[A-List] European credit cycle turns

["Michael Keaney" <michael011@xxxxxxxxxxx>]

About turn for consumer credit cycle
By Paul J Davies
Financial Times: February 24 2006

The point at which the credit cycle turns in the corporate world is
still a matter for debate - but the fact it has turned among consumers,
at least in the UK, appears beyond doubt.

This week Barclays reported that charges for bad loans had jumped 44 per
cent to more than £1.5bn last year, driven by credit card defaults.
Other banks due to report annual figures in the coming days are also
expected to show higher bad debt provisions.

While this might be painful for banks, investors in the market for bonds
secured against consumer debt have yet to demonstrate concerns. This is
so even though charge-offs for bad credit card debts have risen
significantly and arrears - particularly in the non-conforming, or
sub-prime, mortgage sector - are also showing an upward trend.

The consumer asset-backed securities market saw issuance of more than
$200bn in Europe last year, according to figures from Dealogic. Most of
that was secured against mortgages, of which the sub-prime sector was a
significant part. Credit card debt accounted for about $12.1bn, most of
which was from the UK.

Analysts say these developments have not yet triggered investor selling.

"We've not seen much selling, which is quite surprising really," says
Alexander Devic, structured credit analyst at Lehman Brothers.
"Investors have confidence in the structure of credit card deals, but if
any go into early amortisation then we could see some negative selling
pressure."

According to Chris Such, director and product manager for ABS at
Standard & Poor's, which rates credit card-backed bonds and other
securitisations, the picture has been worsening for some time. Default
rates among credit card borrowers have grown from about 4.5 per cent to
about 6 per cent in the past two years, he says, and some, such as
Capital One, are higher at 7.5 per cent. These figures are borne out by
analysis from Ganesh Rajendra at Deutsche Bank (see chart).

"If default rates generally were to exceed about 8 per cent then that
would be significant," Mr Such says.

Capital One this month said its charge-offs could soon rise to 8.5 per
cent.

One reason why investors are not yet reacting is that there is a great
amount of protection built into securitisations, particularly on credit
card deals. The bonds are structured with a reserve fund that helps to
soak up any losses and generate what is known as an excess spread. This
is the yield over and above that needed to pay bond holders that in good
times provides earnings for the issuing bank.

Sarah Barton, a Morgan Stanley analyst, says excess spread on credit
card deals is deteriorating and things are getting worse. "[But] there's
still a very strong appetite for these products."

She adds that demand is especially strong for the more junior tranches
of such deals, those with BBB or BB rating. These provide investors with
a higher yield, but would suffer most in a severe downturn.

Many observers expect things to worsen further this year. "The UK credit
card market has been under stress and we saw a deterioration in
performance in 2005," says Heather Dyke, at Fitch Ratings.

"I expect to see further deterioration in performance in 2006 before
seeing some stabilisation. However, I do not expect the deterioration to
be severe enough to impact the current ratings of the notes," she adds.

Banks and other card issuers can protect excess spread levels in a
number of ways, many of which they are already using to protect profits
on lending operations. These include increasing interest rates, stepping
up collections procedures and cutting back on borrowing limits or
loyalty schemes.

However, they also face threats to yields on UK card lending operations
from regulatory moves to tackle high late payment penalties and the
interchange fees that banks charge for processing transactions.

Mr Rajendra wrote in a note this week that while charge-offs for UK
credit cards were likely to be higher in coming months, yield enhancing
measures were already bearing fruit for issuers.

He adds: "A change in [UK interest] rate direction or heightened
regulatory pressures on fees and default charges remain significant
risks to our outlook."

If the downturn in people's ability to pay back their credit card debt,
mortgages, or loans on new cars - another popular area for
securitisation in Europe and the US - were to become severe and lead to
prolonged periods of negative excess spread, investors are still
protected by triggers forcing issuers to make earlyrepayments of the
bonds. However, Mr Devic points out that this would notnecessarily be
entirely welcomed.

"Early amortisation is a double edged sword: if you hold a discounted
bond trading below par, then it may be good to get your money back
early, but if it's trading above par then you can potentially lose
money," he says. "Many older deals are trading above par because spreads
used to be much wider, especially pre-2004."

Most analysts think the likelihood of early repayment of credit card
deals remains remote - and for some issuers unthinkable.

"For some groups, securitisation is their main funding tool, they are
reliant on these investors so they certainly don't want to hit pre-pay
triggers," says one. "So I would think they'd do everything possible to
avoid early amortisation."

That said, analysts point out that UK data on credit card
securitisations goes back no further than 1995. The market therefore has
no previous evidence about what could happen if consumers suffered
broadly from high interest rates and a housing market crash, as they did
in the early 1990s.

*****

European credit cycle 'has turned'
By Paul J Davies
Financial Times: February 24 2006

Morgan Stanley will today become the first leading investment bank to
call the turn in the European credit cycle, advising investors to begin
reducing their holdings in both high yield and investment grade bonds.

Neil McLeish, head of credit strategy at the US bank, said yesterday
that the risks from leveraged buyout and mergers and acquisition
activity, which was likely to increase from levels already seen, along
with an expected rise in broader systemic risks was likely to lead to a
deterioration in credit markets over the comingquarter.

Credit strategists at a number of investment banks have started to talk
about the likelihood that this year will begin to see a rise in
corporate bond yields - which are referred to in terms of the spread
overgovernment bonds - and a corresponding fall in their prices.

However, Morgan is the first to make a strong call that investors should
begin repositioning themselves now before market movements lead to
potential losses.

"We thought there was now enough evidence to say that investors are
better off reducing credit and doing that now," Mr McLeish said. "The
risk is that we may be a couple of months early, but we think that when
the change comes things may move quite quickly. We are willing to pay an
uncertainty price in terms of timing in order to be in the right
position."

The timing problem comes from the difficulty in predicting how long it
might take for the inversion of the US Treasury curve - with the yield
on 10-year bonds below that of 2-year bonds - to translate into a
broader increase in risk for credit from an economic downturn, as Mr
McLeish thinks it will.

LBO and M&A event risk is already apparent, with regular bids emerging,
such as Eon's ?55bn proposed deal for Endesa in utilities and the
surprise move by Ferrovial of Spain for BAA of the UK.

In the note to be published today, Mr McLeish said there was a
two-thirds probability that spreads would widen by 20 per cent over the
next three to four months.

He has changed his recommendation on European credit markets from
"neutral" to "material underweight".

"We don't think a material number of investors are positioned for that
in the market, which is understandable because many wait for a trend to
begin before jumping on the bandwagon," he said.

The time lag between an initial US yield curve inversion and corporate
credit spreads widening by 20 per cent had varied between one month and
10 months over the past 40 years,Mr McLeish said, with an average of
four months.


-- 
http://www.fastmail.fm - Send your email first class