EUROPACE ABS Monitor

08 May 2008

European ABS spreads tighten on improved sentiments, however country disparity remains

There has been significant spread tightening over the past few weeks in the European ABS market. Though there is some reluctance among analysts to call the bottom of the market, in case another unexpected shock emerges, sentiment has undoubtedly improved a great deal since late March and early April.

Triple A prime UK RMBS tranches have moved in 70bp over the past month, to around the 100bp level, while Dutch RMBS have moved in 55bp to 85bp. But Spanish RMBS have continued to drift outwards, widening another 25bp to 250bp. German and Portuguese tranches have been quite stable at around the 180bp level.

The steepness of the tiering between prime Triple RMBS tranches in different countries remains excessive, and the 150bp gap between the UK and Spain, both of which have overheated residential markets, is a prime example.

But though the ABS market continues to exhibit volatility and thin volume, the sight of spreads tightening on some tranches is a welcome reverse of the almost continuous widening that was seen between mid- January and mid-April.

As spreads tighten in, it may bring sellers into the market who still want to dump large positions, so there could be a series of overhang selloffs. So volatility may continue to be a feature of the market over the summer.

Positive news with Capmark sale of large whole loan portfolios

Another positive sign for the recovery of the financial markets was the recent sale of two large whole loan portfolios. In late April Capmark Financial Group completed the sale of a $896m portfolio of 24 commercial real estate loans to GE Real Estate. Earlier in the month Capmark sold another five large loans to GE Real Estate for $910m. The loans are backed by retail and office properties in the UK and Germany.

These loans would typically have found their way into Commercial Mortgage Backed Securities offerings, but with the CMBS market basically closed, Capmark elected to sell the loans instead.

Given its Triple A rating, GE Real Estate finds it easy to raise funds in spite of the credit crunch, and is well placed to take advantage of discounted loans being sold by originators. Last autumn it acquired a £2bn portfolio of residential mortgage loans from UK building society Bradford & Bingley, at what is thought to have been a 4 per cent discount to book value.

BlackRock bargain hunting with $15bn sub prime purchase from UBS

And in another sign that bargain hunters are at last willing to step up and buy loans, this week global investment management company BlackRock confirmed that it is to buy a $15bn sub prime mortgage portfolio from UBS.

UBS has made a total of $37bn worth of writedowns on its subprime assets, and the portfolio being sold to BlackRock has already been marked down by 32 per cent. With BlackRock willing to buy the loans at current book value, this 32 per cent discount could act as some sort of new benchmark for banks holding subprime loans.

With the SIVs gone, and buying only gradually returning from a few Asset Backed Commercial Paper conduits, the market in 2008 has been heavily dependent upon bank investors who are still some way from adding ABS assets to their books, and may even be potential large sellers. So the appearance of large specialised real estate players such as GE Real Estate and investment managers such as BlackRock for either whole loans or securitised tranches is an encouraging sign.

Meanwhile, analysts note that in Europe ABS spreads remain very distorted both with regard to credit performance and different asset classes, as well as between differently rated tranches within the same asset class.

Falling prices to cause problems for junior RMBS and CMBS tranches

Loan To Value triggers remain a problem within the CMBS asset class, as the falling value of commercial property activates LTV triggers. The latest deal to be affected is REC 5 Plantation Place, where the sponsor needed to put an additional Pounds16.8m on deposit to bring the LTV down to 82.14%.

Clearly not all sponsors will be able to find the extra cash to correct loan covenant breaches, and in a falling market (especially in UK office property) some CMBS defaults are likely during 2008. Quick sales of repossessed properties will impact deals, and could leads to substantial credit losses on junior tranches. But in well structured transactions Triple A holders could find themselves paid back in full ahead of time.

In the RMBS asset class, there is still a steady flow of negative news out of the UK, with the market stalled as buyers are either staying away from the market because they think prices will fall further, or simply because they are unable to get a mortgage.

It s notable that Triple UK RMBS tranches have tightened in just as the news on the underlying market has worsened. But analysts believe that at the Triple A level, prime RMBS tranches are structured well enough to withstand a 10 per cent or 20 per cent fall in property prices. Concerns are more at the Triple B level, and in the buy to let sector.

BoE a late mover in providing emergency bank funding

The Bank of England recently changed its mind over providing emergency funding to banks, after a great deal of criticism comparing its passive approach to the activities of the Federal Reserve and the European Central Bank.

An initial £50bn is being made available, with Triple A rated prime RMBS tranches to be used as collateral, as well as some credit card tranches. This is going to lead to a spate of retained RMBS deals being structured, as has been the case in Spain. First up with a retained transaction is HBOS, which has put together a £9bn deal out of its Permanent master trust.

Retained deals in Spain and Netherlands

Recent retained deals in Spain include IM Terrassa, a €500m RMBS transaction from Caixa Terrassa, and IM Caixa Girona Empresas, a €350m SME CLO from Caixa Girona.  And AyT Kutxa Hipotecaria III is a €500m retained RMBS from Kutxa (Bank of Bilbao).  Out of The Netherlands, ING Bank has structured and retained a €9.4bn RMBS deal, under the name Stichting White Lion RMBS.

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