With the year 2008 in its home stretch, consumer ABS has managed to hold up relatively well, despite increasingly deteriorating economic conditions.
However, market pundits are cautiously optimistic, citing further weakening in the housing sector, the rising unemployment rate, and higher food and energy costs, as well as tougher lending conditions in the credit markets.
Spreads have reacted to such news, continuing to gap out to new wides over the past few months. Last week, triple-A credit cards went from 180 basis points to 215 basis points on the five-year duration, and triple-A auto and FFELP student loan ABS widened by 10 basis points to 15 basis points, JPMorgan Securities analysts said in a report. Auto spreads stand at all-time wide levels, the bank said, with three-year triple-A fixed-rate spreads at swaps plus 275 basis points last week.
And as SIVs continue to liquidate, spreads will face additional pressure. Last week, Sigma Finance Corp., a $27 billion SIV run by London-based asset manager Gordian Knot was rumored to be liquidating after Moody's Investors Service cut its senior debt rating level to 'Ca' from 'A3' and Standard & Poor's dropped its 'A' investment vehicle rating to 'CCC-'. In addition, four bank-sponsored SIVs were put on review for a downgrade by Moody's last Wednesday. These include Carrera Capital Finance, Harrier Finance Funding, Kestrel Funding and Links Finance Corp.
While consumer ABS deals have gotten through the market, it has been a struggle. Many deals that have been done have been pre-placed and not sufficient in size relative to financing and refinancing needs, said James Grady, managing director and fixed-income portfolio manager specializing in structured finance securities at Deutsche Insurance Asset Management.
Furthermore, with half the banks gone - including Merrill Lynch, Lehman Brothers, Washington Mutual and, the latest, Wachovia - and with Goldman Sachs and Morgan Stanley now existing as bank holding companies, the new issuance landscape has changed dramatically.
In the 1Q08 to 3Q08 ASR Scorecard database public only league tables, the top three ABS managers were, not surprisingly, JPMorgan, Banc of America Securities and Citigroup Global Markets, respectively. These three, in addition to being among the few currently surviving banks, held the top three positions over the same period in 2007.
As expected, however, issuance dropped off dramatically. JPMorgan topped the tables with 19.8% market share and 44 new issues totaling approximately $27.5 billion. For the same period last year, JPMorgan had only 11% market share but 77 new deals totaling $60 billion. Bank of America and Citigroup also took larger portions of the market, now accounting for 18.7% and 16.6% respectively. This is a rise from 8.9% and 8.4% for the same period last year, but volume was almost halved. Bank of America took in 40 new deals for the first three quarters totaling $26 billion, a drop from its 66 new issues totaling approximately $50 billion in the first three quarters of 2007. Citigroup totaled approximately $23 billion in 35 deals, a drop from approximately $47 billion in 61 deals during the first three quarters of 2007.
Barclays Capital and Deutsche Bank Securities came in fourth and fifth, with 23 deals totaling $10 billion and 18 deals totaling $8.7 billion, respectively. This marked a jump from 2007, when the banks placed thirteenth and tenth, respectively, but there was also a drop off in issuance. Over the first three quarters of 2007, Barclays ramped $23 billion in 31 deals and Deutsche brought in $29 billion in 54 deals.
A consolidation of banks means a bigger piece of market share for the top players, industry participants expect, but it also means a decline in the number of potential issuers. Offsetting this is the possibility that the larger banks that have purchased these former issuers may need to securitize more than in the past for regulatory capital relief, said Amy Martin, a senior director in the structured finance ratings group at S&P, referring to the auto ABS market.
The credit card operations of the large money-centered banks appear to be unaffected by the various mergers and bank failures.Those events, in and of themselves, don't appear to be affecting credit card performance," said Kevin Duignan, managing director and head of U.S. ABS for Fitch Ratings.
Through its recent acquisition of Washington Mutual, JPMorgan Chase will become the successor seller/servicer for the Washington Mutual Master Note Trust (WMMNT), which provides $8.5 billion of term ABS financing for the $26 billion Washington Mutual managed credit card portfolio, Merrill Lynch noted in a recent report. This financing will remain in place, as early amortization due to receivership of Washington Mutual Bank was prevented by the Federal Deposit Insurance Corp., which agreed to waive the early amortization event and sell the majority of the assets to JPMorgan.
