Long-Term Bullish Outlook for the Housing Rehabilitation Industry

INSIGHTS

Long-Term Bullish Outlook for the Housing Rehabilitation Industry

May 2023

The aging U.S. housing stock, slow new home construction pace, and postpandemic shifts in housing utilization create strong tailwinds for housing rehabilitation and remodeling activity

Rehabitation and remodeling are important tools in addressing the U.S. housing undersupply problem

A recent Harvard study notes that across the U.S., 49% of owner-occupied housing was built before 1980; in certain geographic areas – including Boston, New York and Los Angeles – two-thirds or more of the owner-occupied homes were built before 1980.1 The aging of the U.S. housing stock is a consequence of the sharp slowdown in new home construction that began in 2007 and that has extended through 2023, per Exhibits 1-2 below.

The continued aging and deterioration of the U.S. housing stock points to a large market of homes in need of rehabilitation. The 2023 Harvard study notes that recent improvement spending has focused not just on cosmetic enhancements but has also been directed at core replacements of basic housing components including roofing and HVAC systems which have extended beyond their functional lifetimes.1 Pretium and our affiliated lending partner Anchor Loans believe that modernization and rehabilitation of the already existing U.S. housing stock will play an important role in addressing the general problem of housing undersupply across the country. Further, it is likely that the extensive amount of modernization required for many homes will be difficult for typical homeowners to manage and finance; rather, such extensive rehabilitation will often be most conveniently executed by professional developers who purchase homes for sale, bring them up to modern standards, and then subsequently resell the homes once the improvements are complete.

Post-pandemic shifts in living patterns provide additional positive impulse for home improvement

Post-pandemic changes in patterns of housing activity are another force that is likely to put upward pressure on the demand for home improvements. Measures of U.S. office space occupancy remain at below 50% of pre-COVID levels, now three years after the initial pandemic shock (Exhibit 3), suggesting that the move towards work-from-home has become structural. Exhibit 4 relatedly shows a large increase in inflation-adjusted consumer spending on categories such as exercise equipment and furniture since the start of the pandemic. With the growing amount of both work and leisure activity taking place at home, homeowners will demand newer and better housing features that can support these pursuits. Again, it is likely that the extensive home remodeling needed to bring housing quality and size up to the level that can facilitate increased home-centered living activity will often be most efficiently executed by professionals with access to scale economies and efficient and stable financing vehicles.

Demographic trends are supportive of housing rehabilitation

Not only is the U.S. housing stock aging, the population of U.S. homeowners and homebuyers is aging as well. The National Association of Realtors has noted that over 40% of all the 2022 U.S. home purchases were made by homebuyers from the so-called baby-boomer or silent generation cohorts6; per Exhibit 5, the share of homes purchased by older homebuyers has trended higher over the past two decades. An older homebuying population will likely be supportive of housing rehabilitation activity: the Harvard home improvement study notes that older homeowners will tend, for example, to value homes modified for improved accessibility and safety. Older homebuyers also have relatively high levels of average net wealth, per Exhibit 6 below, to help facilitate the purchase of improved homes.

The aging of the U.S. housing stock, combined with post-pandemic shifts in lifestyles that benefit from expanded and modernized single-family housing, and demographic trends leading towards an elevated share of older homebuyers, are strong tailwinds for the housing rehabilitation industry. Pretium and Anchor Loans remain constructive on the long-term outlook for the professional home improvement sector and look forward to playing a role in the ongoing process of rehabilitation of the U.S. housing supply.

This is not an offer, advertisement, or solicitation for interests in any Pretium managed vehicle and should not be construed or relied upon as investment advice or as predictive of future market or investment performance. Past performance is not indicative of future results.


1. “Improving America’s Housing 2023”, Harvard Joint Center for Housing Studies, March 2023.
2. American Community Survey, Pretium. Data as of December 2021.
3. Census Bureau, Pretium. Data as of February 2023.
4. Kastle, Pretium. Data as of April 2023.
5. BLS, Pretium. Data as of December 2021.
6. “2022 Home Buyers and Sellers Generational Trends Report”, NAR, March 2023. Boomer and Silent Gen cohorts are defined as the groups born during 1946-1964 and 1925-1945, respectively.
7. FHFA National Mortgage Database Program, Pretium. Data through June 30, 2022.
8. “2022 Home Buyers and Sellers Generational Trends Report”, NAR, March 2023.

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2021 Single-Family Rental Factsheet

2021 U.S. Housing Outlook

Pretium’s Second State of ESG Report

INSIGHTS

Pretium's Second State of ESG Report

April 2023

The past year of our environmental, social, and governance journey features milestones for Pretium and our operating companies.

We believe sound ESG principles and practices can help maximize returns to our investors by having a positive impact on our employees, our residents, our borrowers, the communities in which we operate, and the businesses we serve.

