The Financial Times has a long analysis, “Value to Unlock,” on how various financial players are starting to pick and choose among distressed mortgage assets. This may prove to be premature (recall how Wall Street firms eagerly bought subprime brokers through January 2007) and the housing market itself appears unlikely to hit its floor before 2010, but even at this stage, there may be pockets that are so cheap that the downside is (or appears) modest.
Note this seems to be a theme du jour: Calculated Risk also saw signs of buying in some distressed markets, and too is cautious about reaching conclusions.
The set up is that the Mortgage Bankers Association, a sober and sparsely attended affair this year, is galvanized by the report that a BlackRock fund will buy $15 billion of UBS’s subprime debt for 75% of face (UBS is a minority investor in the fund; query whether there was more than meets the eye here).
The piece comments on various players buying servicers allegedly to gain expertise. Maybe I am talking to the wrong people, and Tanta et al will correct me, but my sources tell me servicers are factories, and don’t have skills that are relevant to evaluating mortgage pools. Remember, the credit decision was made long before the securitized mortgage got in the hands of the servicer (and in the recent environment, calling them “credit decisions” is generous. More accurate might be “handing out cash to anyone who had a pulse and could fill out a form”). I’m a little perplexed that this factoid, while narrowly accurate, keeps being bandied about uncritically.
From the Financial Times:
Policymakers, bankers and investors all want more buyers like BlackRock to emerge for mortgage securities and other risky assets, to provide a tipping point that ends the credit crisis. Yet thus far there has been only patchy evidence that this healing wave of purchases is under way.
Certainly, the market for corporate debt has shown some positive signs. The $23bn buy-out of Wrigley by Mars, agreed two weeks ago, involved more than $10bn of debt – although less than $6bn of that debt came from investors, with the rest provided by Warren Buffet’s Berkshire Hathaway.
The debt capital markets, which last year made possible deals that were twice that size, still have a long way to go before they recover fully…..Banks are so desperate to rid their balance sheets of these loans that they are offering their best clients sizeable discounts and lots of leverage to sweeten the sales….
Investor fear of buying distressed assets too soon and catching the “falling knife” is even more intense in the mortgage market, where premature buyers have been badly burnt by plummeting asset prices…
Nevertheless, BlackRock’s deal with UBS represents one of the more significant examples of a small but growing number of contrarian bets on distressed mortgage assets by opportunistic buyers. Goldman Sachs, TPG and other investment banks, private equity firms and hedge funds have also started looking to buy portfolios of mortgages – in some cases reversing bearish bets made last year.
Indeed, in the past 10 months more than 80 funds have begun raising money to buy bad mortgage debt on the cheap, including Marathon Asset Management, GSC Group, Pimco and Fortress Investment Group. Goldman is trying to deploy around $4.5bn to invest in mortgage assets…
Placing values on distressed mortgage assets remain an enormous problem for both buyers and sellers, in part because it is hard to predict the full extent of the continuing slide in US home prices and the accompanying level of mortgage defaults and foreclosures.
Part of the difficulty is that faith has been lost in the measures of probable losses on which lenders used to rely, such as credit ratings and historical data. For pools of subprime mortgages, guides such as loan-to-value ratios, used to compare the size of a loan against the value of the property on which it is secured, have proved unreliable.
Mark Fleming, director of economics at First American CoreLogic, a research provider, says that while reported loan-to-value ratios for many subprime mortgage pools had been around 100 per cent, the existence of unreported “piggyback” loans meant that in some instances the ratio could be as high as 160 per cent.
“The problem is that while market-based pricing is not necessarily commensurate with the true risk, it’s still hard to measure the mismatch between pricing models, rational pricing opinions and prices driven by fear,” says Mr Fleming.
The valuation problem is worse for more complex instruments, for which there are still no buyers, particularly if these fall under fair-value accounting rules that require securities to be “marked to market” – priced on the books at no more than what is achievable. Susanna Kondraki, vice-president at Risk Span, an advisory firm, says one client spent $250,000 on valuation services for a $1bn portfolio of collateralised debt obligations backed by mortgages, only to discover that the portfolio had to be valued at zero.
James Fratangelo, head of whole loans sales and acquisition at Bayview Financial, says snags like this are why many parts of the mortgage market are yet to establish clearing prices. “There is plenty of liquidity for distressed assets but there is still a huge gap between where buyers want to buy and where sellers want to sell,” he adds – with the gulf between bids and offers remaining as wide as 20 cents on the dollar for many assets.
Robert Gaither, head of the secondary marketing group for mortgage securities at Bank of America, illustrated this problem at last week’s conference. He described receiving bids for a portfolio of so-called “Alt-A” mortgages, between prime and subprime, that the bank had marked down to 91 cents on the dollar. After a series of bids from prospective buyers at 50 cents, he finally received one at 86.5 cents. Yet the bank’s pricing model said the mortgages should be priced in the mid-90s.
The bank decided to hold on to the portfolio, even though it was forced by mark-to-market accounting rules to write down the mortgages to match that 86.5 cent bid.
Many European banks are also refusing to sell at prices that they consider to be artificially depressed….
She says European banks’ belief that such asset prices have fallen too far has been bolstered by a recent Bank of England report suggesting that triple-A tranches in particular were mispriced……
Still, there are signs – including UBS’s sale of loans to BlackRock – that some higher quality assets are beginning to move…Traders say the scale of buying generally remains small, however. In the European markets, buyers are placing orders of just €20m (£16m, $31m), far below the €500m orders that were normal before the crisis broke.
Many funds say they remain constrained in the volume of deals they can do by the sheer difficulty of raising finance. Others fear this means there is too little capacity to absorb the volume of distressed assets in the market.
“What worries some people is that you have seen a few people fill up but it’s not clear whether there will be more buyers after that – it could just be one or two groups that are ready to buy,” says one London-based hedge fund official. “The market is so thin and prices are so volatile that if they stop buying, we could go back down again.”….
One of the biggest problems facing prospective buyers of distressed mortgage assets is that US house prices continue to fall and the flood of late mortgage payments and foreclosures shows few signs of abating. Unless the rising tide of losses in the housing market can be stemmed, establishing a floor under asset values may be difficult, writes Saskia Scholtes.
Mark Kiesel, a portfolio manager at Pimco, the big US bond investor, says: “We may need housing prices to bottom for this entire process to trough and for most markets to rebound.”