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Mortgages Beating Junk Bonds as Homes Top Europe

Mortgages Beating Junk Bonds as Homes Top Europe
The U.S. two-year interest-rate swap spread, a measure of debt market stress, fell 0.07 basis point to 30.37 basis points, the lowest level since May 7. Photographer: Sam Hodgson/Bloomberg

Bonds tied to U.S. residential mortgages without government backing, the impetus for the last financial crisis, are weathering Europe’s sovereign-debt strains better than speculative-grade company debt and stocks after their biggest annual losses since 2008.

The $1.1 trillion market is holding onto gains in June after returning 0.53 percent in May for the fifth straight monthly increase, according to Amherst Securities Group LP. Junk-rated corporate bonds are little changed this month after losing 1.2 percent in May, and the Standard & Poor’s 500 Index has lost 6.7 percent this quarter.

As Europe’s escalating crisis threatens to derail a global economic recovery, non-agency mortgage securities are being buoyed by signs that property prices have stabilized after the biggest crash since the 1930s. Government programs may support further gains in housing, and relatively cheap mortgage bonds have lured new investors while limiting price swings, said Angelo Gordon & Co.’s Jonathan Lieberman.

“We’re the best suit in a closet full of dirty suits at the moment,” said Lieberman, head of residential mortgage securities at the New York-based investment firm, which oversees about $24 billion. “The final piece to the puzzle is definitely fund flows.”

Luring Funds

So-called non-agency mortgage securities, which lack guarantees from government-supported Fannie Mae and Freddie Mac or U.S.-owned Ginnie Mae, gained 10.5 percent in the first five months of 2012 after losing 6.9 percent last year, according to Amherst. U.S. speculative-grade company bonds, coming off gains of 4.4 percent in 2011, are up 0.2 percent this month, with gains of 5.2 percent in 2012, Bank of America Merrill Lynch index data show.

Last year’s losses lured new funds to invest in mortgages created by managers including Goldman Sachs Group Inc., Cerberus Capital Management LP and Canyon Partners LLC., often in pools with longer investment horizons than mutual funds. Insurers including American International Group Inc. also added the debt to portfolios.

Elsewhere in credit markets, a gauge of U.S. corporate credit risk rose for a second day as Fitch Ratings cut credit ratings on 18 Spanish banks. The bailout of Spain’s lenders is unlikely to trigger payouts on credit-default swaps protecting against losses on the nation’s debt, an industry group said. EQT Partners AB is said to be seeking about 1.1 billion euros ($1.4 billion) of loans to back its acquisition of German bandage-supplier BSN Medical.

Credit Swaps

The Markit CDX North America Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses on corporate debt or to speculate on creditworthiness, rose 1.4 basis points to a mid-price of 126 basis points as of 10:50 a.m. in New York, according to prices compiled by Bloomberg. The index, which has climbed 5.4 basis points the past two days, reached 127.5 on June 4, the highest since Dec. 19.

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings jumped 5 to 184.3. Both indexes typically rise as investor confidence deteriorates and fall as it improves. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

No Payout

The U.S. two-year interest-rate swap spread, a measure of debt market stress, rose for the first time in seven days, climbing 0.76 basis point to 31.13. The gauge, which has declined from a four-month high of 39.13 on May 15, widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.

The 100 billion-euro ($125 billion) bailout of Spain’s banks is unlikely to be a so-called credit event for swaps linked to the nation’s debt, a spokeswoman for the International Swaps & Derivatives Association said in an e-mailed statement.

There’s speculation investors holding bonds issued by Spain and its banks will rank behind official creditors after the nation asked for a bailout. The rescue is a response to a build-up of bad loans at the nation’s lenders and makes Spain the fourth euro-area nation to seek help since the crisis started almost three years ago.

“It would not meet the threshold required under the ISDA CDS definitions related to a subordination -- essentially that it either represents an agreement among existing bondholders or a change in law,” according to the ISDA statement. “It’s important to note that we do not have all the facts in this situation.”

EQT Funding

EQT, a private equity firm partly owned by Sweden’s Wallenberg family, is seeking financing for the BSN Medical acquisition that includes about 740 million euros of senior loans arranged by Deutsche Bank AG, JPMorgan Chase & Co., Morgan Stanley and Goldman Sachs, according to a person familiar with the matter.

KKR Asset Management LLC, Highbridge Principal Strategies, JPMorgan Mezzanine, Mezzvest and Partners Group are providing 392 million euros of mezzanine funding, KKR said in a statement yesterday. Mezzanine loans are a type of subordinated debt used to fund buyouts and may give lenders a stake in a company.