Opportunities for Generating Alpha in the U.S. CLO Market

INSIGHTS

CLO Performance Report, April 2023

April 6, 2023

U.S. CLO debt offers high average yields due to persistent complexity and liquidity premiums, with return dispersion providing opportunities for generating alpha through active management

CLO debt offers strong average returns due to persistent complexity and liquidity premiums

CLO debt securities have historically delivered strong positive returns across a wide range of economic environments: Exhibit 1, below, shows that BB-rated CLO bonds have outperformed leveraged loans and high yield corporate bonds over the past 3-year, 5-year, 7-year and 9-year horizons. Pretium believes CLO debt has the potential to continue to outperform other assets with comparable ratings profiles: Exhibit 2, for example, shows that BB CLOs currently offer average yields of 13.7%, 6.5% above the yields available on similarly rated corporate bonds. Exhibits 1 and 2 represent the average opportunity accessible through the CLO market – that is, by passively allocating to the entire universe of outstanding BB CLO debt instruments, an investor can earn high average returns relative to the returns available from competing asset classes due to the persistent presence of a CLO complexity premium.

CLO debt offers significant alpha opportunities

In addition to the opportunity for earning strong average index-level returns, the CLO market also features a meaningful amount of return dispersion across different CLO transactions; as a result, there is potential for earning additional alpha returns through judicious active selection of specific CLO bonds. Exhibit 3, for example, shows the annualized total unlevered returns of the underlying loan portfolios for the population of CLOs issued between 2013 and 2022: for a typical quarterly vintage of CLO transactions (e.g., those issued in 2019Q2), the range of loan portfolio returns exceeds 200bp. Given the degree of natural leverage embedded within CLO transaction structures, this amount of return dispersion across loan portfolios translates into an even larger amount of dispersion in returns for junior CLO debt and equity tranches, providing an alpha-rich environment for active CLO investors.

Exhibit 3 highlights one potential means by which active CLO bond investors might outperform the index – namely, by identifying specific CLO managers whose loan portfolios consistently manage to deliver high average returns. In this Exhibit, the loan portfolio returns delivered by one particular CLO manager, here labeled as “Manager X”, are seen to frequently come in near the high ends of the ranges of returns of CLOs issued in nearby time periods. CLO bond investors with tools for and expertise in monitoring CLO manager performance may thus be able to generate alpha by over-allocating to CLO bonds issue by such high-performing managers.

Exhibit 4 shows an alternative sample screen that may be used to actively select CLO bonds with high return potential. The chart in this Exhibit compares the yields on BB CLO bonds traded in the secondary market in the month of February 2023 to a proprietary quantitative measure of risk levels of the bonds. The bond yield and the aggregated risk measure levels are fairly highly correlated, with high risk bonds usually trading at wide spread levels, suggesting the CLO market is roughly efficient. However, there are bonds, such as the ones labeled “Bond Y” and “Bond Z” in the chart, which appear to have high yields relative to the measured amount of risk. CLO investors aided by tools that can similarly help identify bonds with high risk-adjusted yields thus have the potential to generate positive alpha and deliver returns above those earned by the broad CLO index.

The CLO asset class has grown significantly over the past two decades, in large part because of the consistently strong performance of the sector through a wide range of economic scenarios including the global financial crisis episode. The CLO sector offers strong index-level return potential given the high average yields available across the sector’s bonds; there are also meaningful opportunities for earning alpha, or extra returns above the average CLO index, via active management. The potential for earning high returns from CLOs in the current environment suggests that many investors who allocate to sectors such as high yield corporate bonds could benefit from investing as well in CLO debt.

Confidentiality and Other Important Disclosures

This confidential presentation was prepared exclusively by Pretium for the benefit and internal use of the party to whom it is directly addressed and delivered (the “Recipient”). None of the materials, nor any content, may be altered in any way, transmitted to, copied, reproduced or distributed in any format in whole or in part to any other party without the prior express written consent of Pretium. As used in this presentation, “Pretium” refers to Pretium Partners, LLC and/or its affiliates.

Pretium’s Credit investment strategies are focused on corporate credit, structured products collateralized by corporate credit, distressed debt and equity and legal opportunities financing. The team invests in broadly syndicated loans, debt and equity of public and private companies, as well as securities issued by CLOs. Investments in high yield securities are subject to greater risk of loss of principal and interest than higher-rated securities and are generally considered to be predominantly speculative with respect to the issuer’s capacity to pay interest and repay principal. Investments in distressed situations expose the investor to the difficulty in obtaining information as to the issuer’s true condition; legal risk, including laws relating to fraudulent conveyances, voidable preferences, lender liability, and bankruptcy; litigation risk; and liquidity risk. In addition, accounts will not be diversified among a wide range of types of securities, industry, markets, or countries. Litigation finance depends on whether the cases in which the fund invests will be successful, will pay the targeted returns and will pay those returns in the anticipated time. Assessing the values, strengths and weaknesses of a case is complex and the outcome is not certain. Should cases, claims, defenses or disputes in which the fund invests prove to be unsuccessful or produce returns below those expected, the performance of the fund could be materially adversely affected. Furthermore, laws and professional regulations in litigation funding can be complex and uncertain and details of certain cases are unlikely to be disclosed because of confidentiality and other restrictions.

