Robust securitization market on course for a stellar 2022
The European securitization market is on course to break issuance records in 2022, as it comes to the end of one of its best years since the global financial crisis. Bill Thornhill reports
At roughly €72bn, 2021’s securitized issuance was just shy of breaking the post global financial crisis high of €73.5bn set in 2018. Rabobank expects a similar volume in 2022, although JP Morgan is calling for €85bn, which would be the highest since the global financial crisis.
Although supply was vigorous, it was a year of two halves. Excluding jumbo refinancing, ABS volume was “relatively light in the first half of 2021”, says Colin Parkhill, head of European ABS and CLO syndicate at Deutsche Bank. But thereafter volumes picked up, with deals being well absorbed by cash-rich investors.
At about €35bn, half of 2021’s supply was made up of RMBS, with almost 60% of that being UK non-conforming RMBS. The next largest component was auto ABS, which, at almost €19bn, accounted for a little over a quarter of total supply.
In contrast, UK and Dutch prime RMBS, which had been the biggest contributor to the securitization market a decade ago, was diminutive and accounted for less than 10% of overall volume.
The past year was also notable for its performance, with the magnitude of spread compression in European ABS outperforming the rest of the fixed income market, according to JP Morgan. This was particularly the case with UK securitizations, which, it said, had been “the clear outperformers”.
Even so, at the senior level, non-conforming UK RMBS widened 10bp-12bp in the final quarter of the year, as investors became more selective and liquidity began to dry up. Parkhill believes this is likely to prove a temporary phenomenon, noting that non-conforming UK RMBS has begun to attract more bank investors. With budgets refreshed in January 2022, he expects a partial correction of this modest widening early in the year.
All in all, it has been an inspiring year, according to Rob Ford, a portfolio manager and founding partner of TwentyFour Asset Management. “We have had an encouraging year, with issuance up, spreads well supported and strong demand,” he says.
The spread performance has been particularly marked at the mezzanine level — with, for example, ‘E’ and ‘F’ class notes of SC Germany’s consumer loans ABS deals respectively tightening by 120bp and 180bp compared with a year ago.
“There has been a good pick-up in demand for mezzanine paper from established and new names, causing the credit curve to tighten somewhat,” says Ford.
The strong performance was all the more surprising for the fact that Covid-related lockdowns had persisted for much of the first quarter when payment holidays were in force across much of Europe and the UK.
In theory, the impact of these measures should have affected the credit performance of a wide swathe of the securitization market, especially in the mezzanine notes. In reality, credit performance turned out to be stable.
“Despite the massive dislocation in 2020, the securitization market has performed well through the pandemic,” says Miles Hunt, head of private credit syndicate at NatWest Markets, who draws particular attention to improvements in transparency.
Since the global financial crisis, regulators, issuers and trade associations have put a lot of effort into improving transparency, which culminated in the Simple, Transparent and Standardised label initiative that is designed to ensure noteholders receive regular, informative updates on their investments.
Just as importantly, banks can expect preferential capital treatment for STS-compliant investments, thereby improving demand, effectively enabling issuers to lower their funding costs.
“The feedback loop between investors and borrowers is working,” says Hunt. “Regular standardised reporting, which provides investor comfort, enables borrowers to access the markets and, in return, investors maintain ownership — or buy more, as they can see how the pools are performing.”
Taking all this into account, and disregarding the arrival of the Omicron variant, the European ABS market enters 2022 in an exceptionally strong position, implying it is set up well for growth. “I don’t think the number stays flat to 2021,” says Hunt, with reference to the coming year’s issuance. “I think it goes up, with more prime STS labelled supply, in particular, alongside more CMBS and CLOs.”
Volumes should also be propelled by the large amount of UK RMBS that will need to be refinanced. A considerable amount of legacy UK non-conforming and buy-to-let legacy RMBS are coming up to their coupon step-up dates in 2022, according to Cas Bonsema, ABS analyst at Rabobank. Given spreads are not far from their historic lows, he expects most of these portfolios to be refinanced, which is bound to boost volumes.
