Securitized Debt Has Been Oasis For Yield, But It's Running Dry

(Bloomberg) -- It’s become nearly impossible to find yield amid the ongoing spread compression across credit markets. One of the last harbors for value, securitized debt, still offers upside in some specific areas, though returns are quickly diminishing.

Some investment-grade slices of commercial and residential mortgage-backed securities, as well as collateralized loan obligations, are still cheap to lower-rated corporate bond spreads, investors and analysts say.

“Seasoned single-A and BBB CMBS look attractive” compared to corporate paper, said Paul Norris, managing director and head of structured products at Conning said in an interview. “We believe not every single mall will go out of business, and not every single retail shop will go defunct. At the single-A level, perhaps 3% yield with a four-year duration CMBS is a good place to invest right now. We are able to stress-test them through different scenarios.”

CMBS tranches rated AA-, A-, and BBB- will continue to rally, Cantor Fitzgerald LP head of strategy Darrell Wheeler said in a Tuesday research note.

Across all credit markets, near-zero interest rates and massive Federal Reserve bond purchases have fueled a search for returns and helped buoy asset prices downstream, including those of risky investments such as speculative stocks, cryptocurrencies and high-yield debt, thinning value in those segments.

“Nothing is outright cheap these days,” said Henry Song, portfolio manager at Diamond Hill Capital Management. “But relatively speaking, structured products still offer value versus investment-grade corporates, especially when you adjust for credit quality and duration.”

RMBS and CLO Favored

Private-label RMBS, including some AAA slices, and CLOs, also still look cheap to corporates and even to some other areas of ABS that have tightened, Norris said.

“We prefer last-cash-flow AAA prime RMBS paper,” he said. “You’re getting a 3% yield, so you’re outperforming BBB corporates of the same duration. If you’re trading in the 10 year part of the curve in BBB corporates, you’re not yielding anywhere near AAA pass-through RMBS. And with RMBS, it’s closer to par.”

Conning also likes CLOs, and favors AA rated CLOs at this point. “They’re a little bit cheaper than AAAs and spreads over time may tighten quite a bit once the (CLO) supply deluge is over.”

Cantor Fitzgerald agrees with that assessment. “The CLO credit curve offers some of the widest rated credit spreads available in the capital markets,” Cantor’s Wheeler said.

“CLO spreads for AA, A, BBB-, and BB- of about 155, 200, 290, and 625 basis points, respectively, are still some of the widest floating-rate spreads available in capital markets and cheap for those with a neutral corporate credit outlook and ability to research the managers,” Wheeler said.

Pockets Get Expensive

Even some so-called esoteric or non-traditional ABS sectors that offered yield last year -- such as timeshare, aircraft-lease, and container-lease ABS -- have tightened so much that they’ve lost their relative-value luster, Norris said.

“Timeshare is expensive now and it’s difficult to find a 2% yield for a triple-B rated asset,” Norris said. “Aircraft is now at 3.5%, which is good but not as good, and container lease is currently offering approximately 100 basis points over swaps, which may be an all-time tight. The relative value is just not there from a spread perspective.”

Read more: Fed warns of peril for asset prices as investors gorge on risk

Differing Views on CMBS

Spreads on CMBS AAA slices have narrowed so much the paper is no longer considered cheap, according to Norris. But further down the capital structure, there may still be a bit of opportunity left.

Deutsche Bank AG analysts, however, said it may still be possible to find higher-rated tranches of CMBS that are still cheap to lower-rated corporate bonds with similar durations. For example, CMBS known as single-asset, single-borrower trades, which are often linked to a single trophy office building, have offered higher yields this year than other asset-backed debt and corporate paper. They are often floating-rate securities, an alluring quality at a time when many foresee interest rates rising.

The AAA rated slice of an April CMBS transaction linked to high-quality midtown Manhattan office towers priced at 98 basis points over a swap-spread benchmark for 10-year paper. That compares to a spread of just about 78 basis points over swaps for an average single-A rated corporate bond with a seven- to nine-year duration, according to Edward Reardon, an analyst at Deutsche Bank.

Meanwhile, any debt that is consumer-related, such as auto or consumer-loan ABS, “is still lagging a little bit” in terms of spreads, said Diamond Hill Capital’s Song, meaning that the risk premiums still have room to rally. Spreads can still tighten, “especially when you consider how strong consumer balance sheets are,” he noted.

Relative Value: CMBS

• Deutsche Bank analysts like CMBS conduit junior AAAs and AAs at current spreads, according to a Wednesday research note
• Single-A conduit is fully valued, however, BBB- look rich given Covid-19 loss uncertainty, the Deutsche Bank analysts wrote
• Agency CMBS spreads are at record tight levels, but are an effective portfolio stabilizer should there be a recession, according to Cantor Fitzgerald analysts
• Agency CMBS portfolios should contain a mix of Freddie K and DUS deals for liquidity, the Cantor analysts said in a recent note

Quotable

“I don’t understand all the interest around commercial real estate CLOs,” Conning’s Norris said. “We prefer (leveraged-loan) CLOs, which are trading cheaper.”

What’s Next

ABS deals in the queue include Credit Acceptance (subprime auto), Flagship (subprime auto), World Omni (prime auto), Sallie Mae Bank (private student loan) and Marriott Vacations Worldwide (timeshare ABS).

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