Voya Perspectives

Market Insight

Credit Strategies for the End of the Cycle

The Power of Securitized Credit in Diversifying Fixed Income Portfolios
Executive Summary
■■ Understanding the differences between the current market environment and the dynamics leading up to the 2008
Dave Goodson
Head of Securitized crisis can help investors more effectively prepare their portfolios for the next phase of the cycle.
■■ While housing was a significant catalyst of the last crisis, a closer look at today’s economic data reveals that
residential mortgage debt and the consumer are actually in the earlier innings of their cycle when compared to
corporate debt.
■■ By providing exposure to residential mortgages and the consumer, we believe securitized credit can help investors
improve their credit risk profile.

The Next Cycle is Always Different: Yesterday’s Risk will not Write Tomorrow’s Headlines
In the current market environment, many investors are focused on balancing the need for growth with downside
protection. In this context, we believe the current yield potential, floating-rate instruments and structural protections
Colin Dugas, CFA of securitized credit are particularly valuable. Yet despite these potential benefits, few investors consider standalone
Portfolio Manager, allocations to securitized credit strategies, instead dismissing it as a tactical “trade” believed to have largely played out
Securitized
after home prices and household debt surpassed pre-2008 levels.
Investors tend to characterize the entire securitized space—with its broad array of risk types—as a significant catalyst
of the 2008 crisis, a perception stemming primarily from the lasting stigma around subprime mortgage credit.
However, anchoring portfolios to the risks of the previous cycle may not help investors successfully navigate the path
ahead. History rhymes, as the saying goes, but does not repeat. In that vein, no two cycles are alike whereby current
macroeconomic and regulatory conditions provide a significantly different backdrop for this market cycle versus last.
In fact, a closer look at today’s data reveals that mortgage debt is actually in the earlier innings of its cycle when
compared to the current corporate debt cycle (Figure 1).
Figure 1. Mortgage Debt Cycle Still Early versus Corporate Credit
47% Corporate Debt Cycle 10,000 74% Mortgage Debt Cycle 11
46 69
9,000 10
45 64
8,000 9
44
59
43 7,000 8
54
42 6,000 7
49
41
5,000 6
40 44
4,000 39 5
39
38 3,000 34 4
‘99 ‘01 ‘03 ‘05 ‘07 ‘09 ‘11 ‘13 ‘15 ‘17 ‘03 ‘06 ‘09 ‘12 ‘15 ‘18

Total Debt Debt/GDP Average Debt/GDP 1 Standard Deviation Debt/GDP

Source: Federal Reserve Bank of St. Louis, Federal Reserve Bank of New York, BLS and Voya Investment Management.
Corporate Debt as represented by Federal Reserve Bank of St. Louis Non-Financial Corporate Credit Instruments through 01/31/18.
Mortgage Debt as represented by Federal Reserve Bank of New York Survey of Household Debt & Credit through 03/31/18.

I N V E S T M E N T M A N AG E M E N T
Credit Strategies for the End of the Cycle

Comparison of the corporate and mortgage debt cycles illustrates of households and nonfarm payrolls are higher by 9% and 7%
the current disconnect between U.S. corporations and the American respectively and, perhaps most significant of all, at $19 trillion (and
consumer. While both sectors have recovered in the decade since growing) U.S. gross domestic product is 34% higher than it was in
the 2008 financial crisis, the disparity in leverage between the 2007. Each of these measures points to additional firepower that has
two sectors will likely have meaningful implications going forward. accrued in the U.S., with potential benefit to the housing market and
As the pace of corporate issuance resumed its higher trajectory reinforcing a potential virtuous cycle for consumers.
following the crisis, the debt-to-GDP ratio of corporate debt has
Figure 3. Economic data suggests the U.S. housing market is only just
risen above its long-term average. Meanwhile, a very different exiting the recovery phase
picture is forming in the U.S. mortgage sector. While mortgage debt
Measure 2007 2017 Change
issuance has resumed growing in the post-crisis era, its debt-to-GDP
Population 301MM 327MM +8%
ratio is instead falling.
Households 116MM 126MM +9%

