EUROPACE ABS Monitor

22 May 2008

Prime-grade interest grows with new primary issues, yet sub-prime market remains illiquid

Mainstream asset classes such as Dutch and UK RMBS Triple A tranches have found more interest from buyers in recent weeks, as the ABS market begins to show some signs of life.

Lower rated tranches remain almost totally illiquid, while investors continue to shun Spanish RMBS. But the logjam in the market that has existed since March seems to be easing up, and investors are willing to do some fundamental credit analysis and look for value.

There has even been some primary activity. Part of the Harbourmaster CLO was publicly placed, while Volkswagen recently privately placed Private Driver 2008-1, which is similar in structure to the public Euro1.25bn Driver Five deal which was launched in January. And out of Australia, the RMBS market was re-opened with a domestic Australian Dollar 500m offering from Citigroup, which was also sold to some overseas accounts.

These deals, together with the agreement by investment manager BlackRock to pay $15bn for a heavily discounted US subprime RMBS portfolio from UBS, and the move by GE Real Estate to buy a Euro1.3bn whole loan portfolio from Capmark Financial Group, indicate that investors are beginning to return to mortgage assets and selected ABS.

It is still very much a buyer’s market, and sellers of whole loans are being asked to keep a small first loss piece in some instances in order to get deals done, as was the case for some of the loans included in the Capmark sale to GE Real Estate. That deal featured 39 loans, almost all backed by office and retail space in Germany.

Continued interest in value-buys signals improved market sentiments

The market is no longer seen as a one way street of continually worsening news. Back in January there had been signs that spreads might tighten in, and there was some buying. But spreads ballooned outwards, and these buyers were soon sitting on large mark to market losses, making them nervous about buying anything, regardless of the price.

That situation has now changed, and investors are willing to come into the secondary market where they see value, or buy heavily discounted portfolios from banks who have already made big writedowns, and would rather sell now and get rid of the problem rather than play a long term game waiting for asset values to recover.

Decline of U.K. and U.S. asset performance continues

Ironically, the technical factors that are leading to an improvement in market sentiment are coming at a time when the overall European and US economic picture is getting worse, and ABS performance data is deteriorating.

Leading the slide is the UK, which given the vast issuance of RMBS and CMBS in recent years, makes up the biggest slice of many European ABS portfolios.

With its dependence on financial services, the UK is being hit harder than many other countries by the subprime fallout, and there are serious concerns about a further drop in commercial property prices, as slack demand for office space coincides with a large number of new developments nearing completion. The problem is especially severe in the City of London.

Meanwhile the UK residential market is getting worse. Repossession activity in the first quarter was up sharply on the fourth quarter of 2007. The record for repossessions came in 1992 when the number hit 180,000 but analysts suggest that this will be exceeded in either 2008 or 2009.

The big increase in non conforming mortgage products, high LTV mortgages and Buy To Let mortgages that were signed between 2005 and early 2007 are to blame, and will push up delinquency figures and repossessions.

In the United States, the latest data on credit card performance shows that charge-offs hit 5.71% in the first quarter, compared to 4.49% in the same quarter in 2007. Moody’s estimates that this figure could hit 7% either this year or next. 

New Australian high-grade primary issue well received by market

The new RMBS deal out of Australia gives some indication of what issuers are going to have to do to access the market. The transaction is for Citigroup, under the name Securitised Australian Mortgage Trust (SAMT) series 2008-1. In addition to overcollateralisation and cash reserves, the pool features a very low average LTV of 51.5%, and 29.9% of the mortgages in the pool carry insurance. The Weighted Average Life of the single tranche is 2.94 years.

Only the Triple A tranche was offered, at a spread of 145bp over the one month bank bill swap rate. With such a strong structure and generous pricing, the A$500m deal attracted strong investor appetite. It was three times oversubscribed, with 21 real money accounts buying a piece of the deal, a quarter of them from outside Australia.

The terms of the SAMT deal are quite tough for the originator, but Citigroup has shown that with some innovative structuring the primary market can once again be accessed, and the SAMT deal has provided a foundation for other originators to build on and consider doing their own transactions.

European market – Primary /secondary spreads tighten, yet country factors remain important

Back in Europe, Harbourmaster CLO 11 is backed by corporate loans in more favoured sectors such as business equipment and services (10.4%), cable and satellite TV (9.03%) and chemicals/plastics (8.56%). Analysts say that part of the Euro485m deal was publicly placed.

In the secondary market, the recent tightening of spreads brought out some sellers, and there was reasonably liquidity as traders looked at bid lists offering good value. But the market remains almost entirely made up of Triple A paper.

Dutch RMBS are the tightest at 70bp, followed by prime UK RMBS at 90bp. The illogical tiering is illustrated by the fact that German and Portuguese RMBS are listed at 170bp, but in reality there has been very little trading volume to back up screen prices. Investors continue to stay away from Spanish RMBS, which are listed at 230bp. UK Buy To Let and non conforming are still being treated with extreme caution, and are listed at 300bp and 350bp respectively at the Triple A level.

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