While the financial markets were in trepidation last week ahead of Alan Greenspan's comments, the Fed chairman seemed to reaffirm a measured tightening bias - which most agree translates to a 25-basis point hike on Aug. 10 - despite some disappointing economic indicators over the past several weeks. Some were betting that the August hike would be postponed.
At a Deutsche Bank Securities economic outlook held last week, Anthony Thompson, head of ABS and CDO research, noted the bulk of first-half ABS supply came from the 20 leading issuers, and nine of the top 10 are mortgage lenders (Sallie Mae at No. 5 is the exception). As a result, Thompson said, the impact of higher rates on real estate assets is the "leading risk currently facing the ABS market."
In any event, fears over what would happen to the collateral mix in subprime home equity - even if speeds on the fixed-rate bonds were to slow dramatically - are largely unfounded, argues Charles Schorin, head of global ABS research at Morgan Stanley. A recent report on the available funds cap found that even under highly stressed prepayment scenarios, HEL ABS held up well. "The triple-As would not be impacted under our stressed prepayment scenario even for 200 basis points upward shift in forward Libor, a scenario that would imply spot Libor over 7% in three years," Schorin wrote in the report.
Mezzanine and subordinate home equity ABS also showed surprising fortitude as Libor rose, he said.
Meanwhile, overall volume has been stable considering the rise in rates. "Volume has stayed reasonably high for the past several months even as rates have gone up. Originators have accepted compressed margins to try to keep volume up," Schorin said.
However, their forbearance is bound to wear thin, and eventually originators will have to accept lower volume as a result of higher rates. Schorin expects to see a dent in ABS volume become more apparent sometime in the fall.
On credit cards...
Initially, there was concern over the adverse impact a rapidly rising rate environment might have on excess spread levels in credit card trusts. However, with excess spread levels looking robust, and loss rates continuing on a downward trajectory, much of the pressure has been relieved. For bellwether issuers such as Citibank and Capital One Financial, three-month average excess spread levels are at 7.30% and 9.27%, respectively, said Barclays Capital Director of ABS Research Jeff Salmon. "The excess spread levels on most of the credit card deals out there are running from roughly 6% to 8%," he added. "Almost every major credit card ABS trust out there could withstand a shock in rates."
"Rates are going to rise, but not nearly as rapidly and dramatically as people had been thinking," Salmon said. "The scenario we anticipate is a gradual rate increase; this will be a healthy development for securitization in general, and consumer ABS and credit cards in particular."
The Fed raised interest rates 25 basis points on June 30, the first hike in more than four years, ending "an unprecedented period of ease, and we expect that the Federal funds rate will gradually revert to 3 percent to 4 percent over the next two years," said David Wyss, Standard & Poor's chief economist.
Meanwhile, Peter Hooper, chief economist at Deutsche Bank, anticipates the Fed funds rate to reach 2.25% by the end of this year, and expects the Fed to continue moving rates up next year. Hooper also expects the Federal Open Market Committee to raise rates 25 basis points at the next two meetings and 50 basis points in November, with no change at the December meeting.
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