The tone in the asset-backed market has turned bearish for the first time this year, with many overweight recommendations removed in the past week, and many banks shifting allocations away from sectors with potential for blowups. While any weakness is relatively minor versus what has happened in the corporate debt and equity markets in recent weeks, ABS is no longer untouchable as it had been throughout the first half of the year. Consequently, money may begin flowing into other fixed-income markets.
"It is hard to advise more buying into triple-A rated ABS, as there is not much room for further tightening," said Morgan Stanley research analyst Charles Schorin. "At the margin, within triple-As, I would recommend home equities over credit cards. But overall, it seems like the market is monetizing its gains in ABS and looking for the right time to move into corporates."
Also shifting his opinion for the first time this year, JPMorgan's Chris Flanagan has removed the safe haven status from the ABS market and now recommends an underweight of some ABS product amid what he calls "incipient weakness" across numerous sectors. Despite "recently sound fundamentals" in the market, Flanagan adds that it is "difficult to be a hero" in today's environment, and that the current troubles hitting the market are justified and may well be self-fulfilling.
Among other changes, JPMorgan now advises investors to underweight part of the credit card sector. Flanagan recommends investors stay away from fixed-rate cards - as does Morgan Stanley - and off-the-run issuers of auto loan, equipment lease and manufactured housing ABS. While standing neutral on prime auto, home equity stranded cost and global RMBS, the firm recommends an overweight on the student loan sector and says that, across all credit rating levels, name selection is as important as ever.
In an investor conference call held last week, Salomon Smith Barney research director Peter DiMartino said he would favor top-tier floating-rate, credit-card-backed ABS, which have cheapened over recent weeks, but advised investors to exercise caution in the sub-prime arena in the near term due to servicer and headline risks. While he noted that the credit card sector now looks attractive on the cheapening, DiMartino cautioned that ABS is more susceptible to corporate headline risk - although to a lesser extent.
"While asset-backeds have proven to be structurally sound versus events of insolvency," said DiMartino during the call, "the market has been prone to widen in sympathy to the unsecured credit and the overall weakening of the servicer's financial well-being."
Salomon also recommends student loans, the most secure collateral in the ABS market, and global RMBS. The auto loan sector has stayed out of trouble of late but remains relatively rich. "Going forward, the auto sector has a greater propensity to widen," said DiMartino.
Morgan Stanley's Schorin concurs that student loan and global RMBS-backed ABS should be part of an ABS investor's core holdings and selling is not advised; but while "it is hard not to like these sectors, room for tightening is limited." The home equity sector, by contrast, is roughly 10 basis points outside of the all-time rich levels seen prior to the 1998 Russian debt crisis and has room to tighten, Schorin added.
ABS should not necessarily be underweighted versus other fixed-income markets, but most research analysts agree the upside is greater elsewhere. Certain sectors of the corporate market offer good value, such as healthcare, gaming and banking, Salomon analysts added. High-quality insurers as well as old-fashioned utilities offer protection against recent blowups - for now.
"We anticipate that the incipient weakness in ABS will quickly be passed on to the consumer in the form of reduced liquidity, which will provide powerful support for the double-dip' recession scenario and, consequently, further widening," JPMorgan said in its most recent Global ABS/CDO Weekly Market Snapshot.
