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Famine and Feast

14 October 2016 by Ben Hayward

2016 has been an interesting year for issuance in European ABS, not least because of the stark contrast to 2015.

While 2015 had many obstacles to market performance across the entirety of fixed income, the effect on the ABS market was exacerbated by the size and timing of new deals coming to market, notably two bumper deals from The Co-op Bank, materially larger than expected, and the potential for the refinancing of the £13bn Granite transaction. When a sizeable new issue is presented to a market that is already in a negative frame of mind it makes it very hard for that market to perform.

Once those obstacles were removed (the Co-op deals absorbed by the market and the Granite refinancing pushed down the line), the ABS market had a positive end to 2015, while other markets continued to labour, weighed down by concerns around Fed move timing, oil, global growth and so on. At the end of the year the majority of participants who were willing to predict volumes for 2016 were looking for a healthy increase.

This was largely put on hold due to the material volatility seen in the first quarter, and then the reaction to the UK referendum, but the positive risk sentiment the market has been enjoying since the Bank of England’s extraordinary policy measures has allowed issuers to come back to the market since, and in sharp contrast to 2015.

To this end €11bn of new issuance was brought to market in September, all being well taken by the market and with spreads tightening at the same time, a stark contrast to 12 months earlier (€8.5bn issued into a widening market). This was driven in part by increasing appetite in the market from new investors, in particular overseas investors bidding strongly for AAA rated tranches.

The typical measurement of how successful a new issue is would be the pricing that the borrowers have achieved and the level of interest from investors. The latter is typically judged on the basis of how much more interest a tranche received than there were bonds available.

There was an interesting new issue this week – a five tranche securitisation of vintage UK Buy-to-Let mortgages. The underlying loans are good quality, and the market is familiar with them, having been originated by a lender that has brought numerous other deals to market. The difference with this deal is that the mortgages are now owned by a private equity investor, with arguably different commercial aims. With the exception of one tranche (AAA tranche at Libor+105 basis points), the deal only just managed to attract enough interest for it to clear into the market. We believe that this was partially due to the deal being upsized, but also partially due to weak structuring on the mezzanine bonds (all of which priced at the wide end of guidance) which in our view may present material risks to the full payment of interest on those bonds.

So while sentiment is good and spreads are tightening, investors are not getting carried away by the opportunity at the cost of quality. As we see a more balanced risk sentiment this week across the majority of markets driven by hard Brexit fears, the positive spread progress allied with rational credit underwriting is to be applauded.

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