Appetite for German consumer bonds shows deep demand in ABS

Despite higher interest rates and cost of living increases across jurisdictions, there is no sign as yet of any impact on issuance levels in European consumer ABS.

Historically, unsecured consumer ABS transactions have struggled more than mortgage-backed deals during economic downturns; when belts are tightened, consumers tend to prioritise mortgage payments over car finance and other loans. This time around, while the surge in inflation and interest rates from mid-2022 onwards did provoke some deterioration in asset performance for unsecured consumer ABS, in general we have seen consumer balance sheets in Europe faring better than expected. Primary issuance of consumer ABS has clearly not suffered from any weakening of sentiment in recent months either (amid a general glut of ABS supply), but one recent deal in our view demonstrates why investors should remain vigilant.

Last week, Santander, a regular issuer in the market, successfully priced a German consumer ABS transaction. The initial €700m offering had seen the four classes of mezz notes 5-6 times oversubscribed. Even after the deal was increased to €1bn, the senior mezz notes attracted the same level of interest and the BB+ rated mezz notes had a whopping 8.9x coverage. At final pricing, spreads had been tightened by around 40-50bp across the mezz from initial guidance; the deal could arguably have been priced after another round of tightening.

This appetite for lower-rated consumer-backed paper dispels any notion that investors might be nervous about Santander’s below-par collateral performance over the past two years. We have seen its consumer default rates rise to levels last seen around the global financial crisis, with recovery levels being equally disappointing. More recently the German economy has emerged as a particular area of concern, with its industrial and manufacturing sectors struggling and consumer confidence poor. All-in-all this new issue was a good opportunity for us to speak to management, update our stress testing and reassess our holdings.

Reportedly, the challenge for German consumer lenders such as Santander these days is that there is less appetite for unsecured loans; consumers with the best credit profiles are not keen on the higher rates on offer. Historically, the level of household debt in Germany has been relatively low compared to other European countries, so this is not surprising. Another problem is increased competition on online brokerage platforms, which has eroded the pricing power of established lenders. However, the rates being charged are not far off what we observed in 2015, so there must be more to this story, especially as other German lenders have performed better in this environment.

In other regions in Europe, the performance of Santander’s consumer ABS platforms has been more or less consistent with peers. It has certainly seen an uptick in payment problems, but not nearly to the extent that we’ve seen in Germany. Santander’s Spanish and Italian deals in particular are now performing better than the German platform. Greater tightening of lending criteria in these periphery countries post-crisis could be one explanation for this, but it is also evident that Spanish and Italian consumers are in a better place overall.

Historically, we have been a supporter of Santander’s German consumer ABS platform. However, this time around the price in our view didn’t offer enough compensation given the weakening of fundamentals. Indeed, we were surprised to see such a level of demand for the transaction, which to us is a clear sign of the very strong technical in ABS. That said, it is worth noting that even under the elevated default rates Santander is experiencing, the structural downside mitigation features of ABS still offer investors significant protection.

Ultimately, it is clear to us that the strength of the technical in European ABS has the potential to push spreads to levels that should make investors uncomfortable, particularly in cases where we think performance could remain on the weaker side in the current environment.

Currently, we see opportunities elsewhere in the market offering better risk-adjusted return potential.