NEW YORK -(Dow Jones)- Problems with asset-backed securities grabbed the limelight Thursday, setting off a firestorm in money markets that forced central banks in the U.S. and the euro zone into unscheduled injections of funds.
The abrupt tightening of borrowing conditions in dollar and euro money markets was prompted by problems with three asset-backed funds run by French bank, BNP Paribas. The bank said it was unable to find prices for the funds' assets in the U.S. credit markets. Liquidity, it said, had dried up suddenly this week.
That's hardly a surprise. The U.S. asset-backed market - where all types of consumer debt, from home loans to credit card debt is packaged - has been hit hard by the fallout from the subprime mortgage market woes. Issuance of securities backed by home loans - the market's main driver in years past - has plummeted and buyers are few and far between.
"Traders would call this a buyer's strike," said Michael Kastner, managing director at Sterling Stamos, an investment partnership with $5 billion in assets under management. "There is uncertainty about the collateral and any paper that comes in is discounted."
No one wants to invest only to find that the originators and lenders of the loans that underlie the bonds have gone out of business, he added.
Worries about shuttering subprime lenders, poorly underwritten loans and rising delinquencies in an environment of slowing home price appreciation - or in some areas, outright declines in home prices - have brought issuance in this sector of the asset-backed market to a near-standstill.
Mortgage-related issuance of securities in the U.S. - that is bonds backed by mortgages, home-equity lines of credit and other types of home loans - fell to $41.92 billion in July from nearly $80 billion in June, according to Asset-Backed Alert, a trade publication. In May, that number was $92.86 billion.
The slowdown has been going on for longer, though, than just the past three months. According to data from industry group SIFMA, growth rates of outstanding home-equity backed securities have been slowing since 2005. It's still a significant part of the total market, however, with a total volume outstanding of $583.4 billion at the end of the first quarter of 2007- or about 26% of the overall ABS market.
The fall-off in issuance in part reflects the decline in the number of mortgages being written as the housing market remains weak and lenders tighten standards, particularly in the sector catering to borrowers with poor credit histories.
"The origination of subprime loans has stopped," said Mike Kagawa, a portfolio strategist focused on ABS at money management firm Payden & Rygel in Los Angeles. "When you don't have loans, then the new issue market comes to a halt."
Michael Youngblood, portfolio manager and director of research at Friedman Billings Ramsey Investment Management, estimates issuance of bonds backed by subprime mortgages will be about 25% lower this year than in 2006.
Ratings Agencies Create More Uncertainty
The actions of the ratings agencies, which play a central role in the asset-backed market, have further added to investors stress.
Asset-backed securities typically carry high ratings as they are seen as safe; the idea being that because the bonds are backed by a wide array of loans, it would take a massive number of defaults to jeopardize their payment streams.
But under fire from buyers for being slow and late in recognizing the extent of the subprime woes, the ratings firms have recently begun to review their criteria for rating such bonds. With their models being called into question - and investors as well as politicians pointing fingers at them - the firms have all announced an overhaul of the way they assign the ratings.
With the sheer number of downgrades they have announced on these securities, it is clear their premises were "incorrect," Kagawa said. "Nobody knows what the right price or rating is, so there is fear of uncertainty," he added.
The problems in the subprime market are unlikely to evaporate in the near future and market participants have different estimates of how long it may take - months or years - before the stream of negative headlines stops.
"This is not clearing up tomorrow," Kagawa said. "This will take a while to unwind."
The deterioration will continue because the credit losses on these bonds is being caused by people defaulting on their mortgages, said one analyst at a broker-dealer firm. "Real economic losses are hitting issuance," he said. "The whole credit market arena is getting incinerated and has to be rebuilt."
Autos, Credit Cards Still Holding Up
Still, with U.S. unemployment low and incomes still rising, the U.S. consumer remains in fairly robust health. As a result, securities backed by auto and credit card loans haven't been hit as hard as the mortgage sector.
On the contrary, credit card ABS issuance climbed to $8.4 billion in July of this year from $7.54 billion in June, according to Asset-Backed Alert.
Auto loans saw a dip to $2.9 billion in July from $8.62 billion in June but analysts say this isn't part of a downward trend.
"New issuance volume in the credit card, auto and student loan ABS sectors has slowed over the past couple of weeks but Fitch believes that the underlying credit fundamental in those assets remain solid," said Kevin Duignan, managing director in Fitch Ratings' ABS group.
Duignan also points out that upgrades in credit card, auto and student loan ABS have "substantially" outnumbered downgrades over the past two years.
"While the pace of upgrades may slow as consumers feel the pressure of a shifting economy and a deterioration in the housing market, ratings in credit card, auto and student loan ABS are expected to continue to remain stable," he said.
(Anusha Shrivastava writes about investment-grade and asset-backed debt for Dow Jones Newswires. Madeleine Lim is assistant managing editor for money coverage at Dow Jones.)
