FLASH UPDATE: Initial MBS impact on Rep. Watt's decision to delay "g-fee" hike is muted

On Friday Dec 20^th  Rep. Mel Watt, the incoming Director of FHFA, announced his intention to delay the implementation of "g-fee" hikes and changes to the risk-based pricing plan announced on Dec 9^th.  This promises to be the first volley in an ongoing course change for the FHFA between outgoing Director DeMarco and Watt. 

Approximately one week after the announcement by Watt, we see premium coupon (4.5s, 5.0s) MBS underperforming their hedges by about a quarter point - but pretty much in line with underperformance for lower coupon MBS as well.  Because these fee changes were not slotted to take effect until the end of 1Q14, we hadn’t expected to see much of an immediate impact on pricing deriving from this announcement.

Longer term, the importance of this decision is that it confirms the upcoming policy direction for the FHFA will clearly be steered toward supporting the availability of credit to homeowners versus accelerating the exit of Fannie and Freddie from the mortgage market.  All else equal - which is rarely the case - this will delay the return of private capital into the mortgage market and support the primacy of agency-backed mortgages in the mortgage market today.

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

FLASH UPDATE: MBS tightening ahead of the FOMC announcement at 2pm today - Housing Starts Portent Taper Today

On Dec 9^th we discussed on this blog the “cornucopia’ of economic data during the prior week pointing to Fed Tapering in the near term and advised investors to await further confirmation via both data and “Fed-speak”.  Today, as of now, we have/will receive both.

This morning we received Housing Starts for Sept, Oct and Nov as we had been having a blackout on this statistic for the past 3 months.  Housing Starts for November crossed the psychologically important 1MM mark, up 23.5% from the last published value in August!  With mortgage rates now above 4%, this puts to rest the FOMC’s fears in September about "Tapering" too soon.  Mortgage rates have now risen +100bps since the Fed first suggested in 2Q13 that "Tapering" may begin prior to year-end and the housing market has now proven robust in the face of such higher housing costs.

Treasury yields have risen about +10bps since the release of strong economic data earlier this month.  However mortgage spreads have tightened about an equal amount.  Clearly investors are handicapping a near-term Tapering of Fed QE and are expecting it to be biased more toward the Treasury market than in mortgages.  Mortgages today are performing extremely well across the coupon stack.  Mortgages are up slightly stronger in the belly of the stack and slightly stronger in 30 year mortgages versus 15 years.  FNCL, FGLMC and GNMA 4s are leading the way, each up about +7 to +8 ticks as of this writing (1:00pm).

 

At 2:00pm there is a risk that the Fed announcement could disappoint investors.  However we expect a strong upward bias in Treasury yields and rally in mortgage yield spreads to Treasuries should the Fed announce a "Tapering", or an intention to soon "Taper", its QE program more biased toward Treasuries than mortgages.

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

FLASH UPDATE: Mel Watt-led FHA is expected to have non-uniform impact on the MBS market

With the confirmation last week of Mel Watt as head of the FHA, mortgage investors are watching closely and awaiting possible policy changes and their impact on the mortgage market.  The Obama administration is strongly supportive of policy that continues to promote refinancing and low income housing in particular.  Here are a few mortgage policy dynamics to be aware of:

One of the most important would be the extension of the HARP cutoff date for FNMA/FHLMC conforming loans from June 2009 to June or December 2010 and allowing for borrowers to refinance mortgages that had previously been HARP refinanced.  At current levels of mortgage rates this could raise refi speeds for 4.5%  and 5% coupons by 5 to 14 CPR.  This would have a deleterious effect for mREITS who hold significant balances in higher coupon mortgages.  But it would be beneficial to mortgage servicers who process refinancing activity.  Perhaps more importantly, the presumption is that the FHA would match any cut-off date extension by the FHFA, which would have an even larger impact on GNMA collateral.  

The FHFA could reduce or eliminate Loan Level Pricing Adjustments for low FICO, low LTV loans which could also boost speeds by 5 to 9 CPR in higher coupon MBS.  Currently, this group of borrowers represents about 29% of HARP eligible borrowers; new borrowers in this cohort could see their mortgage rates drop by over 1.00%

Lastly, under a Watt-led FHFA, the likelihood for reducing the loan limits for what qualifies as conforming FN/FH collateral would almost certainly go down-, which would not be helpful in re-accelerating the return of the non-agency mortgage market.

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

FLASH UPDATE: Who Will Be the Last One Holding Junk Bonds when the Music Stops?