There can be no assurance that Pretium’s objectives will be achieved, that any risk management will adequately protect against downside losses, or that an investor will receive any return on its investment. An investment should only be considered by persons who can afford a loss of their entire investment. Past activities of investment entities sponsored by Pretium provide no assurance of future results. Past or targeted performance is not a guarantee, projection or prediction and is not necessarily indicative of future results.

These materials do not constitute, or form part of, any offer to sell or issue interests in an investment vehicle or any other entity. Any such offer or solicitation will be made solely by means of a definitive offering document, which will describe the actual terms of any securities offered and will contain material information regarding the securities. Any information contained herein will be superseded by information delivered to Recipient as part of an offering document. No representation, warranty or undertaking, express or implied, is given as to the accuracy or completeness of the information or opinions contained herein.

Past performance is not necessarily indicative of future results and there can be no assurance that targeted returns will be achieved. There can be no assurance that Pretium will achieve results comparable to or that the returns generated will equal or exceed those of other investment activities of Pretium or that Pretium will be able to implement its investment strategy or achieve its investment objectives. Pretium does not make any representation or warranty, express or implied, regarding future performance.

Certain information contained in these materials constitute “forward-looking statements,” which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “seek,” “expect,” “anticipate,” “project,” “estimate,” intend,” continue,” “target,” “plan,” “believe,” the negatives thereof, other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events or results of the actual performance of an investment vehicle or strategy may differ materially from those reflected or contemplated in such forward-looking statements.

Certain information contained in this presentation has been obtained from published and non-published sources prepared by third parties, which, in certain cases, have not been updated through the date hereof. While such information is believed to be reliable, Pretium has not independently verified such information nor does it assume any responsibility for the accuracy or completeness of such information. Except as otherwise indicated herein, the information, opinions and estimates provided in this presentation are based on matters and information as they exist as of the date these materials have been prepared and not as of any future date and will not be updated or otherwise revised to reflect information that is subsequently discovered or available, or for changes in circumstances occurring after the date hereof.

These materials are intended to assist the Recipient in connection with its due diligence and to assist the Recipient in understanding the strategies that Pretium intends to pursue to seek to maximize portfolio performance. They are not intended as a representation or warranty by Pretium as to the actual composition or performance of any future investments that would be made by Pretium. Assumptions necessarily are speculative in nature. It is likely that some or all of the assumptions underlying the potential investments will not materialize or will vary significantly from any assumptions made (in some cases, materially so). The Recipient should understand such assumptions and evaluate whether they are appropriate for its purposes.

Recipients should note that COVID-19 has, among other things, significantly diminished global economic production and activity of all kinds and has contributed to both volatility and a decline in all financial markets. The ultimate impact of COVID-19 — and the resulting precipitous and near simultaneous decline in economic and commercial activity across several of the world’s largest economies — on global economic conditions, and on the operations, financial condition and performance of any particular industry or business, is impossible to predict, although ongoing and potential additional materially adverse effects, including a further global or regional economic downturn (including a recession) of indeterminate duration and severity, are possible. The extent of COVID-19’s impact will depend on many factors, including the ultimate duration and scope of the public health emergency and the restrictive countermeasures being undertaken, as well as the effectiveness of other governmental, legislative and financial and monetary policy interventions designed to mitigate the crisis and address its negative externalities, all of which are evolving rapidly and may have unpredictable results. Even if and as the spread of the COVID-19 virus itself is substantially contained, it will be difficult to assess what the longer-term impacts of an extended period of unprecedented economic dislocation and disruption will be on future macro- and micro-economic developments, the health of certain industries and businesses, and commercial and consumer behavior.


1. Bloomberg, Markit, Palmer Square, Pretium. Leveraged loan, high yield bond, and CLO returns are derived from the Markit iBoxx USD Liquid Leveraged Loans Total Return Index, the Bloomberg High Yield Corporate Bond Total Return Index, and the Palmer Square BB CLO Total Return Index, respectively, Data as of January 2023. Bloomberg, Pretium. Data as of February 2023.
2. Bloomberg, Pretium. Data as of February 2023.
3. Pretium. Data as of January 2023.
4. Pretium. Data as of February 2023.

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Pretium’s Housing Insights, February 2023

INSIGHTS

Pretium’s Housing Insights, February 2023

February 28, 2023

Summary

Single-family and multifamily supply outlooks have diverged meaningfully.

It will likely take much longer to absorb multifamily vs. single-family units under construction.

