Margin calls bring mortgage funds to their knees

Banks have increased margin calls over the past few weeks as residential mortgage-backed securities (RMBS) have underperformed against market expectations. The ABX.HE.06-2 AAA index, which is a synthetic index of US home equity loan ABSs, decreased from 78.2 on February 28 to 67.13 on March 6. It closed at 70.88 on March 14.

“The hedge funds that have been caught out by margin calls have suffered because most of their money is tied up in highly leveraged assets and they do not keep much liquidity on their balance sheets,” said Jochen Felsenheimer, head of credit strategy and structured credit research at UniCredit Markets & Investment Banking in Munich.

Some funds have found the increased demands for capital difficult to meet. Carlyle Capital Corporation, the Carlyle Group leveraged fund that invested in AAA-rated residential mortgage-backed securities, announced on March 13 that it had defaulted and was unable to reach a deal with lenders to refinance its portfolio on sustainable terms. This followed reports it received $400 million of margin calls from lenders a few weeks before.

Meanwhile, on March 16, Fitch Ratings downgraded the issuer default rating of Santa Fe-based mortgage lender Thornburg Mortgage to RD from CCC. This is because Thornburg Mortgage was in default under, and has failed to meet a margin call for, one of its reverse repurchase agreements. As of March 6 the company had outstanding margin calls of $610 million, which significantly exceeded its available liquidity at that date, according to a statement on March 7.

Thornburg Mortgage chief executive officer Larry Goldstone said in the same statement: “The mortgage financing market’s complete inability to differentiate and appropriately value superior AAA-/AA-rated mortgage securities from all other mortgage assets is as unprecedented as it is frustrating… Quite simply, the panic that has gripped the mortgage financing market is irrational and has no basis in investment reality.”

Some say these troubles are widespread among funds that invest in asset-backed securities to a greater or lesser extent.

“Margin calls are a significant problem. It is unlikely there are many funds with leveraged ABS exposure that haven’t suffered from increases in margin levels recently,” said Chris Greener, senior ABS analyst at Société Générale Corporate and Investment Banking in London.

High margin calls have forced funds to liquidate some of their assets to meet the requirements. If many of the funds using similar investment strategies have to unwind assets at the same time, there is potential for a domino effect among them of missing margin requirements, according to UniCredit’s Felsenheimer.

“This may lower asset prices in the market from a rush to sell them and the lack of buyers would mean the asset prices could crash,” he said.

See also:
Bank practices undermined liquidity, says BIS
Peloton ABS fund suspended as ABS market worsens

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