Wellington Management's investment expertise extends across the financial markets. For a wide variety of mostly institutional clients, it manages more than $1 trillion in assets, including $124 billion in securitizations. Wellington was among the first investors in mortgage-backed securities (MBS) when the market emerged in the 1970s, and it began investing in asset-backed securities (ABS) in the early 1990s, commercial mortgage-backed securities (CMBS) in 1997, and collateralized loan obligations (CLOs) in 2004. Along the way it has collected a wealth of experience.
The asset manager's first dedicated securitization mandate was in 2006, and today those mandates from more than 70 clients comprise $55 billion in assets. Twenty-seven Wellington professionals are dedicated to the firm's securitization investments, including portfolio managers, traders, and researchers.
Wellington manages $34 billion in leveraged credit for clients and has invested approximately $12 billion across the CLO capital structure, from AAAs through unrated portions. That experience was a factor prompting it to launch its first CLO last September, a $364 million transaction led by Morgan Stanley.
Alyssa Irving, a fixed-income portfolio manager at Wellington, initiated her career in finance as a CMBS analyst at Nomura in 1996. She gained experience at Fitch Ratings and Citigroup, and has held positions at Wellington since 2006 that have given her insight into the securitization market's performance through different parts of the credit cycle and major market-stress events. She recently spoke with Asset Securitization Report (ASR) about what she believes are key issues and opportunities across the securitization market in 2024.
ASR: A hot button issue has been private credit, which some banks anticipate representing upwards 30% of the CLO market this year. How do you view the asset class?
Irving: It's gotten a lot of negative press that I think is unfair. Historically, we've had middle market loans and broadly syndicated loans (BSL), and private credit has straddled the two. It has provided a tailwind to the BSL market in the last few years, when lower cohort borrowers weren't able to refinance. The pendulum may be starting to swing the other way, with three borrowers—Wood McKenzie, WellSky and Crash Champions—returning to the BSL market this year.
ASR: Will that continue?
Irving: In a soft-landing scenario where the Federal Reserve is lowering rates, that's an environment where BSL becomes more competitive again.
ASR: Where do you see investment opportunities elsewhere in securitizations?
Irving: For investment-grade type mandates--those constrained to AAA-only--the biggest opportunity is in short- to intermediate-term ABS, spanning consumer and commercial sectors, including esoteric. So prime and sub-prime auto and credit cards on the consumer side, and for the commercial and more esoteric securitizations, datacenter, whole-business and aircraft are particularly attractive. There was a plethora of issuance in 2023 and we expect that to continue.
With an unconstrained investment framework and more of a total return focus, commercial mortgage-backed securities (CMBS) probably offer the more attractive opportunity in 2024. There are clearly fundamental pressures from secular changes related to remote work after Covid and the availability of financing, but there's huge opportunity for those who can pick winners.
ASR: What do the CMBS winners look like?
Irving: Areas with fundamental tailwinds include industrial properties, warehouse and self-storage, and destination hotels. Delving into where distressed opportunities are, it's really single-asset office deals and conduits that have heavy office exposure. At the highest level, the winners will be class A properties in cities that have rebounded in terms of office traffic, and most importantly they are buildings that are energy efficient, LEED-certified, and have amenities that will remain attractive to lessees when their leases roll over.
Distressed opportunities are in more suburban locations and lower quality properties—older buildings requiring a significant amount of capital expenditures or some sort of turnaround story. No two properties are the same, and it's going to be a function of tenant mix, the length of the lease relative to the maturity of the bonds, your assumptions on the ability to refinance the loan at balloon maturity, and what you see the economic environment being at that time.
ASR: What's your outlook for CLOs?
Irving: CLOs are one of the more investable asset classes in terms of volume and an active secondary market. It's another sector with very attractive opportunities up and down the capital structure, including equity. For yield-focused investors there's a very attractive income component, with SOFR starting at such an elevated level.
ASR: Where do you see CLO volume headed in 2024, after a drop in 2023?
Irving: BSL CLO issuance was about $116 billion last year and we expect it to increase by $5 billion or $10 billion in 2024. We've started to see refinance and reset activity pick up, and that probably will continue.
ASR: And residential mortgage-backed securities (RMBS)?
Irving: We expect delinquencies may rise as unemployment increases, but conservative underwriting, significant homeowner equity, robust [deal] structures, and better-equipped GSEs (government-sponsored enterprises, including Fannie Mae and Freddie Mac) are constructive for credit.
Non-agency RMBS valuations are mixed as some subsectors have tightened more than others, but we expect lower supply should support spreads. Higher prepay speeds would also be a positive. The bonds are attractive from an income perspective, and so especially appropriate for insurers.
ASR: Has asset-liability arbitrage improved from last year, when the lack of arbitrage was often viewed as hindering CLO issuance?
Irving: My view may be non-consensus, but arbitrage is often quoted as a fixed number based on where a CLO is priced and the weighted average spread of its loan pool. However, the structure offers a lot of optionality, since it's really only a two-year, non-call period, and you have the ability to reset liabilities tighter at a later date, if spreads are there. So I view it much more as a scenario-based investment. Your internal rate of return is dependent on what bank loans spreads do over that time period, the manager's investing [expertise], prepays in the loan market, and the path of defaults. Arbitrage is really a moving target.
