Asset-Backed Securities and CLOs: No Bond Left Behind
The Fed’s QE “vaccine” has left investors flush with cash but few yielding investment alternatives.
The recovery in credit markets that occurred following March did not pass over the CLO market, where prices have fully recovered from the COVID-19 correction. Senior and subordinated CLO tranches both participated in the rally and are currently trading at the tightest spreads in the last two years.
Investment-Grade CLO Spreads Have Tightened From Recent Peaks
Senior and subordinated CLO tranches both participated in the rally and are currently trading at the tightest spreads in the last two years. Similarly, leveraged loans, the collateral for CLOs, rallied back to pre-COVID levels and largely avoided the wave of COVID-related defaults many had feared.
Source: Guggenheim Investments, J.P. Morgan. Data as of 3.5.2021.
Similarly, leveraged loans, the collateral for CLOs, rallied back to pre-COVID levels and largely avoided the wave of COVID-related defaults many had feared. As a result, rating agencies, which had downgraded a significant number of CLO tranches by mid-2020, have reversed course and now are reviewing many CLO tranches for upgrades. With this constructive backdrop, CLO new issuance surged in the fourth quarter of 2020 and should continue to exhibit considerable strength in 2021.
Q4 CLO Issuance Rebound Looks Set to Continue in Q1
CLO new issuance surged in the third and fourth quarters as investor demand and pricing spreads recovered from COVID trough levels. In 2021, we expect a continued uptick in primary market activity, especially refinance/reset activity.
Source: Guggenheim Investments, J.P. Morgan. Data as of 1.22.2021
Further, the rally in CLO spreads and leveraged loan prices has created a favorable environment for CLO refinancing and reset activity. We estimate the combined activity in both new issue and refi/reset will rival levels last observed in 2018. However, investor demand will likely meet the heavy primary market supply in step and keep CLO spreads tight and range-bound for the balance of 2021.
Most ABS subsectors have also fully recovered from the COVID-19 correction. Prices for bonds across all subsectors rose sharply as both interest rates and credit spreads collapsed in the second half of 2020. Many ABS securities now trade at large premium prices that may limit further price upside, though yield advantages versus similarly rated corporates still exist. ABS borrowers and Wall Street underwriters have capitalized on the strong investor demand by both improving execution levels and reintroducing transactions that had failed to launch in 2020. In the fourth quarter of 2020 and the start of 2021, new issue subscription levels have routinely exceeded 3x–5x on offered securities. As a result, borrowers have been able to substantially improve bond pricing execution. In fact, demand has been so strong at the start of 2021 that two separate transactions in rail and real estate that had failed to find enough investor interest in 2020 were successfully reintroduced in January 2021 at spreads that were tighter than the original failed levels. There is simply too much cash in investor coffers and too few high yielding alternatives.
Our current investment focus balances our prioritization of strong, creditworthy investments with a constructive view on macroeconomic conditions. We have recently found compelling risk-adjusted profiles in financial ABS, aircraft sale-leaseback transactions, and subordinated CLO debt investments.
—Peter Van Gelderen, Managing Director
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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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*Assets under management is as of 6.30.2021 and includes leverage of $16.3bn. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Fund Management (Europe) Limited, Guggenheim Partners Japan Limited, GS GAMMA Advisors, LLC, and Guggenheim Partners India Management. Securities offered through Guggenheim Funds Distributors, LLC.
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