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Angel Oak Capital Advisors
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As inflation appears to be under control, with the economy slowing toward a soft landing and lower rates on the horizon, we believe 2024 is setting up to be a historic opportunity to increase fixed-income allocations. With rate declines expected over the course of the next year, high-quality fixed-income portfolios of intermediate duration have the potential to generate total returns that are greater than current yields and to help mitigate reinvestment risk. Given current valuations, we believe there is an opportunity to add mortgage-backed securities (MBS) at some of the most compelling spreads and yields seen in decades.
Figure 1: Current Coupon Agency Spread Wider Than IG Corp. SpreadSource: Bloomberg as of 7/31/24.
Figure 1 shows spreads in agency RMBS are trading wider than investment-grade (IG) corporate credit for the first time in more than 20 years. Corporate credit spreads (both IG and HY) are trading at cyclical tights and provide less of a relative value versus agency and non-agency (NA) RMBS securities that are trading wider to historical averages (Figure 2). MBS may offer compelling relative value due to strong fundamentals, conservative underwriting, and a resilient housing market.
Remember, agency mortgages are guaranteed, whether explicitly or implicitly, by the U.S. government, but corporate credit is not. Although agency MBS are historically attractive, when it comes to a normalization of the MBS basis, investors may find the best relative value opportunity within NA RMBS. Spreads in new-issue areas of the non-agency market are trading at or near historic wides to similarly rated corporate bonds (Figure 3). As mortgage spread means revert, we see more upside potential from a price perspective. Total return opportunities in mortgages are rare, given their callable nature and premium dollar prices during normal times. In today’s market, however, value potential is historic due to these assets trading at steep discounts.
Figure 2: Historical SpreadsSource: Bloomberg, Wells Fargo, Bank of America as of 7/31/24.
The Federal Reserve’s historic 2022 hiking cycle combined with the subsequent sustained period of interest rate volatility and bank failures resulted in two of the largest holders of MBS – the Fed and banks – moving out of the market. This weakening technical demand has resulted in significantly widened MBS spreads versus U.S. Treasuries and corporates, presenting an attractive opportunity for investors to increase MBS weightings in core asset allocations. We believe now is the time for investors to lock in higher yields with historic total return opportunities.
Figure 3: Non-Agency vs. Corporate SpreadsSource: Bloomberg as of 7/31/24.
DEFINITIONS AND DISCLOSURES
Agency Mortgage-Backed Securities (AMBS): Securities issued or guaranteed by the U.S. government or a GSE.
Basis Point (bps): One hundredth of one percent and is used to denote the percentage change in a financial instrument.
Bloomberg U.S. Corporate High Yield Bond Index: An unmanaged market value-weighted index that covers the universe of fixed-rate, non-investment-grade debt.
Bloomberg U.S. Corporate Investment Grade Index: An index that measures the investment grade, fixedrate, taxable corporate bond market. It includes USD-denominated securities publicly issued by U.S. and non-U.S. industrial, utility and financial issuers.
Current Coupon: Refers to a security that is trading closest to its par value without going over par. In other words, the bond’s market price is at or near to its issued face value.
Duration: Measures a portfolio’s sensitivity to changes in interest rates. Generally, the longer the duration, the greater the price change relative to interest rate movements.
Morgan Stanley 30Y Conventional Current Coupon ($100) ZV Index: The index represents the ZV (zero volatility) spread for the hypothetical $100-priced 30-year conventional mortgage over time.
Mortgage-Backed Security (MBS): A type of asset-backed security which is secured by a mortgage or collection of mortgages.
Non-Qualified Mortgage (Non-QM): A loan that does not meet the standards of a qualified mortgage and uses non-traditional methods of income verification to help a borrower get approved for a home loan.
Prime Jumbo: Prime jumbo mortgages are non-agency loans typically because the lending amount exceeds the conforming loan limits. These tend to be high-quality mortgages with high credit scores that, for the most part, comply with agency mortgage underwriting guidelines.
Spread: The difference in yield between a U.S. Treasury bond and a debt security with the same maturity but of lesser quality.
Yield Curve: The U.S. Treasury yield curve refers to a line chart that depicts the yields of short-term Treasury bills compared to the yields of long-term Treasury notes and bonds.
Opinions expressed are as of 8/1/24 and are subject to change at any time, are not guaranteed, and should not be considered investment advice.
Investing involves risk; principal loss is possible. Investments in debt securities typically decrease when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in lower-rated and nonrated securities present a greater risk of loss to principal and interest than do higher-rated securities. Investments in asset-backed and mortgage-backed securities include additional risks that investors should be aware of, including credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments. Derivatives involve risks different from — and in certain cases, greater than — the risks presented by more traditional investments. Derivatives may involve certain costs and risks such as illiquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lead to losses that are greater than the amount invested. The Fund may make short sales of securities, which involves the risk that losses may exceed the original amount invested. The Fund may use leverage, which may exaggerate the effect of any increase or decrease in the value of securities in the Fund’s portfolio or the Fund’s net asset value, and therefore may increase the volatility of the Fund. Investments in foreign securities involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks are increased for emerging markets. Investments in fixed-income instruments typically decrease in value when interest rates rise. The Fund will incur higher and duplicative costs when it invests in mutual funds, ETFs and other investment companies. There is also the risk that the Fund may suffer losses due to the investment practices of the underlying funds. For more information on these risks and other risks of the Fund, please see the Prospectus.
