Identifying dislocations in Securitized Credit

Nov 03, 2022

Fixed income and other risk assets have come under pressure in 2022, following the global battle against inflation and the resultant significant tightening of financial conditions. This has been combined with several other factors to put pressure on risk asset valuations, including the effects of the war in Ukraine on natural resources and, more recently, a glut of supply following liquidations by asset managers on behalf of UK defined benefit pension schemes.

In some markets, valuations have become dislocated from fundamental risks. The key to investors taking advantage of dislocations is to target those that are more technical, rather than fundamental in nature. We believe that Securitized Credit markets have dislocated more than other fixed income asset classes and thus offer a very attractive opportunity. On top of attractive absolute and relative valuations, Securitized Credit is fundamentally robust and offers significant protection from defaults – preservation of capital in today’s environment is also of utmost importance.

In this report, we dive deeper into the relative value of Securitized Credit versus other asset types to help identify the most attractive dislocations.


A good place to start is with Collateralised Loan Obligations (“CLOs”) – these are securitizations backed by corporate loans. As the underlying collateral are corporate borrowers, this makes direct comparison to corporate bonds on a like-for-like basis possible, given the similar underlying risk factors. The first chart shows the credit spread on offer in BB-rated CLO bonds compared to BB-rated corporate bonds in Europe. The basis between the two is much wider than in less volatile periods and has dislocated close to Covid-era levels.

By comparison, in the second chart the same analysis in the US shows the dislocation is much less meaningful i.e. European CLOs are more dislocated than their US counterparts and will outperform if spreads normalise. Part of the reason for this difference is the higher fundamental risks faced by European corporates. However, we believe that prices have overshot fundamental concerns, given the embedded level of protection from defaults in CLOs, and that numerous technical factors are dominating price action. These include huge oversupply following liquidations from UK pension funds and the changing buyer base for European Securitized Credit. Finally, on CLOs, it is also important to note that this analysis can be replicated for different rating bands and the outcome is similar – European CLO valuations are dislocated from fundamentals across the capital structure.

Chart 1: Credit spread on offer in BB-rated CLO bonds compared to BB-rated corporate bonds in Europe

identifying-dislocations-in-securitized-credit-chart-1.jpgSource: Wells Fargo, Bloomberg

Chart 2: Credit spread on offer in BB-rated CLO bonds compared to BB-rated corporate bonds in the US

identifying-dislocations-in-securitized-credit-chart-2.jpgSource: Wells Fargo, Bloomberg

US Agency Mortgage CRT

CLOs are not the only sector of Securitized Credit markets that currently offer compelling value to investors. One other sector is US Agency Mortgage Credit Risk Transfer (“CRT”) – these are securitizations issued by Fannie Mae and Freddie Mac and backed by prime mortgages in the US. The third chart below shows how valuations in this asset class have moved relative to corporate spreads at the BBB-rated level.

Chart 3: Basis between BBB CRT new issue and BBB Corps

identifying-dislocations-in-securitized-credit-chart-3.jpgSource: Goldman Sachs

It’s always important to ask why valuations are dislocated. In this case – supply, a technical factor, in the early part of the year overwhelmed markets as Fannie Mae and Freddie Mac worked through huge mortgage volumes which originated in 2021, as can be seen in our fourth chart. On top of this, the uncertainty of how the housing market would handle substantially higher mortgage rates fed into the volatility. This is a risk that can be mitigated by concentrating investments in more seasoned mortgages that have embedded house price appreciation, the fact that US mortgage underwriting has been high quality and that mortgages are fixed rate i.e. the existing cohort does not come under pressure purely from an increase in current mortgage rates. Going forward, mortgage issuance is expected to decline significantly due to higher rates and, as such, supply will also come down dramatically.

Chart 4: CRT New Issue Supply

identifying-dislocations-in-securitized-credit-chart-4.jpgSource: Goldman Sachs


Our final example is UK RMBS. AA-rated bonds are extremely well protected from increased fundamental risks, yet all the factors discussed above and the current uncertainty the UK faces has led these bonds to fall dramatically in price. This can be seen relative to UK corporate bonds in our fifth chart. In order for a AA-rated bond to be impaired and not return full principal, then cumulative losses need to reach around 20% in the underlying pool of mortgages – when this is compared to ~4% losses witnessed during the GFC (a period where mortgage underwriting was much worse quality), one can see that these bonds are extremely well protected fundamentally and that the change in valuations is driven by technical factors.

Chart 5: Basis between UK NC AA and UK AA corps

identifying-dislocations-in-securitized-credit-chart-5.jpgSource: Citi

In conclusion, dislocations are currently prevalent across the Securitized Credit asset class – different asset types, parts of the capital structure and geographies. These dislocations allow investors an excellent entry point on a relative and absolute basis, with the potential to generate outsized, high quality, risk-adjusted returns.

Sign up for insights by email

Subscribe now to receive the latest investment and economic insights from our experts, sent straight to your inbox.

