Monday, September 29, 2008

Hold to Maturity Value

During the U.S. Bailout debate Bernanke introduced the buzzphrase "hold to maturity value". The argument is that mortgage backed securities currently trade for irrationally low prices in the markets given the likely cash received if the security was held to maturity. In other words, some loans will default but not as many as implied by current prices. One of the purposes of the "bailout" is to push up the prices of these securities closer to their intrinsic values in order to help keep financial institutions from becoming insolvent.

Many of the closed end funds I own trade at similarly irrationally low prices in the markets:

As you can see, some of the discounts to net asset value are more than 50%. I wondered what effect accounting for all these closed end funds would have on my net worth. As the table shows, using NAVs instead of current share prices would value these funds at $A147,000 instead of $A102,000 adding $A45,000 or about 10% to net worth.

I expect that eventually when the financial crisis diminishes these funds will trade nearer to their NAVs as they have in the past. In most cases I expect NAV to also rise though in the case of NCT it will probably fall. Its NAV is given by valuing both its assets and liabilities at current market prices for mortgage related securities and its liabilities are poorer quality than its assets.

1 comment:

Anonymous said...

The problem is that the "hold to maturity" value depends very heavily on house prices. Different assumptions about future house price declines lead to different values, because it is well established that declines in prices, defaults and losses are closely linked. So a little wishful thinking would lead to massive overpayment, which is of course what Hank and Ben intended. There is no shortage of liquidity for the toxic waste. It is just that the owners can't stand those bid prices.

That's a different situation than the closed end funds, which the fund can choose to correct anytime by buying in shares.