Secondary market spreads in European ABS have followed the trends set by US ABS and European vanilla debt in tightening over the last few months, by over 200bp in some asset classes.
What’s behind this? The near total absence of new primary issuance, steady amortisation of outstanding securitisations — between 14% for Spanish prime to 23% of UK prime RMBS a year, according to research estimates — government support for bank balance sheets and the reclassification of bank holdings into held-to-maturity buckets have greatly eased investors’ concerns about the secondary market being flooded with paper.
For most currently active investors, of which there are admittedly far fewer than before the crisis, the greatest worry is extension risk caused by declining payment rates on the underlying assets or originators’ failure to call bonds at their step-up date. Those concerns have in many cases been eased as bank originators have given an indirect vote of confidence to the securitisation market by buying back tranches of securitisations. Santander on Monday announced the largest such tender yet, offering to buy back 27 tranches of its securitisations, with an outstanding balance of Eu16.5bn. In addition to tender offers, many other banks have been informally sucking up their own paper on the secondary market, to the tune of Eu10bn notional according to one estimate.
Spreads have tightened so much — UK RMBS now trades as tight as 160bp over interbank rates in some cases — that investors say some mainstream originators are sounding them out for potential new issuance, potentially even without government support.
Investors say that HBOS and Barclays, for instance, are putting out feelers for new RMBS issues, which could be brought to market as early as September.
The known unknowns
On the other hand, many investors feel the current rally is unsustainable. Trading volumes are always thin in the summer months, meaning that small amounts of paper changing hands move prices more easily. A further fall in confidence in financial institutions, caused perhaps by the transition of losses from securities portfolios to loan books, would have immediate knock-on effects.
There are other areas of uncertainty. In Europe, transparency initiatives remain in their infancy when compared to the US’s Project Restart, with little progress made on loan level disclosure.
In many markets such as CMBS and credit cards, the credit story has yet to play out, leaving considerable uncertainty as to the extent of downside risk.
Recent bankruptcy hearings have challenged some of the fundamental principles on which securitisation is built, highlighting yet another area of risk for which investors were ill prepared.
The long term outlook for securitisation as a whole also remains unclear, which will dissuade many investors, especially banks, from re-entering the market. Lawyers and analysts are still poring over the revisions to Basle II and the Capital Requirements Directive to assess the impact, but all are agreed that they will increase the cost and regulatory burden of investment for small investors, and of origination for banks. Investors and issuers could also be exposed to legal risks over which they have little control.
With spreads tightening so much against this background of uncertainty, it certainly seems fair to say that in most cases market values for ABS are no longer irrationally dislocated, while the enormous liquidity premium has declined somewhat as the expectation gap between buyers and sellers has narrowed. The panic and extreme volatility that characterised the early and middle stages of the financial crisis has faded, with bad news now taken much more calmly.
For originators with a long term commitment to the market, the end of the summer break would be an opportune time to test the market — if their funding programmes can support the still-elevated liability cost. But it’s still a market that must be approached with caution.