Whenever the capital markets – or any other market, for that matter – experiences extreme booms and busts, there is usually talk of an overarching repricing of its products.
Deutsche Bank in a report released March 2 bluntly said: “We are in the midst of a landmark event in structured credit trading,” analysts wrote. “The repricing of risk has occurred rapidly and the market has and will feel the effects of tighter underwriting standards, tighter financing covenants and higher loss assumptions.”
While most of the troublemakers have been the BBB-‘ bonds in the ABX index, the ABS market took the initiative to widen spreads on some triple-As anyhow. HSBC Securities’s HASC Trust 2007-HE1, which priced on March 2, started out with pricing talk at six basis points over the one-month Libor on its one-year tranche, a level to which the market had become accustomed last year. The deal saw guidance on its AAA’ widen by two or three basis points, before pricing at 10 basis points over the one-month Libor. That figures. Overall, spreads on AAA’ HEL spreads widened to the mid-30s range, after trading in the low 20s on the ABX, according to Barclays Capital.
Lehman Brothers recently noted in its fixed-income research piece, among other things, that subprime mortgages account for 15% of themarket, so that there should be little cause for concern as long as “recent noise is contained in the subprime market”. As home price appreciation (HPA) numbers rose just 1.1% in the fourth quarter of 2006, according to the Office of Federal Housing Enterprise Oversight, the investment bank decided to remain cool-headed and wait for more data to see where the current trend is headed.
“There has been a re-rating of risk,” said Scott Valentin, a managing director of specialty finance equity research at Friedman Billings Ramsey. The trouble is, as one market player put it, the legs that powered the CDO machine for the last three years have fallen off.
“Over the last three years, it has been a CDO-driven market,” said one market player. “You take CDOs out of the market … who buys?”
Traditional institutional investors, who were priced out of the market long ago and who have been more accustomed to saner fundamentals and underwriting practices, are balking at providing liquidity to some of the previously CDO-driven issuances out on the market. The solution seems simple: improve credit by tightening underwriting standards on subprime mortgage loans and keep standards for other types of home loans taut.
“The medicine is good, but the pain is very difficult now,” one market professional said.
Early last week, professionals deeply involved in the subprime mortgage ABS sector talked optimistically about the eventual outcome of the market, and sifted through all of its technical intricacies to support trading rationales. Whether the general equities and bond markets appreciate all of those particulars is beside the point. Those markets have become acutely aware of the importance of the subprime mortgage market, which means the MBS market at large can no longer avoid the heavy short-term price for its miscalculations or its lasting implications.
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