Non-Agency RMBS – Brian Choi

The residential housing market continued to display strength in October, driven by low rates and favorable supply/demand dynamics. Borrower performance also continued to improve month-over-month. The total percentage of borrowers in forbearance declined from 6.8% to 5.7% during the month, according to Black Knight. Looking through October remits, the total percentage of delinquent borrowers decreased while prepayment speeds stayed elevated in most, if not all, non-agency RMBS subsectors.

Since the unprecedented volatility experienced earlier this year, non-agency RMBS spreads have marched relentlessly tighter each month toward pre-pandemic levels, particularly at the top of the capital structure. However, we saw a slight reversal of that trend in October, attributed to elevated supply in RMBS coupled with broader riskoff sentiment, as coronavirus cases spiked, fiscal stimulus talks broke down, and the presidential election loomed closer.

To put RMBS supply in context, October had the highest monthly volume of new issue deals since February, at $9.5bn / 25 deals, while secondary bid list volumes increased 62% month-over-month, from $4.6bn to $7.5bn. TRACE reported overall trading volumes of $15.4bn (up from $10.3bn in September), leaving dealers net longer by $1.5bn.

Overall, RMBS spreads ended the month unchanged to 10 basis points (bps) wider at the top of the capital structure and 20-30bps wider for longer duration profiles.

While fundamentals look great thus far, we continue to monitor for potential performance deterioration as the effects of fiscal stimulus wears off, foreclosure moratoriums expire, and temporary job losses turn permanent. Since spreads have retraced most of the widening earlier this year, we prefer staying defensively positioned while actively looking for opportunities during periods of volatility.

Total Delinquencies Across Resi Credit Products

Source: Intex, Freddie Mac, Morgan Stanley Research

Speeds Remain Fast Across Products

Source: Intex, Freddie Mac, Morgan Stanley Research

CMBS – Sagar Parikh

October delivered the CMBS market its first retail, hotel, and multifamily SASB deals since March.

Retail – While a regional mall deal seemed almost unthinkable six months ago, Brookfield financed its Oakbrook Center in suburban Chicago with 3yr floating-rate debt. The deal was multiple times oversubscribed and priced 20bps tight to initial guidance, benefiting from lower leverage on the mortgage debt and strong historical sales per square foot ($800+ ex-Apple / $1000+ with Apple) at the Class A property.

Hotel – Taking advantage of extended stay outperformance, Starwood Capital Group financed a portfolio of 58 extended stay properties with 2yr initial / 5yr max floating-rate debt, consolidating portfolios previously financed across three separate CMBS transactions.

Multifamily – Amid near-constant headlines of New York City multifamily market weakness, a SASB deal, backed by an 11-property Brooklyn multifamily portfolio, priced. The properties benefit from their location in the Bushwick, Williamsburg and Bedford- Stuyvesant neighborhoods of New York City, which are expected to be more resilient than high-end Manhattan multifamily, the latter seeing reductions of over 15%.

In terms of collateral performance, CMBS delinquencies remain elevated, though they’re down over 200bps from their peak in June. The lodging sector saw the largest decline in delinquencies, down 400bps from the peak earlier this year.

Percentage of CMBS Marked as 30+ Days

Source: Trepp

However, the broader decline in delinquency may be short-lived as nearly $30Bn of the CMBS universe has received some type of temporary forbearance, with most loans expected to resume their full principal and interest payments within the next three months. We expect some of these properties may still be unable to support full principal and interest mortgage payments.

From a fundamental perspective, we’re monitoring the rise in office sublease availability across major MSAs as a clear signal for lower rents and prices ahead. We’re also watching rising landlord concessions in dense urban multifamily markets such as San Francisco, New York and Boston, where effective rents have dropped a minimum of 8-10% with two to four months of free rent more common.

Delinquency Rate by Property Type (%30 Days+)

Source: Trepp

ABS – Tony Lee

ABS trading levels remained anchored in October, even in the face of elevated new issue volumes and broader market volatility into month-end.