During the pandemic, both single-family and multifamily construction climbed in response to strong home purchase and rental demand. The contraction in construction over the past nine months has played out differently, with single-family construction falling sharply while multifamily construction has been much slower to react. As of January, single-family starts have been falling for a year and are already down 35% from their pandemic peak; on the other hand, multifamily starts were still reaching new multidecade highs in November1. The differing trajectories are partly driven by the inherently greater flexibility of single-family homebuilding where each unit is started independently vs. multifamily projects where all units in a structure are started at once. Also, single-family projects typically have shorter timelines and are less complex compared to multifamily projects2. Finally, since 95% of singlefamily homes are built for homeowners, their rate of building is especially sensitive to changes in consumer behavior and mortgage rates; on the other hand, 94% of multifamily units are built for investors who have longer-term time horizons3.

The difference in trajectories of single-family vs. multifamily construction has important implications for the rate at which construction backlogs are likely to be worked down. The number of housing units under construction reached record highs during the pandemic driven by the synchronized surge in home purchase and rental demand. The sharp contraction in single-family construction means that as of January, the pace of single-family completions is 45% higher than the pace of new single-family units being permitted1. As shown in Exhibit 1, single-family construction backlogs have been falling since mid-2022 and at their current pace of decline will be back at pre-pandemic levels by mid-2024. By contrast, multifamily construction backlogs are still rising since multifamily permits remain 70% higher than multifamily completions. As shown in Exhibit 2, multifamily construction backlogs are approaching their all-time highs of 994,000. Even if multifamily construction backlogs began to decline immediately, Pretium estimates that it could take until mid-2026 for multifamily construction backlogs to return to their pre-pandemic levels.

As described in Pretium’s November 2022 Housing Insights, we believe that supply-demand imbalance will remain a central driver of US housing market dynamics4. Elevated construction pipelines aren’t enough to resolve a supply-demand imbalance that measures in the millions5; however, they do represent both an investment risk and opportunity as developers work their backlogs down. Over the next 12-18 months, we expect single-family homebuilders to continue to be proactive in working to reduce their construction backlogs, but not in a manner broadly disruptive to single-family home prices. The multifamily outlook is cloudier given the continued momentum of construction and the potentially long period over which it will be resolved.

Exhibit 1

Exhibit 2

Source: US Census, New Residential Construction, as of January 2023.

Want more Housing Insights from Pretium?: Increased long-distance migration persisted in 2022

This is not an offer, advertisement, or solicitation for interests in any Pretium managed vehicle and should not be construed or relied upon as investment advice or as predictive of future market or investment performance. Past performance is not indicative of future results.


1. US Census, New Residential Construction, as of January 2023.
2. NAHB, “Slightly Longer Time to Build Apartments in 2021”, July 7, 2022 and “How Long Does it Take to Build a Single-Family Home”, September 30, 2020.
3. US Census, “Quarterly Starts and Completions by Purpose and Design”, as of 3Q22.
4. Pretium Housing Insights, “The US is already underbuilding again, worsening the long-term supply shortage”, November 2022.
5. Pretium White Paper, “The US Housing Shortage”, October 26, 2021.

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2021 U.S. Housing Outlook

Pretium’s Housing Insights, January 2023

INSIGHTS

Pretium’s Housing Insights, January 2023

January 26, 2023

Summary

Increased long-distance migration persisted in 2022

The pandemic is likely to have a structural, long-term impact on housing demand

One of the most important debates about the pandemic’s impact on the housing market is whether the surge in demand that began in mid-2020 is a temporary or structural phenomenon. There are numerous indicators of structural pandemic driven changes in household behavior, including the persistence of work-from-home,1 increased online shopping,2 a greater focus on wellness,3 and elevated business formations.4 However, many investors still question whether the pandemic simply pulled forward housing demand, especially since rising rates have obscured underlying trends. Consumer surveys find that households continue to expect the pandemic to have a permanent impact on their housing choices.5 Also, recently released data from the Census indicates that the pandemic boost to long distance migration accelerated well into 2022 even as many other aspects of life returned to prepandemic patterns.6 The Census data is notable because it is a direct measurement of long-distance migration whereas indirect measurements of migration such as postal change of address forms had indicated that migration slowed during 2022.7

As shown in Exhibit 1, interstate migration increased meaningfully in the year ending July 1, 2021 – the first year of the pandemic. If the pandemic’s impact on housing demand was mainly temporary in nature, migration levels should have slowed in the second year of the pandemic as its impact on day-today life waned. Instead, interstate migration increased further in the year ending July 1, 2022 to 1.5x pre-pandemic levels. As shown in Exhibit 2, the increase in migration was a combination of larger outflows from states such as California and New York as well as larger inflows into states such as Florida and Texas. Migration levels are likely to decrease as higher mortgage rates and a slowing economy limit households’ financial ability to move; however, online home search activity indicates that the desire to move to a different metro continued to increase in 2H22.8 Pretium believes that migration data demonstrates the likely structural impact of the pandemic on long-term housing demand and that this increased demand should become apparent again as economic and rate pressures ease.

