Bloomberg News

Subprime Mortgages Lead Credit Rally as Greek Concern Ebbs

July 01, 2011

July 1 (Bloomberg) -- Investor confidence in debt from subprime mortgage securities to investment-grade bonds is rebounding after tumbling last month on concern that a Greek default would infect credit markets.

A Markit ABX index tied to subprime-mortgage bonds climbed the most this week since September 2009. The cost to protect corporate debt in the U.S. from default is poised for the biggest drop since last July and relative yields on junk bonds are on pace to fall by the most in more than a year.

A selloff in credit markets, fueled by Europe’s sovereign debt crisis and concern that the economic recovery is slowing, reversed as Greece moved closer to receiving as much as 85 billion euros ($124 billion) in new financing and U.S. manufacturing unexpectedly accelerated in June. Demand for riskier assets accelerated after the Federal Reserve Bank of New York said yesterday it would halt the sales of assets acquired in the rescue of American International Group Inc.

“It’s pretty phenomenal,” said Bonnie Baha, head of the global developed credit group at DoubleLine Capital LP in Los Angeles, which has $12.5 billion in assets under management. “The prospect of a European financial collapse has been pushed off for a couple of months,” she said. “Those issues will come back to haunt us, but in the meantime, the market had anticipated such a dire case outcome we’re due for a little pickup or bounce back in spreads.”

The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, fell 2.4 basis points to a mid- price of 89.5 basis points as of 4 p.m. in New York, according to Markit Group Ltd.

Weekly Decline

The index, which falls as investor confidence improves, dropped every day this week from 101 basis points on June 24, in the biggest weekly decline since the period ended July 9, 2010. The benchmark is at the lowest level since May 31.

Benchmarks tied to junk bonds, subprime mortgages and commercial-property debt, which rise as investor confidence improves, surged.

Markit’s CDX North America High Yield Index added 0.8 percentage point to 102.5 percent of face value. It’s headed for the biggest rally since the week ended July 23, according to Markit.

The extra yield investors demand to hold speculative-grade debt instead of U.S. Treasuries has dropped 38 basis points since June 24 to 542 basis points, or 5.42 percentage points, according to Bank of America Merrill Lynch index data. That’s on pace to be the largest decline since the 45 basis point decrease in the week ended June 18, 2010.

Subprime Debt

The Markit ABX index tied to subprime-mortgage bonds added 3.9 percent this week, after dropping the same amount from April 1. The index reached 50.35 yesterday from 46.4 on June 24, prices from London-based Markit show. A similar index tied to junior AAA ranked commercial-mortgage bonds created in 2007, known as the Markit CMBX, climbed to 69.3 yesterday from an almost nine-month low of 63.7 on June 27.

The extra yield investors demand to own a top-ranked commercial mortgage security commonly cited as a market barometer narrowed 10 basis points to 200 basis points more than the benchmark swap rate this morning after the Fed announced it was halting the sale of the Maiden Lane II portfolio, according to Philadelphia-based investment and banking firm Boenning & Scattergood.

“This past week we’ve seen two issues go away, so clearly we’re in better shape,” Joshua Myers, a debt trader at Boenning & Scattergood in New York said referring to Greece and the Fed auctions. “Whether the rally can last and whether we can make up all the ground we’ve lost is a big question mark.”

Maiden Lane

The New York Fed began unloading the Maiden Lane bonds piecemeal after rejecting a $15.7 billion bid from New York- based AIG for the entire pool in March. As traders blamed declines in debt on the sales, the bank slowed their pace. Its last auction ended June 9.

Investor sentiment has also been aided as U.S. economic data improves from a weak patch, pulling stocks higher, said Martin Mitchell, head government bond trader at the Baltimore unit of Stifel Nicolaus & Co., a St. Louis-based brokerage firm.

“If the Fed’s going to be off the table for a while, then there’s a chance for some stabilization in the market and even some improvement,” he said in a telephone interview. “All these factors are helping to pull more credit-sensitive markets higher.”

The Institute for Supply Management’s factory index rose to 55.3 last month from 53.5 in May, the Tempe, Arizona-based group said today. Economists estimated the index would drop to 52, according to the median forecast in a Bloomberg News survey. Figures greater than 50 signal expansion.

Bounce Back

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.

The bounce back in credit markets this week can be characterized as a “relief rally,” said Jon Duensing, the Boulder, Colorado-based head of corporate credit at Smith Breeden Associates, which oversees $6.5 billion.

“At this point, specifically in the derivatives market, we’ve pretty much taken out the lion’s share of the sell-off that we had through May and June,” Duensing said. “There’s maybe a little bit more data that’s saying that the potential of this domestic growth soft patch story could be viable. The important thing over the next month going forward is really going to be that we get the indicators that support that is the case.”

--With assistance from Sapna Maheshwari, Tim Catts and Jody Shenn in New York. Editors: Pierre Paulden, Alan Goldstein

To contact the reporter on this story: Mary Childs in New York at mchilds5@bloomberg.net; Sarah Mulholland in New York at smulholland3@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net


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