Investment banks in the U.K. have started to backtrack on earlier statements that U.K. ABS would remain bullish well into August. The forecast looks cloudy, with pricing spreads inching wider on the back of continued negativity resulting from the U.S. subprime market.
U.K. RMBS structures are now being put to the test. Dresdner Kleinwort traders said most market participants are looking for any way possible to get short risk.
"Given the illiquidity inherent in the cash market, going long protection is the only way to do it for most dealers," Dresdner traders said. "The problem with this strategy is that no one is willing to offer protection at anything approaching sensible' levels, whatever sensible' means." But with the growing Bid Wanted in Competition (BWIC) lists appearing, most dealers are ending up longer and longer risk, instead of going short as desired. According to the Dresdner traders, three lists were being traded by Monday of last week, and around 40 million ($54.9 million) of mezzanine paper was expected to trade by midweek.
"Another excellent illustration of the state of the market and, in particular, the differences between primary and secondary, is the performance yesterday of the Spanish RMBS deals BBVA RMBS 3," Dresdner traders said, adding that although the 6.03-year triple-A's printed at 20 basis point spread, there were no trades in cash, while CDS were quickly bid at 21 basis points, then 23 basis points and finally at 25 basis points.
European structured finance is the weakest and widest it has been so far this year, and observers fear that the sector is now showing signs of starting a more prolonged bear market. Spreads have jumped wider, with mark-to-market prices, causing pain especially for mezzanine holders, Societe Generale analysts said.
With reports emerging from the U.S. saying that difficult housing and mortgage market conditions are expected to persist, it's likely that Europe will continue to feel the jitters ripple right through, creating more tiering between asset classes.
But it's not just the U.S. problems at fault here, say sources. In the U.K., the persistent rain has led to catastrophic floods in many areas of the country. Fitch Ratings announced that it is keeping a close eye on the potential impact the recent flooding will have on U.K. RMBS. Fitch's insurance division estimates damages will tally in at more than GBP3 billion.
Although the rating agency said the damages are unlikely to lead to any rating actions on U.K. RMBS, it could have a short-term effect on arrears and recoveries in the regions affected. Flood-impacted borrowers across the Southern plains of the country and in the North counties may suffer short-term liquidity strains while they make insurance claims and effect repairs. These strains could place added pressure to the increasingly volatile U.K. mortgage market as borrower ability to remain current with mortgage payments becomes less certain with the affordability problems resulting from five interest rate rises over the past two years.
U.K. banks were also expected to report a general rise in mortgage arrears at the end of last week. According to market reports, U.K. banks wrote reported arrears at GBP56 million in the first quarter of this year, and that number is expected to have more than doubled to GBP140 million between April and June. Data on mortgage lending in the U.K. released last week by the British Bankers Association (BBA) showed that net mortgage lending for the month of June 07 rose GBP5.1 billion, down from GBP5.8 billion in May and GBP5.7 billion in June last year. Credit card lending continues to be weak, falling GBP73 million for the month compared with a fall of GBP386 million in May and an average monthly fall of GBP184 million over the past six months.
But Christian Parker, capital markets partner at London based law firm Cadwalader, Wickersham & Taft, blames news headlines for creating a reality that didn't exist.
"There is a lot of negative press, especially about CLOs, but that market is still issuing three, four, five new deals a week even in current markets. There would appear to be investor appetite for leveraged loans, and no doubt the same is true of U.K. RMBS," he said.
To be sure, even with the seasonal lull at hand, nearly 30 billion remains in the European ABS pipeline, apart from another 10 billion of arbitrage CDOs and CLOs - there is no shortage of supply. "Calling spread direction in the coming quiet summer months is difficult, but the fundamentals remain strong and ratings solid, offering significant value across many transactions in our view," SocGen analysts said.
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