Global ABS 2023: KBRA's Day 2 Recap
Wednesday in Barcelona brought market outlooks, performance reviews, and discussions on topics such as ESG, SRT, autos and NPLs
The Global ABS conference’s Day 2 proceedings typically comprise a very packed agenda alongside a plethora of business meetings, and the event on 14 June did not disappoint. The day began with an address from Shaun Baddeley, Managing Director and Head of Securitisation at the Association for Financial Markets in Europe (AFME), followed by one of the architects of the European Capital Markets Union, Lord Jonathan Hill.
Panels featured a range of topics including broad market outlook and review of performance, as well as discussions on various markets such as ESG, CLOs, solar ABS, SRT, auto ABS, consumer ABS, NPLs, RMBS, and more. There were also a number of discussions on broader topics similar to Day 1, such as innovation in the market, regulation and ESG and sustainability, including the popular Researchers’ Roundtable series. Below we provide a recap of a selection of some of the day’s panel topics:
Keynote: Lord Jonathan Hill
Lord Jonathan Hill was a key individual in the development of the European Capital Markets Union. In his view, the European market should be looking at regulation through the prism of competitiveness. After the global financial crisis (GFC) era, the European securitisation market needs to rethink the current regulatory environment in order to encourage growth and remain economically competitive. Regulatory bodies and politicians should be held more accountable to the impact of the current state of regulations. In his view, there should be an honest debate on economic growth, risks, and the trade-offs between competitiveness and conservatism. Further, securitisation should also play a bigger role in Europe in order to maintain economic competition and support growth.
The biggest long-term financial stability risk in Europe is a lack of growth and the loss of its global competitive advantage, mainly to the US. As a result, European regulators should look at the broader impact of regulation on Europe’s economic growth and competitiveness. A lot of regulation has been implemented since the GFC, both in response to the GFC and in the development of the European Union (EU).
While European governments have increased borrowing, more spending is needed in the coming years due to an aging population, deteriorating infrastructure, and investment to secure the region’s energy needs. Governments are seeing increased pressure for higher public spending at a time when public support for government is thin. The way forward is to support growth. In Lord Hill’s view, one way to encourage growth is to reduce the size of the regulatory burden. Europe should be seeking ways to introduce regulation reforms and unlock capital tied up in banks that could be put to better use. Financial regulators should have a more sensible discussion of how securitisation can play a bigger role in Europe’s economic growth. Trying to achieve a high growth economy with zero risk does not make sense and is not feasible. Europe and the regulators need to accept a new balance of risk. An evaluation of the global markets and what is effective in other regions should be explored and lessons brought back to Europe. Rules and regulations are not easy to change, but to support growth, they need to be regularly evaluated on their effectiveness and changed to best support a strong and growing economy.
ABS Market Outlook and Performance Assessment
The first panel of the day discussed the broader European securitisation market and the outlook for the remainder of the year. Panelists stated that performance has been strong to date, but increased stress is anticipated to impact on performance. Stress is lagging with further performance deterioration expected. An audience poll found that 52% were reasonably confident for strong performance going forward, while 21% were somewhat nervous, 11% were very confident, 9% were pessimistic for the market, and 7% were neutral.
The main asset class that panelists and the audience expected to perform the best in the next 12 months is RMBS (41%) followed by auto ABS (31%), CLOs (13%), SMEs (9%), CMBS (3%), and credit cards (1%).
Panelists noted that performance is actually very strong despite the current economic environment. The view is that the transition mechanism between monetary policy and credit is longer in duration than many in the market expect. More stress is expected in the future, though the peak is expected to fall below the stress experienced in the GFC. In particular, one panelist expects affordability in the UK to deteriorate to levels not seen since 2008, with long-term arrears anticipated to rise this year and 2024. The key factor to collateral performance will be unemployment. Currently, there are very low unemployment rates across Europe and if they start increasing, this will impact performance.
The panel pointed out that as the market gets closer to refinancing dates, and the higher the interest rates, there will be a further problems to impact performance. In particular, with respect to commercial real estate (CRE), there are structural changes separate from the current environment which is impacting value. However, structures to date have proven to be very resilient. The liability side of an ABS structure is floating rate rate in nature, which does appeal to investors in the current environment.
At the moment, RMBS and covered bonds are pricing at similar levels, as highlighted during Day 1’s Traders’ Roundtable, which mainly focused on liquidity. As a result, there is likely to continue to be increased issuance from the banks. To date, European bank issuance has not significantly improved over previous years. A lot of deals that would have occurred on the public side have been placed privately, with banks making greater use of synthetic balance sheet transactions.