Investors should carefully consider the investment objectives, risks, charges and expenses of the Angel Oak Funds. This and other important information about each Fund is contained in the Prospectus or Summary Prospectus for each Fund, which can be obtained by calling 855-751-4324 or by visiting www.angeloakcapital.com. The Prospectus or Summary Prospectus should be read carefully before investing.
Index performance is not indicative of Fund performance. Past performance does not guarantee future results. Current performance can be obtained by calling 855-751- 4324.
The Angel Oak Funds are distributed by Quasar Distributors, LLC.
© 2024 Angel Oak Capital Advisors, which is the adviser to the Angel Oak Funds.
The post Mortgage-Backed Securities: A Historic Opportunity in 2024 appeared first on Angel Oak Capital Advisors, LLC..
AAA-rated collateralized loan obligations (CLOs) have performed exceptionally well for short-term bond allocators. Rising front-end rates, coupled with a soft-landing economic expectation, provide the ideal environment for these floating-rate bonds. However, falling front-end yields from a cutting Federal Open Market Committee alongside a slower economy could be quite the opposite capital market reality for AAA-rated CLOs. The fixed-income winners of the past 24 months – that is, during the Federal Reserve’s tightening campaign – may not be the winners of the next 24 months. We believe investors should look to lockin higher yields and diversify their short-duration allocations.
Furthermore, AAA-rated CLO spreads are near all-time tights (Figure 1), limiting further potential spread compression. This compression has been driven by significant demand from allocators of all types – including ETFs, where these securities are now broadly available for the first time.1 Concentrated AAA-rated CLO investors should consider diversifying into other segments of the securitized credit market that are not trading at historical tights.
Figure 1: AAA-Rated 5-Year Floating Rate U.S. CLO vs. SOFRSource: Bloomberg, Wells Fargo, Bank of America as of 6/30/24.
Figure 2 shows the current spreads and the wideness of those spreads for several types of fixed-income asset classes relative to history. Note that spreads of high-quality securities related to corporate credit – CLOs and corporate bonds – are trading near all-time tights. High-quality securitized credit backed by other asset types, including those backed by agency mortgage-backed securities (MBS), non-agency MBS, auto loans, credit cards, and commercial mortgage-backed securities (CMBS), are trading wide compared to historical levels.
Figure 2: Historical SpreadsSource: Bloomberg, Wells Fargo, Bank of America as of 6/30/24.
AAA-rated CLOs currently tend to offer a yield premium relative to other high-quality bonds within the credit market. This is driven by two key factors:
- A longer maturity profile of three to six years with capped upside from callability.
- The current inverted curve favoring one-month floating coupons.
The longer maturity profile of AAA-rated CLOs may surprise some investors in the coming six to 18 months. While their coupons are floating rate, which limits the price volatility if rates were to increase, sensitivity to spread widening has been muted because spreads have been stable and tightening. If rates begin to decline amid a rapidly deteriorating economy, spread volatility may create larger-than-expected price changes for shortduration investors, simultaneous to falling coupon income.
This longer maturity profile is particularly notable relative to other AAA-rated securitized credit bonds, like AAA-rated auto or credit cards, which have spread durations closer to one year. CLO investors demand a spread premium for taking on additional risk in the event of spread widening while their price upside is capped due to callability. Figure 3 shows examples of the price performance for different changes in spread for a hypothetical AAA-rated CLO and a high-quality securitized credit bond, with durations of three years and one year, respectively. Note the greater downside in AAA-rated CLOs.
Figure 3:Source: Bloomberg, Wells Fargo, Bank of America as of 6/30/24.
As for the second factor, AAA-rated CLOs tend to be floating rate whereas other elements of the securitized credit market tend to be fixed rate. When the yield curve is inverted, floating-rate securities will offer higher yields than fixed-rate securities. Floating-rate securities will also not appreciate as much if Treasury yields decline (Figure 4).
Figure 4:Source: Bloomberg, Wells Fargo, Bank of America as of 6/30/24.
AAA-rated CLO spreads are at or near all-time tights. In addition, their significant spread durations and lack of interest-rate exposure offer risks if CLO spreads widen toward historical levels and if rates decline. Therefore, we believe investors should consider diversifying away from just AAArated CLOs into other elements of the securitized credit market.
DEFINITIONS AND DISCLOSURES
Agency Mortgage-Backed Securities (AMBS): Securities issued or guaranteed by the U.S. government or a GSE.
Basis Point (bps): One hundredth of one percent and is used to denote the percentage change in a financial instrument.
Bloomberg U.S. Corporate Investment Grade Index: An index that measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by U.S. and non-U.S. industrial, utility and financial issuers.
Collateralized Loan Obligation (CLO): A single security backed by a pool of debt.
Current Coupon: Refers to a security that is trading closest to its par value without going over par. In other words, the bond’s market price is at or near to its issued face value.
Duration: Measures a portfolio’s sensitivity to changes in interest rates. Generally, the longer the duration, the greater the price change relative to interest rate movements.
Floating Rate: A floating-rate security is an investment with interest payments that float or adjust periodically based upon a predetermined benchmark.
Secured Overnight Financing Rate (SOFR): A broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities.
Spread: The difference in yield between a U.S. Treasury bond and a debt security with the same maturity but of lesser quality.
