NEW YORK, March 8 (IFR) - With interest rates and benchmarks tighter than ever, asset-backed securities investors are flocking to bonds backed by unusual collateral in a hunt for higher yields.
At least five so-called "esoteric" ABS transactions have either been sold to investors over the last three weeks or are in the pipeline, backed by untraditional debt such as cell tower site lease payments, franchise fees, timeshare receivables, drug-royalty cashflows, and structured settlement payments.
Even typically staid investors such as insurance companies have been willing to diversify away from "traditional" commoditized consumer ABS -- such as bonds backed by auto loans, student debt, and credit card payments -- into "off-the-run", or less typical, collateral that may be harder to understand, but much higher-yielding.
While the trend has been developing for more than a year, in a more recent twist, these insurance companies have been willing to buy more subordinate debt of these esoteric ABS, moving out of their natural comfort zone of Triple A slices.
And even beyond esoteric collateral, investors have been willing to move down the capital structure of traditional consumer ABS offerings, buying either lower-rated or unrated residual pieces of more plain-vanilla transactions in order to juice returns.
"As traditional money-market managers have entered into consumer ABS as a cash alternative, traditional ABS investors continue to search for yield in off-the-run and esoteric ABS," said Tony Lee, a structured finance analyst in the US fixed income group of Los Angeles-based investor TCW. "Demand for prime and subprime auto subordinate, timeshare-backed, shipping container, and aircraft lease-backed ABS all increased during February with supply for these bonds still hard to find" in both the primary and secondary markets.
With swaps benchmarks at historical lows, yields on recent auto loan-backed transactions with maturities of three years or less have been 1% or less, and continually decreasing. Investors are hungry for any product that will offer even a little more yield.
While auto-related ABS still comprises more than 60% of yearly issuance, new esoteric volume is poised to increase this year. Of the roughly $31.6 billion in total ABS issued year-to-date, more than $5 billion, or nearly 16%, is comprised of so-called "off-the-run" collateral, according to IFR Markets data.
For the same period last year, only $900 million, or about 4% of the $22.4 billion total could be considered esoteric cashflows.
Of the approximately $125 billion in total ABS issued in 2011, about $15.5 billion, or 12.4%, consisted of debt backed by non-traditional cashflows, according to the Securities Industry and Financial Markets Association.
In terms of volume, non-traditional ABS reached its peak of US$66.1bn in 2005, according to SIFMA, but that year it only comprised 8% of the then-robust total ABS market of $754 billion, which included home-equity ABS issuance, a sector that was just beginning to ramp up amid the housing boom.
Given the much slower pace of current ABS issuance, however, esoteric deals are likely to comprise a larger percentage of the total market over the next few years, according to securitization experts.
"There is robust investor appetite for these deals, and they are now willing to move down the capital structure into subordinate tranches," said Jay Steiner, the co-head of the global credit solutions group at Deutsche Bank. "Even insurance companies are willing to take the time to get their arms around these transactions, which are typically much more complicated and have longer marketing periods than traditional consumer ABS."
A spate of off-the-run transactions have been pitched and successfully sold to investors over recent weeks, including a franchise-fee ABS refinancing from Domino's Pizza, a timeshare receivables transaction from Orange Lake Resorts, and a cell tower site lease offering from Global Tower Partners.
Due to investor demand, the Domino's deal was upsized at pricing this week to $1.575 billion from an original size of $1.475 billion. Several insurance-company investment managers were interested, and even called in to an issuer-led private conference call pitching the transaction to qualified investors on Feb. 29, including Debbie Adami of AIG Global Investment Corp., who asked a question to underwriters regarding the risk of prepayment on the deal.
Another off-the-run transaction – a so-called stranded-cost transition bond – priced on Wednesday from AEP Texas Central Company.
The $800 million offering consisted of three Triple A pieces and was issued to help the utility recover certain costs and regulatory assets. Usually, a specific charge imposed on the distribution of electricity to customers supports principal and interest payments on these types of bonds.
Meanwhile, a rare securitization backed by royalties flowing from pharmaceutical patents on established drugs is about to enter the asset-backed market next week. Credit Suisse and Wells Fargo have been mandated as joint bookrunners on DRI Capital's upcoming $195 million Drug Royalty LP1 transaction. Credit Suisse will act as structuring lead.
The offering will be backed by the cashflows of 18 royalty streams on 14 patent-protected drugs. It is expected to be rated Baa2 (sf)/ BBB (sf) by Moody's/Standard & Poor's.
DRI Capital purchases royalty streams on established pharmaceutical products developed to treat chronic, critical, and rare diseases. The partners in the company have been investing together for nearly ten years.
Other "esoteric" deals are also in the hopper: Next week, Barclays Capital (structuring lead) and Deutsche Bank will be joint-lead underwriters on a $226 million transaction backed by structured-settlement streams for J.G. Wentworth, the nation's largest buyer of illiquid financial assets and annuities.
A structured settlement securitization allows companies such as J.G. Wentworth to fund the purchase of monthly settlement payments from people who are willing to sell long-term payouts for a lump sum. Investors in these securitizations share in the risks and profits of such an arrangement.
Also next week, Sierra Wyndham will issue a $250 million offering backed by timeshare receivables. Deutsche Bank, Credit Suisse, and Royal Bank of Scotland
REVIVED OFFERINGS
Two of the recent offerings, the Domino's refinancing and the DRI Capital drug-royalty deal, were originally pitched to the market in the second half of 2011, but were each pulled at the time due to the macroeconomic global volatility caused by the European sovereign debt crisis.
Both offerings have now resurfaced in a much more upbeat, "risk on" environment, and investor interest in recent esoteric deals has been keen.
On February 23, a two-part $282 million cell tower transaction from GTP Cellular Sites attracted more than 25 investors across all tranches. The offering was backed by a portfolio of 1,177 ground-lease cashflows on various cell-tower sites.
GTP was able to achieve attractive leverage on the transaction -- about nine times cashflows down to a Triple B minus tranche -- and offered a blended yield of 5.03% to investors down to a Double B tranche. These tight spreads reflected a fairly attractive financing for the company.
The quest for higher yields has recently expanded beyond just esoteric collateral. Certain hedge funds have been buying deeply subordinated tranches on traditional consumer-asset deals as well, according to securitization specialists.
For instance, a recent $1.3 billion prime retail auto-loan ABS from Columbus, Ohio-based Huntington National Bank that priced on March 1 contained an "invisible" unrated residual tranche below the Triple B bond – the first such unrated tranche seen in the market since 2006.
Structured-credit hedge funds with an expertise in judging the direction of consumer behavior are able to leverage what they know in order to buy unrated auto ABS paper in order to get much higher yields, according to people familiar with the Huntington
"They know these sectors so well, they don't need a rating in order to buy it," said one dealer away from the transaction.
Adam Tempkin
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