ABS comes alive as credit card, auto investors return

By Nancy Leinfuss - analysis

NEW YORK (Reuters) - Signs of life are emerging in the U.S. asset-backed securities market where growing investor demand for lower-risk securities is signaling a positive shift for a market nearly shut down by the crisis in subprime mortgages.

Several measures by the Federal Reserve aimed at bolstering liquidity in the U.S. credit markets after a lengthy series of interest rate cuts have helped to reverse the trend, analysts say.

Among recent measures, the Federal Reserve broadened the collateral that can be pledged to borrow from its Term Securities Lending Facility to include all "AAA" credit card, auto and student loan asset-backed securities, or ABS.

Reassured by the moves, investors began returning to less riskier segments of the consumer ABS market, namely credit cards and autos, leading spreads to narrow from historic wides and boosting supply. The added liquidity should lower funding costs and narrow spreads further, market watchers say.

"A lot of liquidity premium has been taken out of the market to some extent, given the Fed's policy and ongoing steps by the government. That has given people confidence that the Fed is going to step in here and try to improve the liquidity situation," said Allison Owens, assistant portfolio manager at GE Asset Management in Stamford, Connecticut.

Non-mortgage ABS spreads had ballooned to record wides late last year as subprime contagion fears swept through the market, forcing investors to flee and setting off a prolonged period of illiquidity.

"The reversal in tone was prevalent across the credit markets as investors began to regain confidence in the stability of the financial markets," Deutsche Bank said in a report.

Credit card and auto ABS spreads began narrowing in April for the first time since October 2007. Demand has been centered primarily around top "AAA" securities, deemed the safest after weathering the credit crunch better than other securities.

Credit card "AAA" ABS spreads have narrowed five to 15 basis points in May, while prime auto ABS tightened between five and 50 basis points, according to JPMorgan. That followed 30 basis points of spread tightening for each asset class during the month of April, analysts noted.

"The recent (spread) tightening has been supported by accommodative Fed policy and ongoing steps to improve liquidity," said Chris Flanagan, a home equity analyst at JPMorgan.

The firm recently moved to "overweight" in ABS, noting the improving liquidity conditions in credit and the underperformance of ABS spreads relative to other credits as the basis for their adding ABS risks more aggressively.

GROWING DEMAND, FRESH SUPPLY

The growing demand for ABS has led to an increase in new supply from the auto and credit card segments.

"The shock and awe of last year's debacle in the credit markets is starting to defrost. People need product and real prime-rated stuff is coming through now," said Darcy Morrison, senior analyst at Evergreen Investments in Charlotte, North Carolina.

Investors easily digested about $7 billion in credit card and auto ABS sales last week. In most cases, issuers increased the size of their sales to accommodate the stronger demand.