PHOENIX - Amid another volume record in 2004, and seemingly endless demand driving spreads to heretofore unseen levels, more than 3,000 delegates and 143 corporate sponsors gathered yesterday for the opening panel discussion of Information Management Network ABS West 2005 conference held here last week, to discuss the next 12 months in securitization markets. While all agreed that the current market conditions were unprecedented and that fundamentals remain positive, many panelists expressed doubt that this environment was sustainable in the long term.
While nobody could definitively say what external event would lead to a market disruption, the theories were abound - from slowing home prices, to the falling dollar and a hedge fund failure.
Western Asset Management Portfolio Manager Ron Mass summed it succinctly in saying that the market has "gotten used to positive credit performance, but as values increase there is a possibility of a reversion to the mean," comparing the current spread environment to equity valuations of the late 1990s. "We can't get spoiled by past credit performance," Mass added.
Fellow buysider Sanjeev Handa, managing director at TIAA-CREF concurred. Noting that he does not foresee a big movement in credit quality, he cautioned, "investors should be careful because we are at a market top."
"No one thought spreads would be as tight as they are now," added Alliance Capital Management Senior Vice President Bill Sidford. "We're poised for a correction. The market is waiting for a reason to go the other way. The spreads aren't justifiable," continued Sidford.
Merrill Lynch's head of non-mortgage origination Ted Breck forecast spread stability in 2005, "with a widening bias in the second half," based more on a spreads-can't-get-much-tighter view.
The reason for such tight ABS spreads is the increased demand from numerous sources, combined with a generally tight credit market, in which ABS offers a "pick-up available versus corporates," added TIAA-CREF's Handa. The spate in hedge fund buying as well as foreign accounts - particularly Asian central banks - has been the source of almost endless demand for high-grade and lower-rated ABS product alike.
Offering insight to the prevailing market dynamics, United Capital Markets President John Devaney noted that the current market is the result of "conditions that are unique to the past two or three years."
"There are too many upsets that occur every 18 months, something is due to happen to remove the leverage from the system," Devaney said.
Noting the yield-curve driven carry trade, which has allowed investment banks, hedge funds and other collateral acquirers to buy collateral specifically to securitize them, Devaney theorized that just 30% of ABS investors are traditional long-term buyers, such as insurance companies. "The CDO bid has exploded due to the yield curve," Devaney said. "Yield-curve driven demand could wane" going forward, he added.
Of course, the much-discussed topic of new mortgage products was also breached, as pundits compared the home equity ABS market to that of the late 1990s. Comparing IO mortgages to the high LTV loans offered by now defunct lenders, panelists went just short of predicting impending doom.
Western Asset Management's Mass theorized that credit enhancement levels for new-issue mortgage ABS "should be multiples of where they have been in the past," based on slowing housing price appreciation and the untested performance of the collateral in recent transactions.
MBIA's head of structured finance Mark Zucker simply cautioned investors, "whoever it may be...stay short."
And UCM's Devaney, seemingly hoping for a market repricing for which to profit, warned that investors have "short memories." Reminding the audience that he trades subordinate ABS for a living, he offered a scenario in which collateral deteriorates, spreads widen but there is no prepayment wave to trigger clean-up calls, which, in turn, bail out ABS holders. With a lack of housing appreciation and lower prepayments ABS investors "may face a prepayment environment that extends a five-year [bond] out to a 10-year [bond]."
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