Structured Finance Havens Are Cracking Under the Weight of Broad Selloffs

(Bloomberg) -- One of Wall Street’s go-to shelters in times of trouble is showing cracks as broad concerns pile up.

Bouts of selling have hit bonds backed by mortgages, auto loans and credit card payments -- typically havens during periods of stress -- amid the carnage in financial markets this month.

Certain sectors of so-called securitized loans are “experiencing some headwinds,” said Neil Aggarwal, senior portfolio manager and head of trading at Semper Capital. “A combination of rates, earnings, and global concerns are having an ongoing impact.”

The debt class usually does better than corporate bonds during market turmoil because the securities are linked to consumer payments, rather than company performance, and typically have cash cushions to absorb initial losses. But recent weakness highlights how the sector may be unable to shrug off the chaos enveloping other assets.

Commercial mortgage-backed securities may be the most affected. The Sears Holdings Corp. bankruptcy has added to pressure on the already brow-beaten retail sector. Moreover, commercial properties, which tend to be valued based on a yield spread, are being hit by rising rates, according to Aggarwal.

Average spreads -- the premium above a perceived risk-free rate -- on CMBS deals as a whole have widened in secondary trading as much as six basis points so far this month, while the riskier benchmark BBB- rated spreads widened by about 25 basis points, according to index data from Bank of America Merrill Lynch and ICE Data Services. In comparison, BofA’s high-yield bond index widened 23 basis points over the same period.

That weakness also spread to the new issuance market. During the week of Oct. 15 after stocks plunged, primary CMBS spreads edged wider compared to recent deals.

“CMBS can get led around by corporate spread movement to a degree -- which has been widening -- and certainly also by broader macro volatility,” said Chris Sullivan, chief investment officer at the United Nations Federal Credit Union. “However, this could be just periodic equity volatility.”

Here are more examples of how structured finance is being affected:

• In the consumer sector, spreads on asset-backed bonds widened last week amid heavy supply and the stock sell-off, according JPMorgan Chase & Co.
• Auto-loan ABS spreads also widened across tranches during the same week, BofA said in a recent note.
• The trading of pre-crisis residential mortgage bonds, a popular RMBS strategy, seems to be the most immune to the wider volatility. Despite the overall weakness in the housing sector, the decreasing supply of these legacy securities is supporting the sector.

“The market volatility is creating trading opportunities within structured products as certain markets are underperforming while others remain well supported,” Aggarwal said.

To contact the reporter on this story: Adam Tempkin in New York at atempkin2@bloomberg.net

To contact the editors responsible for this story: Christopher DeReza at cdereza1@bloomberg.net, Randall Jensen

©2018 Bloomberg L.P.