--Maiden Lane III may be depleted next month
--Demand has resulted in little or no discount for CDO structure
--LibreMax took profits in subprime as investor interest rose
(Adds New York Fed declining comment in sixth paragraph, LibreMax trade in 12th paragraph.)
By Al Yoon
The Federal Reserve Bank of New York is set to sell the last of the assets taken on during the bailout of American International Group (AIG) by next month, based on the current pace.
The New York Fed plans to sell another $11.9 billion in face value of complex mortgage debt from the vehicle known as Maiden Lane III this month, which would reduce the amount left in the portfolio to less than $7 billion.
The completion of the sales will eliminate a reliable source of debt for buyers seeking higher-yielding assets. Expectations that capital-constrained European banks would sell their holdings haven't yet panned out, leaving investors to bid for the Maiden Lane portfolios or the well-picked and shrinking pool of the private, nonagency bonds in the secondary market.
"In some regards, this is the last big shot of supply," a trader at a primary dealer that participates in the auctions said of the dwindling Maiden Lane III.
Because the nonagency, residential mortgage bonds that make up most of the portfolios have appreciated, the New York Fed could potentially earn double the $2.8 billion profit on its similar Maiden Lane II portfolio, the trader estimated. As with Maiden Lane II, Maiden Lane III assets are mostly residential mortgage-related, but many have an added layer of complexity as collateralized debt obligations.
The New York Fed on Monday said sales from Maiden Lane III resulted in full repayment of the $5 billion of AIG's equity in the portfolio. It will keep two-thirds of future profits, and AIG will get the rest. A New York Fed spokeswoman declined to comment on future sales.
About $53 billion in loans for Maiden Lane III and Maiden Lane--used to facilitate J.P. Morgan Chase & Co.'s (JPM) takeover of Bear Stearns--were repaid in June. Sales from the Maiden Lane II portfolio of AIG bonds resulted in the repayment of a $19.5 billion loan in February.
Many investors are warming to the market following signs that home prices have found a bottom and delinquencies have peaked. Investors have used previous auctions to access mortgage debt that is being held tightly by long-term money managers versus traders who quickly bought and sold such assets a year ago, analysts said.
"The Fed has been an aggressive seller, and so the Maiden Lane auctions have provided investors the ability to add exposure in decent size," said Deepak Narula, a managing partner at Metacapital Management LP., which bought bonds sold from Maiden Lane II.
But some bonds have slowed or even given back part of their gains as the European sovereign-debt crisis overshadows the market. The "dark cloud hanging over Europe" is "the only thing keeping us from an outright bullish call" on nonagency mortgage bonds, analysts at J.P. Morgan said.
Prices on some nonagency mortgages that posted double-digit losses in 2011 have gained 15% or more this year. Bonds backed by so-called option adjustable-rate mortgages--one of the riskier types of nonagency bonds--in June traded at 49 cents on the dollar, up from 42.5 cents on the dollar in December but off highs of 51 cents in April, according to Amherst Securities Group.
At least one high-profile trader has taken some chips off the table. LibreMax Capital, run by Greg Lippmann--who helped Deutsche Bank earn billions of dollars by betting against mortgages in 2008--sold some subprime bonds in June as "broadening investor interest" allowed it to book some profits and add commercial-mortgage debt, according to an investor letter.
A LibreMax spokesman didn't immediately return a call or email.
For now, the desire for extra yield has buoyed bonds that are becoming scarcer by the month. Since the issuance of new nonagency bonds is rare, the market is contracting by $15 billion to $20 billion each month due to the normal paydown of mortgage loans. The nonagency market is currently about $1.1 trillion.
Demand for the Maiden Lane III assets has virtually erased the discount that traders had been demanding for the complexity of the CDOs that made up most of the portfolio, the primary dealer trader said. CDO bids had been 10% below the value of the underlying mortgage bonds, he said.
Some of the CDO bids might even represent a premium to the underlying collateral, he added.
"The Fed is receiving proceeds on sales far greater than expectations of a few months ago, when they first announced it was going to sell," he said.
-Jeffrey Sparshott contributed to this article.
Write to Al Yoon at albert.yoon@dowjones.com
