Bonds still jam the pipeline as volatility continues

Moves to lift restrictions on US government-sponsored loan agencies may help to stabilise the market, but some are forecasting more troubles ahead for creditors.
The announcement that Fannie Mae, the largest source of funding for US home loans, and its smaller rival Freddie Mac, may be allowed to expand their mortgage portfolios helped Asian bond spreads to tighten early yesterday.

Spreads also moved in on the back of higher global equities, with the benchmark Hang Seng index opening 1.07% higher at 21,973.58 at the beginning of trade yesterday.

Portfolio restrictions were imposed on both Fannie Mae and Freddie Mac in 2006, following accounting irregularities. Should these restrictions be lifted, the government-sponsored enterprises would be in a position to buy more loans, and thus boost demand for mortgages, helping to ease the crunch in the US credit markets.

For the time being, however, volatility is still causing unpredictable market moves with equity gains early in the day being cancelled out ahead of yesterdayÆs Federal Reserve meeting. Many expect the Fed not to cut rates to ease the US housing slump, and maintain interest rates at 5.25%. ôIt is a close call, but we suspect that events to date are not yet sufficient for officials to retreat from their focus on the risks of higher inflation,ö says CitiÆs economist, Chris Wiegand, in a report released by the bank.

Despite many market observers feeling confident that Asia is currently in a position to absorb more losses in the US market, due to good fundamentals, strong balance sheets, and solid reserves, others are not so sure. ôWe are concerned by the repeated mantra that æfundamentals are fineÆ,ö says Geoffrey Dennis, euro credit strategist at Citi.

ôAs liquidity falls, refinancing will become more difficult and the default rate will likely rise, just as it did in 1999. Over the past month, liquidity has steadily evaporated. Worse, there is a vicious circularity to the whole thing: the more hedge funds that fail - and have their assets seized by brokers - the more liquidity is likely to be withdrawn, hence potentially causing further failure. The more we look, the more it feels like 1998.ö

ôThatÆs not to say a downward spiral is inevitable: as CitadelÆs acquisition of SowoodÆs assets demonstrates, but the trouble is, for the near term, we fear more Sowoods, and fewer Citadels,ö he added.

Dennis is referring to the recent move by US hedge fund, Citadel Investments, run by billionaire Kenneth Griffin, to step in and take over the credit portfolio of Sowood Capital, a smaller fund, which had run up heavy losses in the credit markets.

But the fear of contagion of the US subprime crisis, which many also thought would be contained, is increasing. ôWhat started as a subprime problem is now threatening to contain a broad part of credit and equity markets. For instance, the widely watched CDX investment-grade index is now more than 30bp wider in July, which according to our fixed-income strategists implies the probability of defaults has increased by 75% in the last month,ö says CitiÆs European quant analyst, Manolis Liodakis.

American Home Mortgage Investment Corporation became the latest home mortgage casualty to file for bankruptcy protection. The company, which specialised in mortgages for people who fall just short of top credit scores, announced it would halt operations and cut staff of 7,400 to just 750. The filing is widely interpreted as a sign that mortgage defaults have spread from subprime borrowers to homeowners with good credit histories.

In this uncertain environment, three high-yield Asian deals are still stuck in the pipeline, namely Hong Long Holdings, Mobile-8 Telecom, and PT Cikarang Listrindo. ôThe only deals pricing in these markets globally are high double-A and triple-A rated financial institutions and sovereigns. We need to see at least one corporation price a transaction before we can think of going ahead with ours,ö says one syndicate banker.
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