Sector, Selection Will Be Key in 2013

The weather in Las Vegas at the end of January was cold and grey, but attendees at the American Securitization Forum (ASF) conference saw mostly clear skies ahead.

Michael Binz, a managing director at Standard & Poor’s, said the degree of enthusiasm in the securitization market was where it had not been in years. “A year ago, the mood was starkly different,” he said at one of the opening panels. “There were fewer investors participating, supply was rapidly diminishing and regulatory uncertainty was stifling market activity.”

By comparison, “Today many sectors of the market are rallying, investors have returned, there’s a level of enthusiasm and demand we haven’t seen in years.” Also, “there’s a degree of regulatory certainty taking shape.”

One of the most salient manifestations of that has been an extraordinary tightening in spreads on structured products across a number of asset classes.

“Last year was a good year for spread products,” said Gagan Singh, chief investment officer at PNC Bank, a view echoed by other panelists. The tightening, he said, was both “justified” and “a long time in the making.”

Strong liquidity, courtesy of exceedingly low interest rates, an improving macroeconomic picture and falling volumes of outstanding deals have all played a part in compressing spreads, panelists said.

But after such a strong rally in 2012, Singh said, certain asset classes are already looking rich. This year, sector and security selection will be important.

One sector where spreads are likely to keep tightening, panelists agreed, is collateralized loan obligations (CLOs). That is partly because CLO spread tightening to date has lagged behind other sectors, such as commercial mortgage-backed securities. “The demand side is not in question whatsoever,” said Leland Hart, a managing director at BlackRock.

There are technical factors that may keep other sectors from widening much, if at all, this year. In RMBS, for example, Peter Sack, a managing director at Credit Suisse, noted that amortization is running ahead of new production.

On the issuance front, Sack predicted more private-label RMBS this year, although he pointed out that this wouldn’t be a difficult feat, given the paltry $3.5 billion placed last year.

Claire Mezzanotte, managing director at Dominion Bond Rating Service, said that she expected many other asset classes to see healthy issuance. Volume in credit card ABS would likely go up slightly, she added, with Canadian issuers likely to make their presence felt.

The auto sector ­— which took off in January — will also see more deals this year than last, according to Mezzanotte. But she warned that standards may start to slip in origination as competition among lenders grows more intense. “We’ll be looking at that 2012 vintage carefully,” she added.

Spreads on CLOs to Play Catch Up

Interest rates on sub-investment grade loans are still relatively attractive, and corporate defaults are still quite low, but the main reason the panelists expect CLO spreads to continue tightening is that they have some catching up to do with spreads on other kinds of structured products.

“If you compare what you’re paid on a risk basis,” for the triple-A rated tranches of CLOs and some other kinds of securitizations, “it’s not even close,” Hart said.

He said the limited supply of corporate loans available to be securitized, versus some other kinds of assets, will only contribute to the spread tightening. “What determines whether we see $50 billion or $70 billion (of issuance) is the availability of loans and the increased use of warehousing.”

How much could CLO spreads tighten this year? Singh pointed out that spreads on new-issue triple-A tranches of CLOs are currently around LIBOR plus 139 basis points; although that is much narrower than at this point last year, when they were closer to LIBOR plus 150 basis points, it is still rich compared with triple-A tranches of commercial mortgage-backed securities. The latter are pricing in the range of LIBOR plus 70 basis points.

Even if corporate loans and commercial mortgages are different asset classes, Singh said, that kind of spread differential is unlikely to be sustained.

Hart predicted that secured bonds will play an increasingly important role in the CLO market. CLO documents typically stipulate that the majority of assets, often 90% or more, be invested in senior secured loans. But he said new deals could carve out bigger investment buckets for secured bonds. That’s because they are becoming more plentiful and also because investors are realizing that they offer the same protection as secured loans, even if they are fixed rate, rather than floating rate.