Panelists contemplated whether this would migrate back to a more balanced public versus private mix. Issuers want the certainty of execution and as a result, there is currently a large degree of pre-placement targeted to the same investors. Issuers know their investor base well, so are leaning towards private placements. Pricing does play a role in the choice between going with a public transaction versus a private one.
Panelists also felt that for European securitisation, there is a fundamental problem with the market as the investor base remains very concentrated. The market needs to open up to more investors, and this is a fundamental challenge the market has been dealing with for many years. This should help to create more liquidity, better execution, and greater demand for the product.
The panel also discussed the call options within transactions and the exercising of these options has been questioned recently as many investors believe that every deal will be called. Recent focus on this topic has led to more conservative structures. Generally, issuers do try to call the transaction if they can in order to avoid reputational risk.
Institutional Investors Roundtable
An important panel of the day focused on investor thinking amid the current environment and how markets are providing opportunities. For their part, investors are reacting with both excitement and caution. Broadly speaking, investors are taking differing views on the direction of prices. This view is mirrored in a KBRA investor survey done prior to the conference, where participants expressed diverging views. The panel’s consensus is that asset prices have reached an inflection point and it is difficult to take a long-term view, hence the divergent opinions. In European securitisation markets, engaging carefully and while the future is uncertain, there was one panelist how expressed the view that it was unlikely to get worse, and was more likely to get better.
Markets have so far been resilient in light of the macroeconomic stress, but this is not expected to continue in all areas. Investors are looking at various opportunities that could arise as they adjust to a higher for longer interest rate sentiment. In the European securitisation market, panelists feel that short-term rates drive performance and long-term rates drive long-term value. While collateral performance has yet to fall, there was a consensus that the future remains uncertain, albeit with newly created opportunities. A poll on what keeps investors up at night found that high inflation and interest rates ranked highest at 70%. The panelists added that the risk of a prolonged recession with rising defaults was also a concern.
Secondary markets are still active in terms of both sellers and buyers, with no widespread selling as yet. The strong technical demand for assets is driving spreads down and any potential sell-offs have so far been met with flows of liquidity. Prime RMBS trading inside covered bonds from the same originator, as occurred earlier this year, struck the panel as a shock to securitisation investors.
Panelists believe there are still substantial potential losses in the system that need to roll off. Many securities are not marked-to-market so there is greater uncertainty when they will be re-marked or need to be sold, as per the issues that occurred in the US banking system earlier this year. Other areas of concern centred on the larger risks asset types such as CRE, where refinancing and defaults are a concern. The nonperforming loan market is a concern as the government support programmes are at risk of ending, and performance has not matched expectations. Further, consumer delinquencies are starting to show signs of increasing.
An audience poll of what is the best relative value in the senior European structured finance sector found that 50% of respondents felt that leveraged loan CLOs offered the best option. The panel added that the diversity in the collateral pools helps to widen out the storm with CLO AAAs much wider than other AAA markets. This was followed by auto ABS (20%) and prime RMBS (15%). The audience was unanimous in their negative sentiment that CMBS offered any value whatsoever, as the market needs to wait for a repricing.
The SRT market is holding up well this year, and volumes continue to increase with more investors, more originators, and more enquiries into the market. As the asset class matures, the market and structures will evolve, which may create challenges, according to panelists. At the moment, the supply and demand balance remains supportive.
CLO Market Overview
The CLO panel, moderated by KBRA’s Gabriele Gramazio, covered a broad range of topics including primary issuances and spreads, CLO arbitrage, relative value and investment opportunities in the secondary market, and CLO performance. The CLO market is turning into a hot topic at the conference this year. New issuance volumes have been declining in the past year with 29 European deals so far, which is down 10% year-over-year. The panel highlighted that the CLO market has been resilient in 2023 in the face of a challenging and volatile year. The positive momentum currently building in the US market has been passed across to Europe. As highlighted in other panels, the view is there is value in the European CLO market, however, panelists could not agree on where they see AAA spreads heading.
In a debate about pricing and relative value, one panelist said they were seeing increasingly fewer B notes trading across Europe as these were trying to price at tighter levels than usual. Another panelist noted that BB notes were a lot more attractive than single-B and supply was available. A third panelist highlighted the level of analysis needed to explore the CLO market in the lower tranches to find suitable transactions. But the appeal of the current pricing meant that it was worth the diligence required.
