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TCW is a leading global asset management firm with over 50 years of investment experience and a broad range of products across fixed income, equities, emerging markets, and alternative investments. In each episode of TCW Investment Perspectives, professionals from the firm share their insights on global trends and events impacting markets and the investment landscape.
Asset-backed securities have been a relatively quiet
corner of Wall Street, turning things like auto loans
and student debt into tradable securities for decades.
Not much has changed over the years, until now.
Welcome to another edition of TCW Investment
Perspectives, focused on fixed income.
I'm Jeff Katz, joined by senior Securitized Analyst Dom
Bea and Co-Head of Global Securitized, Peter Van Gelderen,
to discuss the surprising new trend in fixed income.
It's fueling an explosive surge in new issuance, that
has ballooned 44% over the last year, to $144 billion.
This natural evolution for a market that hasn't seen many changes is considered
a good sign for the growth of new industries and the overall economy.
Welcome to the podcast, Dom and Peter.
Thank you.
Pleasure to be with you.
Well, maybe we start with, what do you think, and what drivers
do you think there are to what's driving this explosion
in new issuance in the asset-backed securities arena?
Yeah, I mean, I think, look, it's a very
exciting time in the ABS markets, right?
The demand specifically from insurance companies over the
last, call it, two years has simply been extraordinary.
It's fueled, in part, by the higher interest rate
environment and the growth in the insurance businesses.
With that growth comes demand for new investment.
ABS securities offer a very compelling alternative.
They're, generally speaking, fixed rate, which
match well to insurance company demands.
They're, generally speaking, investment grade,
which also fit insurance companies well.
They are out of index, which has been a historical hurdle for asset managers.
But as the credit performance of these securities have
been tested, they've become much more widely adopted.
Just as a refresher, you know, asset-backed securities, they
started as just credit cards and residential mortgages.
But as the world has evolved and collateral types have increased from credit
cards and mortgages to consumer loans, to maritime containers, to digital
infrastructure, financing solutions, be that through private credit,
corporate credit, or the securitized markets, have also
evolved and provided solutions for these borrowers.
Given the seat that I sit in as an analyst, I'm seeing a lot
of new issuance in key sectors such as data center, fiber.
We still see a good amount of issuance in towers, as well as whole business.
There's demand in these sectors for financing, and the ABS market provides
really the dominant form for a lot of these issuers, where they can give up
some structure and give them some pricing to get some modestly higher leverage.
And it means that the ABS market in particular is the go-to financing
source, particularly, I think we'll talk about more later, for data centers.
Given the growth in issuance and the growing menu and options that you
have to select from to complete your portfolios, maybe discuss some of
the things that you're seeing that you do like, and
maybe some of the things you've tended to pass on.
Yeah, so I think one example of things that we like is a
recent issuer came out with contracted fiber to the premises.
So this particular issuer will run fiber optic cables to an
HOA, so think either a vertical tower community or say a
planned community with a bunch of single family homes.
This particular issuer will build to a 10 or 12-year
contract to provide fiber internet to that community.
And this issuer is paid not by the individual residence but by the community
as a whole, which means that it's attaching to a really excellent credit.
It's an important example because it shows it's a new technology,
but it's also something you know, use in touch every day.
I think sometimes when people use the word esoteric or explosion in
esoteric, they're trying to create a mystery where there simply isn't one.
This is the backbone of internet connectivity
for a planned community in Florida, right?
These are things you know use in touch every day.
And that's not to say that everyone should invest in these type of securities
without proper credit work, but it does show that investors can access a unique
form of credit and increase portfolio yield and increase portfolio diversity
without introducing highly idiosyncratic risks that are not understandable.
These aren't algorithms.
These aren't emerging markets.
These are things you know use in touch every day and can provide
a very important component to any fixed income portfolio.
It's interesting to hear your perspectives and with the thought of safety and
with all the issuance that's coming to your market, given that there's a capital
structure, given that there's the ability to both seek safety in the higher
parts of the capital structure and also take risk down the capital structure,
how do you go about thinking about the collateral structure
and putting your process over your investment decisions?
