Central Banks did not rock the boat
With almost 5,000 participants, it is fair to say that last week’s Global ABS Conference in Barcelona was extremely well attended and in particular we noted a significant overseas investor presence this time around.
Now in its 27th year, the conference is a great way to gauge investor sentiment and to hear from speakers about the issues concerning the products that we are invested in so we left London with high expectations for this year’s edition; recession fears are real, inflation is high and borrowers are feeling the cost of the higher interest rates, but at the same time it’s the first year since QE came to an end and the ECB has ceased new investments in buying AAAs, so a good recipe for some interesting discussions.
We found that investors were more bullish than we expected, clearly supported by a very strong first half of the year and high current income. Most investors were generally realistic about upcoming fundamental challenges (higher interest rates and the potential for increasing unemployment creating payment stress leading to rising arrears, especially in non-prime and unsecured lending for example), but that bond structures are proving resilient and current valuations look to be pricing in this risk accordingly. With a higher Sonia/Euribor investors should also have more protection against future volatility as well. Having said this, some panels sounded overly opportunistic in our view, especially around commercial real estate (CMBS) where neither the rating agencies or bank analysts seemed to be too concerned about poor liquidity, excessive property valuations or dropping occupancy levels, and on these points we tend to disagree.
One of the key discussion points centring around CLOs was on the current lack of leveraged loan supply and the resultant sharp slowdown in the primary market. While all investors seemed to agree on the tremendous amount of value opportunities available in CLO liabilities (particularly in AAAs and BBs), there is less confidence in CLO equity and in general the view is that loans are looking expensive vs. high yield (senior secured) bonds. Interestingly this lack of loan supply creates a very strong technical in the loan market and we think this in itself could lead to some refinancings of CLOs, which could clearly be a good source of alpha in the future as most CLOs still trade at considerable discounts.
Away from CLOs we noticed that there were a lot of bank issuers at the conference, which in itself isn’t unusual, but post-ECB QE they actually had something they wanted to talk about. Clearly the frequent issuers were all there, but this year we saw a significant increase from lenders that have relied on the ECB for cheap funding for a long time, and they now appear to be shifting their focus to the ABS market for public funding. Clearly this is welcomed by the market, as it helps to improve much needed diversification (both in terms of asset classes as well as jurisdictions). They weren’t just looking for funding though, bank capital rules are getting tighter, and they were keen to discuss options for Significant Risk Transfer (SRT) transactions, to look for capital relief, and also to introduce a wider range of asset classes and jurisdictions to their product ranges. So next to AAAs, we think we should also expect more mezzanine and junior ABS supply to the market in the future and while the exact format doesn’t always work for us, we do welcome the opportunity to invest in some good consumer risk that banks have tended to keep to themselves.
As always, regulation was also high on the agenda, as securitisation is probably the most heavily regulated market in all of fixed income - and we can probably dedicate a full paper on regulation ranging from risk retention to due diligence requirements! But there isn’t a great deal of progress to report in our view, other than it’s noticeable that regulators are currently in listening mode, which is a refreshing change after several years of what we would characterise as authoritarianism, and so we have some mild optimism that positive progress might get made to ease some of the unintended technical pressure points on investors.
It was not all halleluiah however, we discussed higher mortgage rates (especially in the UK), LDI volatility, the limited size of the active investor base (although asset managers such as ourselves do of course invest on behalf of a huge amount of underlying end investors), the implications of extension risk, earnings slowdowns for corporate borrowers, the potential for another Euro crisis etc., but really nothing we didn’t know already on the whole.
Overall we left Barcelona with a much more constructive feeling which really mostly relates to a more diverse investment opportunity and the potential we see for some further spread tightening in the medium term. So to stay with the weather theme….. some sun, some rain…. rainbows from Barca!