Only problem there is the high short interest (60% of the float). finance.yahoo.com
Housing Bears Bet on Shaky Credit
As Interest Rates Increase,
Hedge Funds Are Profiting
From Credit-Default Swaps
By MARK WHITEHOUSE and GREGORY ZUCKERMAN
Staff Reporters of THE WALL STREET JOURNAL
December 12, 2005; Page C4
Cracks are appearing in the foundation of the housing market, and a growing cadre of hedge funds is using a new tool to profit if things begin to crumble.
Hedge funds and other investors, many looking to make money on a downturn in housing, are driving a growing trade in Wall Street's latest invention: derivatives that rise and fall in value based on the likelihood that homeowners will pay back their mortgages.
"The market has taken off," says Dan Ivascyn, a portfolio manager at Pacific Investment Management Co., or Pimco, a $513 billion asset-management firm in Newport Beach, Calif. "It's become a big story."
Until recently, investors who wanted to bet against stretched homeowners had no easy way to do so. The derivatives, known as credit-default swaps, offer a solution. Like insurance policies, they allow investors to protect themselves against defaults on packaged pools of home loans. The insurance pays off if homeowners miss payments on their loans. But even if nobody defaults, the insurance tends to rise in value when homeowners' credit starts to look shaky -- for example, as the result of a drop in home values. Likewise, if the housing market strengthens, the insurance can lose value.
The new market came to life in June, when dealers agreed on a standard contract applying credit-default swaps, already widely used in the corporate-bond market, to the pools of home, auto or credit-card loans known as asset-backed securities. So far, trading has focused mainly on the riskiest part of the market for home-equity securities, which are backed by adjustable-rate loans to folks with shakier credit -- a category that has grown in recent years as mortgage lenders have plied high-risk borrowers with easy financing.
Among the biggest players: hedge funds that specialize in debt trading, as well as those that try to profit from global macroeconomic trends. The new credit-default swap "allows us to express a bearish opinion" on the housing market, says Steve Persky, managing partner at Dalton Investments, a Los Angeles hedge fund with about $1 billion in assets. "A lot of people debate whether the housing market is overpriced, but, for sure, the credit quality of home borrowers has deteriorated."
The market is still small in the context of the broader $4 trillion market for mortgage-backed securities, but it is growing rapidly. Dealers estimate that investors have bought and sold insurance on a face value of as much as $100 billion in bonds, from next to nothing earlier this year.
Investors buying insurance see ample reason to worry about the credit of homeowners. Interest-only mortgages and other aggressive loans have surged in recent years. As the Federal Reserve raises short-term interest rates, many holders of such loans will face higher monthly payments, which float along with short-term rates. Delinquencies on newer subprime mortgage loans already have started to rise, suggesting that mortgage lenders have reached the bottom of the creditworthiness barrel.
Recently, housing bears have done well on credit-default swaps, at least on paper. In mid-September, an investor seeking insurance on $10 million in mortgage securities with the lowest investment-grade rating of triple-B-minus, for example, could have bought a credit-default swap by agreeing to pay an annual premium of about $170,000 a year. Now, with hedge funds and others piling in to buy insurance as the housing market shows weakness, the premium on the same swap has risen to about $320,000, allowing the investor to sell the insurance at the new, higher price and pocket the difference.
Dalton's Mr. Persky says his hedge-fund firm has purchased credit-default swaps on subprime home deals. He also is betting against mortgage-finance companies that focus on lower-quality home borrowers, such as New Century Financial Corp., whose stock is down more than 30% in the past year, and Accredited Home Lenders Holding Co., which has dropped almost 6%.
The hedge funds' bearish bets could become a self-fulfilling prophecy. By pushing up the price of insurance, they also have helped push up the yields on riskier home-equity securities. If sustained, the higher cost of borrowing could force subprime mortgage-finance companies to make fewer loans. That, in turn, could cut into demand for houses, causing prices to fall and homeowners' finances to head south.
"It's a vicious circle," says Ed Steffelin, a portfolio manager at GSC Partners, a $9.2 billion asset-management firm active in the market. He says he has made bearish and bullish bets in the market.
Some of those buying the insurance are trying to hedge other investments, such as holdings of shares of real-estate investment trusts, rather than making outright bets against the housing market. And because the market is still small, a few players can provoke a big move in prices.
"I think a large part of this volatility has more to do with the fact that it is not yet a very deep market," says Peter DiMartino, an asset-backed securities strategist at RBS Greenwich Capital. He says the jump in yields on the riskiest home-equity securities, for example, hasn't happened in higher-grade securities.
Some investors say they are still wary of the new credit-default swaps. For one thing, the gap between the prices at which dealers buy and sell insurance is relatively wide, potentially cutting into any gains. A typical dealer might offer to buy protection on $10 million in bonds for $300,000 a year and sell the same protection for $350,000 a year.
Also, the market has yet to be tested by a wave of defaults. Even in the relatively mature market for credit-default swaps on corporate bonds, payouts are frequently disputed. Meanwhile, the advent of credit-default swaps on mortgage-backed securities opens a Pandora's box of potential conflicts of interest. Mortgage lenders, for example, have privileged information on the finances of borrowers, and companies that service mortgages have some leeway in deciding when a borrower will default.
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