Non-Agency RMBS –Michael Hsu

Macro uncertainty in December kept market participants waiting to see if they would be left holding coals at the end of the year as risk appetite continually shifted over concerns including growing inflationary pressures and another wave of COVID. With a hawkish tilt from the Fed following the December FOMC meeting, central bank policy is once again front and center as investors face a new environment of reduced policy accommodation. The rapid spread of the Omicron variant was another driving force behind market movements, further exacerbated by year-end illiquidity. Despite these negative macro dynamics, risk assets managed to swing to a ‘risk on’ posture in the second half of the month. As it has done through much of the year, the Non-Agency RMBS sector largely weathered the volatility, remaining steady thanks to tailwinds from continued housing data strength. In fact, with CoreLogic HPI rising 17.7% YoY in October, homeowners now have more equity in their homes than ever before. According to Black Knight, home price appreciation has pushed tappable home equity (defined as the amount available to a homeowner with a mortgage before hitting a maximum 80% combined loan-to-value ratio) in the U.S. to an all-time high of $9.4 trillion, up 32% year over year and nearly 90% higher than the pre-GFC peak in 2006.

Tappable Equity of U.S. Mortgage Holders

Source: Bank of America

Spreads for legacy profiles continued to clear within a narrow range near pre-COVID tights (senior passthroughs in swaps + 120-140 basis points (bps) spread context) albeit on muted seasonal volumes. Secondary market trading fizzled with Trace reporting a mere $5.1 billion in monthly volume (the monthly average in 2021 prior to December was $8.7 billion). Total secondary volume for 2021 hit a record low of $101 billion. Total BWIC volumes clocked in at $2.7 billion, with nearly three quarters of that coming in the first two weeks of December. Without any meaningful BWIC supply towards the end of the month, dealers managed to work through their inventory, reducing risk by $121 million in the last week of December and ending the month lighter by $102 million.

One of the top storylines throughout the year in Non-Agency was the robust pace of the primary market, with issuance rebounding 84% YoY from $110 billion in 2020 to a post-GFC high of $202 billion in 2021. Supply was initially absorbed without much difficulty, but the surplus of new securitizations ultimately weighed on demand as the year progressed. With liquidity thinning heading into the holidays, the $15 billion that hit the market during December highlighted investors’ focus (or lack thereof) and preferences in certain sectors. With annual issuance soaring to an all-time high of $54 billion, deals backed by Prime Jumbo collateral closed the year near YTD wides with 2.5% coupon passthroughs pricing in the range of 2-00 to 2-20 back of benchmark TBA versus their February tights of 0-28 back. On the other hand, Non-QM AAA spreads continued to firm with the help of structural enhancements in the form of either coupon step-ups or sequential principal paydowns. AAA pricing levels settled into the swaps +90-100 context, well off of the tights at swaps +50-60 in January/February but a noticeable improvement from the local wides of swaps +100-110 seen during November.

Source: Bank of America

CMBS – Vincent Sokhanvari

• New issue CMBS prices wider, investors contend with new J-Curve pricing convention.
• Secondary demand tempers into the holidays. SASB MF and industrial continues to find strong demand.
• Office drives uptick in overall delinquency rate, other sectors see decline in delinquency.

New Issue / Deals

Source: Trepp

Generally speaking, new issue spreads widened further in December. The benchmark LCF AAA class came in at an average of swaps (S) +74 bps versus S +71 bps in November. Three conduit deals priced between S +69 bps and S +80 bps. These were the widest prints since April 2021.

One noticeable change in the CMBS community is that conduit and fixed-rate SASB bonds are moving away from pricing bonds to the N-Curve (Swaps) and will now price to the J-Curve (Treasuries) going forward for hedging reasons. We’ve already seen most dealers start sending out inventory and markets quoted on J-Spread. We look forward to more color and feedback on the transition following the CREFC as well.

