TwentyFour cuts UK mortgages to recession proof income trust

Specialist debt fund TwentyFour Income has reduced its exposure to high-risk debt including UK mortgages as it worries about the risk of recession.

TwentyFour Income (TFIF ) has reduced is exposure to lower-rated debt and UK mortgages as it battens down the hatches in the face of market volatility.

The £768m specialist debt fund saw its underlying asset value rise 8.5% in the six months to the end of September, driven by collateralised loan obligations – repackaged loans sold to investors – and residential mortgage-backed securities (RMBS).

Fund manager Aza Teeuwen said the market for asset-backed securities (ABS) had picked up and September was the ‘busiest single month for ABS since the onset of the global financial crisis’, with ‘debut deals from new borrowers together with repeat issuers and from platforms that have not been seen in the market for a number of years’.

In particular, the RMBS market saw the return of ‘many bank lenders’ in the UK and Europe, which was ‘clearly due to the rolling off of central bank funding schemes’.

‘While the overall performance of the UK and European mortgage market is understandably deteriorating, the levels of losses observed within RMBS and ABS structures and our internal stress tests indicate that the performance of the underlying assets would need to deteriorate by many multiples of the levels that were seen in the global financial crisis before significant losses would be seen on the transactions,’ he said.

Teeuwen said the ABS credit market has dealt with ‘multiple headwinds’ and ‘spreads have gradually tightened during this volatile period’, prompting him to reduce leverage from 5.4% to just under 1% of the company as he continues ‘to value liquidity and flexibility in the portfolio’.

Although Teeuwen said there have been no defaults of underlying issues within the assets in the portfolio due to his focus on Western European debt.

However, he acknowledged that ‘wider market volatility is likely to remain elevated and a deterioration of fundamental performance is expected’.

‘We have taken the opportunity in certain instances to improve the credit profile in certain sectors,’ he said. ‘This has been achieved through selling lower-rated bonds and in their stead purchasing other bonds with a higher rating, or by reducing exposure to assets where our deal monitoring has shown that the performance of those assets has reduced.’

This includes a paring back of the exposure to UK RMBS equity through refinancing about £32m during the period.

Teeuwen said his focus remains on ‘higher-yielding floating-rate ABS’ which with a backdrop of higher for longer interest rates ‘should continue to deliver ongoing, attractive levels of income’ and keep the fund on track to hit its annual dividend target of 8% per year. It declared a six-month dividend of 4p.

For commercial property, the issues are more acute and Teeuwen said they will ‘take a long time to be resolved’ and suggests ‘refinancing in the sector will become more challenging and most commercial mortgage-backed securities (CMBS) deals are likely to extend in the near term’.

To counter this, he has underwritten all his CMBS holdings and reduced the allocation to this area to just 3.8%.

Teeuwen’s ‘base case’ scenario is for a ‘soft economic landing… but a recession in the EU, UK and/or US cannot be ruled out’.

‘We expect short-term rates to remain elevated for longer,’ he said. ‘Market sentiment has already priced in rate cuts in the fixed rate market and floating rate bonds should benefit in the medium term from higher income due to elevated base rates.

‘Given the current uncertainty in the global economy, we believe that flexibility and liquidity remain important and remain of the view that raising the credit quality of the portfolio seems prudent at this time.’

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