Panic continues to grip the European ABS market in the wake of the U.S. subprime debacle. While many still claim that this reaction is unreasonable, the liquidity crunch that has inflicted the market has taken the U.S. subprime contagion to another level and has now extended into the short-term cash markets.
By the start of last week, the disruption to the European commercial paper market was enough to prompt the European Central Bank to step in with several liquidity injections of more than 300 billion (around $403.5 billion).
While the ECB interventions have helped bring some order, these moves have done little to quell increasing speculation about where the current environment is headed and, instead, have added to the market's fear. "There is little point in speculating why the situation was exacerbated just after credit conditions appeared to have calmed down and equities had recovered," said Christoph Rieger, fixed-income strategist at Dresdner Kleinwort. "We believe a confluence of adverse rumors hitting an anxious market, where psychology is key, is probably to blame."
Overnight Rates
Rieger said that the ECB reacted promptly and swiftly with its offering of unlimited cash to the banking system that has helped stabilize unsecured overnight rates. "But its tools are limited when it comes to motivating banks to lend to each other for longer periods than overnight," he added. "The true signs of money market stress can therefore currently not be observed in overnight rates but rather in longer-dated deposit rates and volumes."
The current ECB strategy is to exert downward pressure on overnight rates, according to Dresdner Kleinwort, with hopes that this will spill into other deposit rates, thereby jump-starting the euro money market. "Yet, until credit institutions' trust of one another returns, banks are likely to remain reluctant to expand credit to one another for longer periods, and the risk in longer-dated deposits will remain high," Rieger said.
The shortage in liquidity means rolling CP funding for ABCPs and SIVs is at immediate risk. This shortage in funding in ABCP could trigger restricted operating modes, and in the case of SIVs, the sponsoring banks would have to provide liquidity with capital consumption implications to equity.
"From an asset perspective, we see ABCP portfolios as riskier, reflecting to a large extent the asset allocation shift since 2003/4 to higher-yielding, economically viable investments," Deutsche Bank Securities analysts said. "SIV portfolios are inherently more conservative, but these vehicles are mark-to-market sensitive, unlike ABCPs. Whatever the outcome, as a best case, we see these arbitrage investors as effectively on hold' in the near term."
The same risks are true for money market investors. Money market funds have been so badly hit by reduced liquidity that as cash is withdrawn, the funds are forced to dispose of assets at depressed levels, which further reduced mark-to-market prices. Among some of the funds to be affected so far in August were three of BNP Paribas ABS funds. BNP froze withdrawals from the three funds, which, according to market reports, together have around a third of their money in U.S. subprime RMBS. These withdrawals have affected BNP's market capitalization, which plummeted by far more than the total 1.6 billion of client funds invested, according to securitization market analysts at Societe Generale.
Union Investment Management also halted withdrawals on Aug. 3 from a fund holding about 6% in assets related to U.S. subprime after investors withdrew 100 million (or about 10%) of the fund over the past month. Frankfurt-Trust, a subsidiary of BHF-Bank, closed its FT ABS-Plus fund on Aug. 7 in response to outflows from the fund. The manager reported that investors had sought to withdraw 40 million from the 160 million fund in the past couple of weeks.
The fund management unit HSBC Trinkaus & Burkhardt closed its 190 million HSBC Trinkaus ABS fund on Aug. 6, citing liquidity difficulties. WestLB Mellon's Compass Fund also suspended redemptions effective Aug. 6, although the 235 million fund reportedly did not have any U.S. subprime exposure.
"We are somewhat concerned that other cash managers may face increased redemptions, as ABS nervousness grows, pushing discount margins wider in the near term," SocGen analysts said. But they added that given that the total volume of ABS disposed of in the last three weeks was well below 10 billion, once funds return to buy, ABS spreads should stabilize, if not tighten.
One market source who stuck around to weather the European summer drought agreed, adding that the market had not gone completely mental. "Instead, steady nerves need prevail, and the market can slowly be brought back," he said. "After all, it's not like a bunch of subprime borrowers in Europe have suddenly foreclosed, so it's just sentiment. But it's still not doing anything for ABCP, and it's not doing anything for mark-to-market rates."
Barclays Capital analysts added that any funding problems in the ABCP conduit would not translate into further liquidation of ABS assets at fire-sale prices, as the banks would likely keep the assets on their balance sheets. "This is of course positive news for European ABS investors (although potentially negative news for those liquidity facility providers), but is tempered by the fact that we have yet to quantify the risk SIVs and SIV-lites pose, as well as the risk of continued redemptions in real money accounts," Barclays analysts said.
Ted Packmohr, who sits on the covered-bond desk at Dresdner Kleinwort, said that market performance was leading investors to stay away for the moment, especially those interested in low or flat exposure deals. "The current market woes are imported, be it from U.S. subprime, and not an example of any long-term credit turbulence," Packmohr said. "We've seen some spread widening, and every credit product is underperforming. You won't find a single trading desk - be it securitization, covered bond, or treasury bonds - that isn't affected in some way at the moment."
The market is now in the middle of a liquidity crunch, according to Dresdner's trading desk analysts. "The CP market is closed," they said. "The covered bond market is closed. The unsecured bond market is closed. And the ABS market is closed."
Solace in CMBS?
One area that is expected to continue to perform well in Europe is CMBS. London-based Xavier Poussardin, vice president at the Bank of New York, said that his investors will be looking at more commercial-backed investments. "Investors are generally nervous at this point and will stick to traditional CMBS transactions. The overall sentiment is that there will be a busy pipeline after the summer break, although some banks might shelve plans for the entire summer, but we expect to see some fairly large transactions."
At the London-based law firm Cadwalader, Wickersham & Taft, lawyers are currently working on five potential CMBS deals for the fourth quarter. The Royal Bank of Scotland also noted a rise in CMBS, but said that in July, issuance was 1.5 billion, compared with 11.3 billion in July last year - representing a huge trading drop, considering that this past June saw 14.6 billion of trading in CMBS.
The recent Titan Europe 2007-1 deal, a combination of both health-care and whole-business securitizations, as well as commercial mortgages, was seen as an appropriate example of the pure-vanilla deals investors are likely to become involved in. The Titan deal was believed to have 3.3% of its issuance written on CMBS from the Czech Republic. While some sources say that such deals are currently seen as too risky, investors are likely to return to deals involving "more enticing areas" in the emerging Eastern European CMBS market, one market player said.
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