Portfolio manager Ben Hayward, who is responsible for ABS research at the boutique fund manager, said while bond issuance by the sector rightfully raised concerns, securitisations like ABS or residential mortgage-backed securities (RMBS) are “bankruptcy remote”.
Unlike other debt instruments, such as covered bond, senior debt or lower tier 2, which are issued by the bank itself, ABS and RMBS are issued by a special purpose vehicle.
“In other words they cannot be bailed in to any restructuring, and they are secured on the asset pool rather than the general balance sheet, which is what got the banks into trouble in the first place.
“For the effectiveness of this I refer you to the solvency issues suffered by Northern Rock, SNS Bank, Co-op Bank [and others]. Suffice to say that Co-op covered bonds were downgraded from AAA to BBB – when everything else went to non-investment grade rated – but the securitisations retained their AAA rating.”
Hayward said while the banks faced the issue of having high levels of non-performing loans (NPLs) on their balance sheets, which in turn raises questions about the accuracy of their valuations – given their quality, and the banks’ capability of meeting their minimum regulatory requirement.
TwentyFour said it largely avoids Italian banks, taking only very selective positions. In its Dynamic Bond fund Italian banking exposure is just 0.5%.
TwentyFour is confident in the quality of the information it has access to, with deep insights over loan to value, specific terms of the loans as well as how many of the underlying loans are up to date on payments, how many are not and how many are in long-term arrears.
“We have much better information about asset quality than any investor who is buying bank bonds or equity,” he said in a recent blog.
“We know that these assets are performing well, and within our expectations.”
Rather than focusing on different tiers of capital, he looks at the equivalents for securitisations.
“Each transaction will assume that borrowers may miss coupons and default on their obligations, leading to the potential for income and principal hits being taken.
“To that end the issuers structure a ‘loss cushion’ for bondholders. This will be made up from excess profit in the deal – or the net margin between the yield on the assets and the interest on the bonds, and the reserve fund/junior bonds held by the originating bank and other investors.
“This is a simple calculation, and can be easily measured against current NPLs, enabling us to calculate how many NPL/defaults and losses we need to eat through this capital buffer.”
He said a good example of the capital versus asset quality is Siena 2010-7 A3, a bond from one of the most stressed of the Italian banks, Monte Paschi di Siena.
Hayward points out it only has 1.37% of loans in long-term arrears but it has a “whopping” 42.79% loss cushion.
“I am sure any bank investor would love to have CET1 capital at 43% and with a strong performing loan book.”
Yet he notes the issues these banks are facing relate to their corporate lending book, not loans to customers.
“So where Italian bank bond investors are suffering from lack of transparency, poor asset quality and uncertainty on real capital levels, we can relax knowing that we don’t share those problems, and can enjoy particularly attractive returns at the same time.”
In the Monument fund the exposure to Italian ABS is 11%, while in the higher yielding Income fund it is 7%.