Changes to the program by JPMorgan will be minimal, if any, but could include originations or retention efforts in the subprime credit card sector; closure of accounts with significant risk of default (effectively making them installment loans); reduced credit lines, higher pricing and/or some closures in the marginal account segment; and retention efforts for accounts meeting JPMorgan's credit criteria, Merrill said.
Charge Offs Follow Job Losses
One of the major drivers behind expected losses in the consumer ABS sector is the rising unemployment rate, which was expected to jump further on Friday's unemployment numbers. This will have a particularly significant impact on underlying credit card receivables, Duignan said, a sector that investors have maintained some level of comfort in.With the unemployment rate up 30% over the past six months and expected to rise further, we expect credit card charge offs to follow," he said.
The seasonally adjusted unemployment rate rose to 5.5% in June 2008, a two-year high, according to Fitch. Year-over-year, the amount of people seeking part time employment for economic reasons rose by close to 21%, the rating agency said.
Duignan said Fitch currently expects charge offs to be north of 7% by year-end, and to deteriorate further by the first half of 2009.
Adding fuel to the fire, there is doubt over issuers' ability to re-price risk in the future, especially if charge offs continue to rise. Credit card issuers typically re-price risk periodically by raising interest rates and fees to offset an increase in charge offs. But there is some concern that because of legislation currently under discussion, a credit card issuer's ability to re-price risk may be limited, Duignan said.
Structural Protections Drive Auto Optimism
On the auto ABS side, losses are also expected to continue to rise in the near term, particularly for the 2007 vintage of securitizations, and for 2008 transactions that include largely 2007 originated-loans. However, 2008-originated loans appear to be stronger in credit quality as reflected by higher FICOs, reduced LTVs and some constraint on term, Martin said.
Given the issues with the Big Three - General Motors, Ford Motor Corp. and Daimler Chrysler - there is not a ton of demand in the auto sector. But the performance of auto ABS deals, with notable exceptions, has remained within expectations, Deutsche's Grady said. In addition, people take comfort in the fact that these deals are self liquidating and relatively short in duration, he said.
While a few downgrades are expected over the next several months, the number and magnitude will be modest, Martin said, since in addition to credit enhancement, most transactions also have structural features that help to protect note holders, particularly regarding the senior-most notes. Some transactions are full sequential pay from the outset, while others that pay pro-rata among the rated classes switch to full sequential upon a performance breach. Other transactions build cash in the reserve account or build overcollateralization upon a performance breach, she said.
Public auto loan ABS volume is expected to drop to about $60 billion this year, and auto lease ABS issuance, a sector experiencing far more turbulence than the retail loan sector, will fall below $5 billion, according to S&P.
Auto loan ABS issuance for the remainder of the year will hinge in part on the passage of the Troubled Asset Relief Program (TARP), Martin said, which had not passed as of press time. "If it passes, we think issuance should be more robust. There are currently a number of issuers who are waiting for market sentiment to improve before they launch their transactions."
Indeed, the implementation of a TARP plan - and the finalization of its specifics - is going to be a huge factor in determining what asset classes stand to benefit. "Figuring out which spread sectors benefit the most is going to be dependent on the implementation of the program," Grady said. Important questions include which assets the
government is going to buy, and at what prices.
Student Loan Trusts Stalled By ARS
Student loans could also use a boost, as the freeze on the auction-rate securities (ARS) market, having no end in sight, may begin to force negative rating actions on U.S. student loan trusts that use ARS, according to Fitch.
"While most trusts have shown resilience, no trusts were structured to withstand permanent market dislocation, making ratings actions on affected transactions less a case of 'if' and more a case of 'when.'" Fitch said. Transactions with low and/or quickly declining asset-to-liability ratios will likely be subject to negative rating actions, particularly at the subordinate note level. This is in addition to the stagnant market conditions that exist for new issuance in the sector.
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