Is Morgan working both sides of credit-insurance derivatives market?


Funds Attack Banks' Aid
for Subprime Borrowers

By Saskia Scholtes
Financial Times, London
Thursday, May 31, 2007

NEW YORK -- Hedge funds are attacking bank decisions that help delinquent US mortgage borrowers remain in their homes in a move that pits some of the country's richest people against its least well-off.

The dispute centres on derivatives contracts that pay money to investors when bonds backed by subprime mortgage loans -- extended to people with past credit problems -- run into trouble. The $1,200 billion US subprime mortgage bond market has been hit recently by rapidly growing defaults, and hedge funds have profited from the crisis by buying such derivatives.

Some hedge funds say they are concerned that banks that both sell the derivatives contracts and handle mortgage payments could be involved in a form of market manipulation. The funds fear that banks are making concessions on the underlying mortgages to avoid making good on derivatives contracts that pay off in cases of default.

The controversy pits hedge fund interests against those of stretched US mortgage borrowers and politicians who want to help them keep their homes, underscoring the political dilemmas created by the growth of the mortgage bond market.

A group of more than 25 funds has asked the International Swaps and Derivatives Association, the derivatives industry body, to act on their concerns, according to a letter seen by the Financial Times.

"ISDA should actively promote an industry solution that assures market participants that no one can engage in practices that are manipulative and prohibited by existing securities laws," the funds said. ISDA declined to comment.

The hedge funds' concerns centre on loan modifications that are often used to help overextended borrowers keep up with payments. In such cases, 40 percent of the modified loans fall back into arrears within a year, credit analysts say.

Yet these changes do not automatically trigger writedowns on the bonds, which would result in a payment to purchasers of the credit-insurance derivatives.

One member of the group that wrote to ISDA said the hedge funds were not trying to force subprime borrowers from their homes, just to make sure that banks were keeping the interests of their trading desks and their mortgage arms separate.

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JPMorgan Quietly Climbs Subprime Ladder

By Tim McLaughlin
Thursday, May 31, 2007

NEW YORK -- JPMorgan Chase & Co. is downplaying its role in subprime lending even as spectacular flameouts in that sector have turned the Wall Street bank into one of the biggest originators of risky mortgages.

"We don't do much in the subprime business -- at all," JPMorgan Chief Executive Jamie Dimon told investors earlier this month at the company's annual meeting. "It will be a good business, by the way."

Indeed, the No. 3 U.S. bank, along with other Wall Street companies, has stepped into a void triggered by a meltdown in the market for lending money to homebuyers with weak credit.

JPMorgan's first-quarter subprime mortgage originations, through Chase Home Finance, jumped 11 percent to $3.02 billion, according to Inside Mortgage Finance. The bank was No. 11 in a ranking that included No. 7 New Century Financial Corp., which now is being liquidated in bankruptcy.

Not much subprime business at JPMorgan translates into a subprime mortgage portfolio that stood at $13.2 billion at the end of last year, or about 3.6 percent of the company's $367 billion consumer loan portfolio. JPMorgan sold most of its 2006 subprime production, offloading risk.

JPMorgan does not specify how much subprime lending contributes to its bottom line, but the earnings potential is there. In March, Charles Scharf, head of JPMorgan's retail division, said home equity loans and subprime mortgages have the potential to contribute a total of $800 million in annual net income when working with the company's investment bank.

Profits increase when JPMorgan's investment bank packages pools of loans into securities and sells them to investors. That's one key reason why Wall Street banks have stepped up their subprime game.

CitiMortgage, a unit of Citigroup, originated $8.1 billion in subprime mortgages during the first quarter, a 29 percent year-over-year gain that catapulted the bank to the top spot among U.S. subprime lenders.

While CitiMortgage, JPMorgan, and Merrill Lynch & Co.'s subprime unit, First Franklin Financial, showed gains, industrywide subprime lending plummeted 32 percent to $95 billon in the first quarter, Inside Mortgage Finance said.

Countrywide Financial Corp. and HSBC Finance, the U.S. unit of London's HSBC Holdings Plc, have reined in their subprime lending, but remain the No. 2 and No. 3 lenders in the sector, respectively.

Merrill Lynch Chief Executive Stanley O'Neal recently told Bernstein Research analyst Brad Hintz that Merrill's $1.3 billion acquisition of First Franklin will allow the company to boost its market share for mortgage-backed securities.

"Mr. O'Neal admitted that it's hard to make money in mortgages now," Hintz said in a research note. "But he pointed out that 25 competitors have left the market or declared bankruptcy and (First Franklin) leaves Merrill Lynch with large origination capabilities that will prove its value as the market adjusts to new issuance standards and economics of the mortgage business."

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at the
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in Vancouver, British Columbia, Canada
Sunday and Monday, June 17 and 18, 2007

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