The Federal Reserve Bank of New York’s sales of the mortgage securities it assumed in the 2008 rescue of American International Group Inc. would probably fetch $15 billion “at most” at current prices, less than the insurer offered, according to Barclays Capital Inc. analysts.
“As such, while it does not have to be the case, a significant slowdown or even a temporary halt in sales till the market recovers should not be ruled out,” New York-based analysts at Barclays Capital led by Ajay Rajadhyaksha wrote in a June 10 report.
The New York Fed is selling the bonds piecemeal after rejecting a $15.7 billion bid for the securities from New York- based AIG in March. Before AIG’s offer for the $31 billion of debt was declined, investment banks including Barclays Capital, Credit Suisse Group AG and Morgan Stanley tried to put together groups of investors to offer rival bids for the entire pool, people familiar with the matter said at the time.
The central bank’s auctions have combined with signs of a weakening U.S. economy and a deepening European sovereign crisis to help roil markets, including those for subprime-mortgage securities and high-yield corporate bonds, as investment banks seek to dump risk on stockpiled debt. Drops last week in commercial-mortgage securities, which were stoked partly by the Fed’s auctions, “evoked memories of the 2008 market meltdown,” Bank of America Merrill Lynch said in a June 10 report.
The Fed, after earlier suggestions that the auctions were damaging markets, has been holding the sales at a slower pace and increasing their size.
The New York Fed’s decision to accept bids on only $1.9 billion of $3.81 billion of AIG-related bonds offered in a June 9 auction, its latest, shows that it “is not a distressed seller,” which is among “reasons to believe we are at or approaching the bottom in subprime prices,” the Barclays analysts said.
Jack Gutt, a spokesman for the New York Fed, declined to comment.
“There will be no fixed timeframe for the sales and at each stage the Federal Reserve will only transact if the best available bid represents good value for the public,” the New York Fed, which is being advised by BlackRock Inc., said in a March 30 statement announcing the sales.
$10 Billion Sold
The New York Fed has sold $10 billion in face value of the home-loan securities once owned by AIG and now held by a vehicle called Maiden Lane II, leaving it with about $21 billion to be auctioned, Barclays data show. Subprime-mortgage bonds tied to the weakest home-loan borrowers represent about $12 billion of the remaining holdings, with so-called Alt-A debt ranked a step above in terms of expected defaults accounting for most of the rest.
A Markit ABX index tied to subprime-mortgage bonds rated AAA when issued in 2006 has dropped 8.6 over the past month to 47, while typical prices for the senior-most bonds backed by Alt-A loans with a few years of fixed rates have declined 4 cents on the dollar to 62 cents, according to Barclays.
LibreMax Capital LLC, co-founded by former Deutsche Bank AG trader Greg Lippmann, who gained fame for his bets against subprime debt in 2007, overcame losses last month on its holdings of the bonds with wagers against the debt through ABX index credit-default swaps.
Hedge Fund Gains
The firm’s main hedge fund gained 1.15 percent in May, bringing its returns to 5.9 percent for this year and 10.3 percent since starting in October, according to a letter to investors obtained by Bloomberg News. Jonathan Gasthalter, a spokesman for New York-based LibreMax, which manages almost $700 million, declined to comment.
Hedge funds worldwide lost 1.15 percent in May, advancing 1.58 percent for the year, as those focused on fixed-income products gained 0.31 percent, bringing 2011 returns to 3.5 percent, according to estimates by researcher HedgeFund.net.
LibreMax is 45.6 percent invested in subprime-mortgage securities. Gains on hedges tied to subprime bonds and speculative-grade corporate debt offset a 0.65 percent price decline on the fund’s holdings, according to the letter.
The firm has a “large” position in junior-ranked subprime bonds issued from 1997 to 1999, which were more stable in price than newer securities, and it “increased our hedge positions in ABX, high-yield and equities,” according to the letter.
‘Worst Subprime Subsector’
ABX indexes and the bonds to which they are tied from 2005, 2006 and 2007 represent “the worst subprime subsector, in that home equity has been completely eaten up by the fall in home prices,” Karlis Ulmanis, a bond manager at Wilmington, Delaware-based DuPont Capital Management, which oversees about $27 billion, said in an e-mail. “The Maiden Lane II liquidations have pushed the ‘ABX’-type subprime bonds substantially wider.”
Securities tied to subprime and second mortgages have on average lost 1.8 percent since the start of April, the month that the New York Fed’s sales began, according to Bank of America Merrill Lynch index data.
Estimated trading volume in widely marketed auctions of so- called non-agency home-loan securities, which lack government backing, totaled about $13.3 billion last month, with $4.4 billion coming from the Fed’s sales as “overall trading volumes continue to suffer” from them, according to LibreMax’s letter.
Yield on junior-ranked, originally AAA rated commercial mortgage bonds jumped to 8.12 percentage points more than U.S. Treasuries last week, the highest in 10 months and up from 6.76 percentage points the previous week, Morgan Stanley data show.
The Fed’s sales “have weighed on securitized-product credit in general as dealers have been forced to lighten up exposure to make room for” the home-loan bonds that the central bank is selling, Chris Flanagan and Jimmy Nguyen, New York-based Bank of America analysts, wrote in their report.
“The Fed may be recognizing that the market and economy are not strong enough to absorb either the slow drip approach to selling or the larger scale approach,” they added. “In our view, halting the ML2 sales altogether is the next logical step.”
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