Despite falling out of favor, the securitized sector merits reconsideration for, among other things, diversification, yield advantages, and availability.
And the Basel Committee on Banking Supervision may have recently made it easier to use. The committee in July published new criteria to help investors assess the risks involved in asset-backed securities.
The BIS issued final criteria “for identifying simple, transparent and comparable
Securitizations” on July 23. However, “the purpose of these criteria is not to serve as a substitute for investors’ due diligence but rather to identify and assist in the financial industry’s development of simple and transparent securitization structures.”
Nonetheless, the new criteria could mean an easing of capital requirements on qualifying products.
The Basel III regulations have restricted banks ability to issue time deposits and taken away an important asset class for cash investors. If asset backed securities (ABS) are allowed this would ease some to the supply/demand imbalance-taking place in the cash market.
Breakdown of the meltdown.
Before embarking on investment in this sector it is important to understand what happened during the financial crisis. Credit-fueled borrowing, combined with poor under¬writing and heavy reliance on complacent rating agencies brought on the market collapse. Spreads widened and liquidity decreased. It is no wonder investors pause before reentering this sector, even though traditional ABS bondholders incurred no losses.
Anything with cash flow is securitized.
Most cash flows in the market today can be securitized: auto loans, credit card receivables, home rentals, and music royalties; just about anything (a David Bowie bond and solar panels to name a few of the exotics) can be bundled into a short-duration fixed-income securities.
During The NeuGroup’s Spring 2015 Treasury Investment Management Peer Group (TIMPG) meeting, RBC Global Asset Management presented to members what they should consider when evaluating asset-backed issues, or what your manager should consider:
•Assets—Focus on well-established asset classes with predictable residual values and longer track records.
•Strong servicer with robust systems.
•Issuer—Look for large, frequent issues for better liquidity.
•Structure—Focus on well-defined structures with supportive trigger mechanisms.
•Issuance Type—Prefer public versus private for increased liquidity.
•Term—Like to see it match the asset. For example, a shorter term for autos.
ABS offers relative attractiveness in the market.
The ABS market can be viewed as an alternative to corporate bonds. The high quality, AAA-rated ABS compares favorably to corporates and thus can add some sector diversification. One TIMPG member shared with the group that his company added ABS issues in 2005 as part of a blended short-duration strategy. When these issues were added the member felt as if the sectors were an extension of what they were already doing, and a complement to their existing government and credit portfolio.
They also decided to hold these securities in the externally managed portfolios since these sectors required special expertise that they did not have internally. A few years after this change, a detailed performance analysis revealed that the issues have enhanced portfolio diversification; overall, the experience has been positive, with no major issues, even during the financial crisis. One change this member made to the guidelines post-financial crisis is to allow only AAA-rated issues. (Previously the guidelines allowed anything AA or better.) They recommended that anyone adding this sector to their investable universe start with AAA issues only.
Buyers beware when selecting external managers.
“Managers have to have expertise in this space, and we talked with a lot that did not,” noted one TIMPG member. When interviewing managers, it was very important that the managers had the resources and talent to properly evaluate these issues. Another consideration, this member said, is whether they include this asset class within their blended portfolio or should they have a dedicated ABS portfolio? Managing only ABS issues in the portfolio allows you to choose an investment manager truly dedicated to the asset class. It does add though another layer of reporting for the corporations to blend the two portfolios for total portfolio statistics.
Despite the horrified looks you may receive when you mention to management that securitized debt offers value, the sector is worth revisiting. With careful review and sticking to a disciplined review process, relative value can be discovered. (RBC also suggested you may want to avoid the Bowie bonds.)