Copying and distributing are prohibited without permission of the publisher.


ABS rises from ashes but fails to convince on long-term health

24 Sep 2009

The launch of two public securitisations, the first in their sectors for over a year, has in the past two days given Europe’s stagnant structured finance market a huge boost, with demand for both deals exceeding expectations.

But despite the presence of real money investors in the books, some market participants were damning in their criticism of the deals, saying that they did nothing to bring back stability to the asset class.

On Wednesday, Lloyds Banking Group priced a £3.6bn RMBS from its Permanent master trust — the first public deal from the trust since May 2008. Meanwhile Volkswagen Financial Services priced a Eu519m car lease ABS on Thursday afternoon.

Those who voiced caution argued that demand was driven mainly by technical factors, particularly the absence of sellers in recent months, and that the longer term viability of the primary market is far from assured.

Permanent 2009-1, with Barclays Capital, JPMorgan and Lloyds as joint bookrunners, was supported by what amounted to a £2.82bn lead order from JPM, but in total 56 investors from 16 countries participated in the deal — far wider distribution than had been thought possible mere months ago.

"It was the Who’s Who of European real money," said Miray Muminoglu, a director in syndicate at Barclays Capital in London. "The largest buyers were investors who were active in the secondary market and had maintained their ABS focus in the last two years."

Lloyds was able to increase the sterling ‘A2’ tranche from the £1.25bn JPMorgan agreed to buy to £1.65bn, and placed a Eu750m ‘A3’ tranche with investors.

A further £1.565bn will be retained by Lloyds to use in a securities lending arrangement with JPM. Both publicly offered tranches were roughly two times covered.

"We were extremely pleased with the final result and the investor participation both in terms of diversity of type and geography as well as that amounts far exceeded our expectations," said Robert Plehn, head of structured securitisation at Lloyds Banking Group in London.

Both of the publicly offered tranches carry a coupon of 170bp over interbank rates, although the sterling tranche was offered at a discount to yield 180bp over Libor. These margins were inside secondary levels for Permanent paper before marketing began and roughly in line with the bank’s senior unsecured paper.

All the tranches come with an effective put option to Lloyds at their five year soft bullet maturity, although any amounts accumulated on the principal deficiency ledger by then will not be recouped by investors. This feature, which mimics in concept the UK government’s proposed liquidity guarantee for RMBS, was designed to ease investors’ concerns about extension risk, which have been heightened by sharply declining prepayment rates on UK mortgages.

Other changes to the Permanent formula included a hefty increase in the Funding 2 reserve fund from 1.65% to 8.23%, while the Funding 1 reserve was increased to 7.01%. Lloyds also funded a yield reserve to counteract the difference between the high liability cost of the new issuance and the lower average margin on the portfolio — for similar reasons, the notes step down rather than up at the expected maturity.

Detrimental performance?

Permanent’s successful launch had an immediate effect on the secondary market, pulling in spreads for outstanding Permanent issues by up to 10bp on Wednesday. The real impact was felt on Thursday, however — by the end of the day the new issue was bid as tight as 125bp, nearly half the spread of a week ago. Little paper changed hands, however.

The execution and subsequent performance prompted divergent opinions among investors, with concerns mounting over the course of Thursday’s trading.

"From the initial bids we’ve seen this morning, it seems they’ve paid up a little bit to make sure it was a success, and that’s probably the right thing to have done," said one investor who participated.

"The performance we’ve seen is almost detrimental," said another investor later in the day. "If it tightens dramatically, and it already has tightened dramatically, what does that say to the real money investors? Once upon a time we had a very stable market — spreads never moved and a movement of 1bp in a day was a shock. All of a sudden Permanent has moved by over 100bp in a week. A new issue came yesterday at 180bp over and now it’s 140bp bid. For me, that doesn’t send great signals to the market."

Some investors were also concerned by the extremely rapid marketing of the deal.

