01/16/2009

Spread Tightening Seen as Short-Lived Trend


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CORRECTION: A Jan. 16 article, "Spread Tightening Seen as Short-Lived Trend," incorrectly stated that Ford had received support from the U.S. Treasury Department's Troubled Asset Relief Program (TARP). The automaker hasn't accepted government bailout money.

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Don't expect the values of asset-backed securities to continue rallying at the torrid pace seen last week.

Industry insiders anticipate that now-tightening spreads on those issues will level off in the U.S. within the next two weeks or so, as investors retreat from a brief surge in trading activity that boosted values by up to 250bp. The upshot is that overall values will remain far below pre-credit-crunch levels for the foreseeable future.

Some buysiders need the breather so they can gauge the impact of the federal government's latest efforts to prop up credit-market liquidity. They are also anxious to see whether an annual wave of corporate earnings reports indicates where the recession is headed.

J.P. Morgan was the first major bank to release earnings this week, boosting its tally of writedowns on mortgage-related products to $13.3 billion since the credit market collapsed in mid-2007. In announcing the results, chief executive Jamie Dimon predicted that the battered economy would get worse before it gets better.

The U.S. Treasury Department also moved this week to deploy the remaining $350 billion in its Troubled Asset Relief Program (TARP). The $700 billion facility has already been tapped, with mixed results, to keep numerous banks, along with AIG, Chrysler, Citigroup, Ford and General Motors, from collapsing under the weight of the prolonged financial crisis.

In the secondary market for securitized products, one trader at a major investment bank predicted that overall spreads will only contract by another 50-100 bp before hitting a plateau. And it wouldn't be surprising if they start widening again soon after, other market players said. New securitizations remain scarce.

"In order to maintain [the rally], you're going to have to get some normalization in the market in terms of new issuance," an investment bank analyst said. "I think that's coming, but how fast do we get there? It may take most of 2009."

In addition to broader economic concerns, many investors are worried about how securitizations of consumer-related assets will be affected by rising unemployment. They're also fearful of pending legislation that would permit bankruptcy-court judges to alter mortgage terms for troubled borrowers.

In the meantime, technical factors are helping spreads tighten. After spending the last four months on the sidelines, traditional buyers started jumping back in when they saw spreads tightening last week. Betting that a long-running slide in bond values had finally hit bottom, many buysiders rushed to scoop up outstanding securities at steep discounts while prices are still going up - allowing them to book potential profits in the process.

Meanwhile, some investors simply want to put cash to work after reopening their books for the year, Wachovia researcher John McElravey said. "There is all that pent-up demand out there."

McElravey also attributed the jump in demand to investor optimism over the Federal Reserve's $200 billion Term Asset-Backed Securities Loan Facility (TALF). The program, due to get underway next month, would foster consumer lending by allowing investors to borrow against holdings of new bonds backed by auto loans, credit-card receivables and student loans.

"There's some idea that TALF is going to lend some support to the market and get things going again," McElravey added. The anticipated liquidity injection is contributing to rising values of outstanding ABS because buyers and sellers in the secondary market often look to new issues for price guidance.

"Now, you're getting close to where people expect the TALF deals to come," in terms of spreads, one trader said.

A buyside source also noted: "If this degree of spread tightening continues, then you may not need the TALF."

Average spreads on fixed- and floating-rate ABS tightened by 100-300 bp over the last week or so. That translated into price increases of 3-7 cents on the dollar, depending on the types of underlying assets and when the bonds mature. "For top-tier cards and autos, we're seeing them a couple hundred basis points tighter since last week," said Katie Reeves, a researcher at Deutsche Bank.

For instance, spreads on 2-year senior securities that Nissan issued in June have contracted by 100-150 bp, to 300 bp over Eurodollar futures. Some of those bonds changed hands over the last few days at a premium price of $1.004, up 3 cents from the going rate a week earlier.

Elsewhere in the auto-loan sector, spreads on senior 3-year securities tightened by 175-200 bp over the last week, to 350 bp over swaps. Discounts on those bonds dropped by half, to about 5 cents under par.

Three-year credit-card issues with top ratings are trading at similar spreads to Libor, reflecting a tightening of 175-250 bp. That equates to a price of 85-93 cents on the dollar, up 6-7 cents.

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