Several firms last week commented that investor appetite for subprime ABS has strengthened in light of improving economic indicators that have benefited the equity market over the last few weeks.
For the past year, bank researchers have been periodically warning investors that subprime assets, including non-prime credit cards, autos and home-equity loans, would be the first to deteriorate as the economy worsened.
Noting that spreads in home-equity ABS have tightened recently, despite an onslaught of supply, the Mortgage Strategist team at UBS Warburg writes, "Signs of economic recovery have clearly banished lingering fears that the subprime market might be seriously impacted by the recession."
"With this incredible flow of bonds over the last couple weeks, the floater side has sort of stabilized, but the fixed-rate side has seen some tightening," said Tom Zimmerman, in the ABS research group at Warburg. "People are feeling pretty good about the economy right now, so they're feeling pretty good about spread product in general. And you're seeing that in a number of markets, including CMBS, mortgages, home-equities, and others. I think relative value-wise, the floaters look pretty good right now."
Merrill Lynch last week issued an update on home-equities and manufactured housing, stating that it appears delinquencies won't spike as high as it seemed they would just a few months back.
Still, delinquencies in home-equity pools continued to rise in February, as consumer credit deterioration typically lags corporate credit (i.e., the lag between the event of unemployment and missed loan payments).
Merrill believes that delinquencies will continue to worsen, though, "This is well within the level of stress that most triple-B HEL ABS are designed to withstand and few HEL ABS (assuming continuous servicing) would come under downgrade pressure in this scenario," Merrill said.
BAS puts out CFO piece
Meanwhile, on the CDO front, the structured credit products group at Banc of America Securities last week put out a lengthy piece on collateralized fund obligations (CFOs), called Hedge Fund CDOs: Leveraging Sharpe Ratios.
The firm believes that hedge-fund deals could become the next major CDO asset class, mainly because the risk-adjusted return on these deals seems promisingly attractive. BAS says that the spread pickup from other CDO types is likely between 15 basis points and 35 basis points on the triple-As.
Utilizing market-value CDO technology, "The hedge fund CDO offers publicly rated coupons in addition to rated principal for the first time, thereby opening up the product to a much larger investor base. Further, the structure allows for multiple publicly rated tranching out of risk above the first-loss equity piece, which is levered 200400%. Fund collateral returns above 5% to 7% - depending on the structure - provide for significant leveraged upside in the hedge fund CDO equity, with the only significant expense being that of less liquidity as compared to an outright investment in hedge funds."