Hedge Funds and other large investors continued to buy Real Estate – especially single family homes – with an eye towards renovating and renting the properties. This has helped solidify the housing market which seems to have established a floor for prices this past summer. Many real estate markets have enjoyed a 10% – 30% bounce since the bottom. From our perspective, rising home prices are welcome as they give our borrowers incentive to continue making payments and help minimize loss severity when we liquidate foreclosed properties.
Fixed Income markets have been choppy for most of 2013. The 10-year Treasury has ranged from its 1.63% low in May to nearly 3.00% in September before falling to 2.50% when the Fed announced it would continue its program of Quantitative Easing. Since then, the benchmark has quietly risen to 2.85% – evidence to some that it is becoming more difficult for the FED to control interest rates.
After being extremely active through the summer months, we found it difficult to find attractive bonds this autumn. It is impossible to say how much of the issue was attributable to the FED vs. other market factors.
There has been no shortage of UNATTRACTIVE bonds on the market, and many had similar characteristics:
1) 2004 – 2007 Vintage Interest-Only loans. Housing bubble prices pushed many borrowers into Interest Only loans where monthly payments are minimized for the initial 120 months (10-years). In many cases these borrowers face dramatic increases to their monthly payment, as the loan principle finally begins to amortize. Delinquency will spike if enough of these borrowers struggle with the increased payment. It is difficult, if not impossible, to predict how many of these borrowers will default and how high loss severities will climb. We are avoiding these bonds until the borrowers have proven they can/will make higher monthly payments.
2) Long, Locked-Out Subprime Structures. In many Subprime deals the underlying loans are performing well, but investors must be cautious to study the deal’s structure. In some cases the rules of cash flow are confusing with triggers that can re-route principal in unexpected ways. In some cases the bonds are modeled inaccurately and must be examined by hand. We are avoiding these bonds at their current prices.
Rather than adding over-priced bonds to our portfolio we have remained patient, choosing to allow our cash reserve to grow to 15% of assets. We will spend this money opportunistically as we find better opportunities at more attractive prices.