EUROPACE ABS Monitor

21 December 2007 

Emphasis on synthetic deals

As the European ABS market prepares to shut down for the Christmas break, there is an emphasis on synthetic balance sheet management deals, with most of the cash tranches either retained or pre-placed, but very few publicly offered.

Royal Bank of Scotland completed a $9.63bn partially funded synthetic Collateralised Loan Obligation backed by a static pool of 355 corporate loans in the US, UK and Western Europe. The deal, under the name Arran Corporate Loans No 2, included a $7.9bn Super Senior Credit Default Swap. The Triple A, Double A and Single A notes were pre-placed, with the remaining junior tranches not offered.

Rabobank has been in the market with a Euro7.5bn Collateralised Loan Obligation backed by loans to Small and Medium Sized Enterprises, under the name Best SME 2007. This was a fully funded synthetic, though with most tranches retained.  However some of the smaller subordinated tranches were pre-placed, with the Double A rated notes paying a spread of 85 basis points over Euribor.

Spreads in the non-conforming sector

And an Irish RMBS deal for Ulster Bank was pre-placed. The Euro2bn Celtic 13 transaction is backed by prime mortgages , and was split into six tranches, including 3.8 year Triple As at a 47bp spread over Euribor, and four year Triple Bs at 400bp.

In secondary trading spreads have ballooned outwards on prime Spanish RMBS as worries continue about the weakness of the Spanish property market.  Hit even harder are UK buy-to-let and non-conforming RMBS tranches, which is where the weakness will be most felt if the UK property market slides in 2008, as forecast by many economists.

The Citizens Advice Bureau in the UK, which is a first point of contact for many households unable to meet their debt burden, has issued a report that is highly critical of lending practices in the non-conforming mortgage sector. It highlights the fact that basic credit checks were often not carried out by mortgage brokers anxious to make a sale, and that in particular little attention was paid to whether householders would be able to meet monthly payments once the initial discounted interest rate period ended.

Though nowhere as bad as the US subprime market, there are real concerns about credit losses on UK non-conforming subdordinated tranches in 2008. In secondary market trading, Triple B rated non-conforming RMBS tranches have widened out by 300bp over the past five weeks, to trade around the 700bp level.

In contrast, analysts feel that in the UK prime RMBS market, and even more so across continental Europe where there is generally less of an asset price bubble, worries about credit losses on RMBS are overdone.

Evolutions in prime RMBS

Prime RMBS Triple A tranches are well protected by junior tranches, which make credit losses seem unlikely outside of an extreme property crash.  Thus it is forecast that, as the liquidity problems hopefully ease in the early part of 2008, investors will take a more fundamental look at prime Triple A RMBS, and begin buying again.

Banks have been hoarding cash to make their year end balance sheets look better, and their unwillingness lend to one another has necessitated the provision of liquidity by central banks. Under an optimistic scenario, once the New Year begins banks will begin to lend to one another once more, and will also start investing in highly rated ABS such as RMBS. 

But over the past month, in thin secondary market trading spreads have become much wider, with few buyers willing to enter the market, even at what look like bargain levels. Prime Spanish Triple A RMBS have been trading at 90bp, and Triple Bs at 400bp. Market jitters have even hit Dutch subordinated tranches, with Triple Bs widening out another 100bp to 300bp.

The global exposure of SIVs

And in the UK, worries about a softening property market with too many speculative buyers have pushed Triple A rated buy-to-let tranches out 30bp to 100bp, and Triple B tranches out by 200bp to 500bp.

The UK buy-to-let and non-conforming sectors are likely to suffer from negative news flow well into 2008, so the immediate focus in the European market early in 2008 will be to see whether prime RMBS tranches from countries such as the UK, France, Germany The Netherlands can finally find some buying support, and tighten in the levels where primary issuance might be kickstarted.

This would also have the beneficial effect of allowing Structured Investment Vehicles to sell more of their high quality Triple A rated assets, and so tackle the problem of the overhang of paper owned by the SIVs.

Recent data from Standard & Poor’s on global exposure of SIVs that it rates indicated holdings of $35bn (Euro24bn) of non-US prime RMBS out of total SIV portfolio holdings of $284bn. One analyst points out that much of this is held by SIVs undergoing some sort of restructuring, so sudden firesales are unlikely.

Thus the supply overhang from the SIVs of mainly European (and some Australian and other countries) prime RMBS and is very limited, the analyst reasons, which sets the stage for prime RMBS spreads to tighten during the first quarter.

More SIVs are being restructured, with sponsor banks putting in place liquidity lines which will avoid any pressure to quickly dispose of assets. For example, the $4bn Premier Asset Collateralised Entity, a Jersey registered SIV, has been restructured with Societe Generale providing a funding facility that permits the redemption of senior debt as it falls due.

The SIVs managed by Citigroup

The SIV crisis has hit Citigroup harder than most. In late November Moody’s placed on review for possible downgrade the ratings of six SIVs managed by Citigroup, Beta Finance, Centauri Corporation,  Dorada Corporation, Five Finance, Sedna Finance and Zela Finance. On 17 December Moody’s extended its review period, as it waits for Citigroup to take action.

The new Citigroup CEO Vikram Pandit was not associated with the subprime debacle which led to the SIVs funding crisis, and is able to pursue new ideas. Significantly, he has signalled that around $50bn worth of SIV assets will be brought back onto the Citigroup balance sheet, when previous management had been determined to keep those assets at arms length in off-balance sheet vehicles.

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