A securitization community coming off of record issuances in 2014 has entered the new year with a mixture of nerves and optimism. An estimated 6,500 finance professionals and attorneys converged for the 2015 ABS Las Vegas conference. The new risk retention rules, and their impact on CLOs in particular, were on everyone’s lips – to the point that one panel moderator opened his remarks by saying that he was narrowing the stated discussion topic to focus exclusively on CLO risk retention, at the urging of the panelists and audience.
CLO managers seemed to feel the new rules’ impact most directly. Contrary to the usual desire to be first to market, and despite a large universe of managers chasing a limited universe of equity investors, the common sentiment was “everyone wants to be second to market” given ambiguity in the new regulations. In particular, the amount of equity needed to constitute a “controlling financial interest” (which is key to determining how capital-intensive the new manager structures will be) produced sharp disagreements between managers, investors and accounting firms, and industry participants seemed uncertain as to several strategies that issuers have proposed to exempt existing CLOs from being subject to the risk retention rules if they undergo repricing or refinancing.
Looking forward, the industry seems to be coalescing around the capitalized manager vehicle structure, and nomenclature, that attorneys from this firm have publicized in recent months (to the extent that one industry insider deadpanned, “You’d better be right”). Equity investors, for their part, seemed content to watch from the sidelines until some certainty returns to the marketplace, particularly given the attractive pricing currently available for CLO equity in the secondary market after recent writedowns. In the face of this uncertainty, predictions for overall issuance volume in 2015 varied widely, from $60 billion to over $100 billion. One thing that everyone could agree on was that the management industry, and managers, will look very different in the medium- to long-term than they do today.
Investors in rated CLO debt were more optimistic, believing that risk retention, like so many regulatory hurdles before it, will eventually be solved, and that rated CLO debt still provided a better risk-weighted return than just about any other fixed-income investment. Defaults remain almost nonexistent, the macroeconomic environment is overall positive, and underlying loan maturities are historically low, making an uptick in loan defaults unlikely; even difficulties in the energy sector were seen as an opportunity for managers to demonstrate their expertise, rather than a threat to portfolios. If the risk retention rules encouraged consolidation and chased some smaller and weaker managers out of the space, at least the managers remaining would be stronger, better-capitalized and more capable. Ultimately, if the buy-side demand remains strong, the industry will be certain to meet it one way or another.
Elsewhere around the conference, consumer ABS continued to impress generally, and market participants strongly pushed back against the notion, common in recent press coverage, that a bubble was forming in subprime auto ABS. Lower gas prices and improving economic conditions have left consumers with more money to spend, and experience from the 2008 financial crisis has shown that subprime borrowers will prioritize car payments over other spending if necessary. In addition, realization on the underlying assets is far less uncertain in auto loans than in the residential mortgage loans blamed for the 2008 financial crisis, as investors assume cars will depreciate rather than hope they will continually appreciate, and auto repossession presents few of the difficulties of home foreclosure.
Similarly, the residential mortgage space seemed to be opening back up to private deal making. With agency securitization booming for owner-occupied properties, conference-goers anticipated an increase in rental deals, with single-family REO-to-rental and multi-borrower single-family rental (SFR) transactions in particular seen as likely areas of growth. While multi-borrower SFR transactions have presented challenges in the past, in terms of standardizing property-level data, and while risk retention remains an obstacle, industry participants appeared confident that these hurdles would be overcome and deals would be done in the new year.
Framing the entire conference was the keynote address by the always entertaining, and combative, former U.S. Representative Barney Frank. After defending his actions leading up to the financial crisis – which he argued was the inevitable result of securitizations transforming the credit markets so quickly that regulators and rating agencies had no time to react – Frank portrayed risk retention as the best way to let the market determine lending standards, rather than having them imposed by regulators directly.
And he complained repeatedly about regulators exempting agency RMBS from Dodd-Frank’s risk retention requirements, after residential mortgage lenders, more than in any other sector, had loosened lending standards prior to the financial crisis because they knew they bore no risk of loss once the loans were sold into securitizations. Far better to simply require mortgage lenders to retain a risk of loss, rather than having the regulators decide what kind of loans a lender should or should not make, he argued.
Perhaps unexpectedly, Frank admitted that the risk retention regulations were so complex, and the lines so uncertain, that he wished that the regulators could simply tell the first person to commit a particular violation that they had violated the rule and should not do so again. While this would be a welcome message to most in attendance, conference-goers seemed far too busy making deals (and trying to figure out the impact of the new regulations on those deals) to hear it.