The European ABS Market – A Week in Review

Bad news about the housing market continued to weigh on the European asset-backed securities market this past week.

The Chartered Institute of Purchasing and Supply (CIPS) housing index fell to an all-time low of 18.7 in July, the eighth consecutive sub-50 reading (below chart).  This CIPS Housing Index decline helped further push the CIPS/Markit UK Construction index down to 36.7, also a new low.
 

“Purchasing Managers in the UK construction sector saw conditions worsen across the board in July. Housing was again the sick man of the industry, as levels of activity plunged to a record low. July marked an end to constructors’ optimism about recovery, as spirits were knocked by the persistent and rapid decline in new business and activity,” said Roy Ayliffe, Director of Professional Practice at CIPS.

Meanwhile, Northern Rock, the British bank taken over by the UK government in February, returned to the headlines with a £500 million loss due to bad mortgages. Yield spreads on Northern Rock RMBS issued by Granite Master Trust widened on the news, but maintained a low delinquency rate of 1.3%. The Master Trust had a year-over-year increase in 90+ day delinquencies of less than 1% entering into the July 2008 reporting period. Please see Appendix 1 for a detailed description of Granite Master Trust collateral provided by Markit European ABS Performance.

European ABS investors appear to be more worried about Northern Rock’s latest results and its impact on the issuer than about Granite Master Trust performance itself. Granite ABS traded last week between UK prime and subprime levels:

The usual suspects continued to deteriorate in our weekly analysis of the European ABS market’s biggest movers, which again showed only losers: 

This trend is confirmed by our European ABCDS levels at the end of July which continued to show a negative basis among AAA securities:
 

Negative basis generally occurs in a stable market since synthetic players, for the most part, use a fixed cap. In the case of an interest shortfall, protection sellers pay up to the coupon premium. A comparable investment in cash ABS would be affected by the entirety of any interest shortfall.

As any principal amount due under a synthetic contract is only applicable at the time of the writedown, protection sellers have opportunities to find new funding/investment strategies. With cash ABS, the principal is invested in the security as soon as the investor goes long, hence this long position will have higher funding costs. These functional differences are key drivers of negative basis.   Clearly present on the most liquid names, we assess cash and synthetic basis:

The primary market remained stable with deals priced to be retained:

European sector levels continued to widen with Spanish RMBS remaining the widest and Dutch RMBS the tightest:

Despite another housing index decline, the outlook for UK borrowers may have improved thanks to some drastic measures announced by British Chancellor of the Exchequer, Alistair Darling. These are similar to assistance and tax measures used by the US government during the last six months. The initiative includes plans to:

• Reintroduce income support for mortgage interest payments for homeowners who lose their jobs
• Suspend stamp duty so buyers only pay the tax after several years in their new home or perhaps not until they sell the property.
• Create a new, tax-free fund to help first-time buyers raise the deposit they need to get on the housing market.

To cap the week off, with oil prices below $120, inflation may slow and give Europe’s central bankers more liberty to lower main rates in the coming months. Despite this boost in forward expectations, the ECB is expected to hold steady on rates this week, as the Federal Reserve did at its last meeting.

Appendix 1 - Collateral performance of the Granite Master Trust (provided by Markit Euro ABS Performance)

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