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Bad News Greases Secondary-Market Trading
Asset Backed Alert, Harrison Scott Publications Inc. (December 7, 2007)

Secondary-market trading of structured products surged over the last two weeks, despite another wave of bad news about the subprime-mortgage business.

In fact, the dire headlines actually appear to have triggered the uptick in activity, by bringing sellers' expectations more in line with those of bargain-seeking buyers. The sellers include a large group of banks that took some $70 billion of writedowns on their structured-finance holdings in recent months (see table on Page 6).

While secondary-market business had been brisk in October as well, liquidity dried up almost completely last month amid a series of rating downgrades on mortgage bonds and CDOs, causing trading to freeze.

The current thinking is that because little has happened since then to brighten the outlook, holders of the securities no longer feel safe sitting on the positions until conditions improve. Instead, they're resigned to accepting "ridiculously cheap" bids just to get the investments off their books, one bond salesman said.

That has brought trading back to life, to the tune of at least a few billion dollars since late November. "At this point, the market believes that the dislocation could be experienced for another eight to 24 months," said David Castillo, who heads the fixed-income department at broker-dealer Further Lane Securities. "There's no optimism in cashflow modeling right now." He added that "it's a much broader-based participation than it was a month or two ago."

There hasn't necessarily been a corresponding shift in bond values, since last month's lack of activity left buyers and sellers without reliable benchmarks - resulting in prices that are still all over the map.

Nonetheless, both sellers and buyers are getting a better handle on what to expect after seeing values tank since the onset of the credit crisis. "If you're already looking at single-digit dollar-price bonds, how bad is it?" one trader said, referring to the lessening potential that investments made now will lose value down the line.

Indeed, many recent purchases were made by mainstream institutional investors who were previously driven to the sidelines by such fears. Industry players say it was only a matter of time before those buyers were lured back in by juicy yields, which had already captured the attention of opportunistic investors.

Plus, the secondary market offers buyers a place to focus their efforts at a time when pickings have been slim on the new-issue side. Only a few new transactions were in play in recent days, including a $500 million equipment-loan securitization that ABN Amro and Barclays priced for CNH Global yesterday. Citigroup was also shopping $2.4 billion of auto-lease bonds for GMAC this week, and Sallie Mae sold a $1.6 billion student-loan issue last Friday via underwriters Citi, Deutsche Bank, Merrill Lynch and Wachovia (see Initial Pricings on Page 10).

The recent increase in secondary-market trading defies conventional market wisdom, which holds that buyers should be running for cover in times like this. That should especially be the case given that huge bid lists making the rounds have been loaded up with mortgage-related bonds and CDOs whose underpinning receivables are experiencing alarming rates of delinquencies and defaults.

To be sure, some market participants did take a breather in the past few days to digest the U.S. Treasury's plan for lenders to freeze interest step-ups on certain subprime mortgages. Citi, Washington Mutual and Wells Fargo were among the mortgage companies that spent the last week hammering out the controversial rate-freeze plan with Treasury Secretary Henry Paulson.

Securitization professionals were waiting anxiously yesterday to see what Federal Reserve chairman Ben Bernanke would say about the prospects for cutting short-term interest rates later this month as well.

Also giving buysiders pause has been the ongoing deterioration of structured investment vehicles. Just last week, Moody's downgraded or put on watch for potential downgrades more than $100 billion of senior and subordinate debt issued by 20 SIVs.



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