Wednesday, July 2, 2008

CDO Managers Raising Distressed Mortgage Funds

(Housing Wire) There really isn’t anything quite like Wall Street, where second and third chances often abound for money managers that have seen prior investments fail — and often in spectacularly blinding ways.

The latest proof of this hidden rule comes courtesy of various CDO managers, whose former investment vehicles imploded along with the private-party mortgage boom that they helped fuel; many such managers are now behind distressed mortgage funds that will look to clean up the mess they helped create, according to a published report Wednesday.

Bloomberg News’ Jody Shenn and Jonathan Keehner found that the two firms topping the list of managers of failed CDOs — TCW Group Inc. and Harding Advisory LLChave raised more than $4.3 billion to invest in distressed residential mortgages. Half of the 20 largest subprime mortgage-led CDO managers are now building funds in the distressed mortgage space, according to the story.

Of course, other large private equity players managed CDOs as well, including BlackRock Inc. (BLK: 168.10, -4.50%), the biggest publicly traded U.S. asset manager. It said in March it was backing a new company called Private National Mortgage Acceptance Co. LLC, also known as PennyMac, that will buy mortgages at a discount and look to make money in the so-called scratch-and-dent business.

PennyMac has a $2 billion war chest to step in and start buying, and will bankroll its own in-house servicing platform; in May, BlackRock also negotiated a deal to snap up $15 billion in subprime mortgage exposure from Swiss bank UBS AG (UBS: 19.83, -2.56%).

Nonetheless, the fact that many of the largest CDO managers will potentially profit both from the run-up in U.S. mortgages and the historic crash has left some market participants rolling their collective eyes.

“Why is it that in finance, nothing succeeds like failure?,” asked Yves Smith, who authors the well-read Naked Capitalism blog, calling the move by CDO managers towards distressed mortgages “the latest chapter in trying to trade in on a dubious track record.”

Bloomberg’s sources, including a senior managing director at the sixth-largest manager of mortgage-tied CDOs, cited the collapse of Drexel Burnham Lambert Inc., the now-infamous Michael Milken-led junk bond flame-out, as an example of Wall Street’s rebirth mantra — many former Drexel bankers and investors helped clean up the mess left in the firm’s wake.

Not that everyone buys the logic, however, that today’s failed CDO managers are akin to Drexel cast-offs.

“[T]he Drexel guys were always specialists in junk bonds,” said Smith. “The CDO managers were supposed to be buying good assets but it was later revealed that what they had bought was junk … we are supposed to trust someone with demonstrably failed credit judgement [sic] as skilled in recognizing value in distressed assets?”

Regardless of personal take on the matter, it’s becoming clearer and clearer that the market for bad mortgages is hot right now on many different fronts — both bonds as well as whole loans.

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