EUROPACE ABS Monitor

02 August 2007 

The end of cheap money?

The European ABS market faces a month of uncertainty, as many issuers are likely to put deals on hold during the traditionally slow August, and look for direction on pricing once the pipeline fills up again in September.

The volatility in the bond markets finally spilled over into the equity markets in the last week of July, and analysts are proclaiming the end of the period of cheap money which has driven global financial markets over the past five years.

This general re-pricing of risk is hitting sectors such as leveraged buyouts hard. With their balance sheets full of loans that are yet to be syndicated, the leading commercial banks have virtually shut their doors to new loans backing takeovers by private equity firms.

Re-pricing of risk in the RMBS and CMBS markets

With the flow of bad news from the United States mortgage market getting worse by the week, there has been re-pricing of risk in the European RMBS and CMBS markets, which has in turn dragged other ABS asset classes wider.

In UK non-conforming RMBS sector, issuers are having to price generously in order to entice investors into Triple A tranches, and are paying up heavily in order to get the subordinated tranches away. But there may be more spread widening to come at the Triple B level. One analyst remains cautious on many subordinated tranches, believing that spreads remain tighter than likely losses through the economic cycle.

Hawthorn Finance, a buy to let RMBS deal from West Bromwich Building Society, has officially rescheduled its upcoming deal, citing difficult market conditions, and other issuers are likely to put transactions on hold. Issuers not requiring funding or capital relief ahead of the summer holidays are well advised to wait for more favourable conditions to return.

And jitters in lower quality RMBS deals are spreading through into the prime sector, as investors question whether Triple B prime mortgage tranches could withstand the stress test of a major property market correction. Even at the prime Triple A level, tiering is becoming very pronounced, with top UK prime issuers selling at 10bp and Spanish deals at 20bp, with the Portuguese in the middle at 15bp.

Investor reception of the latest RMBS & CMBS deals

Another area of concern is the CMBS sector, where sky high property prices in cities in the UK and US have been accompanied by weakened lending criteria. Triple B CMBS tranches have typically widened out by 30bp during the course of the year, to around 110bp or 120bp. But a number of lists containing CMBS have recently been circulated on the secondary market, and there is still pressure on spreads.

In primary, in late July Lehman Brothers launched its Pounds707m Windermere CMBS deal, which had 5.1 year Triple As at a 25bp spread, 5.9 year Triple Bs at 120bp, and 6.8 year Double Bs at 300bp.

In the RMBS sector, in late July the Douro Mortgages from Banco BPI in Portugal featured 5.7 year Triple A notes at Euribor plus 16bp, and 7.2 year Triple Bs at 48bp. Lead managers ABN AMRO highlighted the strong quality of the portfolio (19,000 mortgages with an average 64% LTV) and said that the deal achieved broad distribution and a solid investor reception in spite of recent uncertainty in the credit markets.

In contrast, a high LTV (88%) transaction from Lusitano Mortgages (originated by Banco Espirito Santo) priced at 20bp over for the 5.9 year Triple As, and 85bp for the 7.7 year Triple Bs. And TDA 28 from two Spanish savings banks, Caixa Terrassa and Credifimo, had 5.9 year Triple A notes at 20bp and 10.3 year Triple Bs at 80bp.

A Dutch subprime deal from ELQ Hypotheken, Eurosail NL, featured 3.08 year Triple A notes at 20bp and 4.68 year Triple Bs at 120bp. And UK non-conforming deal Eurohome Mortgages from Deutsche Bank included 3.1 year Triple A notes at 19bp and 4.3 year Triple Bs at 140bp.

Looking for spread direction

Clearly much of the contagion from US sub-prime into the European ABS market is psychological, rather than based on fundamentals, and some analysts suggest that Spanish Triple A prime mortgage spreads have been pushed out too far at 20bp. But the market is at last undergoing a re-assessment of risk. During 2005 and 2006 there were many complains that tiering had flattened out under the weight of money chasing deals.

As one analyst notes, looking for spread direction in a quiet month like August will be difficult, though as some traders offload tranches there may be some bargains to be had on some of the bid lists that are circulating.

The market still hopes that Triple A tranches will avoid downgrades, and that the series problems can be contained within the riskier Triple B and Double B tranches, where significant losses may lie ahead for more investors. 

In spite of all the volatility, July has been a busy month, with many issuers willing to pay the extra basis points to get their deals away, rather than hold back for a possible improvement in market conditions come September.

Deals in pipeline

The visible pipeline is modest, and is dominated by CLOs, accompanied by a few RMBS and CMBS transactions. One interesting deal looming on the horizon is the huge Pounds7bn ($14.2bn) whole business securitisation from Ferrovial of Spain, to refinance its 2006 takeover of UK airports operator BAA, whose assets include Heathrow, Gatwick and Stansted airports. This deal has encountered many delays, and Ferrovial will regret not getting it away in the first half, when market conditions were less difficult.

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