Conning’s Paul Norris Demystifies Esoteric ABS

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Stewart: Insurers are facing a yield starved environment and looking for places to drive investment income. Some investors are looking at esoteric ABS as a solid risk adjusted alternative. We're joined by Paul Norris of Conning today, to talk about this subject. Paul, welcome.

Paul: Thank you, great to be here, Stewart.

Stewart: Thank you, and thanks for the reminder, Stewart Foley, I'll be your host. So, Paul, can you just give us a quick rundown of your background? That'd probably be a good place to start.

Paul: Sure thing. I am, again, Paul Norris, I'm the Head of Securitized Assets at Conning. Spent many years in the beginning of my career at Fannie Mae and then I moved on to a hedge fund for a while, before I started at Conning. And I should, I guess, remind everyone in terms of Conning who we are, if that's okay, Stewart?

Stewart: Absolutely.

Paul: Conning is a leading global investment management firm, we've got a long history of serving the insurance industry. We're actually founded in 1912 and we've expanded quite a bit since 1912 in that we've got investment centers in Asia, Europe and North America, so we're out there helping global insurers find solutions to their problems and helping them manage their assets.

Stewart: I mean, your assets, if you looked at your total AUM, insurance is the majority of those assets, is that fair?

Paul: That's correct. I think as of right now, we have around 200 billion. Majority is focused on insurers, either life or P&C and other types of insurers.

Stewart: So, let's talk about, and I mean, people who listen to these podcasts are industry people, so no need to worry about jargon and getting in the weeds here, so everybody knows what ABS is, the term esoteric ABS tells me that these are unusual collateral types, right? So what's the difference between traditional ABS and what we're calling esoteric ABS?

Paul: That's a great starting point, Stewart. I would say at least in terms of how we look at it at Conning, we're going to break it out into two categories really to start. And we're going to talk about commercial and then consumer esoteric ABS. And you mentioned before, esoteric ABS is really similar to the plain vanilla sectors like credit cards or autos, really the same concept, same type of structures. The really big difference in esoteric is that these assets or these deals are issued less frequently. So, it's not going to be on a regular cycle, like a large auto issuer that's coming every month with the billion dollar deal. That's not this. The deals are really smaller deal sizes, typically 500 million and they're backed by less mainstream loans or assets in terms of what's driving these deals and I'll just give you a couple of examples.

Paul: On the commercial side, we can think of examples like aircraft, shipping containers, rail car boxes and those are typically the equipment contributed by the issuer, which is usually a large leasing company, such as, there's a couple of big names out there in terms of containers or aircraft, and I'll just mention in terms of commercial, one of the reasons we're really fond of this asset class as these are mission critical assets for the firms that are using these assets. So in other words, they can't survive without these assets, they can't make money without these assets, so that's why we're a big fan.

Paul: And then quickly on the other side is consumer. And for us on the consumer side, these are loans that are backed by things like timeshare or unsecured consumer loans or something called PACE, which is really property assessed clean energy and what does that mean? That means like solar panels, clean energy windows, et cetera, that help someone in their home basically be more energy efficient and that's kind of how we define it.

Stewart: So, when we talk about assets backing ABS, and you just named several classes, when we talk about shipping containers, we're all familiar with,”used car market right now is crazy hot, housing market's hot,” but I don't know anything about the shipping container market. It sounded like there's an active market for it, so what affects the value of some of this, what I would call sort of, well, it's esoteric collateral, but it's also not something that's a household term?

Paul: Right, and that's a great question. What I would say is what's funny about the market, you may not know about containers or container boxes, but they're just as hot as used cars for very similar reasons. What's interesting about containers, and just to frame it up for people, these are the 40 foot or 20 foot boxes you'll see on the picture of a container ship in port, or when you're driving down 95 and New Jersey where you see all those tractor trailers with those container boxes on them. But interestingly enough, what's fascinating to us about containers is that where they're made is actually in Wuhan, China. And so, in the beginning of the pandemic, that really impacted containers, because the ability to create and make containers was basically stopped because of COVID and because it was in Wuhan. Then Wuhan got up and running and then supply was still limited, but demand has really outstripped supply in terms of the ability to make these containers.

Paul: And so, what we've seen is really a skyrocketing, just like you've talked about used cars, we've seen a skyrocketing of value in some of these container boxes and also what it costs to really reserve a box on a container ship. And so, these numbers are quite frightening, but in terms of- I don't mean frightening in that it's scary, but the amount of cost increase over the last six months, it's been astronomical. So we've seen basically the price of, to reserve a cargo, a 40 foot container, has moved up to $10,000 per container, which is almost two and a half times what we saw pre pandemic. So, the value of these actual container boxes has also increased to a much higher value.

