European Structured Finance to Feel Pinch in 2008
The healthy movement in the ratings of European Structured Finance Assets over the last year will be threatened in 2008 as markets feel the pinch of the troubles that began in the US, according to a pair of new reports from Standard & Poor’s.
The damage to European securities from US Residential Mortgage-Backed Securities, in the most direct sense, however, is relatively limited: “collateral performance issues over 2008 are most likely to affect speculative-grade or low investment-grade ratings, with most high investment-grade ratings expected to remain generally stable.” Only a small number of European Collateralized Debt Obligations, after all, have much exposure to US RMBS.
The major exception is with some pension funds and other holders of US RMBS which have structural triggers that will result in early liquidation of assets into a very depressed market, S&P says.
“Rating performance in most of European RMBS is expected to remain broadly similar in the coming year” and thus will likely not place ratings under much pressure, in either direction.
However, some UK securities will face increased ratings pressure: “In 2008, many loans are due to reset from initial fixed- or discount-rate periods.” A stronger regulatory framework, less competition among banks, and smaller swings in mortgages rates, however, all combine to mean that in the UK, “lending activity probably did not extend as far down the credit quality spectrum as in the US.” That being said, there is still “some scope for structural issues to place ratings under pressure.”
…repossession rates in the prime sector have also been rising from a historically low base since 2004, and we believe the trend is likely to continue in 2008.
Importantly, the subprime crisis’ ripple effects could also prove significant throughout the market, as “current capital market disruption could now act as a catalyst for some deterioration [in value].” If difficulties with US RMBS impinge significantly on broader credit markets, then downgrades on synthetic CDOs could become more common.
Speaking more generally of European structured finance assets, “pockets of weakness” have emerged in the latter half of 2007, despite the year’s general stability. On the whole, ratings either stayed the same or were raised more often in 2007 than in 2006. Furthermore, the ratio of downgrades to upgrades reached a new low.
Overall change in credit quality was positive, though less so than in the preceding two years.
In addition, “The relative number of European structured finance rating transitions also continues to compare favorably with corporates. Provisional data suggests that 2007 downgrade rates for European structured finance ratings were significantly lower than for global corporates at most rating categories.”
The S&P reports European Structured Finance Performance Outlook 2008, and Transition Study: European Structured Finance Ratings Stable In 2007, But Pockets Of Weakness Emerged, are available for purchase.
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