Who Will Be the Last One Holding Junk Bonds when the Music Stops?

“Troubled borrowers hide behind a wall of yield-hungry investors.”  Low interest rates on benchmark bonds have driven investors to the worst-of-breed CCC and B-rated junk bonds.  Companies have taken full advantage of this investor appetite by issuing $16.5 billion worth of PIK bonds.  These bonds allow the issuer to make “payments-in-kind” with additional bonds (more IOU’s) in liu of cash payments.  According to the Bank for International Settlements, new PIK bond issuance is nearly triple the amount issued in 2012.  The $16.5 billion has now far surpassed the $11.1 billion issued in 2007, which coincides with the end of the last credit cycle.  BIS also indicated that about 30% of issuers that issued PIK bonds in the previous cycle have already defaulted. 

Record sales of PIK junk bonds are triggering uneasiness among international regulators concerned that investors will suffer losses when central banks tighten monetary policy.  BIS is nervous about the artificially low default rate and what happens to the companies that have been hiding behind the wall of liquidity.  “What is happening in corporate markets is unusual,” said BIS.  “It is as if the typical relationship with (the) macro economy has taken a holiday.  Spreads are low and so are default rates…” (for now). 

We here at Tradex have maintained that we see cracks in the individual junk companies, long before the headline default rate is flashed all over Squawk Box.  There are a lot of these “bad” bonds and a very small appetite from banks and dealers in the current banking environment.  So, who will be the last one holding these when the Fed’s music stops.  

Michael Beattie

Chief Investment Officer 

FLASH UPDATE: Cornucopia of economic data last week points to Fed Taper - Advise Caution for the Short Term

Last week we saw a veritable cornucopia of data releases - all pointing toward safe passage to the advent of Tapering by the Fed later this month.  Wednesday’s ADP payroll data showed growth by +45k jobs, more than expected in November along with a +54k revision upward for October.  Thursday saw initial jobless claims undershoot expectations by -22k and GDP (Q/Q) swell to a robust 3.6% annualized.  Friday completed the trifecta with headline unemployment dropping to the magical +7.0% and Univ of Michigan confidence survey rising to +82.5 versus expectations of +76.

Not surprisingly, treasury yields rose for the week by +6 to +7bps uniformly across the 5 to 10 year part of the curve.  This reflects expectations of a slowdown in purchases of $45bln/month in the Treasury market.

However, mortgages tightened by -7 to -10 bps on the week from their recent highs for both 15 year and 30 year mortgages.  This reflects a market expectation that the pace of Tapering will be skewed toward more Treasury than in the mortgage sector.   We would advise caution initially as markets can be quite fickle in charting a new course until confirmed with “Fed-speak” later this month.

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

FLASH UPDATE: Procrastination Can Burn You

Procrastination, in delaying being short high yield, is like standing too close to the fire

I have recently read a short piece in The New Yorker discussing “procrastination”, which effects all of us in one form or another.  It is interesting that George Akerlof authored the piece.  His wife, for those that are unaware, is Janet Yellen (our soon to be new Federal Reserve Chairperson).  She may want to read closely what her husband has written on the subject of procrastination when she thinks about “Tapering”.  I have spoken to several very smart investors, many of which are much more educated than myself, but regardless of the Ivy League pedigree or the Nobel Prizes on the mantel, we can all have a case of procrastination from time to time.  

The current investment theme we are focused on and excited about is shorting high yield companies who never procrastinated when “free” money became available.  I am surprised by some potential investors’ theories which suggest that they can time the fall in high yield…or is it just procrastination rearing its big ugly head?  

George Ainslie, the well-known psychiatrist, psychologist and economist, wrote in an essay that procrastination “…is as fundamental as the shape of time, and could well be called basic impulse…”.  The word procrastination itself means “to put off for tomorrow”, and entered into the English language early in the sixteenth century.  By the eighteenth century, Samuel Johnson was describing it as “one of the general weaknesses” that prevails in all great minds.  In a study done at the University of Calgary, the percentage of people who admitted to difficulties with procrastination quadrupled between 1978 and 2002.  

In this light, I now understand why so many colleagues and intelligent investors sometimes procrastinate in making fairly obvious decisions.  I thought it was timing, but maybe in some cases I was wrong and it’s just old fashioned procrastination.  As for me, I really hate to put off what I can do today for tomorrow.  This probably comes from my strict Grandmother and all of her values.  

