05/04/2012

Dutch Mortgage Bonds No Longer Unshakable

Investors and bankers are growing uneasy about Dutch mortgage bonds.

The concerns, stemming from signs that asset performance could weaken, could subtract from the securities’ usual status as a safe haven among structured-finance instruments. That might lead to increased selling and falling values on the secondary market, along with a more difficult issuing environment for new deals.

“The Dutch housing market is starting to feel pressure,” one banker said. “The U.K. and Dutch sectors held up quite well in the recent volatility, but Dutch collateral is facing some issues.”

The headwinds include the fact that the Netherlands economy fell into recession during the fourth quarter of 2011. Because Dutch mortgages often carry high loan-to-value ratios, and home prices are falling, that’s creating worries about the abilities of borrowers to keep up with their payments. “There are reasons to be slightly concerned,” another banker said. “It’s a very high LTV market . . . that encourages people to borrow more. If you were a bondholder and felt there was a possible downside, now would be the time to sell before there is a negative event.”

He added that investors would be wise to look closely at how the market for Dutch mortgage bonds might be affected by austerity measures that the nation began implementing on April 26, following the collapse of its government four days earlier. The steps include limiting the maximum loan-to-value ratio for residential mortgages to 100% from 106%, which among other things could remove home buyers from the market. It also would become harder for homeowners to deduct mortgage interest from their tax obligations.

“We believe borrowers, underwriters and, ultimately, RMBS investors will need both more information and more time to fully assess the impact of these changes,” J.P. Morgan researchers Gareth Davies and Flavio Marco Rusconi wrote in a May 2 report. They said homeowners would start to feel the effects in 2013, pointing out that loan performance is unlikely to suffer a dramatic deterioration.

Indeed, market participants’ doubts about the performance of Dutch mortgages don’t seem to center on fears of widespread defaults. Rather, they’re trying to measure how much weight to give to concerns about an asset class that they’ve become accustomed to viewing as bulletproof.

So far, investors have clung tightly to their holdings of Dutch mortgage bonds. But that could change if they sense danger ahead. The securities accounted for just 3.2% of the €4.1 billion ($5.4 billion) of structured-product bid lists sold in Europe during the first quarter, according to an April 27 report from Citigroup.

That’s despite the fact that Dutch deals account for about a quarter of outstanding home-loan paper in the region. Meanwhile, mortgage debt made up about 70% of the first-quarter bid lists — with about a quarter of the overall trading volume involving deals from Greece, Italy, Ireland, Portugal or Spain, where investors have been aiming to reduce their exposures.

Should a similar pattern take hold for Dutch transactions, values could fall as secondary-market supply overtakes demand. Likewise, investors might take a more cautious approach to buying new deals from the nation.

That said, spreads on Dutch mortgage paper appear to be holding steady for now. One underwriter pointed out that the main factors in making the securities popular with buysiders — strong asset performance and strict lending standards — remain solidly in place. He added that the unemployment rate in the Netherlands remains low, and downplayed any effects of reduced loan-to-value ratios on lending capacity.

Others suggest that the worst may be over for Europe as whole. “We think there is value to be had,” one bullish investor said. “It’s easy to forget that the world has already come to an end over there. The world ended, and securitization is doing just fine.”

In general, secondary-market prices for European structured products have remained flat in recent weeks. Trading volume has slowed at the same time, as investors take stock of the situation in the Netherlands and elsewhere.

Issuers in the Netherlands have completed just $8 billion of mortgage-bond deals this year. That follows $110.7 billion of transactions in 2011, according to Asset-Backed Alert’s ABS Database.

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