Government Investment Officer’s Association 2019 Annual ...Leverage ratios (e.g., Net debt/EBITDA,...
Transcript of Government Investment Officer’s Association 2019 Annual ...Leverage ratios (e.g., Net debt/EBITDA,...
Government Investment Officer’s Association2019 Annual ConferenceAsset-Backed Securities and Corporate Notes
March 20, 2019
Jim Womack, CFAManaging Director-Fixed Income, Principal
Asset-Backed Securities and Corporate NotesThe Quest For Yield (Spread): The ONLY Reason We Look At Non-Treasuries
SPREAD!
Time
Yie
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US Treasury Yield Curve
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Highest Quality Aaa AAA 2%(Smallest Degree of Credit Risk)
High Quality Aa AA 15%(Small Degree of Credit Risk)
Upper Medium Grade A A 46%(Largest Rating Category)
Medium Grade Baa BBB 37%(Neither Well Protected or Speculative)
83% Rated‘A’ or ‘BBB’
Corporate NotesCorporate Investors Get Paid Spread Primarily For Taking on Credit Risk
Moody’s S&P Weight*
* Credit weights by market value within the Bloomberg Barclays 1-3 Year Corporate Bond Index
12 Bonds Rated ‘AAA’
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Corporate NotesWhat Is Credit Risk? There Are Three Answers That All Boil Down to Losses
Downgrade Risk
Default Risk
Price Volatility Risk
THIS DOES HAPPEN! But its been a long time since average default rates have moved up much, so investors have/can get complacent.
Most investors have a minimum credit guideline. When a bond rating falls below the minimum, it generally results in a forced sale, often after values have declined.
Even without a downgrade, company specific business conditions can rapidly change asset valuations. For bond investors, it’s usually to the downside…after all, a bond matures at par!
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GE Bond Price (GE 2.7% 10/09/2022)
General Electric’s Story:
Deteriorating business conditions, most recently in the Power Generation segment.
Leverage ratios (e.g., Net debt/EBITDA, etc.) moving up.
SEC is widening its probe of certain accounting treatments used by GE in its power business.
GE using asset sales to reduce debt, this results in declining revenue and cash flow remains challenged…stay tuned!
Corporate NotesGeneral Electric: A Recent Example of Corporate Credit Risk
Pric
e in
Dol
lars
S&P Downgrades to BBB
General Electric 2.7% 10/9/22
Duration: 3.6 years
2018 Price Change: (7%)2018 Peak Decline: (12%)
GE Credit Rating (Standard & Poor’s)
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JUNK
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Corporate NotesMitigating Risk: Guidelines Should Be Developed Before Investing
Most Guidelines Specify: Maximum MaturityMinimum Credit RatingMaximum Issue Size
Important to Consider: Maximum Issuer ConcentrationMaximum Industry AllocationMinimum Outstanding Issue SizeSector Duration Targets
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Corporate NotesMaximum Issuer Concentration: The All-The-Eggs in One Basket Deal
New Jersey Bell 8.0% 06/01/2022
GTE Inc. 8.75% 11/01/2021
Alltel Corp 6.8% 05/01/2029
Verizon Communications 8.75% 11/01/2021
BNSF Railway Co 6.55% 01/01/2020
The Lubrizol Corp. 7.25% 6/15/2025
MidAmerican Energy Co 3.1% 05/01/2027
Northern Natural Gas Co 4.25% 6/01/2021
Northern Pacific Railway Co 3.0% 01/01/2047
PacifiCorp 6.75% 10/26/2023
Precision Castparts Corp 2.5% 01/15/2023
Sierra Pacific Power Co 3.375% 8/15/2023
GEICO Corp 7.35% 7/15/2023
Finial Holdings Inc. 7.125% 10/15/2023
MidAmerican Energy Co 3.1% 05/01/2027
Northern Natural Gas Co 4.25% 6/01/2021
Limiting Exposure to an Issuer is SMART! ADiversified Portfolio Can Protect You In An Economic Downturn Or If A Specific Company Gets Into Trouble
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New Jersey Bell 8.0% 06/01/2022
Alltel Corp 6.8% 05/01/2029
PacifiCorp 6.75% 10/26/2023
Precision Castparts Corp 2.5% 01/15/2023
Sierra Pacific Power Co 3.375% 8/15/2023
Finial Holdings Inc. 7.125% 10/15/2023
Northern Natural Gas Co 4.25% 6/01/2021
Northern Pacific Railway Co 3.0% 01/01/2047
Verizon Communications 8.75% 11/01/2021
Corporate NotesMaximum Issuer Concentration: The All-The-Eggs in One Basket Deal
GTE Inc. 8.75% 11/01/2021
BNSF Railway Co 6.55% 01/01/2020
The Lubrizol Corp. 7.25% 6/15/2025
MidAmerican Energy Co 3.1% 05/01/2027
Northern Natural Gas Co 4.25% 6/01/2021
GEICO Corp 7.35% 7/15/2023
MidAmerican Energy Co 3.1% 05/01/2027
But Always Look Under the Hood,There Are Only Two Different Issuers On This Page!
