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Structured Product Investment Highlights Investment - Attribution Were Generally Tighter Bank of New for the Month

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Structured Product Investment Highlights Investment - Attribution Were Generally Tighter Bank of New for the Month Investment Highlights 2021 FEB Structured Product The Structured Product composite returned -0.17% gross of fees for the Attribution month of February 2021. Representative Portfolio Feb 2021 (%) NARMBS Performance Review Fannie Mae/Freddie Mac Credit Securities 0.08 During the month, non-agency residential MBS (NARMBS) credit risk Pre-2007/Other NARMBS 0.33 transfer (CRT) securities issued by Fannie Mae and Freddie Mac as well as also legacy NARMBS securities contributed to performance as we CMBS continue seeing positive data releases on the US housing market. Legacy Legacy CMBS 0.00 securities remained difficult to source. Recent data on housing and mort- New Issue CMBS -0.68 gage applications has surprised to the upside for the most part, while ABS 0.06 mortgage lending rates remain low, leading to tighter spreads and higher Credit Hedge -0.04 prices for structured residential securities. By many metrics, housing has Treasury -0.11 already experienced a V-shaped recovery but spreads have lagged due to Other 0.01 continued uncertainty and less direct Federal Reserve (Fed) intervention. New-issue commercial MBS (CMBS) detracted from performance. The Accounting Difference 0.01 sector as a whole performed well in the portfolio even though certain Total -0.34 new-issue CMBS large loan credit deals detracted from returns due to Source: Western Asset. As of 28 Feb 21 deal-specific idiosyncratic developments. The asset-backed securities (ABS) sector contributed to returns and US consumer balance sheets, on the whole, remain strong supporting the sector. The fund holds interest- the US dollar was mixed versus developed market (DM) currencies but rate hedges as a hedge against risk-off and failing economic reopening generally strengthened versus emerging market (EM) currencies. environments and this position detracted from returns. Valuations Market Review According to JPMorgan, CRT markets closed the month with spreads Optimism over the global outlook continued to rise during the month widening by 22 bps to 418 bps. Legacy mortgages widened by 28 bps against a backdrop of slowing COVID-19 case counts and the anticipation to 252 bps. The S&P CoreLogic Case-Shiller 20-City Index of property of a robust spending package from the Biden administration. Markets values climbed 10.1% in December from a year earlier following a 9.2% began to anticipate that the additional fiscal stimulus and higher near-term gain in November. US home prices, fueled by the lowest mortgage rates growth might cause inflationary pressures and could result in central in history, surged in the fourth quarter, according to National Association banks raising rates earlier than previously anticipated, sending US Treasury of Realtors. (UST) yields higher on the month. The Bloomberg Barclays Non Agency CMBS Index posted a total return of Throughout the month economic data releases were mixed, with strong -1.05% for the month. The option-adjusted spread (OAS) of the index was retail sales but weaker than expected initial and continuing jobless claims. 26 bps tighter for the month, reaching 70 bps while the BBB rated piece of Toward month-end, Fed Chair Jerome Powell delivered a semiannual the index has an OAS of 531 bps. The US National All-Property Index rose monetary policy report to both the Senate Banking Committee and 6.9% year-over-year (YoY) in January, climbing back near growth rates seen the House Financial Services Committee. During his testimony, Powell before COVID-19 struck, according to RCA. The index rose 1.2% in January reaffirmed the Fed’s commitment to maintaining an accommodative from December, nearly 100 bps higher than the pace of a year ago. Office policy stance, noting that the Fed would continue to offer support to prices rebounded into the new year, up 3.3% from January 2020. While the the economy until “substantial further progress has been made,” which commercial sector remains further behind in terms of recovery, momentum is “is likely to take some time” to achieve. also building in this sector as reopening continues and properties cash flows are improving. Single Asset Single Borrower (SASB) collateral is performing In the final days of the month, the House of Representatives passed President better than conduit collateral. We believe SASB with strong equity sponsors Biden’s $1.9 trillion Covid-relief package, then sent the legislation on to will benefit as COVID-19 restrictions begin to lift and the economy moves the Senate for its vote. toward a more fulsome reopening. During the month the S&P 500 rose 2.6%, the yield on the 10-year UST The JPMorgan Asset-Backed Index was up 0.15% for the month. Floating- rose from 1.11% to 1.44%, and the front-to-intermediate segment of the rate ABS returned 0.56% while