EQT said yesterday it purchased the medical supplier from Montagu Private Equity LLP for 1.8 billion euros in Germany’s largest buyout since before the financial crisis. Leveraged loans and high-yield bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at S&P.

Shrinking Market

The market for non-agency home-loan securities shrank to $1.05 trillion on March 31, from a record $2.32 trillion in mid-2007, quarterly Fed data released June 7 show. The underlying loans range from so-called subprime notes to borrowers with weak credit and option adjustable-rate mortgages, which allow for homeowners to increase their balances, to jumbo loans that are too large for government programs.

The debt, which helped fuel the 2007-2009 global financial crisis, is attracting investors such as the U.S. Housing Recovery Fund started in April by Goldman Sachs.

Goldman Sachs has raised at least $128 million for the fund, according to a May 14 securities filing. The “dry powder” available to all managers of closed-end private real-estate funds that focus on debt investments stood at $26 billion as of March 31, according to London-based research firm Preqin Ltd.

Yield Expectations

Almost 60 percent of investors surveyed by JPMorgan last week said they expected yields on non-agency securities relative to benchmark rates to be lower in six months. Those who anticipated spreads to narrow more than 100 basis points dropped to less than 10 percent, from 20 percent in a May poll.

“When I talk to a lot of my hedge-fund clients and many of the billionaires I manage money for, they say every single day it seems somebody comes through and says, ‘Buy a bunch of subprime-mortgage garbage, throw it in a shoe box and open it in three years and you’ll get 12 percent,’” DoubleLine Capital LP Chief Executive Officer Jeffrey Gundlach said at a May 17 conference.

The growth of the DoubleLine Total Return Fund has added to demand. Its assets have risen to $26.6 billion from $15.2 billion at the end of 2011, when it returned 9.5 percent to beat all of its peers. The share of holdings attributed to non-agency debt was 33.4 percent as of April 31, according to the firm’s website.

AIG Buys

AIG increased the non-agency holdings of its $250 billion bond portfolio to $20.1 billion as of March 31, from $10 billion at the end of 2010, according to regulatory filings. Andrea Raphael, a spokeswoman for Goldman Sachs, and Jim Ankner of AIG declined to comment. Both companies are based in New York.

In the corporate junk-bond market, $3.6 billion was pulled from mutual funds that buy that debt in the week ended June 6, the biggest weekly outflow since August 2011. The withdrawals forced sales that depressed prices even with inflows this year still at $18.5 billion, EPFR Global data show.

Senior-ranked subprime bonds created in 2005 through 2007 returned 0.82 percent this month through last week, according to Barclays Plc index data. Typical prices for similar securities tied to so-called option adjustable-rate mortgages were unchanged last week at 55 cents on the dollar, after falling from a 10-month high of 58 cents in early May, Barclays data show.

Junk Returns

High-yield company notes gained 0.03 percent through June 8, according to Bank of America’s U.S. High Yield Master II Index. Commercial-mortgage securities, which lost 0.23 percent last month, are up 0.16 percent in June, the bank’s CMBS Fixed Rate Index shows. Government-backed mortgage securities lost 0.08 percent in June through last week after gaining 0.33 percent in May, according to Bank of America Merrill Lynch’s Mortgage Master Index.

During the 12 months ended March, home values in 20 U.S. cities fell at the slowest pace in more than a year. The S&P/Case-Shiller index of property values fell 2.6 percent from a year earlier after a 3.5 percent drop in the period ended February. The decline reported May 29 matched the median forecast of economists surveyed by Bloomberg News, and the index rose from the prior month on a seasonally adjusted basis.

A variety of actions by the government also are all providing a better back-drop for the securities, Angelo Gordon’s Lieberman said.

They include a program to help “underwater” borrowers refinance Fannie Mae and Freddie Mac loans to lower payments and avoid default, as well as consideration of bulk sales of properties seized by the companies to firms that would rent them, reducing distressed supply, he said. A settlement between state and federal authorities and loan servicers over foreclosure practices also is supporting the market after the probe slowed liquidations of bad loans, he said.

While Gundlach criticized how some rivals analyze the securities at the event last month for Bloomberg LP customers in New York, he said the bonds pair well with government-backed mortgage notes and that the prices are “low enough” to offer solid returns on their own even if the economy sours.

“You can still walk away with 5 percent to 7 percent if that Depression-case happens,” he said.

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