Two massive securitizations representing industries coming back from the dead were sold this week, potentially kicking off an era of structured-credit mega deals.
The bonds, backed by cash from the rental-car business and extended-stay hotels and the largest this year, were handily absorbed by an eager investor base this week clamoring for even a modicum of extra yield in a tight credit market. More of these giant deals may be on the way as the pandemic fades in the U.S., market observers say, especially in commercial real estate.
“These reopening trades are made up of formerly strong businesses that were just blindsided by Covid, and now they may have some good years ahead of them,” Daniel Lucey, a senior portfolio manager at Sun Life Capital Management who invests in securitized credit, said in an interview. “You can find solid assets that still offer somewhat wider spreads than other areas of fixed income such as corporate bonds.”
This week a Blackstone Group Inc. and Starwood Capital Group joint venture financed its acquisition of Extended Stay America Inc. through a $4.65 billion sale of commercial mortgage-backed securities. Also, Hertz sold $4 billion in rental-car backed bonds, its first since beginning the process of emerging from bankruptcy, which will be complete by the end of the month.
Demand was especially heavy for Hertz, with dealers seeing investor orders totaling around $20 billion, according to a person with knowledge of the matter, who asked not to be identified because the details are private. That allowed dealers to increase the offering from its original size of $2.2 billion. One tranche of the transaction rated single A was more than 34 times oversubscribed, Lucey said.
Signage for Hertz Global Holdings Inc. stands at a rental location in Berkeley, California, U.S., on Tuesday, May 5, 2020. Photographer: David Paul Morris/Bloomberg
Photographer: David Paul Morris/Bloomberg
In CMBS, spreads on Extended Stay, one of the largest so-called single-asset, single-borrower (SASB) CMBS in the past decade, tightened at pricing, but still offered a bit of extra value compared to ABS with similar duration or even multi-borrower CMBS, investors said.
“More mega SASB deals are likely on the horizon,” JPMorgan Chase & Co. analysts led by John Sim said in a research report last week, noting increased real-estate M&A activity, including the recently announced Blackstone acquisition of QTS Realty, a data-center operator valued at roughly $6.7 billion. These M&A deals often pursue financing through the CMBS market.
Good Picks
Bonds on battered and uncertain properties from shopping malls to hotels and skyscrapers are giving investors with faith in the recovery trade better returns than U.S. corporate bonds.
For example, Deutsche Bank AG reports commercial mortgage-backed securities are returning more than 60 basis points above investment-grade corporate bonds, though the gains are barely positive.
Even after converting corporates to a swaps benchmark to make them more comparable to CMBS, BBB corporates are at about 116 basis points while CMBS conduit spreads for BBB paper averages about 281 basis points, according to the ICE data services.
For Hertz, a 5.28 year BBB slice of the deal landed at 155 basis points over a swaps benchmark, while the option-adjusted spread on corporate BBBs is at about 101 basis points, according to the Bloomberg Barclays Baa Corporate Statistics Index.
The Hertz bonds also stand up to subprime auto ABS, “which is pricing tighter than ever,” Lucey said. A BBB rated slice of the Hertz deal priced at 145 basis points over the swaps benchmark, while a BBB slice of a recent General Motors Financial subprime auto ABS with a similar maturity priced at 70 basis points -- meaning investors would earn more relative yield on Hertz.
And for the Extended Stay CMBS, investors cautioned that its positive performance can’t be generalized for the whole hospitality industry, which is still hobbled by the pandemic.
“The higher-margin business model for Extended Stay America is quite different from the traditional short-stay hotel model and so it has outperformed sectorally and competitively throughout the pandemic,” said Chris Sullivan, chief investment officer of the United Nations Federal Credit Union.
Relative Value: CMBS
- Deutsche Bank AG analysts advise clients to buy so-called back-pay last-cash-flow (LCF) CMBS tranches inside of 5-year maturities; these are cleaner deals and have better rolldown, according to a Wednesday report
- New issue front-pay LCF spreads consistently price -2bp to back-pay LCF bonds, the analysts said
- Seasoned deals have seen front-pay LCF trade wider than back-pay LCF tranches, and seasoned bonds trade at a premium
- Front-pay LCF CMBS bonds have exposure to recoveries from term defaults and greater exposure to high constant prepayment yield
- A Covid delinquency spike has increased term default risk for seasoned deals
Quotable
“We’re past the recovery phase in the rental-car industry,” Scott Hofer, a senior ABS analyst at Loomis, Sayles & Company, said in an interview. “Used car prices are at an all-time high and some rental-car sponsors believe their fleets will reach pre-pandemic levels in just a few months. Moreover, the relatively wider spreads on this (Hertz ABS) transaction compared to other rental-car ABS issuers will likely attract demand at these levels.”
What’s Next
ABS deals in the queue include Sabey Data Centers (data center ABS), FirstKey (single-family rental ABS), and DigitalBridge (secured fund fee ABS).
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