Excess Spread - Fear and Loathing on Las Ramblas

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Excess Spread - Fear and Loathing on Las Ramblas

Owen Sanderson's avatar
  1. Owen Sanderson
6 min read

Let’s get the good news out of the way first - Global ABS was brilliant. Genuinely an excellent event, sorely missed since 2019, finally back in its spiritual home. It’s great to see everyone again, great to get a few drinks in, some sun (and some sunburn), some good food, some beach.

Order of the Golden Cava Bottle to Baker & McKenzie, Mayer Brown, Alantra, Barclays, BNP Paribas, NatWest, Credit Suisse, Bank of America, Deutsche Bank, Allen & Overy, PCS and BlackRock for their excellent hospitality to your correspondents. Order of the Stinking Hangover to Citi, whose role as Unofficial Afterparty was not performed this year, with the party at Opium downgraded to a more niche event at Soho House.

Now the bad news, which is a market backdrop that could hardly have been worse. Crossover blew out 30 bps on Monday, then another 30 bps on Tuesday. The market bounced in reaction to the Fed (by which time most of the European ABS market was a few beers deep) and comments from the ECB, but the rates moves were massive - hardly conducive to sensible pricing discussions. European securitisation and loans was probably so illiquid this week that levels hardly mean anything, with all the traders and investors alike out, but it’s difficult conditions for sure.

My own unscientific survey suggests roughly two camps of market views….those that made it through 2008 and those who are experiencing their first real bear market and not enjoying it.

In the former corner the view is that it’s a mere flesh wound by comparison to the GFC, and the better capitalised banks, investors with high cash balances, tighter lending standards and so forth will eventually pull us through. There’s nothing remotely like the huge unwind of leverage and forced selling that drove the financial crisis. Markets might be terrible but macro isn’t too bad, with unemployment low, and reasonable corporate profitability. Hard to know when exactly we get a functioning primary market, and what the right approach is for sponsors who have to finance 2021 loan books at 2022 levels, but eventually things adjust and we return to some kind of equilibrium, at wider but stable levels. The view a few weeks back that everyone should sit tight and hope for some conference cheer is pretty dead now, but maybe September, October, or 2023 will see some green shoots.

If you squint hard enough you can even see an argument that of all the asset classes out there, the one that’s floating rate ought to be the winner from all this. TwentyFour Asset Management’s Rob Ford, a man that’s seen a credit cycle or two, said “this ought to be our time in ABS” at Afme’s press briefing, which, when the dust settles, is probably right. Admittedly ABS does seem to have been selling off basically in lockstep with Crossover and risk markets generally, but duration has been the killer for most fixed income funds this year, and we don’t have much of that.

The latter camp is going for full-on freakout, though, and looking to the ominous effects of inflation on hard-up borrowers, either corporate or consumer, rising default expectations in leveraged credit, central banks that have lost control of economies and run out of ammo, divergence in European govvie markets, and any number of other headwinds.

A more ABS-specific issue is the extent to which call options are heading out of the money. I’m not going to try to pick deals - there are much smarter much better paid people out there doing that - but I’d be looking closely at low rate legacy mortgage pools owned by sponsors, especially if they don’t have much of a front book, or much of a reputation they need to maintain. For the specialist lenders still originating assets, they depend on the market, and they’ll want to keep their reputations in good shape and call deals in a timely fashion, even if the economics are marginal.

Investment banks do seem alive to the issues, and are still out there offering balance sheet, we understand, so calls can be exercised and assets warehoused until a more opportune refi moment.

The relative strength of the arranging banks in securitisation seems to me a reason to be medium-term optimistic…..the banks are still putting on risk, still hiring people in securitised products, still willing to do new forward flows, still supporting new lenders. Just this week JP Morgan has a new buy-to-let forward flow with MT Mortgages, for example.

There’s been selective grumbling about secondary liquidity, but when is there not? Dealers, one imagines, have no desire to sit on inventory they keep having to mark down, so a certain lack of enthusiasm about bidding bonds might be expected. Fundamentally, if the major intermediaries in securitised products are still there and still active, the market is going to make it through, somehow, some time.

Of course, if we’re just looking at a mark-to-market blip, then the ideal asset class is something that barely trades. The direct lending funds have always enthusiastically promoted themselves as less volatile than liquid credit - can’t mark to market if there isn’t one! - but the same is kind of true of risk transfer. Yes there are marks, there’s even mark-to-market repo financing for some of the bonds, but there’s also a lot of very bilateral, mark-to-model deals done, and many of the players in the market don’t do anything else. If they’re not buying risk transfer deals, they’re not deploying capital at all.

That’s helped risk transfer remain more resilient than most other corners of securitised products. Even as CLO equity NAVs have cratered, SRT deals, which are also first loss positions in books of corporate credit have continued to get done, and pricing has widened nowhere near as much as CLO tranches.

In CLOs more generally, the market has been looking for direction - and will hopefully have found some this week. There’s no way of working around the fact that financing a loan book bought at 98 and 99 in this market is going to hurt, the question is just how badly it will hurt and when. Is it better to take the pain now, or keep crossing fingers? Flipping a warehouse into a static deal could also help - the liabilities will be tighter and the structure more efficient - but on the other hand this just locks in a poor performance. At least a deal with a long reinvestment period might turn things around in a year or three, even if the arb is worse up front.

Away from the parlous state of the market, Kensington’s sale process was the talk of the town, as it creeps closer to completion. Every year but this one, Kensington is the most active RMBS issuer in the largest market, with the most liquid deals - if it disappears from markets under new ownership, that will make a massive difference to volumes. Theoretically that ought to tighten spreads for every other lender (though that seems like a pretty remote possibility right now), but it’s beneficial to have a regular benchmark shelf from a non-bank out there.

Barclays is buying the platform, which could be valued around £400m according to Bloomberg - and the big question is what it plans to do with it. Specialist lending with High Street funding costs could cause trouble for Kensington’s competitors - mortgage pricing has been moving quickly as lenders are trying to follow swap rates higher without losing market share. It’s already been a delicate operation but the heft of Barclays could make it even harder.

Expect more specialist lender M&A down the road. Institutions caught on the wrong side of the swap rate steeplechase - of which Molo is the most prominent example so far - may be looking to sell up, and others will be keen to grab some market share. Who is predator and who is prey though? That will shape the securitisation market for 2023 and beyond.

This Excess Spread is a slightly truncated version, for which we can only apologise - we’ve got a notebook full of half-formed scribbles to follow up, but we’ve got a plane to catch too. Hope everyone had a fantastic one!

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