Positive sentiment coupled with the growing wall of money had created a one-way market: issuers expected a historic print on each new issue while syndicate managers' most onerous task was allocations. Some market traders had begun to question the wisdom of playing at all in a bid-only environment.
With five-year prime UK RMBS squeezed to an unsustainably tight Libor plus 7bp in mid-March, investors scented an opportunity to seize the momentum. Buyers of senior RMBS tranches, the core component of the ABS investor base, had long argued that inexorably tightening spreads failed to compensate them for the risk: credit events in the auto manufacturing sector provided the catalyst for an overdue reversal of control.
Suddenly, risk sensitivity returned and investors only had ears for the weaker, negative aspects on borrowers and deal structures. Over-supply in the sterling UK RMBS sector did not help things either, as spreads drifted from the low teens to mid 20s over margin within weeks.
A benchmark UK RMBS issue in May saw Triple A spreads return to the mid-teens: the one-way street now accepts traffic in both directions. While the GM and Ford downgrades brought significant volatility to most ABS asset classes, it is important to realise that this was not because any particular ABS was critically wounded by the credit events. Even ABS transactions sponsored by the two auto giants have performed in line with the wider market – or even outperformed, as the products' bankruptcy-remoteness and structural credit cushioning comes into its own.
Even in the synthetic CDO sector, where 745 tranches of 561 transactions have exposure to either GM and Ford or their financing subsidiaries, the impact has been limited. Claims that the sector has survived its first true test appear to have been overblown, though; it is very likely that there is a true-test lurking somewhere in the future, and recent auto ills were not it. The immediate fall-out did see movement in equity and mezzanine portions of the synthetic credit curve, but this manifested itself in wider bid levels, rather than panic selling.
Will the German sleeping giant awake this year? We have already seen a couple of small frontrunners, with cash CMBS, RMBS and auto loan precedents now established. However, the extent of demand for German real estate risk has yet to be tested, as with non-performing loans. The recent Viterra portfolio sale shows that the giant is growing ever-larger in its hibernation.
Most observers expect 2005 to be flat, with the keenest optimists predicting a 10% improvement at best on last year's issuance total of €240bn; some are even calling for a similar margin of reduction in volume as the rate origination in the key asset classes slows down.
One sector which cuts against this trend is CMBS, definitely the asset class of the year so far. Although the pace of origination of commercial mortgage loans and the distribution of CMBS has been frantic, it has been dominated by UK retail assets: investors are still looking for more euro-denominated deals, as well as multi-borrower/multi-loan transactions.