Esoteric ABS set to clear political and policy hurdles in 2017
Esoteric ABS was a focus for investors hunting for yield in 2016. The market for these assets blossomed, as issuers were lured by attractive relative value in comparison to other sources of financing. But rising interest rates, the potential for trade wars under a new US president and fits of capital markets volatility top the list of concerns for market players this year. Max Adams reports.
Esoteric ABS is an increasingly important point of focus in the post-crisis era, as yields on traditional assets have tumbled against the backdrop of low interest rates. The pick-up in yield that investors can get to compensate for illiquidity or complex structures and unfamiliar collateral has been a draw for those willing to put in the due diligence.
But securitization as a funding tool also became more attractive in 2016 for issuers, including some first timers, as the yield chase hit an inflection point, creating a supply and demand circle that made ABS more attractive.
Dealflow in 2016 was on a par with the year before, with around $35bn issued, but new issuers and untested collateral were the highlights of the sector.
A maiden issuance in July from Verizon Communications was a good demonstration of the demand for new assets. The telecommunications carrier priced the $1.69bn VZOT 2016-1 backed by contract payments made by customers on their mobile devices to heady demand, at 55bp over the interpolated swap for the senior class.
Verizon followed up with a second deal in November, pricing the senior bonds 20bp tighter than those from the first offering, at 35bp over swaps.
“Issuance of assets like mobile phone payments becomes an economic question,” says a banker who worked on the Verizon deal. “In that space in particular the issuers are seeing enough added value to put in the work. Where before, saving 25bp compared to corporate debt wasn’t compelling enough, they’re now saving a lot more.”
He adds that the order book included a good deal of crossover investors from the corporate bond market who had been frequent buyers of Verizon’s senior unsecured debt. The second deal also saw around a quarter of the book made up of first time investors enticed by the success of the earlier offering. Those bonds have also enjoyed a rally in the secondary market, with the senior notes of the first deal tightening by over 20bp in the three months after the deal was issued.
The offering, and the strong demand from investors, has opened the door for other US carriers to consider tapping the ABS market in 2017, sources say.
However, the initial groundwork that needs to be laid can be an obstacle for first time issuers.
“It could take some time for some of the other carriers that have not issued a securitization like this before to do the basic work of getting their ducks in a row,” says Jody Shenn, assistant vice president and analysts in the structured finance group at Moody’s in New York. “There are also carriers for which it is less clear how ABS would fit into their funding profile.”
Regardless of how and when other carriers decide to follow Verizon into the securitization market, industry players are optimistic that the asset class will grow in 2017, as these companies are sitting on vast amounts of contract receivables.
At the ABS East conference in Miami Beach in September, a panel of portfolio managers were unanimous in their views that cell phone bonds would be an area of focus for them in the coming year.
But for all of the talk about new asset classes and debut issuers, the esoteric ABS market in 2017 is exposed to a new set of risks that could take the shine off of securitization as a source of funds.
Keith Allman, vice president and senior securitized asset analyst at investment manager Loomis Sayles, says some of the anti-free trade rhetoric Donald Trump voiced on the presidential campaign trail looms large over some esoteric assets, as does the potential for trade wars to break out. ABS tied to shipping, such as container lease-backed deals, as well as aircraft ABS, would be negatively affected by a more hostile global trade environment.
“Looking forward in the long run, the election is not very positive for the container market, given some of the protectionist rhetoric,” he says. “The [Trans Pacific Partnership] is gone and the [North American Free Trade Agreement] could be changed. How is this going to impact global trade?”
According to Allman, contracting global trade and a devaluation in local currencies against the dollar are problems for container lessees, as well as aircraft ABS issuers. Companies that include cargo planes in ABS collateral pools could take a hit if global trade slips in 2017.
On the bright side, however, equipment and railcar collateral could get a boost from Trump’s proposals to ramp up infrastructure spending. An overhaul of US infrastructure would increase the demand for construction equipment and rail shipping, boosting lease rates and filtering down to ABS trusts backed by these assets, say market players.
In another corner of the esoteric ABS market, players in renewable energy finance are hoping that residential rooftop solar securitization can finally take off the way it was meant to in 2016.
At the start of last year, market analysts predicted a boom in issuance of ABS backed by rooftop solar assets. However, new issue volume disappointed, as issuers were spooked by early capital markets volatility or otherwise found alternative ways to clear their balance sheets. Only one deal was issued last year, a transaction from SolarCity that was sold in March.
In May, SolarCity sold a $227m portfolio of solar assets totalling 201MW to John Hancock Financial. These kinds of portfolio sales allowed issuers last year to avoid the headaches of securitization and sell on an as need basis, rather than having to wait to hit a critical mass of assets.
What little ABS has trickled into the new issue market has also shifted, from deals backed by leases and power purchase agreements (PPAs) to loans on the systems themselves.
“We think we will see more loan transactions… The market for ABS backed by leases and PPAs has been very quiet,” says Tracy Rice, vice president and senior credit officer in the structured finance group at Moody’s in New York. “SolarCity has been doing whole loan sales, so they haven’t securitized.”
But like many other corners of the economy, policy changes are on the horizon with the potential to disrupt the sector. President-elect Trump has vowed to make traditional fossil fuels competitive again with renewable power generation, and his administration could funnel money away from federal support for green energy. Players in the sector have voiced concern in particular for the investment tax credit (ITC) for solar and wind energy development, which some fear may not be renewed under a Republican legislature.
Yet, in a twist, the end of the ITC could mean that securitization becomes more attractive for solar finance companies to fund themselves.
“The worst case scenario, the way solar is currently financed, is that Trump will remove the tax credit and that would only cause temporary pain,” says Benji Cohen, CEO and founder of T-Rex, a renewable energy risk analysis and valuation company in New York. “The industry is reliant on the tax credit for now but it doesn’t mean that there aren’t other viable sources of capital out there — like securitzation.”
Virgin brings mobile phone bonds to Europe
While esoteric ABS has been a thriving part of the US securitization market, the use of securitization to finance more unique collateral is rarely seen in Europe. That may be changing. In November, Virgin Media landed a £125m transaction backed by customer payments on mobile devices, similar to the two deals from Verizon Communications sold in the US in July and November.
Virgin Media owner, Liberty Global, has historically turned to the high yield market for funding. However, treasurer Nick Marchant told GlobalCapital in November that the ABS transaction offered funding at an equivalent double-A corporate level. The company has a BB- corporate credit rating from Moody’s, Fitch and Standard & Poor’s. Marchant said that the transaction saved the company around 150bp-200bp compared to funding via high yield.
While small, the deal could pave the way for other telecommunications companies to tap the ABS market. The demand has already been demonstrated in the US, where investors heavily oversubscribed to the two Verizon deals.
Analysts say they see no reason why the market for mobile phone ABS in Europe could not experience volumes similar to the US, which is said to have the potential to grow into a $20bn sector.