EUROPACE ABS Monitor

12 November 2007 

Second rounds of write down

During the last weeks of October there was growing optimism that the European ABS market was finally stabilising, with a pipeline of transactions starting to build. But as November has got underway investor confidence has been hit once again, sending secondary market spreads wider and putting deals on hold.

The news that Merrill Lynch and Citigroup have drastically increased their write-downs on subprime RMBS holdings has led to concerns that many other banks may have also underestimated losses. Thus, instead of getting all the bad news out of the way in the third quarter, the banks are heading for a second round of write-downs.

The prospect of another round of marking down the value of securities, which may in turn push more forced sellers into the market, may mean that the primary markets cannot now re-open for sizeable offerings before Christmas. 

More uncertainty

During October the focus had been on the need for SIVs to liquidate their holdings, most notably Cheyne Finance and Rhinebridge, which are both in the hands of a bankruptcy receiver, leaving around $9bn worth of paper overhanging the market.

In contrast, bank trading desks were not big sellers, and were even tentatively returning as buyers during October. But renewed pressure on their balance sheets may mean less buying from this direction.

And just to add to the uncertainty, Fitch Ratings has announced a review of its ratings of the monoline insurers, which could mean names such as FGIC, Ambac or even MBIA losing their Triple A status. Shares in both Ambac and MBIA have both fallen by over 50 per cent over the past month.

Bank investors, who own hundreds of billions of Dollars worth of wrapped bonds, will be hit hard if some of these are downgraded from Triple A to Double A. Tiering is now developing according to the monoline providing the wrap, and the strength of the underlying rating, with underlying Double A or Single A rated bonds much preferred to Triple B.   

The first publicly offered RMBS transaction since July

All this flow of bad news came just after the European primary market began to show some signs of life in late October, with the first publicly offered RMBS transaction in Europe since July. E-MAC Program II Compartment NL 07-IV is backed by mortgage loans originated by GMAC-RFC Nederland, Quion and Atlas Funding.

It was seen as good news that a high profile European issuer was coming back to the market, since the various Spanish deals seen during September and October had al been retained. But the market was taken aback by the wide pricing, with the 4.5 year E-MAC Triple A notes printing at a 50bp spread.

Prime RMBS had been recovering to as tight at 25bp in secondary trading, and even taking into consideration the slightly lower credit quality of the E-MAC portfolio, the 50bp spread level came as something of a shock.

As one analyst comments, bank trading desks who were tentatively buying RMBS paper at 30bp or 35bp had their bank credit committees call a halt to more exposure being added, after seeing primary activity at 50bp. The deal has prompted a re-think as to where pricing will settle when the markets re-open.

Wide pricing on the latest VCL transaction

Also in primary, Volkswagen Car Lease came with its latest VCL transaction backed by auto leases. The Euro940m worth of 1.4 year Triple As priced at a 37bp spread over Euribor, and the Euro30m worth of 1.75 year Single As at 85bp. This was the tenth deal in the series. Earlier this year VCL had sold Triple A notes at 6bp and Single As at 13bp.    

The wide pricing on these deals, coupled with the fallout from the resignations of Stan O’Neal at Merrill Lynch and Charles Prince at Citigroup, have set the market back again, as investors worry about where additional losses may be located across the financial system.

The pipeline for November seems to be drying up again

A number of CMBS offerings that were being quietly marketed are once again on hold, and the pipeline for November seems to be drying up again.

One deal being marketed is Eurosail NL 2007-2, which is a non conforming RMBS transaction backed by mortgages originated by ELQ, a Dutch subsidiary of Lehman Brothers. Euro280m worth of Triple A rated notes are being sold, with the other classes not rated, and probably being retained.   

Most of the concerns in the European RMBS market are liquidity driven, with difficulty in pricing bonds, whereas in the United States sub prime mortgage loans have already developed into a catastrophic credit issue. The ABX.HE subprime indices hit new lows last week in the United States. Current pricing levels on the Triple B indices suggest that the market is factoring in a complete write-off of principal on these tranches.

The situation on the European housing market

The problems in the European housing market are nowhere near as bad, though there are continuing signs of stress in the Spanish RMBS market. Fitch recently downgraded the BBB and BB plus tranches of TDA 25 FTA to BBB minus and BB minus respectively.

In the UK, personal bankruptcies and mortgage repossessions actually declined in the third quarter, after rising throughout 2006 and into 2007. In addition, many credit card issuers have tightened rules on borrower quality and credit limits, which means that the traditional surge of credit card spending over Christmas in the UK may not lead to as heavy an increase in delinquencies and charge-offs as has often been seen in March or April. However there are worries about a potential drop in house prices in 2008, and the effect this would have on consumer confidence.

With UK, Dutch and German prime Triple A rated RMBS all trading around 40bp in secondary the market is still some way off a major prime offering, since many of the big bank originators would be reluctant to issue at 40bp plus, and will prefer to wait until the New Year.  

There is likely to be some issuance out of Australia and New Zealand, from originators that are heavily dependent upon securitisation. Analysts suggest that selective value is to be found from these originators, who cannot avoid issuing even in a wide spread environment.

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