Yield Premiums in Select ABS

Recent spread widening across several areas of the ABS market, particularly in post-crisis mezzanine CLOs, creates a compelling entry point.

March 17, 2016


This sector report is excerpted from the First Quarter 2016 Fixed-Income Outlook.

The ABS Sector Team evaluates opportunities across the ABS universe, from consumer ABS to more esoteric areas, such as whole-business ABS. Currently, the asset class in which we find most value in the ABS market is CLOs. CLOs’ price performance often reflects the bank loan market, where weakness spread into below-investment grade CLO tranches and eventually into higher-rated tranches as well, leaving CLO spreads attractively wide.

CLO New Issue Spreads Remain Above Historical Average

Prior to the financial crisis, new issue AAA CLO spreads averaged 41 basis points over LIBOR, while current new issue AAA CLOs price 210 basis points over LIBOR.

CLO New Issue Spreads Remain Above Historical Average

Source: Bank of America Merrill Lynch, Guggenheim. Data as of 2.29.2016.

As measured by J.P. Morgan’s CLOIE indexes for post-crisis bank loan deals, post-crisis AAA tranches, AA tranches, and A tranches delivered returns of 1.5 percent, 2 percent, and 3 percent for the year, respectively. BBB, BB, and B-rated tranches posted negative returns of -0.8 percent, -5.8 percent, and -10.9 percent. More broadly, ABS returns were positive for the year, with the Bank of America Merrill Lynch AA-BBB U.S. ABS Index posting a total return of 2 percent. Highquality CLO tranches outperformed higher-risk credits, however, and new-issue spreads remain well above historical average. The widening has continued, even accelerated, in early 2016.

We expect most, but not all, CLO debt to weather current market distress without cash flow interruption, particularly tranches at the top of the CLO capital structure. Although distress in the oil and gas industries has led to a sympathetic widening in CLO debt, the CLO debt market remains fairly insulated (oil and gas accounts for only 3.2 percent of total CLO holdings). Heading into 2016, we were actively purchasing AAA, AA, and A-rated tranches from both pre-crisis and post-crisis CLOs. In response to the continued dislocation, we have shifted our focus down the CLO capital structure into BB-rated CLOs. Until 2016, we avoided such deep mezzanine tranches from post-crisis CLOs, anticipating a more attractive entry point. That said, CLOs issued after the financial crisis generally feature better credit protection with stricter collateral eligibility requirements than pre-crisis structures. As such, the volatility created by distress in energy and commodity sectors, along with bank loan mutual fund outflows, have created an attractive entry point.

CLO Spreads Are at Their Widest in a Year

The selloff in credit markets has extended to the structured credit market, where CLO spreads are currently at 52-week wides across all rating categories. We expect most CLO debt to weather current market distress without interrupting cash flows, which underscores our favorable view on the market. We believe recent widening presents an opportunity for long term investors to capture attractive pricing in the CLO market.

CLO Spreads Are at Their Widest in a Year

Source: Bank of America Merrill Lynch, Citi, Guggenheim. Data as of 2.29.2016.

—Brendan Beer, Managing 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, Transparent Value Advisors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management.


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