EUROPACE ABS Monitor

06 March 2008

High-grade margins widening

Secondary market spreads on ABS tranches have pushed out wider over the past few weeks, adding to the pressure on investors marking their portfolios to market.

Spreads on Triple A rated tranches edged gradually wider in January and early February, but since the second half of February have deteriorated at a rate that has taken market participants by surprise.

Triple A rated tranches are typically now trading at double the levels seen at the beginning of the year, while Triple B spreads have moved out another 200bp on many issues.

Analysts point in vain to the solid credit fundamentals of most Triple A rated ABS tranches, but it is technicals that are driving the market.  And the fact that the latest spread deterioration has been concentrated at the Triple A end of the credit curve is especially worrying, since it is hitting many fund investors who thought they could play a waiting game and ride out the liquidity crisis.

Market spooked by Peloton Fund liquidation

One event that has been pushing spreads wider is the liquidation of the ABS fund run by London hedge fund manager Peloton Partners. Peloton had been viewed as one of the hedge funds which had accurately identified the problems in the sub-prime market, and had done well out of taking short positions in 2007, while holding very large positions in Triple A rated prime ABS. So their sudden demise is a shock to the market.

The highly leveraged Peloton ABS fund is being liquidated after bank lenders who act as prime brokers to the hedge fund asked for more capital to be put up via margin calls. Peloton was unable to meet these growing margin calls, after spreads on its Triple A rated ABS blew out and pushed the value of the leveraged fund relentlessly downwards.

Liquidity crisis – a vicious cycle of fear

Thus it is once again the liquidity crisis, rather than fundamental problems with the underlying assets, which have caused the liquidation of a fund. The Peloton case has caused particular concern because it was regarded as a well run operation.

Indeed Peloton put out a statement saying that there had not been any material deterioration in the credit quality of the fund’s assets, but that because of their own problems, credit providers were tightening terms ‘without regard to the creditworthiness or track record of individual firms.

The trend towards bank credit committees (with their own huge internal ABS writedowns) wanting to reduce their risk exposure by scaling back lending to hedge funds is potentially a vicious circle. The forced liquidation of ABS portfolios will simply add to the problems of all ABS investors, including the banks themselves.

This week the London market is nervous about bank lenders making similar margin calls putting other hedge fund ABS portfolios into liquidation, which would usher in a new phase of the liquidity crisis.

New issues – from Volkswagen and Morgan Stanley

The primary market remains very quiet, but another Volkswagen deal was recently publicly placed, making VW one of the major issuers of 2008 so far. The two year Pounds500m Driver UK One deal is backed by auto loans originated by Volkswagen Financial Services in the UK. The senior Triple A tranche was split into Sterling and Euro denominated pieces, which printed at 70bp spreads versus Libor and Euribor.

In the CMBS asset class, the Euro695m ELoc 29 transaction was the latest offering from the Morgan Stanley CMBS conduit. It is backed by commercial property loans in The Netherlands, Belgium, Switzerland and Germany. The Euro575m Triple A tranche priced at Euribor plus 120bp, while the junior tranches were retained.

But most deals continue to be retained. UCI FTA 18 was a Euro1.7bn transaction from UCI in Spain, but was retained. Spanish banks have been structuring deals where the Triple A rated tranches can be used as collateral with the European Central Bank. Up to now it is the German banks which have done most of the borrowing from the ECB, but Spanish institutions have large volumes of ABS collateral ready and waiting if they require more liquidity over the course of 2008, and a continued stream of retained ABS deals is expected.

Spreads continue growing in a quite market

In secondary, spreads continue to be quoted in a very illiquid market, though sizeable trades are few and far between, as most market players adopt a wait and see approach.

But in little over a month spreads on prime Triple A RMBS tranches have widened out another 50bp to 60bp, and now stand at 120bp for The Netherlands, 125bp for Germany, 130bp for the UK, 150bp for Portugal and 175bp for Spain.

The rout continues in UK buy-to-let where Triple As are now quoted at 200bp, and non-conforming where Triple As are now at 250bp. And spreads on Triple B tranches have widened out another 100bp or 150bp over the past four weeks in many asset classes.

Whisteljacket deterioration continues

The situation at Whistlejacket SIV run by Standard Chartered has also been a fast moving story, illustrating how fast the market has deteriorated over the past two months. Standard Chartered had intended to agree to pay the obligations of Whistlejacket as they came due, but a fall in the value of the assets triggered a sudden liquidation event before the plan could be put into effect.

The market had grown used to the idea that bank ABCP and SIV sponsors would bail out investors and put the assets on balance sheet, but Standard Chartered no longer has any obligations to Whistlejacket, which is being liquidated by the receiver.

Monoline affirmation – sunshine for the market

One ray of sunshine was monoline MBIA being affirmed at Triple A. If Ambac can complete its capital raising and be affirmed as well then this will be a big relief for the market, and shares in Ambac and other financial institutions rose on 4 March as speculation grew that the re-capitalisation of Ambac will be successful.

Avoiding another round of downgrades on monoline wrapped securities, and the associated  mark-to-market losses will be crucial to the recovery of the market.

US near prime provides more bad news

Meanwhile the US mortgage market continues to throw up more bad news, and the focus is now shifting from sub-prime to so called Alt-A or near prime mortgages, which though not given to borrowers with bad credit records were often either self-certified or with no credit records. Also known as near prime, some of these securitisations could blow up if property prices continue to fall in the United States.

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