Loan Servicers' Contractual Obligations Create Opportunity For Buyers Of Mortgage-Backed Junk Paper

Barron's reports:

• YOU KNOW THOSE TOXIC SUBPRIME-MORTGAGE-BACKED securities that priced at par just a year ago, but now are quoted at pennies on the dollar? Well, a few hedge funds are buying them, in anticipation of a sweet payoff. Seriously.

• "Mention subprime mortgages, and the connotation is so negative that just the sound of them makes people cringe," says Steve Persky, chief executive officer at investment-advisory firm Dalton Investments. "That's the hallmark of a great distressed opportunity."

• OK. Getting real, Persky doesn't expect to see much principal, if any. But subprime and Alt-A asset-backed securities, or ABS, do pay interest. And even when a homeowner stops paying, the mortgage-servicer has to step in and pay interest and principal to a trust until the home is sold in foreclosure. The trust pays the bondholders.

• The timeline is the key. Persky's strategy is to buy the ABS at 4 to 4½ cents on the dollar and break even in about a year. A typical foreclosure takes as long as 18 months. "It will pay interest significantly longer than the price [of the distressed debt] indicates," he says.

For more, see Junk Mortgages for Just Cents -- and Just a Year (Opportunities in subprime-mortgage-backed securities). (Might require subscription; if no subscription, try here - then click link for story, then "Refresh" web page if necessary). MortgageServicingIssuesAlpha