Spreads on commercial asset-backed securities (ABS)1 widened considerably as a result of the COVID-19 pandemic, with transportation-related sectors leading the trade down.
Spreads for aircraft lease ABS,2 which traded as tight as 195 basis points (bps) over swaps early in 2020, ballooned to 1,500 bps in the span of a few weeks. As governments around the world enacted record fiscal and monetary stimulus to combat the economic fallout from the pandemic, spreads recovered much of the widening although many subsectors remain near multi-year wides. Looking forward, we believe many commercial ABS subsectors can offer attractive relative value, particularly for non-transportation related sectors such as subordinate equipment leasing and timeshare loan ABS. Read on for our current assessment of major commercial ABS sectors.
AIRCRAFT LEASE ABS:
Aircraft lessors have been directly impacted by travel restrictions related to COVID-19, with airlines around the world requesting payment relief from lease obligations. As a result, deals have experienced cash flow disruptions and many senior tranches are not currently receiving scheduled principal. Over the course of the next year, lessor remarketing capabilities will be challenged by increasing airline defaults and a glut of aircraft supply. We expect many issuers will need to access liquidity facilities in the deals to help cover upcoming expenses and that senior tranches will likely fall further behind on their principal payment schedule over the next 12 months. At roughly swaps3 plus 650 bps, we expect spreads on senior tranches to continue to trade in line with other high-beta sectors that are sensitive to the recovery. Given the high level of uncertainty around the recovery in global air travel, we are approaching this sector cautiously.
RENTAL CAR ABS:
Despite headlines related to the Hertz bankruptcy, spreads on senior tranches have tightened by almost 300 bps since March and are currently trading at spreads of 250 to 300 bps. The recent rebound in used vehicle prices has bolstered investor confidence in the asset class, particularly for subordinate tranches, which have rallied over 20 points (in dollar price) from distressed levels in March. We prefer issuers in the space that have conservative depreciation schedules and strong track records of managing residual values.
CONTAINER ABS:
Spreads for senior container ABS tranches, which reached as high as swaps +750 bps in March, retraced most of their spread widening and are currently in the low 300 bps range. We believe that COVID-19’s impact on maritime trade, which is forecast to decline by 10% in 2020, will likely be less severe than the impact to air traffic, which may take years to recover to 2019 levels.
FLEET LEASE ABS:
Operators of medium and large sized fleets of light-duty trucks continue to mostly remain current on their leases, and we do not expect delinquencies to increase materially for the remainder of 2020. Losses in this asset class have historically been very low due to the conservative depreciation schedules built into the assets and the open-ended nature of the majority of the leases, which shifts residual value risk from the lessor to the lessee. While spreads on senior tranches have retraced most of their widening, investors may find value in subordinate tranches that range from 100 to 260 bps+ in spread.
EQUIPMENT ABS:
Performance for large-ticket equipment ABS backed by agricultural and industrial equipment remains stable, and spreads on senior tranches have retraced all of their first-quarter widening. Spreads for subordinate tranches remain elevated, however, and we believe these tranches can provide attractive relative value compared to similarly rated unsecured corporate bonds.
TIMESHARE LOAN ABS:
Despite a modest increase in delinquencies, asset performance has remained stable as issuers continue to support their deals by repurchasing/substituting defaulted collateral. Although systemwide occupancy remains below 2019 levels, we expect product utilization to improve as many owners opt to vacation locally and use their points. With spreads on senior bonds trading at levels 70 bps higher than the 2019 average, we believe the sector can offer value across both senior and subordinate tranches.
FRANCHISE WHOLE BUSINESS SECURITIZATIONS ("WBS"):
Spreads on securitizations backed by franchise royalty fees from quick-service restaurant operators are currently in the mid-200bp range and have recovered most of their first quarter widening. Although quick-service restaurants have been winners in the post COVID-19 environment, we believe that further spread tightening will be limited due to lower all-in yields and investor sensitivity to premium dollar prices.
End Notes
1 Securities backed by operating cash flows or payments from commercial obligors.
2 Reflects the spread to the Anticipated Repayment Date (7 years). Please note that aircraft ABS are rated to a 20-year legal final payment date.
3 Interpolated swap rate: the calculated benchmark rate for ABS that have weighted-average lives in between two commonly quoted swap maturity dates. For example, if the 2-year swap rate was 2% and the 3-year swap rate was 3%, the interpolated swap rate for a bond with a weighted-average life of 2.5 years would be the midpoint between the two rates (2.5%). Weighted average life is the average time to receive future principal cash flows, weighted by the proportion of the future principal cash flow received to the original principal balance.
Disclosure
This paper is provided for informational purposes only and should not be construed as investment advice. Opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Other industry analysts and investment personnel may have different views and opinions. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted, and actual results will be different. Data and analysis does not represent the actual or expected future performance of any investment product. We believe the information, including that obtained from outside sources, to be correct, but we cannot guarantee its accuracy. The information is subject to change at any time without notice.
This is not an offer of, or a solicitation of an offer for, any investment strategy or product.
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Indices are unmanaged and do not incur fees. It is not possible to invest directly in an index.
Market conditions are extremely fluid and change frequently.
Past performance is no guarantee of, and not necessarily indicative of, future results.
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