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Uncertainty Persists in September Forecast
Asset Backed Alert, Harrison Scott Publications Inc. (September 7, 2007)
Structured-product values could be headed for another big dip in the weeks ahead.
As the subprime mortgage industry's troubles stifled trading of asset- and mortgage-backed bonds last month, causing spreads to widen rapidly, many market players said they expected activity to pick back up after Labor Day and thus bring some pricing relief. That's not happening yet, however, due to a convergence of factors that are keeping supply-and-demand technicals off kilter.
Part of it has to do with persistent investor fears about anything related to mortgages - the bread-and-butter of many structured-finance transactions. And improvements in market conditions appear even less likely due to a related liquidity crunch that has already put pressure on commercial-paper conduits and is now making it harder for structured investment vehicles to fund themselves.
For now, the extent of near-term widening of spreads on asset-backed securities, mortgage bonds and CDOs is tough to predict, as new-deal production remains scant. Of the $5 billion of term offerings actually making the rounds in the U.S. and Europe this week, only two senior tranches of a $671.5 million subprime home-loan securitization from Bear Stearns' EMC Mortgage unit appeared to price as of yesterday.
Few bonds are changing hands on the secondary market either, despite a heavy supply of bid lists that stretches back about two months. While buysiders seem to be picking over everything available, the consensus is that most are still hesitant to pull the trigger at a time when the investments could lose value almost immediately.
For mortgage lenders who are likely to bring a rush of deals to market later this month, as they typically do at the end of each quarter, the upshot is likely to be painfully high funding costs. Still, many will have little choice but to cough up the extra yield.
Auto lenders could feel the pain as well, as they prepare some $8 billion of new issues for the next two weeks.
Also likely to take a beating are issuers in a range of asset classes who have been holding off on floating new deals, in many cases since July, in hopes that funding costs would come back down. The miscalculation could prove quite costly, as those players' funding needs eventually force them back into the market.
One investment banker estimated that issuers have sidelined well over $100 billion of transactions so far. That includes a number of offerings in the student-loan sector, where $11 billion of deals were completed in September 2006. The asset class isn't expected to produce any real action this month, except maybe for one issue from Sallie Mae.
Spreads have been widening across the market for several months, with the most pronounced swelling taking place since mid-July. Heading into Labor Day weekend, for example, five-year home-equity loan bonds with triple-A ratings were trading for 260 bp over Libor. In mid-July, similar products were going at spreads of 80 bp.
The degree of spread widening ahead will depend largely on an expected selloff of SIV holdings. Like commercial-paper conduits, such securities-arbitrage vehicles have found it far more difficult to roll over maturing paper over the last month, especially for those whose portfolios include mortgage-related securities.
Volatility in the term market is also undermining collateral values and making it harder for SIV managers to mark their holdings to market. Some are certain to begin liquidating their holdings as a result. The only questions are how much they will seek to unload, and how quickly.
There are currently about two dozen SIVs operating around the world, accounting for about $400 billion of investments - about half in structured products. Any "de-leveraging" by those entities could immediately upend market technicals, by removing an outlet for new deals and by flooding the secondary-market with their existing holdings.
"There's big trouble brewing in the SIV market . . . It's going to be a wild September," said Hanna Smittenberg, a managing director in the capital-markets group at education lender Nelnet. In fact, the Lincoln, Neb., company hastened to complete its most recent securitization, totaling $1.5 billion, on Aug. 22 because it fears funding costs might rise once SIVs back away from the market (see article on Page 1).
Moody's this week downgraded or placed on watch for downgrades $14 billion of SIV paper.
However, some argue that an SIV selloff, if it even happens, wouldn't take place as quickly as many envision. That's because the entities rely on asset-backed commercial paper to fund only about a quarter of their portfolios, and buy most of the rest with proceeds from sales of slower-maturing medium-term notes. "Those that will unwind will do it in a more orderly fashion than the market thinks," said Alex Roever, a fixed-income strategist at J.P. Morgan Chase.