Non-Agency RMBS – Michael Hsu

Heading into the close of the second quarter, secondary activity was muted in June, with bid list supply down 19% month over month to $3.5 billion. The technical backdrop continued to be strong, with low supply and robust demand from real money accounts that left dealers lighter by $490 million. Total trading volume reported by TRACE was $8.5 billion. The Non-Agency market looked past interest rate volatility to close out June tighter as fundamentals remained intact. Housing remains on a strong footing, with HPA and forbearance rates continuing their upward and downward trajectories, respectively.

Investors’ positive outlook has continued to be affirmed by bond performance (e.g. elevated prepayment speeds and forbearance recoveries, declining severities) and reflected in modeling assumptions steadily drifting in an optimistic direction. This has led to further compression in spreads across the credit curve as investors look to add incremental yield by going down the capital structure. While legacy senior passthroughs were well bid and traded tighter by approximately 10 basis points into the swaps + 120-140 context, the largest moves in spreads were seen in subordinate tranches. For example, while shorter investment grade M2s off GSE Credit Risk Transfer (“CRT”) transactions ended June 0-10bps tighter, their unrated subordinate B2 tranches rallied 50-60bps.

One of the recurring themes throughout June was the rapid pace of new issue deals. Primary volume reached new highs for the year and, in fact, June’s total ($16 billion) was the third highest month in the post-crisis era. Volumes were primarily driven by activity in the Prime Jumbo and Non-QM sectors. Prime Jumbo led the way with $6 billion securitized and Non-QM’s total came close to $4 billion. In both sectors, heavy issuance weighed somewhat on the senior bonds. Non-QM AAA rated A1s started June pricing in the area of swaps + mid 60s but ended the month in the low 70s. Similarly, in the Prime Jumbo sector (whose year-to-date issuance of $26 billion has already surpassed all 2020 issuance), spreads on super seniors are stuck at multi-year wides, with AAA rated 2.5% coupon passthroughs clearing around two points back of benchmark TBAs (they were ~1 pt back at the beginning of this year).

Source: Bank of America Global Research

CMBS – Sagar Parikh

First half 2021 issuance in the CMBS market reached $66+ billion by the end of June. New issue volumes have already nearly doubled last year’s private-label CMBS volume of $37 billion. CRE CLO issuance, in particular, has been very strong with over $21 billion in issuance (vs $5 billion last year). Of the private label volume, the majority has been floating rate issuance. Driving this dynamic are borrowers who are looking to increase their cashflows off of COVID lows (before locking in long term financing) and investors with a preference for shorter, floating-rate product (in anticipation of higher future interest rates). Asset managers continue to dominate most of the private-label demand throughout the capital stack:

Turning to fundamental underlying data (as seen through remittances): the percent of borrowers receiving forbearance continues to decrease, with 27.8% of outstanding hotel borrowers and 7.1% of outstanding retail borrowers having been granted forbearance as of June. In total, 7% of hotel borrowers and 7.9% retail borrowers have voluntarily canceled their forbearance requests between March 2020 and June 2021. Meanwhile, the percentage of loans in special servicing also continued to decrease, dropping to 8.5% of the outstanding universe. For loans that received appraisals during the month, the weighted average reduction was -39% (the majority of loans receiving refreshed appraisals were either 90-120 days delinquent or in foreclosure/REO as of the June remittance date). As more loans transition out of forbearance and enter the non-performing special servicing bucket, we should expect more appraisals of seriously delinquent loans later this year.

Percentage of Post-GFC Conduit Loans that Canceled Forbearance by Property Type

Source: BofA Global Research, Intex

As capital markets have opened up and special servicers have begun to work through their pipeline, we have seen an increasing number of CMBS borrowers request DPO’s (discounted payoffs). Historically, a special servicer would only grant a DPO if they felt the net recovery to the trust would be lower over time (in the case of a large tenant leaving or an asset in structural decline like retail). Savvy borrowers, meanwhile, have seen leasing volumes and valuations increase and have tried to negotiate discount pay-off options as part of negotiations with the special servicer. Thus far, retail owners have the greatest success negotiating such options, as the special servicers are less inclined to manage such properties going forward. Below is a snapshot of the DPO’s that been issued YTD versus the past seven to eight years:

DPOs Have Been Fairly Spotty in Recent Years, But Increased in 2021 YTD

Sources: Trepp & Citi Research

Finally, when considering loss severities for different property types; retail and hotel properties have taken the highest losses to date. The weighted average loss severity rate has been 38.6% as of June 2021, but many of the larger early vintage retail loans are expected to take much higher severities in the coming years. Thus far, $15 billion in CMBS 2.0 loans have been liquidated, with the highest volume coming out of the retail sector.

