Bank of America Advocates for Credit Tranches Amid Widening Spreads

Bank of America strategists are advising investors to seek protection from initial losses in the credit market, favoring tranched products as high-yield spreads widen. In a recent note, the bank observed that yields have returned to levels last seen in late 2023, driven by soft macroeconomic data, geopolitical tensions, and increasingly visible default risks.

A Defensive Stance on Credit

According to Bank of America, the current market environment warrants owning exposures that are insulated from the first wave of potential losses. The bank highlighted that while higher yields offer support for credit, underlying risks are mounting. This is compounded by specific market concerns, such as the heavy concentration of French corporate debt, which the bank notes makes up a significant portion of key European credit markets.

• France Exposure: The country represents 21% of the Crossover index, 22% of euro high-yield bonds, and 20% of euro leveraged loans.
• Investor Sentiment: BofA states that most credit investors hold negative views on French credits and are concerned about potential contagion from sovereign risk to corporate issuers.

Value in CDS Index Tranches

To mitigate these risks, the bank pointed to specific credit derivative tranches that offer a protective buffer. The XO (Crossover) 10-20% tranche, for example, is highlighted as an attractive option. This instrument only begins to absorb losses after post-recovery losses on the underlying index of companies exceed 10%.

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Bank of America noted that historically, this 10% attachment point has only been marginally breached once, during the global financial crisis. The tranche currently trades at approximately 96 points with a 500 basis point coupon, offering a yield above 9% and a steeper roll-down than comparable bonds or the untranched CDS XO index.

Opportunities in CLOs

In the Collateralized Loan Obligation (CLO) market, BofA acknowledged that fundamentals have deteriorated amid a softer loan market, leading to a steeper CLO credit curve. Despite this, the bank identifies value in certain segments.

For investors, BofA sees opportunity in shorter-dated secondary BB-rated CLO tranches yielding approximately 9.5%. For those with a higher tolerance for mark-to-market volatility, the bank favors clean new-issue single-B tranches from top-tier managers, which can offer yields above 12%.