Hella Weird Bonds: Asset-Backed Securities and Dieter's 10 Principles

For Paul & Bond-Lovers:

• Private credit with products like asset-backed securities, synthetic risk transfers, and net asset value are percolating rises as interest rates rise.
• Goldman Sachs packaged capital-call loans into ABS, marketed as having “historically close to 0%” default on capital-call commitments from large institutions.
• The security offers bond-like returns, primarily aimed at insurers and pension funds.
• Synthetic risk transfers allow banks to shift credit risks to hedge funds and private equity firms. With projections nearing $200 billion in loans, SRTs are expanding but bear potential risks.
• Net asset value loans provide PE firms with capital by borrowing against their portfolio’s NAV rather than individual assets, keeping capital accessible even as interest rates rise.
• Driven by distressed debt performance, private debt returns are expected to rise, with IRRs projected to reach 12% by 2029. Assets under management could grow from $1.5 trillion in 2023 to $2.6 trillion by 2029, as institutional allocations trend upward.

For Halloween Investors:

Listen. I’m a little sick when I start this writing.

There’s a heck of a lot of headlines about private credit and a string of stories about hella weird — the technical term used in the CAIA Level II curriculum — that sound like it could be another pyramid of bad debt that are stacked on top of each other that put investors on the line — or originators, or someone in the chain, or everyone; my head’s a bit foggy as is the structure to any non-suit — if the loans go bad...

...which Goldman says there’s almost 0% chance of that happening, the loans going bad.

”Defaults on capital-call commitments from large institutions ‘have been historically close to 0%,’ according to a marketing document for Goldman’s bond viewed by The Wall Street Journal,” EXCLAIMED the Wall Street Journal.

This is in reference to Goldy’s $475 million asset-backed security insurance.

Close to 0% sounds safe, but isn’t one of the main schticks of finance that ~past performance is no guarantee of future results.~

Call me uninformed and out of the loop but you have to at least give me like a decimal to build trust. I was born in the caves of marketing — people like decimals.

My lawyer tells me that banks like Goldy give these loans to private equity firms that the PE firms use to make investments, the loans are bundled and shoved into special purpose vehicle and stickered ?? asset-banked securities ?? and sell them to investors who receives bond-like interest payments. The private equity firms pay back the loans via their investors.

The buyers of such ABS loans are insurers and pensions funds. Why? Some sweet, sweet returns.

Then you read some more WSJ articles from Matt Wirz and you add on SRTs, synthetic risk transfer, that give hedge funds, PE firms, and fun connected folks that option to trade some more credit risk.

That market has projections for $200 billion in loans.

Add on top of that some net asset value loans, another newer lifeline to help private equity get some cash as interest rates are now not at forever-zero percent. If a PE firm doesn’t close a deal fast enough, they borrow against the value of their dund’s portfolio of investments instead of individual assets.

Private debt’s performance is projected to improve, driven by distressed debt.

Preqin forecasts the average IRR for private debt to increase from 8.1% (2017–2023) to 12.0% (2023–2029), with distressed debt expected to average 13.4%.

Note the decimals. Marketing!

Private debt assets under management are expected to grow from $1.5 trillion at the end of 2023 to $2.6 trillion by 2029.

Allocations to private debt have been up. Texas County & District Retirement System reported an actual allocation of $13.10 billion to private debt, slightly above its target of $12.13 billion.

Up is up.

Now — is this all run of the mill financial product innovation and probably small numbers for banks to shuffle around numbers on documents to make sure they comply with capital regulations coming from the omnipotent capital god? Probably.

Does it really matter? A little bit. And a lot more bit depending on where you get your cash flow from.

But can asset-backed securities really be 0% defaults even if they have high-quality borrowers, backed by investors, and short maturity with credit enhancements?

Freaking I guess so. Someone can tell me why if you’d like.

Dieter Rams said there’s 10 principles for good design. Financial innovation is design, after all, right, pals?

They are the following:

• Good design is innovative.
• Good design makes a product useful.
• Good design is aesthetic.
• Good design makes a product understandable.
• Good design is unobtrusive.
• Good design is honest.
• Good design is long-lasting.
• Good design is thorough down to the last detail.
• Good design is environmentally friendly.
• Good design is as little design as possible.

When you’re telling me about 0% chance of default, you can also tell me how many of those 10 principles this new financial toy hits.

With appreciation,

Your asset-backed friend

JDR

Nov 1 2024