Will securitization market's new buyers stick around?
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Will securitization market's new buyers stick around?

Orlando, FL/USA-7/19/20: A bin of Elmers Glue in the school supply aisle at a Walmart in Orlando, Florida.

Spreads tighten as money chases assets but taking the easy money raises risks

The atmosphere at Global ABS 2024 in Barcelona a couple weeks ago was as upbeat as it has been for years. Understandable, given, so far this year, money has poured into European securitization markets. Spreads have tightened, while issuers have had their pick of funding routes, from warehouses to forward flows to public market trades.

It clearly raises the question; can it stay this good?

Certainly, the topic was under discussion in Barcelona and naturally there were worries. The suspicion is that some of the money coming into securitization could be pulled back quite quickly if relative value shifts against the sector.

So far, securitization spreads have lagged broader credit spreads, which have tightened even further. That means securitization looks attractive, offering a bit more yield over a floating rate — also attractive if rates remain high.

Collateral has also performed exceptionally well so far with the predicted downturn in performance underwhelming. Deterioration has been confined to pockets where interest rate exposure is particularly acute, floating rate and interest-only loans and commercial real estate.

As such, adding some ABS paper to a portfolio offers diversification and increases its resilience. That resilience of the market is a key factor in the broader asset backed finance craze, which has brought the biggest names to securitization and its related markets at scale.

Hype might also be contributing to the rush of cash into securitized products. Synthetic risk transfer (SRT) is having a moment in the sun. At points, the right niche of social media can feel flooded with posts lauding the virtues of the sector.

SRT offers yields in the teens and high quality bank-originated assets. It looks attractive when compared to liquid markets on a like for like basis. Many, particularly US, hedge funds have been tempted to jump in on banks’ syndicated deals. According to some incumbent investors, there’s no longer enough to go round.

But what if relative value shifts away from SRT? What happens if a deterioration in performance creeps in? The so-called fast money might get spooked.

SRTs are meant to be buy and hold. They do get traded, but at wide levels. If there’s a stampede for the exits, secondary liquidity would dry up all together. It also risks a change in how problems in deals are worked out, with litigation becoming much more likely.

All of this matters for issuers, who as it stands hold all the cards. Most issuers have radically expanded their warehouses and their ability to pick and choose when to go to market after a bruising couple of years. Cutting back would save money, but narrow options if times turn bad.

The wisest or most fortunate issuers have the most nimble facilities, but even they can ill afford to get complacent. As quickly as investors bought into securitization, they can sell up and out.

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