EUROPACE ABS Monitor

17 July 2008

Fed rescues Freddie Mac and Fannie Mae

The intervention by the Federal Reserve to shore up the position of mortgage guarantors Federal Home Loan Mortgage Corporation (Freddie Mac) and Federal National Mortgage Association (Fannie Mae) has given investors a temporary breathing space, but also underlines the severity of the crisis in the US mortgage market.  
  
The Fed made its move on Sunday, as nervousness grew that an auction of bonds to be held on Monday by Freddie Mac would not be taken up by investors. The Fed has authorised direct lending by itself to the two mortgage guarantors, and is seeking approval from Congress to buy equity stakes if it chooses.  
  
This week the shares have continued to fall, since existing shareholders are likely to lose out even if debt holders are helped by the government action. Shares in Freddie Mac fell to $5.26 on Tuesday, from $28 in May and $67 twelve months ago. And shares in Fannie Mae fell to $7.07 Tuesday compared to $30 in May and $70 twelve months ago.  
  
The two entities buy mortgages from originating banks and sell them on to investors via RMBS offerings, so US banks are heavily dependent upon them to support new origination. Fannie and Freddie between them guarantee $5.3 trillion worth of US mortgages, or around half of all outstanding US mortgages.   

IndyMac goes bust

Late last week investors were already digesting the failure of California based IndyMac, the tenth largest mortgage lender in the US, which is now continuing business with all its deposits transferred to the Federal Deposit Insurance Corporation.  
  
Other mortgage lenders such as Washington Mutual and Cleveland based National City have seen their shares drop rapidly over the past few weeks, and more failures are seen as a possibility, particularly among regional mortgage specialists.   

Santander buys Alliance & Leicester

Meanwhile, in a sign of the problems gripping the UK housing market, it was announced that building society Alliance & Leicester is to be taken over by Banco Santander and merged with Abbey, which Santander already owns. Large numbers of layoffs are expected from the 8,000 Alliance & Leicester workforce.  
  
The general atmosphere in the financial sector in both the US and Europe, which had slowly improved since the low point reached in March, has now reached crisis levels once again. In the United States, hedge funds are being so aggressive in betting on the collapse of some banks that the Federal Reserve is looking at placing limits on short selling.  
  
Not surprisingly, in such an environment very few European ABS investors are willing to step up and buy paper. And the continuous flow of poor data from the UK housing market, where completed sales are down more than 50% compared to last summer, has led to a worsening of sentiment over prime UK RMBS tranches.  

UK RMBS tranches widened out 40bp in the past month

They have widened out by 40bp at the Triple A level over the past month, to trade around the 140bp level. This compares to 150bp for Italian issues and 175bp for German RMBS. Dutch RMBS now stand out as the asset class with the tightest spreads, and trade around the 85bp levels in secondary.  
  
Triple A rated UK Buy To Let tranches are trading at 350bp, and non conforming at 400bp. In the BTL sector, delinquencies remain quite low, but the history of this market segment is quite short, and does not cover a full housing cycle. Moody’s has noted that though repossessions remain low, during the first half of 2008 both delinquencies and repossessions increased in transactions such as the Aire Valley Master Trust, originated by Bradford & Bingley.  

The weighted average delinquency trend for all BTL deals rated by Moody’s was 1.09% in the second quarter of this year, versus 0.63% in the same quarter in 2007. Moody’s notes that one of the features of the UK BTL market was low rental returns, with investors looking instead at capital appreciation. Now that the UK market has seized up, it remains to be seen how this feeds through into BTL performance.  

Most RMBS deals still retained, though another auto deal comes to market

In primary, one estimate of deals structured for the month of June stands at Euro83bn. But very few deals have been sold, and most have been retained for collateral for central bank liquidity lines.  
  
Bank of Scotland retained the Pounds10bn Brea Financing RMBS deal. And Mercurio Mortgage Finance is a Euro4bn RMBS from Barclays Bank Italy, also retained.  
  
One deal which will be placed involves a Euro1bn German auto loan securitisation for Banque PSA, illustrating the fact that auto paper remains a favoured asset class, though even here Triple A tranches have widened out by 10bp to 95bp over the past month.   

Australian banks still sell RMBS in spite of wide spreads

Australian RMBS issuance continues to be surprisingly strong. This is in spite of the fact that arrears have risen for five months in a row according to Standard & Poor’s data. But the Australian economy is quite buoyant, helped by high commodity prices. One analyst is recommending buying Triple A tranches at 120bp, but suggests that heavy issuance will not be seen until the margin contracts to 100bp.  
  
The recent Puma Masterfund deal from Macquarie Securitisation priced the A$630m Triple A tranche at a 180bp spread, but these were low documentation loans, and arrears on low doc loans are running at twice the level of full doc mortgages.   
  

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