US property slowdown could increase risk for CDOs

Decelerating house price inflation and competition among commercial mortgage lenders could hurt US structured credit products, according to a Dresdner Kleinwort report.

The bank's analysts noted losses on home equity loans had increased in the past two years, partly due to slowing US house-price inflation. Such loans typically make up more than 50% of assets in US high-grade collateralised debt obligations (CDOs) of asset-backed securities (ABS), and more than 60% in US mezzanine CDOs of ABS. The report said increasing spreads on home equity loans meant mezzanine deals, in particular, could be repriced. Spreads of BBB(minus) and BBB-rated loans have widened sharply in the last month, from 200-300 basis points to 400-600bp for BBB, and from 300-400bp to 600-900bp for BBB(minus), according to Dresdner Kleinwort's research.

In the commercial sector, the report marked a 58% increase in volumes of US commercial real estate CDOs in 2006, to $33 billion. This was fuelled by high investor demand for the deals, coupled with a healthy underlying market for both commercial property and commercial mortgage-backed securities. But the report also encouraged investor diligence, citing competition among lenders in the commercial mortgage sector that could produce “weaker underwriting standards”.