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Corporate NotesMaximum Industry Allocation: Goal is Capital Preservation, Liquidity, Income…
BofA Merrill Lynch 1-3 Year A-AAA Corporate Bond Index:
Percent bySector Market Value
Financials 57%
Industrials 40%
Utility 3%
Percent ofSector Issuers
Financials 38%
Industrials 52%
Utility 10%
Important to Consider If Index Composition Is At Odds With Your Primary Objectives
Index Using Market Weight Index Using Equal Weight
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Corporate NotesMaximum Industry Allocation: Goal is Capital Preservation, Liquidity, Income…
Industrials: 40%
Automotive 5.6%Basic Industry 1.3%Capital Goods 4.3%Consumer Goods 3.8%Energy 6.9%Healthcare 4.0%Leisure 0.1%Media 2.0%Real Estate 1.0%Retail 2.2%Services 0.3%Technology & Elect 7.4%Telecommunications 0.5%Transportation 0.6%
Financials: 57%
Banking 51.3%Financial Services 2.0%Insurance 3.8%
Utilities: 3%
Electric - Dist. / Trans 0.4%Electric – Generation 0.2%Electric- Integrated 2.2%
Much greater diversification within Industrials vs. Financials
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Corporate NotesMinimum Outstanding Issue Size: When to Say When…$500 Million?
BofA Merrill Lynch 1-3 Year A-AAA Corporate Bond Index:
20%<$500mm
80%>$500mm
Issues by Size Market Value by SizeCharacteristics of
Less Than $500 MM
7%7%
Utility 26%Financial
51%Industrial
93%>$500mm
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Corporate NotesMinimum Outstanding Issue Size: When to Say When…$1 Billion?
BofA Merrill Lynch 1-3 Year A-AAA Corporate Bond Index:
57%<$1 Billion
43%>$1 Billion
Issues by Size Market Value by SizeCharacteristics of
Index Over $1 Billion
0%Utility
65%Financial
35%Industrial
57%>$1 Billion
43%<$1 Billion
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Corporate NotesSector Duration Target: Don’t Fall Too Much In Love With Spread
Time
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US TreasuryYield Curve
CorporateSpread Curve
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Corporate NotesSector Duration Target: Don’t Fall Too Much In Love With Spread
Overall Duration
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Overall DurationY
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US TreasuryYield Curve
CorporateSpread Curve
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Corporate NotesSector Duration Target: PS: Holding Only Short Bonds Won’t Help In a Default
Which of These Investors Owned Lehman1-Year Paper vs Long Bonds?
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Corporate NotesBeyond Credit Analysis: Other Issues to Be Aware Of Before Pulling the Trigger
Senior vs. Subordinated Debt(Typically Associated with Financials)
Subsidiaries(e.g., Industrials with Finance Co., Utilities, etc.)
Make Whole Calls(What?)
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Corporate NotesBeyond Credit Analysis: Senior vs. Subordinated Bonds ( Just Be Aware)
Wells Fargo Corporate Bond Wells Fargo Corporate Bond
Two Wells Fargo Bonds With Different Credit Ratings…The Wells Fargo Bond on the Right Isn’t “Cheap” After All
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1) Pull up Bond2) Type DDIS <go>3) Set “Breakdown
By” to “Payment Rank, and hit <go>
Corporate NotesBeyond Credit Analysis: Senior vs. Subordinated Bonds ( Just Be Aware)
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Corporate NotesBeyond Credit Analysis: Subsidiaries ( Just Be Aware)
General Electric Corporate Bond General Electric Corporate Bond
Not Seen As Much Today (Post the Financial Crisis)But Still Common in the Utility and Telecom Sectors…Be Sure You Understand Exactly What You’re Buying
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Corporate NotesBeyond Credit Analysis: The Make Whole Call (MWC)…Just Be Aware
Could This Possibly Be a Big Deal? Yep
Originally intended as a sweetener for bondholders.
