Unformatted text preview: March 13, 2007 CREDIT MARKETS Mortgage Shakeout May Roil CDO Market
Subprime Defaults Lead to Wavering At Big Street Firms
By SERENA NG and MICHAEL HUDSON March 13, 2007; Page C3 DOW JONES REPRINTS This copy is for your personal, non commercial use only. To order presentation -ready copies for distribution to your colleagues, clients or customers, use the Order Reprints tool at the bottom of any article or visit: www.djreprints.com . • See a sample reprint in PDF format . • Order a reprint of this article now . For years, an obscure class of Wall Street investment vehicles has acted like a locomotive in the housing -finance business, driving growth by soaking up risky mortgage bonds and parceling them out to investors around the world. Now, as mortgage problems mount and a wave of mortgage-bond downgrades looms, these investments, known as collateralized debt obligations, are starting to look like a different vehicle -- rockets overloaded with combustible fuel. Some big investment banks have been wavering when launching new CDO deals because of problems in the subprime mortgage market, which caters to the least credit-worthy borrowers. The problems also have investors demanding much higher returns on the CDOs they buy, which makes them harder to sell and drives down their prices. CDOs are an integral part of Wall Street's mortgage dicing-and -slicing machine. After mortgages are written, investment banks pool them together and use the cash flows they produce to pay off mortgage-backed bonds, which the investment banks underwrite. The mortgage bonds, in turn, are often packaged again into CDOs and sold off in slices. Investors can choose to buy the risky pieces of the bonds or purchase slices with less risk. Last year CDOs soaked up an estimated $150 billion of mortgage-backed bonds, the vast majority of which were underpinned by subprime mortgages, according to Deutsche Bank. In recent weeks, rising defaults among subprime borrowers have sparked worries of a sharp downturn in the U.S. housing market. In December borrowers were at least 60 days late on roughly 14% percent of subprime loans packaged into mortgage bonds, up from just over 8% a year earlier, according to research firm First American LoanPerformance. A CDO usually takes several months to assemble a portfolio of bonds before it raises money from investors by issuing securities of its own. During the "ramp up" period, CDO managers -- typically big money managers -- work with a Wall Street bank to buy and collect the securities that will be bundled together. The bank often bears the risk of short-term fluctuations in prices of the bonds prior to the sale of the CDO. Goldman Sachs Group recently sold off some subprime -mortgage bonds that were slated for a few upcoming CDOs, according to people familiar with the matter. One of them was a CDO that was to be managed by J.P. Morgan Asset Management and launched in the coming months. The assets for that pending deal, which included subprime bonds, were being held by Goldman. After recent market turmoil eroded the values of the bonds, Goldman moved to sell off the securities, in some cases at a loss. market turmoil eroded the values of the bonds, Goldman moved to sell off the securities, in some cases at a loss. It's not clear how large that deal would have been, but CDOs generally run from $500 million to $2 billion in size. A Goldman spokesman declined to comment, as did a J.P. Morgan spokeswoman. Other banks have also taken steps to limit their exposure to the subprime market recently. And Goldman still has CDO deals in the pipeline, including some that are backed by riskier subprime bonds, according to people familiar with the matter. Money managers and analysts say the market for new CDOs backed by subprime -mortgage bonds is still active, though the pipeline of upcoming deals appears to be thinning and investors are demanding significantly higher returns before they will invest in these pools. "It's definitely harder and less profitable to do deals now than a few months ago," says Dan Castro, chief credit officer at GSC Partners, an alternative investment manager that manages some CDOs. Among BBB -rated securities of CDOs that focus on riskier subprime -mortgage bonds, investors now require to be paid interest rates of 6.25 percentage points over the London Interbank Offered Rate, according to Credit Suisse. At the end of 2006, interest rates on these securities were 3.5 points over Libor. The sharply higher "risk premiums" reflect a vast change in investor perception of the risks of CDOs. To date, credit-ratings companies have downgraded less than 1% of subprime bonds issued in 2006. But some investors say the woes could mount, particularly for CDOs holding the riskiest mortgage bonds. "The downgrades of subprime bonds are just starting, and they are going to accelerate," says John Cutting, a managing director at MBIA Asset Management, which invests in and manages some mortgage CDOs. "In time they'll start triggering downgrades in some of the lower-rated classes of CDOs."
Treasurys Post Gains Treasurys rose as developments in the mortgage lending area prompted investors to seek safety. The 10-year Treasury note rose 10/32 point, or $3.125 per $1,000 face value, at 100 19/32. Its yield fell to 4.552% from 4.591% . The 30year bond was up 17/32 point at 100 30/32 to yield 4.691%. Write to Serena Ng at [email protected] 1 and Michael Hudson at [email protected] 2
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- Summer '08
- Subprime mortgage crisis, subprime mortgage, Subprime lending, Goldman Sachs Group, subprime mortgages, subprime bonds