As the tail of the newly developed ABS CDS market wags the dog of the home-equity ABS market, analysts are hoping a more mature CDS market could bring the end of recently volatile home-equity ABS spreads. According to sell-side researchers, widening of home equity ABS CDS spreads is largely thought to be the primary cause for the recent widening seen, particularly for triple-B rated tranches.
The growth in two-way liquidity within the CDS of ABS market has allowed market players a method of efficiently shorting the ABS market, effectively creating a flip-flop of demand, according to Deutsche Bank Securities. "The supply of synthetic exposure in conjunction with the new-issue cash supply has overwhelmed the once dominant CDO bid with the market violently reversing the tightening trend," Deutsche Bank analysts reported last week.
Last week's spread for the triple-B plus class was wider than 88% of spreads in the past 52 weeks, while spreads on the triple-B class was wider than 96% of spreads over the past year, and triple-B minus spreads were wider than 92% of spreads, added Friedman Billings Ramsey researchers.
Heavy new-issue deal flow could also be a cause of spread widening, according to FBR, as issuers aim to execute deals before year-end. Last Monday alone, as issuers looked to price deals before an early ending holiday week, New Century Financial Corp. announced a $2 billion home equity transaction, Countrywide Home Loans Inc. priced part of a $1.6 billion home equity transaction and Merrill Lynch priced portions of its SURF home equity offering. When all is said and done, November home-equity ABS issuance is expected to total $70 billion and December is expected to at least match that amount. August and September alone saw $98.3 billion and $113.4 billion, respectively. "Therefore," wrote FBR, "market participants are reluctant to buy securities whose value may soon be discounted."
Triple-B minus floating rate home-equity spreads are trading at the most erratic levels, while other spreads in the asset class have remained relatively stable. Triple-B minus spreads widened by 75 basis points last week, to more than 275 basis points over one-month Libor. Meanwhile, the triple-B class widened by 45 basis points to 185 basis points over one-month Libor, while the triple-B plus class widened by 35 basis points to 155 basis points over one-month Libor.
As some market participants look to hedge the risk of an expected downturn in subprime credit quality they are paying more money to buy protection - causing the synthetic market to look like a better opportunity than the cash market, according to FBR. "The attractive levels in the synthetic ABS market have ultimately weakened demand in the cash market. As the synthetic ABS market matures and develops standard documentation and settlement procedures, we expect that the market will also stabilize," FBR analysts added.
Meanwhile, investor appetite for triple-A tranches is strong, according to FBR, and fixed-rate triple-A tranches were trading relatively cheap.
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