Some Investors Wary of Tightening Spreads in ABS Market

When bond spreads have been tight across the spectrum, investors have typically been able to find a safe haven in structured finance bonds such as consumer ABS to eke out more yield or earn carry. However, Bloomberg reports that may no longer be the case, as ABS spreads in the U.S. approached historically tight post-crisis levels in 2017, and are expected to continue narrowing through 2018. This may leave some investors to question if holding/buying these bonds still makes sense, in light of the credit risk in some asset classes.

John Carey, head of structured securities investments at BNP Paribas Asset Management, who invests in spread sectors to earn extra carry, said "we're not necessarily forecasting a recession or a slowdown, but are concerned that we're not being adequately compensated for risk-taking in certain areas." He later added that "it's a time to be nimble and tactical."

The tightening has been widespread across asset classes and issuers. For example, the AAA-rated slice of a subprime auto bond from a large issuer priced at 18 basis points over LIBOR last month, down from 38 basis points for a similar bond a year earlier.

Similarly, a student loan ABS from a large issuer tightened to 27 basis points over a benchmark for the AAA tranche of an October deal, down from 55 basis points over for a similar slice of their year-ago trade.

"Spreads will get tighter for a while," said Ken Purnell, head of ABS portfolio management at Invesco. "The macro view is very positive and is supportive of spreads remaining low."

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