Company Focuses on Possibilities with Short-Term PaperFederated Investors plans to remain on top of the asset-backed game this year by avoiding riskier-type asset classes and investing in money-market eligible transactions, said Deborah Cunningham, senior vice president and senior portfolio manager with the company.
Cunningham foresees Federated investing in new types of asset-backed securities in the near future, perhaps tweaking bonds that are already in its portfolio.
"I think there is a way to take credit-card securities, floaters in particular, and make them money-market eligible," explained Cunningham. "Typically credit cards, floating-rate securities have been sold to investors with a three- or five-year time horizon. I'd like to see that form taken and put into something that becomes a money-market eligible transaction."
The money market is a market for short-term debt instruments, such as commercial paper, Treasury bills and agency discount notes. "Money-market eligible" refers to bonds that have a final maturity of 13 months or less. More importantly, what these instruments have in common are safety and liquidity.
Although the company is very open when it comes to dealing with different asset classes, there are some things that it plans to stay away from, such as the subprime home-equity and auto markets, Cunningham said.
"We have not been involved in it and have no intentions of getting involved," she added. "It is an area of the market where we can find no comfort. We think that the players purchasing those sectors of the ABS market are not necessarily getting the appropriate amount of returns for the amount of risks that they are taking."
While she admits that initial issuers have "some okay results" because of the very strong economic situation as well as "some funny accounting methods," Cunningham believes that with any kind of an economic downturn, the subprime sector (both autos and home-equities) will be "the first one to be hit and have problems."
Since Cunningham's view is that the U.S. is at "pretty much a high-point from an economic-cycle standpoint", she feels that subprimes have "nowhere else to go but sideways or down."
Open to Innovation
Currently, the company's ABS portfolio is $1.4 billion in term asset-backeds and $10 million in asset-backed commercial paper.
"We're comfortable with having 30% to 40% of our overall portfolio assets in asset-backed securities," Cunningham said. While investing in various sectors of the market, the company deals more in trade receivables-type transactions, auto receivables, equipment-lease receivables transactions and synthetics that would not necessarily be money-market eligible in their original form, Cunningham noted. "Because of some synthetic feature applied to them, they become money-market eligible," she said.
The Pittsburgh-based company was started in 1959, with the goal of managing and distributing mutual funds to the institutional investor. It has worked with companies such as GMAC, Arcadia Financial, AT&T and more recently, First Sierra Financial Inc.
"On the synthetic side of the equation, it's mostly been investment bankers that have taken existing inventory from the marketplace and put the deal together in a money-market eligible form," said Cunningham.
Federated is no stranger to private placements either, with 10% of its ABS portfolio being dominated by privately placed deals. Although it participates in this part of the market, Cunningham views it as being unlikely that the percentage of privately placed deals will increase.
"The size that we can do in privates is never going to make that big a portion of our portfolio," said Cunningham. "We invest for publicly traded money-market funds, where we can't have anything more than 10% in illiquid restricted types of securities."
The company has already bought several transactions this year, reviewing them on a case-by-case basis, paying special attention to the credit of the issuer.
"Credit is where we place our key emphasis in," Cunningham explained. "If we're comfortable from a credit perspective and we're comfortable from a pricing perspective, then we'll bid on it."
But innovation is certainly what makes Federated stand out from the rest. Not only does the company do a very good job from a credit perspective, but Cunningham says that her shop is always open to having a discussion with issuers or bankers who bring in something that is "not quite fitting within the black box."
"I think that they will find us always willing and able to have a discussion on whether we can utilize it and figure out a way to make it fit if we like it," Cunningham noted. "We dot our i's' and cross our t's.' We make sure from a credit perspective we are comfortable from the inside-out with any issuer we approve and purchase."
CLOs and CBOs, Anyone?
Coming out of Y2K, Cunningham was bewildered by the fact that the market had such a slow start in 2000.
"I thought that people would be out of the gate immediately in the early part January once they saw that the Y2K effect was null and void," said Cunningham. "But in fact, it really took until the third or fourth week of January until we saw anything."
Now that things have gotten under way for 2000, Cunningham also offered her prognostications of what asset classes will see the most growth, citing that CLOs and CBOs show the most promise.
"I think that there are enough asset-management firms that would like to continue to develop their expertise at managing some of these different types of asset classes, such as high-yield CBOs, mortgage-backed CBOs, asset-backed CBOs," said Cunningham.
As far as what we will be seeing from Federated this year, Cunningham feels that the market should expect the company to be "more defensive from a duration standpoint."
"Simply because we feel that the Fed is in play and that there will be some increasing rate environments that will be plaguing the marketplace early in the year," Cunningham elaborated.
She also feels that the lower-rated tranches, as well as the more riskier types of receivables, will be plagued with more problems than ever before, but that if they are tied to a stronger entity, such as Ambac, there will be fewer problems.
Cunningham further speculated that consolidations will come into play this year.
"I'm not sure what that effect would be," she said. "Some of the companies that we've been active purchasers of and dealt with in the marketplace on a fairly regular basis have been consolidated in another entity."
Moreover, Cunningham predicts a more level playing field for the asset-backed arena, where there will be a larger group of names, but no dominant players as there have been in the past.
"It's a stronger market from a credit perspective but I think that future issuers may not necessarily need the diversity of funding," she added.