Even as spreads on home-equity ABS reach dizzyingly tight levels, analysts are still touting them as the best place to find relative value in the ABS market. As always, the question remains just how tight spreads can come in. The answer, for now, is quite a bit.
Last week's $1 billion offering from Centex Corp.'s Centex Home Equity Loan Trust, with fixed and floating portions, shocked the market with spreads on some of its floating-rate tranches. The largest tranche of the deal, a $339 million one-year sequential floater, priced at a slim seven basis points over one-month Libor, shattering previous spread lows for 1-year tranches. The deal's three-year floating tranche priced at 17 basis points over Libor, also considered to be a new tight.
"The numbers certainly get your attention," said Peter DiMartino, head ABS strategist for RBS Greenwich Capital. "HELs are in uncharted territory," he added. The kicker is that spreads still have room to come in. "In my view, there appear to be no major impediments that would stop spreads from grinding tighter from here," noted DiMartino.
DiMartino added that the home equity sector is merely behaving like other ABS sectors that have ratcheted tighter as market participants stood by in disbelief. Demand for home equity paper is so strong now precisely because all of the other sectors have tightened so much.
"The question is what else is there?'" asked Chip Schorin, head of ABS research at Morgan Stanley. One-year floating-rate auto paper is hovering at around one basis point through one-month Libor, while one-year student loan paper is even tighter at two basis points through one-month Libor. One-year triple-A home equity paper still offers eight to 10 basis points over that. "I don't love home equities at seven [basis points above Libor] for one year, and I don't love them for three years at 17 a lot either," he said. However, noted Schorin, they still present relative value at those levels. "The likelihood of losses or credit problems is extremely remote with these bonds," he said. "The greater risk is that spreads could widen, but that risk exists for any product, in particular, the more subordinate classes."
At this point, no level of spread tightening seems unrealistic. "[Home equity spreads] are probably not going to come in on top of auto spreads, but because HELs are short amortizers, why couldn't they?" asked DiMartino. "A lot of investors are probably asking themselves that already," he said. As always, weakening supply could drive spreads in even tighter, and, after last week's lackluster home equity issuance volume, sources are already scratching their heads.
On the week, $6.3 billion worth of home equity deals priced. Bank of America's Asset Backed Funding Certificates Trust issued a $1.74 billion deal, and Barclays Capital's Securities Asset Backed Receivables Trust priced a $1.28 billion transaction as the two biggest last week. Delta Funding's Rennaisance Home Equity Loan Trust, GMAC-RFC and IndyMac Mortgage also issued deals under the $1 billion level. None of the one-year floating rate tranches of those deals priced on top of Centex.
"This week's been slow, and it's not obvious what is causing that right now," said Schorin, who last year predicted a 20% drop-off in home equity issuance for 2005. He said it may be that lenders, who have kept issuance high during a rising rate environment, are looking for new ways to keep issuance strong. Last year it was interest-only loans that fed the home equity market, but issuers are going to have to come up with new products to keep volumes high.
For now, triple-A home equity ABS remains an oasis of value in a desert of tight spreads.
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