The weather in Las Vegas at the end of January was cold and grey, but attendees at the American Securitization Forum (ASF) conference saw mostly clear skies ahead.
Michael Binz, a managing director at Standard & Poor’s, said the degree of enthusiasm in the securitization market was where it had not been in years. “A year ago, the mood was starkly different,” he said at one of the opening panels. “There were fewer investors participating, supply was rapidly diminishing and regulatory uncertainty was stifling market activity.”
By comparison, “Today many sectors of the market are rallying, investors have returned, there’s a level of enthusiasm and demand we haven’t seen in years.” Also, “there’s a degree of regulatory certainty taking shape.”
One of the most salient manifestations of that has been an extraordinary tightening in spreads on structured products across a number of asset classes.
“Last year was a good year for spread products,” said Gagan Singh, chief investment officer at PNC Bank, a view echoed by other panelists. The tightening, he said, was both “justified” and “a long time in the making.”
Strong liquidity, courtesy of exceedingly low interest rates, an improving macroeconomic picture and falling volumes of outstanding deals have all played a part in compressing spreads, panelists said.
But after such a strong rally in 2012, Singh said, certain asset classes are already looking rich. This year, sector and security selection will be important.
One sector where spreads are likely to keep tightening, panelists agreed, is collateralized loan obligations (CLOs). That is partly because CLO spread tightening to date has lagged behind other sectors, such as commercial mortgage-backed securities. “The demand side is not in question whatsoever,” said Leland Hart, a managing director at BlackRock.
There are technical factors that may keep other sectors from widening much, if at all, this year. In RMBS, for example, Peter Sack, a managing director at Credit Suisse, noted that amortization is running ahead of new production.
On the issuance front, Sack predicted more private-label RMBS this year, although he pointed out that this wouldn’t be a difficult feat, given the paltry $3.5 billion placed last year.
Claire Mezzanotte, managing director at Dominion Bond Rating Service, said that she expected many other asset classes to see healthy issuance. Volume in credit card ABS would likely go up slightly, she added, with Canadian issuers likely to make their presence felt.
The auto sector — which took off in January — will also see more deals this year than last, according to Mezzanotte. But she warned that standards may start to slip in origination as competition among lenders grows more intense. “We’ll be looking at that 2012 vintage carefully,” she added.
Spreads on CLOs to Play Catch Up
Interest rates on sub-investment grade loans are still relatively attractive, and corporate defaults are still quite low, but the main reason the panelists expect CLO spreads to continue tightening is that they have some catching up to do with spreads on other kinds of structured products.
“If you compare what you’re paid on a risk basis,” for the triple-A rated tranches of CLOs and some other kinds of securitizations, “it’s not even close,” Hart said.
He said the limited supply of corporate loans available to be securitized, versus some other kinds of assets, will only contribute to the spread tightening. “What determines whether we see $50 billion or $70 billion (of issuance) is the availability of loans and the increased use of warehousing.”
How much could CLO spreads tighten this year? Singh pointed out that spreads on new-issue triple-A tranches of CLOs are currently around LIBOR plus 139 basis points; although that is much narrower than at this point last year, when they were closer to LIBOR plus 150 basis points, it is still rich compared with triple-A tranches of commercial mortgage-backed securities. The latter are pricing in the range of LIBOR plus 70 basis points.
Even if corporate loans and commercial mortgages are different asset classes, Singh said, that kind of spread differential is unlikely to be sustained.
Hart predicted that secured bonds will play an increasingly important role in the CLO market. CLO documents typically stipulate that the majority of assets, often 90% or more, be invested in senior secured loans. But he said new deals could carve out bigger investment buckets for secured bonds. That’s because they are becoming more plentiful and also because investors are realizing that they offer the same protection as secured loans, even if they are fixed rate, rather than floating rate.
Hart also predicted that some of the CLOs issued over the past two years could be refinanced to take advantage of the subsequent narrowing in triple-A spreads.
Still Bullish on CMBS
Although there has been some pushback on spreads from investors in recent deals, participants at ASF’s conference were bullish about the sector’s prospects. Speaking at a panel on the sector, Richard Hill, director of CMBS strategy at RBS Securities, said that given the roughly $8 billion in issuance so far in 2013, a full-year volume of $80 billion could be feasible.
“There’s a pipeline that we know of going through the spring,” said Kenneth Cheng, managing director of CMBS new issuance ratings at Morningstar Credit Ratings. He said that among the mix of looming deals are fixed-rate conduit transactions, Freddie Mac K deals in the multifamily sector and single-loan CMBS. His agency knew of a number of deals in the single-loan category that are in the pipeline, Cheng added.
Hill noted that CMBS conduits have been particularly active recently as insurance companies have proven to be weaker competition for financing loans. As interest rates have fallen to historic lows and insurance companies have floors on the yield they can offer, conduits have been able to offer better terms for originating and refinancing commercial loans.
