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In the Subprime Uproar, European Spreads Finally Find Their Place
Asset Securitization Report--SourceMedia (July 23, 2007)
The hullabaloo created by the recent aggressive U.S. RMBS downgrades has led to some much-needed price repositioning in European trades. Market players say that the credit news is likely to continue to chip away at the tight pricing, which has held steadfast over the past few months, since the eruption of the U.S. subprime market woes.
"Credit news is doing exactly what it wasn't doing five months ago - sticking and holding versus the Teflon conditions the market had grown accustomed to," analysts at the Royal Bank of Scotland said. "Guidance has been adjusted accordingly."
While the pipeline looks nowhere near a summer lull, analysts said it is likely that deal flow will be affected if weaker demand technicals persist. "We believe that confidence will also have been shaken in the ABS market by the speed and severity of agency downgrades in the subprime sector last week," Morgan Stanley analysts said.
The clearing spreads and price talk on sectors such as autos and prime mortgages in the European structured finance market are evidence that the pricing fallout has spread to the most vanilla types of assets, including even the senior triple-A market, according to Deutsche Bank research. Morgan Stanley data show that the U.K. nonconforming market has widened the most. Triple-Bs are around 70 basis points wider relative to three months ago, followed by Spanish RMBS, whose triple-B spreads are around 55 basis points wider. Prime RMBS is also wider, with triple-B paper trading around 10 basis points wider relative to three months ago. For CLOs priced in Europe in recent weeks, spreads on lower-rated, triple-B tranches in the primary market have widened by 30 to 35 basis points to around 180 to 225 basis points, and double-B paper has widened to around 415 to 475 basis points, depending on manager quality.
"At this point, there can be no mistaking the weakness in U.K. nonconforming RMBS, leveraged loan CLOs and conduit CMBS, particularly in the mezzanine and subordinated parts of the capital structures," Deutsche analysts said. Analysts said they saw the recent cheapening as result of a mixture of pricing contagion as well as the heightened sensitivity to potential bearish credit trends in certain asset classes. Credit performance in Europe, they added, is, for the most part still benign.
Analysts at Societe Generale said that while some banks can turn to alternative funding sources, the securitization economics for nonbanks - such as nonconforming RMBS platforms, CLO managers and CMBS conduits - may be squeezed to the extent asset margin pricing remains tight.
But RBS analysts said that an overcautious market may run the risk of bundling the risks and thus miss investment opportunities over the short term while the subprime wreckage is better understood and greater clarity on risk and losses on the ABS side of things is established. "We detect an ongoing dislocation in the perception of the relative vulnerability of Euro CLOs to the current credit turmoil," RBS analysts said. "We think European CLO risks are being overplayed and that buying opportunities will present themselves over the coming weeks."
Though Euro credit assets in general, and Euro CLOs in particular, aren't immune from general credit volatility and repricing, primary CLO widening so far is based on a couple of deals, and the European CLO market has yet to be tested meaningfully, according to RBS analysts. "With nine European CLOs in the pipeline, this test is imminent," they said. The pricing on Avoca and Alcentra, both top tier, will signal general appetite for European CLOs. They said that together with the rest of the pipeline, this will highlight the extent of manager tiering.
It's likely that the weaker CLOs might be pulled from the market on the back of cautious investors and arrangers. But the higher-rated tranches are expected to remain well-bid while spreads on lower-rated tranches widen further, which could offer opportunities for bargain hunting. "The summer may well be choppy. However, we do not expect this widening to continue throughout 2007. Later in the year, loan and CLO fundamentals will reign over volatility concerns," RBS analysts said.
Among some of the new deals that joined the pipeline last week, amid growing unease about subprime paper, was the GBP730 million ($1.49 billion) multicurrency nonconforming RMBS from Lehman Brothers' Eurosail platform. The new issue, Eurosail-UK 2007-4BL, is backed by loans originated by Southern Pacific Mortgages, Preferred Mortgages, London Mortgage Co., Alliance & Leicester, Matlock London and Langersal No 2. Pricing is slated for this week.
Details of a new Windermere transaction also began circulating. The 1.52 billion ($2.09 billion) CMBS Windermere XII is backed by a single loan secured on the Coeur Defense complex in the financial district of Paris. The deal is arranged by Lehman Brothers and is also expected to price this week.
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