John McElravey, director of structured debt research at Banc One Capital Markets, says short-term home equity bonds have the potential to tighten by as much as 20 basis points from their current levels over swaps sometime in the first quarter. He reasons that HELs spreads are bound to narrow because those bonds-when compared to fixed-rate prime auto asset-backed securities-are trading at their widest spread in one year. He adds that there is also a supply factor that will play in favor of HEL spread tightening. He says HEL supply tends to increase toward the end of each quarter as originators try to wrap up deals. Supply then tends to decrease early in the quarter as issuers begin to warehouse their loans. Based on this seasonal factor, HEL spreads should begin to tighten again starting in January, after the market absorbs supply.

In absolute terms, a two-year triple-A rated HEL is trading at 65 basis points over swaps, while the spread for a two-year prime auto ABS bond is only 12 basis points over swaps. McElravey notes that the 53 basis points relative spread is at its widest in a year. He adds that for the past two years, this relative spread differential averaged 36 basis points.