Pacific Investment Management Co. is scaling back its investment in structured finance CDOs this year due to performance concerns. The move could be the "catalyst for concern in the entire market," said Steven Finnk, an analyst at United Capital Markets.
The Newport Beach, Calif.-based fixed-income manager, with $464 billion in assets under management as of March 31, has "really pulled back" from investing in the market in the last four-to-six months due to concerns about underlying collateral credit quality seen in the structured finance CDO "explosion" since the beginning of the year, said a source close to the company.
Back in February, head of PIMCO's MBS team Scott Simon said the company had a sober view of future economic conditions and was "very nervous" about deals containing a high percentage of IO loans.
"In the subprime floating rate market, we're buying very, very short cash flows. We are also buying cash flows that are in the first third of the triple-A-rated cash flows. So, literally, if two months were to go by and half the people defaulted and their houses went down 50%, we would still get our money back. We're giving up spread for structure certainty at this point," Simon said in a February commentary.
PIMCO was the fourth-largest cash flow CDO manager at yearend 2004, according to Standard & Poor's.
"PIMCO hasn't been a major player, and CDOs is not one of the most attractive or the main focus, but facing tougher times, it may not be appropriate for them to put more resources on ABS - I wouldn't be totally surprised," said one source.
Subprime RMBS comprise 40% to 60% of most diversified structured finance CDOs, according to An April 15 Fitch Ratings report
Fitch's RMBS group does not anticipate most funds caps for typical triple-A subprime floaters to be triggered, unless faced with a 400 to 500 basis point Libor increase; about 250 basis points would trigger AFC risk in triple-B subprime RMBS floaters.
UCM's Finnk said he has been "shocked that people aren't being more cautious" before investing in new-issue structured finance CDOs loaded with residential collateral.
Finnk said cashflow modeling techniques used by the primary issuers have flaws, making default scenarios appear rosier than they may prove to be when defaults cut cash flows. Despite the specters of prepayments and spread tightening, Roland Ho, a managing director at Los Angeles-based money manager Trust Company of the West, said he expects ABS CDOs to perform well in the near-to-mid-future.
"Everyone talks about potential housing trouble, housing prices too high, the rate might be going higher, borrowers would have higher risks, and so on - while those concerns are valid - the underlying assets of CDOs, for example subprime mortgage bonds, are expected to have adequate credit enhancement and loss protection against these risk factors," Ho summed.
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