Lessons Learned Labor Force 153MM 161MM +5%

Often the most important and lasting lessons are those learned Nonfarm Payroll 138MM 147MM +7%
the hard way. By just about every measure, today’s post-crisis U.S. GDP $14.5T $19.5T +34%
residential mortgage market is a prime example of lessons not only S&P 500 1,468 2,674 +53%
learned the hard way, but also of those with lasting influence. Case Shiller* 184.6 203.8 +10.4%
Following the 2008 crisis, significant changes have affected HH Debt $12.7T $12.9T +1.6%
Government Sponsored Enterprises, banks, broker-dealers, As of 12/31/17. Source: Bloomberg, Case Shiller, Voya Investment Management, and
rating agencies, mortgage servicers and—perhaps most The Federal Reserve.
*Case-Shiller is an index that tracks nationwide, single-family housing values in the U.S.;
dramatically—mortgage lending standards. With conservative the beginning value is measured from its pre-crisis peak, which we set as 07/2006.
lending dynamics still in play, mortgage loans exhibit vastly
superior credit characteristics, including less leverage, compared to Investment implications: Complement corporate
those underwritten before the financial crisis. Also of importance, exposure with securitized credit
securitizing “non-qualifying” risks like residential mortgages Given the identified differences between the current stage of
requires investors to keep skin in the game—so called risk retention.1 mortgage and corporate credit cycles, many investors may find that
While the regulatory backdrop will continue to evolve (see removal current portfolio allocations leave them overexposed to corporate
of CLOs from risk retention requirements earlier this year2), the post credit risk. We believe securitized credit, with its U.S. focused,
crisis regulatory backdrop in securitized is decidedly in favor of consumer and real estate centric risk drivers, is an effective way to
investors. Figure 2 outlines the long list of regulatory and market diversify a portfolio otherwise dominated by corporate credit debt.
enhancements implemented in recent years. And for those investors who remain dubious on the prospects
In addition to regulatory and market enhancements, a closer look at for investing in pre-crisis issued forms of securitized credit, the
the broader macroeconomic backdrop reveals dynamics supporting market has evolved meaningfully in recent years. In addition
the U.S. residential lending environment (Figure 3). While home to these ‘legacy’ non-agency residential mortgage-backed
values and household debt are above their pre-crisis levels, the securities, relatively new RMBS sub-segments include transactions
U.S. population has grown by 26 million and the U.S. labor force collateralized by prime jumbo loans, re-performing loans, non-
is 8 million stronger than in 2007. Meanwhile, the current number qualifying mortgages and GSE issued credit risk transfer (“CRT”)

Figure 2. The Evolution of Securitized Credit: Increasing Legislative and Regulatory Clarity
< 2014
■■ HARP/HAMP Programs
■■ GSE Risk Transfer Issuance
■■ Basel III Reforms
■■ Qualifying Mortgage Rules implemented
■■ Risk Retention Rules finalized
Source: Voya Investment Management
2015 2016 2017 & Beyond
■■ Terrorism Risk Insurance Act ■■ Risk retention rules for ABS, CLOs, ■■ FRTB Final Rule
(TRIA) Renewed CMBS implemented
■■ Reg A/B II finalized ■■ Reg A/B II implemented ■■ Mutual Fund liquidity requirements
■■ New mortgage disclosure rules ■■ Final mortgage disclosure ■■ GSE reform
implemented then delayed rules implemented
■■ Executive Office Deregulation Efforts

1 
https://www.sec.gov/rules/final/2014/34-73407.pdf
2 
https://www.lsta.org/news-and-resources/news/clo-risk-retention-the-window-to-appeal-has-closed