In this regard, Bonsema says February could prove to be a particularly active month as about £7bn buy-to let UK RMBS loans originated by Bradford & Bingley will reach their coupon step-up date and will therefore probably be refinanced.
But despite this sanguine picture, not everyone is totally convinced 2022 will be a stellar year. “It would be sad to see the market shrink, but I would be surprised to see significant growth,” Ford cautions, noting that some established non-bank UK RMBS issuers are planning to leave the market or cut their appearance.
Apollo is increasing its mortgage activity using cash from its Athene and Athora insurance companies. Fortress is looking for mortgage assets, after buying Foundation Homes. Though Pimco securitizes mortgage portfolios, these are structured and sold within the organisation.
Added to that, some specialist lenders may choose to follow Charter Court Financial Services and OneSavings Bank, which merged to create a £1.6bn deposit-funded lender, effectively removing the need for RMBS issuance. Kensington Mortgages has signalled it is up for sale, suggesting its mortgage portfolio could be bought by an institution with no need for capital market funding.
Ford hopes that this potential contraction will be balanced by growth in other areas such as the prime RMBS sector. Some prime RMBS bank originators, that have not syndicated deals since the onset of Covid, are expected to return in 2022, says Parkhill, who wonders whether their return might cause the spread differential between prime and buy-to-let RMBS to compress.
But, as far as eurozone issuers are concerned, Bonsema is less convinced. He says that Targeted Longer Term Refinancing Operations liquidity will not need to be repaid until 2023-2024 and, along with high deposits, he thinks there won’t be a large increase in prime RMBS in 2022.
Notwithstanding this mixed prognosis, parts of the market are expected to remain forceful. One such sector is the market for significant risk transfer (SRT). SRT trades allow issuers to sell the riskiest credit exposures sitting on their balance sheet, thereby reducing their capital requirements.
On the other side, investors get an opportunity to consider and potentially buy higher yielding subordinate exposures. In a negative yielding environment SRT investments can provide a much-needed boost to their returns.
Though SRT issuance fell at the start of 2020, it bounced back strongly and has continued to grow throughout 2021, setting it up for a strong 2022. The SRT market “should get even bigger in 2022, as conducive regulation and enhanced transparency bring greater liquidity and, with that, issuance,” Hunt says.
In November 2020 the European Banking Authority published a landmark report on the SRT market with the aim of streamlining and harmonising the various approaches taken by different national regulators across Europe in a move that was expected to provide certainty and predictability.
As a consequence, the SRT market began to flourish, as regulatory certainty paved the way for issuers to come to the SRT table and provide potential buyers, such as TwentyFour Asset Management, with an opportunity to juice up their returns.
Ford says his firm had been active in the market for SRT trades, giving prodigious access to mezzanine assets down the capital stack — “after all, man cannot exist on bread [seniors] alone”.
Issuers can either keep assets on their balance sheet and transfer credit risk synthetically, usually with a private placement. Or they can transfer assets into a special purpose vehicle and sell a full capital stack of notes that is often rated down from triple-A to single-B.
In this respect, Santander Consumer Loans Germany has been a standout and regular issuer in size. It was lately seen in the market with SC Germany, Compartment Consumer 2021-1, a full capital stack transaction which noticeably attracted the strongest demand in the most junior notes.
Issuers like these are expected to become a regular feature of the ABS market in 2022, according to Bonsema. “We again expect to see full capital stack deals in the mix, where in certain cases balance sheet relief can be achieved next to a funding objective.”
Bankers are also optimistic on the outlook for CLOs. Record European CLO issuance, which exceeded €30bn in 2021, is expected to remain as strong in the coming year, according to Barclays, which forecasts €30-35bn of CLO issuance in 2022.
Hunt is also optimistic, noting that a lot of capital has continued to flood into private equity, fuelling the supply of high yield bonds and leverage loans, of which roughly 45% is bought by CLO managers.
Spreads should also stay well supported. According to the head of European CLOs at Deutsche Bank, Nikunj Gupta, Libor transition to Sofr in 2022 presents a source of uncertainty. This could result in lower US CLO volumes and, as such, “it’s possible that some US CLO investors will start to look more closely at the European market,” he says. GC