Exhibit 1

Exhibit 2

 

Source: US Census, Population and Housing Unit Estimates, 2022 Vintage as of December 2022. Years are measured from July 1 to July 1. Top 5 states are Florida, Texas, North Carolina, South Carolina and Tennessee; Bottom 5 states are California, New York, Illinois, New Jersey and Massachusetts.

Want more Housing Insights from Pretium?: Expanding Build-to-Rent Construction Increases Housing Supply and Preserves Rental Access

Statements above regarding the housing market represent the opinions and beliefs of Pretium. There can be no assurance that these will materialize. This is not an offer, advertisement, or solicitation for interests in any Pretium managed vehicle and should not be construed or relied upon as investment advice or as predictive of future market or investment performance. Past performance is not indicative of future results.


1. Barrero, Bloom & Davis, “Why working from home will stick,” National Bureau of Economic Research Working Paper 28731. Data as of January 17, 2023.
2. US Census, Monthly Retail Trade Quarterly E-Commerce Report, Data as of November 18, 2022.
3. McKinsey & Company, “Still feeling good: The US wellness market continues to boom”, September 19, 2022. Placer.AI Quarterly Index – Q4 2022, January 2023.
4. US Census, Business Formation Statistics, Data as of January 17, 2023.
5. UBS, “UBS Evidence Lab inside: 4Q housing intentions remain resilient despite affordability headwinds”, January 5, 2023.
6. US Census, Population and Housing Unit Estimates, 2022 Vintage. Data as of December 2022.
7. Bloomberg, “Urban Migration Slows in 2022 for Many Major US Cities”, September 3, 2022.
8. Redfin, “Homebuyers Are Flocking To The Sun Belt, Attracted To Relatively Affordable Home Prices”, December 19, 2022.

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2021 U.S. Housing Outlook

Pretium’s Housing Insights, December 2022

INSIGHTS

Pretium’s Housing Insights, December 2022

December 21, 2022

Summary


Expanding build-to-rent construction increases housing supply and preserves rental access

Build-to-rent typically produces smaller, more affordable homes that are in shortest supply

Pretium believes single-family rentals are an essential part of the US housing landscape because they provide access to suburban neighborhoods where opportunities and amenities for residents have historically been most abundant.1 Unfortunately, the housing market has over time struggled to create enough rentals in single-family neighborhoods. Recent research by Harvard’s Joint Center for Housing Studies finds that rental deserts — neighborhoods with the fewest rental options — tend to be disproportionately found in suburban locations.2 We believe the primary driver of the shortfall of single-family rental options is that relatively few single-family homes have historically been built as rentals. As shown in Exhibit 1, over the past 10 years only 5% of single-family homes were built as rentals — a much smaller proportion than the 18% of existing single-family homes that serve as rentals. The burden to create single-family rentals thus falls on investors purchasing existing homes; however, as described in Pretium’s October Housing Insights the stock of single-family rentals fell during the pandemic despite increased investor activity.3 Build-to-rent capital flows have increased in recent years4 and residential land surveys show increased activity in the build-to-rent sector5, but even with this increased activity the percent of homes built for rent in the four quarters ending 3Q22 was just 6%.6 Overall, the data suggests that there is considerable scope to increase investment in the build-to-rent sector. Not only would this investment broaden access to single-family rentals; but also, it would help to alleviate the long-term housing supply shortage that has worsened housing affordability. 

Growth in the build-to-rent sector would be particularly beneficial in terms of creating new housing supply because the sector has consistently built smaller, more affordable units compared to homes that are built for sale/ownership. As shown in Exhibit 2, the existing stock of single-family rentals is both older and smaller than the existing stock of owned homes. Importantly, homes built for rent in 2021 remain similar in size to existing singlefamily rentals at just over 1,500 sq. ft. By contrast, homes built for sale have become progressively larger over time to the extent that recently built homes for sale are 17% larger than existing owned homes. In other words, even as worsening supply constraints over time have prompted homebuilders to build larger homes for sale, the build-to-rent sector has maintained its focus on creating the affordable home supply that is in greatest need. 

 

 


Source: US Census, American Housing Survey, 2021; Annual Characteristics of New Housing, 2021; Quarterly Starts and Completions
by Purpose and Design, as of 3Q22. % of Construction is calculated on a trailing 10-year basis as of 3Q22.

1. Whitney Airgood-Obrycki, “Suburban Status and Neighbourhood Change”, Urban Studies, November 2019.
2. Harvard Joint Center for Housing Studies, “Rental Deserts Perpetuate Socioeconomic and Racial Segregation”, August 4, 2022.
3. “Investor activity in housing had no discernible impact on homeownership during the pandemic”, Pretium Housing Insights, October 2022.
4. John Burns Real Estate Consulting, “The Light: Now Tracking $50+ Billion of Capital Flooding SFR and BTR Sector”, January 28, 2022.
5. John Burns Real Estate Consulting, “3Q22 Residential Land Survey”, October 26, 2022.
6. US Census, Quarterly Starts and Completions by Purpose and Design, as of 3Q22.

