Beyond US sub-prime
If Philip Weingord, co-founder and CEO of Seer Capital Management, isn’t ‘Mr Structured Credit’, then co-founder and CIO Richard d’Albert would be just as good a candidate.
The two have worked together for 25 years, since the mid-1980s, when Weingord was global co-head of securitised products and d’Albert a member of the securitised products group at Credit Suisse First Boston. They – and a good number of their team – moved across to Deutsche Bank in 2000, where Weingord ended up heading US fixed income and derivatives activities and d’Albert rose to become global head of structured credit. The 15-strong team that struck out on its own in 2008 – with significant support from Deutsche, which facilitated their transition – now boasts average industry experience of more than 22 years.
“Phil and I have been doing this since these markets were in their infancy,” says d’Albert – who is also a former member of the management committee and an advisory board member of the American Securitization Forum. “We’ve had a hand in many of the unique deals out there, whether trading them or structuring them. Having the fundamental credit expertise is critical because many still trade at distressed levels and even those that are performing have some challenges. We get down to loan-by-loan analysis even when we’re looking at an RMBS with a thousand underlying loans – it’s very, very complex.”
Seer Capital launched its flagship fund in May 2009 – terrific timing for the opportunity in structured credit, of course. But its decision to do so with the formidable start-up fixed costs associated with 15 professionals indicates the extent to which it already saw this opportunity as something more than just beaten-up US sub-prime RMBS.
D’Albert reminds us that securitisation technology has been applied to numerous different consumer and commercial assets, from aircraft leases, UK pubs, the Miramax movie library and the senior part of Eurotunnel’s capital structure, to the $500bn (€375bn) tobacco litigation settlement, payable to US municipalities over the next 20 years.
“We are now seeing others feeling the need to expand beyond the US focus and the RMBS market,” says d’Albert. “We deliberately wanted to cover the entire spectrum of securitised products, the unique attributes of which can be very broad.”
The logic is clear: once we get beyond the distressed beta play, the natural, uncorrelated cycles of the different types of underlying credit come back to the fore and exploiting them demands tactical asset allocation.
“Right now, credit card deals are incredibly tight and we have no interest in getting involved in that market at all,” says d’Albert. “But manufactured housing – mobile homes, prefabricated homes and the like – which absolutely blew itself sky-high in the late 1990s and early 2000s, has been beaten down to a point where they are very attractively priced but have very stable cash flows, because these are 15-year-old bonds. Our specialist teams have insights into other areas of securitisation that enable them to look at something in aircraft leasing and see how compelling it is relative to something else we’ve seen in, say, pub securitisations.”
Moreover, 25% of what Seer Capital buys at the moment is not legacy assets but rather new transactions, and the degree of new-issuance recovery in any one sector is often directly related to its proximity to the epicentre of the financial earthquakes of 2007-08.
Non-agency RMBS market is amortising away at $150bn a year with little new issuance. On the other hand, CLOs fared better than most people recall (AAA tranches were downgraded, but they remained money-good), and US CLO transactions are picking back up to around half the levels reached in 2007. Similarly, CMBS is reaching the point where it is no longer a shrinking market, and because credit cards and auto deals held up robustly, consumer asset-backed issuance has recovered pretty strongly.
What does Seer Capital’s portfolio look like today? Three-quarters of it is devoted to US and a quarter to European transactions. The sector split is balanced, one-third each in RMBS, CMBS and other ABS – but perhaps the more interesting fact is that a significant part is in the senior tranches of impaired securities.
“The yield there remains compelling, while the stability of the asset performance lends itself to a flatter return profile – you can be conservative in your loss estimations and still achieve your target yield,” says d’Albert. “We like that profile – a good yield that can hold its value through pretty onerous stress tests.”
In Europe, d’Albert remains wary of value traps, even among more recent and prudently-underwritten issues, given the still-deteriorating state of the economy. The euro-zone periphery remains “a little adventurous”, he says, but he sees “some very interesting opportunities” in CLOs of mid-market debt from the core.
“Moreover, the CLOs tend to be better-underwritten than some of the traded bank debt that provides the raw material,” he adds. “Buy a senior tranche of a CLO and, while it is more complex than just buying the underlying loans, you are deriving a significant amount of protection from the structure. With whole-business securitisations like UK pubs you’re ringfencing these cash flows from the parent, which is significant – bankruptcy can be a tricky process in the US, let alone in European jurisdictions.”
However, while the greater complexity is often the source of the protection around the cash flows, there is no doubt that it also pays a premium to complexity-wary investors. High-yield trading at 400 basis-point spreads – perhaps the high-200s on a loss-adjusted basis – compares unfavourably with the 7% loss-adjusted return d’Albert expects from a diversified portfolio of structured credit.
“There is more value in these sectors than anywhere else in credit I can think of, particularly after the run-up we’ve seen,” says d’Albert. “But the trick to exploiting it fully is to be nimble.”
The story of Seer Capital over recent months is also the story of the institutional investor community coming to recognise this value opportunity. It currently manages over $2bn – but that has shot up from just $600m a year ago. For the first three years of its life the fund was attracting capital from family offices and funds of funds, but now it is seeing more US endowments and pension funds, European insurance companies, and a select few European pension funds and consultants.
“This was never an established asset class for alternative asset management firms before the crisis. It really was about banks and a small handful of firms. And even today, with the proliferation of firms looking at securitised products, there is only about $60bn of the total hedge fund capital focused on a $3trn market,” explains d’Albert. “Even compared with the amount allocated to high yield or bank debt, it’s still a very small sector.”
The sector is still battling against “crisis stigma”, d’Albert concedes. But investors are also daunted by its perceived complexity. “Securitisation still feels more complex to most investors than ordinary stocks and bonds,” he says. “But do investors really understand the complexities of those ‘traditional’ asset classes? It’s often a case of ‘familiarity breeds consent’, if you will.”
The element of truth in that statement is difficult to deny. But if Seer Capital’s AUM is any indicator, the consensus against the much-maligned ‘alphabet soup’ of securitised credit may just be starting to break down.