RMBS spread moves say more about market size than asset quality
Big swings are a sign of a market with too few investors, not rising risk or liquidity fears
RMBS spreads have widened in the past few weeks in Europe. But before the doom-mongers read too much into what it means, it is wise to point out that it has more to do with a lack of investors than rising risk in the asset class.
For example, the spreads on new sterling buy-to-let (BTL) RMBS tightened from 150bp over Sonia in January all the way into 110bp at the end of April. They have since swung back out to 115bp and might yet retreat further.
That would suggest that investor perception of the quality of the collateral in these securitizations improved until last month, when it suddenly got worse again.
But this is not what is happening, of course. There haven’t been any wild swings in the quality of BTL collateral, nor major fluctuations in the macroeconomic outlook, even if interest rates have moved over the period.
The problem is there are not enough investors to keep the market ticking over, and this means it is a market where new issue spreads are almost all driven by quite fickle technical dynamics. For many asset managers, it is not worth spending what it costs to set themselves up as buyers — staffing and regulation costs — to access such a small market.
Therefore, there is not much diversity of opinion on the buy-side. When volatility shuts the market, it can close for months at a time and spreads widen. When it is open, buyers want every bit of paper they can get their hands on, hauling spreads back in again.
Demand is therefore usually simply a function of how much cash investors have on hand, which is inversely proportional to how much recent issuance there has been.
For example, despite a strong month for the market, nagging doubts remain over whether headline acts such as Lloyds Bank’s Permanent 2023-1 — priced last week — will lead to something more, well, permanent.
RMBS is still subject to harsher regulatory treatment than, say, covered bonds, which means that a market already limited by its complexity in terms of attracting buyers is even further hobbled.
So, despite a May bonanza, the ups and downs in the RMBS market will be self-reinforcing until it becomes easier for more buyers to get involved.