While double-B rated tranches have become a more regular feature of the mortgage ABS landscape in recent months, it is the brave few who look to venture that far down the capital structure. However, some investors may even be ready to take the plunge into single-B territory - provided the price is right - and issuers are looking to oblige.
"There will more double-B activity, and maybe even a few opportunistic single-B pluses," said Chris Schiavone, vice president at JPMorgan Securities. The rating agencies are more conservative than the market, he added, creating more opportunities to distribute lower-rated classes.
"Additionally, there is a glaring liquidity gap below investment grade that the market needs to, and ultimately will, address if its cheap enough and presents the enhancement value that it does today," Schiavone said.
Market sources are aware of at least one single-B plus home equity class being structured to date; however, the details were unavailable. Similar to the recent profusion of double-B classes, these bonds would likely be private, Rule 144A transactions driven by reverse inquiry. While these classes may be hard to find, sources were not surprised to hear of a market for this kind of risk developing. Tom Warrack, a managing director at Standard and Poor's, called it the "natural evolution of investor acceptance," and noted the rating agency's role in making single-Bs more palatable.
"Now that we are less willing to forecast large amounts of excess spread in these deals, the forward vectors are rising and squeezing a lot of the excess spread out of the deals, so there is a need to find credit enhancement below investment grade in other forms," Warrack said. "This is driving the double-Bs, and it would not be surprising to see a single-B market form."
"Wall Street has been selling single-B credit risk for years," one investor quipped. "But it had been rated triple-B."
Armand Pastine, a managing director at Maxim Group LLC, viewed the birth of single-B home equity as a sign of a mature market and a more open investor base, yet he was skeptical of how widely accepted these bonds would be. "The lion's share of the subprime and home equity buyer base is made up of ABS CDOs, which typically can't buy single-B bonds, unless there is another structure out there affording them the ability to buy those assets," Pastine said.
Hedge funds might appear to be the logical customer for these notes, but the spread has to be there for an opportunity fund to play. Typically, the hedge fund community is seeing returns of roughly 10% to 12% unlevered, and close to 20% levered on a credit-adjusted basis on home equity paper in the secondary market, Pastine said.
"The risk-reward ratio in the home equity market bodes well for the double-A, single-A and triple-B levels; investing in triple-Bs, there is a quantifiable known profile of risk," Pastine said. "I am not sure how well compensated you would be for taking a single-B risk in a pool of subprime home equity."
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