06/25/2010

US Shops See Opportunity in Europe's Woes

Asset managers in the U.S. are exploiting what they view as a rare opportunity to buy triple-A-rated mortgage bonds at double-digit yields.

The play involves securities from issuers in Ireland, Portugal and Spain, where values have been depressed by broad fiscal and economic woes. Those in on the action include BlackRock, Fidelity Investments, Pimco, State Street Global and Vanguard, along with some smaller shops.

The strategy is driven in part by a fear of missing out on cratering prices - something many investors experienced when the values of U.S. mortgage bonds fell to all-time lows in late 2008 and early 2009. The thought is that prices in Ireland, Portugal and Spain will eventually climb back, just as they have been doing in the States.

In fact, the pattern may already be emerging. Mortgage-bond values in Portugal, Ireland and Spain began sliding in April as worries about the nations' abilities to repay their sovereign debt roiled trading in a range of financial instruments. MBS prices then improved a shade about a month ago, when the U.S. players started jumping in.

The window of opportunity could close quickly. Market players say more U.S. investors are interested, driven by an opinion that their European counterparts have essentially thrown out the baby with the bathwater. "They see their chance to get in at distressed prices," said Elton Wells, head of structured products at illiquid-asset exchange SecondMarket.

Some of the shops already taking part in the trade have been able to flip their investments, in certain cases using the proceeds to buy even higher-yielding junior mortgage securities from the same nations. Few are looking for long-term holdings.

Not all of the buyers have experience in Europe, however. Instead, they're betting on market momentum and the fact that there has been little reason to believe the securities' asset pools face direct threats from the countries' sovereign-debt woes. That said, repayment isn't a sure thing. For example, mortgages written just prior to the 2007 credit-market crash have continually underperformed older accounts. "It is still a very risky trade," one trader said.

Another problem investors are encountering is a shortage of supply. Issuers in Ireland, Portugal and Spain have never produced many mortgage securitizations, and dealflow has been light in Italy and Greece - also among the Eurozone's weakest countries.

Senior five-year bonds backed by Spanish mortgages are trading at effective spreads of 320 bp over euribor, which is about 40 bp tighter than a month ago. Similar instruments from Portugal are unchanged at 260 bp. Benchmark issues from the U.K. and Netherlands, meanwhile, are going for 120-130 bp - a narrowing of about 35 bp.

In Greece, which is seen as weakest of all, the few senior five-year mortgage securities available are fetching 650 bp over euribor. Spreads are even wider for junior securities. Five-year paper with double-A grades from Portugal and Spain is trading at 475-525 bp over, and comparable issues in Greece are at 1,250 bp.

The spreads work out to yields of 12-20% for the top pieces of home-loan issues from the Europe's struggling nations, compared to 6-8% for U.S. product with a similar profile.

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