The brief August lull might offer only a temporary respite from the widening trend that has hit Spanish RMBS. Despite sound fundamentals in the Spanish economy, supply pressure, coupled with investor weariness over the subprime debacle unfolding stateside, means spreads might potentially widen further in the short-to-medium term.
Spanish economic growth has been nothing short of stellar. Over the last 10 years, GDP growth has come in at 3.8%, compared with 2% for its neighboring European countries. But the current pattern of economic growth is unsustainable, Fitch Ratings analysts said, and the market is set to undergo a slowdown. Home price data released by the Ministerio de la Vivienda at the end of July showed further slowing in growth across the country. The year-on-year increase in prices across the whole country now stands at 5.8%, which compares with 10.8% a year ago and a peak of 18.5% in 2003. House price declines were recorded for the first time in Madrid, which saw a 0.4% drop over the last quarter - the first dip in six years. "Madrid tends to lead other regions, suggesting that the slowdown will gradually spread to other regional housing markets," Deutsche Bank analysts said.
Although the current pattern of economic growth is unsustainable, Fitch analysts have ruled out an outright property market crash. Nonetheless, investor worries of a looming house price crash have driven Spanish RMBS spreads wider despite the strong fundamentals supporting the market.
"Spreads have widened due to a preponderance of supply compounding investor concerns over house prices in Spain," explained Royal Bank of Scotland analysts. "We believe that the credit drama needs to be played out before rationality will return to yields."
Predicting where the market is headed is tricky, as the market has never been tested in a downturn. In terms of performance, delinquency ratios are very stable, but Juan Garcia, a structured finance analyst at Fitch, said it's hard to predict how the servicing capabilities of these structured deals will accommodate a stress period. "According to our in-house surveillance database, any upward trend in the delinquency curve for RMBS is linked to product characteristics and attached to regional or industry concentration of the portfolio," he said in a teleconference held by the agency last Tuesday.
To be sure, the Spanish market has moved to trade almost in line with U.K. nonconforming over the past couple of weeks. According to Morgan Stanley data, Spanish triple-As have moved six basis points wider and triple-B paper has moved more than 100 basis points wider. A slowdown in supply should help spreads stabilize, but dealer overhang could cause a longer period of price instability before spreads begin to tighten again. Morgan Stanley analysts warned last week that spreads could potentially move wider and the market could see the gap with U.K. nonconforming close, particularly at the triple-A level.
According to the Spanish Mortgage Association, 11.4% of all Spanish mortgage stock is being securitized. In 2006, Spanish RMBS volume totaled 91 billion ($124.43 billion), placing the country second behind the U.K. As of June 2007, RMBS represented roughly 50% of issuance volume, and Spanish RMBS now represents more than 10% of the total supply of European ABS new issues. The heavy supply is expected to continue to drive spreads wider.
"The expected stronger second-half Spanish supply has begun to pressure spreads wider, exacerbated by some fundamental concerns over the markets," RBS analysts said. "Spanish tax issues for certain investor jurisdictions have limited the available demand appetite." The analysts added that these tax issues have sidelined such investors as SIVs and bank conduits based in the Cayman Islands, for example. Should these markets open, Fitch said that some of the supply/demand imbalance could be resolved, although there is still a lot of market volatility.
Over the last two years, the Spanish RMBS market has also seen a significant trend in securitizing high loan-to-value portfolios. According to Fitch, as of June 2007, these high LTV portfolios represented 42% of RMBS volumes. Lenders used Spanish covered bonds for funding efficiency that required high-quality collateral. Barred from inclusion in covered bond transactions, mortgages that have LTVs above 80% were left for inclusion in securitized pools. Planned changes to covered bond legislation will accentuate the distribution of Spanish covered bonds and securitization - with low LTV mortgage credit funded via covered bonds and these higher, increasingly common LTV products funded in the securitization market.
"The new legislation mimics the German one, and issuers will be able to securitize mortgages with LTVs in excess of the 80% limit [up to 95%, if insured or guaranteed], rather than restricting [Spanish covered bonds]-eligible collateral to 80% LTV or less," RBS analysts said. "These changes likely will prompt higher LTV securitizations than seen historically."
Fitch's Garcia said that over the past year, the rating agency has observed interest from international players exploring subprime capabilities in Spain. Although the market's current economic fluctuations may have put developments on hold, appetite for subprime paper is likely to grow in Spain. Garcia predicted that specialist players could still come to market by year's end.
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