Text on screen: What's happened in the structured credit markets?
Josh Anderson, Head of Global ABS, Portfolio Management: On March 23rd, the Fed and Treasury announced a series of measures to support financial markets after the dislocation arising from COVID 19.
Shots of U.S. Federal Reserve Building.
Many of these initiatives were new iterations of programs implemented during the 2008 and 2009 financial crisis.
One example of this was the TALF program,
Image of Federal Reserve Chairman Jerome Powell
Text on screen: TALF: Term Asset-Backed Securities Loan Facility
one of the more impactful programs from the Fed and treasury, aimed at promoting credit availability in consumer, commercial mortgage and certain corporate markets.
This program was initially rolled out in March, focusing primarily on Consumer ABS. They've since expanded it to commercial real estate CMBS and then a little bit to corporate CLOs as well. They have not yet expanded to the RMBS sector, and we think there's a better than 50% probability they do expand this program because parts of the mortgage market are under pressure. And self-employed borrowers, as an example, are having trouble getting mortgages.
So expanding TALF into the residential mortgage market would help some of those borrowers.
At the time of the announcement, spreads in these markets were under significant pressure due to forced deleveraging from a variety of levered market participants, primarily REITs and certain hedge funds.
Text on screen: What was the impact?
Similar to TALF 1.0, Since being rolled out, structured credit markets have stabilized and spreads have rebounded from the wides in March.
Chart: The line graph depicts how spreads have become compressed across senior structured credit since the TALF program was announced. CLOAAA, Prime Auto Fixed AAA (3 yr), Credit Card Fixed AAA (10 yr), Legacy Non-agency RMBS Option ARM and CMBS AAA (10 yr) are mostly steady from January 2017, spiking in March 2020 and now in decline in April 2020.
3-year AAA ABS are roughly 100 bps+ tighter from the wides, but remain 50-100 wider from pre-Covid levels.
Non TALF eligible assets are underperforming relative to TALF eligible assets. But clearly this program has helped overall sentiment across the structures credit markets.
Text on screen: What’s next?
In general, we believe the fundamentals in this market to be quite solid relative to the 2008 and 2009 financial crisis.
TALF’s announcement has provided support to many of these asset classes already and we believe they will remain well supported by demand for high quality spread.
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Program details remain fluid and our view on the impact of the program could change if it expanded into residential mortgages, or even expanded its coverage of CMBS, CLO and other ABS sectors.
Similar to the last cycle, PIMCO expects to be a leading participant in this market, particularly given our understanding of many of the underlying asset classes.
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While there will likely be attractive opportunities to invest in TALF-eligible assets, we generally believe TALF is better as part of a broader mandate versus a standalone strategy.
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Identifying bonds with the potential for spread compression may be key to maximizing returns, as levered yields alone are unlikely to be as compelling as many initially expected.
Patience is key in the corporate market as this is where we expect more downgrades, credit events and technical pressures.
Unless mortgages are added to the TALF program, we expect the program to be relatively small and a broader opportunity set, including CLOs, bank loans and fallen angels in the high yield market,
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may offer a better risk adjusted return or a broader opportunity set.
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