ABS vs GiltsNine months ago you could buy really solid AAA UK RMBS at between 60-70% of face value. I and some others pointed out this outstanding buy opportunity at the time. Now the price is 90-100. Has the buying opportunity gone, or is there still value to be had?
An institution such as an insurance company or pension fund which invests in fixed income could be expected to have put a lot of money into Gilts or other sovereign bonds in the last couple of years. The income might be poor, but you couldn't be blamed/fired for being risk averse. But there are now good reasons to look again at ABS:
-Sovereign risk. Taking Ireland as an example, Fitch rates the sovereign at AA-. But you can buy Irish ABS which is still AAA, three notches higher. (Sovereign risk is not the same as country risk). The UK could well be downgraded in the medium term. ABS offers a good yield at a higher rating than many governments are or might be.
-Rating stability. Yes, in spite of what sensationalist journalists might write, Standard and Poor's points out "between mid-2007 and the third quarter of [2009], more than 98% of our 'AAA' ratings outstanding on European residential mortgage-backed securities (RMBS) and consumer asset-backed securities (ABS) remained AAA".
-Risk diversification. What it says on the tin.
-Quantity of sovereign debt. A lot of governments have an awful lot of money to raise. This might impact on the price of sovereign bonds currently held.
We are recommending to institutional investors that they look carefully at the benefits of investing a proportion of their money in ABS. This obviously involves having a thorough knowledge of ABS to find the right bonds, and avoid the wrong ones. Which is where we come in.
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Central banks and pundits alike keep repeating the mantra that banks should increase their holdings of liquid assets. That no doubt suits governments which have an awful lot of debt to flog over the next few years.
But what is liquidity? The ability to sell for cash at any time? For there to be real liquidity, there has to be a real buyer at the end of the chain, not just pass-the-parcel traders.
Keynes was characteristically cutting about this in the General Theory, now over 70 years old:
"Of the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of “liquid” securities. It forgets that there is no such thing as liquidity of investment for the community as a whole."
Don't we have central banks as lenders of the last resort? The Bank of England lent £61.6bn to RBS and HBOS at the height of the crisis. This could not have been avoided by forcing these banks to put more gilts in their balance sheets. Mind you, central bank intervention doesn't help to bale out governments issuing vast quantities of debt. Printing money and buying gilts, plus forcing banks to buy more than they would otherwise buy, does.
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There's been a lot of stuff in the press recently about banks such as RBS and HBOS losing 'vital' staff in the securitisation, structured finance or other areas due to limitations on pay and bonuses.
Seen from where I sit the answer is simple-get in the consultants!
Here's why:
-We have loads of experience. My colleagues and I have all personally structured many deals, and run departments in big banks;
-We just get paid for our time, and don't have any claim on the bonus pool;
-We're not part of the headcount, so easier to bring in as & when required to get a specific job done;
-We're not part of the hierarchy, so do not get involved in office politics; we're just there to make things happen.
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Back in September, Barclays caused a stir in the markets with the Protium transaction. The FT's headline was "‘Curious’ case of Barclays assets sale". What was it all about, and is it relevant to other banks?
Barclays sold $12.3bn of assets to a new, unrelated entity in the Cayman Islands. Not only did they transfer the assets, they also lent the majority (but importantly not all!) of the funds to purchase them, and transferred the staff to run them, effectively creating a new fund management entity.
Chris Lucas, the Barclays FD, is on record as saying that they weren't trying to change their risk profile. So why did they do it? Step forward our old adversary "Fair Value Accounting". If they left the assets on the trading book, there is a fair chance of taking a big hit if market prices fall. If they put them into banking book, they are to some extent protected from the vagaries of "Fair Value", but can't sell as freely as if they were on the trading book.
The Protium deal should mean that the bank is protected from the whims of "Fair Value", but the assets can still be freely managed. And the bank gets a predictable income stream over 10 years.
What about other banks? This type of approach could make sense to anyone who has toxic assets. We're already in discussions with one.
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The Bank of England has good intentions. It knows that the big banks are not lending where lending is really needed-to middle market companies (MMCs). So it launches initiatives to try and get money where it is needed. One of these is the Secured Commercial Paper Facility (SCPF), launched earlier in 2009.
The BoE has announced that the number of firms benefiting from the SCPF to date is-nil. Zero. Not a single one.
Why is this? One reason may be that the original concept was fairly academic. It wanted to fund via commercial paper conduits, presumably because they are already there. But conduits can fund themselves cheaply by issuing in US dollars and swapping via the spot-forward market anyway. The BoE also insists on a rating. But getting ratings on small pools of receivables is labour intensive. So why wouldn't an arranging bank just stick with bigger customers. Which is what has happened to date.
So the poor old MMCs miss out again. The next initiative is supply chain finance. There's a lot more mileage here, but there are still inherent problems:
-Big banks aren't lending as much as they should, or indeed promised. Why would they lend any more under SCF?
-Everyone's simplistic illustration is a small customer selling to, say, Tesco. Under SCF the supplier gets paid up front, and the "lender" collects from Tesco in e.g. 90 days. That gives everyone a rating to cling to. But the real requirement is MMC to MMC business, where there isn't a rating.
-So we need some credit insurance. But credit insurers also only want the best risks. So the unloved MMCs are left grovelling to the banks.
Incidentally, I'm constantly amazed how many capital markets firms assert that they don't rely on ratings, do their own credit work etc etc-but actually cling to ratings like a toddler to its security blanket.
What we need is either a trade receivables-type rating approach-the credit enhancement comes from the discount on purchase, not a third party-or an insurer to enter the market and grasp this opportunity in the same way as ACE and XL did some years ago in a different insurance sector when reinsurers were running scared.
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