Investors are hungry for ABS paper and rightly so
Opportunities to buy floating rate paper at wide spreads before issuers stop coming are limited, investors are taking notice
The ABS market has been flooded with supply this week. So far it seems demand is matching up as investors snap up deals — and so it should.
This is a great opportunity to buy short dated, floating rate paper with wide spreads. Conditions might not be this good again for the rest of the year.
Issuers are rushing to market, perhaps burnt from their indecision last year, perhaps anticipating volatility in the second half of the year. Either way, current levels work for them and many are taking the chance to come to market.
Eight deals — five in euros, three in sterling — are in the market, the question is whether there will be enough demand to match.
So far, bankers are confident, citing impressive levels on Friday for Castell 2023-1, Pepper Group’s pre-placed non-conforming UK RMBS. Other deals are succeeding too. Books are already fully covered for Mercedes’ €700m Silver Arrow 15, which only announced on Thursday.
That alone is not particularly novel, but in this instance it is not just issuers that are bullish, investors are coming in strong too. That demand is well deserved. Primary supply might not be so strong for a while and secondary markets are unreliable for anyone hoping to do deals in scale, so the surge of supply is a fleeting opportunity to stock up on floating rate paper.
Benchmark conditions are also favourable. According to Bank of America’s research team, the market expects 3 month Euribor to reach 3.6% at the end of the year, from 3.2% currently, and suggest it could even reach 4.1%.
Yet, the persistence of inflation has been downplayed at every turn, driving rates higher, particularly in the UK. The Office for Budget Responsibility (OBR) underestimated inflation in each of its March 2021, October 2021 and March 2022 forecasts. The February 2023 figure of 10.4% was above its 10.2% November 2022 forecast for the first quarter of 2023.
There may well be a fall coming in headline figures, as supply chain shocks and the energy crisis recede, but core inflation, now around 6% in the UK, can be surprisingly sticky.
Bank of America estimates CPI in the UK will be above the Bank of England target of 2% until September 2024, even if the OBR estimates it will drop to 0.4% by April.
High inflation is good news for those holding floating rate paper, as interest rates are unlikely to fall and may continue to rise.
But even without the floating rate element, spreads in ABS are attractive. Amazingly, spreads are wider now than this time last year, less than two months after Russia invaded Ukraine. Heavy supply may force deals to compete for attention and could push spreads out even further.
Hiltermann priced the senior notes of their debut auto lease ABS at 70bp over 1 month Euribor in April 2022. On Monday, the Dutch leasing company released IPTs of 80bp over 1 month Euribor for their second deal.
There are certainly risks in the economy. Consumers are suffering, while loan defaults are expected to rise across Europe and across asset classes, but few expect the damage to touch senior ABS tranches.
Yet spreads are even elevated on triple-A notes. Prime RMBS spreads are around 10bp wider and prime auto spreads are around 20bp wider than this point last year. To make the proposition even more attractive for ABS investors, deal executions are cautious. Most deals have short lifetimes.
Tesco Bank appears to have structured its credit card ABS, Delamare Cards 2023-1, to give the publicly offered notes a short weighted average life (WAL) of 2.9 years rather than the 4.9 years for the retained triple A tranches.
The longest WAL on the seniors of all the deals in the market is Premium Credit's PCL 2023-1, and even that is only three years.
Issuers are showing appropriate caution in the executions, but a window is now open for doing deals. And that means investors have a chance to get hold of ABS paper.
So far, it seems the market is sending a clear message on both sides: Get your funding done. Put your cash to work. The moment might not last.