As the European structured finance market matures it is becoming evident that asset-backed securitizations are quickly catching up to residential mortgage-backed securities (RMBS) in terms of volume - but the pace is not fast enough to beat what has become the dominating asset class in the securitization market.

Indeed, with record volumes posted in 2001, RMBS issuance is expected to remain on top when it comes to cashflow structured finance.

"RMBS is expected to continue to be the largest asset class in terms of cash transactions (excluding synthetics), whereas CDOs naturally dominate the volume of total transferred risk," said Yaron Ernst, vice president and senior credit officer at Moody's Investors Service. "However, it should be noted that ABS issuance is narrowing the gap, due to new types of receivables that are securitized and the increased popularity of ABS in countries that were mostly MBS markets before."

Impressive volumes last year made 2001 a record year for RMBS issuance, with nearly all countries posting record volumes, steering the market away from historical U.K. dominance. According to Moody's, the 74 transactions to come to market amounted to a total volume of EURO67.3 million - a 25% growth from figures listed in 2000. Among the most notable originators is Italy, which recorded 16 transactions in 2001, a dramatic increase from the five completed the year before.

Standardization of deals

One recurring trend in European RMBS is the standardization of the deals' structure and documentation, on both the securitization and on the origination side. "This is the case in countries like Italy, France, Netherlands and Spain, where we see more repeat deals and generally better understanding by issuers and investors of the deals' structures and the rating agencies' criteria," Ernst said.

Nonetheless, with the growing popularity of flexible mortgage pools in Spain, the mixture of non-performing loans and bonds seen for the first time in Italy and the introduction of government-sponsored programs, such as German Provide, the market is clearly not devoid innovation. More innovation is expected in 2002, Ernst added.

Macroeconomic outlook

"The low interest-rate environment is likely to remain unchanged in 2002 so long as European central banks are under pressure to kick-start the flat economy," said Ernst. However, this low-rate environment can be a "double-edged sword" when it comes to RMBS performance. According to Ernst, such an environment reduces the probability of a payment "shock" in the case of variable mortgage loans. In the worst-case scenario, however, it can minimize the deals' excess spread.

"[Excess spreads] are squeezed by both the weakening spread on the underlying loans, coupled with the widening spreads on the notes due to the overall economic situation," explained Ernst.

Moreover, in the face of a deteriorating economic outlook, there has been an increased focus on credit quality. While some lenders have tightened their lending criteria, the growing competition in some markets means that other lenders must consider relaxing criteria in order to avoid losing current and prospective customers.

Ernst said: "There is a growing competition in some markets, such as the U.K., Germany, Italy and Spain, where the current tendency is to offer more attractive products to a larger borrower base, which is often translated to loans with weaker credit profiles.

"As for performance, the continued increase in unemployment rates is likely to affect higher rates of delinquency and default of mortgage pools," added Ernst. "In addition, the slowdown in the real estate sector may apply a downward pressure on housing prices, and thus increase loan severity loss in the event of default and foreclosure."

Still, the performance of rated RMBS in 2002 is expected to remain generally in line with the good performance of the last few years, primarily due to the enhancement levels that are built into these structures and the stress scenarios that are applied to investment-grade securities. According to Moody's, in 2001 no issue was downgraded; in fact, the rating agency upgraded seven classes of RMBS that year.

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