The US structured finance market is not entirely in favor of a wholesale repeal of post-crisis reform under President Trump’s administration due to widespread belief that tighter regulation may be a good thing.
Large parts of the Dodd Frank Act of 2010 were geared towards reforming the US securitization market - a flashpoint of the crisis - and many rules were recently implemented after years of negotiation and as banks took pains to comply.
But Trump said last week his administration expects “to be cutting a lot out of Dodd-Frank”, and ordered a review of the legislation - making some investors nervous that a lot of positive work could be undone.
New bond structures that meet the requirements - specifically those on risk retention - have become a big hit with the buyside. Risk retention came into effect late last year and calls on lenders to keep 5% of each new deal.
“It’s been a huge driver in terms of market technicals,” said Tracy Chen, the head of structured credit at Brandywine Global Investment Management.
“We see this not only in CMBS, but also in subprime auto.”
Though some bankers are still wary that too much regulation can hinder business, the new landscape has increased confidence in the market and helped drive in pricing.
New CMBS bonds designed to adhere to the new rules started springing up months before the December deadline. But they have now become a regular fixture and are driving up competition for bonds.
Bank of America Merrill Lynch, Wells Fargo and Morgan Stanley priced a conduit CMBS with a retained 5% vertical slice at multi-year lows - showing just how far the market has come.
Its largest 9.84-year Triple A class priced at 88bp over swaps, a level not seen since June 2015, according to Wells Fargo data.
The riskier Triple B minus class, meanwhile, cleared at 350bp over swaps, or half the 700bp spread tied to similar bonds sold in November before the new rules went live.
Part of the reason for that tighter pricing, at least on Triple B notes, is that there is less supply for investors to buy.
The 5% vertical risk retention option in CMBS includes just a small portion of Triple B minus notes. But the “L shape” or horizontal CMBS structures can keep large swaths of Triple B minus notes entirely off the open market.
“Conduit Triple B minus had pretty much gotten beat up,” Chen told IFR.
“Now it is not only the scarcity of [Triple B minus] supply, but the perception of better collateral quality.”
BIG IMPACT
Even in subprime auto ABS where bond issuers have often voluntarily kept skin in the game, riskier notes have suddenly become a hot commodity.
DriveTime saw its US$435m subprime trade oversubscribed by two to five times on Monday, with demand coming in strongest for its lower-rated tranches.
Its 3.64-year Double B class cleared at 410bp over interpolated swaps, whereas its prior deal in September cleared at 550bp.
“Anytime you see 140bp of spread tightening it has a pretty big impact,” a banker on the trade said.
A fresh influx of cash into bond portfolios is also spurring a dash for subordinate subprime auto bonds as investors rush to put that money to work, he said.
Investors now hope Trump’s administration will look to keep some reforms intended to keep the market safe and orderly - even if they are more onerous - rather than push through blanket deregulation.
That looks likely to be the case, at least in the near term.
Cowen and Company analysts warned that, despite the recent flurry of executive orders coming from President Trump’s desk, little can be done to roll back Dodd Frank without lawmakers - and the approval of the US Senate.
“Legislation cannot become law without the Senate,” wrote Cowen’s Jaret Seiberg. “Even moderate Democrats are sticking with progressives rather than be seen as cooperating with the President.”
Jan Stewart, a partner at law firm Mayer Brown in Chicago, also said issuers were unlikely to change their approach just yet.
“I don’t think issuers are waiting for anything to be pared back,” Steward told IFR.
“They say, this is our issuance plan, and they take advantage of market opportunities as they see fit.”