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Sub-prime woes spread to short-term securities

Several issuers of commercial loans backed by housing mortgages may get downgraded

NEW YORK – TURMOIL in the sub-prime mortgage market spread again yesterday – this time to a type of short-term security held by money market mutual funds.

These funds have become the investment of choice for many people seeking a safe haven.

Ratings agency Standard & Poor’s (S&P) warned yesterday that it might downgrade several issuers of commercial paper – a short-term IOU by companies that promise to repay loans typically within a few weeks to a year.

In these cases, S&P said, the commercial paper was backed by residential mortgages.

The amount of commercial paper in the United States has grown to US$2.2 trillion (S$3.3 trillion), according to Lehman Brothers, with about US$1.2 trillion backed by residential mortgages, credit card receivables, car loans and other bonds.

Major buyers include pension funds, insurance companies, hedge funds and short-term money market funds.

Investors have flocked to money market funds as they try to avoid volatile stocks as well as bond markets that have seized up. Last week, they put more than US$36 billion into money market funds, the largest move since December 2005. In all, about US$2.6 trillion is in money market funds, according to AMG Data Services.

Such funds are sold to investors as the equivalent of cash, and their net asset value per share of US$1 is considered sacred. But if the funds experienced big losses, the value of the assets could be vulnerable.

S&P acted a day after a US$1.6 billion cash management fund run by the Sentinel Management Group halted redemptions because it could not sell its assets at what it considered acceptable prices.

Until recently, the crisis in the credit markets has been limited to problems related to sub-prime mortgages, those given to borrowers with questionable credit histories. But as these troubles seep into other parts of the securities markets, fears of losses are rising in unexpected places.

The borrowers, companies that issue asset-backed commercial paper, have found it highly profitable. These companies usually use the money they borrow to buy securities such as slices of mortgage pools that generate yields much greater than the interest paid to the short-term lenders.

But there are several risks. First, the companies that issue short-term notes backed by assets with considerably longer terms are exposing themselves to the risk that the interest they earn will not exceed the amount they must pay to their lenders.

Perhaps more significant, the borrowers must be concerned about possible losses in the assets they buy, especially when investors will no longer lend them money by buying their commercial paper.

S&P highlighted four issuers of commercial paper for possible downgrading – Broadhollow Funding, which was set up by American Home Mortgage Investment, a lender that filed for bankruptcy last week; KKR Atlantic

Funding Trust and KKR Pacific Funding Trust, two affiliates of the buyout firm Kohlberg Kravis Roberts (KKR); and Ottimo Funding, an affiliate of Aladdin Capital Management, an investment manager in Stamford, Connecticut.

KKR declined to comment on Tuesday.

Ottimo Funding holds about US$3 billion in residential mortgages, all rated AAA.

Mr George Marshman, chief investment officer of Aladdin, said: ‘It’s a negotiation process. We’re working with all the investors to make things as orderly as possible. I’m optimistic that we can get a good outcome.’

Among the money market funds that held commercial paper issued by the companies singled out for possible downgrading were two offered by Evergreen Investments.

 

Source: The Straits Times 16 Aug 07

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