Asset-Backed Securities and CLOs: Spreads to Tighten Further
Concern over high demand and record post-crisis tights has us focused on quality and liquidity.
ABS spreads continue to tighten in parallel with credit markets, with most ABS products at multi-year tights. Investor demand remains strong across ABS asset classes, while new-issue supply exceeds 2016’s pace. Widely reported concerns of increasing consumer delinquencies have not affected market perception or performance to date. The breadth and depth of off-the-run ABS subsectors is increasing and continues to provide diversification and spread pickup for investors willing to conduct new credit work and tolerate reduced liquidity versus traditional issuers.
Esoteric ABS Offers Opportunity
A healthy new-issue market has expanded the breadth and depth of off-the-run ABS subsectors, providing diversification and spread pickup for investors willing to do new credit work and tolerate reduced liquidity versus traditional issuers.
Source: Bloomberg, Guggenheim Investments. Data as of 9.30.2017. COOF = confirmation of originator fee. PACE = property-assessed clean energy.
In CLOs, strong demand from both U.S. and overseas investors continues to be met with robust primary supply. Year-to-date U.S. CLO new issuance is $83 billion, while CLO refinancing and reset volumes are $89 billion and $43 billion, respectively. Bellwether new-issue AAA spreads have remained anchored in the range of 118–121 basis points, while the credit curve for investment grade-rated tranches (AAA–BBB) has flattened by 30–40 basis points since the second quarter. Amid an active primary market, secondary market trading volume declined to $11.4 billion in the third quarter from $20.5 billion in the second quarter, dominated by trading activity in non-investment grade tranches. U.S. CLO portfolio fundamentals were generally stable or improved, but Toys R Us filing for Chapter 11 bankruptcy protection focused investors’ attention on distress in the retail sector.
Per the JPM CLOIE indexes, lower-quality CLOs continue to outperform higher quality, with BB-rated post-crisis CLOs returning 2.1 percent versus returns of 1.9, 1.1, 0.8, and 0.7 percent for BBB-rated, A-rated, AA-rated, and AAA-rated CLOs, respectively. The broader post-crisis CLO index returned 0.9 percent. Discount margins tightened across all tranche ratings, with the average discount margin ending the quarter at 212 basis points, the tightest since mid-2015.
We expect CLO spreads to tighten further amid rising short rates, strong technicals, and stable fundamentals, although we remain cautious on valuations at post-crisis highs. We are rotating toward liquidity and quality, with a preference for investment grade-rated refinancing CLOs with relatively short spread durations, as they offer reasonable spreads for a short and principal loss-remote profile. While refi spreads tightened materially relative to new-issue levels in recent months, we continue to believe the credit enhancement and spread duration benefit of short weighted average life refi paper merits the tighter spreads.
Post-Crisis CLO Credit Curve Tightens Across All Ratings
Bellwether new-issue AAA spreads have remained anchored in the range of 118–121 basis points, while the credit curve for investment grade-rated tranches (AAA–BBB) has flattened by 30–40 basis points since the second quarter.
Source: JP Morgan, Guggenheim Investments. Data as of 9.30.2017.
—Matt Lindland, CFA, Senior Managing Director; Michelle Liu, CFA, Director; George Mancheril, Vice President
Important Notices and Disclosures
This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.
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