Welcome to Winter Issue of The Journal Structured Finance where we look at securitization in the time of COVID. The securitization market has, against the odds, regained its footing after having knocked off balance by one of the strangest, unprecedented shocks to the global financial markets, and indeed the world, in recent history. Someone who had slept through 2020 and woke up at the start of 2021 one would barely suspect that only nine months ago the securitization market was at a standstill and that Federal Reserve was on the verge of embarking on an extraordinary level of fiscal and monetary support, including a reboot of the Term Asset Loan Facility (TALF), the Federal Reserve’s lending facility, which has been credited with stabilizing the securitization markets in the wake of the Great Financial Crisis.
Despite a three-month period when issuance slowed to a trickle, total new issue supply increased from $2.2 trillion to $3.3 trillion, a 49% year over year rise. The uptick was disproportionately led by an 87% increase in new issue Agency RMBS, which, boosted by record low interest rates and record levels of home sales and refinancings, reached $2.8 trillion. Private ABS, RMBS, CMBS, and CLO markets closed 2020 near $550 billion, 25% below its level in 2019 (Exhibit 1). Secondary market trading essentially came to a halt immediately following President Trump’s state of emergency declaration on March 13, but returned a few weeks later at the mere announcement of the TALF program. Reflecting the heightened level of uncertainty, secondary market spreads for benchmark private products widened three to five times 2019 levels (Exhibit 2). For less liquid, esoteric asset classes, the spread widening was even more pronounced. By year-end, spreads on most securitization products had reverted or were near pre-pandemic levels.
New Issue Supply ($ billions)
SOURCE: Structured Finance Association.
Secondary Market Spreads 2020 (bp)
SOURCE: Structured Finance Association.
In this issue we present a selection of essays discussing the impact on securitization markets of this most unprecedented year and the implications for 2021 and beyond.
We start off with John McElravey’s article “A Reach for Risk: Pricing Credit and Liquidity in ABS.” McElravey examines the increase in risk appetite for consumer ABS despite the ongoing weakness in economic fundamentals. In an environment marked by low all-in yields and slow economic growth, McElravey discusses two areas where one might achieve better risk adjusted spreads.
We follow this with Simon Mui, Edward Reardon, Andrea Andric, and Bipul Sinha’s article, “2020 Office Quarantine.” The authors review the health of the office sector, the single largest property sector behind CMBS. They consider the success of Work-From-Home policies and the implications on office demand beyond the pandemic.
In their article “Rebuilding the Non-Agency Market: Why Modernizing Data and Reporting Is Critical,” Vadim Verkhoglyad and Perry Rahbar examine the challenges facing data reporting in the non-agency mortgage market. These challenges were laid bare as legacy reporting systems struggled to report the performance of mortgage loans in COVID-related forbearance programs.
Kevin Park’s article “Measuring Risk and Access to Mortgage Credit with New Disclosure Data” looks at the recent expansion of data collected under the Home Mortgage Disclosure Act. Park contends that this data provides an unprecedented opportunity to examine racial, ethnic, and gender disparities in access to mortgage credit and loan performance.
Stephanie Mah explores residential and commercial PACE financings in “Earth, Wind, and Fire: PACE Plays a Vital ESG Role.” Mah holds that momentum in the sector has been driven by legislation and an article increased focus on environmental, social, and governance initiatives.
In their article, “Aircraft Lease Asset-Backed Securities and Aircraft Enhanced Equipment Trust Certificates Workouts,” David Yu, Christopher Papajohn, and Tasos Michael examine how two major aircraft asset-financing structures, aircraft asset-backed securities and enhanced equipment trust certificates, may be affected by the near-term challenges facing the aircraft leasing industry.
The last two articles go beyond from the US market. In “Observation on How COVID-19 Affected the Securitization Market in Japan,” Yukio Egawa looks at the impact of COVID-19 on the Japanese economy and the Japanese securitization market and compares this to massive natural disasters of the past.
Finally, Nicholas Spizzirri offers an exposition of fat tail distributions in “Fat Tails: An Untrustworthy Friend.” Spizzirri contends that once we realize that fat tail distributions are more common in the real world than in our models, we will be better prepared to safeguard against the kind of challenges we saw in 2020.
Elen Callahan
Guest Editor
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