While the European primary ABS market for vanilla issues has been quite healthy, analysts say that esoteric asset classes have suffered in the secondary markets - with nearly frozen secondary trading on these deals.

"Primary issuance [of esoteric assets] is still going quite well and still being picked up, while secondary trading [of theses assets] is extremely poor," said one investor. "The bid-offer reflects the general market notion that these are difficult deals, but what is interesting is... buyers seem to be all right on the primary side, yet for some reason there seems to be a problem on the secondary side."

For instance, the investor said that a typical esoteric transaction issued on the primary side is tarnished only three months later in the secondary market. "It can be very costly if you want to maneuver your portfolio in any way because you simply want to get your cash back and reinvest in something else," he said.

CBOs, in general, have been the hardest hit on the secondary level. With downgrades still an ever-present threat, investors tend to shy away from the product but this reservedness does not translate on the new-issues front, said one market source. New issuance at the moment continues to be priced at relatively similar levels of last year and does not reflect the deteriorating secondary market liquidity, which perhaps best defines how the primary and secondary markets have become disjointed.

A rude awakening

Esoteric assets - non-conforming loans, new asset classes, complex deals, new jurisdictions - attract a smaller investor base, which naturally translates into less trading liquidity. A limited audience is reflected in the trades and it is this particular psychology that can create unrealistic marked-to-markets when it comes to formal bids, said one source.

"Lately the marked-to-markets in no way reflect bid levels," explained the source. "You will get a marked-to-market, which when you compare to an actual bid is far away from reality, primarily because the traders are reluctant to show their true bid level in a marked-to-market because they don't want to upset their customers.

"They will only give a true bid level when forced to do so. It's almost as if you live in a dream world and then it becomes reality only when people want to trade. It can be a very rude awakening."

When it comes to vanilla deals, however, the bids are generally right on the mark. One source noted that if an investor steers away from those assets into the more complicated arena of esoteric, chances are that marked-to-markets are being presented at unrealistic levels.

For such assets the secondary marked-to-markets typically have not reflected the value of the transaction, which makes reshaping portfolio holdings virtually impossible because there is no appetite for the product. The disparate pricing between primary and secondary levels forces buyers to hold issues because a trade at such wide secondary levels could present a loss so great it would be virtually impossible to replenish.

Who's buying

Despite this volatility, there are still market participants that just can't sit on the fence. Often the motivation stems from a necessity to trade, in particular from investors who have limited room for below-investment-grade investments, or from investment funds, in particular bank investors that can't accommodate sub-investment-grade in their portfolio criteria. They have no choice but to get a bid in some cases.

"A lot of investors have developed their portfolios totally reactive to what was happening in the market as it came," said one analyst. "Now they want to put some shape to their portfolio, partly because they want to make sure they could securitize it themselves and if necessary do a CDO of the asset-backed holding. It's partly also motivated by a need to have a more balanced portfolio."

The typical buyers that will take on such stories from industry-negative areas are vulture funds, because their return on capital is significantly above the return on capital of investment banks and other investors.

Improving liquidity

Nonetheless, it is clear that the maturing European ABS market has made a significant improvement in secondary market liquidity. This especially rings true for RMBS issues, which typically come in greater size and are often offered by repeat issuers, usually through a master trust structure or similar product.

Perhaps the same is required of esoteric assets before they become more popular in secondary trading. "There is a limited audience for esoterics so naturally you will have less liquidity, but the trading firms have to help that by providing regular input, ensuring that cash flows are available, taking away all the handicaps of these deals," said one investor. "It's a tainted area and [nobody] wants to be a part of it at any price. And the reason for it is that it requires education, it requires work. Someone has to work at that, to say Not everything is bad and these are the reasons why it's not bad,' but investment banks are only providing this at the primary [market] stage."

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