I think step one is to look at the assets and not to get lost in the structure.
Do you like the assets?
Do you think that it's a good loan or whatever
form of credit you're providing here?
When it comes to picking your place in the capital structure, that's
kind of a mix of do you like the collateral a lot or kind of like it?
And then that's where you start to get the modeling.
Some asset classes are better suited to sort of pinpoint modeling
and deciding I want to be in the As and the Bs and not the Cs.
Some asset classes are a little better to stick in the
seniors and some are good to go through the stack.
There's a recent business that we referenced earlier, the contract to fiber
provider, given the tenor of the contracts provided, this is one where the
assets are so strong that we want to be invested up and down the stack.
There are other asset classes where particularly
where sort of partial recoveries are likely.
Think of things that have some sort of real assets attached to them.
Commercial buildings you might sell at a discount.
If you're going to have a partial recovery, that's a place where sitting
down and doing the work and making a decision about where you're
going to sit in the capital structure is really worthwhile.
Again, I think it starts with the assets.
Do you like the assets?
Then you start to think about where might I have
differentiated outcomes in that capital structure.
I think when we talk about the growth or explosion in ABS markets, you
just have to look at a security and say, one, do I understand the asset?
Two, does the loan against this asset make sense?
If you can answer both of those positively, then
there's something to think about from the security.
It's when there's a mismatch.
What I mean by an asset and a liability matching is you're not going
to extend a 10-year interest only loan on a car because by the
end of the 10 years, there's been no amortization on the loan.
The warranty is gone and the car is breaking down.
On an asset that's long-lived like this fiber-to-premises, you might because
the cables, the need for the internet and so forth, you might come with a
view that this is actually a reasonable tenor
in loan structure against that type of asset.
It's this 360-degree review that's required.
Is the asset good enough and does the loan make sense?
When we look at these ABS securities and the rapid growth
in this market, we say, one, do we like the asset?
Two, is the borrower sufficiently resourced to handle the loan?
Three, are the terms of the loan sufficient such that if things
go other than we have originally expected, can we expect
a recovery, a full principal recovery on our bonds?
Once we go through that checklist, we then can make a relative
value decision on whether it's suitable for accountant objectives.
I think that's the other great part about
securitized is the tail does not wag the dog here.
You have to understand what a client's objectives are and
if these securities fit well within those objectives.
I'd say generally speaking, ABS offers enough alternatives on
tenor, on rating, on risk-reward that we've been able to find a
lot of suitable investments for all of our investment mandates.
You bring up an interesting point, Peter.
Given the growth in the asset class and the esoteric nature of the asset class,
how do you think about how it fits into the context of a portfolio from a
liquidity perspective versus other asset classes and relative
value versus other things in the securitized markets?
First thing to understand here is that these are non-index securities.
Liquidity can't be taken for granted.
Sizing the position appropriately to the account, understanding
the particular client's liquidity needs is really important.
Ultimately, we're going to make a relative value determination if
we think that giving up a little bit of liquidity is worth it.
Again, always being mindful of what the client's
mandates are as you're constructing that portfolio.
Then of course, there's just a lot of groundwork to do in terms of knowing your
positions, knowing your trade history, knowing the trailing volumes, and having
an understanding as, "Hey, do you think you're going to be able to move
this if you need to?" Really having a high conviction on that question.
I think that question of liquidity is actually a very interesting one.
I tend to relate things back to the financial crisis
because there are nightmares that I can't outlive.
Back then, liquidity was the only thing people cared about.
Now, the hottest term in fixed income investing is
private credit, which by definition is totally illiquid.
I think for a long time, ABS securities were painted as illiquid because the
buyer base hadn't developed, the market itself was relatively small, and
there were relatively discrete mandates that thought
these securities were interesting or suitable.
That's considerably evolved, particularly with insurance demand.
What we've seen is that there actually is liquidity in these
securities, unlike private credit, that you can still pick
up considerable spread to corporate credit alternatives.
