Negative Equity
Subprime and option adjustable-rate mortgages originated at the peak of the market, with weaker underwriting standards, have the highest exposure to negative equity, Deutsche Bank analysts led by Steven Abrahams wrote in the report. Defaults and losses to bondholders are expected to decline as home prices continue to rise, with estimated gains of about 6.8 percent this year, the report said.
An index tied to subprime bonds created in the second half of 2006 that were issued with AAA ratings rose to 59.5 cents on the dollar this month from a low of 31.1 cents on the dollar in October 2011, according to London-based administrator Markit Group Ltd. The debt last year outpaced returns for less risky non-agency mortgage debt, such as Alt-A, which is backed by borrowers who often qualified with limited documentation.
‘Very Bullish’
“In 2013, we were very bullish on subprime,” said Anup Agarwal, head of mortgage-backed and structured products at Pasadena, California-based Western Asset Management. “It was overall a big winner and you saw that reflected in prices.”
Agarwal, whose firm managed $443 billion in fixed-income assets as of Sept. 30, has in the past six months turned more negative on subprime and started shifting money into Alt-A securities.
One William Street Capital Management LP, a hedge fund firm with $2.7 billion in assets, is expecting reduced losses as home prices continue to rise, according to a letter sent to investors this month. The investment firm said increased regulations have added to costs for firms that deal with troubled mortgages.
For subprime prices to make sense, recoveries must improve but won’t because of the backlog of loans, Gundlach said.
The money manager has cautioned investors before about avoiding subprime. In 2012, he said investors can’t assume the “lines will head south” speaking about loss severities for loans and then last year, referred to the debt as being stubborn.
Brash Pronouncements