I can honestly say that two of the best trades I have been involved in would have been missed if I had been a procrastinator:  1) Short Subprime, and 2) Short HY.   Both trades were so cheap to have on that I never really thought about waiting for tomorrow when, for pennies, I could have it on early when bonds were at the highest levels, allowing us to maximize the returns. These two trades were the most profitable trades for myself and our investors in the crisis period.  (Of course we should have had double the size).  I encourage everyone who is looking seriously at our Short-Biased High Yield Portfolio to get invested now (or soon) as bonds are generally at their mathematical peaks and fundamentals in the HY companies we focus on are eroding fast.

Best Regards,

Michael Beattie

Chief Investment Officer

FLASH UPDATE: MBS Continue to Underperform on ADP Jobs Data

The ADP Payroll yesterday showed better than expected employment gains for November.  The monthly ADP report is always closely watched as it foreshadows the monthly Unemployment Rate to be published on the first Friday of every month – November’s unemployment numbers will be published this Friday.  The 215k jobs gained for the month by ADP overshoots the survey expectation of 170k and last month’s employment gains for ADP were revised upward by 54k jobs as well.  The strong report points to a strong employment report on Friday and modestly increases the likelihood of a Fed Taper at its December meeting.

Mortgage spreads to 7 year treasuries have now widened ~10+bps since the recent lows seen in at the start of last month.  Continuing what has been a recent theme, until and unless data or announced policy changes the trajectory of the recent  spread movement in the mortgage market, we expect spreads to continue to slowly drift wider.

Flash Update: Short HY Case Study - Mirabela Nickel - MBNAU 8.75% 4/15/18

Mirabela Nickel Ltd is a Brazilian mining company with significant nickel and other related assets.  With nickel prices under pressure in recent years due to overproduction, the price of the stock (MRBAF) has fallen from $7 in 2008 to essentially $0 this year.  Capital proceeds reinvestment from the $375 MM debt issuance in 2011 did not stem the losses in 2012; in fact, they accelerated.

Nevertheless, with profitability and other financial ratios signaling red flags for the company throughout 2012 and with the equity trading at $0.50 as recently as February 2013, the bonds continued to trade near par.  In fact, Moody’s and S&P upgraded the credit rating of the company on December 13, 2012 and March 27, 2013, respectively.  On September 26, 2013 the company announced that it would miss its upcoming debt payment and the bond price dropped by 50% in one day (see chart below). 

Mirabela Nickel Ltd has seriously deteriorating fundamentals, in addition to nickel losing more than 20% of its value this year.  This mispricing of the bonds and the Q1-2013 upgrade was further evidence of the disconnect between financial assets and the ‘Main Street’ economy.  Please contact Tradex Global to further discuss our short high yield strategy.

Business Overview:                        Mirabela Nickel Ltd is a Brazilian mining company with significant nickel and other related assets.                                                                                        

Rating:                                               Moody’s:       Ca – “Highly speculative and are likely in, or very near, default with some prospect of recovery of principal and interest.”

S&P:                D – “Payment default on financial commitments.” 

Rating Agency: Moody’s	From:	To:
12/13/2012	Caa1	Caa1 (upgrade from Negative to Stable)
10/2/2013	Caa1	Caa3 (downgrade to Negative)
10/22/2013	Caa3	Ca (downgrade to Missed a Payment)

Rating Agency: S&P	From:	To:
3/27/2013	CCC+	B- (upgrade to Stable)
10/2/2013	B-	CCC+ (downgrade)
10/23/2013	CCC+	SD (downgrade to Selective Default)
11/18/13	SD	D (downgrade to Default)

Issue Size:                                         $375 MM

Use of Proceeds:                             “Repay/Refinance Debt” and “General Corporate Purpose”

Call Prices/Dates:                            4/15                104.3750

4/16                104.1875

4/17                100.0000

Financial Highlights:                       Income Statement:  ($millions, except per share data)

Period	12/31/2012	12/31/2011	12/31/2010
Revenue	343	303	210
Net Income	(452)	(51)	(48)
Earnings Per Share	(0.3)	(0.1)	(0.1)
Total Debt	450	402	263
Leverage (Total Debt/EBITDA)	12.1x	71.0x	8.7x

         

Recent Prices:                                  99.375            (2/12/13)

35.000            (11/26/13)

Yield to Worst:                                 43.5%

Company Outlook:                        The company’s  difficulties have mimicked the long secular decline in the price of nickel.  In addition to being concentrated within a single commodity, it also was dependent upon having only 2 prime customers.  When one of those customers (Votorantim Metals) announced it was closing its nickel smelting facilities, the price of Mirabela’s debt dropped 50% on September 24, 2013.  The Company has delisted from the Toronto stock exchange and entered in waiver and standstill arrangements with its major creditors.  

