Marjorie Hogan, senior portfolio manager at Capstone Credit Advisors, answers SCI's questions

Q: How and when did you become involved in the credit and MBS markets?
A: My first exposure to the MBS markets was in the late 1980s when CMOs were in their infancy. In 1986 I built an OAS model for First Boston, which was used to analyse relative value and estimate hedge ratios for fixed income securities, particularly mortgages.

Just as the CMO market was taking off, I moved into risk management. At this time, credit risk was not the main issue - our focus was the interest rate risk driven by the refinancing option that gave rise to negative convexity and issues of relative value and duration.

I joined Bear Stearns in 1991 to begin a mortgage derivatives trading business when most action centred on agency mortgages. Only a minor part of our business was in whole loan private-label mortgages with some credit-sensitive tranches. I began doing the earliest credit derivative transactions on mortgages involving forerunners of subprime in the mid-1990s, including 125 (underwater) mortgages.

In 1996, I was involved in executing derivatives transactions involving our earliest CBOs. Over the next few years transactions included high-yield collateral deals, emerging market bond deals, ABS CDOs, mortgage-backed market value deals and CLOs.

In 2000 I moved much deeper into the world of credit when I started making markets in CBOs, becoming the first and only such trader on Wall Street for the next several years. I moved into proprietary trading in 2005, focusing on CDOs and mortgages. The issuance markets were very healthy, both in CDOs and in exotic credit mortgages.

When mortgages were starting to show signs of stress in late 2006, I turned my attention to what I believed was a looming mortgage, credit and housing crisis. By late 2007 I was focusing on the way this financial infection would spread to other institutions and products.

Q: What are your key areas of focus today and what have you focused on during your career?
A: My focus today is on a broad swath of the structured credit space - CDOs, RMBS, CMBS and ABS. Though I've witnessed evolution and development in the markets, the elements of how to understand transactions, find value and trade bonds never really changes.

We still try to recognise the fundamental legal, market and political risks of a security, which involves a deep understanding of the collateral and the interplay of the legal structure and collateral performance. This is completely in line with what I've done my whole career, with the exception that now the main risk in the instruments is credit risk, while in the first half of my career it was interest rate risk.

Q: What, in your opinion, has been the most significant development in the credit market in recent years?
A: One significant development occurred in 1994, when the CMO market collapsed, taking down many institutions and hedge funds. Even though kitchen sink bonds were largely blamed, I believe extending-duration companion bonds, inverse floaters, low-cap floaters and leverage were culprits. That situation was primarily an interest-rate risk issue.

When the corporate credit markets collapsed in 2001, weaknesses of poorly underwritten issues and the pushing up of default rates were exposed. In the CDO market, this again resulted in hedge funds closing and large institutions exiting the CDO investment business.

The biggest difference between this crisis and earlier ones, aside from the severity, was the involvement of the government. Though Federal Reserve programmes have stabilised the markets relatively quickly, they have moved us down a path of ongoing government involvement that will be difficult and slow to unwind. It has also put the government on the hook for almost open-ended credit losses.

The big concern now is the knock-on effect in our deficit spending and our ability to fund ourselves. I believe there are a lot of unknowns regarding how this may dampen GDP and impact interest rates.

Q: How has this affected the way markets are traded and the number of market participants?
A: Surprisingly, the trading is far more concentrated than in the past. The large hedge funds have become far larger, while many smaller hedge funds have closed. The banks continue to take very large positions.

There is a lot of chatter about insurance companies outsourcing their investment expertise, which should also point toward further investment concentration. Additionally, there are more buyers today than in past crises.

In the past, holders such as insurance companies, pension funds and banks would dump positions to new buyers (hedge funds) as they were downgraded. This typically led to new buyers entering the market solely to buy up distressed assets, making liquidity very poor as these buyers first emerged.

Today, within the distressed credit space, many institutions traded these assets before they were distressed and continue to trade them now, even though they have far different risk profiles. Though this gives rise to an increase in liquidity and market participants, the money is in very concentrated hands. One result of this trend is that small or unusual positions languish, while larger or more generic positions trade tighter.

Q: Given the prevailing market conditions, where do you see opportunities arising?
A: There are great opportunities in structured credit today. These instruments are more complicated than corporate debt or individual mortgage loans, so the complexity creates a barrier to entry that produces chronically cheap assets. Over the next year, as the commercial property problems begin to work themselves out, CMBS should be a good investment area also.

Q: What major developments do you expect from the market in the future?
A: I expect some semblance of normality to slowly return to the market. Over time, secondary market levels will tighten up so the new issue market can compete and reinitiate itself.

I expect this to happen first in CMBS and CLOs. That should be a healthy development, which will allow private issuance in CMBS and additional avenues to distribute leveraged loans to resume and increase access to cheaper credit.

Regarding RMBS, I believe the market will be dominated by the governmental programmes for the foreseeable future. Eventually housing will begin to improve, foreclosure pipelines will be reduced (either through liquidation or through modifications that reclassify the loans as reperforming) and home prices will be on the mend.

The mortgage market will take the longest of all credit markets to return to a healthy private market since loan terms will have to contend with end-game modifications as phase-outs kick in. RMBS private market recovery should begin with the jumbo loan market, since it has not received governmental assistance.

I would not be surprised to see some deals completed in 2011 or even late 2010. Even though the Federal Reserve's mortgage purchase programme has ended, I do not expect there to be a serious digestion issue, particularly as the RMBS are still guaranteed by the government.

I expect it will be several years before the private mortgage market grows large enough to rival the agency market again. It could be many more years before the agencies are either spun out into the private sector or their business is largely moved back to the private sector again.