Monthly Archives: November 2010

Finding Value in the Mortgage Madness

Finding Value in the Mortgage Madness

By: SEI Investment Management Unit
Significant media attention has recently focused on concerns regarding the paperwork for mortgage loans created over the past several years. Specifically, loans are being examined to determine whether the correct procedures were followed and if the necessary documents were executed in the legally prescribed manner in order to foreclose on delinquent borrowers. This issue also calls into question whether the loans, which were bundled together as non-agency mortgage-backed securities1 and sold to investors via a process known as securitization, were underwritten with proper disclosure to the buyers at the time of issuance. Despite the headline noise, SEI’s Fixed Income team believes that active investment managers can still find substantial value in this sector.

Background

Concerns about the processing of mortgage paperwork resulted in the much-publicized temporary halting of foreclosure proceedings by some of the nation’s largest mortgage servicers. Given the information available at time of this publication, it is SEI’s belief that these issues will be resolved. Large mortgage servicers will need to commit additional resources to ensure that the current backlog is appropriately processed. In addition, new procedures will need to be put in place to address any deficiencies in the foreclosure process.

In general, longer timelines in the foreclosure process result in a greater loss on the underlying property, which is a negative for both the banks that hold loans in their portfolio and for bondholders in the non-agency mortgage market. For banks, it means thinner margins on their servicing businesses and a modest increase in loan losses for properties that enter the foreclosure process. For residential mortgage-backed bondholders, it means less at recovery on a foreclosed property, especially for bonds backed by pools with high levels of delinquent loans.

Investment Manager Perspective

While this is relatively new information to the market, the investment managers SEI works with have witnessed the extension of foreclosure timelines and expect those timelines to continue to extend as the volume of delinquent loans exceeds the foreclosure capacity of the servicers. In addition, as a part of routine surveillance and ongoing updating to their models, the investment managers run various stress scenarios that incorporate these lengthened times in foreclosure. While the news is unfortunate and negative headlines will likely persist, we and our managers expect the potential impact to portfolio performance to be minimal.

A second issue centers around the ability of mortgage-backed bondholders to “put back” certain loans, which involves forcing banks to repurchase mortgages and securities related to them. A group led by the New York Federal Reserve and several investment managers is looking to essentially “ask” some of the large originators/banks to take back loans that they deemed to be deficient. For example, the bondholder group might ask for an originator to take back 10 loans out of 100 in a specific deal. The problem is that these 10 loans are currently worth 20 cents on the dollar, and if the originator agrees, it effectively results in an 80% write-down on those loans. The windfall goes to the mortgage-backed security holder, while bank earnings suffer. On paper it looks simple, but in practice it could prove quite challenging, as there are large logistical and legal hurdles that need to be overcome.
As a result, it is likely that the outcome of these types of actions could take years to play out. If the banks in question (Bank of America, Wells Fargo, JP Morgan) were to settle, or if the bondholders were to succeed through a legal remedy, the banking industry would take additional write-downs and security holders would reap the windfall. If the bondholder action is successful, the investment managers SEI oversees believe that write-downs will be manageable for the banks given they will be spread out over a three- to five-year period.

Our View

The portfolio managers on SEI’s Fixed Income team are analyzing holdings in the mortgage sector to assess the potential for an adverse impact. However, the non-agency mortgage sector has made a notable contribution to our performance over the past year, and we generally feel that the market still offers attractive opportunities despite the recent headlines on mortgage foreclosures, since prices already reflect poor scenarios. SEI benefits from implementing active management in this space, because the managers we have selected, such as Western and MetWest, have focused on identifying attractive segments and seeking to avoid those that are considered too risky.

Our Fixed Income team has engaged in detailed discussions about the mortgage situation with MetWest, Western and JP Morgan, all of which hold an overweight to the non-agency mortgage sector. Following those discussions, we continue to believe that, despite the recent headlines, good security selection in this sector still offers substantial value. As a result, SEI’s U.S. Fixed Income and Core Fixed Income Funds are maintaining their allocations to non-U.S. mortgage-backed securities and have maintained an overweight to financial debt as well. We will continue to monitor the situation and will provide an update should our views change.
 
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the Funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts. There is no assurance as of the date of this material that the securities mentioned remain in or out of the SEI Funds.



SEI Investments Management Corporation (SIMC) is the adviser to the SEI Funds, which are distributed by SEI Investments Distribution Co. (SIDCo.) SIMC and SIDCo are wholly-owned subsidiaries of SEI Investments Company. For those SEI Funds which employ the ‘manager of managers’ structure, SEI Investments Management Corporation has ultimate responsibility for the investment performance of the Fund due to its responsibility to oversee the sub-advisers and recommend their hiring, termination and replacement.


To determine if the Fund(s) are an appropriate investment for you, carefully consider the investment objectives, risk factors and charges and expenses before investing. This and other information can be found in the Fund’s prospectus, which can be obtained by calling 1-800-DIAL-SEI. Read it carefully before investing.


Investing involves risk including possible loss of principal. Bonds and bond funds will decrease in value as interest rates rise. Mortgage-backed securities are subject to prepayment and extension risk and therefore react differently to changes in interest rates than other bonds. Small movements in interest rates may quickly and significantly reduce the value of certain mortgage-backed securities.


Index performance returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index. Past performance does not guarantee future results.


Current and future portfolio holdings are subject to risks.


