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Jurriaan Oerlemans: Managing Partner, Faxtor Securities

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Oerlemans co-founded Amsterdam-based Faxtor in 1997. Before creating the firm, Oerlemans was an attorney at Loeff Claeys Verbeke in Rotterdam. Faxtor has E435 million in assets under management and specializes in collateralized debt obligations backed by asset-backeds. In addition, the firm invests in U.S. mortgage-backed securities and distressed debt. The firm is beginning to market itself as an institutional asset manager for ABS mandates.

Describe your investment strategy. Are you considering making any changes?

With regard to our investment strategy, we have been investing in asset-backed mezzanine and junior paper for several reasons. We are looking for exposure to consumer assets with granular pools, while looking to avoid event risk. We look at collateral trends and analyze deals in a bottom up way--on a loan-by-loan basis. With European ABS mezzanine debt it is really just a couple of defaulting collateral loans which may cause an economic loss to the bond you hold.

For example, with RMBS which are regional markets in Europe, we study each market in depth. We just went to Portugal and talked to originators, servicers and real estate brokers there to better understand market trends so we can do a thorough credit and structural analysis. We do that rather frequently.

Within each deal we are looking for pristine collateral and over-protection (credit enhancement) as required by ratings agencies. However, that protection is disappearing rapidly. The first RMBS deals in the Netherlands in 1997 had total credit enhancement of 4-5%. Today we are looking at the Monastery transaction, which in my mind is a sub-prime deal, that has credit enhancement of 0.5% to 1%.

We also like to see deals with amortizing features in the underlying loan pools. If there is a bucket of interest-only mortgages or a master trust, then a deal has direct exposure to future developments in real estate markets and/or the housing price index. Those are not structures that benefit from seasoning and/or principal repayments and prepayments.

In terms of changing our investment strategy, I think we may be moving up the credit curve a little bit. There has been a tremendous interest in triple-B tranches of securitizations and the single- and relatively double-As are left alone. We are looking at both on a selective basis. Also, we are looking at the U.S. with renewed interest. We are still kind of hesitant on sub-prime product but are looking at it again.

What are the major challenges you face in the current market environment?

Four or five years ago we were pretty much the only specialized investors in European mezzanine and junior ABS tranches and today there is an aggressive bid for ABS mezzanine tranches. ABS mezzanine is a good alternative for obtaining a yield pick up and diversification. Recently, it has been attracting a lot of blue chip investors to the market, but part of that market has not been doing the analysis they should. They haven't been doing the micro analysis, the loan-by-loan analysis. Additionally, at this time, there is a substantial CDO bid. At some stage the CDO bid just needs to fill certain buckets in its transaction. Occasionally the blue chip and CDO bids are making for some very strange out-lyers liers in pricing.

Even with the big pipeline so far this quarter there has been an aggressive bid. Spanish and Portuguese RMBS and U.K. sub-prime deals went like warm sausages. And, we're seeing some irrational pricing. In the recent Portuguese RMBS deals, Lusitano and Magellan, both differed quality of collateral and were different structurally and both still priced very tightly at approximately the same (equivalent) levels. I'm not going to say which one was priced irrationally.

Where are you seeing the most value in European ABS? What sectors are you favoring?

We are seeing value in German RMBS because the bonds, as an asset class--for obvious reasons --are unpopular but in some pools the 30-, 60-, 90-day delinquency numbers or even cumulative losses are very good despite the economic downturn. In that field we would be looking for pristine and seasoned collateral, amortizing features and structural robustness. Because there has been such a lot of issuance in the Dutch RMBS market, there has been some spread widening and we have been able to selectively find some value there. We also like Scandinavian and Swiss RMBS because they are less correlated to the rest of the European market. The Portuguese assets have a tendency to be mis-priced due to the imperfection of that market as a whole.

Recently there has been a proliferation of CDOs of ABS in the European market. How has this affected the ABS market as a whole and how much longer will there be enough arbitrage to make deals viable?

Only about six or seven true European CDOs backed by European consumer ABS mezzanine have been issued so far. If you look closely you will notice that there are distinctions to be made within the universe of European CDOs of ABS, according to underlying collateral, weighted average rating factors, structure and eligibility criteria.

Pure euro deals have a lot to offer. I like them because the idea behind such deals is the over-protection (credit enhancement) requested by ratings agencies. There should be spread arbitrage for 12 to 18 more months, but the ratings arbitrage is disappearing. And for a deal to be a good one there needs to be a thought behind it more than just the "spread arb" and diversification. At the end of the day, it's a question of if you are being overpaid for the risk you are taking, and right now I'd say yes. But with spreads coming in on a structural level and credit enhancement diminishing that won't be the case for much longer. When the ratings arbitrage disappears, we may be less interested in doing these types of deals.

Right now, we see "tiering" of ABS managers. I think managers ramping up their first CDOs of consumer mezzanine ABS are going to be too late to carve out a franchise in the market simply because it still is a niche market to some extent and there is only place for let's say three or four independent specialist managers.

There has been talk in the market that investors are beginning to consider buying equity in European consumer ABS and CDOs of ABS. What developments are you observing in this area?

We have been looking into U.S. RMBS equity for five or six years. Only two years ago, the European originators did not want to sell their equity to us. Now driven by Basel II and accounting incentives coupled with ambitious securitization programmes, some German and Dutch RMBS originators have been marketing equity in their own deals and structuring it to be what they think investors want to see. There have only been a few deals, but we definitely see increased activity. CDO of ABS equity is not a hard sell, when marketed in the right format to the right client base. I do think for the European securitization market to develop to maturity, it is mandatory that some sort of equity market will be developed.

From an investors' perspective, where do you see the European market heading? What are going to be the big stories in the next six months?

I hope the market will be heading toward some more uniformity in structuring and more standardization in its benchmark products. What do I think we will be seeing in the coming months? The most obvious is that we are going to see rating migrations and in my opinion the upgrade/downgrade ratios are going to tweak negatively. We might see the imperfection in pricing become somewhat less.

Furthermore, I think it is safe to say that we expect more covered bonds and perhaps beginning of '04 some deals from Germany's true sale initiative. We will also be seeing the KfW synthetic securitization platform expanding outside Germany. We may also see some German non-performing loan deals as well as other deals from new jurisdictions.

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