Post-Crisis Tights

With CLO debt at post-crisis tights, we prefer less credit risk and spread duration.

February 17, 2017

This Asset-Backed Securities and CLOs sector report is excerpted from the First Quarter 2017 Fixed-Income Outlook.

The CLO primary market experienced a busy November and December as issuers rushed to issue new deals or refinance existing deals ahead of the Dec. 24, 2016, risk retention deadline. In the secondary CLO market, the BB CLO rally has been nothing short of breathtaking. Securities that traded at dollar prices in the low 60s in late February 2016 traded in the low 90s in December, and in the high 90s in early January 2017. U.S. asset managers seeking low-risk floaters, and Asian investors seeking dollar-based credit, have driven up senior CLO tranche prices. The entire CLO capital structure reached post-crisis tights in the first weeks of 2017. Despite this tightening, the CLO arbitrage (bank loan yields minus the cost of CLO liabilities) remains challenged with loan spreads tight, Libor levels surpassing floors, and newissue volumes meager, restricting the pace of new-issue CLO creation.

CLO Arbitrage Remains Challenged

Even as CLO debt spreads tighten, the CLO arbitrage—the difference between bank loan spreads and the cost of CLO liabilities in basis points—remains tight, helping to restrict the pace of new CLO issuance.

CLO Arbitrage Remains Challenged

Source: Intex, S&P, Moody’s, Wells Fargo Securities, Guggenheim Investments. Data as of 12.31.2016.

Outside of CLOs, we expect a heavy calendar of aircraft lease securitizations in 2017. In October, HNA Group’s Avolon unit acquired CIT’s commercial aviation leasing business for about $4 billion, highlighting two aircraft market trends: significant capital markets activity, and Asian investors seeking dollar assets. Meanwhile, consumer performance observed in traditional ABS, such as credit cards and auto loans, remains strong.

According to J.P. Morgan’s benchmark CLO indexes, CLOs returned 1.01 percent in the fourth quarter, with lower quality tranches outperforming. For post-crisis CLOs, BB-rated tranches returned 4.87 percent, compared to 2.13, 0.81, 0.80, and 0.58 percent for BBB, A, AA, and AAA tranches, respectively. Spreads tightened across all tranche ratings, ending the quarter at or near their post-crisis tights.

Given current CLO debt valuations, we prefer less credit risk and spread duration, favoring the shorter AA and A-rated tranches offered in refinanced 2013–2014-issued deals. Investment-grade tranches of middle market CLOs continue to offer a significant spread pickup versus CLOs backed by broadly syndicated loans. As CLO spreads continue to tighten, we find new issue CLO equity tranches intriguing, as a contrarian may wish to lock in those tight liabilities anticipating wider entry points to buy loans during a four- to five-year reinvestment period. Within ABS, we have observed a stabilization within the shipping container market, and find value in select container ABS issues and aircraft lease securitizations.

Post-Crisis CLO Spreads Tighten

CLO prices have been driven up by strong demand from U.S. managers seeking low-risk, floating-rate assets, and Asian investors looking for dollar-based credit.

Post-Crisis CLO Spreads Tighten

Source: JP Morgan, Guggenheim Investments. Data as of 12.31.2016.

—Matt Lindland, Senior Managing Director; Michelle Liu, 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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