Dutch Gamble on U.S. Housing Debt After Patience WinsJody Shenn and Maud van Gaal
The Dutch government’s decision to hold onto U.S. mortgage debt acquired during the 2009 bailout of ING Groep NV has paid off so far as prices of the securities soared, more than doubling in some cases from lows that year.
The nation now is planning to sell all $12 billion of the bonds, many of which are tied to borrowers who were deemed more risky after failing to document their incomes or taking on mortgages with growing balances. ING, the Netherlands’ biggest financial-services company, said last week the current market value of the bonds is about 71 percent of the face amount. The government may see a gain of almost 800 million euros ($1.1 billion), Finance Minister Jeroen Dijsselbloem told Parliament.
The payoff for the Netherlands and the consequences for the $800 billion market for U.S. mortgage bonds without government backing will depend on how well it can unwind the bet with the help of BlackRock Inc. The sales, which require European Union approval, are targeted to be finished within the next year. Risks over that period include the forecasted reduction of the U.S. Federal Reserve’s unprecedented economic stimulus, potential continued sales of the debt by Fannie Mae and Freddie Mac, and the possibility of more budget battles by U.S. lawmakers like the one that roiled global markets last month.
“Timing is everything,” said Michael Canter, head of securitized assets at AllianceBernstein LP, which oversees more than $250 billion in fixed-income investments. “If they try to sell when there’s not a lot of liquidity out there, it could be a really bad thing. But if the markets are in a good place, it definitely could be absorbed without a hitch.”
ING received a 10 billion-euro capital injection in October 2008, when mortgage-backed securities held at its U.S. units plunged in value after foreclosures soared and property prices plunged. In a second round of aid in January 2009, the Netherlands assumed 80 percent of the risk on the 27.7 billion-euro portfolio of mortgage bonds.
ING sold the securities to the Dutch state at a discount, while giving the government a loan, which shrank as the mortgages underlying the debt defaulted or were repaid.
While down from post-crisis peaks reached earlier this year, prices have gained in 2013, ratifying the Dutch decision to hold. Typical prices for a type of Alt-A bonds among the holdings rose last week to 73.75 cents on the dollar, from 65 cents in January, Credit Suisse Group AG data show. The debt, tied to borrowers who often qualified with limited documentation or bought investment properties, rose as high as 75 cents in May.
The rally in U.S. non-agency home-loan bonds fueled by a housing recovery and the Fed’s $85 billion in monthly debt buying was interrupted in June as speculation grew that the central bank would scale back the purchases. It resumed after the Fed unexpectedly said in September it would hold off on tapering.
Over the past month, securities backed by option adjustable-rate mortgages, another type held by the Dutch, have gained 2 cents to 70 cents, according to Barclays Plc data. The notes, tied to loans that can allow borrowers to pay less than the interest they owe by increasing their principal, fell as low as 33 cents in 2009.
Option ARM securities represent more than 42 percent of the Dutch portfolio, almost 92 percent of which carries non-investment grades, JPMorgan Chase & Co. analysts led by John Sim wrote in a Nov. 1 report.
“We don’t see the sales as being disruptive, as long as they are properly timed” the analysts said.
The Fed is now expected to delay the first reduction of its bond-buying program until March, according to the median estimate of a survey conducted Oct. 17-18.
The Dutch government is seeking to return money to taxpayers after it provided more than 95 billion euros to rescue companies including ING, ABN Amro Group NV and SNS Reaal NV.
“This is a clear step closer to being detached from state aid,” Cor Kluis, an Utrecht, Netherlands-based analyst at Rabobank International, said by e-mail. “If ING will now pay back the remaining capital it will be fully government-free.”
ING could repay the state aid by mid-2014, ahead of a schedule agreed on with EU regulators last year, Kluis said. He recommends that clients buy the shares.
The EU approved ING’s rescue with some conditions, including that the company return the financial aid with premium and interest. Other strings attached included a ban on management bonuses for as long as aid is outstanding. The company also said it won’t pay dividends to shareholders before completing repayment.
ING shares rose 1.7 percent to 9.69 euros at 3:12 p.m. in Amsterdam trading. A close at this level would be the highest since Oct. 14, 2008, five days before the 10 billion-euro capital injection was announced.
To maximize proceeds, the Dutch will invite competing bids throughout the sale process, which can be halted at any point, Dijsselbloem said in a letter to lawmakers. Progress and results will be published on the Dutch State Treasury Agency website, he said. ING will pay about 400 million euros to the Netherlands from a provision it took in 2009 to unwind the transaction, meaning the state may see a gain of almost 800 million euros.
Large sales of non-agency mortgage securities have met with mixed consequences. A sale of $8.7 billion of debt by Lloyds Banking Group Plc in May resulted in a pretax gain of 540 million pounds ($860 million) for the lender that boosted the group’s core Tier 1 capital, a measure of financial strength. Still, it weighed on the market with the offering completed as speculation grew the Fed could begin reducing its bond buying.
Auctions in 2012 of non-agency securities acquired by the U.S. central bank during the rescues of American International Group Inc. and Bear Stearns Cos. proved a catalyst for market demand. The previous year, the Fed’s sales as it sought to unwind the portfolios exacerbated a slump in the market as Europe’s debt crisis deepened.
The non-agency market, or home-loan bonds not backed by the U.S. government, is regularly shrinking as foreclosures get completed and homeowners refinance into new loans. The amount of the debt outstanding fell to $849.2 billion as of June 30, from a peak of $2.3 trillion in 2007, Fed data show. It probably will contract an additional $60 billion next year, according to Barclays analysts including Sandeep Bordia and Jasraj Vaidya.
The involvement of BlackRock as an adviser to the Dutch suggests a program similar to the unwinding of the Fed’s Maiden Lane vehicles is possible, the analysts wrote in Nov. 1 report. At the same time, it’s unclear whether the nation will sell the bonds in blocks or individually, and at what pace, they said.
“We do not expect this sale by itself to have a huge effect on prices, especially if the sales are conducted in a manner that is cognizant of market conditions,” they wrote.
One risk is that Fannie Mae and Freddie Mac, the U.S.- backed mortgage companies that own about $150 billion of privately issued residential and commercial bonds, may continue with auctions of the assets, according to AllianceBernstein’s Canter and Barclays. As part of sales ordered by regulators to shrink their illiquid holdings this year, they’ve already sold many of the investment-grade securities that are easiest to trade, Barclays said.
The Dutch probably will be “try to be smart about it,” Canter said.