fixed-rate ABS returned 0.00%. Spreads yield curve steepened. WTI oil rose $9.30/barrel (+17.8%) to $61.50 and were generally tighter for the month. The Federal Reserve Bank of New Structured Product York released its quarterly report on household debt and credit for the to continue recovering. We believe SASB non-agency mortgages secured final three months of 2020. Credit card balances increased in the fourth by high quality commercial properties with strong equity sponsors will quarter by $12 billion, a modest seasonal increase following the sharp $76 benefit as COVID-19 restrictions begin to lift and, again, as the economy billion contraction in the second quarter and $10 billion decrease in the moves toward a more fulsome reopening. third. Credit card balances are $108 billion lower than they had been at the end of 2019, the largest yearly decline seen since the series began in The combination of better than expected fundamentals with depressed 1999, consistent with continued weakness in consumer spending as well valuations suggests significant potential for the asset class to generate as paydowns by card holders. Auto loan balances increased by $14 billion strong performance. The largest dislocated opportunities are in residential in the fourth quarter, while student loan balances increased by $9 billion. and commercial mortgage credit, which are sectors that have not received the benefit of a Fed backstop and have lagged other credit sectors in the Positioning Changes rebound since March. From a technical standpoint, mortgage credit (both During the month, we have increased exposure to ABS and NARMBS, and residential and commercial) has lagged corporate credit in the post-Covid to non-agency CMBS sectors. recovery as there has not been explicit policy support from the Fed for much of the structured credit asset class and there are uncertainties Investment Outlook impacting certain subsectors collateral performance. In corporate credit, The COVID-19 pandemic fears have turned into “reopening” optimism. the Fed’s purchase programs included significant support for investment- However, credit spreads remain wider relative to pre-Covid levels in grade-rated securities (down to BBB rated securities) and even fallen angel spite of strong consumer and US housing fundamentals. Home price credits in the high-yield segment. Within mortgage and consumer credit appreciation (HPA) posted a YoY gain of 10.4% in December 2020. Fueling markets, only AAA rated conduit CMBS and new-issue AAA rated ABS the housing boom of the post-Covid world are historically low mortgage have been supported by the Fed, which has resulted in a full recovery rates, a dismal lack of supply on the market, tight lending conditions of spread-widening in these subsectors. The team believes mortgage and a rebirth of household formations. Consumer fundamentals have credit offers value backed by real assets that benefit from a rising inflation improved post-Covid with increased savings rates, revolving consumer environment and can generate attractive risk-adjusted returns. The holdings credit outstanding YoY and lower interest rates that have decreased debt in the structured product representative portfolio are secured by assets burdens to the lowest levels in 20 years. While the commercial sector with low loan-to-value ratios and high quality borrowers with significant remains further behind in terms of recovery for certain property types recovery value and low default risk. The team believes the strong total hit hardest by the pandemic such as hotels and retail, the reopening of return potential and diversification benefits will provide value to investors. economies supported by the release of multiple effective Covid vaccines should be a positive catalyst for commercial non-agency mortgage spreads For more information on Western Asset, visit westernasset.com. © Western Asset Management Company, LLC 2021. This publication is the property of Western Asset and is intended for the sole use of its clients, consultants, and other intended recipients. It should not be forwarded to any other person. Contents herein should be treated as confidential and proprietary information. This material may not be reproduced or used in any form or medium without express written permission. Past results are not indicative of future investment results. This publication is for informational purposes only and reflects the current opinions of Western Asset. Information contained herein is believed to be accurate, but cannot be guaranteed. Opinions represented are not intended as an offer or solicitation with respect to the purchase or sale of any security and are subject to change without notice. Statements in this material should not be considered investment advice. Employees and/or clients of Western Asset may have a position in the securities mentioned. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. It is your responsibility to be aware of and observe the applicable laws and regulations of your country of residence.
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