Prudential Financial Inc., the second- largest U.S. life insurer, said it's still buying securities backed by subprime mortgages and expects turmoil in the market to cost the company no more than $150 million over five years.
Prices of some subprime securities rated AAA and AA are now ``disproportionate to the underlying risk and are primarily liquidity-driven,'' Prudential Vice Chairman John Strangfeld said on a conference call with analysts today. ``As a consequence, we see selective opportunities to take advantage of that.''
Prudential is capitalizing on a faltering market for mortgage bonds that's making it difficult for sellers to unload even the most highly rated securities. The secondary market ``is not functioning,'' Michael Perry, chief executive officer of Indymac Bancorp Inc., the ninth-largest mortgage lender, said in an e-mail to employees yesterday.
Here's the central problem right now. A ton of subprime mortgages are performing badly. This is lowering the prices of a whole swath of bonds in the market. This in turn is hitting hedge funds, and we know how that has turned out.
However, if we start to see investors come in and buying distressed securities, the credit issues will start to mellow in the market. Investors will have a bit more confidence that if a hedge fund has to liquidate there will be a buyer or two on the sideline who are actually interested in buying.
This is welcome news, although we shouldn't jump for joy yet. There are still a ton of issues to deal with. For example, are there enough buyers to purchase a whole mess of securities? We don't know the amount of securities that might come to market. If we see a literal flood, expect serious losses.
What price are the buyers willing to pay? In a forced liquidation, the buyers are obviously in much stronger negotiating position to get a really cheap price.
So, let's not pop the champaign corks just yet.