SASB Deals Priced in December

Source: Bloomberg

The Northridge regional mall transaction priced wide with the AAAs on the transaction coming at L+165. A couple of smaller hospitality transactions were also privately placed. DB priced their SASB transaction backed by the Gurney’s hotel in Montauk, NY at levels wider than the initial guidance; with the bonds syndicated to a small group of investors. Last month, CS priced the 2021- BHAR transaction (backed by the St. Regis in Bal Harbour, FL) to two investors. Both the Gurney’s and St. Regis have seen outsized RevPar growth since COVID-19 as they cater to luxury guests and have positioned themselves as premier destination resorts.

In terms of expected 2022 SASB transactions, one of the notable transactions expected in January is the Old Post Office Building in Chicago. The property was first securitized in September 2019 when Blackstone (BXMT) originated a $835 million transitional floating rate loan on the property. The sponsor, 601W Co’s, had first acquired the asset back in 2016 and is expected to refinance the transitional loan with a $830 million senior mortgage (syndicated through SASB) and a $125 million mezzanine loan.

For 2022, it’s expected that many downgrades will be driven by previously downgraded transactions with weaker assets that may have a harder time rebounding from the pandemic.

Secondary

CMBS secondary volume slowed significantly toward the end of the month going into the holidays. Overall, we see better investor demand for higher quality SASB/CRE CLO transactions. SASB MF and Industrial transactions are seeing solid demand down the stack, while CRE CLO transactions have been well oversubscribed with strong retail demand up and down the stack.

Higher quality SASB office transactions continued trading well at the top of the stack, while the bid for below-IG SASB securitizations thinned significantly going into year end. Some of the notable SASB transactions that were out to bid include the single-B rakes off of the 225 Bush Street office building in San Francisco, as well as the rakes off of the McDonald’s corporate HQ in the Fulton Market submarket of Chicago. The other notable transaction out to bid earlier in the month was the 2020-LOOP transaction.

Collateral Performance

Delinquency

Fifty-seven loans totaling $1.8 billion became newly delinquent in December and the delinquency rate increased for the first time in 18 months. Following two large increases at the start of the summer of 2020 (May/June), delinquencies had steadily declined for 17 consecutive months. Large office delinquencies mainly drove the increase that ended this streak.

Delinquency Status

Source: Trepp

Chicago office seems to be the main culprit driving the uptick. 245 Park Avenue (NY) and 181 West Madison Street (Chicago) became delinquent following PWM Property Management, an arm of Chinese Conglomerate HNA Group, filing for bankruptcy. Combined, these loans total more than $1.2 billion. Two other loans backed by Chicago office properties, 175 West Jackson and 135 South LaSalle, became 30 days delinquent as well. Both loans have been impacted by Chicago downtown vacancies that hit a 15-year high of 20.1% in Q3 2021, as reported by CBRE.

On a positive note, delinquencies decreased across most other sectors, specifically industrial (1 bp), lodging (61 bps), and multifamily (14 bps). Office (72 bps) and retail (19 bps) drove the largest increases in delinquency.

Servicing, Modification and Liquidation

Loans in special servicing dropped to 6.75% in December, down from 6.94% in November. Some 18 new loans entered special servicing this month with a balance of $683.2 million.

Conduit loans totaling $363 million were liquidated in December at a weighted average severity of 44%, slightly higher than the trailing six-month average of 42%. The largest of these liquidations was the $31.5 million Shoppes on Main loan in White Plains, NY (GSMS 2012-GCJ7). This liquidation resulted in a $30 million loss. On the flip side, a larger regional mall also ended up liquidating in December with a better-than-expected principal recovery. The Montgomery Mall in suburban Philadelphia sold for slightly over $50 million (versus a $57 million appraisal) resulting in a 55% loss severity on the loan (versus the 80-90% loss severity that the market was pricing in last year).

Some 27 loans, totaling $476.8 million, became newly modified in December.

Appraisal Reduction

A total of 17 loans with a balance of $599.2 million were subject to an ARA in December. Of these loans, seven had received updated appraisals that were 45% lower on average. Across the universe, 775 loans with a combined balance of $18.5 billion are currently subject to appraisal reduction.

