NEW YORK (Reuters) – U.S. mortgage investors are uncovering fresh opportunities in 2011 as the desolate market for private residential mortgage credit shows few signs of revival and returns on a dwindling field of existing bonds drop.
Finding ways to play the $11 trillion U.S. mortgage market has been tough as government competition, regulatory reform and a lingering distrust by some investors has frozen the flow of private capital into the housing market.
That leaves the time-tested strategy of sifting through existing bonds and loans, or bypassing Wall Street altogether.
Instead of investing through broker-dealers, insurance companies and others who must limit risk are starting to go directly to banks for pools of new, high-quality loans, said Jeffrey Taylor, chief development officer at Digital Risk, a mortgage analytics and risk management firm, and who has advised the U.S. Treasury.
“This is a completely different mindset than they’ve had for the last 15 years,” Taylor said of mortgage investors.
These large investors have ramped up the strategy over the past six months, said Taylor, whose firm has helped price and manage the loans for these buyers. It also represents a hint of private capital returning to the U.S. housing market that has been the largest drag on the nation’s economic recovery.
Sales of new loans undercut the notion that banks have little incentive to give them up: the loans are of high quality and banks enjoy wide margins thanks to cheap funding costs. RMBS issuance may remain in hibernation as long as cheap unsecured funding exists for banks, Bank of America Merrill Lynch’s mortgage finance chief said in November.
But banks are selling to foster important trading relationships, said Taylor, who wouldn’t name his clients.
What’s more, there are banks that still have limited capital to support further growth for their mortgage units, said Clifford Rossi, a fellow at the University of Maryland’s business school and a former chief risk officer for consumer lending at Citigroup.
“I could very easily see that as being a decent (investment) model for the insurance world,” Rossi said.
The trend comes as investors expect little, if any, new RMBS for a third year in 2011. Once funding the lion’s share of U.S. mortgage credit, RMBS are the last type of securitization yet to bounce back. Most loans today get directed into government programs that eliminate credit risk, which limits the yield desperately sought by investors.
“We hear talk about more jumbo mortgages being pooled for securitizations, but that doesn’t seem to be happening yet,” said Jim Lockhart, vice chairman at WL Ross & Co. and a former housing finance regulator who is set to address the vexing issue at the annual American Securitization Forum conference next week.
The trend described by Taylor is eyed by Wall Street. New issuance could be affected if investors bypass the RMBS market “entirely,” Bank of America Merrill Lynch said in an outlook.
OTHER ALTERNATIVES
Other avenues taken by mortgage investors won’t do much to expand housing credit. Controversy over rules that will govern risk that lenders must bear and falling house prices are also curbing a market comeback, according to bankers who will debate those issues at the ASF conference, which is expected to draw 4,500 attendees.
Since March 2009, snapping up some of the existing $1.5 trillion in private-label RMBS has been the trade of choice and a big win for investors who found valuable scraps within the wreckage. But RMBS are now at a point where they “look pretty fully priced,” said Lockhart, of WL Ross.
Prime 30-year fixed-rate mortgage bonds are closing in on 100 cents on the dollar, compared with a low of 63 cents at the darkest moments in March 2009. Strong technical support — the market is shrinking by $25 billion a month — has also helped.
RMBS buyers have thus started to turn to hedge funds, such as Carrington Capital Management, to buy and manage troubled assets, or non-performing loans (NPLs) shed by banks as they clean up balance sheets. Purchased at a discount, those pools can result in double-digit returns as loans are modified or properties acquired and sold, managers of the pools said.
“We have talked with several traditional RMBS investors who are seeing the benefits of an NPL strategy … especially given the tightening yields and lack of supply of RMBS,” said Steve Kirch, president of Carrington’s broker-dealer.
Other investors unsatisfied with RMBS yields are buying esoteric asset-backed securities or looking to Europe where supply of higher-yielding asset-backed bonds is on the rise.
“In the beginning of last year, cross-border flows with U.S. investors were extremely limited,” said Pradeep Pattem, an asset-backed bond strategist at RBS in London. “But toward the end of the year the main driver of spreads in certain European ABS turned out to be U.S. demand.”
Reuters
By Al Yoon
(Editing by Leslie Adler)
