(Bloomberg) -- Investors betting that lawsuit-related debt will rise in line with a recession are looking to buy bonds backed by advances made to plaintiffs.

The volume of litigation asset-backed securities -- bonds that repackage funding for settlements and verdicts -- soared to about $533 million in 2021, from $393 million in 2020, according to data compiled by Bloomberg. And those numbers are only expected to keep growing as the number of borrowers seeking funding for legal proceedings increases during trying times.

In the litigation ABS sector, the most common settlements relate to personal injury cases, of which there are around 300,000-500,000 in the US each year, according to Kroll Bond Rating Agency. 

“There could be even more litigation as the economy goes south,” said John Kerschner, head of US securitized products at Janus Henderson Group, while pointing out that the underlying collateral is mostly uncorrelated to the economic cycle.

Litigation finance is the business of financially supporting plaintiffs in exchange for a portion of their future settlement profits. The industry has been around for more than 20 years, but its only within the last five years that the number of funders and levels of financings have risen, Kroll said in a July 11 note.

Much like issuers of other types of asset-backed securities, litigation finance companies build up pools of collateral. Non-recourse advances are diversified by case type, plaintiffs, insurers and law firms, which are then repackaged and sold to investors. Since 2020, Kroll has rated about $1.2 billion worth of litigation finance ABS deals. 

Despite expectations that the pools of collateral will keep growing, ABS deals are still few and far between, with only one coming to market this year. In May, Libra Solutions, which extends credit to plaintiffs, attorneys and medical providers in consumer-related lawsuits, sold more than $105 million of bonds secured by litigation debt and medical liens. 

The dearth of deals means that investors tend to scoop them up as soon as they come to market. The offerings also tend to be much smaller than other ABS deals and often come with attractive terms. Libra’s transaction offered a yield of 4.75%, while other ABS deals that priced on the same day came well under or close to 3% on their main tranches. For instance, a Hyundai prime auto asset-backed deal yielded 3.378% on the main chunk of the bonds.

“Our expectation is that we will continue to see a few litigation finance ABS transactions per year going forward,” said Joanne DeSimone, senior director of ABS ratings at Kroll, in an interview. The increase in the number of larger, consolidated litigation finance companies in the market also raises the likelihood that more issuance is coming. 

“Once you have a number of new issuers, they usually repeat transactions about once a year,” she said. “That tends to generate a handful of deals.”

In November, litigation finance companies LawCash, Momentum Funding and Ardec Funding came together under a new unified brand called Cartiga, named after the tradition of cartographers navigating challenging terrain. In April, Experity Ventures acquired Florida-based consumer litigation finance firm Liberty Legal Funding. 

Litigation ABS investors also take on the risk that a case could either be lost or abandoned by the plaintiff. Settlement proceeds will also sometimes be less than anticipated and there can be legal risks associated with transactions, said DeSimone.

“If the case proceeds are zero, or if they are less than the amount of the advance, the remaining amount of the advance is not payable by the plaintiff,” said Kroll in its note. “Even if proceeds are realized, the timing is dependent upon the length of the settlement negotiations or, in a small percentage of cases, length of the trial to verdict.”

Unlike the loans backing other types of ABS, advances in litigation finance do not have fixed repayment dates and charge fees instead of interest. This means that investors are repaid when cases are resolved, most often through settlements rather than a trial.

As a result, litigation ABS tend to be buy-and-hold investments and are more illiquid than their auto bond or credit card counterparts. 

Yet, this also gives way to one of the most appealing features of the deals: the length of the securities. Litigation-backed bonds often pay down very quickly, usually taking no longer than a year to repay, said Kerschner. 

Relative Value: ABS

  • BofA Securities analysts believe subprime auto loan and equipment asset-backeds look relatively cheap compared to prime auto loan and credit card ABS
  • They also recommend looking at pockets of the agency-mortgage market, such as moving up in coupon in TBA and overweighting 30 year versus 15 year
  • MBS is looking more attractive than corporates, the analysts said in their weekly note

Quotable 

“In today’s market, we’re seeing the double benefit of higher yields and wider spreads, giving investors opportunities in the double-digit range, which we haven’t seen in the last decade,” said Michael Vranos, CEO and founder of Ellington Management Group LLC. 

What’s Next

ABS deals in the queue include Hilton Grand Vacations (timeshare ABS), Verizon (device payment plans ABS), World Omni (prime auto loan ABS), Sallie Mae Bank (student loan ABS), Capital One (prime auto ABS) and Exeter Finance (subprime auto loan ABS).

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