Most investors in a recent survey said they want to ditch the pricing benchmark now used for many kinds of securitization.
JPMorgan analysts recently took a poll of those who buy asset-backed and commercial-mortgage-backed securities and found 61% of respondents wanting to go back to pricing bonds against Treasuries.
For the last 15 years it’s been standard practice for floating-rate paper backed by a range of assets to price at a spread against the “swaps curve.” This benchmark is derived from swaps, which are agreements to exchange one set of cash flow for another. The pricing of these agreements helps create a curve of fixed interest rates across different maturities.
In a recent report, the analysts didn’t disclose the number of respondents but said it covered “a range” of their clients in the ABS and CMBS worlds.
The analysts launched the two-week survey to gauge whether the recent “collapse” in the spread between the swaps curve and Treasury curve had made the former a less reliable benchmark for investors. Typically the spread between swaps and the Treasury curve moves more or less in sync with the spread between asset-backeds and swaps.
But since the summer, the swaps-to-Treasury spread has plunged, out of whack with both the ABS-to-swaps spread and ABS-to-Treasury curve. The latter two have widened as one might expect with the looming rate hike and global economic uncertainty.
In general, the larger investors in the survey preferred switching back to Treasuries by a bigger margin. Some 81% of those who self-identified as managing more than $10 billion were in the pro-Treasury camp. On the other end of the spectrum, the $1 billion-$5 billion cohort were evenly split between Treasuries and the swaps curve.
Before 2000, pricing against the Treasury curve was the convention for securitization. The catalyst for change was the 1998 financial crisis, which exposed the risk of using government bonds as hedging instruments. Within a couple of years Treasuries had lost favor as a pricing benchmark in the securitization world, although they remained the standard for other kinds of bonds.
Just because most respondents to the survey want to go back to Treasuries, it doesn’t mean it would be easy.
Many investors would have to change their portfolio-hedging strategies.
A full 60% of those polled said they hedged interest rates on their ABS and CMBS books. Among the hedgers, the instruments used included, naturally, Treasuries (62% of respondents), swaps (72%), and futures (64%).
Out of ABS investors, 75% used more than one hedging instruments. The figure for CMBS was 68%.
Among the respondents, 47% were money managers, 20% insurance companies, 15% hedge funds, 10% banks, 4% pension funds, and 4% other investor types. As a reflection of the wider ABS/CMBS investment universe, hedge funds were overrepresented and money managers underrepresented.
The JPMorgan analysts see the benchmark discussion continuing into 2016.
They said that their colleagues who cover mortgage-backed securities had observed mortgage pricing following Treasuries more closely than swaps in recent months. There too, “the sharp flattening in the swap curve [is] raising concern about the right valuation and benchmark.”
The MBS analysts, though, warn that a switchover would be fraught, with the potential to “derail the entire valuation framework” for the sector. They added: “A switch to a Treasury benchmark would be far too premature, despite expectations for mortgages to continue to be more linked to Treasuries through the end of the year.”