Asset-Backed Securities and CLOs: A Wild Ride on Santa's Sleigh
A sharp December selloff highlights the need to remain vigilant.
CLO spreads, under pressure since the first quarter of 2018, gapped wider in the last months of the year with other risk assets. CLO spreads ended the year 20–200 basis points wider compared to the start of the year (depending on tranche rating) and CLOs ended the year roughly flat on a total return basis. The soft pricing environment did not discourage issuers: 2018 set the high watermark in new issuance at around $130 billion, and there are now 111 CLO managers, up from 68 in 2012 (see chart, top right). New issuance supply in 2019, however, may be negatively affected by less attractive pricing and fewer CLOs exiting their non-call period. From a collateral perspective, leveraged loans continue to feature no or low covenant structures. In 2018, 85 percent of leveraged loan issuance was covenant lite, resulting in 79 percent of all outstanding leveraged loans either having no or low covenant packages. Nonetheless, CLOs offer good value in the medium term, given a short average life profile that contributed to better performance relative to corporate credit of comparable quality.
2018 Set Record for CLO Issuance and Managers
2018 set the high watermark in CLO new issuance at around $130 billion, while total CLO managers now stand at 111, up from 68 in 2012.
Source: Guggenheim Investments, Wells Fargo. Data as of 12.31.2018.
Esoteric ABS spreads also marched wider in the fourth quarter. While fundamental credit performance remained sound across esoteric ABS subsectors, the general risk-off environment negatively affected price performance in the space. Commercial ABS experienced strong levels of issuance in 2018, with commercial and financial ABS sectors issuing over $25 billion. Current expectations call for a similar issuance in 2019. We are becoming more selective, as many market participants fail to distinguish credit quality and structural nuances within each sector. For example, new structural features in certain aircraft ABS were developed in 2018 that permit the syndication and trading of equity certificates. While this structural evolution has been met with enthusiastic demand from hedge funds, we are sensitive to the potential coordination and agency problems syndicated equity may present in times of distress and/or the transaction’s scheduled maturity.
Most Leveraged Loans Lack Investor Protections
In 2018, 85 percent of leveraged loans issuance was covenant lite.
Source: Guggenheim Investments, S&P LCD. Data as of 12.31.2018.
While spreads have recovered from the December wides, our focus remains on short, amortizing senior securities. Aircraft finance and esoteric commercial ABS will remain a focus in 2019.
—Peter Van Gelderen, Managing Director; Josip Zdrilic, CFA, Director
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