BofA sees value in credit tranches amid wider spreads

Bank of America said high-yield credit spreads have widened in October, with yields returning to levels last seen in late 2023. The bank noted that macro data remains soft, geopolitical risks continue, and default risk is becoming more visible.

The bank said higher yields help support credit, but recommended investors own exposures that do not take the first loss. Tranching offers this protection for both bond and loan risk, according to the report.

Bank of America highlighted that France represents the largest country exposure across three markets: 21% of Crossover, 22% of euro high-yield bonds, and 20% of euro leveraged loans. The bank said most credit investors hold negative views on French credits and worry about contagion from the sovereign to corporates.

The XO 10-20% tranche trades at approximately 96 points with a 500 basis point coupon, nearly matching BBB2 euro high-yield bonds, Bank of America said. The tranche absorbs no losses until post-recovery losses on the index exceed 10%. Yields stand above 9%, with steeper roll-down than bonds or the CDS XO index.

Since the XO index launched, a 10% attachment point would have been breached only marginally around the global financial crisis, the bank noted.

Bank of America said CLO fundamentals have deteriorated amid a softer loan market, reflected in a steeper CLO credit curve. The bank sees value in shorter-dated secondary BBs at approximately 9.5% yield, broadly in line with XO junior-mezz.

For investors who can tolerate more substantial mark-to-market volatility, Bank of America favors clean new-issue single-Bs from tier 1 and 2 managers with more defensive manager style at yields above 12% over unclean resets.