Greg Lippmann, Partner and Chief Investment Officer at LibreMax Capital, joined Keith Black, Managing Director of RIA Channel, to discuss the impact of how regulations put in place after the global financial crisis (GFC) can create opportunities for today’s investors in securitized credit.
Asset-backed securities (ABS) and mortgage-backed securities (MBS) often purchase loans originated by banks as well as corporate receivables secured by assets. The amount of capital available to borrowers increases, and the cost of credit declines as external investors provide capital to the banking system through the ABS and MBS markets. Investments in securitized credit vehicles are backed by assets such as residential and commercial mortgage loans as well as consumer credit such as student loans, credit cards, and automobile loans.
Lippmann was chronicled in “The Big Short,” a book by Michael Lewis. Lippmann profited by selling short subordinated tranches of residential mortgage-backed securities (RMBS) at the beginning of the GFC after questioning the assumptions used by the rating agencies and originators of the RMBS. The asymmetric trade profited when realized home price appreciation fell short of the assumptions used to support the RMBS structuring.
Lippmann notes that the GFC was caused when aggressive consumer loans were packaged into securitized vehicles and sold to highly levered financial institutions. Regulations were enacted after the GFC to prevent a similar crisis. The founding of the Consumer Financial Protection Bureau and the implementation of the Dodd-Frank rule and the qualified mortgage rule have resulted in a preference for the origination of fixed-rate consumer loans. The greater availability of fixed-rate loans has enabled US consumers to exhibit more resiliency in today’s environment of higher interest rates than has previously been seen, as a greater percentage of the debt is locked in at pre-tightening levels. The regulations also resulted in higher capital charges for banks, as the charges to hold securitized products rose from 2 to 4 times the capital required to hold corporate bonds before the GFC to 10 times today.
The increased capital charges have caused securitized products to trade at wider spreads relative to corporate bonds than had generally been seen before this change. This is especially prevalent at lower credit ratings, as regulated buyers such as insurance companies, mutual funds, and banks have capital charges or other regulatory constraints that prevent them from purchasing some securitized products, such as the BB tranches of ABS and MBS. While rating agencies are careful to rate new issues of corporate bonds and securitized products accurately, credit ratings can become stale, which creates an opportunity for investors without the constraints of capital charges and regulatory limits and the in-house investment in data and technology combined with the requisite experience to purchase the tranches of securitized products determined to have a credit quality higher than implied by the current rating or the price of the issue.
WEBCAST – The Big Short’s Greg Lippmann on Using Structured Credit to Enhance Fixed Income Portfolios
We believe securitized products, such as asset-backed and mortgage-backed securities, are an under-allocated asset class that offers diversification along with attractive fundamentals and value relative to high-yield and investment-grade credit. This is an alpha-rich investable universe that is an essential part of the US economy, providing financing for American consumers.
Please join Greg Lippmann, Founder & Chief Investment Officer of LibreMax Capital for a discussion on:
- Market overview and the basics of structured credit
- Why structured credit is especially compelling today
- How LibreMax capitalizes on the space
- How LibreMax can help increase the return and lower the volatility of a fixed-income allocation
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