Paul: And really, it comes down to the fact that everything ships out of China, we don't have enough cargo boxes, containers to go on the ships and then even the ships, we don't have enough ships. And I think a great example is, I read somewhere that Home Depot has actually bought their own ship to put their own containers on those ships, so it's just like used cars, it's just like housing, there's a shortage of everything with this just huge demand.

Stewart: Yeah, it's interesting. I mean, just on a personal note, decking material, there's something called tracks and it's just months to get and I think it's just every which way, there's shortages every which way. So, a lot has transpired since the financial crisis, in terms of investor protections, can you walk us through some of the significant changes that may impact this asset class?

Paul: Yeah, absolutely, I think that's a great question, a great point. One of the things that we saw really in the great financial crisis, was that if you did a compare and contrast versus esoteric asset backed securities versus, say, non-agency mortgages or commercial mortgages, really what we saw is that there was little to no losses on any of the deals in asset backed securities, especially esoteric. And even with that, what we saw coming out of the crisis was increased structural protections. So for us, that's one of the reasons that we really love the sector is that we can basically take our most stressful scenarios and put them to some of these deals and they don't break and we don't see them getting downgraded based on some of the levels. So, the examples that I would share that what's changed is that I think, four or five things here, so one is, more credit enhancement. So each one of these deals post great financial crisis has more credit and enhancement, so that's great.

Paul: And number two is there's more transparency. A lot of the investors got together and pleaded with the SEC and others that govern some of these issuance and asked for more transparency about the borrowers, about the container boxes, about the issuers and that was basically granted. The other thing is that there much simpler structures. I remember pre-crisis, you might see, this is not esoteric, but you might see a commercial mortgage deal with 30 tranches. Now, all these deals are really simple, they've got basically five tranches, makes a lot of sense. The other advancement, I think, that's really important to more is trace, so that is the ability to see where a transaction price is in the secondary market, so it really makes pricing more transparent.

Paul: And then finally, the really big deal is that risk retention, so these deals and these issuers bringing these deals have to retain 5% in terms of the deal or in terms of equity. And one of the things we look for is someone who is basically eating their own cooking, so we really prefer issuers and esoteric that are retaining the entire equity slice as part of their business plan, which we think is really important, because it aligns our interests with their interests. So the bottom line is, what's exciting is that we can run our most severe stresses back to the great financial crisis and today these assets don't suffer losses. So we're really, really excited about that.

Stewart: I think you made a very good point earlier on, which is that the people who are using these assets for the most part, it is a core piece of their business, right? I mean, shipping containers, if you're in that business, you've got to have them. It's not like it's optional, so you kind of answered my next question, so let me just throw maybe something a little different here. My fixed income geek portfolio hat goes on here and I go, “Esoteric ABS, that's got to be a give liquidity trade,” which a lot of insurers have done in search of yield. How much liquidity do you see in this market compared to more mainstream ABS?

Paul: Another great question. I would say in good times, liquidity frankly is the same as these other asset classes. And the example I would use is of course it might have a little bit of a different bid offer spread, so whereas credit cards, let's just make a number up, might have one to two basis points, these might be five basis points, 10 basis points depending. But the reality is, Stewart, if you called me up and said, "Hey, Paul, I really need to raise some capital and I need to sell this bond." We could put that out on a BWIC this morning and sell the bond within a half hour. So that, in terms of liquidity and being able to buy and sell, I think is highly liquid. The bid offer spread may be dependent on the underlying asset class, but it's not going to be more than 10 basis points in a regular market.

Paul: The other thing that I find really interesting is going back to the COVID crisis when spreads really widened out, I mean, liquidity on everything basically went to zero. So, whether it was a AA or A corporate versus an esoteric versus a non-agency mortgage, liquidity was terrible for everything and then it slowly started recovering. So, it really depends on the market that we're in, but in our normal functioning markets, esoteric ABS has been really liquid from our experience for a long time.

Stewart: It's interesting. I think a lot of insurance companies have had a second look, or a third or fourth look, at their need for liquidity, so if you're an insurer and you need to raise capital, you're probably going to look elsewhere for your liquidity, right? And then if you've got a federal home loan bank membership or line of credit options, I mean, you've got liquidity options short of, and I think you've seen insurers go down in liquidity as a result.

