Excerpted from Chase Securities ABS Monitor, 2001 Year Ahead Outlook, Published Dec. 28, 2000
By Christopher Flanagan, Ralph DiSerio, Ryan Asato and Linda Yu
The ABS market had a relatively good year in 2000. Public issuance hit a new record of $224 billion and, in spite of heavy supply, spreads to swaps were reasonably well behaved. Due to the Treasury debt reduction, the market benchmark shifted away from Treasurys to the swap market. The total and excess return numbers for the fixed income market (see chart) show the challenges faced by spread product in competing against Treasurys as the debt reduction dynamic unfolded in force. Though positive for most of the ABS sectors, the cumulative excess return was dampened by mortgage-related ABS, particularly the manufactured housing sector. However, looking at cumulative excess returns of ABS vs. corporates and MBS provides a clear picture of the market's best feature its ability to provide relatively stable, if not always extraordinary, returns.
Against the new benchmark, credit cards and autos were particularly good performers, as investors correctly perceived the benefits of structure and liquidity afforded by these sectors. Remarkably, while the credit picture for corporates deteriorated during 2000, the credit quality of the underlying assets for cards and autos is about as good as it has ever been. The good performance is testament to the efficacy of risk-based pricing models introduced to these sectors in the mid-1990's, as well as the historically low unemployment rate. The performance facilitated relatively cheap access to the capital markets through the ABS market, where the firm spreads were in stark contrast to what was seen in the corporate market. Ford Motor Credit's issuance of $17 billion of ABS paper, by far and way the largest single issuer amount, was directly related to the relatively attractive funding available in the ABS market.
The news was not so good on the mortgage-related side of the ABS market, which was roiled by Conseco Finance's announcement of further residual writedowns and subsequent financial difficulties. The manufactured housing part of the market was hit particularly hard by the news and, as discussed, dragged down excess returns for the ABS market as a whole. In spite of its woes, Conseco ended up the year as the ABS market's third largest issuer and the top issuer of mortgage-related ABS. Spreads appeared to be relatively generous on the Conseco issues. Nonetheless, we encourage investors to remain focused on whether the deal WACs are high enough to allow Conseco to pay the bond coupons, cover losses, and, most importantly, retain a highly profitable net excess spread cash flow stream. If the last condition is not met, it may well prove that the new issue spreads were not generous enough.
A couple of key structural developments were seen in the credit card and auto sectors. Citibank introduced a new structure that affords it greater flexibility in the issuance of senior and subordinate classes. After an extended absence from the market, Citibank wasted little time in actively using the new structure to issue $6.5 billion of credit card ABS. In the auto sector, we saw an extension of the soft bullet structure that was enabled by issuance of VPTN's (Variable Pay Term Notes) by Ford and GMAC's asset-backed CP programs. In the new structure, the short term liquidity provided by the CP market is replaced by a Term Warehouse ABS facility.
As we head into 2001, we are encouraged by the solid performance put in by the cards and autos in 2000 and troubled by the weakness in manufactured housing ABS. The relatively low spread volatility seen in cards, autos and even subordinate home equities validated the benefits of structure in a weakening credit environment, at least from a psychological perspective. It was also consistent with the stable returns provided by the ABS market over the years. Other positives for the market entering the new year include the seasonal bias towards tighter first quarter spreads, the growing chorus of analysts recommending spread product of all sorts, and improving chances that the Fed decides to become more accommodative. With this in mind, our bold outlook statement is to look for spreads to Treasurys to tighten along with other sectors in the first quarter of 2001. We are neutral on the spread to swap basis.
As a result of this outlook, we maintain a generally favorable view of the market and recommend a modest overweight of cards, autos, and short HEL and MH sectors. Our neutral weightings come in sectors where issuer and/or collateral credit quality may be more severely pressured in an economic downturn and where that pressure is most likely to have a material impact on spreads, including longer dated and subordinated MH and HEL. As our above comments suggest, we are particularly concerned about the manufactured housing sector, which has already racked up the lion's share of ratings downgrades in the ABS market.
Looking beyond the first quarter, we are more inclined to take a skeptical view of the ABS market's ability to perform, particularly if spreads do tighten in the first quarter as anticipated. We do not assume that the ABS market and the consumer are immune from the devastation in the NASDAQ and the corporate and high yield bond markets. Rather, we believe there is meaningful risk that there is a lagged response and that it is only a matter of time before trouble makes its way to the consumer and, subsequently, to segments of the ABS market. Sub-prime borrowers in all asset classes are the most vulnerable to this scenario and we would be particularly cautious about subordinate and long duration bonds backed by loans to these consumers. As a general rule, we think it prudent to heed the lesson of NASDAQ, to be very mindful of the downside in the year ahead and to ask whether spreads sufficiently compensate for downside risk. However, this week's aggressive action by the Fed has diminished this risk significantly.
We expect that public ABS supply will be about $220 billion in 2001.