 Not FDIC Insured


 No Bank Guarantee


 May Lose Value

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David E. Robbins Joins Compass Securities Corporation

Braintree, Massachusetts, May 1, 2010 – Compass Securities Corporation announced today that David E. Robbins , a highly-regarded Affordable Housing Tax Credit executive with 20+ years industry experience, has joined the firm as an independent affiliate through his practice, Strategic Tax Credit Investments, LLC.
“We are pleased to have David join our growing network of distinguished institutional investment executives,” said John R. Ahern, President of Compass Securities Corporation. “His demonstrated commitment to excellence and extensive experience in the Affordable Housing Tax Credit channel makes David an ideal match, and he will be invaluable to Compass as we continue to grow our organization.”

David has worked in the affordable housing industry for 20 years. Prior to joining Compass Securities as a Registered Representative, he worked for MMA Financial and its predecessor companies, Lend Lease and Boston Financial. Mr. Robbins joined Boston Financial in 1990 as part of the Consulting Group, performing real estate appraisal services to third-party clients. In 1999, Mr. Robbins was promoted to lead Lend Lease’s Investment Valuation Group, the firm’s real estate consulting group that provides property and market specific analysis for the affordable housing tax credit business unit. In 2001, Mr. Robbins moved into institutional sales, and was responsible for raising more than $4 billion in investor equity from corporate investors for their tax credit funds. His responsibilities included raising equity for both unguaranteed and guaranteed LIHTC funds as well as solar ITC funds. He was also responsible for oversight of the sales and fund management team, and managing their external broker dealers. David was also a member of the senior management team of the affordable housing business. Mr. Robbins was formerly a certified General Appraiser in the Commonwealth of Massachusetts and an MAI Candidate in the Appraisal Institute. He was a member of the Board of Directors of the Affordable Housing Tax Credit Coalition from 2007 until mid-2009. He has been a panelist speaker for the National Council of State Housing Finance Agencies and a contributing columnist for the New England Real Estate Journal.  Mr. Robbins graduated with a BS in Finance from the Pennsylvania State University.
 
Compass Securities Corporation (member FINRA, SIPC) is an institutionally focused broker/dealer specialized in debt and equity private placements of tax credit syndications, venture capital and alternative investments, as  well as long only, and hedge investment manager representation. Compass was established in 1985 as a wholly owned subsidiary of Compass Capital Corporation.

Optimistic Market Outlook

Two weeks ago at SEI’s corporate headquarters in Oaks PA, I heard Bill Miller, the Chairman and Chief Investment Officer of Legg Mason Capital Management (Legg Mason) present an optimistic market outlook (which I share) for the remainder of the year into 2011. I attended this adviser conference at SEI as part of my semi-annual due diligence meetings.

Legg Mason is one of the active specialist investment managers in SEI’s Large Cap Value Fund, and Bill Miller is well known in the investment industry and is frequently quoted on the markets. (Bill actually traveled to SEI, located right outside of Philadelphia, after appearing on CNBC in New York.)

I thought you would find some of the market research and perspectives he presented insightful:

· Following the 13 periods since 1871 in which 10-year real stock returns were negative, stocks averaged returns in excess of 10% per year over the next 10 years[1]. This represents 50% more than the 6.66% real return of stocks in all 10-year periods and two times the return of long-term Treasuries.

· Stocks appear to be “cheap” relative to bonds; in the following chart you can see the S&P 500 trading at 13 times earnings while Treasury Bills are trading at 535 times earnings2.

Miller also shared some interesting historical insights on what happens when Warren Buffet talks about the markets – which he rarely does – but recently he commented,

· “It’s quite clear that stocks are cheaper than bonds. I can’t imagine anyone having bonds in their portfolio today when they can own equities.”

It was valuable to hear and learn from industry experts like Bill Miller and the SEI investment professionals. As you know, SEI is the firm we have chosen to work with that selects and monitors the investment managers in your investment portfolios. They also provide us with ongoing educational sessions and insights such as the information I have shared here.

I hope you found you find this information of interest. Let me know if you would like to discuss further. As you know, I can be reached at 781-535-6083 x305

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results.


For those SEI Funds which employ the ‘manager of managers’ structure, SEI Investments Management Corporation (SIMC) has ultimate responsibility for the investment performance of the Funds due to its responsibility to oversee the sub-advisers and recommend their hiring, termination and replacement. SIMC is the adviser to the SEI Funds, which are distributed by SEI Investments Distribution Co. (SIDCo.) SIMC and SIDCo are wholly owned subsidiaries of SEI Investments Company (SEI). Neither SEI nor its subsidiaries are affiliated with your financial advisor.

Carefully consider the investment objectives, risk factors and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses, which may be obtained by calling 1-800-DIAL-SEI. Read it carefully before investing.


There are risks involved with investing, including loss of principal. Current and future portfolio holdings are subject to risks as well. Diversification may not protect against market risk. There is no assurance the objectives discussed will be met.


Past performance does not guarantee future results Index returns are for illustrative purposes only and do not represent actual portfolio performance. Index returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index.


§ Not FDIC Insured
§ No Bank Guarantee
§ May Lose Value
[1] Source: Jeremy Siegel, Financial Times, October 6, 2009
2. Source: Bloomberg, Factset Data Systems, LMCM analysis. Dividend yield is based on estimated dividends over the next 12 months. P/E ratio and earnings yield for S&P 500 is estimated earnings over the next 12 months.