Issuance of home equity line of credit-backed ABS is on a torrid pace halfway through the year - having topped the $10 billion mark last week - and spreads are starting to show the effects of the supply. After having pushed the 20 basis point threshold over Libor, spreads have moved out on recently priced transactions to the mid-20 basis point area over Libor.
An attractive option for borrowers who have already executed cash-out refinancings over the past three years, HELOC origination has spiked in the last year, leading to the current spate of HELOC ABS issuance. According to the Federal Reserve, depositories hold $1.2 trillion of HELOCs on their balance sheets.
"HELOCs have been hot products this year as every bank, broker, and bagel store seem to be offering them," says RBS Greenwich Capital head of ABS research Peter DiMartino. "It is a relatively low cost financing option that can give homeowners a lot of flexibility. If done at the initial closing of a home purchase, it requires no additional legwork for the borrower."
Through the first six months of 2004, 15 HELOCs have priced, totaling more than $10 billion. Throughout 2003, 11 HELOC ABS transactions priced, totaling just over $7 billion. In 2002, just seven HELOC ABS deals priced, totaling $6.7 billion.
Spreads, which started the year in the low 20 basis points over one-month Libor, are now moving out, as supply hits more frequently. The most recent transaction, from Countrywide Home Loans Inc. was slated to price its 3.3-year triple-As at 25 basis points over one-month Libor, out from talk in the 23 basis point area. The tightest prints this year - employing the relatively new targeted maturity structure - have priced in the low double-digits over Libor, although the majority of deals price in the low-to-mid 20 basis point range over Libor.
These levels are in from the mid thirties over Libor seen throughout 2003 and the low-to-mid forties over Libor seen in 2002.
But even at the tightest spreads seen, traders are calling HELOCs a bargain versus traditional home equity and subprime mortgage transactions. HELOCs typically trade roughly 10 basis points inside their standard home equity or subprime MBS counterparts.
"When accounting for the available funds cap in subprime versus the uncapped HELOC, HELOCs are like gold," one syndicate head noted. "Given the Prime Rate-to-Libor differential, which is 200 to 300 basis points [268 basis points as of last Thursday] you get a big spread cushion in HELOCs in a rising rate environment. If you were to go out and purchase those caps in the market it would cost at least the 10 basis point differential [between standard home equity ABS and HELOC] that you give up," he added.
Going forward, many expect HELOC supply to continue at a fast clip, as originations grow and banks remove the rapidly increasing HELOC exposure from their books. "Banks love HELOCs on their books for the carry," said Banc One Capital Markets home equity researcher Glenn Schultz. "But as loans on balance sheet, they need 100% risk weighting and as the proportion of HELOCs increases they will have to sell."
Shultz believes the increased volume will continue. "This will be the trend throughout 2004, into 2005 and beyond," Schultz added. "Future innovations in HELOC structures, like the targeted maturity structure implemented by some issuers, will only make the cost of funding more advantageous for depositories."
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