The Changing Tide
Now that investor demand is starting to tick up, and lenders may not need to presell bonds, the cost of funds for the issuers — or rate of return demanded by investors — is decreasing. This is because issuers are not having to adjust their spread levels — which determines, in part, the overall cost of funds — on the lower-rated bonds as much, Bradley said.
In 2013 and 2014, the ABS market was considered a “seller’s market,” with a lot of investor demand for all of the tranches, he said. In early 2015 though, it became a “buyer’s market” where investor demand migrated toward the AAA- and AA-rated tranches, and as a result, the spreads widened on the lower tranches. “This can loosely be seen as investors starting to ‘worry’ about credit and moving toward buying ‘safer’ credit tranches,” he said.
Year over year, the cost to securitize has risen, said Hylton Heard, senior director at Fitch Ratings Agency, primarily because of deteriorating credit performance. “With interest rates high — going up 25 basis points late last year — that boosted the expense for lenders to issue an ABS, and clearly there has been some investor yield demand, for investors who are looking for higher yields on the bonds, so that could contribute to higher expenses,” he said.
There is a general thought that credit performance isn’t as good as it was a couple years ago, Bradley said. “Credit performance is still very good, and when issuers started preselling bonds, investors started realizing they have to be more aggressive in pricing to get more bonds, and that’s what has happened recently,” he added.
“We all thought prices would have continued to go up, but it’s hard to put a finger on it because it just started recently,” Bradley said. “Wall Street is more comfortable in the industry today, but at the end of the day, there aren’t that many places to get the yields investors are looking for, so in some ways they are more comfortable with auto than other areas. They [the investors] had the opportunity to hold back to see if they could get better prices, but today’s market has pushed back the other way.”
Preselling bonds is a way of “keeping the investor market honest, to some extent,” Bradley said. “If investor demand and the number of investors starts to slip, then issuers will go back to preselling bonds. If investor demand stays strong, then issuers will probably do less preselling of bonds in the future. If the market remains the same, I would think we would not presell bonds in our next transaction.”
Flagship’s Hsieh echoed Bradley’s comments. “If the market continues to stabilize, I would guess it goes back to the normal process,” she said.