LBOs still to finance as mortgage market struggles

By Burton Frierson and Mike Peacock

NEW YORK/LONDON (Reuters) - As investors returned from summer vacations after the worst credit squeeze in a decade, the focus on Tuesday turned to the financing of more than $300 billion of announced leveraged buyout deals.

However, U.S. mortgage markets continued to provide reasons for investor concern, despite moves by U.S. President Bush last Friday to provide assistance for less creditworthy borrowers, and assurances from Federal Reserve chairman Bernanke that the Fed stands ready to provide further liquidity.

Financial markets continued to expect the Fed will cut its fed funds rate from 5.25 percent at its next policy meeting on September 18th, though the U.S. manufacturing sector continued to expand in August, according to data from the Institute or Supply Management on Tuesday.

Losses in U.S. subprime mortgage markets were the main cause of the recent credit squeeze, and further evidence of damage came to light on Tuesday when two U.S. financial firms with close links to the housing sector announced job cuts.

Subprime mortgage lender NovaStar Financial Inc NFI.N said it will cut will cut 275 of 400 retail lending jobs, and its auditor expressed doubt that the company will survive.

First American (FAF.N), the largest U.S. provider of insurance to protect homeowners against property claims, said it will cut 1,300 jobs, on top of 600 cuts announced in the second quarter, citing rapidly changing economic conditions.

"Housing prices remain way out of line with people's incomes, and were boosted by a lot of specialized mortgage products that aren't available anymore," said David Olson, co-founder and president of Wholesale Access, a Columbia, Maryland-based firm that tracks the mortgage industry. "In a slowing economy, the mortgage and real estate markets will have to adjust."

Slumping investor demand for mortgage-backed securities also led to the biggest monthly rise ever in mortgage related loans by Federal Home Loan Bank system to its members in August.

Outstanding collateralized loans to the FHLB's 8,100 member financial institutions rose $110 billion to $769 billion as of August 31, while debt issued by the FHLBs in the $2.7 trillion "federal agency" market also rose by $110 billion, the FHLB said.

The lack of demand for mortgage related securities also saw Freddie Mac (FRE.N), one of the largest providers of financing for U.S. home mortgages, decide to refrain from issuing its Reference Real Estate Mortgage Investment Conduit, or Reference REMIC in September, for the first time since April 2005.

The outlook for the mortgage markets was not uniformly grim, though. Thornburg Mortgage Inc TMA.N, a U.S. mortgage company, said it raised cash on Friday by securitizing $1.44 billion in prime loans.

Benchmark U.S. stock indices were also higher for a second session in a row, after the Labor Day holiday on Monday, helped partly by news the U.S. manufacturing sector continued to expand in August, albeit at a slower pace, according to the Institute of Supply Management.

"People were getting worried, and the 'R' word has become popular -- 'R' as in recession," said Al Goldman, chief market strategist at A.G. Edwards in St. Louis. "But we think it's going to be R like in economic recovery, especially when the Fed cuts interest rates, and I think that's going to happen."

With stock prices recovering the need for safe-haven U.S. Treasury bond investments eased, leaving bond yields little changed. The U.S. 10-year Treasury note US10YT=RR remained near six month lows in yield around 4.55 percent.

In Germany, the European country hit hardest by the credit squeeze, Deutsche Bank (DBKGn.DE) said it was optimistic about the current quarter and saw signs the market was stabilizing.