Source: Bloomberg and Tradex Global Advisors

* The above trade case study may not be an investment in an existing stand-alone investment entity.  The information for the trade case study was gathered from various sources.  No representation is being made that any vehicle managed by Tradex Global Advisors will or is likely to have this position in any of its Portfolios.  This trade case is neither a recommendation to buy nor a recommendation to sell the referenced security or securities.

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

Bloomberg Brief: Ex-James Alpha’s Libby Joins Tradex as Portfolio Manager

Ex-James Alpha’s Libby Joins Tradex as Portfolio Manager

K. Daniel Libby, a former senior portfolio manager at James Alpha Management LLC,
joined Greenwich, Connecticut-based alternative asset management company Tradex
Global Advisors LLC, he said in a telephone interview.

Libby, who started at Tradex as senior portfolio manager in September, will manage a
short-biased high yield fund that will start before year end, he said in a telephone interview.
Libby also plans to start a liquid mortgage hedge fund strategy in the first quarter of 2014
that will focus on mortgage basis and prepayment arbitrage, for which the firm is targeting
$50 million to $100 million, he said.

Before Tradex, from 2011 to 2013, Libby was a senior portfolio manager at James Alpha,
the family office for Dennis Nayben, the former chief executive officer of General Electric
Capital Corp., Libby said. Prior to that, he was a senior portfolio manager at Sands Brothers
Asset Management LLC from 2005 to 2011, where he managed the Vantage Point Partners
Mortgage Credit Fund and the Select Access fund of funds, he said. He was also a director
at BlackRock Inc. in its risk management services bureau from 2001 to 2003.

“There’s tremendous opportunity in high yield from the short side because the market is
late in the credit cycle due to all the liquidly the Fed has put into markets,’’ Libby said. “High
yield will be the first asset class that will show signs of cracks and distress. We have a
bearish view in fixed income in general – mortgage basis trading and prepayment arbitrage
trading are well positioned to take advantage of the bearish backdrop in the markets.’’

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

FLASH UPDATE: WILMAAAAAA, The High Yield Models are BROKEN!

It is very clear that the models used to determine the ability of a HY company to repay its debts are severely broken.  There have been many instances of incorrect recommendations made based on historical data and criteria.  In numerous cases, a Buy or Hold recommendation was just wrong.  (See the case study on Mirabela Mining Ltd. that we are putting out this week on our blog.  The bonds were still trading at par earlier this year after the equity had fallen 93%! The company is now in bankruptcy.  Clearly someone’s model was wrong.) 

As in the late stages of the housing boom, underwriting standards in the corporate credit markets have loosened as the offer continues to get lifted at higher prices for CCC credits.  Today more than 50% of the new issuance for senior bank debt is cov-lite, approximately double what we saw in the previous cycle’s peak (2007).  In such a lax underwriting environment, with high yield issuance near record highs and spreads near all-time tights, the only question that remains is ‘When?’   When the liquidity stops (or even as it “Tapers”), the weak underwriting and excessive leverage in “specific” HY companies (150-200) will force a wave of defaults, potentially larger than the normal 50% ratio.  We have a structure in place that allows us to wait for the music to stop. 

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

Tradex Global Advisors Announces Daniel Libby as Senior Portfolio Manager

Greenwich, CT, November 20, 2013 – Tradex Global Advisors, LLC, an alternative asset management company, announced today that K. Daniel Libby, CFA has joined their investment team as Senior Portfolio Manager. Mr. Libby will play a significant role across all of Tradex's internally managed Hedge Funds and Fund-of-Hedge Fund Portfolios.

"We are delighted that Dan has joined us. We’ve known him by reputation and have followed his performance for many years. Dan is a seasoned portfolio manager who has stellar records in fixed income and mortgage products in all market cycles, including during the most stressful periods in recent memory.” said Michael Beattie, one of the firm's founding partners and its Chief Investment Officer. “We are particularly excited about leveraging Dan’s skills in building out our internally managed product offerings in the mortgage and high yield space." said Jeff Trongone, President of Tradex Global, who also recently joined the firm having previously served as CEO of Malbec Partners, a hedge fund platform sponsored by BNP Paribas, and CFO of JP Morgan's asset management business.

