• Home
  • About
  • Subscribe
  • LATIF
  • Conferences
  • Dashboard
  • Edit My Profile
  • Log In
  • Logout
  • Register
  • Edit this post

Room 151

  • 151 BRIEF

    What's New?

  • £400bn pension group collaborates on climate transition initiative

    May 17, 2022

  • CIPFA rejects proposal for vote on publication of fraud hub report

    May 17, 2022

  • John Turnbull elected president of the SLT

    May 12, 2022

  • Pension pool identifies biodiversity as a priority

    May 11, 2022

  • TfL latest to face credit-rating downgrade by Moody’s

    May 10, 2022

  • Government proposes ‘fairer, more accurate’ business rates system

    May 10, 2022

  • Treasury
  • Technical
  • Funding
  • Resources
  • LGPS
  • Development
  • 151 News
  • Blogs
    • David Green
    • Agent 151
    • Dan Bates
    • Richard Harbord
    • Stephen Sheen
    • James Bevan
    • Steve Bishop
    • Cllr John Clancy
    • David Crum
    • Graham Liddell
    • Ian O’Donnell
    • Jackie Shute
  • Interviews
  • Briefs

Cash Investment: Tackling the headwinds

1
  • by Editor
  • in Treasury
  • — 3 Sep, 2015

Chris Gaskarth of Institutional Investment Advisors explores the benefits of residential mortgage and asset backed securities.

Thinking about what to do with cash, local authority treasury managers are currently facing a number of headwinds:

  • A reduction in UK government ownership of both RBS and Lloyds
  • Multiple downgrades of previously strongly rated banks to long term ‘A’ or ‘BBB’, including RBS and Lloyds

So there are now:

  • Smaller limits for eligible bank counterparties, by size and term
  • Consequently, a smaller eligible investment universe for AAA rated money market funds

And to make it even more difficult

  • Term deposits of < 1 year now offer lower returns due to the consequences of new regulations on bank liquidity
  • Bail-in risk is now a real consideration

A review of treasury management strategies (‘TMS’) reveals that many local authorities and their treasury advisors are addressing such concerns by adjusting their permitted investments, e.g. by now including new assets classes such as covered bonds and tri-party repos.

We believe that selected AAA / AA rated residential mortgage and asset backed securities (‘RMBS / ABS’) from the UK and other core-European countries are also worth considering to further strengthen TMS.

However, in general, RMBS / ABS have been overlooked, possibly due to a lack of knowledge or awareness of their strength, stability and resilience through the challenges of both economic and market volatility, particularly over the last 8 years.

The DCLG1  guidance on local government investments highlighted their three key investment attributes as security, liquidity and yield (in that order) – SLY.  These are all highly applicable to RMBS / ABS:

Security
The senior bonds from almost all core-European RMBS / ABS are typically rated AAA. There have been zero defaults in these bonds since the asset class began in 1987.

Most importantly however, they are all secured against pools of highly granular and transparent assets, just like covered bonds. But unlike covered bonds they are fully bankruptcy-remote from the issuing bank, meaning that they are completely immunised from any bail-in risk.

In addition, the bonds are typically issued as floating rate notes, thereby virtually eliminating interest rate risk. They are also usually fairly short dated, helping to keep mark-to-market volatility relatively low.

Liquidity
Being the most senior bonds, they have the largest issue sizes, often larger than a typical corporate or senior unsecured bank bond: with trading desks at all the major dealers they are at least as liquid if not more so.

In addition, the value and quality of these bonds has been recognised by central banks around the world. The BoE, the ECB and the Fed have taken hundreds of billions of senior RMBS / ABS on to their balance sheets as part of their various repo funding and QE programmes. For these purposes, central banks require asset classes that are both liquid and of the highest credit quality.

Of course, in the most extreme market conditions, liquidity in anything but the highest quality government paper tends to diminish significantly. However, even during the worst depths of 2008-2009 RMBS / ABS was still one of the few asset classes that the market was prepared to bid on, although prices were of course lower.

Yield
As can be seen from the table below, RMBS / ABS offer higher yields than covered bonds and short term unsecured deposits.  The following is a list of UK banks and building societies who have outstanding issues of RMBS, compared with senior unsecured 1 year CDs and secured but credit-linked covered bonds:

UK Banks and Building Societies – Comparable Long Term Credit Ratings and Spreads (bps vs 3mth Libor)*

*Composite Rating and Floating Rate Spreads.  3mth GBP Libor = 0.59% Source: Bloomberg, TwentyFour Asset Management 1-Sep-2015

*Composite Rating and Floating Rate Spreads.  3mth GBP Libor = 0.59%
Source: Bloomberg, TwentyFour Asset Management 1-Sep-2015

In addition, each RMBS / ABS issuer is a completely separate legal entity from the originating bank and can therefore also help to add diversity to local authority investment portfolios, therefore, in the UK alone, more than doubling the available number of potential investment names.

Total outstandings of prime RMBS from these issuers is comparable in size with both senior unsecured term debt (e.g. from MTN programmes) and covered bonds.  However, issues in both these markets have largely (approx. 85%) been in fixed rate form, adding an extra level of interest rate risk not found in RMBS, which could be swapped out but would then add an extra layer of bank risk to the holding and also further tie-up bank lines.

As with covered bonds and senior unsecured in the UK, whilst there is significant issuance in GBP, there are also bonds available from many issuers in EUR and USD.