This is not an offer, advertisement, or solicitation for interests in any Pretium managed vehicle and should not be construed or relied upon as
investment advice or as predictive of future market or investment performance. Past performance is not indicative of future results.

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The Strategic Case for CLOs vs. High Yield Corporate Bonds

INSIGHTS

CLO Performance Report, December 2022

December 8, 2022

Summary


BB CLOs earn a persistent yield premium – currently over 6% - relative to corporate bonds of equal risk

Pretium believes that most investors who are allocating to high yield corporate bonds should also be considering bonds from the collateralized loan obligation (CLO) sector as well. Per Exhibit 1 below, BB rated CLO bonds have market yields of 13.9% as of November 22, 2022, vs. an average 7.2% yield for BB corporate bonds. Exhibit 2 shows that the extra yield that CLOs earn vs. corporate bonds, the CLO’s “complexity premium”, has grown in recent months, a trend that, we think, has improved the long-run value proposition associated with CLO debt. This yield premium reflects index, or average returns – i.e., “beta”. Industry researchers appear to share the view that CLOs can offer value, as highlighted by the quotations below:

  • Morgan Stanley: “…we believe that the CLO market has more than priced in the downside risks, providing a large margin of safety and attractive risk-reward profile in the debt stack.”1
  • Bank of America: “We continue to see good value in securitized products credit relative to corporate credit, notably in credit risk transfer and CLOs.”2

This is not an offer, advertisement, or solicitation for interests in any Pretium managed vehicle and should not be construed or relied upon as investment advice or as predictive of future market or investment performance. Past performance is not indicative of future results.

While CLOs offer higher yields vs. corporate bonds, a Federal Reserve Bank of Philadelphia study shows that CLO bond instruments have historically had lower default rates compared with the default rates on similarly rated corporate bonds.4 CLOs are backed by senior secured bank loans to corporations, which typically offer higher recovery rates compared with unsecured corporate bonds5; this relatively high collateral quality has helped to limit losses for CLO bond investors. 

CLOs don’t require investors to make material bets on the direction of interest rates

The floating rate nature of CLO bonds tends to reduce risks to investors in high inflation, rising interest rate environments. The BBB rated corporate bond index has suffered a 17% loss in 2022 year-to-date through November 18, 2022; by contrast, the BBB rated CLO index has experienced just a 5% loss, reflecting the relatively lower sensitivity of CLOs to interest rate market drivers including inflation and Federal Reserve policy shifts.6

The CLO asset class has become too large to ignore

CLOs have become a large asset class; in part because of the strong and stable historical performance of the sector, the US CLO market has grown so that over 65% of the $1.4 trillion of leveraged loan debt outstanding is now owned within CLO vehicles.7 Reflecting the growth and maturation of the CLO asset class, a broad range of financial institutions – including banks, insurance companies, mutual funds, pension funds, private equity funds, private credit funds, and hedge funds – are now investing in CLOs.

Why do CLOs earn higher yields than comparably rated corporate bonds?

There are a few possible explanations for why bonds from the CLO sector consistently tend to earn higher yields in comparison with fixed rate corporate bonds. For one, while CLO liquidity has increased over time as the sector has grown, the bonds are not yet quite as liquid as generic corporate bonds. Second, CLO bond cashflows are determined by the performance of a pool of underlying loan assets, and so there may be a complexity premium vs. fixed rate bonds, which are simpler instruments with cashflows driven by a single underlying reference credit. Finally, we think the premium associated with CLOs in part reflects broad underinvestment in the sector, due to investor concerns that CLOs were connected to the problems associated with the global financial crisis. These concerns are, we think, misplaced; while CDO, RMBS and CMBS instruments indeed suffered high default rates in the 2007-2014 period, CLO structures performed far better, with low default rates and high realized returns.8 

In light of the current high yields offered by CLO debt instruments, and the relative return stability of CLOs in periods of volatile interest rates, we think incorporating CLO debt can improve the risk/return profiles of many investors’ portfolios.


1. Source: Morgan Stanley, 2023 US CLO Outlook: Margin of Safety, November 2022.
2. Source: Bank of America, Securitization Weekly, November 4, 2022.
3. Source: Bloomberg, BCBAYW BB Corporate Bond Index and Palmer Square PCLOBBY BB CLO Index, Pretium internal analysis; as of November 22, 2022.
4. Source: “CLO Performance”, Federal Reserve Bank of Philadelphia Working Paper No. 20-48, November 2021, Table 7: Default Rates for CLO Tranches and Corporate Bonds.
5. Source: “Annual default study: After a sharp decline in 2021, defaults will rise modestly this year”, Moody’s, Exhibit 6, February 2022.
6. Source: Bloomberg, LCB1TRUU BBB Corporate Bond Index and Palmer Square PCLOBBBT BBB CLO Index, Pretium internal analysis; as of November 18, 2022.
7. Source: BoA, US CLO Outstanding by Rating, as of November 23, 2022.
8. Source: CLO Performance Report, November 2022, Pretium Partners: https://pretium.com/clo-performance-report.
9. Source: Bloomberg, BCBAYW BB Corporate Bond Index and Palmer Square PCLOBBY BB CLO Index, Pretium internal analysis; as of November 22, 2022.
10. Source: Pretium calculation – BB annual yield compounded over a 5-year period.
11. Source: Bloomberg, BCBATRUU BB Corporate Bond Index and Palmer Square PCLOBBTR BB CLO Index, Pretium internal analysis; as of November 23, 2022.
12. Source: BofA CLO Factbook, Bloomberg LF98TRUU High Yield Corporate Bond Index, Pretium internal analysis; as of November 23, 2022.

