Securitized Credit Market Update

With equity indices close to record highs, credit spreads close to YTD tights and markets trading smoothly, is there anything worth digging in on? More months than most, arguably, at least for securitized credit markets.

Maicro Inputs

• Tricolor: Another ABS issuer filed for bankruptcy early last month. o This time, it was a subprime auto lender, one that focused on lending to undocumented migrants and/or consumers with little credit history – a likely source of stress that contributed to its demise.
  • Within ABS markets, Tricolor wasn’t particularly large but did have consequential size (issued ~$2.5B in ABS since 2018, 7 deals remained outstanding) that previously commanded sponsorship from an array of high-profile lenders and investors.
  • Fraud appears to be a key ingredient to the company’s demise, with the DOJ conducting an investigation into allegations that include double pledging of loans. Reporting on the issue has cited evidence of this, although publicly disclosed facts are few and far between at this stage.
  • Trading in related bonds (TAST shelf) are increasingly telling the story, with market values declining to levels that reflect really bad outcomes for bondholders.
    • While trading appropriately with stress, we do assess rationality within these markets, despite the imperfect information: the most severe discounts are priced for bonds from the most recently issued transactions (2024-2025 vintages) and, within transactions subs are trading dramatically lower than seniors.
  • While more of this story remains to be written, the rest of the ABS market continues to move. Potential implications of this incident (immigrant populations under severe credit stress, lowincome consumers under stress, consumer credit behavior in general higher risk) are slowly getting priced, with the most directly adjacent types of risk getting impacted the greatest.
  • In particular, we’ve seen ABS from other subprime auto issuers with a historical focus on similar consumer credit cohorts (exposure to undocumented, subprime borrowers) are seeing their market values suffer. Rating agencies have played a part, placing certain issuers in their respective rating franchises on credit watch with negative implications.
• First Brands Group: On the heels of the afore detailed Tricolor bankruptcy, this US based auto parts supplier filed for bankruptcy in late September.
  • After a summer of discontent for its creditors, which featured a credit rating downgrade, pulled debt refinancing transaction and bankruptcy of affiliated financing entities, the company filed for bankruptcy protection with $12B in estimated liabilities spread globally.
  • Most directly for securitized credit markets, First Brands exposure was spread across US ($2.2B) and Euro (€0.5) CLOs. A high-level scan of transactions that had exposure suggests the effect will be contained, as relatively few (21 in the US, 2 in Europe) have exposure >=1%.
  • In addition, but not directly related to securitized markets, relatively large amounts of exposure are held unevenly across the globe. A quick scan of headlines can reveal who is more exposed than others. Financial and reputational risk is manifesting accordingly. Securitized Credit Market Update
• CarMax: Also late in September, the used car dealer and lender, which has a long-standing, highly credible presence as an auto ABS issuer, announced Q2 earnings that revealed a surge in provision for loan losses from its lending unit.
  • Sequentially, the loss jumped ~40% ($102MM to $142MM), which represented a ~25% YoY increase. Management cited deteriorating credit trends in support of the higher provision.
  • While not branded as a subprime auto lender, it does have a non-prime branded shelf and as such, this news correlates with the pain being endured in the auto space as evidenced by the afore mentioned bankruptcies.
• Tying these together, we are seeing real signs of economic damage with operators in the auto industry. Each plays/played a different role, but all are signaling difficulties and all arose relatively quickly.
• As it relates to macro inputs, which we usually lead with, the economic shutdown is probably the current lead story.
  • It has kept us from our usual processing of how the latest inflation and employment reports impacted market conditions and may also impact how the Fed acts in their upcoming meeting at the end of this month.
• While it has not been particularly long at this stage, the longer it progresses the greater the impact on the economy and markets, to perhaps state the obvious.
• By the same token, the absence of data doesn’t leave us feeling like we are flying blind – by any stretch. It probably heightens the senses as it relates to the value of information available in securitized markets. Alternative measures are continuously on offer in our industry.
  • Securitized remittance reports are monthly and industry data covering the gamut of consumer related credit behavior.
  • These are further compiled and published upon by a range of experienced vendors and market participants.
• So, in a loose bridging of ‘typical’ macro data to what we have processed, I would grossly characterize data from our markets (consumer, real estate, leveraged loan borrowers) as evidencing a still growing economy far from recession with generational amounts of cap-ex, but one that has pockets of weakness emanating from policy changes and ongoing stresses from higher costs that is weakening the employment backdrop.

• A few pockets of softness have emerged in our markets, owing in part to the afore detailed issuer level stresses across the auto industry.
• But the bigger source of strain has been supply – new issue markets were really cooking in September, which ran right into quarter end and associated drop in liquidity as books temporarily close and market makers clear out some risk positions.
  • This supply strain was most on display in CMBS markets, which saw another month of elevated supply across conduit and SASB sub-sectors. While good for borrowers needing to refinance maturing loans as the sector continues to advance in its recovery, it is taxing a somewhat saturated buyer base.
  • We expect this to drive fresh allocations of capital to the space, as improving fundamentals, lower rates and the overall tight spread environment in credit markets should influence better buying as rel-val becomes apparent.
• Since quarter end, liquidity has returned to being strong and deep in securitized markets, rebounding nicely into October as accounts reposition ahead of typically leaner weeks of supply in late November and December.
• Many of the same micro-trends and securitized market biases remained uninterrupted from prior months.
  • Primary markets remained the place to be. It continues to be the dominant place to source risk, and execution remains reasonably efficient for issuers.
• Aggregated activity across sectors can be observed below, which evidences progress towards another year of record amounts of issuance, despite April disruptions and the elevated rate environment – impressive for public market champions.
  • Secondary market trading volumes remain relatively light, reflective of an investor base not short on cash and likely enjoying reasonably steady inflows.

• Our somewhat tempered outlook from last month’s talking points seems warranted, albeit not entirely for the reasons we articulated.
• Weaker seasonals perhaps played a role, particularly given all the supply that was delivered.
• However, with the additional risk that became apparent to market participants from the Tricolor, FBG and CarMax developments, the ‘extended’ feel we highlighted around valuations seemed vulnerable.
• When we layer in a less-certain feeling macro backdrop, we still feel valuations are vulnerable and advocate a cautious approach to risk taking overall.
• However, within securitized credit, spread premiums to other corporate credit markets remain apparent to us and relative value remains formidable, particularly when risk-adjusting our return profiles in preferred sectors and sub-sectors. So, we remain holders of ‘core’ risk positions and would be a buyer into most extended distortion scenarios we can plausibly see. 

We hope everyone enjoys some cooler temps and processes the new micro developments with good fortune. 

Voya Securitized Team