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Strong ABS technical to persist

22 August 2017 by Aza Teeuwen

After a very slow first quarter, primary supply in the ABS market has picked up since April, but the strong technical driving the positive market direction has persisted. Performance has been strong across the board but more pronounced in Mezzanine ABS & CLOs; so where does that leave us now and what has been driving this strong technical?

Recent Morgan Stanley research highlighted that since the start of the year the amount of outstanding ABS paper has dropped by over €8bn to €454bn, despite the issuance of €51bn of new paper this year. All sectors shrank in size this year with the exception of CLOs (just under €80bn outstanding) and the UK buy-to-let sector, which almost doubled in size to just over €30bn. The last number looks like a big increase, but in reality the vast majority of growth there came from the re-issuance of an existing transaction, Aire Valley, in April this year, following the sale of the £12bn Bradford & Bingley mortgage pool (see our previous blog here). We could consider €51bn to be a decent number, but net supply is still negative as redemptions and amortisations outpace new issuance. The market is expecting (or hoping rather) that total issuance this year will be around €80-85bn, up slightly from recent years, which is still a sharp contrast to €200-500bn numbers seen in 2003-2007.

Source: Morgan Stanley Research

Issuance this year has mainly come from the UK (45% of volume), CLOs (20%), the Netherlands (13%) and small transactions from the rest of Europe. UK issuance looks high at 45% which is mainly the result of the £12bn refinancing mentioned previously (and which was called in September 2016 and therefore not included in the Dec 2016 numbers in the graph above). With that £12bn excluded, the UK issuance would be a relatively fair representation of the market composition. Pre-crisis a lot of UK issuers brought deals to the market in a variety of currencies to facilitate overseas investors, however post crisis GBP is the “go to” currency, which is the result of domestic demand and penal rating agency treatment for currency-swap counterparty risk. Although CLOs have re-established the asset class as a vanilla product, interestingly we haven’t seen any CMBS issuance this year, reflecting the strength of the CRE loan market (a cheaper and simpler funding option for commercial property debt).

Interestingly, issuance of bonds rated BBB and lower has decreased materially in the last 5 years, which is the result of 2 things; cheaper funding levels are resulting in better rating agency treatment but also risk retention (skin in the game) regulation has reduced distribution of lower rated bonds. Sponsors have to retain 5% of the risk in every transaction, which is more often than not done by keeping the 5% residual risk – what would be the first loss piece, so essentially sponsors are now using RMBS as the funding tool that it is supposed to be.

AAA issuance this year made up over 75% of all the paper printed (vs 66% in 2014), put another way that’s a material reduction in sub-AAA issuance. On the flip side, we have seen a greater diversity of issuers and jurisdictions come to the market this year with full capital structures (rare transactions from the Netherlands, Spain, Portugal and Ireland), as well as an increasing number of different CLO managers. The long debated surge of Italian NPL issuance hasn’t happened yet and we expect that it could be a while.

Surely the QE in the ABS market, the ABS Purchase Programme, has been the key driver of the strong technical? Wrong… The ECB owns less that €25bn of ABS, and net purchases in 2017 to date were just €1.9bn, vs €7.6bn in 2016 and €13.6bn in 2015, it almost looks as if they have started tapering already! Instead, strong fundamental performance, a healthy secondary market and reduced issuance of mezzanine ABS resulted in a strong technical for the market, and it’s difficult to see this technical disappear in the short term, particularly in RMBS.

Source: Morgan Stanley Research

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