Pretium’s Housing Insights, November 2022

INSIGHTS

Pretium’s Housing Insights, November 2022

November 30, 2022

Summary


The US is already underbuilding housing again, worsening the long-term supply shortage

Single-family housing construction has fallen meaningfully below long-term averages1

Rising rates have achieved the Federal Reserve’s intended effect of dampening housing demand and bringing down the rate of home price and rent growth. But increased demand was just one side of a historic supply-demand imbalance that drove rapid home price and rent growth during the pandemic. The other side was years of underproduction leading up to the pandemic, especially of single-family homes. The Fed induced rate shock may have brought housing supply & demand back into balance; however, it has also prompted builders and developers to sharply reduce rates of construction, particularly of single-family homes. Consensus forecasts call for rates of construction to continue to decline into 2023, which means the pandemic construction surge lasted less than two years. This wasn’t enough to address housing’s pre-pandemic housing shortage, let alone a post-pandemic housing market that could feature structurally higher levels of demand driven by factors such as hybrid work, increased migration, and an increased focus on the home. Longer-term, Pretium expects that the housing supply shortage is likely to remain a central driver of US housing market dynamics and that this supply shortage will be more pronounced for single-family vs. multifamily homes. 

Permits are the first step in the construction process and monthly permits trends provide an early gauge of overall housing construction levels. In October, US housing permits are down nearly 20% from their early 2022 peaks. As shown in Exhibit 1 this decline is almost entirely driven by declining single-family permits that are down roughly 30%; by contrast, multifamily activity is down just 5%. Single-family permits fell below the rate of single-family completions in June, so homebuilder construction backlogs have been declining since then. On the other hand, multifamily permits remain well above multifamily completions and construction backlogs are still increasing. In the near-term single-family homebuilders have curtailed production more sharply than multifamily developers because of the sensitivity of home purchase demand to rising mortgage rates; over the longer-term, Pretium believes that land and housing supply constraints are also more acutely felt in the single-family market. 

 

Starts represent ground-breaking for new homes and provide the longest time series for analyzing levels of construction. As shown in Exhibit 2, the average level of single-family starts since 1959 has been 1.02 mm. October’s single-family starts pace of 0.86 mm is 16% below this long-term average and consensus forecasts project construction levels to continue to decline in 2023. For example, Fannie Mae forecasts that single-family starts will decrease to 0.79 mm in 2023. Multifamily starts remain above their long-term average, but the decrease in single-family activity has been significant enough to drive overall housing starts below their long-term averages. If housing starts begin to recover in 2024 at the same roughly 6% annual growth rate the market experienced from 2013-19, it could take until 2027 for total housing starts to again exceed their long-term averages. This would result in a 20-year period from 2007-2026 where total housing starts only exceeded their long-term average for two years during the pandemic. 


1. Source: US Census, New Residential Construction, as of October 1, 2022; Fannie Mae Housing Forecast, as of October 10, 2022. 

This is not an offer, advertisement, or solicitation for interests in any Pretium managed vehicle and should not be construed or relied upon as investment advice or as predictive of future market or investment performance. Past performance is not indicative of future results.

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CLO Equity Delivered Strong Returns Through the Financial Crisis Period

INSIGHTS

CLO Performance Report, November 2022

November 10, 2022

Summary


CLO equity delivered strong returns through the financial crisis period

During the Global Financial Crisis (GFC) episode, default rates on the bonds issued by collateralized loan obligations, or CLOs, were far lower than those for other structured credit products such as CDOs, RMBS, CMBS, and ABS. Legacy structured finance CDOs (SF CDOs) and subprime RMBS had average annualized impairment rates of 24.1% and 10.0% respectively, vs. just 0.2% for CLO debt tranches (Exhibit 1). CLO equity tranches also performed well through the GFC. A study by researchers at the Federal Reserve Bank of Philadelphia finds that the median CLO equity tranches issued during 2005-2007 earned 13%-18% lifetime IRRs (Exhibit 2). In contrast, most of the equity and debt securities from RMBS, CMBS, and CDO transactions from the same period experienced negative returns.

