Securitisation 2007: Sub-prime woes
The US sub-prime housing meltdown has caused uproar in the securitisation and equity markets, as sub-prime lenders have succumbed to margin calls and lines of credit evaporate. Issuance has fallen and monoline wrapping has made a return – a change from the previously ubiquitous senior subordinate structure. John D'Antona reports.
What a difference 12 months make. The years 2006 and 2007 have proven to be polar opposites in 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. The exuberance was evident as new deals were eagerly purchased outright by investors or, in many cases, taken up by the insatiable CDO market to be used as collateral for more esoteric deals.
Fast forward to 2007, and that has all changed. Issuance in home equities has slowed and competing sectors, such as automobile loans and credit card receivables, now garner top pricing and demand, even for less than stellar credit-backed offerings.
Since October 2006, over 60 US mortgage lenders, brokers and wholesalers have ceased to exist, either in whole form or in most cases simply forced out of 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. Lenders reported delayed earnings and tightened lending standards, finally succumbing to the unpalatable truth that the industry had been lending on weak underwriting criteria.
The problems surrounding the US's second largest sub-prime originator and poster child of the situation, New Century, epitomise the situation. The company saw a seemingly endless cavalcade of bad news during March, from its stock being delisted, through lawsuits and criminal probes from regulators to the revelation that it was severely undercapitalised and eventual bankruptcy.
And while Joe Public heard all about New Century's woes, even larger players in the sub-prime market could be looking at big losses. They include Countrywide Home Loans, Wells Fargo, HSBC and GMAC. Market participants have been talking not just about lay-offs, but further legal action and the question of how to rescue the sector before it becomes a bloodbath for American homeowners
One New York ABS trader said that while no one was thinking about a collapse of a behemoth like Countrywide, the fact that company was also paring back its workforce showed just how deep the sub-prime crisis might be.
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." He added that he expected the Federal Reserve to cut short-term interest rates later this year to prevent a liquidity squeeze, and so further pain in the US housing market. Perhaps tellingly, Mozilo has also been actively selling shares in his company – according to SEC filings, he has sold several million shares since February.
Spreads on home equity securities that priced recently have reflected all of the market's concerns. As of mid May, money market classes were being shopped at in the one-month Libor plus 11bp area, and Triple A rated three-year tranches were offered at one-month Libor plus 24bp area. That is 9bp–10bp higher than the levels in early January. Subordinate classes have widened even further, by as much as 400bp depending on how far down the capital structure you go.
And while the worst of the situation may be past, there could still be rough spots ahead. Many ARM (adjustable-rate mortgage) loans that were originated in 2006, whether hybrid or negative amortisation, have yet to hit their reset points, which is usually the moment where 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, analyst at Bear Stearns.
"Some borrowers that would have bought homes now may not. It's hard to say what the withdrawal of liquidity might do to home prices or, more importantly, to housing starts. It's also hard to say how much of the likely withdrawal in sub-prime and Alt-A lending might get taken up by FHA/VA lending or by other loans that require small down payments or more documentation," he added.
According to the most recent data from the Mortgage Bankers Association, one out of every five US mortgages underwritten in 2006 was sub-prime, with total issuance at US$1.9trn. The entire US mortgage market totalled approximately US$11.5trn last year.
Back to the future
As a policy of self policing, US ABS issuers have not only tightened their loan underwriting standards, but also fielded more issues that include monoline credit enhancement and shed the more standard senior/subordinate structure.
Several securitisations have already utilised these wraps and insurance guarantees, some being entirely wrapped while others have had only the lower portions of the capital structure insured.
"The world has changed, as at first we were not seeing a lot of wrapped structures, but now it looks like spreads have moved wide enough to prod issuers in this direction," said Glenn Costello, director at Fitch.
"We are seeing and analysing new proposed transactions using monoline wraps. Originally I didn't think the market was in such shape to warrant monolines, but if the issuer is facing headline risk then they must feel they are candidates for using monoline structures," he added.
The involvement of monoline financial guarantors in US ABS securitisations had recently been limited to home equity line-of-credit transactions when investors demanded protection from the open-ended nature of the cashflow payment stream. Standard home equity loans have a definite term, which in effect negated the need for a monoline.
Fitch's Costello noted that the use of wraps or insurance in normal home equity ABS has to date been limited to a handful of individual tranches and classes, especially in the lowest parts of the capital structure as these last cashflow bonds normally have the longest average lives. The longer average life exposes an investor to more risk from extension, prepayment or default.
In the recently completed US$367m SunTrust 2007-1 offering through Deutsche Bank, the US$317.1m 2.5-year A class was wrapped by XL; RBSGreenwich recently completed a US$813m Nomura-sponsored 2007-1 group 1 transaction that had several classes wrapped by FSA, and Ambac has also been active, providing the credit enhancement for Irwin Mortgage's US$268m 2007-1 home equity line of credit.
In some ways this marks a return to the past. The migration of structures from senior/subordinate to surety wraps was a feature of the US ABS market in 1991 and again in 2000, when several sub-prime lenders such as Metris, ContiFinancial and Ameriquest experienced losses from troublesome loans owing to weak underwriting standards.
In order to head off a market meltdown and restore confidence, Metris issued ABS wrapped with MBIA surety bonds and Ameriquest used FSA and Ambac policies to ensure placement of securities. ContiFinancial wrapped specific classes of bonds within its ABS transactions. (See the separate article on the monolines in this report for more on that industry.)
Instalment credit now the focus
As home equity lenders attempt to regroup and salvage something from 2007, structured finance investors 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, said that while sub-prime 'flu had spread to CDOs backed by ABS, the spreads on other consumer-sensitive asset classes had so far remained resilient. In support of this she cited 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 credit card offerings have remained firmly bid and oversubscribed since February. Three-year Triple A rated card paper has steadily priced flat to one-month Libor, and subordinated tranches have priced similarly tight.
Auto-backed ABS have 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 minus 4bp, offering yield pick-up of 5bp– 8bp over benchmarks, once again in certain cases guaranteed by monoline insurers.
"The performance of auto ABS improved significantly over the past month, brought on primarily by the long-awaited 'tax season effect', where consumers use their tax returns to pay down auto debt. This effect has trickled down to ABS portfolios and alleviated some of the rising pressure on losses," said DB's Weaver.
"If the strength of the labour market holds and used-vehicle values remain robust, credit performance in the sector could continue to improve."