For three weeks now, better sentiment has prevailed in European ABS secondary market trading, where spread widening has stopped and triple-A spreads have tightened at a rapid pace.
However, despite these positives, the European securitization market's problems are not close to being fixed. Most players believe that there's still a long way to go to recovery.
"[The] European structured finance market is still in a rather desolate state, and the environment remains quite ugly," said Unicredit analysts. "Various problems are related to ABS - e.g., counterparties, fundamental deteriorations, prepayment changes, regulatory environment changes, call uncertainties - just to name a few. "
There is no one less convinced than the European investor base. Buysiders are remaining on the sidelines for now.
Furthermore, the story on the primary front remains the same. In terms of the numbers, volumes are as healthy as ever, but most of the paper is retained for repo funding purposes.
When this securitize-to-repo trend will change remains very much an uncertainty, and will of course depend on demand.
According to the Bank of England (BoE), treasury bills with a face value of £185 billion ($268 billion) have been lent under the U.K.'s special liquidity scheme between April 2008 and January 2009.
The total nominal value of securities held by the BoE as collateral in the special liquidity scheme (SLS) is approximately £287 billion.
As of Jan. 30, the BoE valued those securities at approximately £242 billion, which is an effective discount to par of about 16%. Most of the collateral received has been RMBS notes or residential mortgage covered bonds.
Although the SLS has proved to be a good instrument to provide some much needed liquidity for financial institutions, it will do little toward reestablishing the moribund U.K. wholesale refinancing market. As a result, the scheme will also have a negligible impact on the revival of a real primary market.
The next step the U.K. government has announced is a move toward the "bad bank" concept that would help existing commercial banks rid themselves of toxic assets.
The government's aim remains to restore shareholder confidence and stabilize the struggling financial sector. Finance Minister Alistair Darling said that the formation of a bad bank to hold ABS and other assets was among the options under consideration to get the British banking system working again.
Could the bad bank be just the thing to revive the market?
According to market reports, after the news of the adaptation of the bad bank concept was announced, credit derivatives on prime U.K. RMBS tightened by around 30 basis points.
Meanwhile, credit default swaps (CDS) on bellwether triple-A RMBS tranches issued by HBOS under its Permanent Master Trust program were trading at around 370 basis points bid and 400 basis points offered.
This rally is the first positive sign. Adding to the good news as well is the fact that recent levels have been much more realistic.
As Unicredit analysts pointed out, the more financials or ABS counterparties strengthen, the more sustainable a stabilization in ABS spreads will become.
Over the longer term, this will also help remove the stigma on securitization and precipitate the return of healthy market fundamentals.
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