As Dom says with proper diligence, there's really no credit concern.
Esoteric has no relation or moment whatsoever
in a conversation of credit quality.
It is simply a new asset with a new structure of loan that
must be reviewed and understood by the investing community.
Given your deep experience in analyzing asset-backed structures and collateral,
I'm sure there's some deals that you've seen over the years that perhaps
didn't work out or had some features to them that, in
retrospect, the market would like to not have had.
Perhaps you can give some examples of things that
either you bought and regretted or things that you've
passed on and you were thankful that you passed on.
We have a pretty well-defined view on whole business securitization.
We tend to like restaurant franchisors.
We tend to like systems that are large, that show
positive growth momentum, that have a relevant concept.
I think we mentioned earlier that as assets come to market to
finance, paradoxically, the best assets are actually financed
first and then credit quality deteriorates as time goes on.
That's happened in the whole business market.
It's a sector that we really like.
It's an important sector for us.
There are a number of concepts, and I refer to the brand
franchisors, that got through in the later part of last decade.
The rents do now for these names, and they're having a lot of trouble.
We've seen multiple franchisors unable to
refinance their whole business securitizations.
Yeah.
I mean, Dom's being a little shy here.
He tells me about things he hates every day.
Within ABS, we're not painting with a broad brush that we love everything.
I think it's very issue-specific and that you don't want to lend to a company
that really could be mistaken for a melting ice cube without much argument.
We pick best in brand.
Whether we're talking about franchise concepts or digital infrastructure
providers, or maritime container lessors, or any of the other
sectors that fall under the ABS mandate, we don't buy writ large.
We do diligence on the manager, the collateral, the
loan structure, the deal terms, pick favorites, and
continue to invest throughout time in those favorites.
We're also, and this should be noted, not of the mind
that there are no bad bonds, but bad bond prices.
I think this is a fallacy parroted by Wall Street too frequently.
If we're not comfortable with the credit, we don't buy it.
We would never abuse our client's trust by buying things we
thought "look cheap" without having a strong credit view.
Yeah.
You see a lot of these names now trading at steep dollar discounts, suffering
downgrades, some sort of trigger event, or past their expected maturity.
Bad things do happen and it takes a lot of homework to make sure
you avoid them and that's what we really pride ourselves on.
Given the unique nature of the collateral, some of the inherent
issues with monitoring deals you've purchased, maybe you could
speak to how you go about approaching that monitoring process.
It's a lot of hard work.
You got to stay close to your names, you got to stay on top of the
markets, you got to stay close to your corporate credit analysts.
These are living, breathing, many of them living,
breathing companies that you need to stay close to.
This is ultimately a question of resourcing an organization and I'd say one
of the strong benefits we've been fortunate and blessed with here at TCW is
well-resourced teams, not just with insecuritized, but within corporate
credit, risk management, and surveillance functions such that we're
able to communicate, collaborate, and watch situations as they evolve.
There have been numerous circumstances where our corporate credit analysts have
highlighted issues or opportunities to us, likewise us to them, such that we
can monitor and help monitor each other's credit exposures by
staying abreast of markets, news developments, and so forth.
Traditionally, there are a lot of consumer ABS shelves that amortize in
such a way that credit tends to improve over time and you get upgrades.
There's definitely a heritage of buying at the time, maybe you did
the work, and then kind of going to sleep and forgetting about it.
We think that's the wrong way to go about it in our DNA is very much
to stay on top of these names and to not just forget about them.
Very well said, Dom.
I think we end on that point.
Thanks for tuning in to another edition of Focused on Fixed Income.
I'm Jeffrey Katz and I want to thank Dom Bea, and Peter Van Gelderen for
coming on the program to share their insights into navigating the markets.
For more information on TCW strategies, please visit our website at tcw.com.
Thanks for listening and we'll pick up next time exploring
the trends and opportunities shaping global markets.
Thank you for joining us today on TCW Investment Insights.
For more insights from TCW, please visit tcw.com/insights.
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