Yield Curve: The U.S. Treasury yield curve refers to a line chart that depicts the yields of short-term Treasury bills compared to the yields of long-term Treasury notes and bonds.
Opinions expressed are as of 6/30/24 and are subject to change at any time, are not guaranteed, and should not be considered investment advice.
Investing involves risk; principal loss is possible. Investments in debt securities typically decrease when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in lower-rated and nonrated securities present a greater risk of loss to principal and interest than do higher-rated securities. Investments in asset-backed and mortgage-backed securities include additional risks that investors should be aware of, including credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments. Derivatives involve risks different from — and in certain cases, greater than — the risks presented by more traditional investments. Derivatives may involve certain costs and risks such as illiquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lead to losses that are greater than the amount invested. The Fund may make short sales of securities, which involves the risk that losses may exceed the original amount invested. The Fund may use leverage, which may exaggerate the effect of any increase or decrease in the value of securities in the Fund’s portfolio or the Fund’s net asset value, and therefore may increase the volatility of the Fund. Investments in foreign securities involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks are increased for emerging markets. Investments in fixed-income instruments typically decrease in value when interest rates rise. The Fund will incur higher and duplicative costs when it invests in mutual funds, ETFs and other investment companies. There is also the risk that the Fund may suffer losses due to the investment practices of the underlying funds. For more information on these risks and other risks of the Fund, please see the Prospectus.
Investors should carefully consider the investment objectives, risks, charges and expenses of the Angel Oak Funds. This and other important information about each Fund is contained in the Prospectus or Summary Prospectus for each Fund, which can be obtained by calling 855-751-4324 or by visiting www.angeloakcapital.com. The Prospectus or Summary Prospectus should be read carefully before investing.
Index performance is not indicative of Fund performance. Past performance does not guarantee future results. Current performance can be obtained by calling 855-751-4324.
The Angel Oak Funds are distributed by Quasar Distributors, LLC.
© 2024 Angel Oak Capital Advisors, which is the adviser to the Angel Oak Funds.
The post Overlooked Risks in AAA-Rated CLOs appeared first on Angel Oak Capital Advisors, LLC..
Less than two years since inception, the firm’s suite of ETFs continues to grow, finding success in solving for potential gaps in advisor and institutional portfolios
ATLANTA — (June 25, 2024) — Angel Oak Capital Advisors, LLC (Angel Oak), a leading investment management firm focused on securitized credit investing, announced that its exchange-traded fund (ETF) platform, composed of its four actively managed fixed income ETFs and its sub-advisory services, has surpassed $1 billion in assets under management (AUM) since launching in November 2022.
“Reaching the $1 billion mark in just 20 months is a testament to the trust that our clients place in us and our deep expertise in the securitized credit market,” said Sreeni Prabhu, Managing Partner and Co-CEO at Angel Oak. “Everyone at Angel Oak is proud of this achievement, and we believe our scale will allow us to help even more investors.”
Following the firm’s first ETF launch, Angel Oak UltraShort Income ETF (NYSE: UYLD), Angel Oak also successfully launched Angel Oak Income ETF (NYSE: CARY) and, earlier this year, converted two of its mutual funds into ETFs — Angel Oak High Yield Opportunities ETF (NYSE: AOHY) and Angel Oak Mortgage-Backed Securities ETF (NYSE: MBS). The ETF suite is one of the few in the marketplace offering investors significant exposure to non-agency residential mortgage-backed securities, consumer asset-backed securities and other securitized credit assets with an actively managed approach.
This AUM milestone underscores the robust growth and strong market acceptance of Angel Oak’s innovative investment offerings in a marketplace that was previously starved for securitized credit ETF solutions. By effectively addressing the needs of advisors and institutional investors, the platform offers compelling investment opportunities that seek a distinct combination of strong yield potential with diversification away from traditional fixed-income assets.
“We are grateful for the affirming response from advisors and institutional investors. It has been nothing less than remarkable. We continue to have productive conversations about the role these different solutions can play in a portfolio, especially given the significant premium currently offered by securitized credit,” said Ward Bortz, ETF Portfolio Manager and the Head of Distribution for US Wealth. “The asset classes we invest in are often underrepresented in investment portfolios — particularly ETF portfolios. We look forward to helping these investors access securitized credit and the continued growth of our platform.”
Angel Oak continues to increase its reach and influence in the investment community, working closely with advisors and institutional investors across the country to grow its ETF platform and explore broader partnership and sub-advisory opportunities. Angel Oak’s ETFs are currently listed on several platforms, including Baird, LPL, Raymond James, Stifel and UBS.
To learn more about Angel Oak’s ETF offerings, click here.
About Angel Oak Capital Advisors, LLC
Angel Oak is an investment management firm focused on providing compelling fixed-income investment solutions to its clients. Backed by a value-driven approach, Angel Oak seeks to deliver attractive, risk-adjusted returns through a combination of stable current income and price appreciation. Its experienced investment team seeks the best opportunities in fixed income, with a specialization in mortgage-backed securities and other areas of securitized credit. For more information, please visit www.angeloakcapital.com.
| AOHY1 | CARY2 | MBS3 | UYLD4 | | --- | --- | --- | --- | | Gross Expense Ratio | 0.56% | 1.00% | 0.80% | 0.55% | | Net Expense Ratio | 0.56% | 0.80% | 0.50% | 0.29% |
DEFINITIONS AND DISCLOSURES
1Gross and net expense ratios are reported as of the 5/30/24 prospectus.
