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Laying down a challenge

10 August 2016 by Ben Hayward

The most interesting discussions we have on the desks normally revolve around where we think the best value is, with the different strategies backing their favourite picks and trying to make each other understand the hidden value that the market isn’t appreciating.

Yields, and the corresponding value, are “not door numbers” as Gary is fond of reminding us, and have been driven by sentiment, fundamentals and direct central bank intervention amongst others.

The last of these – central bank action – took an interesting turn yesterday as the Bank of England, on the second day of buying more gilts, failed to buy their target amount in their reverse auction. Another sign of the technical squeeze in £ fixed income that we are experiencing at the moment.

Already since the announcement of the intention to buy £10bn of corporate bonds, spreads on eligible bonds have tightened significantly, and even ineligible bonds – banks and insurers – have seen the “portfolio effect” push prices up and yields down.

Has this value shift happened across the entire market? Definitely not, and a deal last week in the UK RMBS market emphasizes this.

Hawksmoor 2016-1 is a £2.25bn deal backed by vintage (2007) mortgages originated by GE Money. I’m not going to go into the detail of the trade, or our credit view, rather more interesting is the levels the deal priced at and the demand.

Rather unusually there were a couple of tranches issued with split ratings. The Class D bonds are A-/Baa2 and the Class Es are BBB/Ba2. Investors’ interest for these two tranches were between 2 and 5 times the amount of bonds issued, and they priced tighter than initially expected.

Even with that in mind, the yields these bonds were issued at were sterling LIBOR plus 4.75% and 6% respectively.

That’s an incredible yield for 3yr bonds, when compared to the yield on BBB sterling corporate bonds which is currently 1.85% over the same index.

Asset backed securities markets are not as mainstream as corporate bonds and prices do tend to lag, but I challenge any of my colleagues in our other strategies to find something more compelling.

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