This document is a marketing communication and it may be produced and issued by the following entities: in the European Economic Area (EEA), by BlueBay Funds Management Company S.A. (BBFM S.A.), which is regulated by the Commission de Surveillance du Secteur Financier (CSSF). In Germany, Italy, Spain and Netherlands the BBFM S.A is operating under a branch passport pursuant to the Undertakings for Collective Investment in Transferable Securities Directive (2009/65/EC) and the Alternative Investment Fund Managers Directive (2011/61/EU). In the United Kingdom (UK) by RBC Global Asset Management (UK) Limited (RBC GAM UK), which is authorised and regulated by the UK Financial Conduct Authority (FCA), registered with the US Securities and Exchange Commission (SEC) and a member of the National Futures Association (NFA) as authorised by the US Commodity Futures Trading Commission (CFTC). In Switzerland, by BlueBay Asset Management AG where the Representative and Paying Agent is BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich, Switzerland. The place of performance is at the registered office of the Representative. The courts at the registered office of the Swiss representative or at the registered office or place of residence of the investor shall have jurisdiction pertaining to claims in connection with the offering and/or advertising of shares in Switzerland. The Prospectus, the Key Investor Information Documents (KIIDs), the Packaged Retail and Insurance-based Investment Products - Key Information Documents (PRIIPs KID), where applicable, the Articles of Incorporation and any other document required, such as the Annual and Semi-Annual Reports, may be obtained free of charge from the Representative in Switzerland. In Japan, by BlueBay Asset Management International Limited which is registered with the Kanto Local Finance Bureau of Ministry of Finance, Japan. In Asia, by RBC Global Asset Management (Asia) Limited, which is registered with the Securities and Futures Commission (SFC) in Hong Kong. In Australia, RBC GAM UK is exempt from the requirement to hold an Australian financial services license under the Corporations Act in respect of financial services as it is regulated by the FCA under the laws of the UK which differ from Australian laws. In Canada, by RBC Global Asset Management Inc. (including PH&N Institutional) which is regulated by each provincial and territorial securities commission with which it is registered. RBC GAM UK is not registered under securities laws and is relying on the international dealer exemption under applicable provincial securities legislation, which permits RBC GAM UK to carry out certain specified dealer activities for those Canadian residents that qualify as "a Canadian permitted client”, as such term is defined under applicable securities legislation. In the United States, by RBC Global Asset Management (U.S.) Inc. ("RBC GAM-US"), an SEC registered investment adviser. The entities noted above are collectively referred to as “RBC BlueBay” within this document. The registrations and memberships noted should not be interpreted as an endorsement or approval of RBC BlueBay by the respective licensing or registering authorities. Not all products, services or investments described herein are available in all jurisdictions and some are available on a limited basis only, due to local regulatory and legal requirements.

This document is intended only for “Professional Clients” and “Eligible Counterparties” (as defined by the Markets in Financial Instruments Directive (“MiFID”) or the FCA); or in Switzerland for “Qualified Investors”, as defined in Article 10 of the Swiss Collective Investment Schemes Act and its implementing ordinance, or in the US by “Accredited Investors” (as defined in the Securities Act of 1933) or “Qualified Purchasers” (as defined in the Investment Company Act of 1940) as applicable and should not be relied upon by any other category of customer.

Unless otherwise stated, all data has been sourced by RBC BlueBay. To the best of RBC BlueBay’s knowledge and belief this document is true and accurate at the date hereof. RBC BlueBay makes no express or implied warranties or representations with respect to the information contained in this document and hereby expressly disclaim all warranties of accuracy, completeness or fitness for a particular purpose. Opinions and estimates constitute our judgment and are subject to change without notice. RBC BlueBay does not provide investment or other advice and nothing in this document constitutes any advice, nor should be interpreted as such. This document does not constitute an offer to sell or the solicitation of an offer to purchase any security or investment product in any jurisdiction and is for information purposes only.

No part of this document may be reproduced, redistributed or passed on, directly or indirectly, to any other person or published, in whole or in part, for any purpose in any manner without the prior written permission of RBC BlueBay. Copyright 2023 © RBC BlueBay. RBC Global Asset Management (RBC GAM) is the asset management division of Royal Bank of Canada (RBC) which includes RBC Global Asset Management (U.S.) Inc. (RBC GAM-US), RBC Global Asset Management Inc., RBC Global Asset Management (UK) Limited and RBC Global Asset Management (Asia) Limited, which are separate, but affiliated corporate entities. ® / Registered trademark(s) of Royal Bank of Canada and BlueBay Asset Management (Services) Ltd. Used under licence. BlueBay Funds Management Company S.A., registered office 4, Boulevard Royal L-2449 Luxembourg, company registered in Luxembourg number B88445. RBC Global Asset Management (UK) Limited, registered office 100 Bishopsgate, London EC2N 4AA, registered in England and Wales number 03647343. All rights reserved.

Sign up for insights by email

Subscribe now to receive the latest investment and economic insights from our experts, sent straight to your inbox.