About 1/3rd of corporate bonds have an MWC feature.
Low MWC spreads resulted in few issuers exercising their call option…investors really never thought of these as callable bonds.
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A-AAA Corporate Spreads (0-1 Year)
Bas
is P
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sNobody Thought These Would Ever Be Called
Corporate NotesBeyond Credit Analysis: The Make Whole Call (MWC)…Just Be Aware
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* Data as of December 31, 2018** Annualized duration adjusted excess return vs. Treasuries since December 1996 (earliest available excess return data on ABS)
Source: BofA Merrill Lynch & Bloomberg
Sector Index DurationAnnual
Excess Return
BofA ML Auto ABS (AAA) 1.2 Years 0.79%
BofA ML Credit Card ABS (AAA) 1.8 Years 0.83%*
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Asset-Backed Securities and Corporate Notes Taking Stock: Actually How Much Do You Get Paid?
BofA ML 1-3 Year Corporate (AAA-A) 1.8 Years 0.73%
BofA ML 1-5 Year Corporate (AAA-A) 2.6 Years 0.69%
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* Data as of December 31, 2018** Annualized duration adjusted excess return vs. Treasuries since December 1996 (earliest available excess return data on ABS)
Source: BofA Merrill Lynch & Bloomberg
Sector IndexAnnual
Excess Return
BofA ML Auto ABS (AAA) 0.79%
BofA ML Credit Card ABS (AAA) 0.83%**
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Asset-Backed Securities and Corporate Notes Taking Stock: Actually How Much Do You Get Paid?
BofA ML 1-3 Year Corporate (AAA-A) 0.73% ** 73% A Rated
100% AAA Rated
100% AAA Rated
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Asset-BackedsAsset-Backed Investors Get Paid Primarily For Managing Cash Flows
Highest Quality Aaa AAA 91%(Smallest Degree of Credit Risk)
High Quality Aa AA 3%(Small Degree of Credit Risk)
Upper Medium Grade A A 3%(Largest Rating Category)
Medium Grade Baa BBB 3%(Neither Well Protected or Speculative)
Moody’s S&P Weight91% Rated
‘AAA’
* Credit weights within the Bloomberg Barclays ABS Index
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Asset-BackedsAsset-Backed Investors Get Paid Primarily For Managing Cash Flows
1 Year Maturity
$ Ca
sh F
low
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1 YearAverage Life
$ Ca
sh F
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Asset-Backed Security (Auto ABS Example)
Like Treasuries, corporate bonds typically have a
fixed maturity date
Most ABS pay principal & interest over time
and it varies depending on the underlying loans
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• ABS are backed by thousandsof borrowers.
• Credit worthiness is most often independent of the issuer.
• Significant credit support at issuance that builds over time.
• Strong credit profile not reliant on asset valuations.
Generally Speaking:
Asset-BackedsWhat’s Different About an Asset-Backed Security?
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BBB Rated
A Rated
AA Rated
AAARated
Large Value of Auto Loans
Supports Smaller Value of
ABSBonds
Asset-BackedsHow Do Asset-backed Securities Work?
