Can we complain about ABS supply?

The start of the school year ordinarily also marks the end of summer for the primary bond markets as issuance restarts, though this year feels rather different. After an incredible first half of the year for supply in European ABS the market was gasping for some air, but things barely slowed down over the summer. While primary supply in investment grade and high yield credit have remained muted, the ABS market has seen the pipeline build up very quickly over the last two weeks, and 2024 is well on course for a post-2008 annual issuance record.

European ABS performance has also been strong so far this year; spreads have tightened due to strong demand, collateral performance has held up well and the market has grown in size. Year to date we’ve seen €97.5bn of primary supply, and on top of this around €15bn of CLOs have been refinanced in Europe already. Supply has come mostly from CLOs, RMBS and auto/consumer ABS, with UK issuers leading in mortgage transactions and German issuers in consumer deals.

There are a few trends worth highlighting here. First, the widely expected resurgence of ABS issuance from banks, as they move back to more traditional funding tools in the capital markets post-QE, has very much materialised. We’ve seen UK banks favour using residential mortgages as collateral for funding transactions, while an increasing number of European banks are using consumer and auto loans as collateral to issue ABS both for funding and capital purposes (for the latter, they sell not just AAA but also the more junior mezzanine bonds).

Second, we have seen an increasing number of first-time issuers, especially in the UK. These smaller lenders tend to focus more on non-prime borrowers. While we welcome the diversification for the market, we don’t believe the pricing of these deals has sufficiently compensated investors for the lack of track record and sometimes over-engineered capital structures; this is an area with some pockets of value but caution is warranted.

Third, activity in the CLO market seems has gone from “high” to “higher”, with 2024 pretty much guaranteed to be a record issuance year for issuance. Having said that, it is worth noting that net supply (new issuance minus deals being repaid) is positive in Europe (though relatively low at €15.5bn currently), while in the US the market seems to have stabilised as deals are amortising at a record pace as well, giving investors back cash. After outstanding performance in the first half (AAA notes have returned 4.5% year-to-date and BBs 13%), spreads have widened slightly over the summer and we think AAAs and BBs in particular offer value at current levels (Euribor + 1.35% and 6.5%, respectively).

The investment banks have done well in guiding investors to a large pipeline, and while we thought the market might have been scared about it, it has been met with very strong demand so far. Last week we saw another two Auto ABS transactions priced, one a €600m AAA deal from the Dutch firm LeasePlan and the other a €700m deal from Germany’s Bank11 which offered both AAA and mezzanine bonds. Book coverage was strong, allowing both issuers to tighten pricing significantly from initial guidance, and the mezzanine interest in particular was exceptional at 8-10x covered.

Looking ahead, the current pipeline offers (a lot) more of the same. We know of around 25 different transactions across Europe and Australia covering a good mix of residential mortgages, auto and consumer loans. Banks started wall-crossing investors a few weeks ago and some of these deals are already (partly) pre-placed as issuers looked somewhat nervous given the wall of supply, though we think the market will have no problem absorbing it. What we hope this pipeline brings is an increasing level of price tiering between issuers, as quality and future liquidity is certainly not uniform across the pipeline. The CLO pipeline has been “quieter” in comparison with the broader ABS market, though again we know there is a long list of deals ready to go in the coming weeks. We expect CLO activity to be dominated by refinancings rather than new issues for the remainder of the year due to weaker loan supply, though there are some signs of leveraged buyout and mergers and acquisitions activity slowly recovering.    

The next few weeks and months are looking incredibly busy, but also offer a good opportunity for investors to rotate their portfolios, increase diversification and hopefully pick up some decent yield in the process. So while we’ll no doubt complain along the way, the increased volume is a good development for the European ABS market.