While the Lehman Brothers ABS Index posted strong returns for the first half of 2004, outperforming Treasurys by 53 basis points, the last four months have been less promising, according to researchers at the bank.
The residential sectors have been leading the strong performance, with home equities tallying 122 basis points and manufactured housing posting an impressive 246 points in excess returns.
The first two months of 2004 were characterized by tightening spreads across rating classes and subsectors; at 58 basis points, January and February saw the second-best two-month excess returns in the history of the ABS index. The tight levels, witnessed in benchmark triple-As, were driven by investors seeking safe harbor in short, liquid ABS. Meanwhile, triple-B home equity subordinates rode a strong technical bid from yield-hungry CDO investors. CDO spreads narrowed by as much as 50 to 60 basis points during those two months.
The troubled manufactured housing sector also shone during the early months of 2004, with spreads tightening 60 to 100 basis points due to reduced headline risk, increasing corporate sponsorship and a strong crossover bid from high yield investors.
However, the ABS index performance for the past four months has been slightly negative, at minus 5 basis points. Analysts attribute the underperformance to spread widening across sectors due to rising interest rate concerns. "We advocate a mild underweight to the ABS Index versus Treasurys for [the second half]," analysts said in the report. "The limited carry in the auto and credit card sectors offers minimal protection against any swap/credit spread widening."
The firm expects credit spreads to soften versus swaps, which are also expected to widen five to 10 basis points due to their rate directionality. The fixed-rate home equity sector is subject to extension concerns, analysts said.
"The manufactured housing sector offers the most attractive carry and total return opportunities, but comprises only 6% of the overall index due to recent delistings from rating downgrades," the report noted.
Despite the ominous tidings, the ABS index outpaced other spread sectors with ease during the first half of the year; MBS came at 36 basis points versus Treasurys, Agencies at 10 basis points versus Treasurys and Credit at minus 4 basis points versus Treasurys.
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