Mortgage rally sends sell signal to Metacapital

, Bloomberg

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Bryan Whalen
Bryan Whalen

Investors from TCW Group Inc. to Metacapital Management are growing more cautious on the riskier tiers of U.S. mortgage bonds as a rally in subprime debt accelerates after gains of more than 41 percent last year.

Prices of senior securities tied to so-called option adjustable-rate mortgages that allow homeowners to pay less interest than they owe rose last week to the highest levels since 2008, climbing to 69 cents on the dollar from 65 cents at the end of 2012 and 52 cents a year ago, according to Barclays data. Subprime debt issued before the housing bubble burst in 2007 has returned 4.7 percent this year, its data show.

"There's more than a handful of securities we're seeing trade where the prices are way ahead of the fundamentals," Bryan Whalen, co-head of mortgage bonds at Los Angeles-based TCW, which oversees almost $140 billion in assets, said in a telephone interview. "They're obviously trading on hopes for a very significant improvement in the housing market, which may occur, but it's not a foregone conclusion."

Real-estate values began rising in 2012 after a five-year slump as institutional investors boosted their buying of foreclosed homes to convert to rentals, adding to demand that's facing the lowest supply of properties for sale since 2001. Bond investors are using the $950 billion market for so-called non-agency securities, which lack government backing, to speculate on further improvement in housing.

Narula Selling

The Federal Reserve's policies are also pushing investors to seek higher returns outside of Treasuries and agency mortgage debt, which the central bank is buying. Metacapital founder Deepak Narula, who last year topped Bloomberg Markets magazine's ranking of the best-performing hedge funds as mortgage-focused ones exceeded all other categories, said he's been selling as prices rise.

"We have actually taken down our non-agency market risk by a third this year," Narula said during a panel discussion on Jan. 17 at the Bloomberg Link Global Markets Summit in New York. He sold bonds that will yield less than 3 percent even if housing does better than expected, he said. "There's no reason for a hedge fund to own that."

Returns across the market, from bonds backed by larger jumbo mortgages to subprime debt, averaged about 21 percent last year, according to Amherst Securities Group.

Beating Junk

That beat assets ranging from U.S. high-yield corporate bonds, which have returned 1.6 percent this year after gaining 15.6 percent in 2012, to government notes from Greece, Ireland, Italy, Portugal and Spain, which have climbed 1.9 percent following an 18.5 percent advance, Bank of America Merrill Lynch index data show. The Standard & Poor's 500 stock index rose 16 percent with dividends reinvested in 2012.

Elsewhere in credit markets, Tenet Healthcare Corp., the third-largest publicly traded U.S. hospital chain, sold $850 million of speculative-grade bonds. Electricite de France, the world's biggest atomic-power producer, raised about 4 billion euros ($5.3 billion) in its debut offering of securities that have characteristics of both debt and equity. Apex Tool Group cut the rate it will pay on a $835 million term loan.

The U.S. two-year interest-rate swap spread, a measure of debt market stress, rose 0.8 basis point to 14.93 basis points. The measure widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.

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