Stewart: I mean, I think that, I'm on my soap box at this point, but I think the need for liquidity is sometimes overstated, given the nature of insurance companies, they're cash flow positive and so forth. So, there's been much talk about inflation, we talked about global supply chain shortages; on these podcasts I've heard inflation views all over the place, so is the global supply chain issue driving the inflation pressure in your view and how is it affecting the esoteric ABS market?

Paul: All I have is the experience that we're seeing in terms of pricing and one example that we've used before is the container pricing and the price to ship a container across the major trade routes. And what I think is fascinating, there's some statistics we put together in terms of pricing, so some of the main routes, and I'll just use one, but one of the major routes in terms of shipping on the east-west routes is Shanghai to Rotterdam and the annual change in terms of pricing, now it costs $11,975 to ship a box from Shanghai to Rotterdam. That is 578% increase over the last year. That's not a typo, that's not a misstatement. One that's probably important to us, which isn't as bad, but is Shanghai to New York, is up 249% and that costs $11,180 per box.

Paul: Point being is that this, of course, has to do with what we talked about before and that's the overwhelming demand on the reopening of the world economy, combined with insatiable appetite for goods that people want to get back out, they want to do things. You want your tracks decking, I was looking to buy a generator. I mean, it's crazy how much people are looking to purchase that are shipped in these boxes. And so, all I can think is that this is sustainable for a while, but then eventually the supply-demand is going to even out a bit and I think that would make it a bit more transitory in terms of inflation.

Stewart: Yeah, I mean, I think it's one of those deals it's like, is the inflation sort of a bulge that's going to work itself out? It seems like there's a lot of demand right now, but you got to think that maybe that works its way through. So, what do you think are the better opportunities for insurers in esoteric ABS now and importantly into 2022? I mean, what do you think the most important factors are when you look at this market?

Paul: Yeah, I mean, that's a pretty broad question in terms of, I've got a lot of places to go to answer that, which I love, but what I would say is for right now number one is, the consumer is in great shape, so we think brick and mortar consumer lending is really attractive. And what I mean by brick and mortar consumer lending is where it's not a FinTech in the box type of thing, but where you have to go in and get a consumer loan at the office or at the buildings, hence brick and mortar. And we'd think because the consumer's in such great shape that they're going to be in great shape for quite a while, given these transfer payments, so that's a sector that we like a lot.

Paul: And then on the followup, because of the consumer being in good shape and the demand that you and I have talked about, we think certain aircraft bonds make a lot of sense in here, because the demand for travel is ever increasing. You can see some of the headlines where some of these airlines are looking to buy up to 200 planes. So we see over the next three to five years plane values continuing to appreciate and do really well. And then there's a couple of other sectors that we like, these are a little bit more niche, but it's something called triple net lease, is something that is very exciting to us. Rail car is exciting to us and then small business loans we think are also going to do really well.

Paul: And all of that is really predicated upon a consumer that is still looking to get out, buy things, do things and continue to spend money. So, we think that's a good backdrop for some of these asset classes. What I would say in terms of 2022, I guess in terms of a macro backdrop, we would think that these sectors would continue to do pretty well, but as always it's really going to be dependent on a continued recovery, it's going to be contingent on Fed actions, so it's kind of like, we'll wait and see what happens in 2022 and sort of reevaluate. But for now, we like these opportunities, we think that they will continue to be the same opportunities in 2022, barring some sort of, what's the right word, I guess, break in this recovery. So, bottom line is, we're fairly confident in terms of these assets backing these deals about being very resilient, so it's not really a credit issue that we're focused on, it's more, “Where can we find the best relative value?”

Stewart: Yeah, I think, to your point about the consumer, I know at least here in Chicago land, I see a lot of help wanted signs out there and I don't know where you are, but there seems to be plenty of demand for jobs at this point. So it's always one of those deals, it goes back to 100 years ago and a guy named Peter Lynch, if you remember that name, talked about sort of putting it back to like, what kind of experiences are you having day to day that kind of back up your economic thesis, if you will, so I think that makes good sense.

Stewart: Since you and I are both insurance geeks and I use that term in the most warm way ever, I'm proud to be an insurance geek, are these bonds or are these ABS rated and so, are they rated by a nationally recognized rating agency and where do they show up are they a scheduled D asset?

Paul: Another great question. Yes, these are schedule D, they're going to show up like any other normal bond, like a corporate. One of the reasons we love this asset class is because A, it's not going to hurt risk-based capital. The other reason that we like these bonds and when we were kind of geeking out on our insurance clients, is that we also do a lot of stress testing in terms of ratings downgrade. And so, one of the things we're very proud of is that when we buy these bonds, we're also considering what's the rating volatility going to be on these asset classes? So, for buying a single A or a BBB bond, and there's a fear that it's going to get downgraded to below investment grade, we absolutely want to consider that for our insurance clients, so as not to impair their risk-based capital.