One area of consensus is that AAA notes, which make up approximately 60% of the market, are viewed as attractive right now, with one panelist noting they expect them to remain attractive in the next year. This is because the panelist does not see any major cause to tighten spreads in the next year. Other panel members echoed this sentiment and see an attractive market, although noted that the arbitrage on these notes is challenging. Private credit is a competitor to the CLO market and there could be a migration of issuers on the loan side that migrate towards private markets for funding. However, due to the lack of supply, it was conveyed that loan pricing remains above levels were it arguably should be priced thanks to the supply and demand dynamics of the market.
European Solar & Renewable Energy Markets
European solar ABS has garnered a great deal of attention as a potential growth market. KBRA published a report in February which highlighted the financing market for solar photovoltaic (PV) panels and the potential of the support securitisation can provide. The panel began with an overview of the solar market in Europe, which has seen a steady rise in solar PV panel installation since 2000 and particularly in the past 10 years. Germany is the leading country in the installation of solar PVs, followed by Spain. Panelists said that the lower installation costs in Germany relative to the rest of Europe was a driving factor. This is supported by the regulation in place that requires new homes to have solar panels. It was noted that if other European countries want to grow their domestic solar market, regulatory support and financing is required. Further, it was stated that solar capacity in the German market was evenly split between residential and commercial installations.
A panelist said the lending product type, whether a loan or lease, is a contributing factor in the credit analysis. The lease products are more complex than the loan products where voluntary defaults could be an issue or a scenario where the homeowner sells their house. In the latter scenario, the panelist cited the US, where servicers typically negotiate a deal with the new homeowner.
In regards to the sector’s future, the panel commented that the solar market is currently popular, but still needs regulatory support from governments to keep up the momentum in Europe. The first public securitisation of solar loans or leases will likely be a catalyst in motivating the market, with one panelist stating they expect one or two public securitisations will make it to the market before this time next year.
Auto ABS remains one of the steady sources of securitisation issuance in Europe. However, the panelists were faced with a challenge from an opinion poll. According to panelists, China is viewed as a major jurisdiction for growth with 42% of participants voting for the region over Europe (32%) and North America (21%), and a minority (5%) expect no particular region to see any significant growth.
Another poll found that issuance levels are expected to hold steady, with 50% expecting issuance to stay at a similar pace to historical rates. A total of 42% expect the sector to grow, and only 8% felt that the levels of issuance would decrease. However, the cost of derivatives is a concern, creating difficulties in execution. The repricing of collateral has not caught up to the increase in interest rates, reducing levels of excess spread. Auto ABS remains a popular investment for banks as a short-dated product but is also useful to many European banks as issuers. One aspect of the new issuance market is increasing private ABS transactions. An increasing number of them are making use of the simple, transparent, and standardised (STS) label.
From a performance perspective, auto ABS collateral is very stable. Recoveries are currently very strong, and new registrations are recovering (although they remain below 2019 levels). Going forward, inflation and interest rates remain the biggest concern, according to a poll of the audience (52%), while investor demand is also a key element to the market (24%). A few respondents felt that both ESG regulation (12%) and new entrants and business models (12%) were also a concern.
There is a migration in the market towards greater regulation in the ESG area, which has a proportionately high impact on auto ABS over others. As a result, there is an increasing importance for a regulatory team to understand and support lenders on the current regulation environment. KBRA recently released a research report on the increasingly green proportion of collateral pools as the sales of electric and hybrid vehicles increase.
The consumer ABS panel kicked off with observations on the current market, noting that the buy-now-pay-later (BNPL) products are exploding and that they expect increasing securitisations of this type of collateral. However, it was also conveyed that more regulation is needed for BNPL products on the origination side. In Australia, BNPL regulation has already been announced, which will impact business models in the region. However, the magnitude of this change is not yet clear.
In addition to the BNPL product, the panel expects an increase in nonbank lenders coming to the European securitisation market for funding. For nonbank lenders, securitisation is key to their funding, so they need to be mindful of ensuring access to different sources of funding. Forward flow agreements have been growing in the market as a number of lenders make use of bank funding with the potential for a securitisation takeout for the bank. There has been an increase in fintechs entering the market, as discussed in KBRA’s Day 1 recap of the unsecured consumer ABS panel. These lenders have been a steadily growing segment of the market.
