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| Ganesh Rajendra |
Rajendra is a managing director and head of European securitization research at Deutsche Bankin London, having joined the firm in mid-2001 from Merrill Lynch. He and his team provide market commentaries, credit performance analyses and relative value strategies as part of Deutsche Bank's structured finance research effort. Rajendra holds a degree in Actuarial Mathematics and is a Chartered Financial Analyst.
Where do you expect to see the greatest growth next year and why?
We believe most of the market growth will again stem from non-consumer collateral securitizations such as commercial mortgage backed securitizations, collateralized debt obligations, corporate and public sector securitizations. This trend is already evident in 2005. Growth in consumer asset securitizations including residential mortgage-backed securitizations has slowed in 2005 relative to recent years, which we believe is explained by a combination of weaker underlying origination volumes as well as the changes in accounting and bank capital rules, which is likely to have made a number of issuers re-think their securitization strategies.
Credit card and auto asset-backed securitizations are cases in point, sectors in which issuance has slumped in 2005. These fundamentals look unlikely to change materially as early as 2006, even in economies that are in an advanced stage of the cycle such as the Netherlands or the U.K. Rate cuts in the U.K. may well be a catalyst for a resumption in consumer borrowing in 2006, but we think that this is unlikely to fuel significantly higher securitization volumes as early as 2006.
In terms of growth, we are more bullish on non-consumer asset securitizations, whether that takes the form of CMBS, CDOs or other corporate structured financings. In CMBS, we expect conduit issuance to moderate somewhat, indeed the fact that a number of lenders are pairing up to facilitate CMBS issuance is indicative of the challenges in sourcing assets in the conduit market. But we expect CMBS issuance from corporates and public sector entities to remain strong, whether portfolio or credit-tenant lease structures.
What new asset classes and structures do you see developing?
The European securitization market is in a mature stage of its development, and thus we think that new asset types per se are unlikely to come hard and fast. Potential exceptions may be stranded asset-type securitizations, mainly from public sector entities following on the heels of the GPPS deal, and also possibly non-UK infrastructure financings.
We believe newer securitizations jurisdictions are much more likely, including deals from the debut European Union economies in Central Europe. Generally, we also believe that fundamental changes in securitization structures this late in the market's life cycle are unlikely, again with certain exceptions.
As changes related to Basel II and International Financial Reporting Standards come into full force, it is likely that capital structures will be tweaked, with for example the greater placing of first loss equity. And of course the CDO market should continue to deliver innovations in structure and collateral, namely in response to changing asset-liability economics, development of ABS synthetic or correlation technology and investor demands.
Where can investors find value in the current environment?
Increasing market commoditization has meant that ABS/MBS spreads have been mostly uni-directional in recent years. In the current market, on a rich-cheap basis, we see triple-As as being undervalued generally versus comparables like covered bonds and supras, and within the senior market we think cash CDOs offer the best value, as do bonds that have been cheapened by 'noise' or technical factors like over-supply.
Generally, we think subordinated ABS look rich relative to the senior market following the considerable flattening in the credit curve over the past year, and also in some cases the non-triple-A market is trading special to corporates, which we believe is not justified by technicals nor leverage. We are therefore generally bearish on subordinated paper, especially among certain consumer ABS where the risks of collateral and seller/servicer stress going forward may not be adequately priced in.
A more attractive trade, in our view, is taking non-triple-A leveraged exposure to senior ABS portfolios via cash or, more likely, correlation trades, either bespoke or managed, where the carry is much more attractive especially of course for investors insensitive to mark-to-market risks. Also, broadly speaking, we think liquidity appears to be overvalued in the current market, meaning that off-the-run bonds look cheap relative to benchmarks, the latter including wrapped esoteric assets. Given the markedly lower survival rates among off-the-runs historically, the skill is in the asset selection. Finally, we like the opportunities offered by ABS derivatives, but are cognizant all the same that wide dealer bid-offers may make relative value (including basis arbitrage) trades challenging.
How do you see the market developing for credit default swaps on ABS?
If the past development of the corporate CDS market is any indication, the ABS CDS market will enjoy exponential-like growth going forward. The evolution of ABS from cash-only, long-only market is overdue, we think, considering the market's prominence in today's fixed income universe and considering also how advanced derivatives have become in parallel markets like high grade credits.
ABS CDS is an important development for many reasons, not least as it provides respite to the relatively low non-triple-A supply and also overcomes current difficulties in taking directional bets in the ABS market. But we expect challenges, or growing pains, along the way in Europe, for three broad reasons.
First, there is the challenge of creating a sufficiently deep market, especially seeing as Europe does not have an actively traded, or indeed volatile, cash sector like home equities in the U.S. Second, there's the infrastructure challenge, whether that takes the form of building credit lines with non-traditional buy-side outfits (CDO managers, structured investment vehicles, and so on) or developing pricing models that take into account the unique ABS cash flow profiles. Relative to the U.S., Europe may be disadvantaged in this respect given the general lack of data and cash flow clarity. And third of course is the need to find appropriate CDS terminology and definitions that conform to the structural and collateral nuances in Europe.
At this stage it looks like Europe may trend more toward corporate-CDS-like language as opposed to the pay-as-you-go framework used in the U.S. While the International Swaps and Derivatives Association framework provides a standard template for the market to work with, we believe ABS CDS language will be influenced ultimately by the lessons to be learnt through greater use in different credit cycles, just as happened in the corporate market. All things considered, however, the birth and development of ABS CDS is unquestionably positive, in our view.
How is Deutsche Bank's new DBIQ ABS index different from existing ABS indices and the multi-bank initiative currently in progress? It different from the initiative being set up by traders at eight investment banks?
The DBIQ European triple-A Floating Rate Securitised Bond index captures the return performance of the largest component of the market, that is, the triple-A sector. Index rules are designed so that bond selection is isolated to the most liquid and tradable issues, allowing therefore for replication in the cash market.
We think the development of this index fits in with the evolution of ABS into the fixed income credit mainstream. We believe the index will serve as a powerful portfolio benchmarking tool for cash-equivalent managers, including money-market funds and corporate treasuries. We also expect the index to provide a basis for the development of index-based trading and structured products or derivatives.
Above all, the key impact of any index is that it brings greater transparency. We are mindful of the fact that multi-contributor indices are better received by the market, and hence we remain open to the idea of migrating our index or a version thereof into an index family like iBoxx in the foreseeable future.
The initiative you mention that is being spearheaded by Deutsche Bank among others is what I believe to be a CMBS new issue spread tracker, which I understand amounts to creating a synthetic reference price on a basket of identified primary CMBS. Such a development will not cannibalize existing ABS indices, and can only serve to provide even greater pricing clarity, thus complementing secondary-based indices.
How does Deutsche Bank choose deals to focus on in its new deal-specific research initiative?
There is no one set of rules; instead we are generally guided by benchmark-like or other securitizations where trading flows justify secondary research coverage. This style of research is similar to equity or credit research where name-by-name coverage is common. Our reason for creating such a line of deal reports is that we feel, again, that such coverage is consistent with the stage of market development. The thrust of our research is relative value driven, and in a market like structured finance where bond profiles can be very disparate, we think it makes sense to provide name-by-name coverage as a complement to sector analysis. We will of course continue to publish sector and market-based research.