ABS and CLOs break 2.0 issuance records
The European asset-backed securities (ABS) market saw a record issuance last week with €5bn of primary issuance. This week is set to be equally busy with more than ten deals in the pipeline across a wide range of sectors and jurisdictions, as issuers look to capitalise on the strong technical presence in the market before the industry meets in Barcelona for the Global ABS 2024 conference.
The start of the year has been very busy, resulting in a total issuance of €66.6bn in European ABS and Collateralised Loan Obligations (CLOs), including €5.7bn of CLO refinancing. New supply year-to-date has surpassed issuance volumes since the Global Financial Crisis (GFC). Primary issuance has been diverse across sectors and jurisdictions, with several bank issuers returning to the market moving away from central banks’ funding. However, the net supply is only €15bn, due to amortisations, bringing the total size of the public European ABS market to €515bn.
Investor demand has spanned across a broad spectrum, including banks, asset managers, private equity firms, and hedge funds; seeking both liquidity and yield across AAAs and mezzanine debt. This strong demand has led to primary issuance being well absorbed which is shown by the high coverage levels, especially in investment grade bonds, further supporting spread tightening.
One theme that has continued on from 2023, is the issuance from banks looking to refinance Targeted longer-term refinancing operations (TLTRO) or the Term Funding Scheme with additional incentives for SMEs (TFSME). The Bank of England (BoE) announced the second phase of the extension of TFSME, allowing some drawings to be extended by a further four years. Although this is expected to impact only a small proportion of TFSME participants, and the majority of TFSMSE drawings are expected to mature as planned in 2024 and 2025, which should continue to support issuance of prime residential mortgage-backed securities (RMBS) from banks or building societies in the UK. Even in the past couple of weeks smaller lenders, Principality Building Society, Leeds Building Society and TSB Bank have issued - the latter, for instance, was its first deal in eight years last week and placing £500m AAA notes at SONIA +55 basis points (bps), which has been met with strong investor appetite.
CLO issuance has been strong year-to-date, supported by healthy loan issuance. There has been renewed interest from investors, not only in Europe but also from Asia and US banks being active in AAAs. The tightening of AAA CLO spreads has been limited to a few basis points in the past few months, with new issues pricing at 3-month Euribor +146bps or with a current income of 5.3%. We think at a current yield-to-worst of 4.3% in euros for AAA CLOs offers a strong pick-up, compared to euro investment grade corporate bonds with a yield of 3.8% for an average rating of single A. However, net supply in CLOs has been the lowest in several years, partly due to the liquidation of 12 CLOs with more expected in the pipeline, and an increasing amount of AAA amortisations as loan prepayments increased.
Leveraged loan activity remains predominantly in the form of refinancings, including fixed-rate bond to floating-rate loan refinancings, and refinancing from direct lending into the syndicated loan market to achieve lower cost of debt. This results in a notable reduction in the loan maturity wall, with only 2% of the loan market maturing in 2024 and 2025. There is also anticipation of increased M&A and leveraged-buyout (LBO) activity as rate uncertainties clear, which should support primary loan supply.
The commercial mortgage-backed securities (CMBS) market has also seen a small resurgence, highlighted by a £500m UK last mile logistics deal from Blackstone, as AAAs priced at SONIA +165bps with a coverage of 2.5x for the senior notes, while the mezzanine debt was also well covered. This highlights investor demand for logistic assets, as fundamentals have improved in the commercial real estate (CRE) sector and is characterised by strong rental growth and stabilising valuations following large drawdowns in 2022. This comes after significant headwinds in the CRE sector led to muted issuance in 2022 and 2023, with cumulative issuance of €2.3bn.
Australia has also seen a significant pick-up in primary issuance in the past few weeks, particularly in auto ABS. Australian auto ABS issuance stands at AU$4.5bn, nearly 50% higher than the same period in 2023. The strong growth reflects changes in the underlying lending landscape, with commercial banks exiting lending of auto loans, being replaced by non-bank lenders, naturally more reliant on securitisation as a funding source. We think Australian prime RMBS rated AAAs offer an attractive value, especially considering the product similarities to UK prime RMBS. Macquarie Group, the fifth largest bank in Australia priced its AAAs at AU$ Bank Bill Swap Rates (BBSW) +98bps or equivalent to 6.0% yield in GBP.
In an environment where rates are expected to remain higher for longer, the floating rate ABS and CLO market continue to offer strong relative value compared to corporate credit markets. The busy primary pipeline provides a wide range of opportunities, especially as banks return to the market as active issuers through funding transactions and capital relief trades, including SRT (Significant Risk Transfer) transactions, as they look to manage their capital requirements.
We expect the primary market to remain very active in the coming weeks with issuance likely from new or sporadic issuers, and we are expecting this to continue after the conference halls of Barcelona empty. Primary issuance is well digested, and the technical outlook remains strong, although we remain mindful of geopolitical disruptions and maintain a highly liquid positioning.
