November 14, 2017
ABS spreads continue to tighten in parallel with credit markets, with most ABS products at multi-year tights. Investor demand remains strong across ABS asset classes, while new-issue supply exceeds 2016’s pace. Widely reported concerns of increasing consumer delinquencies have not affected market perception or performance to date. The breadth and depth of off-the-run ABS subsectors is increasing and continues to provide diversification and spread pickup for investors willing to conduct new credit work and tolerate reduced liquidity versus traditional issuers.
A healthy new-issue market has expanded the breadth and depth of off-the-run ABS subsectors, providing diversification and spread pickup for investors willing to do new credit work and tolerate reduced liquidity versus traditional issuers.
Source: Bloomberg, Guggenheim Investments. Data as of 9.30.2017. COOF = confirmation of originator fee. PACE = property-assessed clean energy.
In CLOs, strong demand from both U.S. and overseas investors continues to be met with robust primary supply. Year-to-date U.S. CLO new issuance is $83 billion, while CLO refinancing and reset volumes are $89 billion and $43 billion, respectively. Bellwether new-issue AAA spreads have remained anchored in the range of 118–121 basis points, while the credit curve for investment grade-rated tranches (AAA–BBB) has flattened by 30–40 basis points since the second quarter. Amid an active primary market, secondary market trading volume declined to $11.4 billion in the third quarter from $20.5 billion in the second quarter, dominated by trading activity in non-investment grade tranches. U.S. CLO portfolio fundamentals were generally stable or improved, but Toys R Us filing for Chapter 11 bankruptcy protection focused investors’ attention on distress in the retail sector.
Per the JPM CLOIE indexes, lower-quality CLOs continue to outperform higher quality, with BB-rated post-crisis CLOs returning 2.1 percent versus returns of 1.9, 1.1, 0.8, and 0.7 percent for BBB-rated, A-rated, AA-rated, and AAA-rated CLOs, respectively. The broader post-crisis CLO index returned 0.9 percent. Discount margins tightened across all tranche ratings, with the average discount margin ending the quarter at 212 basis points, the tightest since mid-2015.
We expect CLO spreads to tighten further amid rising short rates, strong technicals, and stable fundamentals, although we remain cautious on valuations at post-crisis highs. We are rotating toward liquidity and quality, with a preference for investment grade-rated refinancing CLOs with relatively short spread durations, as they offer reasonable spreads for a short and principal loss-remote profile. While refi spreads tightened materially relative to new-issue levels in recent months, we continue to believe the credit enhancement and spread duration benefit of short weighted average life refi paper merits the tighter spreads.
Bellwether new-issue AAA spreads have remained anchored in the range of 118–121 basis points, while the credit curve for investment grade-rated tranches (AAA–BBB) has flattened by 30–40 basis points since the second quarter.
Source: JP Morgan, Guggenheim Investments. Data as of 9.30.2017.
—Matt Lindland, CFA, Senior Managing Director; Michelle Liu, CFA, Director; George Mancheril, Vice President
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