Precrisis mortgage securities make a comeback

Leslie Shaffer | Writer for
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The collapse of mortgage-backed securities drove the financial crisis, but many fund managers are snapping up the precrisis offerings.

"We've seen strong demand for those assets recently," said Dan Adler, a senior portfolio manager at Amundi Smith Breeden, adding the demand has been broad-based across the subprime, alt-A and prime offerings.

Some of the precrisis securities are trading "significantly below par," and offer yields ranging from 2-6 percent, when adjusted for potential defaults, Adler said.

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Residential mortgage-backed securities, or RMBS, were one of the main drivers of the Global Financial Crisis. Investment banks bought housing loans of increasingly questionable quality, packaged them into securities and re-sold them into the market.

Although many of the securities were initially highly rated by agencies including Standard & Poor's and Moody's, poor loan standards, outright fraud and a souring economy led to a slew of defaults, causing many RMBS to be viewed as essentially worthless. The domino effect took down storied investment banks such as Bear Stearns and Lehman Brothers and caused the worst recession since The Great Depression of the 1930s.

Revisiting the precrisis RMBS can be a difficult sell for some investors, Adler noted. "There is some reluctance for exposure to U.S. housing given the experience of 2008," he said, noting that many tranches of the precrisis RMBS have little chance of ever paying out.

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But he believes these securities offer an attractive way to gain exposure to a mid-cycle housing market recovery, especially as further mortgage defaults become less of a risk.

"Of the borrowers that are still current, there's a high likelihood that they will remain current," Adler said. The delinquency rate for single-family residential mortgages was around 7.4 percent in the second quarter of this year, down from a high of over 11 percent in early 2010, according to Federal Reserve data.

One factor helping to support the market is relative scarcity. While there's around $700 billion in precrisis RMBS, current issuance is under $1 billion a month for non-agency securities, or securities containing mortgages without backing from government-sponsored enterprises such as Fannie Mae and Freddie Mac, Adler noted.

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Adler isn't the only manager sifting through the precrisis leftovers.

"The legacy (pr-crisis) non-agency RMBS remain attractive. Prices are higher, but housing fundamentals have also improved materially since U.S. home prices bottomed in early 2012," Pimco said in a strategy note in August. But it added that valuations of the agency RMBS have "reached extremes" as the Federal Reserve has been buying the securities.

Fed's housing rescue
Fed's housing rescue

To be sure, some think the play on precrisis assets is yesterday's news.

"They were providing pretty attractive returns based on where they were trading in 2008-09," said Gary Herbert, portfolio manager at Brandywine Global, which has around $48 billion in fixed-income assets under management. The U.S. RMBS strategies, which had around 4$ billion in funds, realized an internal rate of return (IRR) of around 20 percent annualized over three years, he said.

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But he added, "the opportunity in U.S. nonagency mortgages has run its course," and now Brandywine is looking toward another crisis-hit property market with a play on European RMBS, particularly in Portugal, Spain and the U.K.

"You can make a strong analogy between Europe's [current] difficulties and the U.S. [post financial crisis]," he said, adding he expects investments in the continent's precrisis RMBS will yield low double-digit returns.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1