EUROPACE ABS Monitor

03 April 2008

ABS secondary market shows signs of stabilisation in spite of significant further UBS write-downs

There are signs of some stabilisation in the European ABS secondary market, though spreads remain extremely wide and trading volume is low.

But trading desks remain wary of more bad news which could force another round of mark to market writedowns. The latest events at UBS provide an example of how banks have failed to adequately address the subprime problem, but are being forced to keep coming back with additional writedowns, increasing nervousness among investors.

Earlier this week UBS announced that it was making a further $19bn worth of writedowns associated with US sub prime and related structured credit investments. This makes a total of $37bn in writedowns, the biggest of any global bank.

Analysts note that UBS still has substantial net exposures of around $31bn to the US mortgage market, and still carries the risk associated with any further severe deterioration in the ABS market.

UBS has recently completed a CHF13bn cash injection from Singapore sovereign wealth fund GIC together with an unnamed Middle East investor. And now it has announced an additional CHF15bn rights issue in order to restore its Tier 1 capital ratio.

The latest news from UBS came as something of a shock to investors, but there is some sense that the big international banks are moving closer to fully realistic writedowns on their ABS holdings, and that the next round of announcements from investment banks could mark the bottoming out of the ABS market, which is currently being driven purely by technical factors related to the lack of liquidity.

The ABS markets were also buoyed by news that Lehman Brothers has successfully completed a $4bn capital raising exercise.

Buyers return to high grade ABS and some synthetic markets as spreads stabilise on wide margins

Secondary markets remain highly illiquid, but there are reports of a few buyers emerging over the past week in order to buy mainly Triple A tranches at what look like fundamentally wide spreads. Several sizeable UK RMBS tranches are reported to have changed hands.

After the disastrous first two weeks of March, spreads on Triple A tranches have since not widened out very much, though they remain exceptionally wide. Prime Dutch Triple A RMBS are listed at 150bp, UK and German tranches at 180bp, and Spanish deals at 225bp.

In primary, most activity remains focused on the creation of Triple A ABS tranches that will be ready to be used as European Central Bank (ECB) collateral as and when necessary.

There are also some synthetic deals getting done via the KfW securitisation programmes, where KfW acts as a swap intermediary. Prime Bricks 2008-1 is a Euro1.5bn transfer of credit risk by Danske Bank on a portfolio of Danish mortgage looans.

And Promise Mobility 2008-1 is a synthetic transfer of credit risk by IKB Deutsche Industriebank, against a static portfolio of Euro denominated loans to Small and Medium Sized Enterprises.

Both deals have small Credit Linked Note tranches, totalling Euro179m for Danske Bank and Euro58.2m for IKB.

Issuers look to the fourth quarter and tighter Triple A grade tranches for deal prospects

With synthetic and retained deals dominant, the visible European pipeline for funded transactions remains very light. Most issuers are now looking towards the fourth quarter as a likely time to do deals, with hopes of any early improvement to the credit crunch having been dashed in March, which was the worst month so far in the credit crunch crisis.

The market focus will be on whether prime Triple A rated ABS tranches can slightly tighten in, putting an end to the continual marking down of portfolios, which has resulted in a vicious circle of banks not being willing to buy fundamentally sound Triple A tranches for fear of further mark to market losses.

It is a positive for the market that well known banks like UBS and Lehman are attracting new investment from sovereign wealth funds, which see a buying opportunity. In contrast the monoline insurers are attracting little interest from new investors, and are still potentially facing more rating agency downgrades.  This will affect valuations of CDOs containing with wrapped bonds, but the market has already factored in most of the likely effects.

Financial Guaranty Insurance Corporation downgraded on capital adequacy concerns

This week Moody’s downgraded Financial Guaranty Insurance Corporation (FGIC) to Baa3, fearing that FGIC’s statutory capital may fall below the regulatory minimum if it incurs further losses.

FGIC has announced that as of December 31 it had breached regulatory aggregate and single risk limits, which could cause the New York State Insurance Department to order that the company cease writing new business. FGIC disclosed that it has already voluntarily stopped writing new business in an attempt to improve its capital position through portfolio amortisation.

Last week Fitch Ratings also downgraded FGIC to Triple B, and downgraded Security Capital Assurance (SCA) to Double B and XL Capital to Single B.

Opportunities for investing in senior CMBS notes as LTV triggers increase prepayments

With technical factors driving the market, there is not much talk of fundamental credit analysis, but some analysts are highlighting areas where opportunities may be found.

In the Commercial Mortgage Backed Securities asset class, there is attention being focused on Loan To Value triggers, where falling property values can require borrowers to make a cash payment in order to restore LTVs to prescribed levels.

This could benefit senior noteholders as prepayments could be induced on heavily discounted notes, which are trading extremely wide because of technical factors.

Commercial property values in the UK and have fallen by around 10% over the past twelve months, and further falls are anticipated for 2008. 

To take one example, in the DECO 12 deal the LMM Overseas Investments loan was facing an LTV trigger, as an 8% drop in the value of the property pushed the LTV above 80%. The borrower has responded by putting up an addition Pounds500,000 to be held on deposit.

But in the current environment, some cash strapped borrowers will not be in a position to put up extra cash. Where they do not, LTV triggers will cause loan defaults, repossession and loan prepayments.

This will led to losses on junior notes, but for senior noteholders on well structured deals it will mean some early principal repayments on bonds which are currently trading extremely wide. One analyst suggests identifying bonds with loans close to trigger levels, and trying to predict whether the borrowers will be either unable or unwilling to put up additional cash deposits.

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