The number of European structured deals has increased as the end of the year approaches and banks seek to finance their positions for the turn of the new year. But transactions remain either privately placed or retained for central bank liquidity purposes.
These forced sales, lack of liquidity and the lack of investor demand have pushed European prime RMBS spreads to unprecedented wides.
Analysts report that triple-A European RMBS are offering secondary spreads between 450 to 600 basis points. The launch spreads on this paper pre-crisis fell in the range of 10 to 25 basis points.
However, if conditions improve over the New Year, some of the retained and privately placed deals may be restructured to appeal to investors in public deals.
Several distressed funds, and some real money investors, are increasingly looking at this sector to identify quality paper trading below fundamental value. These investors have an eye on the sector "with the aim of monetizing on the current dislocation and thereby capturing the large liquidity premium that markets are presently pricing in," Dresdner Kleinwort analysts said. "We expect this theme to emerge strongly in the first half of 2009."
Cash and synthetic spreads have continued to widen. According to market sources, this trend is expected to continue through to yearend.
"However, current wide ABS spreads offer huge upside potential," explained a Unicredit trader. "While the secondary market is strongly dislocated with only forced sellers in the market and sophisticated buyers that 'safeguard' themselves with wide quotes, some opportunities arise. There is safe paper in the market, with zero fundamental credit risk. Quotes of 350 to 400 basis points for triple-A RMBS do not only reflect the credit risk."
Behind the high quotes, analysts said, is the illiquidity in the cash market, which allows buyers to ask for a sort of "liquidity" premium. In the current market, buyers are sophisticated and know what to buy, while on the supply side there are often forced sellers. This information asymmetry leads to trades occurring closer to the bid quotes.
From an investor's point of view, the main risks refer to prepayment rates and to buying assets that might repay at a later date than expected.
"In a buy-and-hold strategy, it could generate a reduction in expected yields, but, even in an adverse scenario, spreads have limited downside risk, and should still be extremely wide in comparison to the credit risk," Unicredit analysts said. "Eventual government initiatives on outstanding notes should not be excluded in eventual investment considerations. Even if this is still an unlikely scenario, the next step after improving the financial stability of commercial banks will be to boost public primary market activity."
For now, current government initiatives make funding via guaranteed senior unsecured debt relatively cheap for commercial banks - with funding placed at around 90 to 130 basis points. Recent accounting changes should help to curb the forced selling that has driven pricing out - and this will have an effect on both primary and secondary markets.
"The fact that the ABS primary market might remain closed, together with declining funding pressure, might lead to the disappearance of forced sellers and therefore to spread tightening," Unicredit analysts said.
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