Europe’s Banks Turn to U.S. Subprime for SalvationEsteban Duarte, Maud van Gaal and Heather Perlberg
The U.S. mortgage bonds that were exported around the globe and triggered the worst financial crisis since the Great Depression are now helping Europe’s banks and governments repair balance sheets after jumping in value.
Lloyds Banking Group Plc, Britain’s biggest mortgage lender, is auctioning $8.7 billion of mortgage debt to plug a capital shortfall, a month after Lone Star Funds and Credit Suisse Group AG paid 6.7 billion euros ($8.7 billion) for assets taken over from the failed Belgian bank Fortis. The Netherlands can sell debt from the bailout of ING Groep NV for a “decent profit,” Chief Executive Officer Jan Hommen said this month.
While European banks and governments need to sell assets to raise capital or repay taxpayer-funded rescues, investors are seeking riskier, potentially higher-paying securities as central banks globally push down yields on safer debt. With U.S. home prices rising at the fastest pace in seven years, that has turbocharged demand for non-agency bonds, with subprime-backed debt returning 12.7 percent this year after rallying more than 41 percent in 2012, according to Barclays Plc data.
“Fundamentals of housing continue to improve, and the asset class itself continues to shrink in size as borrowers repay debt or default,” said Harrison Choi, a bond manager for TCW Group Inc., which oversees about $131 billion in assets.
Investors outside the U.S. hold more than $194 billion of mortgage bonds without government backing, or 21 percent of the market, according to Inside Mortgage Finance. That includes U.K. and French lenders as well as banks backed by the Dutch and German governments to hold the assets of nationalized firms.
Lloyds acquired billions of dollars of U.S. residential mortgage-backed securities after absorbing HBOS Plc, formerly the U.K.’s biggest mortgage lender, in a government arranged takeover in 2009. After holding onto the assets during the housing slump and recovery, Lloyds plans to accept bids on the portfolio on May 30, according to two people with knowledge of the offering. The auction, originally scheduled for today, was rescheduled, said the people who asked not to be identified because the transaction is private.
Ed Petter, a spokesman for Lloyds in London, declined to comment on the sale and the postponement.
The auction -- mostly securities backed by ALT-A loans, a type of mortgage that typically didn’t require documentation such as proof of income -- is the biggest widely marketed sale of securitized debt in at least three years, according to data provider Empirasign Strategies LLC.
The sale was announced last week before Federal Reserve Chairman Ben S. Bernanke signaled the central bank may reduce its asset-purchase program if policy makers see indications of sustained growth, language which caused stocks and riskier bonds to decline.
“The timing looked great prior to Bernanke’s testimony, but now with liquidity and market sentiment significantly weaker it’s going to be a tough trade, given the size,” said Chris Ames, a senior portfolio manager in New York for mortgage-and asset-backed securities at Schroder Investment Management North America Inc.
“If there is a dip in in the market because of this that would be an opportunity to add,” said Vishwanath Tirupattur, global head of securitized products research at Morgan Stanley in New York. “We have strong conviction in the underlying housing recovery.”
U.S. home prices rose 10.9 percent in March from a year earlier, the fastest pace in seven years, according to an S&P/Case-Shiller index of property values released today. The rebound has been helped by borrowing costs that hit a record low
3.31 percent in November for a 30-year fixed rate mortgage. The average rate rose to 3.59 percent last week, according to Freddie Mac.
Lloyds said last week it wanted to shrink its balance sheet and sell assets to meet regulators’ demands for more capital rather than tapping shareholders. Incentives to hold U.S. mortgage debt have declined in the past year because losses a bank would have to book from a sale have diminished or evaporated.
“If prices are really strong, then there is some potential there would be pressure on other banks in Europe to sell,” said Jasraj Vaidya, an analyst at Barclays.
European investors were among the biggest buyers of U.S. housing bonds in the lead up to the property boom and subsequent crash, which triggered a global credit seizure and more than $2 trillion of losses and writedowns. The global marketing and sales of subprime mortgage bonds centered on Wall Street firms creating securities that were given top credit grades by rating firms.
Fortis, once Belgium’s biggest financial services-company, was one of the first European casualties of the 2008 financial turmoil after it agreed to spend 24.2 billion euros purchasing assets of ABN Holding NV, even as the U.S. subprime mortgage market was collapsing.
After the bailout, a pool of distressed securities was moved into a special purpose vehicle known as Royal Park Investments SA, owned by Belgium, French bank BNP Paribas SA, and Fortis. More than 80 percent of the assets by face value were dollar-denominated at the end of March.
Last month, Credit Suisse and Texas-based Lone Star agreed to buy the assets, with Belgium getting 1 billion euros from the sale, reducing government debt by more than 0.2 percent of gross domestic product.
Dutch taxpayers may also gain on a portfolio of U.S. mortgage bonds taken over from ING in 2009 to stem credit losses at the country’s biggest financial-services firm. In that rescue, ING transferred the risk on 80 percent of 27.7 billion euros in Alt-A bonds at a discount, while giving the government a loan, which shrinks as the mortgages underlying the securities are repaid.
The portfolio stood at 71 percent of its nominal value of $13.7 billion at the end of March, Raymond Vermeulen, a spokesman for the Amsterdam-based firm said, more than the $9.1 billion the Netherlands owes the lender.
The company is in talks with the government on the disposal of the loans, CEO Hommen said this month, adding that taxpayers could earn as much as 4.5 billion euros in total on aid, including a 10 billion-euro capital injection to ING.
Dutch Finance Minister Jeroen Dijsselbloem said in a letter to parliament last week that talks are ongoing, adding he would inform them as soon as there are “concrete plans.”
The outcome of the Lloyds auction may determine whether other lenders, including German banks that are among the biggest holders of the assets, decide to sell. After making the right decision to hold on during the slump, they could overplay their hand and miss selling at an opportune time.
“The world has changed a lot since those bonds were originally bought,” said Morgan Stanley’s Tirupattur. “For many of the banks that hold these, they pose challenges both from a funding and capital perspective. This was also true last year but given the rally, now would be a much better time to sell these bonds than would have been then.”
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