Asset-Backed Securities and CLOs: Spreads Churn Tighter
Finding value in off-the-run transactions.
In the CLO market, which has been dominated by refinancing and resets of 2014–2015 transactions, spreads have come in across all tranches to new threeyear tights and approaching the post-crisis tights set in early 2013. However, CLO spreads have not kept up with tightening loan market spreads, constraining new issue volume. We continue to see room for tightening as CLO spreads remain wider than securities of comparable rating and maturity. Rising Libor rates—up from 63 basis points to 115 points over the past 12 months—also make floating-rate assets more attractive than fixed rate, supporting further spread tightening. Meanwhile, outstanding ABS volume net of CLOs and collateralized debt obligations (CDOs) is down marginally year over year. Auto ABS issuance is down with overall auto sales and increasing concern over potential performance issues from a softening used car market and increasing subprime auto delinquencies. Spreads across the auto sector have tightened year to date. Esoteric ABS new issue has gained ground, as increasing investor confidence has allowed new issues in the container and structured settlement sectors, each of which had counterparty credit concerns stunt new issuance in 2016. Aircraft ABS and whole business ABS have each seen two new issue transactions, while fintechoriginated ABS issuance is expected to be low in both the consumer unsecured and small business loan sectors amid performance issues.
Post-Crisis CLO Spreads Are at the Tightest in Three Years
Spreads have come in across all tranches to new three-year tights and approaching the post-crisis tights set in early 2013.
Source: J.P. Morgan, Guggenheim Investments. Data as of 4.24.2017.
According to J.P. Morgan’s benchmark CLO indexes, lower-quality CLOs again outperformed this quarter, with BB-rated post-crisis CLOs returning 8.0 percent versus returns of 3.9, 1.1, 0.9, and 0.7 percent for BBB-rated, A-rated, AA-rated, and AAA-rated CLOs, respectively. The broader index returned 1.4 percent. Discount margins tightened across all tranche ratings, with the discount margin of the broader index ending the quarter at 246 basis points, the tightest since mid-2015.
Looking ahead, tightening spreads increase the value of moving to off-the-run transactions to improve both credit and yield. Current senior AAA spreads on middle-market CLOs are wider than AA mezzanine tranches of broadly syndicated CLOs, offering the ability to improve yield and credit position. As the cycle matures and investors position for more difficult credit markets, trades like this increasingly make sense as a way to position more defensively while preserving portfolio yield. In broadly syndicated CLO markets, we prefer refinancing to new issue, as the shorter maturities reduce spread duration and increase stress loss coverage.
CLO Arbitrage Is Getting Squeezed by Tight Loan Spreads
CLO spreads have not kept up with tightening loan market spreads, constraining new issue volume. We continue to see room for tightening as CLO spreads remain wider than securities of comparable rating and maturity.
Source: Barclays, Guggenheim Investments. Data as of 4.26.2017. The Sharpe ratio and the information ratio are standard calculations used in performance assessments: The Sharpe Ratio measures excess return per unit of standard deviation of returns, while the information ratio measures excess return versus a relevant benchmark index.
—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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