Investors that were brave enough to stay in the ABS market in the aftermath of the 2007/2008 crisis were richly rewarded. The large price fluctuations and eagerness of other investors to offload assets at any price left the surviving investor base with plenty of buying opportunities. Investment firms that focused on the ABS space between 2009 and 2011 reported as high as 20% annual returns on those funds as stability returned and prices recovered.
Rallies at the end of 2010 and the end of 2012 made it impossible to continue to generate those types of returns on most prime, on-the-run assets. Many investors targeting higher yields have started looking at regulatory capital deals, unlisted assets and other more niche areas.
But in terms of relative value, most ABS and RMBS still trade too wide. Most Spanish banks, for instance, would pay a lower spread for senior unsecured debt than they would for an RMBS or ABS, which are both secured by a bankruptcy-remote pool of assets. When the cost of pledging assets is also taken into account, it is little wonder that Spanish banks have used the senior unsecured market and avoided securitization entirely.
This nonsensical relative value means there is still an easy pick-up for ABS investors. But this is beginning to change. Peripheral ABS spreads are now at their tightest levels since 2007 and show no signs of slowing down. The generally positive market tone and improved economic data in Europe have underpinned the rally, but it has been buttressed by longstanding technical demand and a growing confidence in the performance of deals through Europe’s most distressed period.
Another sign of this confidence came last week when 30 investors piled into the first post-crisis Irish RMBS. The deal from Permanent TSB attracted a three times covered book and was the strongest endorsement of Irish recovery so far.
Just as the market is finally judging risk on underlying credit performance, and not on a product’s reputation, Europe’s regulators should now do the same. Without a change of tack, regulators are in danger of finding themselves hopelessly out of step with reality.
The Basel Committee’s capital framework for securitizations would be an ideal starting point. Stefan Ingves, head of the Basel Committee, said in September that the proposed risk weights for securitizations may need to be revised. Amending the methodology so that capital requirements for securitizations do not wildly outweigh the capital requirements for holding the underlying assets in a securitization makes sense. Everyone would benefit next year from putting reputations to one side.