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Secondary Trades Surge as Sellers Rush In
Asset Backed Alert, Harrison Scott Publications Inc. (April 25, 2008)

Secondary-market trading of structured products has picked up substantially in the past two weeks.

The uptick is partly attributable to an influx of holders of asset-backed securities, mortgage bonds and CDOs who are willing to accept offers from secondary-market buyers, after seeing bids remain level since late March. The thought is that sellers want to take advantage of the stability, which they view as only temporary.

That marks a departure from what was happening just a few weeks ago, when sellers were hiking their asking prices and buyers were reducing their offers - causing so-called bid-ask spreads to widen. Now, as more sellers enter the market and bid-ask spreads gradually close in, trading is on the rise.

"It seems like there are more people playing. I'm doing more trades than I did a month ago," said David Castillo, managing director at broker-dealer Further Lane Securities.

Even with the recent stability, most of the buying is being done by opportunistic fund managers who want to purchase securities far below their par values. Some of those players have recently seen their buying capacities rise, after lining up loans from dealers who received funding from the Federal Reserve's discount window.

Some selling, meanwhile, is coming from bondholders who are finally giving up on investments that have plummeted in value since the credit crunch set in with last summer's collapse of the subprime-mortgage industry.

Most others just want to unload whatever they can before the market tanks again, one CDO trader said. The upshot is that the current trading rally is only expected to last another three or four weeks.

Indeed, there is a strong sentiment among industry players that liquidity will soon evaporate as financial institutions continue to roll out dismal first-quarter earnings reports - repeating a scenario that has already played out twice since mid-2007. Just in the past week, major writedowns were reported by Ambac, Bank of America, Credit Suisse and Royal Bank of Scotland (see article on Page 4).

For now, senior "first pay" home-equity loan bonds that were issued in late 2006 or early 2007 with three- to seven-year lives are fetching bids in the neighborhood of 95 cents on the dollar. "Fourth pay" notes - triple-A-rated bonds that have lower priority for payments - are going for about 55 cents.

Some traders see that figure falling below 50 cents next week, due to an overload of supply caused by a $190 million bid list that was in the market this week. And the leverage that opportunistic investors have recently gotten from dealers won't last forever, they add.

On the other hand, another factor that industry players thought might shake up secondary-market trading has not come into play. Earlier this month, there was a buzz that managers of battered CDOs were about to start liquidating up to $25 billion of their deals' underlying asset- and mortgage-backed securities, causing secondary values to wither as supply outstripped demand.

But that hasn't happened, as super-senior noteholders in the CDOs exercise options that give them first shot at buying the deals' collateral. More than $5 billion of such sales have taken place since early last week, accounting for the bulk of CDO-liquidation activity.

The idea behind the purchases is to recoup losses on the CDO investments by holding the underlying bonds until they mature or their values go up. "It's bid-list city, but nothing's trading from those deals," one salesman said. "It doesn't really change hands."

That can be frustrating for would-be buyers and their broker-dealer representatives, who often spend time researching an offering before they submit bids, he added.

In the broader secondary market, however, "two-way flow [is] probably the best it has been all year," J.P. Morgan researchers wrote in an April 18 report. They also noted that bond values have stabilized on the new-issue front, where more than $6 billion of deals backed by credit-card receivables, student loans and auto-related credits have priced in the last two weeks.



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