While investors scour the couch cushions for yield, the stronger rally seen in the corporate unsecured market does create opportunities. In its third installment of tracking ABS versus unsecured debt spreads, Citigroup Global Markets assesses the relative value ABS offers versus corporate debt, particularly for issuers heavily reliant on securitization.

When Citigroup first noticed this arbitrage opportunity (see ASR 2/4/02), spreads for subordinated credit card ABS and unsecured debt had just started to diverge. Since then the divergence has increased significantly and then reversed course. Using Citi's "Mind the Gap" strategy, an investor buys subordinated credit card ABS and hedges simultaneously buying credit default swap protection against the corporate credit.

Currently, comparably rated credit card subordinate bonds are trading cheap versus unsecured debt from the same issuer, Citigroup researchers find. For example, Capital One Financial Baa3/BB+' rated sub ABS trades 20-25 basis points outside of unsecured debt levels, while MBNA America Bank's ABS is 15 to 20 outside of where its debt trades. Cap One's increased differential is credited to its lower-rated unsecured debt.

This dynamic is a reversal of conditions typically seen in the past four years. Generally unsecured debt spreads continually traded cheap to triple-B ABS. The current flip began early in the fourth quarter of last year and has only magnified since.

This gap reached its peak in mid-August 2002, when spread differentials reached 1,085 basis points for Capital One and 165 basis points for MBNA (see related graphics).

Citigroup researchers theorize that secured sub ABS holders are higher in the capital structure than unsecured holders for issuers that rely heavily on securitization for funding. Despite significantly higher unsecured debt ratings, larger financial entities, by contrast, typically have sold a smaller percentage of their managed receivables into securitization trusts.

Researchers offer an analysis of the post-bankruptcy NextCard situation, where the senior ABS holders received full payment and subordinate ABS holders are on track to receive the lion's share of expected payments.

Citigroup researchers note that a recent portfolio sale by NextCard unit NextBank netted 66 cents on the dollar: "Secured investors should fare at least as well as the portfolio sale proceeds, and perhaps better," analysts pen.

For monolines and specialty finance companies, with a significantly greater percentage of total managed assets sold into securitization vehicles, secured ABS holders are in a distinct advantage in a bankruptcy situation.

By this measure, the issuers most attractive for this play are the ones with the greatest percentage of managed assets sold into securitization trusts. Leaders among programmatic issuers are Advanta Corp. (98.5%) The Metris Companies (90.2%) and MBNA (89%).

Taking this one step further, Citigroup examines the percentage of an issuer's assets sold into ABS trusts versus its total assets. As one would expect, the more specialized the lender, the greater this percentage, and the greater the protection offered by ABS versus unsecured debt.

The leaders in this category include Metris (564.4%), with a significantly greater ratio of securitized assets than the next greatest issuer, Advanta (145.3%). MBNA, meanwhile, has securitized 124% of its total assets.


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