With the return of the CDO bid, one of the biggest winners of late has been home-equity ABS triple-B minus rated subordinates. Routinely pricing with an 800 basis point margin versus Libor, this year, top-tier triple-B minus bonds have cracked the 500 basis point threshold and are now approaching 400 basis point area over Libor.
A pair of recent transactions that priced this month - Countrywide Home Loan Inc.'s 2003-BC6 and First Franklin's 2003-FF5 - have seen discount margins of 525 and 550 basis points, respectively. Just more than one month ago, triple-B minus bonds routinely priced in the 750 to 800 basis point area over Libor.
The additional demand has had an impact up the capital structure as well, with tightening up to single-A bonds, although not as dramatically as the triple-B minus bonds. "It's been a food fight for triple-B minus, triple-B, triple-B plus and single-A minus subordinates amongst the CDO guys," one syndicate source said. Triple-As meanwhile, remain relatively unchanged.
"Triple-A spread performance in both the fixed- and floating-rate sector is flat with the exception of the 10-year fixed-rate tenor that widened a modest three basis points," Banc One Capital Markets notes in research. "At the mezzanine level, floating-rate mezzanine double- and single-A tranches tightened five and 20 basis points, respectively. At the subordinate level, tightening has been seen for both fixed- and floating-rate coupons.
The tightening in triple-B minus bonds, and subordinate home equity ABS in general, is expected to continue, at least through the first quarter of 2004, sources said. There are currently seven structured finance-backed CDOs in the pipeline, with ramp-up periods ranging from two to four months.
"Throughout the summer, there was basically one or two buyers of these bonds," one trader said. "Right now with the CDOs currently in ramp-up mode, the demand [for triple-B minus bonds] is insatiable," he added.
The evolution of these bonds has developed rapidly this year, with the increased CDO bid combining with the maturation of the net-interest margin sector. The NIM market complements the triple-B minus sector, as it allows an issuer to divert overcollateralization into its NIMs.
"These are nice bonds," said Henry Engelken, senior credit officer at Moody's Investors Service. "Triple-B minus bonds were prevalent going back a couple of years but have come back because they are still investment-grade and have lower enhancement requirements, which helps when you want to sell a NIM."
But pricing information on these bonds is difficult to come by. Often the triple-B minus class is placed privately to one account. Additionally, the bonds often price at a discount, typically in the low-to-mid 80s (dollar price), allowing the issuer to keep its coupon payments under 400 basis points over Libor.
"Buyers of these bonds prefer discounts," noted a syndicate manager. "It's done to keep excess spread in the deal while maintaining available funds caps."