The cacophony surrounding the subprime market's recent volatility is beginning to quiet down.
Thirty-day delinquencies among subprime mortgages originated in 2006 leveled off recently. Although most analysts say that development is a temporary respite from ongoing poor performance in the 2006 vintage, others assert that the market is on the verge of improving, and perhaps significantly. That makes way for investors' voices to be heard loud and clear, a welcome market development.
Particularly, buy-side market participants and observers are being increasingly choosy about the types of paper in which they invest and they are demanding more returns when they do commit. Recently, for instance, pricing guidance for Baa2'/BBB'-rated paper in the Home Equity Mortgage Trust 2007-2 deal was at 850 basis points over the one-month Libor. The market ended up pricing the paper at 1,000 basis points over the benchmark.
About a week before the HEMT pricing, one of the bellwethers among top-tier subprime issuers, Wells Fargo completed a $450 million transaction, wherein the Baa3'/BBB-' piece priced at 725 basis points over the one-month Libor. Around the same time, C-BASS priced a transaction in the same rating class at about 440 basis points over the same benchmark.
Although C-BASS is esteemed as a scratch and dent issuer, it doesn't have the same heft in the market as Wells Fargo or even JPMorgan Securities, which was marketing a transaction at press time. Yet, its pricing was a dramatic improvement over a similar transaction that priced just several days before, Michael Youngblood, managing director and head of ABS research at Friedman Billings Ramsey, said.
"Market conditions are improving," Youngblood said. "The cash market is at least trying to discriminate between different tiers in the market and determine appropriate spreads."
Some market participants say this sort of tiering - especially on the triple-B-rated level of the capital structure - was long overdue. For months, more cautious market participants were telling buyers of triple-B-rated paper that they had to evaluate the financial strength of the issuer, and not simply be rest assured that the notes were being issued from a bankruptcy remote entity. Nowadays, it is much more important to be familiar with the track record of the servicer, trustee and other key agents on any transaction.
"Although the collateral remains paramount, the questions of agency are of much greater importance than they were since 1999 and the last bout of such fun," Youngblood said.
Now, let us be clear: Although issuance is down from the first quarter, and the presence of hedge fund liquidity is expected to usher in greater transparency and more competent servicing. In other words, subprime MBS investors are not in a mad grab for product.
There is no clear consensus on tiering from market participants, but overall, Youngblood says, investors and others on the buyside are seriously evaluating every dimension of risk.
"The willingness to pass is still high," Youngblood says.
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