2Gross and net expense ratios are reported as of the 5/30/24 prospectus. The Adviser has contractually agreed to waive its fees to limit the Total Annual Fund Operating Expenses After Fee Waiver/Expense Reimbursement to 0.79% of the Fund’s average daily net assets through 5/31/25.
3Gross and net expense ratios are reported as of the 5/30/24 prospectus. The Adviser has contractually agreed to waive its fees to limit the Total Annual Fund Operating Expenses After Fee Waiver/Expense Reimbursement to 0.49% of the Fund’s average daily net assets through 9/30/25.
4Gross and net expense ratios are reported as of the 5/30/24 prospectus. The Adviser has contractually agreed to waive its fees to limit the Total Annual Fund Operating Expenses After Fee Waiver/Expense Reimbursement to 0.29% of the Fund’s average daily net assets through 5/31/25.
Investors should carefully consider the investment objectives, risks, charges and expenses of the funds. This and other important information about the funds is contained in the Prospectus which can be obtained by calling Shareholder Services at 855-751-4324 or from www.angeloakcapital.com. The Prospectus should be read carefully before investing.
Investing involves risk; principal loss is possible. Investments in debt securities typically decrease when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in lower-rated and nonrated securities present a greater risk of loss to principal and interest than higher-rated securities do. Investments in asset-backed and mortgage-backed securities include additional risks that investors should be aware of, including credit risk, prepayment risk, possible illiquidity, and default, as well as increased susceptibility to adverse economic developments. Derivatives involve risks different from—and in certain cases, greater than—the risks presented by more traditional investments. Derivatives may involve certain costs and risks such as illiquidity, interest rate, market, credit, management, and the risk that a position could not be closed when most advantageous. Investing in derivatives could lead to losses that are greater than the amount invested. The Fund may use leverage, which may exaggerate the effect of any increase or decrease in the value of securities in the Fund’s portfolio or higher and duplicative expenses when it invests in mutual funds, ETFs, and other investment companies. The Funds are a recently organized investment company with limited operating history. As a result, prospective investors have a limited track record or history on which to base their investment decisions. For more information on these risks and other risks of the Fund, please see the Prospectus.
ETFs may trade at a premium or discount to NAV. Shares of any ETF are bought and sold at market prices (not NAV) and are not individually redeemed from the Fund. Brokerage commissions will reduce returns. The Fund is an actively managed ETF, which is a fund that trades like other publicly traded securities. The Fund is not an index fund and does not seek to replicate the performance of a specified index.
The Angel Oak Funds are distributed by Quasar Distributors, LLC.
The post Angel Oak Capital Advisors’ ETF Platform Surpasses $1 Billion in AUM appeared first on Angel Oak Capital Advisors, LLC..
Persistent inflation lingering in the market in the wake of the COVID era has led the Federal Reserve to leave interest rates at elevated levels throughout 2024 after hiking interest rates 11 times since March 2022. While inflation has steadily declined from its 9.1% peak in June 2022 to a recent read of 3.4% in April 2024, it remains stubbornly high. However, the Fed continues to reiterate that they are done hiking rates making fixed income more attractive to own, particularly longer duration assets.
As we head into the second half of 2024, we believe securitized credit—specifically mortgages—is a better place to invest additional fixed-income dollars, due to softening interest rate volatility, increased demand from investors that have a record amount of cash on the sidelines (Figure 1), and better relative value.
We consider this to be an important time for investors to move out the curve and extend duration to capture outsized yields for a longer period of time from existing cash balances that may be impacted by interest rates falling later this year.
Figure 1: Record Amount of Money Market Fund AssetsSource: Bloomberg as of 5/31/24.
Heightened interest rate volatility, along with a buyer’s strike in securitized mortgage credit, led to underperformance versus corporate credit over the past two years. We believe the spread widening relative to corporates has gone too far and created a historically attractive investment opportunity. We believe securitized mortgage credit, where equity-like return opportunities exist in senior secured cash flows, will benefit as allocators return and identify the relative value.
While we recognize there are differences between corporate and mortgage debt, the relative value jumps off the page. Nominal current coupon agency mortgage spreads trade significantly wider than The Bloomberg U.S. Corporate Investment Grade Index and have government backing (Figure 2). Moreover, new-issue non-agency mortgages sectors, such as jumbo prime 2.0 and non-QM, offer considerable yield pickup over similarly rated corporates (Figure 3). Spreads in new issuance non-agency mortgages are still trading wider than before the Fed started raising rates, while corporate bonds are tighter (Figure 4). We believe current spread levels offer a very attractive entry point in the space.
Figure 2: Current Coupon Agency Spread Wider Than IG Corp. SpreadSource: Bloomberg, Morgan Stanley Research as of 5/31/24.
Figure 3: NA Mortgage vs. Corporate SpreadsFigure 4: Change vs. 12/31/21: NA Mortgage vs. Corporate SpreadsSource: Bloomberg, Wells Fargo as of 5/31/24.
Our focus on sustainable fundamentals in high-quality areas of securitized credit positions us to potentially outperform over the long-run credit cycle, as current market dynamics provide the opportunity for both income and capital appreciation potential in the wake of the bond bear market of 2022. We believe the relative value of securitized mortgage credit stands out across risk assets when considering where to invest fixed-income dollars in 2024 and recommend investors step out of cash into longer-duration assets sooner than later for potential outperformance.
