EUROPACE ABS Monitor

11 September 2007 

The crisis in the secondary market

The moves by funds, hedge funds and Structured Investment Vehicles (SIVs) to sell assets in order to raise cash continues to weigh down on the European securitisation market, pushing out spreads in a very illiquid market.

On one day last week there were no less than four bid lists circulating in the market, including a very sizeable list of ABS tranches related to the liquidation of one of the Synapse funds.

But there are few buyers around, since the name of the game at the moment is to preserve liquidity, so spreads are ballooning outwards on the few tranches that do actually get sold. The past month has seen spreads on Triple A rated RMBS move out by an incredible 25bp to 30bp, leaving prime UK RMBS currently priced at Libor plus 45bp in the secondary market, and prime Spanish RMBS listed at 55bp.

Non conforming RMBS Triple A tranches have widened out by 35bp to around the 60bp level, but at least it can be argued that there is some fundamental logic to the selloff in this asset class, which is not true of the prime mortgage space. Meanwhile CMBS spreads have moved out 25bp over the month to around the 55bp mark.

For Triple B tranches pricing is all over the place, with some prime UK RMBS tranches changing hands at a 160bp spread (out by 85bp in a month), and less favoured Spanish deals seeing some trades at 250bp.

The ballooning out of spreads on Triple A rated holdings

The crisis in the secondary market has blown apart the claims of the European ABS market to have evolved into a highly liquid market for Triple A tranches from the big RMBS master trusts. And the spread widening is part of a vicious circle, since as investors such as SIV-lites and funds are forced to mark to market, they are showing big losses, which are in turn triggering the forced liquidation of more ABS portfolios.

Given the solid performance to date of Triple A tranches backed by prime mortgages, the current crisis is more one of liquidity and marking to market, rather than actual credit issues. Fear of actual losses is currently focussed on lower rated Triple B paper.   

As one analyst comments, having to mark down Triple B rated assets is predictable, but the ballooning out of spreads on Triple A rated holdings has come as a big surprise to most market participants. But with many SIV lites unable to sell Asset Backed Commercial Paper, and with banks anxious to avoid committing more funding in the form of liquidity lines wherever possible, it is the forced sellers who are driving the market.    

With little demand for Triple B tranches in such a risk averse environment, SIVs are being forced to dump their Triple A holdings to raise cash, which means that Triple A spreads are being disproportionately affected by the market turbulence.

A faint hint of optimism

One faint hint of optimism came last week, when some of the bid lists did not trade, meaning that the sellers were both willing and able to reject low bids. This could be a sign of returning market discipline, and may suggest that some funds and SIV-lites may be able to sell off their portfolios at a slower pace, instead of simply dumping paper and leaving everyone else to deal with the mark to market implications.

In such an environment, it is going to be difficult for the first few issuers to re-open the market in September, since panicking investors are going to be demanding high spreads in line with what they are seeing in the secondary market. This will make many stronger issuers hold off for a few months, leaving weaker players who need to raise funding to brave the primary market. 

Upcoming RMBS deals

There was only one deal last week, which was a UK Private Finance Initiative transaction for Consort Healthcare (Salford) plc, which was wrapped by monoline insurer AMBAC.  There is a pre-sale report for a Euro2bn Dutch RMBS offering out of the Hermes programme (from SNS Bank) but analysts suggest the deal may not be publicly offered, but instead used for repo collateral.

Given the current environment, it may be a few months before there are firm indicators of how pricing is going to be re-set in the European ABS market. And in spite of continual efforts to distinguish between prime mortgage and sub prime or non conforming deals, prime RMBS looks certain to be considerably more expensive for issuers.

One big issuer tipped to come to market before year end is Northern Rock, which has suffered volatility in its share price over the past month, as it depends very heavily upon the capital markets to fund its mortgage products. The appearance of a multi billion Pound deal from Granite would be a good indicator for the market. But Northern Rock may choose to issue covered bonds instead, which have widened out anywhere between 5bp and 10bp, but which still offer better pricing than RMBS.

A shadow over the UK CMBS asset class

In the CMBS space, profitability in the financial services industry is likely to drop dramatically for the second half of 2007. In London in particular, investment banks will be very quick to lay off staff to get their costs down. This is casting a shadow over the UK CMBS asset class.

Reduced activity in leveraged buyouts will mean less leveraged loans going into CDOs, but at the same time demand from SIVs, who were big buyers of CDOs backed by leveraged loans, will be much lower. Many other investors will be wary of this asset class. 

In the secondary market, there are plenty of traders who would like to get their hands on prime Triple A RMBS at 45bp, but are currently constrained by bank credit committees who have told them not to add more risk exposure to their ABS portfolios.

Some of these bank buyers may yet move back into the market in the coming weeks, which could suddenly push Triple A spreads back in. But equally, more fund redemptions and the winding up of SIV- lites could send spreads ballooning outwards again, so the market is currently delicately balanced.

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