While the credit markets weigh recession risks and watch the slow reining in of inflation, bearish securitized debt market investors say they are looking at pockets of strength: non-qualified, non-agency residential mortgage-backed securities and an aggressive aviation market rebound.
Ed Reardon, head of U.S. securitized products research at Deutsche Bank, says he still expects a recession to get underway by the fourth quarter, with three quarters of negative growth and unemployment to reach 5.1% as a softening economy sheds jobs.
Reardon anticipates private credit investors to continue buying securitized assets, while credit-sensitive banks keep unloading asset-backed securities and other assets from their balance sheets. Deutsche Bank's forecast for 2023 issuance is roughly 36% lower than the 2022 total.
Drops in issuance
By the end of 2023 issuance may vary from -10% in ABS and -22% in collateralized loan obligations (CLO), to steeper declines of -65% in non-agency residential mortgage backed securities (RMBS), and -69% in non-agency commercial mortgage backed securities (CMBS), according to the 2023 Mid-Year Securitized Outlook of Deutsche Bank Securitization Research.
Despite tightening credit conditions for non-agency, CMBS and RMBS issuers to date, however, the report suggests agency MBS spreads will challenge securitized credit in a recession, by weakening both borrower and lender credit increasing default risk. At the same time, higher credit risk could lead to a more liquid market featuring yields of nearly 55 basis points (BPS).
After a challenging 2022, fund flows reverted to positive territory in 2023 even though higher interest rates and wider spreads have considerably reduced the supply of securitized product, according to Reardon. Securitization spreads are tighter, yet "the inverted rates curve provides some nice all-in yield opportunities in shorter securitized sectors, [so] flows should find their way to those opportunities," he noted.
The non-QM RMBS 'bright spot'
In 2023, non-QM RMBS (securitizations backed by mortgages that do not qualify under the Consumer Financial Protection Bureau's ability to repay requirements) is the bright spot in non-agency RMBS issuance, according to Reardon.
Non-QM RMBS volume, on a year-to-date (YTD) basis, represented 48% of the total non-agency RMBS issuance in H1 2023 – compared to 15% in prime RMBS and 3% in SFR.
The total H1 non-agency RMBS issuance was $25 billion, down -73% from H1 2022, driven by high mortgage interest rates, low home sales, and inventory pressures. Deutsche estimates the full 2023 new non-agency RMBS issuance will total $50 billion, improving to -65%, from $137 billion at yearend 2022.
Higher non-QM coupons should significantly surpass agency paper yields in 2024, said Victor Kuznetsov, managing director and co-founder of Imperial Fund, a Hollywood, Fla. based, non-agency, mortgage investment firm.
Another key to non-QM RMBS performance are borrowers, he said, typically small business owners, independent contractors, or real estate investors with disposable income and the flexibility to navigate macroeconomic changes.
Aviation debt opportunities
Aviation debt securitization is another market positive. By April 2023 originations in that sector was less than 10% below pre-Covid levels, a 277 bps improvement from April 2022, and 559 bps higher compared to April 2021, according to data from the International Air Transport Association (IATA) data. IATA expects nearly $10 billion in profits at yearend 2023, up from a net loss of $138 billion in 2020.
Global air travel is recovering at an aggressive pace boosting demand for new aircraft. Combined with restrained production of new aircraft, higher demand will help increase lease rates for lessors and aircraft ABS, explained Douglas Runte, CFA, a managing director at Deutsche Bank.
"Global airlines' capacities have mostly or nearly fully recovered to pre-pandemic levels," said Hylton Heard, senior vice president of U.S. structured credit at DBRS Morningstar. Due to production issues, airlines cannot access new aircraft fast enough to meet the strong consumer demand to travel in 2023.
Heard anticipates the strong rebound in global travel volumes, combined with several other factors—a decline of aircraft in-storage numbers and rising airline operation costs—will continue to sustain the performance of secured aviation debt transactions in 2023 and drive up pricing.
Collectively, aviation transactions debt includes aircraft asset-backed securities, secured loan deals, airline and lessor enhanced equipment trust certificates (EETC).
By June, according to Deutsche, the year-to-date issuance (YTD) for aircraft lessors of nearly $8 billion was mostly unsecured debt. For 2023, Deutsche expects issuance will accelerate in the second half of the year. It forecasts $20 billion to $22 billion in issuance by the largest aircraft lessors of which only $1 billion to $3 billion will be aircraft ABS.
This year U.S. airlines will generate significant operating cash flow and focus on reducing corporate and ABS debt, Runte noted. As of June issuance was $1.8 billion, and $1.3 billion of additional debt in the process of pricing, bringing the YTD issuance to $3.1 billion.
He also expects, some airlines to use the EETC market to secure long-term fixed rate financing for new aircraft deliveries, even as they look to pay off older debt. Hence, Deutsche increased its 2023 airline issuance forecast to $4 billion - $6 billion, from $2 billion - $4 billion.
According to Heard, supported by robust demand for passenger and freighter assets across airlines, lessors, and global freight companies, positive rising asset values and lease rate trends will continue well into 2024.
