Ahead of IMN's ABS East conference in Miami next week, MUFG's head of esoteric ABS Yezdan Badrakhan gave his thoughts on the rest of this year and 2024.
He sees both issuers and investors as having the confidence to be active in the primary market, and feels there could be more spread tightening on the way next year.
Moreover, Badrakhan has detected an encouraging shift in what investors will be looking for at the Miami event. Whereas in 2023 they often wanted to see issuers to discuss their creditworthiness, this time around they are more eager to hear about investment opportunities and first-time issuers.
MUFG has led 19 esoteric ABS deals in the public market in 2023, across sectors like solar, data centers and containers, according to Finsight.
GlobalCapital: The ABS new issue market was largely stagnant in the fourth quarter of 2022. Do you think it is in a better position this year?
Yezdan Badrakhan, head of esoteric ABS, MUFG: I think the fourth quarter of last year into the first half of this year was marked by pronounced market volatility and — consequently — limited acquisition activity. Acquisitions are a driver of issuers needing capital markets debt.
In the last several months, we've seen a reversal of that trend. We saw a busy July, busy first half of August, and an incredibly busy September. Quite frankly, we're going to be busy all the way until we get to the [ABS East] conference. I would expect it to continue to be busy until at least Thanksgiving.
We are probably in the early innings of investor fatigue for the year and investors having spent the capital that they anticipate spending for the year, so I expect December to be a little bit quieter. But really until we hit that point, I suspect we'll continue to see 15-Gs being filed and strong issuance.
The market has a compounding consensus view of higher rates for longer. If you're an issuer, it feels like you're taking risk off the table versus issuing into long term uncertainty, which is probably the feeling that most issuers had for the first half of the year. When we start thinking about next year, I don't see any reason why issuers wouldn't issue in the first part of 2024 absent increased uncertainty.
We're also now into over a year of rates rising and there are certain maturity walls in the next couple of years that issuers will face. Without trying to forecast too far into the future, 2024 again — barring any major macro events — seems like it's as good as any market conditions for refinancing debt.
How do you think is the tone in the market right now? Is there room for spread tightening to continue in the fourth quarter?
We've really seen spread tightening, unilaterally, since the beginning of summer. Based on the supply we've seen in September, we're seeing slight softness relative to where spreads were at their tightest over the past three or so months. I don't think we project any material softness in spreads.
In 2024, it is possible that we go tighter. But I think for the remainder of this year we're probably going to be reasonably range-bound. There's a little bit of investor fatigue, and a geopolitical and rates backdrop. There aren't the mechanics that I think would naturally lend themselves to material spread tightening before the end of the year, but I think that's on the table for 2024.
For a long part of this year, there was a lot of talk about a possible recession in 2023, early 2024. While there are still some macro concerns, the recessionary fears don't seem as imminent. I think that gives both investors and issuers more confidence in either deploying capital or issuing debt into the market.
What do you think has changed in the market after we saw the market volatility at the beginning of the year and March?
Since then, there’s been a reduction of volatility in the market. We’ve seen a flattening of rates curve, and there's been less noise around spread and bank failures. I think all of that contributes to a more benign market condition.
Issuers generally don't like issuing into difficult markets if they have the choice. Once you start seeing some level of normalcy, continuity and some level of [consensus on] rate expectations, it makes it a lot easier for issuers and investors to connect, both in terms of expectation and market views.
If you have a host of varying views on how long rates will stay at their current levels and you've got a materially inverted yield curve, issuers and investors are going to see two very different sides of a coin and will want to behave very differently. I think, when the market comes to the conclusion that rates are going to stay like this for some period of time, issuers and investors are better able to see eye to eye, and the objectives of both counterparties tend to be better aligned.
What were the main challenges for issuers this year given rising rates? How long do you think those challenges will last?
Without question, the rate environment has challenged issuers. We should put in perspective when rates move from zero to 5% in a short period of time, particularly in the securitization markets where we depend on long-term contracted cash flows, it's going to take time for the underlying assets to catch up to the move in rates.
A lot of deals, for some time, were facing a higher cost of debt without necessarily having the commensurate increase in asset yields. And now, pretty far into this rate rise, what we're seeing is new contracts and new asset yields that are more reflective of the current rate environment. While rates do continue to be an important consideration, I think it's probably less of a hurdle than it was six to 12 months ago.
What are your expectations from ABS East? Do you think that the market has a more positive view going into the fourth quarter compared to last year?
Compared to last year, I expect the tone of the conference to be generally positive. We set up meetings on behalf of issuers, and investors seem pretty keen to meet with first-time issuers and issuers in the esoteric space. That tells me that investor appetite to invest in that segment of the market is there.
A year ago, a lot of investors wanted to meet with issuers principally to assess the creditworthiness of those issuers. That's generally not the sense that I'm getting for this conference. While that's clearly always an important point for investors, I think investors want to learn more about investment opportunities, rather than having a defensive take on corporate health. I think it's encouraging for first-time issuers and also for investors as they look for diversified ways to spend capital. It will allow investors to continue to diversify their books both in terms of asset classes and issuers.
Do you think that private securitizations will continue to be an essential part of the market?
I think private placement securitizations have a permanent place in the market. They are a tool that helps issuers diversify their debt sources and procure debt for nuanced situations. Institutional investors are setting up desks and raising capital to support private placement securitizations. This is a way of investors demonstrating to their capital that they have a differentiated solution
I think private placements will continue to be an important part of the market, whether or not [they] grow beyond the current level of around 20% of the market. I think that in more volatile markets you will see the private placement market grow, and perhaps in less volatile markets, the opposite may be true, although I think that's yet to be observed.
Are there any up-and-coming asset classes or sectors that investors should pay attention to? What sectors do you think have the most room for growth in terms of new issue volume?
Digital infrastructure, along with solar, are segments of the market that observed robust issuance — at least as far as it relates to the esoteric segment. I think there is both demand from investors as well as acquisition activity in both of those sectors that will keep [them] very busy markets for the foreseeable future.
Is anything else in ABS catching your eye right now?
I think investors and sponsors are taking a more pronounced interest in securitization in terms of how else you can use it efficiently and what else can be securitized. It seems like there's been a deeper focus on that in the last 12 months than there has historically been. We're spending a lot more time thinking about what is in the art of the possible with sponsors and large asset managers.
In volatile markets, ABS and investment grade debt tend to represent forms of stability, and they tend to create more optionality. There are certain advantages that are present in ABS structures that don't exist in the high yield market, for example. I wouldn't say that's universally true or true all the time, but volatility makes some of those advantages more observable. I think that's what generates some of the interest there.