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 Voya Perspectives

securities. CRTs, now 5 years in the making, continue to grow and
provide securitized investors with access to residential mortgage
credit. As the legacy portion of the non-agency RMBS market
shrinks, new forms of mortgage risk like CRT enables investors to
maintain exposure to residential mortgage credit (Figure 4).
Figure 4. The growing market for Credit Risk Transfer
Outstanding Debt ($billions)
3,000
Non-Agency RMBS (LHS)
2,500 Credit Risk Transfer (RHS)
2,000
1,500
1,000
500
0 0
2004 2006 2008 2010 2012 2014 2016
2018
Source: SIFMA, Bloomberg. Data as of 03/31/2018
And as Figure 5 indicates, securitized credit also represents much
more than residential mortgage credit risk. In addition, securitized
investors can invest in more direct forms of exposure to the U.S.
consumer. While current assessments of particular lending markets
such as student loans and auto debt (perhaps unsurprisingly) look
in later cycle stages, other forms of borrowing like credit cards and
HELOCs look decidedly earlier cycle.
While data in Figures 1 and 5 suggests that the corporate cycle is
more advanced than the mortgage cycle, diversification remains a
key tenant for long term investing. Therefore, maintaining exposure
to multiple forms of risk remains a critical component of constructing
a broadly diversified portfolio. However, potentially adding
corporate credit risk in pursuit of much needed income in the current
environment requires an even greater focus on protecting against
the potential for downside losses. In this context, securitized credit
is an effective addition to a yield hungry fixed income portfolio.
Conclusion: Securitized Credit has evolved into a
“through-cycle” allocation
60
For investors balancing the need for growth with downside
protection, we believe securitized credit represents a compelling
50
solution in the current market environment. More importantly, we
40
believe the asset class has evolved to represent a standalone
30
strategic allocation through a full market cycle.
20
Primary fundamental drivers of performance in the securitized
10
market include residential mortgage credit, the consumer and the
1Q commercial real estate market. In addition, securitized investments
offer strong structural protections, relatively attractive yield and
a lower duration profile. The weighted average life of securitized
credit investments also varies across sub-sectors, providing
potential access to lower volatility investments in a world where
downside outcomes across risk markets may be skewing more
significantly. In this sense, securitized credit can provide both
diversification from other asset classes, as well as a diversification
within a potential allocation.
Securitized credit managers with the appropriate expertise across
each of the sub-sectors can tactically adjust allocations based
on the most attractive opportunities and perceived relative value
at any given time, which creates the potential for consistent
outperformance as market conditions change during and through
market cycles.

Figure 5. Securitized credit sub-sectors are at different points in their cycles

Peak
Consumer (Non-Mortgage) Debt IG Corporate Debt
Auto Debt -1σ -2σ -2σ -1σ
Bank Loans Corp Debt
Student Loan Debt
CPPI
HY Corporate Debt

μ μ μ

Case-Shiller (20 city)

Case-Shiller

Credit Card Debt

Total Household Debt
HE Revolving Debt
Mortgage Debt
1σ 2σ 2σ 1σ
Trough
Expansion Downturn Repair Recovery

As of 6/28/2018. Source: Bloomberg Barclays, S&P and Voya Investment Management. Representative cycles are normalized relative to nominal GDP. Each representative
cycle incorporates all available data starting from the year 2000. Covered time frames and sample rates may vary depending upon availability of specific cycle data.
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Credit Strategies for the End of the Cycle Voya Perspectives

Investment Risks
All investments in bonds are subject to market risks. Bonds have fixed principal and return if held to maturity, but may fluctuate in the interim. Generally, when interest rates
rise, bond prices fall. Bonds with longer maturities tend to be more sensitive to changes in interest rates.
All investing involves risks of fluctuating prices and the uncertainties of rates of return and yield inherent in investing. High Yield Securities, or “junk bonds”, are rated lower
than investment-grade bonds because there is a greater possibility that the issuer may be unable to make interest and principal payments on those securities. As Interest
Rates rise, bond prices may fall, reducing the value of the share price. Debt Securities with longer durations tend to be more sensitive to interest rate changes. High-yield
bonds may be subject to more Liquidity Risk than, for example, investment-grade bonds. This may mean that investors seeking to sell their bonds will not receive a price that
reflects the true value of the bonds (based on the bond’s interest rate and creditworthiness of the company).
Disclosures
This commentary has been prepared by Voya Investment Management for informational purposes. Nothing contained herein should be construed as (i) an offer to sell or
solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Any opinions expressed herein
reflect our judgment and are subject to change. Certain of the statements contained herein are statements of future expectations and other forward-looking statements that
are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events
to differ materially from those expressed or implied in such statements. Actual results, performance or events may differ materially from those in such statements due to,
without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) increasing levels of loan defaults, (5) changes in laws and
regulations, and (6) changes in the policies of governments and/or regulatory authorities. Past performance is no guarantee of future results.

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