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Shift to private, consumer ABS to hedge recession risk

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By Max Adams
26 Feb 2019

Opinions on the likelihood and timing of the next recession were divergent at this year’s SFIG Vegas conference, but speakers on a panel on Monday morning said that they are positioning for the downturn by moving into private deals and consumer ABS assets.

The panel was a real-time example of the range of views on the state of the US economy, and speakers did their best to outline the host of mixed economic signals and interpret them for the audience. On the one hand, the strength of the consumer was touted unanimously as a highlight of the past decade of recovery, with household balance sheets in better shape and labour participation at record levels.

But weak retail and manufacturing figures at the end of last year and bloated corporate balance sheets are signs that there are definite pockets of risk in an otherwise bustling market.

“The animal spirits definitely deserted the market in the fourth quarter of last year,” said Mary Kane, head of securitized products research at Citi. “The jury is still out on the strength of the retail sector and manufacturing orders are also weak.”

Kane tempered some of her uncertainty around these sectors by saying that Citi’s view of the economy is still favourable and that the bank is projecting two more interest rate hikes from the Federal Reserve this year on the back of strong data.

If the consumer is enjoying a period of relative strength and stability, the corporate balance sheet is more worrisome, the panellists said.

Nancy Mueller Handal, senior managing director of private fixed income and alternatives at MetLife, said that the firm has already moved away from high yield corporate debt as a broad strategy to de-risk its portfolio.

“We have started to de-risk, especially from companies we think are most at risk of downgrades or have the most leverage on their balance sheets,” Handal said.

Though the ABS market has more built-in protections since the financial crisis — such as higher credit enhancements and alignment of interests via risk retention — big swings in the corporate debt market will probably spill into securitized products in the future. To position for this, Handal said that MetLife has also begun to shift investments into private ABS to take advantage of the higher spreads offered for less liquid assets.

“Public to private has made a ton of sense for us because we pick up spread to go into something a little less liquid,” she said, adding that triple-A CLOs are also a strong bet in the current environment.

Riffing on the theme of the relative strength of the consumer, the speakers noted that consumer ABS asset classes were solid picks in times of relative uncertainty. The short dated nature of the assets make them natural hedges against both corporate volatility and interest rate risk, despite recent negative headlines around sectors such as subprime auto ABS.

“Securitization is actually financing less than 20% of all auto lending, and the Fed actually said that this is probably the best inventory of auto loans they have looked at since 2000,” said Kane. ”Another factor is that [ABS] is a very short market and a lot of it rolls off, so spread widening doesn’t hurt as much,” she added later in the panel discussion.

By Max Adams
26 Feb 2019