Touching on the macro situation, panelists said that inflation is their biggest concern, although in Europe the collateral has largely been originated to prime borrowers. Household saving levels have been declining, which has been impacting delinquency levels, as they are starting to show signs of increasing. One panelist mentioned that wage increases are a mitigating factor to the inflation concern, although this may create stickier inflation at a macroeconomic level.
Overall, the panel expects to see the likes of fintech, BNPL, and solar products to increase their presence in the market. There is likely to be a consolidation of smaller issuers in the future, as their business models will be challenged with thin capitalisation and increased funding costs.
ABS Researchers Roundtable
The residential housing market in Europe is currently observing a slow deflation. It was stated that house prices are still elevated when you look at the house price-to-income ratio, and there are a number of refinancing challenges, particularly within the UK. However, panelists noted that there remains plenty of support for the housing market in terms of value. The panel and audience were asked which sector is most likely to have the most issues in the future, and over 50% chose CMBS.
The panel kicked off with highlights from the last 12 to 18 months, with one panelist mentioning the sharp repricing that occurred in October 2022 and the normalisation in spreads in the intervening months to date. The panel said that spreads and supply have been in a holding pattern with sideways trading, and there is an anticipation that the European Central Bank’s (ECB) quantitative easing programme ending could support supply. A panelist highlighted that they are not seeing a deterioration in performance from rising interest rates and inflation.
Gordon Kerr, KBRA’s Head of European Research, commented that consumer ABS is potentially concerning, because it is the sector that will show the first signs of weakness as individuals are at risk of failing to make their credit card payments after working through their COVID savings. On a different note, he stated that auto ABS has historically been a steady performer, and the supply chain shock that occurred during the pandemic elevated used car prices. The panel commented that the German auto market is holding up quite well, with low delinquencies and tight pricing levels. One saving grace in regards to potential stress in the market is the low unemployment levels.
The panel and audience were also asked which sectors are likely to have the most value; over 50% of respondents expect it to be CLOs.
SRT Issuer Outlook
Over the past five years the market has been growing, with more and more new entrants on the issuer side. Many are becoming more mature in their approach and use of the market, as they have now originated more than one transaction. The issuer side of the panel still sees a strong pipeline developing, with almost every potential issuer now involved in the market.
The significant risk transfer (SRT) market has been rapidly growing and evolving. While the outlook at the moment remains relatively cloudy, panelists were still positive. Investors could potentially change their view on the market and regulation could also impact future volumes. Nonetheless, it remains a growing and largely private segment.
The use of SRT is considered more mature as far as issuing new trades out of existing programmes. This allows better time to market, and a recent AFME publication shows volumes are up quarter-over-quarter. New banks have recently come to the market, and there has recently been a different focus on assets with a movement away from a high concentration of corporate exposure. Panelists conveyed that as the market evolves, it will be interesting to see how the supply-and-demand dynamics develop over time. Many jurisdictions coming out with SRT have not even done a public securitisation, so the investor base has little to compare.
While there is a positive environment around the European SRT market, panelists also discussed the US market, which is currently paused as the Federal Reserve considers what types of structures it will endorse. If the Fed does support the market, then there should be a flurry of issuance. Panelists did expect a positive outcome from the Fed, but were cautious given the uncertainty.
Structures are evolving, and regulators need to rethink the p-factor and output floors across new structures, but there remains a growing investor base with exposure offered to a multitude of different assets.
The RMBS market is the largest in terms of transaction volumes, with collateral ranging from reperforming loans to prime borrowers. Panelists discussed the various aspects of regional markets with a focus on the UK, given its relative size and diversity. Issuance to date has been focused on the return of prime UK collateral with a transaction from a master trust, the first in a long time. However, transaction volumes are not just focused on the UK; many other regions are also participating, including via large, retained volumes from France.
There was debate around the nonbank lenders, primarily in the UK, although a number of Dutch nonbank issuers continue to make use of the market. Kali Sirugudi, a Managing Director in KBRA’s Structured Finance Group, highlighted the varied products now available, with an increase in reperforming loans and the prospect for an increase in equity release mortgages. KBRA recently published a research report on the potential for growth in the use of securitisation in this market across Europe.
Gordon Kerr, Head of European Research
+44 20 8148 1020
Christopher Noonan, European Structured Finance
+353 1 588 1225
Gianfranco Di Paolo, European Structured Finance
+353 1 588 1205
Stacy Gross, European CMBS
+44 20 8148 1058
Yee Cent Wong, European Ratings
+353 1 588 1260
Adam Tempkin, Director of Communications
+1 (646) 731-1347