Tuesday, February 13, 2007

Mortgage fall out

In what seems like a delayed reaction, the Thursday's announcement from HSBC is finally moving some investment grade corporate issues wider. The following are some quotes from 2/7 vs. this morning.

HSBC '16 was 67/64 now 76/73 9 bps wider

RESCAP (GM's old mortgage unit) '15 was 167/162 now 170/165 3 bps wider

Centex '16 was 138/134 now 139/135 1 bps wider

Toll Brothers '15 was 157/147 now 155/150 3 bps wider

Washington Mutual '17 was 93/88 now 100/95 7 bps wider

Countrywide '16 was 113/108 now 119/114 6 bps wider

Merrill Lynch '16 was 85/82 now 90/87 5 bps wider

Bear Stearns '17 was 86/83 now 91/88 5 bps wider

Bank of America '16 was 64/61 now 67/64 3 bps wider

In today's low vol environment, a move of 5-8 bps in a couple days is a pretty big move. WaMu has been a weak performer over the last couple years, as concern over a housing slowdown have dogged the bonds. Countrywide would be in that boat as well if not for the recent rumor that Bank of America wants to buy them.

Investment banks are mostly 1-2 wider. There are various concerns related to sub-prime lending and investment banks. First, they might have direct exposure through inventory positions. Second, many people are talking that there are sub-prime MBS CDO's which are still in the warehouse stage, and which their positions are deep underwater. In many cases, investment banks have advanced the money to accumulate the portfolio and will suffer losses if these deals break up. There may also be hedge funds that were heavily involved in this sector which wind up failing. I view these risks as minor for credit investors. They may be more serious for stock investors. I think back to Long Term Capital Management. If the brokerage industry figured a way out of that, they'll figure a way out of this.

Interesting that the home builders are hanging in. Is the market saying that the sub-prime problem won't have a material impact on home builders? No, because their stocks have been weaker the last couple days. I think the market is saying that investment-grade home builders are financially strong enough to weather a period of weakness in the housing market. The sub-prime problem may elongate and/or deepen the weak period, but the fundamentals for the credit are in tact. I agree with that hypothesis.

Of the names listed above, I have positions in Bear and Merrill.

2 comments:

Anonymous said...

Something seems to have been lost from that HSBC report when it's been echoed in the media. If you go back and read it along with an excellent piece from the wsj you'll discover that there's nothing really wrong with the sub prime market. There is something wrong with the alt-a (low-doc) mortgage writers. They are defrauding large banks and investors who are buying their pools in an effort to keep loan production high. It's ultimately in my view the result of the tremendous excess liquidity available in the market now.

The HSBC unit responsible for the increase in reserves was primarily engaged in a rapid building of their mortgage book through purchasing pools from third party originators. Rapid asset building by any bank or finance company is a pretty good indicator that there may be problems down the road and surprise, there were. It's likely more of an isolated event than anything else, if it were actually market related they wouldn't have disposed of the leadership of that part of the organization.

Tom G. said...

I think that depends on what you mean by "nothing really wrong with the sub-prime market." If lenders were doing more low-doc/no-doc loans to sub-prime borrowers, then its still a big problem for the sub-prime market. When you buy a pool of sub-prime MBS, there is going to be a contingent of low-doc loans in there, and if an out-sized percentage of them go under, then your security might perform poorly.

That being said, I think weakness in HSBC bonds as well as the brokers is a smart entry point. This will pass.