ABS Primary Slips Into Gear

We have already highlighted the blistering pace of bond sales in both Europe and the US, and this being met with apparently insatiable demand from fixed income investors. Since European ABS markets tend to lag broader fixed income, it seems fitting that we have had to wait another week before seeing that primary machine start to accelerate.

With positive sentiment also permeating ABS markets, we have seen several deals hit the screens in recent days, with the expectation of a frenetic Q1 ahead.

The first offering was a Dutch RMBS from Rabobank subsidiary Obvion, attracting over €2bn of orders and printing tight in our view at 3mEuribor+15bp. In the market currently we have a UK RMBS from Virgin Money (Clydesdale) in multiple currencies, as well as a Dutch BTL RMBS and a French Green CMBS transaction, a first of its kind. Regular issuer Charter Court (recently merged with OneSavings Bank) printed a BTL RMBS deal today which we think is one of the best subscribed deals in recent years, with AAA coverage at 4x and mezzanine bonds up to 10x. The CLO primary market is so far fairly quiet but we expect this to change soon, with a full pipeline by the end of the month.

Despite anticipating a busy first half of 2020, we expect total year volume to be broadly unchanged on 2019 at around €100bn, held back by a fall in jumbo refinancings compared to recent years.

A key theme in 2019 was an increase in capital relief ABS deals by banks like BNP Paribas, Santander and Société Générale. These deals are aimed both at securing funding and reducing risk weighted assets through selling senior, mezzanine and junior bonds to investors (while retaining a minimum 5% of the transaction). This was a key contributor to there being around a 50% increase in the supply of sub-AAA bonds in 2019 versus 2018, a welcome development for investors searching for more yield and something we expect to continue in 2020.

CLOs saw a record year in 2019 with €29bn of issuance and seven new managers joining the European sector’s universe. With current arbitrage being thin, some managers are expected to be wary of raising new warehouses, and we agree with market consensus of €25bn this year and fewer refinancings. But there may also be a few new managers and current spread tightening may help prise open the arbitrage and generate a window for more issuance than we expect.

QE in Europe, particularly the TLTRO 3 in 2019, saw fewer continental banks seeking to place ABS with investors, instead retaining ABS deals on balance sheet and using them as collateral for repo with the European Central Bank. While we do not expect a wholesale shift to public placement in 2020, some banks may test the water in smaller size if spreads continue to tighten.

UK banks and building societies issued ABS through 2019 with good participation despite Brexit concerns, and we expect to see a hastened issuance calendar now calmer waters are present, with the added potential for increased participation by continental investors revisiting the case for UK assets. It is after all the largest part of the market and in our view benefits from strong liquidity and performance through the cycle. The basis between the UK and the Dutch market has been skewed since 2014, firstly with the ECB buying Dutch RMBS, and subsequently by Brexit concerns. With UK prime RMBS now offering around 35bp of pick-up to the Dutch equivalent at the moment, in comparison to -10bp pre-2014, we could see a material change in appetite for UK risk.

These nuances are a key consideration for us. European ABS market performance has historically been more technically driven than other parts of the credit markets, in part because there has been a net decrease in market size each year post-crisis and a series of regulatory challenges which have impacted appetite from insurers in particular. For now, the opportunity set looks good for us; spreads are off 2018 tights – out of step with other parts of credit – so it is unsurprising investors are seemingly happy to add risk.