By Teri Buhl (Housing Wire):
Top bond traders are not as worried about pending cramdown legislation as some might think — and some are now loading up on Alt-A MBS after what they see as a fear-based sell-off. According to top traders in asset-backed hedge funds who spoke with HousingWire, they’re now loading up on certain subprime and Alt-A products while telling investors to expect big returns this year from distressed asset bets in the residential mortgage sector.
“Sure it’s spotty, not everything is moving, but we are definitely trading MBS and making a market,” a trader with New York-based Guggenheim Partners, LLC said Friday on condition of anonymity. “What’s moving now is the last cash-flow senior tranche subprime bonds. At prices in the low 20s, it’s hit bottom and the top ABS traders in hedge funds are gobbling it up.”
With the junior debt whipped out of the bond, pro-rata loss-sharing can kick in, he said — meaning that when principal does get paid, it’s now shared throughout all senior tranches, and not just the super-senior bond classes. Since last cash-flow is cheaper to buy then the super-seniors, that’s where the trader at Guggenheim said “the smart money is running to.”
“I think the good trades are last cash-flow subprime and super-senior option arms with 40 percent subordination,” said Shad Quraishi, former co-head of mortgage backed securities at UBS AG (UBS: 8.34 -7.85%). “These two asset classes generate returns approaching 20 percent yields. I would stay away from prime.” Quraishi left UBS a few months ago, he said, because he saw an opportunity to trade distressed MBS on his own and is now investing his money in the sector, along with advising hedge funds on where the nuggets are.
“The 20 percent yields on the senior tranche of Alt-A and subprime is what I’m banking on,” another trader at a large New York-based hedge fund said, on condition of anonymity. “The prices we are paying for these senior tranche Alt-A’s — mid 40 cent range — is a real deal now. Even if home prices fall a bit more, the yield on these bonds are still going pay.”
According to Hedgefund.net, the HFN Mortgages Average index that measures 22 funds active in MBS trading strategy, rose 2.45 percent in January, reflecting that sort of bullish sentiment.
Scott Minerd, a partner at Guggenheim Capital who runs the firm’s ABS fund, called a bottom in much of the private party MBS market back in late November of last year. People familiar with his trading say he’s been loading up on senior Alt-A ever since. It’s a move that made his fund look like he’d outsmarted former Treasury secretary Hank Paulson in this New York Post story.
Some bond traders and banks holding various MBS on their books are anxiously awaiting the outcome of ongoing Congressional negotiations over the latest homeowner assistance package, HR 1106, which would clearly have an effect on both investors and owners of securitized mortgage products. One RBS Greenwich Capital analyst, however, tried to inspire trading activity last week when he told his clients in a report that certain provisions in the pending cramdown legislation would actually give senior tranches in these MBS a chance to rise in price again.
While the bill appears to prohibit pro-rata loss allocation in deals with “carve-out” provisions, it does not provide guidance to servicers on how they should allocate the losses when principal is reduced in bankruptcy, he said in a research note last week. As a result, the analyst suggested that it’s likely servicers would revert to applying bankruptcy losses in much the same way as they apply other losses, by first allocating them to the subordinate bonds before moving up the credit curve to more senior-rated bonds.
Of course, other analysts have been very vocal in suggesting that the proposed bankruptcy cramdown measure could send the secondary market for mortgages into its latest set of fits and starts, as well. But nonetheless, some hedgies are clearly willing to take a risk, betting that fear has oversold the real impact of the proposed legislation.
Desmond Macauley, managing director of asset-backed mortgage strategy at RBS, told HousingWire, “These bonds have already sold off when the chatter on cramdown legislation first began. But there should be a lift in price if the legislation passes as-is.” That means traders who bought on the sell-off could be looking a nice upward swing in price.
“As currently written, this legislation would therefore be beneficial to triple-As and other senior bonds in shifting-interest prime and Alt-A transactions that have bankruptcy carve-out provisions,” Macauley told clients in a letter last week.
“I see traders selling not from a view of how cramdown legislation might wipe out MBS bond holders, but they’re just reacting to fear,” another trader told HousingWire on condition of anonymity. “I’m buying those MBS they’re selling because I think the legislation, if it’s even passed, won’t have a great effect on the MBS market.”
He expects to ring in double-digit returns for his near-billion-dollar ABS fund this year, he said. “Think about it this way: just because there is new language in a bill it doesn’t mean the bankruptcy judge is going use it. When the market trades on on news out of fear, I go right in for the buying opportunity.”