As the European securitization market moves apace in the second half of the year, with many new deals about to be launched into the market, it may be time for investors to take stock and look at where the real value for money lies.
In Merrill Lynch's quarterly review of the non-US ABS and MBS markets, the bank asserts that secured bonds still offer value over corporate bonds in terms of their credit resilience. However, following the end of Y2K fears, the spreads on international floating rate notes have tightened between two and seven basis points since the start of the year, and there are signs that fixed rate bonds are also beginning to tighten in.
One asset type where this has been evident is the U.K sub-prime mortgage market, where spreads have come in between seven and 10 basis points. And, although CMBS pricing has also come in, the tightening has not been to the same extent, pressing some bankers to suggest that it is one area where there is real value to be found.
"For the more esoteric stuff, the commercial mortgage-backed deals are still really interesting," said Cyrus Korat, vice-president of asset-backed securities at Merrill Lynch. "Any investor who is comfortable with looking at deals with decent underlying properties, should look here because, for me, it presents much better value than a sub-prime deal."
"If you look at where a CMBS deal might price, it might be between the mid-30s to 40, and you are getting sub-prime deals pricing at the same level where the risk is a lot more untested; CMBS is a better option," Korat continued. "These deals also give the investor some diversification from residential mortgage deals, which everyone buys, and they offer more in terms of spreads."
Simon Best, head of West European structured finance for ING Barings, is of the view that value is dependent on what's available, but sees CDOs as a good deal for investors at the moment. "Value depends significantly on what people's objectives are, and up to a point beauty is in the eye of the beholder," he said. "For people who are able to buy a broad range of assets, I still think CDOs offer the best value in terms of ratings and spreads. And, if the ratings agencies are anywhere close to being right in their assessment for senior pieces of the one-off, more exotic deals, then this is still where the best theoretical value lies."
Best still thought that the U.K. market was a safe option for investors, citing Abbey National's recent GBP2.25 billion ($3.3 billion) Holmes Financing deal as an example of a transaction which attracted widespread interest outside the U.K. market.
"I think with something like that deal, where they've put significant portions of it into other currencies, it highlights the fact that as soon as you get a decent volume of U.K. assets, they get taken away into other currencies," he said. "That said, there is still a natural sterling investor base that is keen to take on that kind of paper. The market is so well seasoned and so well tested and I think there is an element of comfort to be taken from that."
The Irish MBS market, which has seen a lot of recent activity, is one that should be treated with more caution, according to Best. Some players in the market have already expressed concern that the market is in danger of overheating (ASRI 5/22/2000 p.12).
"I guess there has been some debate about the Irish MBS market due to the increase in house prices which have gone a long way up without the early 90s correction that the U.K. had," he said. "Inflation is running at two to three times the Euro-zone average - which it is tied to - so one feels that there are a number of potential problems there, and that if they all came home to roost, we could see the housing market take quite a knock."
Best did, however, note that holders of triple-A rated paper in Ireland, and other emerging securitization nations should not be overly concerned at this point. "My general view is that for the newer markets, the ratings agencies tend to err on the side of conservatism in their credit enhancement requirements," he said. "Therefore, I think these deals are able to stand pretty high levels of stress, certainly for the most senior notes."
Korat thought that, although individual countries were not a problem, investors should still be stringent in examining legal frameworks when looking at a deal. "In European terms, it's not really country risk, it's more local legal risk that you have to consider," he explained. "For example, in Italy it is much harder to get your hands on the underlying assets if something goes wrong. Investors have to look very closely at the specifics of laws in each country to see how that affects the timing of cashflows."
Jrgen Geurts, fixed income portfolio manager for Dutch asset manager Robeco, was one investor who questioned the value of triple-A rated paper available today. "When we started investing in ABS in mid-1998, we started with the plain vanilla credit card deals of repeated, mainly U.S. issuers," he said. "At that time, spreads were much wider compared with now. As demand has picked up strongly, spreads are tightening, so we see less opportunities for the higher rated tranches of securitized issues. However, compared to other triple-A issues - corporate bonds for example - the senior tranches of securitized assets still offer good value."
Being a global investor offers opportunities to look for the best relative value irrespective of the currency and Geurts noted that senior euro notes tightened relatively more than dollar notes. With this in mind, he felt the tightening of spreads on senior notes offered opportunities for investors prepared to look further down the credit spectrum. "Investors should be careful with the triple-A rated tranches of synthetic CBO transactions, which are priced quite tight due to the sudden strong demand," he said. "At the moment, we are looking more closely at the subordinated tranches, which seem to offer better value."
