Despite the weakened credit environment brought about in part by the deterioration of the US sub-prime market, primary supply in the European ABS market has continued unabated. However, the sub-prime contagion into other sectors, combined with nervousness brought about by recent LBO headlines, is responsible for a drop in liquidity, and subsequently in demand, for structured product.
Consequently, the process of syndication is changing. "In a seller’s market, it is much easier to build a book," says Chris Pink, head of structured products distribution at Wachovia. "When you have a difficult market, the process becomes more delicate, the burden greater."
Prime European triple-A RMBS are now printing wider by 3 to 5 basis points – which for a five-year average life means borrowing costs have risen by between 5bp to 7bp. Fortunately for them, most large issuers are not big takers of liquidity during the summer months. September will be a different story, however, and this will have significant consequences for both borrowers and investors. In the past few years, the strength of the markets has meant that investment banks have been willing to take on more risk if issuers have demanded it. As liquidity falls, not only will new issues become far less well subscribed than borrowers might have become used to, but the banks might be more wary of buying deals directly before selling on that risk to investors.
"Investment banks are middlemen, with clients on both sides of a trade," says Rob Ford, a partner with Synapse Investment Management, who until May was head of ABS trading at Barclays Capital. "Given the strong market conditions in recent years it’s not surprising that issuers have probably benefited more from this oversubscription than investors." Now that market conditions are weakening and demand for new issues is diminishing, syndicate desks will have to work harder and go further to meet the needs of the buy side.
New pockets
"I hope that as liquidity drops, syndicate desks will be more generous to investors," says Ford. Now that the balance of power between the investors and issuers has shifted, more focus will have to be placed on roadshows, finding new pockets of liquidity and managing risk.
In the benign credit environment of the past few years, the traditional risk-distribution role of the syndicate desks has become less necessary, as most deals have sold swiftly and easily. The duties of syndicate desks have become more administrative. "In the last three or four years pretty much every deal that comes to market has been multiple-times oversubscribed," explains Ford. "The syndicate process has been more about how to allocate the issue."
Different banks have different ways of allocating issues. Some might give preference to investors that come in early, while others might lean toward their more regular clients. Depending on the issue, some banks might specifically seek out buy-and-hold investors, and some might look to encourage the secondary market by allocating to hedge funds. And some might have no specific allocation policy at all, tending toward distributing the issue evenly among all investors in the order book.
In the recent past this pro rata approach has caused problems. Some investors will make an estimation of their likely allocation, and adjust their order accordingly. So if an investor wants $50 million of a particular issue but sees that the order book for that issue is three times oversubscribed, he might order, say, $150 million, knowing that his allocation will be closer to the originally planned figure.
No matter what method a syndicate desk uses to allocate paper, there are going to be some disgruntled investors. "There have been occasions where our own bank is lead-managing a deal, and I’ve had to hire an intermediary to masquerade as an investor just to be able to buy bonds," says one trader. "I’ve had to pay a premium over the issuance price just to buy bonds from my own bank!"
Now, though, conditions have changed. Investors with exposure in both the US and Europe have had to hold back in Europe while waiting to see the full extent of the US sub-prime contagion. This drop in demand comes at a time when supply is still sky-high. According to RBS research, some €30 billion remained in the ABS pipeline in the last week of July.