EUROPACE ABS Monitor

24 January 2008

Capital injections into the banking sector

The European ABS market has been experiencing a renewed bout of volatility, with investors still worried about the final extent of write-downs at the big global banks, troubles at the monoline insurers, and the potential effects of weak housing and office markets on RMBS and CMBS.

The monoline insurers have moved to the top of the list of market concerns, as it has become clear that they are finding it extremely difficult to raise the new equity capital needed to retain their Triple A ratings.

This is in contrast to the situation at big global banking institutions banks such as UBS, Citigroup and Merrill Lynch, who have been able to bolster their capital positions with the help of sovereign wealth funds from Asia and the Middle East. More capital injections into the banking sector are expected from these sovereign wealth funds in the coming months, but for the monolines one analyst sees little chance of public markets being open to raise additional capital.

The rating of monoline insurers

Late last week Ambac announced that it had cancelled plans to raise fresh equity, and was immediately downgraded by Fitch Ratings from Triple A to Double A. Other downgrades could follow, including MBIA which is already on ratings watch negative.

The consequent downgrade of project and Private Finance Initiative securitisation transactions, as well as Diversified Payment Rights tranches, from Triple A to Double A will cause yet more mark to market adjustments in bank trading books, and this is making the market nervous, adding to some of the downward pressure seen on spreads.

Ambac’s share price fell by 52% in one day last week, and MBIA fell by 31%. The monoline crisis, affecting hundreds of billions of Dollars worth of municipal bonds as well as the much smaller volume of wrapped ABS tranches, is viewed by many analysts as the next important phase of the global credit crisis.

A credit crunch for municipalities in the United States, which depend heavily upon the monolines in order to access cheap capital markets funding, will force a cutback in municipal spending and add to the prospects for a recession.  The problems at the monolines are viewed by some analysts as a key factor in the decision by the Federal Reserve to cut interest rates so aggressively by 75bp in one go.

Again widening out of spreads

In the European primary markets, the big prime mortgage originators continue to stay away from new issuance, and are still waiting and hoping that spreads will move in again. In highly illiquid conditions it is hard to get a firm indication of the potential pricing range for new issues, and most issuers would prefer to wait rather than risk a high profile failure of one of their deals.

RMBS have widened out again over the past week, with prime UK RMBS moving out by 5bp to 65bp, and Triple B tranches widening 50bp to 350bp. Italian, Dutch and French RMBS have also widened.

Meanwhile CMBS Triple A tranches are at 95bp in illiquid trading, and Triple Bs are indicated at 375bp, mainly reflecting concerns about the UK commercial property market. UK non conforming Triple As are at 175bp, with Triple Bs trading at distressed levels of around 700bp.

Many Triple A assets are trading wide because of liquidity problems, given the almost total absence of investor appetite. But at the Triple B level there are genuine concerns about collateral performance, which is leading to trading levels of 425bp for prime Spanish RMBS, 500bp for UK buy to let, and 375bp for CMBS.

Auto paper in a better position?

Auto paper is likely to be one of the more favoured asset classes as the markets recover, with one analyst pointing to the good collateral quality and solid historic performance. However, at present issuers prefer to pre-place deals rather than run the risk of a public offering being seen to struggle. In secondary trading, Triple A auto tranches are around the 60bp level.

First away in 2008 is Driver 5, backed by loans/leases originated by Volkswagen. The Euro1bn two year transaction included Euro934m worth of Triple A paper plus a Euro31m Single A rated tranche. But it was privately placed, and the market has few indications on pricing.

Deals from Germany

Arrangers of deals in asset classes outside of the residential and commercial mortgage sectors will have an opportunity to attract the attention of investors later in 2008, as investors look for more diversity away from their huge holdings of CMBS (already being hit by falling UK property prices) and RMBS (where collateral will suffer in the event of a widely predicted fall in house prices).

Countries where there has been less of an asset bubble, such as Germany and The Netherlands, look set to benefit in the second half of 2008.

German auto paper has a willing investor base, as shown by the recent Driver 5 car loans transaction and the VCL auto lease deal in December, both originated by Volkswagen.

More problematic are the German mezzanine CLOs, but nonetheless more of these deals are anticipated later in the year. In late December Moody’s took its latest actions on German mezzanine deals, with a number of tranches downgraded by several notches following multiple defaults.

Hardest hit was CB MezzCap Limited Partnership, which has had three defaults since inception, out of a total of only 35 names in the pool. These losses totalled Euro31m, or 15.5% of the portfolio. All five classes of notes, from Triple A down to Ba1, were put on ratings watch by Moody’s. The Triple As were affirmed, but all other four rated tranches were downgraded.

At the same time Moody’s downgraded two tranches of PREPS 2005-2 from A2 to Ba1. This deal has suffered four defaults, totalling  Euro42m or 11.7% of the portfolio. A number of other deals, including those from the Stage, FORCE and HEAT programmes, were taken off ratings watch and had their current ratings confirmed.

Bankers say that mezzanine deals which will come in the second half of 2008 will need to be more granular. CB MezzCap was launched with only 35 names, PREPS 2006-1 with 62 names, and PREPS 2007-1 with 52 names. But future transactions will probably need 100 names in the portfolio in order to make investors comfortable.

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