- Corporate resilience is being tested and redefined amid the Covid-19 crisis, providing an opportunity to test our sustainable investing thesis as the crisis unfolds.
- Within securitized credit, certain segments aligned with sustainable megatrends may demonstrate greater resilience.
- Sustainability is a long-term secular trend that we believe will persevere through and extend well beyond the crisis.
As the coronavirus pandemic sent shockwaves through financial markets, many fixed income sectors succumbed to a fear-induced market sell-off. Securitized credit was no exception as the asset class became mired in a liquidity-related selloff and de-leveraging events. Subsequent policy interventions by the Federal Reserve, including reintroduction of the Term Asset-Backed Securities Lending Facility (TALF), have provided much-needed liquidity at an unprecedented rate and resulted in a substantial rebound for securitized assets' spreads. Further, securitized sectors aligned with sustainable megatrends may demonstrate greater resilience to the effects of the pandemic as the crisis unfolds.
Evaluating our sustainability thesis
The crisis presents a rare opportunity to test our sustainable investing thesis. That is, issuers and securities that are aligned with long-term sustainable megatrends may outperform over the long-term and may possess greater resiliency in the event of a systematic shock. As outlined in our prior paper on corporate credit, companies with a greater focus on sustainability, such as technology and healthcare, have weathered the most recent downturn relatively well. Meanwhile, industries such as energy and leisure, have suffered immensely.
Assessing sustainable securitized credit
Within securitized credit, many sustainability-aligned sectors are demonstrating greater fundamental resilience to the pandemic due to lower exposure to industries such as energy, retail, hospitality and transportation that are experiencing the greatest adverse impacts. However, they are not immune. As outlined below, sustainability-focused securities are experiencing wide-ranging pandemic-related impacts.
Positioned to win
Private student loans: Borrowers who financed graduate or professional school training, typically have strong established payment histories and higher incomes and are likely to be among the most resilient consumer borrowers. These obligors typically include employees in knowledge-economy fields that can be best adapted to the work-from-home environment. Additionally, new issue student loan ABS' inclusion in the TALF program should provide technical support for the sector.
Communications infrastructure: As with corporate credit, cell tower and data center businesses have clearly benefitted from higher mobile voice and data traffic associated with the stay-at-home environment. Mobile network densification, data transmission and storage supported by these businesses has been a key element in facilitating the transition to working from home.
Solar loans and leases: While residential solar assets are consumer obligations, the combination of alignment of incentives, low monthly payments and prime borrowers has led to little performance deterioration. Solar payments typically displace more expensive electric utility bills. Stay-at-home orders have likely driven higher residential electricity consumption which could further validate the solar use case. Despite these favorable fundamentals, solar ABS became dislocated during the March market downturn and have not fully recovered. We expect further recovery in this sector relative to comparable peers.
Positioned for mixed results
Re-performing residential mortgages: Borrowers will undoubtedly experience stress from pandemic-related income disruption. That said, lessons learned during the last global financial crisis and recent natural disasters provide a proven framework through which temporary payment relief can be used to alleviate borrower strain. Fiscal relief afforded by tax rebates and increased unemployment benefits help provide temporary replacement for lost income. Additionally, these mortgages have benefitted from principal amortization and modifications to very low interest rates, greatly easing borrowers' debt-service burden.
Commercial mortgage-backed securities: Despite a universe secured predominantly by class A office and multifamily properties with strong LEED certifications, CMBS has not been immune to tenants' financial stress and potential secular use changes spawned by mass working from home. While CMBS secured by office and multifamily properties have held up relatively well, overhang from deteriorating macroeconomic fundamentals remains. Low leverage exposures to trophy properties in urban infill locations with high-quality tenants on long leases should moderate risks associated with both the downturn and work-from-home trends. Additionally, the sector has received limited support via conduit CMBS' inclusion in TALF and Federal Reserve Agency CMBS purchases that may bestow modest positive technical benefits.
Positioned for greatest uncertainty
Small business loans: These obligors are heavily concentrated in sectors such as retail trade, construction and hospitality that have been most adversely impacted by pandemic-related closures and the resulting economic fallout. While government assistance may provide short-term relief, these businesses' survival will be heavily dependent on the depth and duration of the crisis. Securitization outcomes will be heavily reliant on structural protections' relative to losses.
A pivotal point for sustainability
Although uncertainty remains, the pandemic could be a pivotal point for sustainability. Some sustainability initiatives may slow in the short term as businesses navigate near-term challenges, but we believe the pandemic has done little to dislodge the long-term trend towards global sustainability. If anything, we think that the crisis will be a catalyst for accelerating existing trends such as the secular shift toward sustainability. From that perspective, we have already witnessed and expect companies will continue to place greater importance on serving the needs of various stakeholders – customers, employees, capital providers, suppliers, and local communities – as the optimal mechanism for delivering competitive, long-term financial returns. To that end, issuers positioned to address the world's sustainability problems may provide attractive opportunities for investors to align with long-term results.
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