"Tradex's focus on providing the highest quality investment program to investors with a significant emphasis on managing both operational and investment risk was an important factor in my decision to join the firm, as was the opportunity to help continue to build a world class investment business. I look forward to working with the Tradex team to provide excellent investment capabilities for our investors," said Mr. Libby.

Mr. Libby has nearly 30 years of investment experience at leading Wall Street and buy side firms such as Goldman Sachs, Nomura, IBM Pension and BlackRock. For the past 10 years, he has managed several successful hedge funds. His investment performance track records include “core plus” fixed income, distressed mortgage-backed securities, long/short high-grade mortgage-backed securities and multi-strategy portfolios. He is a graduate from Columbia University with both his BS and MS degrees in Mathematical Methods/Economics and Mathematical Methods/Finance respectively.

About Tradex Global Advisors Tradex Global Advisors, LLC (TGA), headquartered in Greenwich, Connecticut is part of The Tradex Group of investment companies. TGA manages Fund of Hedge Funds and internally managed Hedge Funds, including their recently-launched short-biased high yield and a liquid real estate strategies. TGA was founded in 2004 by Michael Beattie and Richard Travia and focuses on innovative and niche investment products and strategies for its investors. With its targeted focus, TGA seeks to identify uncorrelated and sustainable investment outperformance (“alpha”) across market cycles in all of its products.

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

HFMWeek Exclusive: Tradex hires industry veteran Libby

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

FLASH UPDATE: The Wall of Worry is Fast Approaching

Savvy investors have long since learned to put something away for a rainy day, because things will not always be so rosy.  Usually, investors tend to have a bias towards being long the market.  Even when investing in a diversified portfolio of long/short alternative investments – typically the net exposure will be a moderately long position.  Today, it is becoming increasingly more difficult for informed investors to ignore certain warning signs, particularly in the US high yield market.  By all signs, this sector appears to be well overextended and we expect it may be the first to fall in the months and years ahead. 

A)  Loan Issuance is Heavily Cov-Lite This Time Around

As we have written previously, the underwriting standards for the alarmingly high percentage of Cov-Lite loans being originated have raised concerns among regulators and industry practitioners alike. 

                                               

B)  Academic Studies Show that Nearly 50% of CCC-rated Issues Default Within 4 Years of Issuance

With the information from the table below, we note that the record pace of high yield issuance has been ongoing for 5 years now.

C)  Next Year (2014) Begins the First of 5 Consecutive Years of Very Heavy Leveraged Loan and High Yield Bond Maturities Confronting Issuers

The maturities rolling over in 2014 are more than 2.5x greater than what occurred in 2013.  This pace of refinancing does not abate for the next 5 years.

                                                                                                                                 

Conclusion:

While no investors are capable of timing the market perfectly, 2014 is shaping up to be the beginning of a very difficult period for marginal high yield investors.  As is always the case, the greatest gains will be available to those investors who get in the trade early.  Today’s data set may predict the future, and we think that there is a certain sense of inevitability in the current HY irrational exuberance.  

 The above charts were compiled from data provided by www.bankruptcydata.com, JP Morgan, Thomson Reuters and the Edward I. Altman-NYU Salomon Center.

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

FLASH UPDATE: Mortgage spreads still driven by Fed Policy

Mortgage Spreads for the past year have been driven by outlook for Fed Policy - We expect that to continue and provide ongoing opportunity in the mortgage market 

The key data out last week was Pending Home Sales for September.  It was down a surprisingly large -5.6% in response to recently rising mortgage rates.  With data such as that on top of the Fed’s September 18^th “No Taper” statement (which they reiterated this past week), mortgage rates have been falling once again and spreads have continued their relentless tightening begun in July.  They tightened another -2 bps this past week and we expect this constructive backdrop to continue.

The Fed’s current QE bias will keep a cap on spread volatility and pressure spreads even tighter in the near term until a change in direction by the Fed is evident.  This makes for a strong positive environment for the mortgage basis and relative value trading over the near term.  However, a change in the direction of mortgage spreads is inevitable.  Once the Fed signals a change in course, what we have seen time and again is that the market impact persists for many months thereafter.  As the chart bellows shows, mortgage spreads since the 2^nd quarter of 2012 have been highly directional and driven by the outlook for quantitative easing.  We expect this trend to continue for the foreseeable future and to provide significant trading opportunities in the mortgage market.

