lehman Brothers data. They have cost investors 9.3 percent so far this year and 18.1 percent over the past 12 months.

It's become difficult, if not impossible, for investors to determine how much holdings of mortgage- or asset-backed bonds are worth because new issuance and trading has nearly ceased, according to bond buyers such as Sanjeev Handa, head of global public markets at TIAA-CREF, and Thornburg Mortgage Inc., the Santa Fe, New Mexico-based mortgage investor.

AAA rated commercial-mortgage securities slumped 3.5 percent last month and have dropped 4.7 percent so far this year, according to a Lehman Brothers index. AA securities fell 10.3 percent in February and have lost 15.6 percent this year, according to an index from the New York-based company.

Top-rated credit-card and auto securities last month returned 0.04 percent and 0.06 percent, respectively, according to Lehman. They've returned 1.9 percent and 0.79 percent this year. Swap rates are the fixed yields paid in return for floating-rate payments based on short-term interest rates.

Underscoring how credit-concerns are only one issue for securitized debt, spreads over the 3-month Libor on AAA rated, two-year bonds backed by government-guaranteed student loans entered this month at 60 basis points, up from 40 basis points at the end of 2007, according to Deutsche Bank data.

European Spreads

Spreads on European securities also jumped again last month, according to a Merrill Lynch & Co. report today. Reaching new highs were: AAA bonds comprised of U.K. prime mortgages, credit cards, and commercial mortgages; Dutch home mortgages; and ``eurozone'' auto loans. Some spreads were in or near ``improbable three-digit territory,'' compared with less than 25 basis points a year earlier, the report said.

The widening has been ``in almost complete disregard for credit fundamentals in Europe,'' analysts including Altynay Davletova, Caspar Cook and Alexander Batchvarov wrote.

Peloton Partners LLP, the London-based hedge-fund manager, said last week that tumbling prices for U.S. home-loan securities and ``severely tightening terms'' on bond-secured lending from banks is forcing it to liquidate a $1.8 billion asset-backed fund.

Margin Calls

The fund owned about $17 billion of securities backed by Alt-A, subprime and other U.S. mortgage debt, along with bets against about $6 billion of subprime-loan bonds, according to people who have seen the firm's positions. Alt-A mortgages fall between prime and subprime loans in terms of expected defaults.

Deerfield said last week that some banks have stopped lending against mortgage securities -- even the bonds backed by non-subprime loans that the company owned -- while other lenders have ``significantly'' increased collateral demands.

Thornburg, which today said it's failed to meet $270 million of margin calls, said last week that AAA rated Alt-A mortgage securities tumbled 10 percent to 15 percent in the first 27 days of February. Mortgage-bond prices fell further in the last two days of the month, the company said today.

Goldman Sachs Group Inc., Morgan Stanley, Lehman Brothers, Bear Stearns Cos. and Merrill Lynch today had their profit estimates for 2008 and 2009 cut by Sanford C. Bernstein & Co.'s Brad Hintz, who cited more writedowns for the world's largest securities firms and a market recovery that may take three years. In the last two weeks, at least seven analysts have cut their first-quarter profit estimates for the brokers.

1 comment:

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