ABS – Adam August and Tony Lee

Capping an explosive year for ABS new-issue, December went out with a whimper. New-issue volumes dropped to $5.8 billion in December from $31.5 billion the month prior. Despite this, FY 2021 ABS new-issue volume set a new post-GFC record at $264 billion. New-issue spreads in December widened slightly in sympathy with macro volatility and secondary trading in a market where liquidity quickly thinned into the year-end holidays.

Secondary volume in December (as measured by TRACE) was $12.5 billion. This was notably lower than the first 11 months of the year, where secondary volume averaged $17.9 billion / month. Dealers took advantage of the quiet primary market to work out of risk. Over the course of December, dealers net sold $1.6 billion of ABS securities. Data from the NY Fed showed that primary dealers ended the year with $7.0 billion in ABS securities on their balance sheets. This was a meaningful increase from where they started the year ($5.4 billion) but also meaningfully below their 2020 and 2021 peak holdings of $12.3 billion and $8.6 billion, respectively.

Primary Dealer ABS Holdings ($mm)

Source: Federal Reserve Bank of NY

Consumer ABS credit fundamentals remained strong in December. Annualized loss rates for Prime and Subprime auto ABS securities registered at 0.37% and 4.42%, respectively (source: Barclays). This is significantly lower than pre-COVID, when Prime auto ABS deals averaged a 0.63% loss rate, and Subprime auto averaged 8.19% in 2019. A significant portion of this outperformance can be attributed to increasing automobile prices. In December the Manheim index of used auto prices registered a 1.6% MoM gain. This capped off a year of exponential growth with the index increasing a staggering 46.6% YoY.

Manheim Used Vehicle Value Index

Source: Cox Automotive

In a similar vein, revolving credit continued to perform extremely well. Bank credit card payment rates increased to 38.66% in December, the highest since at least 2000 (source: JP Morgan). Charge-offs increased slightly to 0.94%, but were only 7 bps off the 20-year low set last month. All-in-all, consumer credit remained resilient in December 2021 and throughout 2021.

Bank Card Payment Rate

Source: JP Morgan

Bank Card Charge Off Rate

Source: JP Morgan

CLO – Palak Pathak & Madison Perry

CLO Secondary

CLO performance was flat in December as light supply in primary and secondary caused spreads to remain range bound. CLOs returned 0.1% during the month, the third lowest monthly return in 2021. For 2021, CLOs returned 2.37%, outperforming IG (-1.08%) and underperforming HY (+5.28%) and Loans (+5.2%). This was the lowest annual return for CLOs since 2018.

AAA spreads were flat to slightly wider over the month on limited supply. Although discount prices on AAA bonds were attractive, many investors had closed their books for the year and thus supply/demand dynamics remained balanced, resulting in little spread movement. Year-over-year AAA spreads are 5-10 bps tighter as increased demand from many investors kept the tranche in high demand despite the heavy supply.

AA spreads were also flat over the month with very little trading activity. Spreads remained in the 150-180 DM context, unchanged from November. Year-to-date AA spreads were flat, the only tranche within the CLO stack to not tighten in 2021.

Single-As were also flat over the month with less than $100 million in BWIC activity occurring during December. Spreads ended the year in the high 100s/low 200s DM, 15 bps tighter versus the end of 2020. Single-As were attractive to insurance companies throughout the year given the higher spread and attractive capital treatment. This may change next year due to revised NAIC capital charges that would favor AAA investments over single-As.

BBBs securities were the only tranche to tighten over the month with spreads 3-5 bps tighter. BBBs were also the only tranche to see a pick-up in BWIC activity from November. BBB spreads over the year tightened 25 bps as asset managers found the tranche attractive given the wider spread relative to the commensurate risk.

BB spreads were 10 bps wider month over month as looming Omicron concerns and limited year-end liquidity caused spreads to weaken. Lower MVOC bonds from less sought after names experienced the brunt of the widening with spreads on those bonds remaining in the 700s-800s DM. Year to date, BBs are 25 bps tighter as MVOCs improved, defaults declined and the economy improved.

