Life returns to troubled debt markets

Life has been returning to the troubled debt markets that caused carnage among investors in products such as ING's Diversified Yield Fund and Forsyth Barr's Credit Sails.

When the financial crisis struck many New Zealand investors realised, to their horror, that the fixed interest funds they had been advised to invest in held extremely illiquid and highly complex portfolios of loans, many to companies with low credit-worthiness, or to sub-prime mortgage borrowers who could not afford to pay them back.

Hundreds of millions of dollars were wiped off the value of their investments, and the outcry that followed forced ING and ANZ to spend about $380 million compensating their angry investors, although other CDO fund operators and distributors did not follow suit.

Credit Sails notes, a complex credit default swap structure, had their value driven down to zero, destroying $91m of investors' money. Macquarie's Fortress notes, a highly geared corporate debt product, suffered a similar fate, wiping out $28m.

The tide has turned, however, and ANZ has been getting back some of the cash it spent buying investors' units.

ING fund manager David Jansen, who joined ING after the launch of its now infamous Regular Income and Dividend Yield Funds co-marketed by ANZ, said three factors were driving change.

The first was that US banks and insurers, which had been forced sellers of packaged debt products such as "collateralised debt obligations" as they sought cash to stave off financial collapse, had either sold their holdings, or no longer had to.

The other two were a combination of liquidity in the market and ratings agencies slashing their default predictions for loans, tempting buyers back.

"They had been forecasting Armageddon in terms of the capital markets and companies not being able to refinance their debts, and, as a consequence, they were expecting abnormally high default rates," Jansen said. "Now they are reversing their view. Moody's was expecting 30% [cumulative] defaults in sub-investment grade companies – 14-15% in 2009 and some next year," Jansen said.

But Jansen said defaults were now expected to peak at 12% this year and fall next year to 4%.

He said money had first flowed into shares and high-yield bonds, but when their prices rose dramatically, big investors started looking further down the risk scale into senior secured loans – loans to companies without strong credit ratings – and also collateralised loan obligations, which are bonds issued against portfolios of these senior loans.

But Jansen said the mortgage-backed CDO market remained largely dormant, adding: "I can't emphasise the frailty of the US recovery and even the European so-called recovery. There are still massive challenges faced by the US economy and you could very easily see a W-shaped recovery where we track back down because corporate earnings are just simply too weak to sustain higher security prices."

Jansen said he was not allowed to speak about how the recovery had affected ING's Regular Income and Diversified Yield funds, and hence how much money the ANZ National bank had made back of the money it paid to buy investors' units.

But the Sunday Star-Times has learned the unit price of the Diversified Yield Fund had risen to 31.37 cents on Thursday last week, indicating a total value of units of around $134m, up from the roughly 21c unit price in mid-June, which equated to a total value of units on offer of around $90m.

A small group of investors did not accept the ANZ/ING offer and remain in the fund, but most of the recovery belongs to the bank.

ANZ and ING are not the only ones to benefit from the market rally.

Investors in the Macquarie Fortress Notes have seen the reported net asset value of their investments rise from zero in February to 24.8 cents at the last count, though the notes are still a long way from paying the income investors had hoped to receive.

Macquarie's Peter Lucas said: "There is potential for them to go up still further, but they are still trading at a considerable discount to their face value." As the borrowers repaid their loans, or refinanced them, NAV should continue to improve.

- © Fairfax NZ News