Maze of money market products is back
EVEN COLLATERALISED-DEBT OBLIGATIONS, BLAMED BY MANY FOR TRIGGERING 2008 MELTDOWN, HAVE RETURNED
The collapse of Lehman Brothers Holdings Inc has consigned some financial products, popularised by their acronyms, to the dustbin of history. But investors’ appetite for highyielding and relatively risk-free securities never went away.
While the financial crisis permanently damaged the reputation of many esoteric, highrisk portions of the credit market, new products, some with more robust structures, have emerged. These days money managers are piling into leveraged loans, via securitised structures known as collateralised-loan obligations, and securities backed by consumer debt rather than mortgages.
Even collateralised-debt obligations, blamed by many for triggering the 2008 financial and economic meltdown, are making a comeback.
Indicators distorted
Meanwhile, money market indicators, which are meant to warn for signs of funding stress, have been distorted by ever-present central banks and ballooning fiscal spending. Highly-watched measures, such as the gap between the London interbank offered rate and overnight index swaps, used to be strong indicators of dollar funding stress, but dislocations there now appear to reflect structural changes.
Here is a look at what these markets are up to today:
With the Federal Reserve hiking rates, money managers have piled into collateralised loan obligations, which carry a floating rate. That demand has helped lift the size of the US leveraged-loan market to around $1.3 trillion (Dh4.77 trillion) — rivalling the dollar highyield bond market. Around 80 per cent of leveraged loans are “covenant-lite,” meaning they lack meaningful protections against, for example, the company’s earnings falling to low levels. In 2006-2007, that proportion would have been less than 25 per cent, according to Moody’s. Consumer Asset-Backed Security (ABS) issuance remains strong, particularly deals backed by auto loans, which saw supply of more than $100 billion last year, the most since 2005, according to information compiled by Bloomberg News and data from Sifma.
Meanwhile, sub-prime auto ABS supply has surpassed its pre-crisis 2007 peak, and saw $25 billion price in 2017.
After flatlining in the wake of the financial crisis, the market for repurchase agreements is showing signs of life again.
New regulations designed to shore up financial institutions’ capital buffers spurred demand for high-quality liquid assets, such as Treasury repos, and pushed short-term funding rates to zero. The combination of the Fed’s interest rate hikes, and Treasury’s rising debt issuance to finance soaring deficits and the balance sheet unwind has pushed overnight repo rates to around 2 per cent.
The collapse in credit standards seen during the housing boom led to the spectacular rise and fall of the private-label MBS sector.
At its height in 2005 and 2006 such debt accounted for higher mortgage origination than Fannie Mae and Freddie Mac combined, but the housing correction put that to an end. Since 2007, private-label MBS has averaged less than 3 per cent of annual gross supply.
$303b was value of CDOs issued last year, the most since 2007