Tag Archives: fixed income

ASF 2001: Part 1 of 5: Renewal

13 Feb

Renewal, Regulation, Reticence, Republicans and Regurgitation

The ninth annual American Securitization Form at the modestly opulent J.W. Marriott Resort in Orlando Florida finished last week with more optimism than last year’s funeral dirge in Washington DC. Last year’s ASF conference participants nervously waited for the U.S. government to impose the new rules of the road for the securitization market. The securitization market was in the middle of its second year of limited securitization. To compound the lousy mood was the decision by ASF to hold the conference at the remote National Harbor in a southern Washington DC suburb.

Let’s not forget ASF membership participated significantly in the collapse of the US housing market and the overall economy. The originators, aggregators, servicers, sell side, buy side and CDO managers earned their money by the funding of mortgages riddled with fraud or to unqualified homeowners. Market participants earned the wrath of populist elected democrats. Bush’s ownership society programs helped to facilitate the problems. Last year, we were talking QE2 and Federal Reserve over purchasing of Agency MBS. Fannie Mae and Freddie Mac, in their second year of conservatorship, played a part in the administration’s effort to stem the wave of foreclosures to slow down home price depreciation.

Last year the conference was run by lawyers and this year it was run by deal people, therefore the parties were way better. Well not all the parties but at least the alcohol was flowing. The Naked Bond Bear crashed … err … attended several of the dealer parties for the benefit of you dear reader. Optimism for the functioning markets (Commercial Mortgage Backed Securities, Credit Cards, and Prime Autos) allowed JP Morgan to rent a pool table in its hospitality suite.

Renewal – sort of…

Many parts of the securitization markets are returning from tepid to low volumes (when compared to 2005-6).  Last year investment banks issued ~$8 billion of CMBS (not including $3.5B of Freddie Mac K-deals).  Citi expects CMBS issuance to be $12B in the first quarter of 2011. Seasoned CMBS senior tranches speads to swaps have tightened from a high of 1,200 in 2008 to 215. (These bonds were originated at a 1 mo LIBOR + 15-25). Auto ABS and Credit Card securitizations are growing at the same pace. According to Citibank’s research, $15B of consumer ABS were issued in 2010 while $9.8B will be issued by the end of February! Even CLOs are seeing a tremendous boost of liquidity, missing since July 2007. Every panel’s future looking statement on these asset classes were positive discussions of growth and renewal.

The missing asset in this massive group hug is the largest of the asset classes: residential mortgages. Only one private label RMBS originated in 2010 for a whopping $255 million by Redwood Trust and no RMBS are expected to be originated in 2011. One very optimistic research analyst predicted $20B of RMBS issuance in 2012.  Why are 95 percent of residential originations being securitized through Fannie Mae, Freddie Mac and Ginnie Mae? Why are banks originating jumbo mortgages (over $729k in high cost areas) only 25-37.5 basis points over agency loans? Why do the super bowl half time shows continue to deteriorate after the famous wardrobe malfunction? Three reasons: Regulatory uncertainty, investor reticence, and the juicy net interest margin returns on portfolio jumbo mortgages.

Next post will discuss the uncertain regulatory environment.

And someone is going to get punched in the face if one more 20-something Harvard-MBA junior trader says “This time pro-forma underwriting will be different”.

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Boring Risk

16 Apr

“Know when to hold ‘em, know when to fold ‘em” – My forecast and trade on the 2/30 had called for 400bps by this time from December 09. Clearly things have not worked out as well, which has warranted increased monitoring of this position. Fundamentally, I believe that the spread will eventually go to those levels for the main reasons:

  1. 30Y bonds are not desirable to many investors given increased geopolitical risks, which should put further selling pressure in the (hopefully) intermediate term.
  2. 30Y swaps are inverting more and more, which is reflecting the perception that the US government could possibly not meet the obligations 30 years hence (I doubt we can meet our obligations 5 years hence, and the swaps market seems to be inching closer to that same picture as well)
  3. Investors will begin to demand higher yields due to selling and to try to minimize any potential fallout effects that DC’s fiscal recklessness could dish out
  4. The shorter end of the curve has less default risk, so I would expect that investors who are looking for a relatively short lockup period for their funds can still get a relatively decent rate (it is still beating what most banks are charging for deposits)

Luckily for me, the 360 bps has not been breached much, and due to me being on vacation for the better part of March, I’m glad I didn’t follow the spread from day to day.

My VaR assumptions for the portfolio were shattered nearly 4 times (although if memory is serving me correctly, intraday that number is much higher), with the most recent being in early March. The historical VaR for the spread has been decreasing along with historical volatility. The primary risks that I continue to see for the spread are: 1) Geopolitical risks both in US and EU 2) A shift in the perception of long term US deficits which could make the long end of the curve desirable.

Out of all the spreads, this particular spread has the lowest HV, primarily due to the lack of significant movement in terms of 30Y yields. The short end of the curve has seen recent spikes in HV, and thus if I do an analysis of the portfolio for both 2Y and 30Y, I see that this is validated. The overall Expected Shortfall (ES) is 9.5% at a 95% confidence interval. The contribution of each leg is: 2YR 90%, 30Y 10%. I have suggested in the past in order to hold on to the position to hedge one or both of the legs with options. In February, I initiated the hedge and by March this hedge had expired. It is, perhaps time to try to hedge against volatile moves on the short end, particularly above 1.10% on the 2Y leg and possibly put in a rate floor on the 30Y around 4.60-4.65, This will enable the individual to hold on to the position while attempting to stem losses from continued flattening of the curve due to exogenous factors such as a flight to quality from some unforseen event, etc. I agree with Bill Gross on this one, but of course I am not totally impartial in the debate between BlackRock and Pimco.