DEFINITIONS AND DISCLOSURES
Agency Mortgage-Backed Securities (AMBS): Securities issued or guaranteed by the U.S. government or a GSE.
Bloomberg U.S. Corporate Investment Grade Index: An index that measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by U.S. and non-U.S. industrial, utility and financial issuers.
Current Coupon: Refers to a security that is trading closest to its par value without going over par. In other words, the bond’s market price is at or near to its issued face value.
Morgan Stanley 30Y Conventional Current Coupon ($100) ZV Index: The index represents the ZV (zero volatility) spread for the hypothetical $100-priced 30-year conventional mortgage over time.
Mortgage-Backed Security (MBS): A type of asset-backed security which is secured by a mortgage or collection of mortgages.
Non-Qualified Mortgage (Non-QM): A loan that does not meet the standards of a qualified mortgage and uses non-traditional methods of income verification to help a borrower get approved for a home loan.
Prime Jumbo: Prime jumbo mortgages are non-agency loans typically because the lending amount exceeds the conforming loan limits. These tend to be high-quality mortgages with high credit scores that, for the most part, comply with agency mortgage underwriting guidelines.
Opinions expressed are as of 5/31/24 and are subject to change at any time, are not guaranteed, and should not be considered investment advice.
Investing involves risk; principal loss is possible. Investments in debt securities typically decrease when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in lower-rated and nonrated securities present a greater risk of loss to principal and interest than do higher-rated securities. Investments in asset-backed and mortgage-backed securities include additional risks that investors should be aware of, including credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments. Derivatives involve risks different from — and in certain cases, greater than — the risks presented by more traditional investments. Derivatives may involve certain costs and risks such as illiquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lead to losses that are greater than the amount invested. The Fund may make short sales of securities, which involves the risk that losses may exceed the original amount invested. The Fund may use leverage, which may exaggerate the effect of any increase or decrease in the value of securities in the Fund’s portfolio or the Fund’s net asset value, and therefore may increase the volatility of the Fund. Investments in foreign securities involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks are increased for emerging markets. Investments in fixed-income instruments typically decrease in value when interest rates rise. The Fund will incur higher and duplicative costs when it invests in mutual funds, ETFs and other investment companies. There is also the risk that the Fund may suffer losses due to the investment practices of the underlying funds. For more information on these risks and other risks of the Fund, please see the Prospectus.
Investors should carefully consider the investment objectives, risks, charges and expenses of the Angel Oak Funds. This and other important information about each Fund is contained in the Prospectus or Summary Prospectus for each Fund, which can be obtained by calling 855-751-4324 or by visiting www.angeloakcapital.com. The Prospectus or Summary Prospectus should be read carefully before investing.
Index performance is not indicative of Fund performance. Past performance does not guarantee future results. Current performance can be obtained by calling 855-751-4324.
The Angel Oak Funds are distributed by Quasar Distributors, LLC.
© 2024 Angel Oak Capital Advisors, which is the adviser to the Angel Oak Funds.
The post The Return of Fixed Income appeared first on Angel Oak Capital Advisors, LLC..
The Banking Crisis That Wasn’tInvesting in banks in 2023 was not for the faint of heart. The regional bank failures in the spring highlighted concerns relating to the rapid rise of interest rates and the resulting impact to bank investment portfolios and accumulated other comprehensive income (AOCI). While the bank failures were more idiosyncratic than systemic, given their unique business models, bank debt and equity markets remained dislocated. Over the past couple of quarters, contagion risk has faded as bank earnings proved resilient and stricter regulation is anticipated. Additionally, as rates rallied into year-end, AOCI and capital levels have likely improved, as have equity valuations to some degree. Bank debt tends to lag equity performance and is well positioned to outperform in 2024.
Figure 1: QABA YTD 2023 Return By MonthSource: Bloomberg as of 12/31/23.
Emerging StrongerThe bank failures and ensuing market volatility beginning in March 2023 were largely driven by liquidity concerns in conjunction with the rapid rise in interest rates. This was particularly evident in the unique business models of the failed regional banks, given their highly concentrated deposit bases and high level of uninsured deposits. Banks typically lag interest rate increases, and similarly were slow to adjust deposit rates to the steep increase in interest rates this cycle. When weakness surfaced in the banking sector, depositors withdrew their funds at an unprecedented pace and banks were forced to sell bonds out of their investment portfolios, realizing losses and, as a result, eroding their capital bases. As part of their response, regulators created a new Bank Term Funding Program (BTFP) at the Discount Window, allowing banks to borrow the par value of a wider range of securities so banks could avoid selling bonds and realizing losses for non-impaired securities. The BTFP was successful as part of the solution to quickly stabilize the banking system. Since then, banks have worked hard to strengthen their deposit bases. Banks adjusted deposit rates higher, to levels more commensurate with market rates (pressuring net interest margins) and also employed creative solutions to enhance the amount of deposit insurance available to their depositors. Additionally, over the course of 2023 the level of uninsured bank deposits improved meaningfully.
Figure 2: Angel Oak Community Bank Composite IndexSource: Angel Oak Capital, Bloomberg as of 12/31/23.