Other Aspects

Credit Analysis
Unlike corporate or senior unsecured bonds, RMBS / ABS allow investment managers to carry out full and rigorous assessment of individual deals and stress testing of projected cash flows, both prior to their launch and on an on-going basis.

Typically, underlying asset performance is published promptly every month and in significant detail, unlike the annual and semi-annual reports from corporates or banks which also usually take some considerable time to be published.

Ways of investing in RMBS / ABS
An investment programme can be implemented simply and cost-effectively by engaging with an investment management team:

  • that specialises in both RMBS / ABS and currency hedged solutions (if required),
  • either in a AAA-rated bond fund and/or in bespoke Segregated Managed Accounts,
  • supported by an independent custodian

A leading investment manager will be able to demonstrate broad and deep access to both the primary and secondary markets to support efficient trading and liquidity.

1 Department for Communities and Local Government (revised 2010)

This article was sponsored by 

2

 

 

Institutional Investment Advisors Ltd. (‘IIA’) www.ininad.co.uk  advises on the design and construction of credit based asset portfolios, including RMBS / ABS, and arranges investments for institutional clientsChris Gaskarth iiincluding Local Authorities, Insurance Companies, Pension Funds and UK Banks. Chris Gaskarth (pictured), director, has extensive experience of treasury and credit markets. Chris is a qualified Member of both the Chartered Institute of Bankers and the Association of Corporate Treasurers, and also holds the Association’s Certificate in Pensions Risk Management. 

Share

You may also like...

  • Clampdown on commercialism ‘could push some councils to the cliff edge’ 4th Feb, 2022
  • Supplier management: The role of finance teams safeguarding essential services 25th Oct, 2021
  • Step-out strategies: Hitting the sweet spot between liquidity and short duration 25th Feb, 2021
  • Putting alternatives at the heart of multi-asset portfolios 12th Jan, 2021

1 Comment

  1. Gary Bennett says:
    2015/09/04 at 11:00

    Not in a million years!

    Log in to Reply

Leave a Reply Cancel reply

You must be logged in to post a comment.

  • Register to become a Room151 user

  • Latest tweets

    Room151 11 hours ago

    More evidence of the importance of emerging markets in the journey to net-zero. @BordertoCoast @BrunelPP @northernlgps @EAPensionFund @WYPF_LGPS Click the link below to read 🔻🔻 #LGPS #NetZero #NetZeroCarbon #EmergingMarkets room151.co.uk/brief/400bn-pe… pic.twitter.com/qCm0EGxzLn

    Room151 5 days ago

    ‘Urgent consultation’ issued in response to continuing audit delays: CIPFA and the Local Authority Scotland Accounts Advisory Committee (LASAAC) have announced another “urgent consultation” to consider proposals to address the latest issue that has led… dlvr.it/SQJ0kV pic.twitter.com/s6vw0bnGXO

    Room151 5 days ago

    Bags of capacity – now to housing delivery: HRAs have been freed up and councils are starting to invest, but some remain cautious, writes Steve Partridge. He suggests that a minimum of £10bn of additional borrowing could be[...] dlvr.it/SQDvxk pic.twitter.com/yZmoWzHv6U

    Room151 5 days ago

    Bags of capacity – now to housing delivery room151.co.uk/treasury/bags-…

    Room151 6 days ago

    To Michael Gove: a modest proposal: Conrad Hall has written an open letter to the levelling up secretary suggesting an unusual (and tongue-in-cheek) proposal to help councils predict next year’s government grant. Dear Secretary of State,[...] dlvr.it/SQ9GpX pic.twitter.com/mSX1xgeL8a

    Room151 7 days ago

    Queen’s Speech: an ambitious plan hampered by omissions: Richard Harbord examines the impact of the government’s legislative proposals on councils, and concludes that local authorities expect and need more from central government. However you view the… dlvr.it/SQ8hmP pic.twitter.com/BsnziyNPIO

    Room151 1 week ago

    Insights and inspiration from LGPS leaders past and present: Four current and former LGPS leaders have recently given powerful and insightful interviews as part of the Fiftyfaces podcast, which showcases inspiring investors and their stories. Hosted by… dlvr.it/SQ53lC pic.twitter.com/IRYMFPxdA2

  • Categories

    • 151 News
    • Agent 151
    • Audit
    • Blogs
    • Business rates
    • Chris Buss
    • Cllr John Clancy
    • Council tax
    • Dan Bates
    • David Crum
    • David Green
    • Development
    • Education
    • Forum
    • Funding
    • Governance
    • Graham Liddell
    • Housing
    • Ian O'Donnell
    • Infrastructure
    • Interviews
    • Jackie Shute
    • James Bevan
    • Jobs
    • Levelling up
    • LGPS
    • Mark Finnegan
    • Net Zero
    • Private markets
    • Recent Posts
    • Regulation
    • Resources
    • Responsible investing
    • Richard Harbord
    • Risk management
    • Social care
    • Stephen Fitzgerald
    • Stephen Sheen
    • Steve Bishop
    • Technical
    • Transport
    • Treasury
    • Uncategorized
    • William Bourne
  • Archives

    • 2022
    • 2021
    • 2020
    • 2019
    • 2018
    • 2017
    • 2016
    • 2015
    • 2014
    • 2013
    • 2012
    • 2011
  • Previous story News Roundup: Devolution requests, Birmingham grant, culture budgets, local government summit
  • Next story Richard Harbord: The ‘indecent haste’ of devolution

© Copyright 2022 Room 151. Typegrid Theme by WPBandit.

0 shares