"If we look at the broader market, across all asset classes, spreads have been tight but there is still a lot of value to be found in European ABS against other asset classes," said a participant at the panel called Relative Value In European Structured Credit Markets: Yield PickUp or Total Return?
Smaller banks may begin to feel squeezed as further tightening is still expected on the triple-A level. In CMBS, expect to see more volatility on the U.S. side where underwriting standards have slipped. Panelists said they are more bullish on European CMBS. Generally, the RMBS market looks pretty sound. Recent issuance levels have triggered spread widening on Spanish paper, particularly on the secondary and, as a result, the market could experience some prepayment volatility.
But panelists reassured the audience that while there is definitely room for widening, it would not be at levels seen during the Asian crisis in the early 1990s that saw triple-A U.K. paper shoot out to the 20 to 25 basis point level. "The Spanish market has seen paper price at 13, even 14 basis points and the U.K. nonconforming has seen paper price at 15 basis points," a panelist said. "You might argue that the difference will increase." Patrick Janssen at Fortis Bank found some irrationality in subprime pricing.
Basel II impact
The impending Basel II proved less of a motivation for spread volatility despite most panelists agreeing that the new regulations have yet to be priced into the market. Levels at the higher end of the capital structure, in particular, do not reflect the new accord. Fergal McGrath at Dexia said that while there is still some uncertainty as to what the full effects of implementation will be, those who opt to take the advanced approach could maintain the attractiveness of their triple-A notes. In terms of RMBS, Basel creates less incentive to keep deals on balance sheet and, as a result, McGrath expects to see more synthetic type balance sheet deals issued over the next few years.
Fortis Bank's Janssen is not so positive on the German multifamily deals, and questions what the motivation behind these transactions is, especially since there has been a lot of turnover in that industry. "Yield on those trades are comparable to the U.K. market, which is overpriced already," he said.
House prices remain a concern for the market. Panelists warned that the combination of mortgage volume declining, aggressive product engineering and the market heavily relying on refinancing leaves room for any market fluctuation to immediately trigger problems in transactions.
Subprime tiering
There is a lack of uniformity in reporting. The latest sector to be hit has been the U.K. subprime sector (ASR, 06/04/06). But Alexander Batchvarov, managing director at Merrill Lynch and panel moderator, said that the calculation issue is coming from all sides - CMBS and nonconforming - yet spreads continue to tighten. The solution is to be picky, he said, adding that he expects to see some tiering in European deals.
"We are in a situation that's amazing - in 2006 there is no tiering in European deals," said one panelist. "I am seeing a dangerous situation develop especially low in the capital structure - everything is treated the same way. It's a concern."
Dexia's McGrath said that the market has already seen some tiering by geography. Italian and Greek paper price at the wider end of the spectrum, Spanish paper prices in the middle and U.K. and Irish paper price at the tight end.
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