BTFP ExpirationDeposit platforms are more stable entering 2024 than they were a year ago. Deposit costs are at or near peak, and margin pressure should alleviate from current levels as 1) deposit competition fades in the face of slower loan growth, 2) maturing CDs begin to reprice lower, and 3) the Fed begins to cut interest rates. The debate on the deposit side centers on whether the BTFP (expiring March 11, 2024) will be renewed. Most market participants expect the facility will not be renewed, given deposit stability, the decrease in rates, and the unintended arbitrage created. Utilization of the facility has been increasing of late, likely due to the arbitrage available between the cost to borrow under the BTFP and the rate of interest the Fed pays on excess reserves (Figure 3).
Figure 3: Gap Between IORB And BTFP Rates At Widest LevelsSource: Bloomberg as of 12/31/23.
Regulators likely view this unfavorably as banks are essentially earning a risk-free spread by borrowing from the BTFP and leaving the funds on deposit at the Fed. Even with the expected expiration of the BTFP, banks still have access to the Fed’s Discount Window and the Standing Repo Facility as contingent sources of liquidity.
The Road AheadWhile 2024 likely brings with it a still-tough operating environment for banks, net interest margin (NIM) pressures are abating, valuations are cheap, and merger and acquisition (M&A) activity should accelerate. Navigating the rate and credit environment and managing expenses will be top of mind for bank management teams.
NIM: NIM pressures should gradually fade with the Fed on pause. Margins will continue to compress on higher funding costs in the near term, but at a decelerating pace, before stabilizing and shifting to expansion in the second half of 2024. Historically, deposit costs continue to rise until the Fed begins cutting rates. Loan and securities repricing will provide an offset to higher funding costs.
Figure 4: NIM Pressure Should Gradually FadeSource: Morgan Stanley Research, FDIC, Federal Reserve as of 9/30/23.
Credit Quality: Given the rapid rise in interest rates over the past several quarters and the ensuing pressure on consumer and corporate debt servicing capacity, credit will continue to normalize from today’s still-low levels. Consumer credit cycles play out faster than commercial credit cycles, and delinquencies have been increasing for both credit card and auto portfolios. Early signs from securitization trusts point to deceleration in the pace of delinquencies, and risk-adjusted margins remain positive.
Commercial real estate (CRE), and particularly office CRE, is a larger headwind; however, it is important to understand banks’ exposure to the CRE market. More than half of CRE resides outside the banking system, and banks tend to be more conservative underwriters in terms of cap rates and loan-to-values. With few exceptions, bank exposure to office CRE tends to be less than 5% of total loans. Over the course of 2023, banks have enhanced their disclosure on CRE portfolios and have built up loan loss reserves. While this CRE cycle will likely be more severe than prior cycles given the shift to increased work-from-home and hybrid work arrangements and there remains headline risk, overall, the banking sector is well reserved and well equipped to manage through deterioration in its CRE portfolios, particularly as CRE credit cycles tend to play out over multiple years.
Figure 5: Historically Low Credit Losses, High ReservesSource: S&P Capital IQ Pro as of 9/30/23.
Figure 6: CRE Losses Historically Manageable Outside Of Construction LendingSource: Moody’s Investor Services, FDIC as of 9/30/23.
M&A: The banking sector is also grappling with elevated expenses, particularly related to increasing regulation and higher deposit costs. While the biggest changes from a tougher regulatory regime are expected for regional banks between $100 billion and $250 billion, all banks will need to operate under a stricter regime. Incremental costs relating to compliance, risk management, etc., will pressure bank expenses. Additionally, compensation costs account for the bulk of banks’ expense bases and technology remains a necessary investment, from both a cybersecurity and a competitive perspective. M&A activity should reaccelerate in 2024 after a slow 2023 as banks focus on improving scale and profitability. Cost savings from bank consolidation are tangible and meaningful, and they typically range from 20% to 30% of the acquired bank’s expense base.
Figure 7: Banking Sector M&ASource: S&P Capital IQ Pro as of 12/31/23.
Investment OpportunitiesThe opportunity set is attractive across the banking spectrum. Despite the recovery in bank equities in the fourth quarter of 2023, valuations remain muted. Additionally, spreads on bank debt remain at all-time wides, with little of the benefit from lower rates being reflected in pricing.
Debt: There is a fundamental mispricing of bank debt in the current market. The most typical instrument issued, subordinated debt (sub debt), is a Tier 2 regulatory capital instrument that is structured as a 10 no-call 5 fixed-to-float structure, meaning a 10-year final maturity, with the bond becoming callable and switching from fixed rate to floating rate at year 5. The key rationale for issuance is the regulatory capital treatment. Once there is less than 5 years to maturity, capital eligibility declines ratably over the last 5 years (i.e., 80% in year 6, 60% in year 7, etc.). The market is pricing these bonds assuming they will be outstanding until maturity. We believe this is fundamentally incorrect. While banks are unlikely to issue below current yields, banks issue these bonds for capital purposes rather than funding purposes. Banks can fund themselves much more efficiently through alternative sources, mainly deposits. Thus, the key consideration for calling a bond and issuing new sub debt hinges on the effective cost of capital. While a case can be made for keeping these bonds outstanding for a year or two following the initial call, the debt becomes expensive funding past that point.
Figure 9:Source: Angel Oak Capital as of 12/31/23.
