Last week in the U.S., the subprime debacle kept grabbing headlines that rattled wider markets. Meanwhile, across the Atlantic, spreads stood fairly firm. Why the disconnect? Well, for starters, Europe has a relatively non-existent subprime mortgage market. Furthermore, when we talk about subprime across the Atlantic, we mean the U.K.
Things just aren't done in the same way in the U.K. as they're done in the U.S. Call U.K. lenders conservative, but it's their very lack of bravado in the past that is shielding spreads today. Even with the ballsier mortgage lending techniques employed by U.K. lenders over the past two years, subprime lending in this country looks rather tame when compared to U.S. lending techniques. If lenders even considered taking a page out of the U.S. style guidebook, these past few weeks may prove to have been the wake-up call that was needed. The U.S. experience shows that riskier borrowers should be treated with more caution because in the event of a dramatic shift in economics, these borrowers will be the most likely to default.
But it's not only contagion risk in the European subprime market that we should be looking at. Tim Travers, CEO of FGIC London, has said that, over the past year, Europe has seen an increase in CDO of ABS deals. Deutsche Bank analysts have reported that so far this year, four CDOs of ABS transactions have already priced, and the pipeline of structured product CDOs looks relatively heavy. It's likely that pools backing these deals will have some exposure to U.S. market volatility. The question remains: do these deals have enough granularity to reduce the impact of U.S. volatility?
In the U.S., the home equity ABS selloff has led to a widening in U.S. structured product CDO spreads, where most collateral is HEL-based. But it's likely that investors in European products will have less of a concentration in this paper and, therefore, less exposure to price widening. Deutsche analysts said exposure to U.S. collateral is limited to the typically small allowable buckets, something also driven by prohibitive hedging costs.
In the shadow of the current turmoil in the U.S., let's hope that Europe is learning a valuable lesson.
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