Mike Cobb examines global trends in portfolio leverage.
Post-2007 the term asset-backed securitisation (ABS) has become a dirty one due to its associations with the subprime market and its direct link to the financial crisis of 2008. Finding investors for the sophisticated leverage tool has become difficult for the five years followings Lehman Brothers’ collapse.
However, according to US trade body the Securities Industry and Financial Markets Association (SIFMA) the value of auto loan asset-backed securitisation issuance in the US has risen from a low of $36bn (£27bn) in 2008 to $90bn in 2012. These are figures close to the heyday of the product in 2005 when more than $106m of ABS was issued.
The signs of recovery in the auto loan ABS market are not restricted to issuers. For investors, too, the product has become one where interest has been renewed.
Investors chasing returns
With the returns from traditional investments such as government and corporate bonds at some of their lowest levels, fixed-income investors are chasing returns.
ABS and other more exotic instruments are therefore growing in popularity due to their ability to outperform other assets. An example of this is the GLG ABS fund.
GLG is a London-based hedge fund specialising in company debt. Its ABS fund has seen annualised returns of more than 8.5% over the last year. This compares to a return of just 1.3% for GLG’s flagship global fixed-income fund. Such returns usually only happen in emerging market investments.
ABS additionally presents the benefits of investing in high-yielding assets without many of the risks associated with emerging markets or corporate debt. As the name implies, asset-backed securities differ from most bonds in having an asset behind them and, for investors, the fact that a great majority of auto loan ABS are credit rated as A-rated bonds or higher makes them a safe asset to hold in their books.
The reason they are so highly rated is because, unlike a corporate bond, there is no single underlying income stream.
The very principle of the ABS bond lies in the fact that the great number of underlying loans are unlikely to default. And in the case of auto loans there is even a secondary hard asset to fall back on. So for investors, ABS, and in particular auto loan ABS, is an attractive investment to make with little downside, but for issuers they bring an entirely different set of benefits.
For motor finance, as long as investors find ABS attractive, they will have access to an ultra-cheap financing model.
Peugeot’s finance arm Banque PSA Finance issuance in June this year of 470m of ABS is an example of what makes securitisation an attractive tool for finance companies and the multiple problems it can solve.
When Banque PSA announced the sale it came with a statement saying the sale was: "Part of Banque PSA Finance’s strategy to diversify its funding sources and to increase the share of funding from its securitisation programme in order to support" Peugeot’s registrations.
It was an example of the unique structure of ABS to use the loans existing in the market as assets to provide a cheap source of money whatever the situation.
As mentioned, the better credit rating the instrument attracts leads to lower interest charges for the issuer.
In the case of Peugeot, the difficulties the manufacturer was finding itself in with regards to car sales would have led to a much higher coupon if it had sought to issue a bond through the more conventional corporate banking stream.
As a result, it sought the cheaper option of an ABS issuance based upon pre-existing sales, thus reducing its future costs and avoiding the problem of capital raising on the stock markets – a wise, if unusual, use of a securitisation.
This access to cheap capital is more commonly used to finance further loans. The ability to raise debts based upon existing liabilities is something motor finance led the field in when ABS entered the markets in 1985.
Back then its primary drive was to push down the cost to end-users for financing vehicles. Even in times of high central bank lending rates it has demonstrated to the major lenders its ability to keep costs down and attract more sales overall. The ultimate beauty of the product is that the more loans you make, the more ABS you can take out and so on, in a theoretical cycle. For this reason the access to finance for consumers is not only cheaper but more widely spread. Finance schemes have now moved from those consumers with excellent credit ratings and increasingly into the subprime space.
Subprime mortgages was the market that led to the end of the ABS boom and the beginning of the financial crisis in 2008. However, industry commentators and, more importantly, investors aren’t worried about history repeating itself with auto loan ABS.
"People", as one industry insider put it, "will pay their car loan before they pay their mortgage". And so far he’s been right.
For the present, securitisation remains a product which brings benefit to all layers of the motor finance industry. And with 2013 looking as though it may potentially be a record year for auto loan ABS, maybe securitisation should stop being a dirty word in the finance industry and one embraced as the cheap source of money it is.