The asset-backed market posted its best year of relative value in 2003, according to returns tracked by researchers at Lehman Brothers. However, it was trounced by the unsecured credit market, which also enjoyed its best year to date. Driven by massive tightening in numerous sectors, the Lehman ABS Index yielded 179 basis points of excess return versus Treasurys, Lehman reports, compared with the 310 basis points of returns seen in unsecured debt last year.

Beset by record-setting mortgage refinance activity, the MBS market was outshone by ABS by a 168 basis point margin.

The manufactured-housing sector made the strongest showing within ABS, realizing 326 basis points in option-adjusted spread (OAS) return on a 368 basis point tightening spree. Home equity ABS returned 103 basis points of OAS on 62 basis points of tightening.

Auto loan and credit card ABS returned 47 and 53 basis points of OAS, respectively, with spread tightening of 38 and 83 basis points. Stranded cost ABS, or rate reduction bonds, also had a strong year with 49 basis points of OAS returns and a significant 125 basis points in spread tightening.

"Outperformance in the first half of the year was driven by triple-A spread tightening, as investors sought safe harbor in short, liquid ABS bonds," Lehman researchers penned. "The second half of the year was marked by a shift to subordinates and off-the run paper as the corporate/high-yield rally created compelling relative value opportunities in ABS."

The credit composition of the Lehman ABS Index changed dramatically in 2003 due to downgrades and the expansion of eligibility criteria. The triple- and double-A components of the overall ABS index declined from more than 96% to 93%. In manufactured housing, for example, the single-A and triple-B rated components of the index increased from 1.7% to 22.5%.

The percentage of subordinate bonds in the index increased in all sectors (except stranded cost ABS, which has no subordinate classes), yet manufactured housing represented the largest percentage of subordinate ABS by far. With 22.5% index-eligible ABS backed by MH, it nearly tripled the next closest asset class (credit cards with 8.4%) in subordinate representation. The primary difference is that while MH single-A and triple-B bonds have been downgraded to the current ratings, credit card subordinates have, on average, been larger due to de-linked issuance vehicles.

In related news, Lehman Brothers announced last week that it launched its first index exclusively tracking European ABS. The new index will consist of 492 floating-rate bonds totaling E195 billion (US$245.2 billion equivalent) and 85 fixed-rate notes totaling E55 billion (US$69.1 billion equivalent). The index tracks both euro and sterling-denominated bonds. Performance data will be made available monthly, beginning Feb. 1.

"The index will initially be made available through a dedicated part of the Lehman Live Internet platform providing access to detailed aggregate and constituent information for this complex asset class," said Neil Wardley of the European Index/Portfolio Strategies Group. "Indicative data for the index will come from the best possible data sources with the pricing supplied by Lehman Brothers," he added.

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