Various measures have been brought in to help consumers meet their debt obligations, including payment holidays for mortgages, credit cards and other consumer-debt products (although the obligation remains with the individual to service the debt). It will be up to lenders to decide whether to extend the payment holidays, although existing arrangements to protect borrowers remain in place.
While governments and central banks have announced supportive measures, we still believe that arrears will rise. Where these mortgages and loans have been securitised, there will be disruptions to the usual cash flows coming into the special-purpose vehicles holding them. This will affect the loans backing collateralised-loan obligations (CLOs), as well as the degree to which individuals are able to repay the debts that underly residential mortgage-backed securities and asset-backed securities.
Structures are designed to withstand borrowers not paying interest and principal for a period of time. The length of time, as well as how much can be covered by reserves in the structure, varies. There are also support mechanisms for companies, although we expect some deterioration in the credit quality of the collateral backing CLOs as revenues have been severely hit. Defaults should increase and agencies are likely to take large-scale action on loans, which will impact the CLOs that hold them.
In this environment, there is more of a need than ever to stress test our underlying portfolios. The scale, severity and duration of the crisis is unknown, and we are working to assess whether structures can withstand the deterioration in performance, lack of cash flow and increase in defaults.
Nonetheless, liquidity has returned to the structured-credit market since the sell-off began. This quarter, structured-credit instruments have risen up our relative-value ranking of fixed-income assets – despite the fact that liquidity in this area was far from perfect during the sell-off. Our analysis suggests that the asset class will benefit from some of the government initiatives and that protection remains more robust than price moves suggest.
Weathering the storm: seeking upside amid the turmoil
The coronavirus crisis has emphasised how critical active credit selection is to portfolio construction. It is vital to assess the idiosyncrasies of each trade by modelling and stress-testing the fundamentals of various economic scenarios, as well as considering the impact of technical and regulatory changes.
At the international business of Federated Hermes, we take pride in the fact that our credit analysts tackle security selection in a high-conviction, bottom-up manner. While we face considerable uncertainty in the near term, we will continue to take an active, flexible approach to seeking opportunities throughout the fixed-income universe – something we believe should stand us in good stead in this turbulent and fast-changing environment.
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The value of investments and income from them may go down as well as up, and you may not get back the original amount invested.
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