Issues & Answers: Capital Strategy

Elizabeth Henderson, principal and director of corporate credit at AAM, said the company has increased its exposure to corporate bonds, preferring ‘A/AA’ quality issuers that are issuing today at levels historically associated with ‘BBB’ type credit risk. “We expect some turbulence in the underlying assets in the months to come, but see a number of opportunities in the deals with the strongest underwriting,” she said. The following is an excerpt of an interview.

Elizabeth Henderson

Elizabeth Henderson
Principal and Director of Corporate Credit
AAM

“We recommend adding to higher quality below-investment-grade strategies (i.e., avoiding CCCs), and we are encouraging our clients to take advantage of attractive government related programs.”

What investment strategies do you recommend to take advantage of the broad sell-off in the capital markets?

As long-term investors, we strive to find investments that will provide a superior level of income and stability over the term of the investment. The significant selling across all markets associated with the COVID-19-related economic downturn was unprecedented. This distressed environment put a number of high quality investments at risk, but also created a number of opportunities. For example, corporations issued record amounts of debt in April to enhance liquidity at significant discounts, and the Federal Reserve announced programs to help jump-start the ABS and CMBS markets. The announcement that the Fed will buy credit instruments, including some high yield, put a backstop to the downside of these markets. Although the economic picture is cloudy with little certainty as to the strength of the recovery in the third quarter, these events have created great opportunities for long-term investors.

Should an insurance company consider drawing from the Federal Home Loan Bank to provide leverage for yield enhancement or arbitrage opportunities?

We have recommended that all of our insurance clients who have the ability to participate in FHLB programs take advantage of this opportunity. The strong market sell-off in March demonstrated why this membership is so important. In the event that liquidity was required for operational needs, the ability to draw from the FHLB at favorable rates allowed companies to avoid the panic and price deterioration across the bond markets. In addition, those clients that had adequate liquidity were able to draw from the FHLB and invest in high quality corporate, asset-backed and other structured product bonds on a matched-maturity program to generate significant yield enhancement or arbitrage opportunities. In particular, short-to-intermediate bonds offered similar yield spreads to longer maturity issues as the spread curves flattened. We were very opportunistic in approaching clients and executing these strategies both before and immediately after the Federal Reserve announced programs to stabilize these markets. Our ability to communicate and execute these strategies within a short period of time was recognized and appreciated by clients who took advantage of this opportunity.

How do you think the ratings agencies will react to the pandemic in structured products and corporate credit?

We think they’re going to be fairly aggressive in taking action against a broad variety of structured products, so they are not playing catch-up as they did in 2008-09. This has already occurred in the corporate bond sector. The agencies were very aggressive on the onset with sectors directly impacted by the virus. Subsequent to that, the agencies have revised their GDP forecasts lower, and they are now more conservative than the consensus. Hence, we expect more actions through the summer in other economically sensitive sectors, as optimistic assumptions fall short. We expect up to $500 billion of fallen angels in corporate credit by the time this is over.