To convince yourself that spreads will widen again at some point, one need only understand that the Fed will soon own a third of  the MBS outstanding.  The longer the Fed’s QE program stays in place, the more concentrated their percentage of the agency MBS market becomes.  Once the tapering begins, their exit - or even simple reduction of their presence in the mortgage market - will present a long period of ‘directional’ spread volatility which will represent significant arbitrage-able trading opportunities in the mortgage market.

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

HIGH YIELD FLASH UPDATE: The Truth

How did the “Experts” Miss the Obvious?

§  UNBIASED OPTIMISM – Apr 11, 2006 – Peterson’s Institute for International Economics – “…With continued strong productivity growth and some recovery of participation, potential GDP growth should be in the 3 to 3¼ percent range…”

§  ROSY OUTLOOK FROM SAN FRANCISCO FED – Nov 11, 2006 – Federal Reserve Bank of San Francisco – “…cooling in housing markets with solid growth in the remaining 95 percent of the economy outside of residential construction…”

§  IMF BEHIND THE CURVE – Jul 25, 2007 – IMF – “…The strong global expansion is continuing, and projections for global growth in both 2007 and 2008 have been revised up to 5.2 percent…”

Bankruptcy waves tend to follow times of indiscriminate high yield issuance

* Data provided by www.bankruptcydata.com, JP Morgan, Thomson Reuters and the Edward I. Altman-NYU Salomon Center

Flash Update: FT reports alarming rise in leveraged loans, especially Cove-Lite debt & PIK notes

This past Saturday (10/22/13) the Financial Times reported about the alarming rise in “cov-lite” loans in the leveraged loan market.  The Fed-induced  “ultra-low rates have made the loans for highly indebted companies white-hot in recent years as investors clamour for the higher yielding assets and corporates rush to refinance old debt.”  In 2013, the volume of leveraged loans written to date is on track to match or exceed the record set in 2007 just before the bursting of the credit bubble.  However, at the same time, the quantity of cov-lite loans within the leveraged loan market has actually doubled since 2007.

So the obvious question is: Has the underwriting quality kept pace even with 2007’s standards?  Do cov-lite corporate loans signal the next sub-prime debacle?  “Once the vast majority of leveraged loans are issued as cov-lite, few will be able to argue that only the strongest credits are getting the cov-lite treatment.  The trend has not gone unnoticed by regulators.” says the Financial Times. 

Yesterday’s Financial Times additionally reported that the issuance of payment-in-kind (PIK) toggle notes, allowing the company to pay lenders with more debt rather than cash, has surged in recent months.  There has been $9.2 B of PIK note issuance this year, already nearly 40% higher than last year and approaching 2008 levels.  32% of companies that issued PIK bonds during the bubble era defaulted at some point from 2008 to mid-2013, according to Moody’s. 

While cov-lite leveraged loans and PIK toggle notes may not in and of themselves represent the type of systemic risk to the economy as the sub-prime market, they could represent a significant trading opportunity and early warning sign for funds such as the Tradex Short-Biased High Yield Portfolio.

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

Flash Update: MBS tighten post weak Non Farm Payrolls (NFP) yesterday

Yesterday’s anxiously awaited September Payroll Report shows the change in non-farm payrolls (NFP) was weak at 148k vs 180k expected.  The Treasury curve flattened -8bps in yield on the longer end as one might have expected.  Mortgage yield spreads also tightened about -2 bps versus their hedges yesterday.  In terms of price performance, this equated to discount 30-year mortgages having rallied +30 bps in total return versus their Treasury hedges yesterday alone!

In total, the 30-year current coupon mortgage rate has tightened -10 bps in yield versus the treasury curve since the “no taper” decision by the Fed in mid-September and almost -30 bps since reaching their widest point in early July, after reacting to the Bernanke statement that tapering could begin later this year.  Clearly mortgages have been on an torrid run in the 2^nd half of 2013.  This is positive for our Liquid Real Estate Portfolio, particularly in the agency IO securities and other agency MBS relative value trades.

However several countervailing data points from yesterday might need to be considered as well.  The August change in NFP was revised upward by an almost equal amount as what the September NFP missed to the downside.  The headline unemployment rate also ticked downward to 7.2% from 7.3%.  The day-of-tapering will return once again and spreads will widen again.  The net take-away is that the mortgage “basis”, i.e. the yield spread between mortgages and Treasuries, remains highly data-dependent and range-bound.  We believe there remains excellent opportunity to trade the mortgage basis in this environment from both the long and the short side.  

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global