Securitization Industry Gathers Ten Years After Market’s Nadir

Securitization Industry Gathers Ten Years After Market's Nadir
Adam Tempkin
25 February 2019

Revitalized, safer market faces end-of-credit-cycle froth
Libor transition may dominate discussions, trade group says

(Bloomberg) -- In February 2009, a demoralized securitization industry gathered for its annual industry conference in Las Vegas, broken from the recent financial crisis.

Glum faces and a dreary outlook prevailed and the media bristled at the notion of Wall Street bankers holding an event in Sin City at that particular time. Conference organizers seemed to take the criticism to heart and it wasn’t held there again until three years later.

Fast forward to today as a revitalized, safer, and fully functioning market gathers at the annual confab. It’s now held at the Aria hotel by a different trade group and attended by more than 7,000 people. A rebuilt securitization machine is firing on all cylinders.

While subprime-mortgage CDOs may be resigned to the dustbin of history, participants heading to the shindig this week can’t avoid grappling with another ominous parallel to that decade-old moment in time: The impending end of a credit cycle and all the frothiness and risk that comes along with it.

“This summer marks the longest cycle of expansion that we’ve ever had,” said Kristi Leo, the head of investor policy at the Structured Finance Industry Group, a trade association running the event. “So people are saying, ‘How much longer until that cycle hits its end? What is going to signal the end of the cycle?’ Everybody has different views. It’s going to be widely discussed, as it can mean both risks and opportunities.”

“Asset prices have gone up a lot in this cycle. Faster than rates have gone up. People are wondering, ‘How does that plane come in for a landing?,’” added Michael Bright, who became President and CEO of SFIG in January after a stint leading Ginnie Mae as executive vice president and chief operation officer.

Lessons Learned?

While spreads have recently widened following December’s credit-market selloff, margins on most asset-backeds have narrowed to historical tights over the last two years, making it hard for investors to find relative value. Subprime-auto ABS spreads, for example, continue to narrow, despite rising costs to issuers of increased credit protection, and record levels of delinquencies on consumers’ car payments.

In fact, asset-backed spreads overall are expected to tighten even further this year. “After a choppy December, January and February have been very positive for the ABS market as risk appetite improved,” said Jay Steiner, co-head of global ABS at Deutsche Bank. “Spreads still have not tightened as much as competing assets classes such as corporates and have room to go.”

Meanwhile, regulators recently highlighted the potential bubble in corporate credit and leveraged lending. The hotter-than-ever market for collateralized loan obligations continues to grow, hitting a record of $130.4 billion last year. But that raised eyebrows. Although the product survived the last recession with hardly a scratch, investors worry that covenant-lite loans and underlying weaker credits mean the bonds may not be adequately tested to withstand the next downturn.

The Libor Problem

Even the private-label residential mortgage-backed securities market is finally showing small signs of life, as demand for non-qualified mortgage transactions grows. This means non-prime collateral is slowly coming back into vogue, albeit at much smaller volumes than 10 years ago.

“Ultimately securitization as an investment is very different than what it was going into the Great Recession,” Leo said. “People are feeling better about it; structures are different, and people are being thoughtful. For instance, they make sure they have liquid assets.”

Leo adds that the consumer is in a much better position compared to the last cycle, and housing is in better shape as well. “The tone, in my view, is constructive.”

But one potentially big wrench is being thrown into the machine as the industry faces this end-of-cycle precipice: Libor is going away, and it’s going to be an operational headache.

The topic is expected to dominate discussions in Vegas, as the process for benchmark replacement and the legal implications are complex and different for every single asset class. It’s unclear what will happen with legacy deals, or if a forward-looking term curve could be developed for SOFR. It’s also unclear whether there will there be a significant shift away from Libor deals ahead of the phase out at the end of 2021.

“The Libor transition -- this is real, and people are realizing it. There’s lots of wood to chop over the next year. There’s a long to-do list,” said SFIG’s Bright.

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