ABS Trust
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Asset-BackedsOverview of ABS Market by Receivables Type: $700 billion Outstanding
Auto Loans31%
Auto Lease11%Credit Card
27%
Other 16%
Equipment 3%
Franchise 5%
Floorplan 8%
Source: SIFMA, Wells Fargo, excludes student loan ABS & CDO/CLO
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Pool of Auto Loans
Placed in ABS Trust
TrustIssues Less
Amount of BondsBacked by Loans
LesserAmount of
AAA Rated Bondsto Total Bonds IssuedAmount of Bonds
Backed by Loans
Overcollateralization
Subordination
Asset-Backeds: How the Typical Auto Structure WorksTwo Types of Credit Support: Overcollateralization & Subordination
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D BBB 29,390,000 3rd Loss Protection 2.0%
Class Rating Size PercentA1
A2-AA2-BA3A4
AAAAAAAAAAAAAAA
297,000,000453,000,00070,000,000
468,000,000104,970,000 93.0%
B AA 42,210,000 5th Loss Protection 2.8%
C A 35,430,000 4th Loss Protection 2.4%
Reserve Account 2nd Loss Protection 0.3%
Excess Spread at Origination 1st Loss Protection 3.6%
11.1%Total Initial Credit Support to Senior Bondholders
Asset-Backeds: How the Typical Auto Structure WorksSubordination Protects The Senior Note Holders 5 Ways
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D BBB 29,390,000 3rd Loss Protection 2.0%
Class Rating Size Percent
A1A2-AA2-BA3A4
AAAAAAAAAAAAAAA
297,000,000453,000,00070,000,000
468,000,000104,970,000 93.0%
B AA 42,210,000 5th Loss Protection 2.8%
C A 35,430,000 4th Loss Protection 2.4%
Reserve Account 2nd Loss Protection 0.3%
Excess Spread at Origination 1st Loss Protection 3.6%
11.1%Total Initial Credit Support to Senior Bonds
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Prime Auto Loan Net Losses (12-Mo Average)
Source: Wells Fargo
Perc
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Asset-Backeds: How the Typical Auto Structure WorksHistorically, Even The Lowest Rated Bonds Have Been Well Protected
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A1 AAA
A2-A FixedA2-B FloatingAAA
A3AAA
A4AAA
B Tranche, AA Rated
C Tranche, A Rated
D Tranche, BBB Rated
Reserve Account and Excess Spread at Origination
AAACredit Support 11.1% 15.9% 24.7% 65.2%
Initial Credit Support to
Senior Bondholders
At Origination
11.1%
Time
Asset-Backeds: How the Typical Auto Structure WorksNatural Deleveraging: The Credit Enhancement Grows As Bonds Pay Down
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Asset-Backeds: How the Typical Auto Structure WorksUnderlying Credit Performance Can Be Monitored Month-to-Month
Type CLC <Go>:• New/Used
• Model Type
• Model Year
• Vehicle Type
• Loan Vintage
• Geographics
NOTE: Bloomberg is not perfect, sometimes you have to go to the servicer reports.
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Asset-Backeds: How the Typical Auto Structure WorksUnderlying Credit Performance Can Be Monitored Month-to-Month
Type CLP <Go>:• # of Loans
• Delinquency Rates
• Cumulative Losses
NOTE: Bloomberg is not perfect, sometimes you have to go to the servicer reports.
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Asset-BackedsThe Unique Advantages of Asset-Backed Securities
Compliments Other Sectors in The Portfolio
Reduce or Eliminate Event Risk Inherent in Single Credit Issues
Credit Stability Through Even the Worst of Market Conditions
Attractive Yields vs. Other Types of Lower Rated Bonds
Achieve Credit and Economic Diversity Within A Single Security
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“Atlanta Capital” AAA-Rated ABS Curve
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US Treasury Curve
º
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Asset-Backed Securities and Corporate Notes Valuations Today: Comparing Large & Liquid Issuers in Both Sectors
Note: Data from 3/13/19
Yield Curves Specific Corporate Bond Spreads
2.3%
2.5%
2.7%
2.9%
3.1%
0.25 Years 0.75 Years 1.25 Years 1.75 Years 2.25 Years 2.75 Years
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Asset-Backed Securities and Corporate Notes Taking Stock: A Purely Hypothetical, Back of the Envelope, What If?
$100 Million Portfolio
ABS Allocation Credit Allocation20% @ 50 bps 20% @ 50 bps
Contribution to Excess Return20 bps / year
$200,000 / year$1 Billion Portfolio $2,000,000 / year
These Sectors Have Historically ProducedMeaningful Excess Returns…Worth A Look!
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*See Disclosures!
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Thank You!This information is not intended as investment advice or a recommendation to purchase or sell specific securities. These opinions may change atanytime without prior notice, there is no guarantee that any forecasts or opinions expressed in this material will be realized. While every effort hasbeen made to verify the information contained herein, we make no representation as to its accuracy. Company names are used for illustrativepurposes only and should not be construed as a recommendation to buy or sell any financial securities. Index and commodity changes are based onprice-only percentage change. It is not possible to directly invest in an index. Past performance does not predict future results.
This Presentation may contain statements that are not historical facts, referred to as forward-looking statements. Future results may differsignificantly from those stated in forward-looking statements, depending on factors such as changes in securities or financial markets or generaleconomic conditions.
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