Mention cumulative charge-offs in single-digit basis points and premiums of more than 100 basis points for 'AAA'-rated bonds, and institutional investors are bound to scoff.
But ABS backed by structured settlement payments do in fact meet those criteria. With just over $3 billion of paper outstanding, this asset class represents a tiny corner of the ABS market, but there is plenty of potential. DBRS reckons that the total volume of payments defendants and insurance companies make to injured parties over long periods of time - typically by purchasing an annuity contract - is approximately $100 billion and is growing by $6 billion to $8 billion a year. And hard economic times increase the likelihood that people receiving structured settlements will decide that they want a lump-sum payment after all and sell these payments streams.
The first structured settlement ABS offering was completed in 1997 by J.G. Wentworth. It remains the largest purchaser of structured settlement rights and the most regular issuer of structured settlement-backed ABS. This is even more true after last year's acquisition of Peachtree Settlement Funding, which was then the second largest market participant.
The most recent broadly distributed transaction by J.G. Wentworth was a $244 million transaction in March. It is split into a $212 Class A note rated 'AAA' by DBRS and Moody's Investors Service, a $20.5 million Class B portion rated single-A, and an $11.6 million subordinated piece retained by the issuer. The Class A tranche priced at approximately 200 basis points over swaps and the Class B at 475 basis points over, with weighted average lives of 10.8 years and 13.5 years, respectively. Barclays Capital was the structuring agent and jointly ran the book with Deutsche Bank Securities, and Jefferies was co-manager. J.G. Wentworth issued two similarly structured transactions last year, including one for $204 million in December that Jefferies structured and, along with Barclays, acted as co-manager.
Stefano Sola, chief investment officer at J.G. Wentworth, said the firm will pursue at least one more similarly sized bond offering this year. "One of our most important focuses has been spending a lot of time with investors to bring them up to speed on the asset class and the underlying asset," Sola said. "That investor base has become very strong and includes insurance companies, money managers and hedge funds." Sola said that the goal is to make structured settlement ABS a more "mainstream" asset class, which means educating investors, regularly issuing deals with predictable structures and using major underwriters.
Firms such as J.G. Wentworth offer to purchase structured settlement cash-flow streams from injured parties in return for discounted, upfront lump-sum amounts, and they may pool those assets to issue ABS or - if they don't have the platform heft and volume - even sell them to individual investors directly. Besides J.G. Wentworth, other firms that have securitized structured settlements include Seneca One Finance, Structured Asset Funding, Novation Capital and Sutton Park Capital. J.G. Wentworth has distributed 31 Rule 144A transactions and one traditional private deal to multiple accredited investors - all rated - as well as several smaller Rule 144A deals, in the $15 million to $75 million range, to single investors.
Structured settlement-backed bonds' highly attractive returns - compare against 60 basis points over swaps for 'AAA'-rated credit card ABS - stem from their limited issuance and the resulting lack of liquidity. Cory Wishengrad, managing director and co-head of the securitized product origination group at Barclays, said he categorizes the bonds as nontraditional ABS rather than "exotic," a label given to infrequently issued bonds backed by the revenue streams of new or uncommon assets.
"The credit performance has been pristine, with virtually no historical losses and a long track record of issuance since the late 1990s," Wishengrad said.
In a report published in April, Barclays said that since 2002, the cumulative charge-off rate on all payment streams purchased by J.G. Wentworth adds up to a tiny 0.09%, and even less for Peachtree's."It should be noted that [2002 through 2012] includes one of the most stressful economic climates experienced in this country, as well as significant legislative activity in the consumer finance space (such as the bankruptcy reform bill)," the report said. Other securitizers of structured settlements approach the market less frequently, and distribution of the bonds tends to be very limited. Novation Capital, for example, sold a $100 million deal under Rule 144A to a single investor in 2010 that was structured as a single-A-rated tranche by DBRS and carried a subordinated portion. It's taking the same route for another $100 million offering to be completed this summer, said Robin Shapiro, CEO and co- founder of Novation. Deutsche Bank Securities' credit solutions group underwrote the earlier deal and will do the same on the upcoming offering, while DZ Bank's asset securitization group has provided a warehouse credit line to finance Novation's structured settlement purchases since 2001.
Shapiro said that the number of people choosing to structure their settlements has declined in recent years, partly because the low interest rate environment favors lump-sum, upfront payments rather than extending payments over time with little upside.(Structured settlement payments include implicit investment earnings that are tax-free; when interest rates are low, so are these implicit returns.) On the other hand, he said, hard economic times increase the likelihood that people who already receive structured settlements will decide that they want a lump-sum payment after all and sell the payment streams. "They may want to buy a house, go to school or fend off foreclosure, and when they look at other forms of consumer financing today they decide to trade at least some of their structured settlement for upfront cash," Shapiro said. "That's the market we serve."
As a result, Shapiro said that originations of structured settlements purchased by mostly private firms such as Novation appear to be increasing, although data to support that claim are elusive in the fragmented market. Shapiro noted that institutional investors including life insurers and pension funds, who know they have expenses coming due in 10 or more years, are especially interested in the bonds because of their duration and lack of prepayment risk. Structured settlement ABS also provide diversification because the asset class is uncorrelated with the consumer credit that backs much of the ABS in investors' portfolios.
"The credit is even better than the senior debt obligations of very big, solid companies, because investors are standing in the shoes of [annuity] policy holders, and they are senior of most bondholders in these life companies," Shapiro said.
J.G. Wentworth plans to continue issuing structured settlement ABS regularly and increasing the size of its deals. How "mainstream" structured settlement ABS eventually becomes, however, is open to question. Wishengrad noted that the deal "structures are less complicated than other more widely traded securitized assets, like mortgages and auto loans," and as more investors do the due diligence to become comfortable with the asset class, liquidity should improve. He added, however, that the structured settlement ABS' evolution into a more standard asset class depends greatly on how much collateral can be originated.
That said, structured settlement ABS may always be something of a specialty asset class. "It's a lot of detailed and time-consuming work to originate [the assets], and every transaction must be reviewed and approved by a court before the consumer can sell the structured payment rights," Shapiro said. He added that firms purchasing the assets must be patient and prepare for a long-term relationship with investors. "We have not seen a lot of new entrants in this space,"