Sunday, 22 July 2018

IFR Top 250 2007: More than a one-trick pony

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The US sub-prime market has been grabbing all the attention of late, whether in the press or at ABS conference drinks parties. But global ABS is far from being a one-trick pony, and while sub-prime suffers, other asset classes and other jurisdictions are on a roll, as John D’Antona and Paul Farrow report.

The US sub-prime housing meltdown has caused uproar in the securitisation and equity markets over the past year, as sub-prime lenders have succumbed to margin calls and lines of credit have evaporated. Unsurprisingly, sub-prime securitised issuance has fallen, and new deals are increasingly looking to monoline wraps to provide investors with protection.

But what a difference a year makes, as 2006 and 2007 prove to be near polar opposites in terms of the state of the US home equity ABS market. In 2006, spreads on new issue ABS were tight and entrenched at near-record levels across the capital structure. Exuberance was in evidence as new deals were eagerly purchased outright by investors or, in many cases, bought by the insatiable CDO market, to be used as collateral for more esoteric deals.

Fast forward to 2007, and issuance in home equities has been transformed.

Since October 2006, over 60 US mortgage lenders, brokers and wholesalers have ceased to exist, in most cases forced out of the business as they failed to keep pace with margin calls and eroding Wall Street credit facilities.

The situation in the US sub-prime mortgage market reached a new nadir during the first months of this year, as lenders reported delayed earnings and tightened lending standards, finally succumbing to the growing evidence that the industry had been making loans using chronically weak underwriting criteria.

"The problem in the US industry is the combination of home price appreciation coming to an end, and the industry's declining underwriting standards," said Karan Chabba, a vice-president at Bear Stearns, speaking in a panel discussion at June's Global ABS conference in Barcelona.

That analysis suggests that there is no quick fix, and those in the industry still find it hard to draw a line under recent events. Referring to the weakness in the US housing market, Angelo Mozilo, chairman and CEO of Countrywide, said in a televised interview: "I don't think we're finished yet. It's going to get uglier.”

There are also moves afoot in the US to tackle the underwriting crisis, perhaps by linking borrowers' qualifications for loans to the normalised rather than the initial, teaser rate of interest.

"That would be a disaster for US sub-prime, and lead to a decline of 50%–60% [in sub-prime securitisation issuance]," said Glenn Schultz, managing director at Wachovia Securities, speaking at the same Barcelona panel discussion.

The spreads on those home equity securities that have priced recently have reflected the market's concerns. By early June, money market classes were being shopped in the one-month Libor plus 9bp area and Triple A rated three-year tranches were offered at the one-month Libor plus 22bp area, up 7bp–10bp compared with the levels seen in early January. And the subordinate classes have seen pricing widen even further, by as much as 400bp in the lower reaches of the capital structure.

US ABS issuers have reacted to these changed circumstance by tightening loan underwriting standards and fielding more issues that include monoline credit enhancement, while shedding the more standard senior/subordinate structure. Some are fully wrapped while others have had only the lower portions of the capital structure insured.

But there could still be turbulence ahead. Many ARM loans that were originated in 2006 – both hybrid and negative amortisation – have yet to hit their reset points, which to judge from earlier vintages is usually the moment when the loan begins to become stressed.

"Sub-prime . . . may stay in the headlines in the next few weeks as banks and broker/dealers report earnings," said Steve Abrahams, an analyst at Bear Stearns.

But others benefit

While the home equity sector attempts to regroup and salvage what it can from 2007, investors who need to invest in the capital markets, and more specifically the structured finance sector, have strategically deployed capital into the other two biggest, most liquid and short-term asset classes in US ABS – automobiles and cards.

Karen Weaver, head of research at Deutsche Bank, explained that while the sub-prime "flu" has spread to CDOs backed by ABS, spreads on other consumer-sensitive asset classes have thus far remained resilient, as investors have been supportive of these parts of the market. She pointed to the: "relatively stable delinquency and loss trends at the trust level. For example, although credit card data show a weakening from where they were a year ago, statistics are still below the levels experienced of their recent high, two years ago."

This explains why the most recent slate of credit card offerings, across the capital structure, have remained firmly bid and oversubscribed since February. Three-year Triple A rated cards have steadily priced flat to one-month Libor while their subordinate counterparts have priced similarly tight.

Auto-backed ABS has also faired well, especially the sub-prime product. Prime auto securitisations from renowned issuers such as Nissan or BMW have priced their money market classes at EDSF less 4b

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