Spreads for senior, high quality consumer ABS sectors like bank credit cards, prime auto loan and lease, and auto floorplan ABS held firm having long recovered from the weakness earlier this year. The rest of the ABS market followed suit, with investors driving spreads tighter in specialized ABS sectors in search of yield, including but not limited to student loan, container, subprime auto loan subordinate, and timeshare loan subordinate ABS.

New issuance totaled $23.9bn during the month, nearly eclipsing September’s high water mark for the year of $26.6bn. At least four auto loan lenders priced deals larger than $1.5bn, illustrating robust demand: Ford (revolving prime auto loan), GM Financial (prime auto loan), Toyota (prime auto loan), and Carmax (prime auto).

Monitoring fundamentals, forbearance and loss metrics continued improving from Covid lockdown levels across various ABS subsectors. For some examples, the balance of newly modified subprime auto loans in ABS fell to 3.3% in September, down from a high of 13.7% in April (see below), while equipment ABS (construction, agriculture, small ticket) saw total delinquencies decline to 2.4% in August from a peak of 4.3% in May. Overall equipment ABS net losses remain stable below 1% in 2020.¹

Subprime Auto Loan ABS Extension Rate

Source: Bank of America Research, Intex

CLO – Palak Pathak

CLOs performance was modestly weaker in October, continuing the trend of late September, with spreads ending the month wider across the capital stack.

AAAs widened out around +5bps, feeling additional supply pressure from investors raising cash ahead of the election or rotating into a heavier new issue pipeline. Tier 1 AAAs traded in the 135 to 145 dm range while the lower tier names traded 160s to 170s dm. The basis between top tier and lower tier AAAs widened, as investors charge a higher liquidity premium with volatility.

In investment grade (IG) mezzanine debt, AAs and single As widened in sympathy with AAA seniors, around +10bps and +5bps, respectively, while BBBs widened +25bps. The quality basis for BBBs also widened – with higher quality bonds trading inside of 400 dm while weaker names covered in the 500s dm.

In below-IG, BBs remained range-bound to slightly weaker. Spreads have been rather static the last few months as most distressed buyers are priced out.

As for equity, Net Asset Values (NAVs) decreased slightly over the month with the median NAV at 16%, vs. 18% in September. However, quarterly equity payments increased significantly by 1-2 points quarter-over-quarter, as LIBOR floor benefits on the loans kicked in. Total 2020 equity payments averaged 11-12%.

From a total return perspective, CLOs delivered -0.14% during the month, the first negative monthly return since March of this year. Year to date, CLOs are returning 0.8%, outperforming Loans (-0.46%) and underperforming IG (+6.44%) and HY (+1.13%) credit.

Reviewing fundamentals, CCC exposure declined another 20bps in October, to 9.35%, down from 12% in May. Lower CCCs have decreased weighted average rating factor (WARF) levels and increased Junior Over-Collateralization cushions; as a result, over 95% of deals were able to make an equity payment during the month.

We noted supply pressure on spreads – indeed, primary saw $13.8bn price across 35 deals, the highest monthly total since April 2019. The surge in CLO issuance resulted from increased new issue loan supply and a pull forward of deals hoping to price ahead of the election.

Primary spreads widened across the board, with Primary Tier 1 AAA spreads starting the month around 127 dm and ending the month 137 dm, +10bps month-over-month. Meanwhile, Tier 1 AA, single-A and BBB spreads also widened + 15-20bps, ending the month at 185, 260 and 400 dm respectively. BB spreads widened +35bps with the majority of deals pricing between 775-900 dm. The widening in new issue increased CLO cost of debt from 171bps to 182bps.

As for our activity, we shifted our focus from primary to secondary as AAA spread widening created opportunities to pick up an additional +10bps in spread, along with 0.5-1 point of discount to par. Granted, sourcing target bonds in secondary remains challenging, given our focus on better quality names and cleaner documentation that contains LIBOR transition language in addition to LIBOR floors.

Secondary CLO 2.0 Spreads (DM)

Tier 1 New Issue Spreads (5 yr reinv)

CLO New Issuance

Source: TCW

¹ Bank of America Research – Consumer ABS Weekly – Equipment ABS Update October 9, 2020