Asset-Backed Securities and CLOs: Wary of Hidden Risks
We continue to find opportunities in CLOs and ABS, but look for ways to limit risk as the credit cycle nears its end.
Total new-issue CLO volume declined from the first quarter 2017, but net new volume (excluding refi/resets) has more than doubled. We have sharply limited participation in new transactions as equity sponsors continue to aggressively weaken CLO documents against creditor interests. Amid a flurry of volume, spreads tightened through January but backed up in the latter part of the quarter as equity volatility increased.
ABS spreads tightened slightly over the quarter, with overall performance marginally negative due to rising rates and rising swap spreads over Treasurys. Total new-issue volume of $66.2 billion remained dominated by auto ABS, though commercial ABS broke into second place with 32 percent share of the market. Aircraft ABS performance remains positive for credit and spread performance, though we remain focused on collateral valuation standards and the strength of servicers and equity sponsors. Container ABS spreads have widened marginally on trade and tariff politics. Whole business ABS spreads broadly performed well. Performance across issuers reflects a range of idiosyncratic factors.
Refi/Reset CLO Volumes Declined in the First Quarter
First quarter new issue volume of $33 billion plus $21 billion of refi/reset issuance was lower than in 2017, but continued to represent the majority of institutional loan demand.
Source: J.P. Morgan, Guggenheim Investments. Data as of 3.31.2018.
Per the JP Morgan CLOIE indexes, quarterly CLO performance was positive despite an environment of rising rates and widening spreads. Post-crisis CLO index returns were 0.61 percent for AAA-rated securities, 0.67 percent for AA, 0.59 percent for A, 0.77 percent for BBB, 1.41 percent for BB, and 1.70 percent for B grades.
Credit performance in leveraged loans remains strong, though cyclical and idiosyncratic risk concerns are increasing. With less than two years remaining until our Macroeconomic and Investment Research team’s projected recession, we are cognizant of the growing risk of a negative credit event related to the turn in the credit cycle. We continue to favor investment grade-rated refi CLOs with relatively short spread durations, as they offer reasonable spreads for a short and loss-remote profile. We also remain alert to the extension risk in new-issue CLO securities and the impact on option-adjusted spreads and price volatility. A CLO with a longer weighted-average life (WAL) typically sees a greater price impact in a spread widening environment than a CLO with a shorter WAL. For this reason, we have now instituted a CLO pre-purchase test that avoids tranches that could become significantly impaired in a downturn as a result of a long WAL and its rating. In ABS, we remain focused on high-quality senior tranches from issuers with demonstrated capability to perform and refinance.
CLO Spreads Tightened to Below 100 Basis Points in the First Quarter
AAA CLO spreads tightened to below 100 basis points in early March, but have backed off marginally since then. A and AA-rated CLO also reached tights not seen since 2014, but have since widened.
Source: S&P LCD, Guggenheim Investments. Data as of 4.30.2018.
—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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*Assets under management is as of 6.30.2019 and includes leverage of $11.2bn. 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, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management. Securities offered through Guggenheim Funds Distributors, LLC, an affiliate of Guggenheim, SI, GFIA and GPIM.
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