Asset Backed Securities

For fixed income investors, we think floating rate European ABS bonds could be an allocation consideration to help improve return prospects and reduce volatility.

Last week UK Asset Resolution (UKAR) announced the sale of its final mortgage loan portfolios, bringing to a close a decade long chapter of state ownership.

This deal, backed by a £472m pool of owner-occupied mortgages partially securitised in a previous transaction, drew over £1.2bn of orders and was printed 10-30bp tighter than initial price guidance depending on the tranche, reaching pre-COVID tights.

I think it’s likely we’ll see new cycle tights for the European CLO sector this year, so in addition to healthy income we believe there is plenty of room for capital appreciation as prices are being pushed higher in the secondary market.

European ABS primary markets have started 2021 at the solid pace that most market participants expected. The market saw a patchy Q4 in which activity petered out early, not helped by the dominant UK market suffering some hesitation whilst tightrope Brexit deal talks went to the wire, but also as a result of a rather more simple fatigue that appeared to have set in.

Our analysis indicates European ABS investors can carry forward little concern about nasty default surprises, and this is likely to be important when considering total returns for 2021.

At the moment CLO spreads are tightening, as they are right across credit. However, we haven’t had any CLO primary deals come to market so far in 2021, so we are operating in a bit of an informational vacuum, at which point these cross-asset class comparisons can be useful.

So while we certainly expect unemployment to increase across Europe, and we expect more borrowers will fail to pay their mortgages, we believe current mortgage performance is very far away from a level that would threaten coupon and principal payments in the major European RMBS markets.

One of the legacies of Europe’s post-crisis lending landscape was a huge retrenchment in risk appetite, amplified by a lack of bank capital and in some instances funding for an extended period of time.

Overall CLO and loan performance have exceeded our expectations, though there are still plenty of headwinds for the market, chief among which is the prospect of further lockdowns and more economic disruption as Europe battles a second wave of COVID-19 cases.

There are still plenty of potential bumps in the road (Brexit, the US election, COVID-19 developments and so on) but the positive technical created by dwindling supply has the potential to push spreads tighter in coming months.

We expect September to be relatively busy with new ABS deals, but there’s a very strong technical developing in favour of ABS and CLOs, which should help performance in the coming months.