This is a remarkable shift from a year ago, when life insurance companies were making major inroads into the sector, displacing other sources of commercial real estate financing.
GSEs Push Forward on Risk Sharing
Mark Hanson, senior vice president of securitization at Freddie Mac, told conference attendees that Freddie and sister government-sponsored agency Fannie Mae hope to issue pilot transactions this year before setting up a more “programmatic approach.”
“The commitment is as strong as ever to get that done in 2013,” he added, saying the GSEs do not have to wait until they have launched the single securitization platform to move forward on this product, although once that infrastructure is in place, the issuance of these bonds could be sizable.
Risk-sharing bonds would be a way for Fannie and Freddie to hand over more residential mortgage risk to the private sector. As such, they would offer higher yields than deals now fully guaranteed by the GSEs.
They were originally slated to launch last year, but an insurance component would have made the deals commodity pools for regulatory purposes, putting them under the purview of the Commodity Futures Trading Commission (CFTC). This would have implied further regulatory burden.
Private sector players in the mortgage space are generally open to the concept of a single securitization platform, although there are still questions and concerns about the final character of its ownership and governance that have yet to be worked out, according to Timothy Yanoti, senior vice president at Fannie Mae.
A single platform will not translate into a single security, panelists said. Laurie Goodman, senior managing director at Amherst Securities, said that both originators and investors prefer having the choice between a Fannie or Freddie security.
But the difference between these securities, at least on the spread front, may be shrinking. Goodman said she expected prices to converge as the once-faster speeds of Freddie deals are slowing down to the pace of Fannie transactions. The liquidity premium enjoyed by Fannie securities, however, will remain.
Covered Bonds Wait for Their Chance
Covered bonds continue to gain ground in the United States, but not among domestic issuers. While there has been about $44 billion in greenback-denominated covered bonds, they are all from foreign banks.
Yehudah Forster, a vice president at Moody’s Investors Service, pointed out that not a single U.S. bank has tapped this market since 2007.
Forster and other speakers at an ASF panel agreed that uncertainty about what would happen to covered bondholders in the event of a troubled issuing bank going into receivership remains a major stumbling block.
Another hurdle is that the market does not have the vocal champions that other businesses do.
“While covered bonds haven’t had any big detractors, they haven’t had any big supporters [either],” said Anna Pinedo, a partner at Morrison & Foerster.
Those that do want the market to happen need the Federal Deposit Insurance Corp. to come on board. The regulatory agency is leery of having strong assets ring-fenced for the benefit of bondholders in the case of a bankruptcy. But Pinedo said that there was talk that the agency could be amenable to covered bond legislation that would set a cap on the volume of covered bonds issued by a bank as a percentage of its total assets.
Australia included this stipulation in its legislation, and only a little over a year since the first deal, banks there have issued over AUD44 billion (USD46 billion) in deals so far, according to Chris Dalton, the CEO of the Australian Securitisation Forum. An Australian bank cannot have an outstanding volume of covered bonds that exceeds 8% of its assets.
“The issuance of all the banks [is] well inside the cap,” Dalton said. He added that the country’s banks have tapped a variety of currencies, with about AUD13 billion denominated in U.S. dollars.
In terms of the composition of the cover pool, the assets of choice for Australian issuers are mortgage loans, as these banks tend to have relatively large mortgage books.
Canadian banks have also tapped U.S. investors, but legislation passed there only late last year could stall the market as players digest the implications. The housing agency Canada Mortgage and Housing Corporation (CMHC) barred banks from using government-guaranteed loans in their cover pool, which had been part of deals before the regulation was passed. Ben Colice, head of covered bond origination at RBC Capital Markets, said that players would eventually get accustomed to the idea of non-guaranteed loans in Canadian cover pools.
Dedicated investment funds will remain crucial to the development of catastrophe bonds, according to Brian Douglas, vice president at Goldman, Sachs.
He told attendees at ASF’s conference that “funds devoted to this 20-year-old asset class have tripled or quadrupled in the past few years,” accounting for about 62% of placed deals in 2012, up from 47% in 2007.
Their management fees tend to be reasonable, given the seasoned expertise they provide the end investor, according to Douglas. “They’re running the catastrophe models . . . they’re able to see more of the market.”
One investor group that has vanished from the CAT bond sector in the last several years is banks, which bought about 10% of bonds in 2007, but were nonexistent last year thanks to tighter capital requirements.
Keith Kennerly, managing director at Aetna, said that one of the advantages to securitizing insurance risk is that the issuer can reduce its counterparty risk. The more traditional way to offload risk — buying reinsurance —involves dealing with the same players, he said. Securitization is a way to diversify.
Kennerly also said that, to the extent that CAT bond issuers can get their bonds into the investment-grade category, it is worth trying. A recent deal by Aetna that had an investment-grade tranche allowed the company to reach “deep-money” investors, he added.