"It’s very striking that there was no roadshow, there was no real information on the portfolio," said one ABS investor who declined to participate in either Permanent or VCL. "Even Fitch said in its report that HBOS was not able to disclose information on its book, so you only have performance on the master trust and the master trusts hide information because of the replenishment. It’s nice for HBOS to be able to do that, but you know why they were able to do that, because they paid 170bp, 180bp for triple-A paper and placed most of their paper with other banks. Because of that they were able not to make any effort in transparency and marketing, but I’m not sure if they can go on like that."

The syndicate said that almost all the investors were very familiar with Permanent, and that the deal required little explanation.

"Some investors wanted to see the language around the put and how that worked," said Muminoglu. "The moment the docs were out on Monday, the syndicate banks pointed out to people how that operated. That’s where we got questions and pretty much nowhere else. Once people understood that, we didn’t really need any more time since the underlying and structure of the trust is well-known to investors."

Volkswagen performs, too

JPMorgan and WestLB’s methodical marketing of VW’s VCL 11 could not be accused of excessive haste. The deal was formally announced two weeks ago, and the issuer went on the road for one-on-ones in four countries. The books were held open from Monday to Thursday (Wednesday afternoon for non-German accounts).

The market’s momentum allowed the leads to increase the German auto ABS from Eu475m to Eu519.1m while tightening pricing from the initially expected 130bp area over Euribor to 110bp for the Eu500m, 1.38 year average life triple-A tranche. The Eu19.1m, 1.8 year, A+/A+ rated tranche came at 250bp over.

At the final terms, the books were 4.7 and 3.4 times covered.

"The great demand from almost 63 investors from 17 countries confirms the high standing enjoyed by Volkswagen Leasing GmbH as the leading automobile leasing company in the market," said the originator in a statement.

VCL 11, Volkswagen’s first public issuance since 2008, is especially notable for offering subordinated notes, unlike Permanent.

Investor demand for such paper evaporated during the crisis because of fears over credit and the severe illiquidity of the small tranches.

In recent months, however, while trading has remained thin, traders have reported increased demand from investors for selected names as the extent of downside risk became more apparent and dramatic tightening at the triple-A level increased the relative appeal of lower rated paper.

While it remains very expensive compared with pre-crisis levels, the ability to place subordinated tranches will be vital to restoring the viability of securitisation as a financing tool for non-bank lenders, who generally lack the capital to retain large amounts of first loss risk.

Flash in the pan?

Despite the euphoria evidenced by the secondary market’s performance during the week, market participants remain wary of declaring the market open again.

"These were good attempts to bring back investors, but I hope it’s not a flash in the pan," said one investor. "It could be a positive cycle — more issuance, more liquidity, tighter spreads. In the context of reopening up the RMBS and wider ABS markets, we do need to bear in mind that one of the big differences now is that in the heyday you had new vehicles springing up all the time using a lot of leverage that were able to be repeat purchasers of programmes such as Permanent. Unless there is a substantial amount of new money coming into either real money or bank treasury investors, will there be the same demand for Perma 2009-2?"

Lloyds sees a future for both Permanent and the Arkle trust that securitises Lloyds-originated mortgages. "They are both important sources of funding," said Plehn. "I expect we will be issuing out of them in the future."

If master trusts are to regain some of their former prominence as funding tools for UK banks, however, they will need to bring back the US investor base which allowed such enormous deal sizes in the run-up to the crisis. Many of the old investors have disappeared, and the rest are wary of mortgage securitisation, especially in a less familiar jurisdiction.

"We are considering issuing in the US, but we will probably need to undertake some work there to explain the differences between the UK and the US in both the types of mortgage lending — higher quality, more regulated, primarily prime product in the UK — and the type of securitisation used by banks as a diversified funding source in the UK," said Plehn.

"We would hope that investors in the US will be re-attracted to Permanent both by the structure of the deal and the quality of collateral but also the relative value given how much spreads have tightened in the US compared to Europe."

Chris Dammers

24 Sep 2009