The fall and financial destruction of 2008 launched a brand-new era for the credit markets. An era marked by government intervention and outright manipulation all committed in broad daylight under the protection of financial apocalyptic prophecies. Our self-styled financial superheroes (Treasury Secretary Geithner and Fed Chairman Ben “Helicopter” Bernanke), wield their collective financial imagination and money printing press like Thor’s hammer on any and all areas of the credit markets they deem worthy. Think of this behavior, if you will, as a massive financial game of ‘Whack a Mole’: When a certain sector of the credit markets pops its head out of its hole and refuses to behave, Batman and Robin fly in on a Mil V-12 and pummel accordingly. We can rail against this free market destroying and dangerous ethic, or we can take advantage of this obscene ritual and profit.
I, for one, choose profit over catharsis and along that vein offer you the following illustration of credit market evolution by our very own Credit Guru, MJ:
Near the height of the credit crisis Capital One announced that were buying back their ABS Auto bonds. They indicated that the returns available in the secondary market exceeded the returns they could earn by originating new car loans. They continued to buy back bonds in the secondary market until secondary market prices increased to the point that it became more profitable to originate new car loans rather than simply buy secondary market loans. Once the economics favored originating new car loans over buying older vintage ABS bonds….credit flowed back into the car financing business…… and car sales began to increase as pent up demand was unleashed.
The recovery in the Auto Finance market and its ability to attract investment dollars has caused Auto finance credit to materially loosen for even non-prime borrowers. The power of this trend manifested itself in GM’s decision to acquire AmeriCredit.
A similar trend materialized in the airplane leasing business. As the credit markets recovered, bonds issued by airplane leasing companies rebounded strongly. Intermediate ILFC bonds were trading in the mid-50s in February 2009 but are now trading strongly through par. Similar to the Auto Finance business, once pre-credit crisis airplane leasing bonds approached par airplane leasing companies were quick to tap the market for new financing. This new financing allowed them to order new planes and pay for planes already on order. As we have stated numerous times since the spring 2009, the reestablishment of an airplane leasing credit market has facilitated a pick-up in aircraft purchasing that we believed would benefit the entire manufacturing industry.
This same basic premise also seems to be working its way through other structured credit asset classes…although it is and has occurred at different paces. In our opinion, CMBS is in the middle of this same cycle. The rally in many pre-crisis CMBS deals and the issuing of new deals will continue to accelerate and deal spreads will tighten as investors use leverage to build their portfolio size. Current 8x-10x leverage will increase and capital raises will provide managers with a great deal of buying power. The expected increase in leverage availability and the high rates of return still available in this market will allow it to continue to attract investment. As demand for CMBS investments increase the market will once again begin to finance an increase in commercial building…..
The RMBS sector is following the CMBS sector’s lead. Although we believe that government driven uncertainty regarding GSE shrinkage and increase regulatory risk is slowing the RMBS sector’s recovery, we do not believe that there is anything in the market at this point that will actually reverse the RMBS Sector’s recovery. The aggressive leveraging of RMBS securities in Hedge Funds, REITS, and other investment vehicles is in the process of driving RMBS prices higher. We expect that the demand for RMBS paper is going to materially grow and outstrip the amount of secondary market bonds readily available as the year progresses. This is one of the reasons the FED is dumping their bonds. By the end of this year we expect a sizable increase in non-GSE related RMBS debt that will begin the process of materially loosening homebuyer credit. This would lead to an increase in residential construction work in 2012 as the loosening facilitates the release of pent up housing demand.