(Bloomberg) -- As investors seeking safer bets clamor for asset-backed securities, Wall Street is turning to increasingly unconventional debt to package into the bonds, including art loans and internet addresses.

Esoteric ABS deals — backed by collateral other than student, auto, credit card and equipment loans — have risen to about 31% of the ABS market from 9% over the last decade, according to Barclays Plc. Collateral pools have also become more diversified with investors seeking out novel structures to earn excess returns as ABS spreads tighten, dropping more than 30 basis points since November. Meanwhile, interest-rates are expected to stay higher-for-longer, which means the benefits to borrowers of waiting to come to market have dissipated.  

A number of esoteric ABS transactions have been seen in the past few weeks. Global internet provider Cogent Communications is offering a $206 million bond backed by internet protocol addresses, marking its debut ABS deal. Auction house Sotheby’s recently sold $700 million of bonds backed by personal loans made to art collectors, and investors also snapped up $570 million of notes backed by fitness franchise royalty payments. The last two transactions were upsized during marketing, stoked by investor appetite for the non-traditional debt.

“We have seen an emergence of several sub-sectors since the pandemic,” said Mike Nowakowski, head of structured products at Conning. “It seems that investors are becoming more comfortable with understanding the risk-reward associated with more esoteric collateral and are willing to do the underwriting to achieve higher yields.”

Asset-backed securities typically bundle up assets ranging from auto loans to credit card debt into bonds. About $95.6 billion of the securities were bought in the first quarter of this year — the fastest pace of sales to start a year since at least 2010 — as previously reported. But the sector is evolving and structural creativity has become more of the norm, according to Powell Eddins, Barclays’ head of US ABS and CLO research. 

“Part of this is attributable to investors of insurance capital becoming more creative in the ways in which they put money to work,” he said. “As more alternative asset managers have acquired insurance capital, they have pushed the industry forward into investing in assets like esoteric ABS.”

Esoterics account for just under a quarter of ABS deals priced in the US primary market this year, compared to a little more than a quarter at this time last year, data compiled by Bloomberg News shows. “In terms of yearly issuance, the very exotic collateral doesn’t amount to a large percentage of the esoteric pie, but it does grab the attention of investors because of its novelty,” Nowakowski said.

While the structure of esoteric deals is similar to traditional ABS, the collateral backing their cashflows is more “outside-the-box” and may not offer much historical data for investors to draw from, according to Nowakowski, which means investors usually demand a concession. “But we’ve seen that even the more novel collateral types have ample liquidity, especially now that all-in yields on the front end of the treasury curve are attractive,” he said.

While exotic collateral carries extra risk because the performance of the underlying assets may be less understood by investors, money managers say the securities are safer than the unusual mortgage-related instruments that triggered the 2008 financial crisis. Since the crisis, the underwriting process has also become more efficient, lenders are better able to manage risks, and structural protections in deals have higher levels of credit enhancement, Nowakowski said in a March 7 interview, noting that A rated securities across various sub-sectors are able to keep paying even at high levels of default.

Other corners of the esoteric ABS universe are also expanding. For 2024, Barclays’ Eddins expects to see $5 billion of ABS deals backed by fiber or small cell networks and $7 billion of deals backed by data centers, which would mark a record year for both markets. Telecommunications companies are piling into fiber securitizations, with Goldman Sachs Group Inc. anticipating financing to top $5 billion this year.

The rise of artificial intelligence has also led to more more corporate spending on digital infrastructure, according to Nowakowski. “As the need for computing power — and more importantly, space — expands, we feel that growth and subsequent issuer tiering in this sector will continue to develop,” he said.

About $119.3 billion of ABS deals have priced in the US this year, data compiled by Bloomberg News shows, with issuance running about 33% higher than this time last year. “Some of that issuance could be pull-forward to avoid potential election volatility,” said Nowakowski. “But the theme of new entrants and new collateral types remains intact.” 

Around 10 new entrants have tapped the US ABS market in 2024, Bloomberg-compiled data shows, including Kobalt Music Group with a $266.5 million deal backed by music royalties, as well as Northwest Fiber — also known as Ziply Fiber — with a roughly $1.6 billion bond supported by revenue streams from its fiber-optic networks. 

“With interest-rates expected to be higher-for-longer, short-duration ABS makes more sense to buy right now,” said Tracy Chen, portfolio manager at Brandywine Global Investment Management. “The market feels healthier and more predictable compared to last year, so we are seeing newer types of issuers coming to the market.”

If the cost of private capital in a higher-for-longer rate environment stays the same, the public ABS market could be a good alternative for issuers, added Nowakowski.

“With spreads near the tighter end of the last five years, the demand for additional spread and yield – even if the collateral is outside the norm — is noticeable,” he said. “To the extent that demand continues, I think we’ll see more of these novel collateral ideas and structures.”

--With assistance from Charles Williams.

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