European securitization closed a record first quarter with RMBS volumes still playing a lead role. If there's to be any U.S. subprime contagion, investor and issuer appetite have yet to show it.
Even with some of the weaker continental markets showing some signs of fatigue, analysts say there is nowhere near the level of anxiety currently driving U.S. fundamentals.
According to Deutsche Bank, primary European RMBS volumes reached 82.6 billion ($110.3 billion) for the first quarter. Deal flow in the U.K. non-conforming sector has also been heavy, with a total of six deals coming to market during the past month. Outside of the U.K., the largest jurisdiction in the European RMBS market was Spain, boosted by two large securitizations from BBVA and Bankinter.
At first glance, hefty issuance volumes in the U.K. subprime sector look more comparable to U.S. lending activity. It's true that, over the years, the market has grown to adopt similar U.S. style techniques. Critics have warned that, in light of rising interest rates and fickle consumer fundamentals, U.K. subprime lending criteria should adopt a more stringent platform or risk ending up where U.S. lenders find themselves today. In an attempt to capture a dwindling first-time buyers market, these lenders are often turning a lax eye to self-certified mortgages and income multiples. Needless to say it's likely that some U.K. borrowers are mortgaged to the hilt.
How this plays in the face of rising interest rates has yet to be seen. The several rate increases that have taken effect since last year have already placed some pressure on U.K. borrowers, although European analysts still believe that borrowers in the U.K. are better placed than their U.S. counterparts. Even in the face of yet another surprise rate hike ahead of the Easter break, the consensus is that U.K. subprime fundamentals are protecting the market from the same sort of debacle happening stateside.
Deutsche Bank analysts report that rising house prices, weak household debt and rising rates during the end of last year led to an increase in the U.K. household debt repayment to income ratio. It's the highest it has been since 1992, and Deutsche analysts say that further rate increases are going to continue to impact this trend. "Even assuming debt growth slows markedly, the current stock of household debt means that higher U.K. rates in the coming months are likely to fuel a sharp increase in household [debt to net ratios]," Deutsche analysts say. "The last time deterioration of such a scale was seen was in 2004/5, which coincided with both a noticeable softening in U.K. house price growth as well as a period of weaker RMBS credit performance, particularly in the U.K. nonconforming sector."
Sarah Barton, lead analyst at Morgan Stanley, believes that although the rise in interest rates in the U.K. will continue to impact affordability for U.K. borrowers, the affordability shock will be much more subdued relative to the U.S. "Interest rates in the U.S. have risen from 1% in June 2004 to 5.25% in June 2006," Barton says. "In contrast, rates moved up in the U.K. from 3.5% in November 2003 to 5.25% in January 2007. The floating-rate mortgages in the ABS portfolios pay a margin over pound three-month Libor in the U.K. and dollar six-month Libor in the U.S. From the low in July 2003, Libor rates have increased by 52% in the U.K. versus 317% in the U.S." And the continued liquidity in the lending markets, both residential and commercial, paired with the protection level of existing securitizations, shouldn't pose any credit risks for the market. Thus any credit or rating volatility should be limited to weaker collateral structures and less defensive lending or manager styles.
Even for Spain, where market reports over the past month continuously drew comparison between its conditions and the U.S. housing cycle of a year ago, things aren't looking completely dire. Although Spain has no subprime market, a lending culture has developed that draws similar techniques established in other subprime markets. Lenders, for example, have gradually increased LTVs and are increasingly lending to self-employed and second-home borrowers.
Deutsche economists project a gradual adjustment in Spanish housing market dynamics, and any slowdown in the Spanish market should not be felt as sharply as it has been felt in the U.S. markets. In fact, Fitch Ratings and Standard & Poor's last week published reports concluding that current Spanish mortgage performance levels have not jeopardized Spanish RMBS ratings. But S&P warned that delinquencies and default dynamics could be affected as the European Central Bank increases the refinancing rate because the Spanish mortgage market is mainly characterized by floating-rate mortgages.
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