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Credit market mops up banking’s toxic legacy

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In one of the many rather surreal consequences of the financial crisis, banks are taking advantage of the QE-driven chase for yield among investors to sell off the very assets that caused all the chaos in the first place. The latest example of this is the public auction by the Dutch state of part of the ING Illiquid Assets Back-up Facility (IABF) that was put in place in 2009.

Under this emergency facility the Dutch state took over economic ownership of an 80% portion of ING’s US Alt-A RMBS holdings – a guarantee for which ING paid a hefty fee. On November 1, Dutch finance minister Jeroen Dijsselbloem wrote a letter to the president declaring that the market value of the portfolio had recovered to the point where it was time to sell.

BlackRock Solutions was mandated to manage the process and undertook the first auction on December 11.

This was the first large portfolio sale of sub-prime RMBS since Lloyds Bank auctioned off an $8.7 billion portfolio of primarily Alt-A mortgages that it inherited as part of the acquisition of HBOS in May. That sale was announced just a week before Ben Bernanke’s May 22 comments that sparked off a summer-long taper tantrum in the markets. The auction nevertheless took place on May 30, with the bonds being placed through Credit Suisse, Morgan Stanley, Goldman Sachs and Bank of America Merrill Lynch at roughly 80 cents on the dollar. This was the largest secondary market sale of such assets since the Maiden Lane sales by the US Federal Reserve.

This first IABF auction acts as a test of current market sentiment for previously toxic assets. It has been a turbulent year in fixed income, with credit spreads coming under growing pressure from the sheer weight of money chasing assets and the beginnings of a rotation into equities. It has also seen renewed legal and regulatory concerns over legacy sub-prime US RMBS. But the return year to date on these securities was 9.6% by early December.

The IABF assets had a nominal value of €24 billion in 2009, which has fallen to €9 billion today. The average price of the assets was 71% at September 30, which values the total pool for sale at roughly €6.4 billion.

This first auction covered 316 individual securities with a $5.1 billion current face value – the balance of the pool is due to be sold by the end of 2014. The sale was split between five dealers: Bank of America ($1.9 billion), Goldman Sachs ($1.3 billion), Morgan Stanley ($788 million), Credit Suisse ($659 million) and Deutsche Bank ($453 million).

Details on the price achieved were sketchy at press time and Interactive Data reckons that around two-thirds of the bonds had been placed by close of business on December 11.

It is not only yield-hungry investors that want to get their hands on this paper. According to Trace data, $5.5 billion of this debt was sold to dealers on December 11 of which they in turn placed $3.7 billion with buyers – leaving them long $1.8 billion.

According to Bloomberg, primary dealers were holding $15.1 billion of sub-prime mortgage debt in late November. So having generated a lot of this paper in the first place, dealers are now buying it back and benefiting from close to double-digit returns for their trouble – thanks to the monetary easing put in place as a result of their own pre-2007 origination prowess.