Asset-Backed Securities and CLOs: Safety First
We favor senior CLO debt and well-protected ABS as the credit cycle ages.
The CLO market appears to be reaching the end of its refinancing and reset wave. The total deal balance of CLOs refinanced or reset in the first half of 2017 reached $117 billion, plus $59 billion of new issuance. After accounting for paydowns and redemptions, we expect full-year net new issuance to reach $25 billion. Coupon refinancing transactions have been most prevalent to date. Resets, which extend the reinvestment period as well as adjusting coupons, have gained share in recent months. Broadly syndicated new issue CLO spreads traded in a relatively tight band over the second quarter and remain near annual tights, and we expect further tightening. Middle-market CLO new issuance has been strong. Recently, international investors have begun to participate in middle-market CLOs, and the price concession for middle-market issuers has begun to narrow. Credit metrics across CLO transactions have remained relatively stable. Concerns over oil, gas, and mining issuers have abated, while credit focus on retailers has increased.
Post-Crisis Spreads Are at the Tight End of the 52-Week Range for 2.0/3.0 CLOs
Broadly syndicated new issue CLO spreads traded in a relatively tight band over the second quarter and remain near annual tights.
Source: JP Morgan, Guggenheim Investments. Data as of 7.17.2017.
U.S. ABS new issue volume increased 25 percent year over year to $68.2 billion, with increases in all major sectors except student loans. Aircraft, container, and franchise finance ABS new issuance have provided opportunities for credit selection and opportunistic purchases. Spreads in ABS have tightened over the first half, particularly in unsecured consumer, maritime container, and franchise finance ABS. Spreads on senior aircraft ABS A-rated tranches have tightened from 325 basis points in December 2016 to 200 basis points in June 2017.
Per the JP Morgan CLOIE indexes, lower quality CLOs continue to outperform higher quality, with BB-rated 2.0 CLOs returning 2.7 percent versus returns of 1.3, 0.8, 0.6, and 0.5 percent for BBB-rated, A-rated, AA-rated, and AAA-rated CLOs, respectively. The broader index returned 0.8 percent. Discount margins tightened across all ratings tranches, with the discount margin of the broader index ending the quarter at 229 basis points, the tightest since mid-2015.
Looking to the second half, we are supportive of CLOs, though we continue to tighten our credit standards in anticipation of the credit cycle turning in the medium term. We prefer AAA/AA new issue securities and refinancing tranches with shorter weighted average life and higher stress loss coverage. In ABS, we favor off-the-run and private ABS issuers as the credit cycle ages, particularly in senior classes of infrequent and niche issuers where higher spreads can be earned for information and liquidity premiums without taking on increased subordination and credit risk.
ABS Spreads Grind Tighter
Spreads in ABS have tightened over the first half, particularly in maritime container, aircraft leasing, and franchise finance ABS.
Source: Bank of America, Wells Fargo, Guggenheim Investments. Data as of 6.30.2017.
—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.
Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management. ©2017, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.
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