During the credit crunch, the market in asset-backed securities, which funds a substantial chunk of U.S. consumer credit, all but came to a halt. To make more credit available and help revive the struggling economy, the Federal Reserve launched its Term Asset-Backed Securities Loan Facility, or TALF, offering nonrecourse ABS-collateralized loans at attractive rates. Investors in effect got to leverage returns in a sector in which yields had reached unprecedented levels of 15 to 20 percent on AAA-rated, consumer asset-backed securities.
Not surprisingly, the TALF succeeded. Lured by cheap finance from the Fed, investors have driven down the spread on consumer ABSs over swap rates (the sector’s benchmark) by as much as 500 basis points over the past several months. Suddenly, investors are being forced to forage elsewhere for high yields. The most likely beneficiary? Esoteric ABSs. Underwriters expect asset-backed investors to turn increasingly to this niche market, where it’s possible to earn a generous spread over the yield on securities backed by auto, credit-card, small-business and student loans.
“If you’re looking for outsize returns, a lot of the remaining opportunity is in esoteric, off-the-run products,” says Brandon Dunn, co-head of fixed-income sales for Stamford, Connecticut–based Rochdale Securities. “They may have complexity, but with the right analysis there’s good opportunity.”
Roughly ten to 20 asset classes make up the esoteric sector including rental-car fleets, transportation, cell phones, aircraft, containers, intellectual property, timeshare loans, trade receivables and casualty insurance. Investors can earn higher yields for these assets — which make up 2 to 3 percent of the ABS sector — because they’re less liquid and require extra due diligence. Though here, too, spreads have narrowed, investors can pocket 100 to 150 basis points more, on average, than they would buying plain-vanilla consumer ABSs.
That is notably wider than the historical spread between these two ABS sectors and reflects the absence from the esoteric market of insurers like Ambac Financial Group and MBIA. Impaired in the credit crisis, most monoline insurers are no longer offering credit wraps for esoteric issues. Their withdrawal has created spread opportunities for investors comfortable doing their own analysis. A three-year AAA-rated rental car loan issue currently trades around 150 to 225 basis points over swap rates. By contrast, a more conventional three-year AAA-rated traditional auto ABS for an issuer such as Mitsubishi Motors Corp. trades around 35 to 52 basis points over swaps.
Cory Wishengrad, a managing director of Barclays Capital in New York, says he’s “bullish on nonmortgage, nonconsumer ABSs for 2010 as investors look for better yield.” Wishengrad adds that “there were few if any credit losses” in the esoterics group in the credit crisis. He is encouraged by interest in recent deals, especially the $1.9 billion securitization of cell-tower leases in January by Houston-based Crown Castle International Corp.
That oversubscribed deal, which had an all-in spread of 232 basis points over Treasuries for three tranches, marked the largest wireless tower securitization, and one of the largest-ever esoteric ABS issues. Wishengrad notes that traditional investment-grade corporate investors represented “a majority of the book in a way we haven’t seen before.”
Further esoteric deals are in the pipeline. Until recently, issuance was focused on cell towers, rental cars and catastrophe bonds. For 2010, Wishengrad expects greater emphasis on transportation assets, such as aircraft, containers and railcar ABSs.
The absence of monoline insurers from the esoterics market may hamper its recovery. But Jordan Yarett, a partner at law firm Paul, Weiss, Rifkind, Wharton & Garrison in New York and an adviser on many landmark nontraditional ABS deals, points out that “a number of successful transactions have been done without monolines, and a broader investor base is likely to develop.”