Exacerbating the dislocation in the bank debt market, primary issuance was de minimis in 2023. By contrast, 106 deals came to market in 2022 for a total of $4.4 billion, 215 deals came in 2021 for $8.5 billion, and 217 deals came in 2020 for $11 billion. Issuance in 2023 was negatively impacted both by issuers’ reluctance to issue at current market rates given the rise in interest rates, coupled with historically wide spreads, and by investors’ hesitance to invest in the sector given potential contagion risk from the regional bank failures in 1H33. This is similar to the dynamics in 2020, when the primary market shut down during the COVID-19 pandemic. Upon reopen, there was a flurry of activity, resulting in the highest single-year issuance for community bank debt since inception.
Figure 10: Bank Debt Primary Market IssuanceSource: Piper Sandler, KBW, Performance Trust as of 12/31/23. 2023 Issuance includes senior debt issuances.
We are optimistic that the primary issue market will reemerge with strength in 2024 for several reasons. First, $1.8 billion of community bank debt is maturing and we fully expect most of these banks will have to refinance those notes as they come due. Secondly, there is an additional $2 billion of debt outstanding that is already in the floating rate period. These bonds have had their coupons reset higher and are losing regulatory capital eligibility at 20% per year, rendering the debt expensive and inefficient. Finally, approximately $4 billion of debt will enter the call/floating rate period this year. A robust primary market should also guide the secondary market, driving attractive investment opportunities across the community bank debt landscape.
Equities: Bank equities are cheap by any measure, as a lack of conviction around the pace of rate cuts and the depth of credit normalization has been keeping investors on the sidelines. As more clarity emerges in 1H34, bank equities could offer investors compelling upside. We favor community banks with strong deposit franchises, attractive footprints, and beneficiaries of an upcoming M&A cycle.
Figure 11: Bank Relative P/E MultiplesSource: KBW Research, FactSet, Bloomberg as of 12/31/23.
Figure 12: Bank P/TBV MultiplesSource: KBW Research, FactSet, Bloomberg as of 12/31/23.
Definitions And Disclosures
Accumulated Other Comprehensive Income (AOCI): Includes unrealized gains and losses that are reported in the equity section of the balance sheet.
Angel Oak Community Bank Index: Tracks spreads on a homogeneous portion of the community bank sub-debt market.
Community Bank Sub-Debt: Subordinated debentures of financial institutions with total assets of less than $20 billion.
Interest Rate on Reserve Balances (IORB): The interest rate paid by the Federal Reserve on balances maintained by or on behalf of an eligible institution in an account at a Federal Reserve Bank.
KBW Bank Index (BKX): The index is designed to track the performance of the leading banks and thrifts that are publicly-traded in the U.S.
KBW Regional Banking Index (KRX): The index seeks to reflect the performance of U.S. companies that do business as regional banks or thrifts.
NASDAQ ABA Community Bank Index (QABA): A market capitalization-weighted index designed to track the performance of banks and thrifts, or their holding companies, listed on The NASDAQ Stock Market.
NCO: Net charge-off.
NPA: Non-performing asset.
NPA Ratio: A ratio used to measure the overall quality of a bank’s loan book.
Price/Earnings (P/E) Ratio: The ratio of a company’s stock price to the company’s earnings per share.
Price-To-Tangible Book Value (P/TBV) Ratio: A financial ratio used to compare a company’s current market price to its book value.
S&P 500 Total Return Index (SPX): The index is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.
Tier 2 Capital: A bank’s supplementary capital including evaluation reserve, undisclosed reserves, hybrid security, and subordinate debt.
It is not possible to invest directly in an index.
Must be preceded or accompanied by a prospectus. To obtain an electronic copy of the prospectus, please visit www.angeloakcapital.com. Opinions expressed are as of 12/31/23 and are subject to change at any time, are not guaranteed, and should not be considered investment advice.
Investing involves risk; principal loss is possible. Investments in debt securities typically decrease when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in lower-rated and nonrated securities present a greater risk of loss to principal and interest than do higher-rated securities. Investments in asset-backed and mortgage-backed securities include additional risks that investors should be aware of, including credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments. Derivatives involve risks different from — and in certain cases, greater than — the risks presented by more traditional investments. Derivatives may involve certain costs and risks such as illiquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lead to losses that are greater than the amount invested. The Fund may make short sales of securities, which involves the risk that losses may exceed the original amount invested. The Fund may use leverage, which may exaggerate the effect of any increase or decrease in the value of securities in the Fund’s portfolio or the Fund’s net asset value, and therefore may increase the volatility of the Fund. Investments in foreign securities involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks are increased for emerging markets. Investments in fixed-income instruments typically decrease in value when interest rates rise. The Fund will incur higher and duplicative costs when it invests in mutual funds, ETFs and other investment companies. There is also the risk that the Fund may suffer losses due to the investment practices of the underlying funds. For more information on these risks and other risks of the Fund, please see the Prospectus.
Index performance is not indicative of Fund performance. Past performance does not guarantee future results. Current performance can be obtained by calling 855-751-4324. As of 12/31/23, no securities mentioned were held by the Angel Oak Funds. The Angel Oak Funds are distributed by Quasar Distributors, LLC. © 2024 Angel Oak Capital Advisors, which is the adviser to the Angel Oak Funds.
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We believe securitized credit continues to be an underrepresented asset class within retail investors’ fixed income portfolios. Institutional investors typically have a greater allocation to the asset class relative to corporate credit. The figures below illustrate one key benefit institutional investors have enjoyed; securitized credit tends to earn a premium to corporate credit. We call this potential outperformance the securitized credit premium.
