Banks May Be Telegraphing Return to ABS Investing

Over the past ten days, there have been several articles indicating that leading banks are increasing their tolerance for risk and are returning to both asset-backed securities and high yield bonds in search of increased performance in their investment portfolios. 

We highlight the word tolerance mostly as a means of signaling that we do not mean tolerance for risk in the classic sense but rather in the context of tolerance for “headline risk”.  The movement to conservative investment principles, on so many different levels over the past several years, is almost unprecedented.  However, as with any downturn and contraction in risk taking that we have been through before, when the market does start to come out of it, the reason is usually groups of investors attempting to outperform their competition and the pressure to keep up with competitors tends to feed off itself.

Last week, the Financial Times ran a piece on the growing number of banks that are returning to investing in “bundled mortgage” products, mostly in the form of CMO’s backed by GSE securities.  While the trend is still small and the number of banks involved is similarly small, we would project that this trend will grow and will likely expand to “non-managed” bundled programs which include private mortgage securities.  We’re not so bold as to predict that the return of CDO’s is around the corner but we remain bullish on the return of at least a segment of the “managed” market over time.

This week has illuminated the return of the high yield bond markets with the announcement of three flagship transactions by Caesars Entertainment, Realology and Energy Future Holdings totaling nearly US$3B.  This could breathe new life into the high yield markets as banks may lead the way in the charge to improve overall portfolio performance.  If this recent activity does turn into a trend, as many expect it will, this will likely have a very positive impact on the CLO market.  We believe it will begin to loosen up what has, up until now, been a relatively small group of institutional investors that have shown a willingness to get back into high yield, either directly or via a CLO structure.

In both cases, the return of more investors to the market will increase the confidence of still other investors and so on and so on…….

Market signals like these are a long time coming for structured finance and there can be any number of false starts along the way.  Nevertheless, we’ll take this double dose of good news as a positive sign that the securitization markets are on the road to recovery.

About markferraris
Managing Principal Orchard Street Partners LLC

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