Numerix and PolyPaths recently attended SFVegas 2024, the premier global capital markets conference hosted by the Structured Finance Association (SFA). The event featured timely subject matter developed by industry leaders and geared at a range of market participants including investors, issuers, financial firms, regulators, law firms, technology firms and more.
We were thrilled to have a booth presence at the event, as it afforded us the opportunity to chat with numerous attendees about various hot topics in structured finance. Our team was also able to attend several sessions dealing with a range of different topics on mortgage servicing rights, the global securitization markets and credit card ABS — just to name a few. Today, we’d like to share a few takeaways we gleaned from this educational event.
Takeaway #1: Changes in the MSR Market
The session, Market Beat: Mortgage Servicing Rights (MSRs) delved into the complexities of risk within this unique market. The industry is transitioning towards a more dynamic, multi-dimensional hedging strategy for MSRs, where the prominence and volatility of T&I float have reached unprecedented levels. In this changing environment, hedging strategies need to address both rate and prepayment risks, in addition to shorting the IO. There’s also been a distinct change in the ecosystem of MSR players, which has been transitioning from traditional banks to non-bank, non-federally connected institutions.
The nuanced nature of MSRs presents a dichotomy: they act as pure interest-only instruments on one hand, yet they bear unhedgeable credit risks on the other. This has prompted a call for tighter regulations on these institutions, emphasizing the need for enhanced oversight and capital adequacy measures.
A significant shift in interest rate dynamics has further complicated the landscape. The previous very low interest rate regime begat a universe of mortgages with very little prepayment optionality. The current higher rate regime introduces the risk of rates decreasing, and much more prepayment optionality, cutting short the duration of and impairing the value of MSR portfolios. Consequently, there is a growing emphasis on cost-effective hedging strategies, with a growing need to accurately quantify the associated risks.
Takeaway #2: Trends in ABS
We also attended a panel discussion on global securitization, which offered some enlightening insights on the Canadian and Chinese asset-backed securities (ABS) markets, highlighting their yield opportunities for investors despite hedging risks.
In the Canadian market, characterized as fairly conservative, the predominant ABS types are auto loans and credit cards. Notably, Canadian banks issue USD-denominated cards, and the market features few complex instruments.
Conversely, the Chinese ABS market is relatively new but has experienced significant growth since 2013. Concerns surrounding issuance include the impact of quantitative easing by the Chinese central bank. Additionally, there are growing concerns regarding data disclosure and increasing regulatory measures. The Chinese ABS market primarily operates domestically, with limited opportunities in USD-denominated assets.
Takeway #3: Changing Credit Card ABS Landscape
Another key session dug into the challenges market players face with credit card asset-backed securities (ABS) in the aftermath of the pandemic. Despite increasing delinquencies and charge-offs, existing models fail to adequately capture these trends as they are calibrated off low unemployment rates.
However, it's argued that inflation should be a more predictive factor, necessitating better integration into models. The pandemic accelerated the shift towards cashless transactions, leading to higher outstanding credit card balances. Furthermore, the government's pandemic relief efforts led to a phenomenon dubbed FICO inflation, which disrupted risk pricing by credit card companies, resulting in over-lending in 2021 and 2022. Addressing these challenges requires recalibrating risk models and adjusting lending practices to adapt to the changing landscape.
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