Insurance Insights: Love, like or leave? Securitized credit has enough love to go around

Abnormal market volatility, outliers and tail risk. These have been the focus of our recent blogs for good reason…

• Extreme moves in inflation and rates have created a macro backdrop unlike any we’ve seen in decades.
• Focusing on the downside is always important.

One of the best ways to improve the risk profile of your portfolio is to make sure you have the right set of tools. Flexibility to invest across a broad spectrum of investments is critical, especially in an uncertain macro environment.

A key asset class to consider is securitized credit, which provides diverse, structured and customizable access to U.S.-centric risk that seems best positioned to weather any economic uncertainty on the horizon. In addition, the recent risk-based capital regime changes offer insurers more granularity from a capital perspective, making skillful security selection even more effective in terms of risk- and capital-adjusted return. Below, we present our views across securitized subsectors, segmented by love (i.e., those we are overweight relative to our risk budget), like (those we are neutral weight) or leave (areas in which we do not invest).

CMBS: We are overweight floating-rate AAA rated commercial real estate CLOs. These securities trade in the mid-to-high 200s and offer yields between 6% and 7%. On the other extreme, we are less constructive on new issue conduits. Many recent deals had a high proportion of interest-only loans — in this environment, we believe structure should be getting better, not weakening.

Non-agency RMBS: We favor non-qualified mortgages (non-QM), which refer to mortgages that fall outside traditional conforming agency mortgage guidelines. With short-term rates starting with a zero and spreads around 100, the non-QM mortgage subsector was in our “leave” category a year ago. Now, with short-term rates starting in the 4s and spreads briefly starting in the 2s, non-QMs are consistently delivering 6%+ yields. Importantly, this cash flow typically has a 100-basis-point coupon step-up if the security isn’t called after four years, negating some of the extensions we have seen in the residential asset class. We’ve also moved seasoned CRT into the “friend zone” — a like, but not a love. Seasoned CRT has benefited from tenders from Freddie Mac and limited supply, providing a strong technical backdrop that has moved spreads justifiably tighter.

US ABS: We favor solar and prime student loans. Student loans drew negative attention following recent regulatory relief for borrowers. But if you look through the headline noise, we believe there are plenty of attractive opportunities. We prefer exposure to ABS secured by private loans to high-income earners, as well as those to graduate students not eligible for relief.

CLOs: We prefer single-As in the high 300s area. That cash flow has similar credit enhancement to CLO 1.0 AAs, which suffered zero credit losses through the 2008 global financial crisis. We think better risk-adjusted returns are available in A rated or better CLOs versus BBB and lower-rated CLOs. We favor what we call Tier 1 managers versus the smaller shops that have seen fewer credit cycles, and we favor broadly syndicated senior bank loans versus the middle markets.