Paul: And that's one of the things that we put into our process, where, frankly, I think there's one of those good sayings, but begin with the end in mind. And we're basically looking to see, okay, if trouble hits, what's been the experience on these asset classes, do the rating agencies downgrade them to a place that's going to hurt our clients and, and we take that into consideration. To answer the first part of your question, these are all absolutely rated typically by S&P, Moody's, Fitch, Kroll, DBRS, all the majors are here. There's usually one or two ratings on these deals, so we feel really comfortable with these asset classes, given the ones that we're focused on at least have a lot of history that we can regress and look into and see how they performed over a long period of time.

Stewart: So, kind of winding down on my last question here, obviously, Conning is a leader in this space, when an insurer goes out and is considering, let's just say that they're not familiar with the asset class and they're looking for an esoteric ABS manager, and so without answering this part, as an insurance company, you need a manager who understands the kinds of things that you just went through, right? Ratings, downgrade impact on risk-based capital, impact on and best rating for the insurance company, all of those things, which is really important. But with regard to just the asset class, if you don't know anything about it, what should an insurer be looking for in a manager of this asset class?

Paul: Well, first, Stewart, they should look no further than Conning.

Stewart: There you go. All right. Well, listen, that was an underhanded pitch there, right? Okay.

Paul: Oh anyway, thank you. Well, no, what I would say is in a dispassionate manner, if you're looking for a manager, what you're looking for is someone who has the experience and the data. And what I mean by that is, a lot of these esoteric asset classes are not going to have data like a regular auto deal or a regular credit card deal, so it's really incumbent on the manager to have gone out, found the data, put it in a database, accumulate the data, have a history of the data and I think that's really important.

Paul: And the other thing is developing proprietary models, which of course we've done, because there's no yield book, there's no readily made model where you just go in and use a service that someone has provided to analyze these things. So for me, that's the really important part of being involved in this sector. Has the manager spent the money to build out the models, to get the data, to develop and look at the history of each and every one of these asset classes? And then, do they have the people that have done this for a long time and are they really entrenched into the sector?

Stewart: Just to geek out a little further, your models are proprietary and you built them?

Paul: Yeah, that's right.

Stewart: Yeah, okay.

Paul: I mean, as an example, I mean, we spent a lot of time about five years ago really getting together with our quant team, as well as our tech team and our analysts to build out something that's proprietary for us. So, we run every single deal every month through our models and we're basically stress testing them every single month and we're coming up with a credit score while at the same time, we're sending these out to clients if they want them every single month.

Paul: And these are built based on the history that we have from getting this data and we're able to build out stress test as well as the fault curves and timelines, et cetera, for each of these asset classes, which I think is really important. You just don't want to step into a market where you really are a stranger and you don't have a real feeling or understanding of the market. And that's what I mean by having historical data in the field.

Stewart: I got to think that your investors take a lot of comfort in that level of transparency to get those reports every month to see that work being done. My final question is one that there's no way to prepare for, so here we go. I want to take you back to a day that I know you remember, and that's the day that you graduated from your undergraduate institution.

Stewart: So, whatever festivities may have occurred the evening before, you are bright eyed and bushy tailed in your cap and gown raring to go. So you're there you are, you wait, wait, wait, they finally call your name, you go up the stairs across the stage, you get a quick handshake and a photo opportunity as they hand you your diploma, the crowd's going bananas, Paul, they're going crazy and you walk off the stage down the stairs and at the bottom of the steps you run in to Paul Norris today, what do you tell your 21-year-old self?

Paul: Wow, well, I tell my 21 year old self, get ready to enjoy life, but work hard, always be fair and treat people well. And if you do those things, I think you're going to go pretty far and don't plan ahead too much, because as Mike Tyson said, everyone has a plan until they get punched in the face and you're definitely going to get punched in the face, so just get up and keep going.

Stewart: I love it. That's great advice. Paul Norris on esoteric ABS at Conning. Paul, thanks for being on.

Paul: Thank you, Stewart, this was really fun.

Stewart: It's good times. I really appreciate our audience listening, if you have ideas for podcasts, please email us at My name's Stewart Foley, and this is the Insurance AUM Journal podcast.


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Conning is a leading investment management firm with a long history of serving the insurance industry. Conning supports institutional investors, including insurers and pension plans, with investment solutions, risk modeling software, and industry research. Founded in 1912, Conning has investment centers in Asia, Europe and North America.

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