Figure 1: Securitized Credit Has Historically Outperformed Corporate Credit: BofA Global Research as of 3/31/24.
This premium can vary over time. During periods of volatility, we believe patient investors that hold through the credit cycle have the potential to achieve attractive returns. While there can be periods of underperformance, securitized credit tends to outperform corporate credit on average, even after adjusting for risk, as shown in Figure 2.
There are several potential drivers of the securitized credit premium, including:
- Lack of representation in fixed income indices, such as the Bloomberg U.S. Aggregate Bond Index, which causes a liquidity premium.
- Complexity of the underlying structures causes less sophisticated investors to potentially shy away from the securities.
- Securitized credit securities tend to cash flow on a monthly basis versus more traditional fixed income that receives cash at maturity
Figure 2: Risk-Adjusted Returns Greater in Structured Credit vs. U.S. Corp. IGSource: BofA Global Research as of 3/31/24.
One of the main concerns investors have about securitized credit is the havoc it caused within portfolios during the Great Financial Crisis. However, since the crisis, the securitized credit markets have become more regulated, underwriting standards have tightened, and issuers must have “skin in the game” or risk retention. These changes have caused the market to experience very little growth compared with the corporate credit marketplace.
Figure 3: Outstanding Debt in Securitized and Corporate Credit MarketsSource: Bloomberg, SIFMA as of 3/31/24.
We believe retail investors, who tend to be under allocated to securitized credit, should consider increasing their allocation to the asset class to help diversify their fixed income allocation and potentially increase their portfolio’s overall risk-adjusted return.
DEFINITIONS AND DISCLOSURES
Bloomberg U.S. Aggregate Bond Index: An unmanaged index that measures the performance of the investment-grade universe of bonds issued in the United States. The index includes institutionally traded U.S. Treasury, government sponsored, mortgage and corporate securities.
Bloomberg U.S. Corporate Investment Grade Index: An index that measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by U.S. and non-U.S. industrial, utility and financial issuers.
Cash Flow: The net amount of cash and cash-equivalents being transferred into and out of a business, especially as affecting liquidity.
Sharpe Ratio: A statistical measure that uses standard deviation and excess return to determine reward per unit of risk. A higher Sharpe ratio implies a better historical risk-adjusted performance. The Sharpe ratio has been calculated since inception using the 3-month Treasury bill for the risk-free rate of return.
The Securitized Products Return Indicator aggregates monthly return performance across the U.S. securitized products credit markets that Bank of America tracks into one number for both total return and excess swap return. The Agency MBS market is not included in the Indicator as it is focused on the return of non-guaranteed securities. There are two subsets of the indicator: 1) a AAA Indicator that tracks AAA-rated structured credit bonds and 2) a Down in Credit Indicator which tracks CLO BBB/BB tranches, CMBS BBB tranches and CAS/STACR below investment-grade rated bonds. The return data is weighted by the 1-month lagged outstanding par value of each indicator constituent. This methodology also applies to the two subset indicators.
Opinions expressed are as of 4/30/24 and are subject to change at any time, are not guaranteed, and should not be considered investment advice.
Investing involves risk; principal loss is possible. Investments in debt securities typically decrease when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in lower-rated and nonrated securities present a greater risk of loss to principal and interest than do higher-rated securities. Investments in asset-backed and mortgage-backed securities include additional risks that investors should be aware of, including credit risk, prepayment risk, possible illiquidity and default, as well as increased susceptibility to adverse economic developments. Derivatives involve risks different from — and in certain cases, greater than — the risks presented by more traditional investments. Derivatives may involve certain costs and risks such as illiquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lead to losses that are greater than the amount invested. The Fund may make short sales of securities, which involves the risk that losses may exceed the original amount invested. The Fund may use leverage, which may exaggerate the effect of any increase or decrease in the value of securities in the Fund’s portfolio or the Fund’s net asset value, and therefore may increase the volatility of the Fund. Investments in foreign securities involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks are increased for emerging markets. Investments in fixed-income instruments typically decrease in value when interest rates rise. The Fund will incur higher and duplicative costs when it invests in mutual funds, ETFs and other investment companies. There is also the risk that the Fund may suffer losses due to the investment practices of the underlying funds. For more information on these risks and other risks of the Fund, please see the Prospectus.
Investors should carefully consider the investment objectives, risks, charges and expenses of the Angel Oak Mutual Funds. This and other important information about each Fund is contained in the Prospectus or Summary Prospectus for each Fund, which can be obtained by calling 855-751-4324 or by visiting www.angeloakcapital.com. The Prospectus or Summary Prospectus should be read carefully before investing.
Index performance is not indicative of Fund performance. Past performance does not guarantee future results. Current performance can be obtained by calling 855-751-4324.
The Angel Oak Funds are distributed by Quasar Distributors, LLC.
© 2024 Angel Oak Capital Advisors, which is the adviser to the Angel Oak Funds.
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We continue to favor high-quality areas of securitized credit, which have been vulnerable to the increased interest rate volatility and widening in agency MBS spreads in the first half of the year. While most areas of securitized credit are historically cheap to corporate credit and may be more reflective of the significant recession in the second half of 2023, we remain selective and focused on high-quality areas with stable credit fundamentals, including agency and non-agency MBS and senior short-duration consumer asset-backed securities.
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