It is now a year since the jitters in US sub-prime turned into an earthquake that engulfed the securitization market. Asset valuations have been falling pretty much consistently ever since. If ever there was a distressed buyers’ opportunity, the ABS market is it – it is hard to argue that a triple-A rated security trading at a double-digit discount to par is anything other than a screaming buy.
But buyers remain extremely nervous about stepping in. This is partly because of a lingering concern that the market could take another lurch downwards on more bad news. Yes, the downgrade of MBIA to single-A would have been unthinkable even six months ago and it is hard to imagine that the impact will be negligible but it is hard to see how some bonds could be priced any lower. What bids there are for many mortgage assets are valuing bonds on an interest-only basis – assuming that cashflows will be zero. It is hard to be much more bearish than that – so why aren’t buyers piling in?
Some are, but the problem is that the volume of assets needing to be sold is so great that supply is simply overwhelming demand – with obvious implications for spreads. Early buyers have been badly burnt and the demand/supply dynamic does not look as if it is going to change soon. Overshadowing the market is the liquidation of the SIVs: the upcoming restructuring of Cheyne Finance will involve nearly $6 billion of assets being either sold or passed through to a new vehicle via a public auction at which asset valuations aren’t going to be pretty.
Nearly half of this portfolio is sub-prime, so it will set a level for these assets for those creditors that choose to liquidate and it is unlikely to be high. The mortgage assets sold by UBS to Blackrock last month reportedly went at a discount of 30% but levels for the Cheyne sale could be even lower.
Another problem is that price discovery in this dysfunctional market is proving extremely difficult. Traders report that the hit rate on bid-offer spreads is about one in 10. For illiquid, esoteric assets such as this the potential buyer needs to do a lot of work and leave themselves some wiggle room and will therefore often find that the seller ends up refusing to sell. For a lot of mezzanine ABS there are only a handful of data points so the marks become meaningless – particularly as in many cases paper has not traded for a year. So often, marks vary hugely from desk to desk – compounding buyer nervousness.
But sellers need to realize that there is no compelling reason to expect bids to improve in the near future. The liquidation of SIV assets is imminent – and if Gordian Knot’s Sigma vehicle is restructured, that is a further $40 billion of supply from one fund. And buyers who need to hold highly rated paper will now become sellers too, thanks to the monoline downgrades. As one trader muses: "People need to realize that that ugly bid out there is the only bid".