LOS ANGELES - For the first time in a long while, volatility has returned to the home equity ABS market. And with that volatility, some would argue, comes a more challenging terrain for ABS CDO managers.
For example, new issue spreads have softened across the board as ABS CDO investors have pushed back amid U.S. housing concerns, according to a report by Citigroup Global Markets analysts. They added that, as of Nov. 29, new-issue triple-B ABS CDO paper had recently traded at Libor plus 325 basis points. Adding fuel to the fire, hedge funds have been rushing to scoop up synthetic protection on subordinate home equity bonds, subsequently helping to widen cash spreads.
In a recent ASR interview with officials at Trust Company of the West, those responsible for the deals said they are confident there will not be a downturn in the U.S. housing market, adding that investor demand for their products remains high. The company - the largest U.S. manager of ABS CDOs last year in terms of sheer dollar volume according to Standard and Poor's - is anticipating that market issuance will continue to succeed through innovation, as evidenced by a number of hybrid cash and synthetic ABS CDO transactions that have closed in the U.S. market this year. And TCW is aiming to price its first long-short CDO transaction by mid-December, said Louis Lucido, a managing director at TCW.
TCW's structured finance CDO group is aiming to reach $23 billion in assets under management by January, said Sajjad Naqvi, a senior vice president in the group, which currently has some $16.5 billion under management. The Los Angeles-based money manager is confident that their CDO deals - backed largely by RMBS - will perform well. And for that matter, interest is strong, particularly from Asia and the Middle East, Lucido said. "We continue to think we are on the sweet spot in international demand whether it be a recycling of petro dollars or dollar surplus in China."
Concerns from investors regarding what many have perceived as a bubble in the U.S. housing market are allayed by TCW through a number of research projects completed in-house, he added. Most often cited by Lucido is a land utilization study completed by TCW, which seeks to prove that continued immigration into the U.S., combined with a limited supply of land available for further home construction, particularly within coastal regions and metropolitan areas, will inevitably result in housing demand and subsequently, support housing values.
But cooling home price appreciation is expected by traders at Lehman Brothers, for example, which, according to the Office of Federal Housing and Enterprise Oversight is occurring in formerly hot areas, although prices rose nationally by 2.86% in the third quarter from the second one, bringing the annualized rate to 11.44%.
An environment of real GDP growth of over 3.25% will prove positive in the absorption of new entrants to the nation's employment mix, correlating to a growth in household formation, Lucido said. He added: "To the extent that you would get into an environment of below potential growth - that would be an environment where we would be nervous, but we don't see ourselves getting into that for the next 12 to 18 months."
TCW said they've noticed on site visits to mortgage servicers that they were beefing up staff sizes in anticipation for the pickup in interest rate resets about to be endured by a slew of subprime borrowers, a situation described by Lehman as "daunting." "As interest rates trend higher and housing appreciation slows, we may see delinquencies and defaults rise sooner than expected in some of the more seasoned deals," Lehman wrote.
According to Friedman Billings Ramsey, one-month prepayments of fixed-rate subprime RMBS originated from 2000 through 2005 fell in October, "reflecting higher mortgage rates and weaker seasonal factors," while default rates of subprime loans rose in nearly every vintage year. The 2005 class, under watch by many investors, posted the largest relative increase, by 20 percentage points, to 1.20%, according to FBR.
While TCW recognizes the tough subprime lending market, challenged by tight spreads and less volume to go around, the company is anticipating consolidation of small and midsized lenders to help weed out those issuers that are overextending themselves to put borrowers in the riskiest loans.
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