How were CLOs able to avoid the distress experienced by so many seemingly similar sectors during the financial crisis? We highlight three factors that contributed to the success of CLO equity and that differentiated CLOs relative to other structured finance asset classes of this era:

  • Long-term funding: CLO equity tranches achieve leverage via long-term funding at fixed credit spreads. As a result, CLO managers were not forced to sell loan assets in the periods of deep market distress experienced during the GFC. By contrast, structures that relied on shorter term funding instruments (e.g., repo financing) faced margin calls and thus were forced to sell assets at distressed prices, eroding returns.

  • Benefits of senior-secured corporate lending: The business loans that back CLOs are senior in the issuers’ capital structures and are typically secured by real estate or other corporate assets. As a result, the recovery rates on loans have historically been much higher than for high yield corporate bonds, say, which are typically junior and unsecured. The high recovery rates on defaulted CLO loan assets in turn helped to limit the losses experienced by CLO equity and debt investors during the financial crisis period.

  • Industry diversification: CLO collateral pools are highly diversified across industry sectors. Most prospectuses limit the fraction of total pool balance that can be allocated to any one sector or obligor. By contrast, many other structured finance products were backed by highly similar assets (such as mezzanine subprime RMBS bond tranches in the case of CDOs)1, which all defaulted at the same time when US real estate prices declined and mortgage foreclosure rates rose.

We believe that the factors above which contributed to solid CLO equity returns during the financial crisis period continue to be broadly relevant going forward. While past performance is never a guarantee of future returns, the resilience shown by CLO equity through the historically extreme global financial crisis scenario helps contribute to confidence that the strategy can offer positive returns even if, as we expect, economic volatility remains elevated over the medium-term horizon.


1. “Collateral Damage: Sizing and Assessing the Subprime CDO Crisis”, Federal Reserve Bank of Philadelphia Working Paper No. 11-30/R.

Pretium’s Housing Insights, October 2022

INSIGHTS

Pretium’s Housing Insights, October 2022

October 26, 2022

Summary


Investor activity in housing had no discernible impact on homeownership during the pandemic

The stock of single-family rental housing has been falling in recent years

One of the more persistent housing narratives to emerge during the pandemic is that a dramatic increase in investor activity has limited the ability of aspiring homeowners to purchase single-family homes. As widespread as this narrative is, it doesn’t stand up to basic scrutiny. The US homeownership rate rose through the pandemic at the same trajectory it was rising pre-pandemic (Exhibit 1). As of 2Q22, the homeownership rate reached 65.8%, up 170 bps from 2Q19 and above the long-term average of 65.2%. If investor activity has been crowding out individual home purchases the homeownership rate would have at best been flat or potentially declining.

Also, recently released data from the Census indicates that the total stock of single-family rental units fell by more than 100,000 to 14.3 mm in 2021 from 2019; by contrast, the stock of single-family owned homes increased by 4.5 mm during the same period (Exhibit 2). In the single-family market investor activity during the pandemic appears to have created no impediment for owner-occupiers. In 2022, investor activity in the housing market has slowed along with the purchase market and in the coming years we would expect it to continue to have little to no impact on owner-occupier trends.

The narrative about investor activity and homeownership largely rests on new data released during the pandemic that portrays record levels of investor buying in 2021; however, this data is far from conclusive. It is directly contradicted by other analyses that show investor buying was at historically normal levels during the pandemic and in fact has been falling in recent years. Even if investor buying trends could be accurately captured, it would only tell half the story. It is equally as important to consider investor sales – a recent study found the smaller investors sold 50% more homes in 2021 than they bought. Since smaller investors hold roughly 97% of single-family rental homes, this helps to explain why single-family rentals fell as a share of the overall housing stock during the pandemic.

If anything, the data argues that more investment in single-family rental housing is needed. The Harvard Joint Center for Housing Studies recently found that rental housing options are most lacking in suburban, single-family neighborhoods. Not only will increased investment in single-family rentals broaden access to the opportunities that high quality single-family housing brings for its residents; but also, increased investment is necessary to resolve US housing’s overall supply shortage.


1. Redfin and CoreLogic Investor Buying Analyses, both as of August 2022..
2. National Association of Realtors, “Impact of Institutional Buying on Home Sales and Single-Family Rentals”, May 2022; Freddie Mac, “What Drove Home Price Growth and Can It Continue?”, June 9, 2022.
3. CoreLogic, “Small Investors Chose to Sell Properties Rather than Rent Them During the Pandemic”, September 5, 2022.
4. Pretium calculations based on John Burns Real Estate Consulting Single-Family Rental Properties by Large Operator data, retrieved October 2022 and US Census, American Community Survey 1-Year Estimates, 2021.
5. Harvard JCHS, “Rental Deserts Perpetuate Socioeconomic and Racial Segregation”, August 4, 2022.

This is not an offer, advertisement, or solicitation for interests in any Pretium managed vehicle and should not be construed or relied upon as investment advice or as predictive of future market or investment performance. Past performance is not indicative of future results.

Related Content

2021 Single-Family Rental Factsheet

2021 U.S. Housing Outlook

 

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