EUROPACE ABS Monitor

05 June 2008

UK prime grade RMBS leading European ABS recovery

The slow process of recovery has continued in the European ABS market over the past few weeks, though investors remain troubled by the deteriorating macro-economic picture and are wary of more bad news.     

The primary and secondary markets for junior Triple B tranches remain at a standstill. But at the Triple A end of the spectrum spreads have tightened in on selected asset classes, and there have been more public offerings.    
      
UK building society Halifax (part of HBOS) has come forward with the first UK RMBS deal to be publicly offered in 2008. Permanent Master Trust plc 2 was quite small with a single Triple A rated Pounds 500m tranche, and was designed to test the waters. The 3.64 year bonds were priced at Sterling Libor plus 85bp. 
       
Ironically, given the fact that falling UK property prices are now in the headlines on a daily basis, prime UK RMBS tranches have moved in at the Triple A level to become one of the tightest priced asset classes, second only to Dutch RMBS at 70bp and the highly favoured auto loans/leases at 75bp.    
       
But the big UK master trusts are well structured with good protection for the senior notes, and seasoned deals look generally strong at the Triple A level, in spite of new forecasts of a potential 15% to 20% drop in UK house prices during 2008. Secondary spread levels touching 180bp seen over the past few months were clearly an exceptional buying opportunity, especially for buy and hold investors not worried about mark to market fluctuations.      

Market remains nervous in junior RMBS market

German, French and Portuguese prime RMBS have been slower to move in, and given the fact that these countries had less of a residential property market price bubble than the UK, they should provide even better value at present.   
          
But the markets remain nervous about the property sector, and lower rated Triple B tranches continue to trade anywhere between 450bp for The Netherlands and 700bp for Spain, even for prime collateral.          
            
This could be explained by lack of liquidity and technical factors, with ABS trading desks not having internal authorisation to add to their overall ABS exposure. But equally, given the uncertain environment and flow of bad economic news, there are some genuine concerns about how delinquencies and repossessions will impact lower rated tranches across Europe.  
  

Continuing demand for auto loan securities

Outside of prime RMBS, it is the auto sector that is contributing most to the tentative progress in the primary market, helped by the fact that credit card paper is still being treated with extreme caution by investors. Most European credit card paper comes from the UK, where household income is stretched, and card delinquencies are on the rise.

But well protected Triple A tranches backed by auto loans to customers with solid credit history continue to attract strong demand from investors, in spite of the poor consumer finance outlook in Europe, where disposable income is being hit by rising household bills and petrol prices, and falling property prices in the case of the UK.   
  
Investors are willing to look at auto loan paper in a range of European countries, and past performance data shows that whereas overstretched households may default on their unsecured credit card debt, having their car repossessed is viewed as a last resort.  

New German and US auto issuances

Volkswagen has been the biggest European issuer of the past six months (excluding Spanish banks whose RMBS deals are nearly all retained) and VW has addressed the concerns of investors by structuring its recent Private Driver 2008-1 transaction primarily in the form of Schuldshein. Since Schuldshein do not generally need to be marked to market, investors can buy without being exposed to the volatile spreads seen in the secondary markets this year.  
  
Thus VW has addressed one of the technical problems in the market and allowed investors to concentrate on the fundamental credit analysis of its German auto loan portfolio, which has very strong performance with low default levels. Private Driver 2008-1 was a Euro253m private placement.  
  
Auto deals are also leading the primary pipeline in the United States, in spite of concerns about fast rising petrol prices. A few weeks ago Ford launched its $1.7bn Ford Credit Auto Owner Trust 2008-B transaction. And there has even been a riskier subprime auto deal, with the wrapped one year Triple As priced at Libor plus 175bp.

UK B&B’s profits fall on rising arrears

On a more negative note, UK building society Bradford & Bingley announced that operating profits for the first four months of 2008 had halved versus the same period in 2007, and that mortgage arrears are rising. B&B Chief Executive Officer Steven Crawshaw has resigned. B&B shares are trading at a quarter of their level only twelve months ago.  
  
B&B, which in 2007 was the biggest Buy To Let lender in the UK market, recently announced a large rights issue to raise extra capital from existing shareholders. And earlier this week it surprised the markets by agreeing to sell a 23% stake to The Texas Pacific Group for Pounds179m. The bargain price for Texas Pacific illustrates the urgent need for fresh capital among some mortgage lenders.  

Long recovery process re-enforced by banking sector downgrades

Also this week, the stock markets were hit by more bad news on the banking sector, as Standard & Poor’s downgraded Lehman Brothers, Merrill Lynch and Morgan Stanley, and put other institutions  such as Bank of America and JP Morgan Chase on negative outlook.  
  
The S&P move reinforced the impression that the recovery in the credit markets is going to be a long running affair, perhaps lasting another two years.  
  
With regard to specific ABS rating actions, Moody’s has downgraded all 19 classes of notes that were issued by Eurosail back in 2006. These were Lehman Brothers deals, with the non conforming mortgages originated by Preferred Mortgages and Southern Pacific.   
  
The Eurosail transactions are performing worse than the UK Non Conforming Index. The 2006-1 transaction has delinquencies in excess of 90 days running at 15.3%, not including homes already under repossession.
  

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