Loss Severity Analysis by Property Type

Source: BofwA Global Research, Intex

ABS – Tony Lee

June continued the trend that’s held steady throughout the first half of this year: unabated demand for ABS, despite a very busy new-issuance calendar. Sponsors have brought nearly $129 billion in new-issue ABS securitizations year to date in 2021, a significant increase from the $80 billion seen in 1H 2020. Toyota kicked off the new issue calendar in June, pricing and upsizing its $1.5 billion prime auto loan ABS at swaps plus zero for all three senior classes (with average lives ranging from 1-3.5 years). The main event in June, however, was Hertz’s triumphant return to the ABS market. The issuer, newly emerged from bankruptcy, priced a $4 billion rental car ABS, with spreads ranging from 60bps or 70bps over swaps (3.3yr and 5.3yr AAA seniors) to 340bps over swaps (3.3yr and 5.3yr Ba2 subordinates). Orders for this enormous rental car ABS drove subscription levels well past what the company was offering, with demand reaching as high as $20 billion in total. As part of the securitization, Hertz used the proceeds to retire its existing ABS facility and transfer its remaining vehicle assets to this one.

The used car market has drawn significant focus lately. Dealerships have had a difficult time keeping inventory on the lot as demand for vehicles and a constrained supply chain have driven automobile values to historic levels. The Manheim Used Vehicle Value Index reached 200.4 in June, a 34% increase year over year. Some used vehicle models are selling for the same price as a new model. This strength in vehicle values also reveals itself in auto ABS fundamentals. The prime auto loan recovery rate for May 2021 reached 96.2%, or a 3.8% loss severity. This is an all-time high. The story is similar in subprime auto, where one month recovery rates peaked in April 2021 at 75.1%, also an all-time high.

Prime Auto Loan ABS Recovery Rates

Source: Bank of America Research

Subprime Auto Loan ABS Recovery Rates

Source: Bank of America Research

CLO – Palak Pathak

CLO Secondary:
CLO performance remained flat in June, with the primary market capturing investor attentions. Carry provided the majority of returns over the month, with prices and spreads unchanged from May for most tranches (BBs/Bs were slightly weaker). AAA, AA, and single-A spreads were flat over the month with shorter, out of reinvest bonds trading in the 80-95 DM range and longer duration bonds in the 110-115 DM context for AAAs. AA and single-A spreads stayed in the 150s and 180s, respectively. Given that most bonds in secondary are trading at a premium, with many out of their non-call periods, there is not much room for spreads to tighten further up the stack. BB spreads widened slightly over the month due to increased supply in primary. High quality, short spread duration BBs remained in the high 500s to low 600s DM. Lower quality BBs, however, widened 10-15bps. Although the relative value between High Yield credit and CLO BBs continues to favor CLO BBs, increased CLO supply via new issue, refis, and resets is keeping CLO BB spreads wide to historical averages vs. High Yield.

The pace of CLO Equity trading declined as valuations are full with many investors running equity to very benign scenarios and fully pricing in the refi / reset option. Further muting equity volumes was investors’ desire to wait for July quarterly payment data, to help them assess how managers are navigating the tighter loan spread environment.

Overall secondary trading volumes declined in June with monthly BWIC volume at $2.7 billion and TRACE total trading volume at $10 billion (vs. $11 billion in May). Trading activity moved from equity to AAAs in June as accounts sold AAAs and rotated into wider new issue. There was, however, enough demand for secondary AAAs from shorter duration buyers that dealers still ended the month lighter by $250 million.

Secondary CLO 2.0 Spreads (DM)

Source: TCW

Primary
CLO primary activity increased significantly month over month with $16.5 billion pricing across 30 new issue deals. This made June issuance the second highest monthly level in history. New issue CLO spreads were wider across the capital stack. Tier 1 AAAs priced 2bps wider at L+112bps. The rest of the stack was also weaker due to continued high CLO supply with AAs 5bps wider, single-As 10bps wider, BBBs 25bps wider, and BBs 10bps wider. Notably, with High Yield credit tightening over the month and CLO BBs widening, the CLO BB/ HY ratio increased to record highs.

Refi and reset volumes increased significantly in June, with a total of 25 refis and 30 resets pricing over the month. This was a significant pickup vs May, which saw 20 refis and 18 resets price. There has also been an uptick in CLO liquidations since April. The principal driver of this is high quantities of CLOs out of their non-call periods with limited ability to refi/reset due to pipeline and rating agency constraints. In Q2 2021 there were over 30 liquidations vs. 25 in Q1. As 2020 post-COVID deals exit their non-call periods, we will likely also see a continuation of increases in CLO refis and resets, paired with wider spreads from the increased supply. Moving forward into Q3, we believe we may witness a decline in new issuance, as wider spreads could make the arb unattractive. We believe the market could also see the comeback of shorter reinvestment period deals, such as 3nc1s, in order to reduce debt costs and preserve optionality for tighter spreads in the future.

CLO New Issuance

Source TCW

Tier 1 New Issue Spreads (5nc2)

Source TCW

Fundamentals
CLO fundamentals improved in June as CCC loans continued to get upgraded over the month. The percent of CCC rated loans in CLOs declined another 10bps to below 6% and commensurately WARF declined 32 points with the median CLO WARF now below 3,000. Equity NAVs also increased to above $60 as loan prices increased over one-quarter pt. in addition, exposure to distressed loans declined with less than 3% of CLO collateral trading below $90.