Institutional Investor's Alpha Magazine - March 2009 - (Page 30) Lumsden and Swallow ager for the CQS ABS Fund, started his career at Abbey in 1993 as a trainee. He swiftly worked his way up, running a portfolio of mortgage- and asset-backed securities for Abbey National Treasury Services and taking primary responsibility for developing the bank’s $15 billion home-equity-loan portfolio before he joined Rabobank in 2001. (Swallow joined him there a year later.) CQS, founded in 1999 by credit and convertible arbitrage expert Michael Hintze, today is a $7.5 billion firm that supports seven hedge funds pursuing strategies that include volatility trading in derivatives and directional and relative-value multistrategy credit arbitrage. Having spent the better part of 12 years working together, the two 40-year-old friends have a cheerful way of stepping on one another’s sentences and finishing one another’s thoughts, but they take their division of roles seriously. The market crisis has them seeing things through a disturbingly dark lens. In an early-January interview with Alpha London Bureau Chief Loch Adamson at CQS’s elegant headquarters on Grosvenor Place in London, Lumsden and Swallow reflected on the wide-ranging damage of the credit crisis, the huge problems facing bond insurers and why they fear that another wave of real estate depreciation is about to strike the U.S. and the U.K. Alpha: When you launched the fund in the fall of 2006, did you have any idea how fast the U.S. real estate market would deteriorate? Lumsden: It became evident very quickly. It became Steven Swallow, head of European ABS and a CSQ ABS Fund portfolio manager, says bondinsurance houses — monolines — will eventually default. most everyone was engaged in massive lending with very few checks on the creditworthiness of the borrower or, to be honest, the valuation of the underlying collateral.” The two men note that the mortgage market may not be the only one affected — they say they are even more concerned about the potential impact on the monoline insurers, big companies like Ambac Financial Group and MBIA that write bond insurance. Their worry is that these companies could be rendered insolvent if defaults rise and they have to make good on their vast insurance commitments. Lumsden says it would create a domino effect on the ratings of all kinds of monoline-insured bonds — municipal and corporate — and that across-the-board downgrades would be sure to follow. Lumsden and Swallow know whereof they speak. They have decades of experience at the hard edge of loan origination, securitization and investment. Swallow, who is head of European asset-backed securities at CQS and a portfolio manager of the CQS ABS Fund, started out in 1987 at NatWest (now part of the Royal Bank of Scotland Group) and spent a decade in residential and commercial property loan assessment before joining Abbey National Bank in 1997. Lumsden, who is head of ABS investing at CQS and is the senior portfolio man- even more obvious in the beginning of 2007, when we realized that it wasn’t just going to be a U.S. subprime problem. So we moved from simply buying protection on some parts of the capital structure in U.S. subprime — positions that we’d had there as hedges against our longs — to going outright net short by selling down our longs. We went from being hedged long to strategically short quite quickly. What form did that protection take? Lumsden: Early on, we saw opportunities to buy protec- tion on ABS CDOs. One of the things that we were, quite honestly, surprised by was the speed with which — once defaults starting rising and things went wrong — our worst-case investment scenario materialized. What were your best trades? Lumsden: Incredibly, some loan companies thought they were going to originate their way through the crisis but instead just drove faster toward the wall. Take New Century Financial, a U.S. subprime originator that was continuing to originate subprime loans into a market where its only exit was a full-blown sale or securitization. It had significant fixed costs, and — in reality — it should have cut staff costs and production. But it did just the opposite: It continued to originate large loans that we know cost 3 points to originate, so its cost was 103, and its exit was 87, Photograph by Sam Holden 30 • INSTITUTIONAL INVESTOR’S ALPHA • MARCH 2009
For optimal viewing of this digital publication, please enable JavaScript and then refresh the page. If you would like to try to load the digital publication without using Flash Player detection, please click here.