Bloomberg News

Mortgages Beating Junk Bonds as Homes Top Europe

June 12, 2012

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, AT&T Inc. sold $2 billion of notes to lead U.S. corporate bonds sales to the busiest start to a week since April. JPMorgan Chase & Co. said it will redeem $9 billion of trust-preferred securities next month amid changes in rules that will phase out banks’ ability to include the securities as a portion of their capital. BAA Ltd., the owner of London’s Heathrow Airport, obtained 2.75 billion pounds ($4.3 billion) of loans to refinance debt maturing next year.

Swap Spreads

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. The gauge, which has declined from a four-month high of 39.13 on May 15, narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities.

The cost of protecting corporate bonds from default in the U.S. rose, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, rising 4 basis points to a mid- price of 124.6 basis points, according to prices compiled by Bloomberg. The index reached 127.5 on June 4, the highest since Dec. 19.

The Markit iTraxx Europe Index of 125 companies with investment-grade ratings was little changed at 179 basis points at 10:20 a.m. in London, while the Markit iTraxx Asia index of 40 investment-grade borrowers outside Japan climbed 4.5 basis points to 191.5 basis points.

Most Active

The indexes typically rises as investor confidence deteriorates and falls as it improves. Credit-default 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.

Bonds of Fairfield, Connecticut-based General Electric Co. were the most actively traded dollar-denominated corporate securities by dealers, with 181 trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The offering by AT&T, the largest U.S. phone company, led $6.9 billion of bond sales in the best opening for a week since April 2, according to data compiled by Bloomberg.

The Dallas-based company split its offering between $1.15 billion of 1.7 percent, five-year notes that yield 105 basis points more than similar-maturity Treasuries and $850 million of 3 percent, 10-year bonds sold in a re-opening that priced at a spread of 135 basis points.

TruPS Redemption

JPMorgan said it will redeem the trust-preferred securities, or TruPS, on July 12 following the Federal Reserve’s June 7 release of capital rules being mandated under the Dodd- Frank financial-overhaul law, according to a statement today from the New York-based bank.

About $30 billion of TruPS, which combine characteristics of debt and equity, may be subject to early redemption after the release of the rules, JPMorgan bank analysts Kabir Caprihan and Matthew Hughart wrote in a note last week.

The S&P/LSTA U.S. Leveraged Loan 100 index rose for a fourth day, gaining 0.1 cent to 92.42 cents on the dollar. The measure, which tracks the 100 largest dollar-denominated first- lien leveraged loans, has climbed from a five-month low of 91.8 on June 5.

Leveraged loans and high-yield bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at S&P.

Emerging Markets

The BAA financing includes a five-year, 2 billion-pound revolving credit, split among a 1.5 billion class A portion, a 400 million-pound class B piece and a 100 million-pound working capital facility, according to a statement. The class A loan pays interest of 150 basis points more than the London interbank offered rate and the class B pays 225 basis points more than Libor, the company said.

The loans, which mature in 2017, will replace a similar facility signed in 2008 and due in August 2013, BAA said.

In emerging markets, relative yields widened 3 basis points to 401 basis points, or 4.01 percentage points, according to JPMorgan’s EMBI Global index. The index reached 440.6 on June 1, the widest since Jan. 13.

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.

‘Dry Powder’

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.

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.

AIG Buys

“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 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.

Shrinking Markets

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.

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.

Government Support

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.

To contact the reporter on this story: Jody Shenn in New York at

To contact the editor responsible for this story: Alan Goldstein at

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