EUROPACE ABS Monitor

03 July 2008

Investors absorb downgrades of monoline wrapped tranches

Asset Backed Securities have been trending wider over the past few weeks, especially at the Triple B level where a widening of 50bp to 100bp has been seen on many RMBS tranches as concerns grow about European property markets.  

Investors have also been re-evaluating their portfolios to take into account the long list of downgrades of monoline wrapped tranches, in the wake of the rating agency moves on Ambac and MBIA.  

Standard & Poor’s downgraded both companies to AA, but Moody’s took an even more pessimistic view, downgrading MBIA to Aa3 and Ambac even further to A2. Meanwhile Fitch removed its ratings for Ambac and MBIA after their managements declined to make available some non-public information.  

The potential downgrades had been the subject of many months of speculation, leaving investors well prepared, though the drop by Ambac into Single A territory came as something of a surprise. Radian has also been downgraded to A2 by Moody’s.  

Sizeable asset classes that used wraps included aircraft securitisations and UK whole business deals such as Anglian Water Services, Punch Taverns and Southern Water Services. Diversified Payment Rights (DPR) transactions are another hard hit asset class.   

In particular from 2004 to early 2007 Turkish banks including Akbank and Garanti were very heavy users of monoline guarantees for their DPR deals, though they often also sold unwrapped tranches in parallel. Some of these deals were widely distributed to institutional investors, though a sizeable quantity of paper is held in bank conduits by the arranging banks.   
     

European RMBS margins widening on fears of rising interest rates and pool arrears

In the European secondary market, Dutch prime RMBS continue to be the asset class most favoured by investors, with Triple As trading around the 75 basis point level. Prime UK tranches have recently widened out slightly to 105bp. The hard pressed UK Buy To Let sector has Triple As listed at 350bp, while over the past month BTL Triple Bs have widened out by 200bp to reach 900bp.  

Prime Portuguese Triple A RMBS tranches are currently trading around 170bp, and Spanish deals around the 210bp mark. At the Triple B level Spanish RMBS tranches are trading at around 800bp, but even at these heavily discounted levels there are few buyers as investors are fearful about rising arrears and losses.  

With the European Central Bank widely expected to raise interest rates from 4% to 4.25% this week, floating rate mortgage borrowers across the Eurozone are entering a period of rising monthly payments which make push up arrears on RMBS loan pools.   

The hardest hit countries will be Greece, Spain and Portugal where most mortgages feature a short one or two year fixed rate introductory offer, and then revert to floating rate.  

In the UK, non conforming tranches have widened in secondary market over the past month from 350bp to 400bp at the Triple A level, and 1100bp at the Triple B level.  
  

Sub-prime lending market continues tightening

One ABS analyst has conducted a survey of non conforming lending, and found six active lenders compared to 38 at the peak of the market. Those that remain have tightened credit criteria, leaving many borrowers who had hoped to refinance stuck with their existing high interest rate loans.  

A wide array of non conforming mortgage products are still being advertised by various lenders, but the actual volume being originated is generally quite small.  With low lending capacity, players like BM Solutions (part of HBOS) and GE Money are able to choose only the best customers and increase their margins.  

Rising arrears levels suggest that there will be losses on junior tranches on many non conforming deals, though many observers feel that Triple A tranches are typically well protected and a 400bp spread represents an opportunity for those brave enough to buy.  
  

Retained primary deals providing collateral but raises systematic concerns

In primary most transactions are being structured for use as collateral with the European Central Bank or Bank of England. However there was a Pounds350m tap issue for whole business pub securitisation Greene King in the UK which was placed. And out of Australia there was a A$315m RMBS with a short 2.8 year average life from Macquarie, under the name Puma P15.  

Retained deals include the Pounds16.8bn Greenock Funding plc 2 RMBS transaction from RBS, and the Euro15bn Bass Master Issuer RMBS deal from Fortis. The latest Euro1.5bn Magellan Mortgages deal from Banco Comercial Portugues was retained, as was a Spanish loans deal from Bankinter.   

There have been concerns raised, most recently by officials at the Basel based Bank for International Settlements (BIS), about the large amount of ABS collateral now held by central banks. However, during the various crises of the past twelve months, access to central bank liquidity with ABS posted as collateral has proven vital to stabilising the banking sector.   

Few governments or regulators are likely to want risk changing the repo collateral arrangements at a time when the markets appear to be slowly stabilising, but could be easily disturbed by another sudden shock.  
  

Banks continue raising capital to strengthen balance sheets

Meanwhile banks continue to raise fresh capital, which is an important part of the recovery process.  Most recently it was the turn of Barclays Bank in the UK, which has strengthened its balance sheet by agreeing a Pounds4.5bn issue of new shares.   

Prominent investors include Qatar Investment Authority, Sumitomo Mitsui Banking Corp, China Development Bank and Temasek Holdings of Singapore. Existing shareholders are also able to take up rights to discounted shares.  

Royal Bank of Scotland has already completed its Pounds12bn rights offering, and HBOS shareholders are currently being asked to decide whether to take up their rights under a Pounds4bn balance sheet strengthening exercise. HBOS is notable for having a very sizeable base of small shareholders, many of who acquired shares at the floatation of the former Halifax Building Society.  

As always, it is the equity investors who are feeling the pain as they have to decide whether to put up extra cash or see their holdings diluted by the sale of heavily discounted shares to new investors.   

But after the hits taken as a result of the subprime debacle the commercial banks are well underway with the process of mending their balance sheets, and this should result in a renewed appetite for ABS from bank investors later in 2008 and early 2009, underpinning the hoped for recovery in the ABS market.

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