Equity trading was very limited in December. That said, higher loan prices boosted NAVs to further bolster total returns for the year. CLO equity had a banner year with median returns in the +30-35% range, the second highest post crisis annual return. Higher NAVs and robust quarterly payments due to LIBOR floors, low cost of debt, and par gains from 2020 purchases were the main drivers behind returns. In addition, secondary liquidly in equity vastly improved as more buyers entered the asset class and trade volume reached new highs.

As previously mentioned, secondary volume was lower in December versus November. Total BWIC activity was $2.4 billion, 45% lower MoM. Total volumes per TRACE were $9 billion, a 10% decline from November led by a 30% drop in Non-IG volume. Total TRACE volume in 2021 was $136 billion, a 24% decline from 2020- largely due to a decrease in IG traded volume.

December 2021 CLO Primary Market Overview

Capping off the highest year in CLO issuance ever, the CLO primary market had a busy start in December with $10 billion of new issues across 15 deals. Issuance was concentrated in the first two weeks of the month so that deals could close before the SOFR transition in 2022 with the last new issue pricing on December 17th. Given that most loans are benchmarked to LIBOR, managers were attempting to avoid basis risk by pricing LIBOR-based CLOs in 2021. We continued to see some spread widening with heavy issuance volumes and market volatility due to the Omicron variant. New-issue AAAs widened 1 bp and BBs widened 10 bps. The rest of the stack was flat on the month, leaving spreads for tier 1, full duration AAAs at 115 DM, AAs at 165 DM, Single-As at 200 DM, BBBs at 300 DM, and BBs at 635 DM. The AAA term curve flattened slightly with the middle of the curve (2-year reinvest) widening to 100-112 DM over the month, as issuers became more price insensitive in order to get their deals across the finish line.

FY 2021 new issuance, bolstered by record loan issuance and CLO demand, reached a whopping $185 billion in December, shattering the previous yearly issuance record of $127 billion set in 2018. In addition, a record 128 managers issued deals in 2021, including 12 first time managers. In spite of record issuance, primary spreads tightened across the stack with the exception of AAs. Year-over-year, primary tier 1 AAAs and Single-As were 5 bps tighter, BBBs and BBs 50 bps tighter while AAs were 5 bps wider.

Refi/reset volumes remained robust in December despite lower overall issuance volumes with $5.1 billion in refis and $6 billion in resets pricing over the month. Refi/reset volumes also set issuance records in 2021 with total refi volume hitting $109.3 billion and reset volume hitting $135.5 billion. Higher refi/reset volumes can be attributed to many 2017- and 2019-vintage deals nearing or exiting their non-call and reinvestment periods throughout the year, as well as 2020-vintage, shorter-dated deals issued in the height of the pandemic being repriced by managers.

Middle market (MM) issuance was robust with five deals pricing in December for a total of $3 billion in new issue. Spreads have remained relatively flat for 4 year reinvest 2 year non-call MM deals with AAA levels ranging from 145-160 DM. Demand for MM CLOs remains strong due to their wider spreads, higher credit enhancement and continually improving fundamentals. FY 2021 middle market issuance reached a record high of $20.6 billion.

CLO Fundamentals

CLO fundamentals were mostly improved in December with WARF levels continuing to decline to 2792. WARF levels have declined 330 bps since December 2020, reflecting a lower exposure to riskier loans in CLOs. The percentage of defaulted assets remains at zero and CCC/Caa exposure declined 30 bps/10 bps MoM, bringing CCC/Caa exposure down by 3% during 2021. Junior OC cushions also improved 10 bps over the month with the reduction of CCC/Caa assets and currently stands at 430 bps, over a 130 bp improvement from the beginning of the year. Value metrics improved as well with median equity NAV up 60 bps to 62.1 and BB MVOC at 107. Equity NAVs improved over 15 bps YoY, commensurate with loan prices increasing 1.3 bps during 2021. n