One of the most significant stories in the ABS market right now is the market itself, which, thanks in large to the ABS CBO bid, has shown remarkable resiliency to wild spread movement. As analysts have noted, this is in contrast to conditions during the liquidity crisis of 1998, when dealers found it nearly impossible to place ABS sub bonds.
Some market sources are quick to point out, however, that the CDOs ramping up post Sept. 11 had most likely placed their equity prior to the terrorist attacks.
"Going forward, placing future equity could be more difficult, and that could perhaps dampen the activity," said Anthony Thompson, CDO analyst at Deutsche Banc Alex. Brown.
The idea is that, if CDO equity investors tighten up, it may be difficult to get these deals going, which could dry up the bid for ABS/CMBS subordinates. The resulting dislocation, though, would improve the ABS CDO equity return profile and add cushion to the deals, making the equity more attractive to investors.
"My personal thought is that we'll probably see even more ABS CDOs, as things move on," said an investment banker working in the sector. "Spreads are wider, equity returns will be higher. We're budgeting for an increase."
Regardless, this cyclical relationship is a dynamic that was not in place for the ABS market last time there was a threat of serious spread dislocation.
"I think the point is that we have a broadly different ABS investor base now than in 1998," said UBS Warburg researcher Tom Zimmerman, remembering the liquidity crisis. "Back then it was hedge funds, and the CBO has sort of replaced the hedge funds."
As Zimmerman points out, because hedge funds were the primary investors in lower-rated fixed-income securities in 1998, when they pulled out, the fixed-income market suffered the most. The equity markets, on the other hand, remained relatively unscathed. In ABS, triple-As widened out substantially, in addition to subordinate tranches.
"It was a liquidity crisis then, but not really a credit crisis, like it might be now," Zimmerman said.
Interestingly, the ABS CDO, which is now providing much of the liquidity that was missing in 1998, was actually spawned by the widening back then, said Deutsche's Thompson. Spreads of ABS sub-bonds never quite returned to their pre-1998 levels.
"People waited and waited and waited for things to slingshot back to where they had been prior to 1998, but they never really did," Thomson said.