Rapidly rising rates and busy primary issuance in the ABS market are expected to lead to wider spreads, with added macro risk threatening newfound appetite in the market.
The ABS market has been soaring over the past few months. Spreads were constantly tightening and more issuers found risk appetite high enough to issue down to double-B rated tranches for the first time in more than a year.
However, concerns about Federal Reserve’s rate policy, accelerating conflict in the Middle East, the end of the federal student loan payment pause, and the lingering threat of a government shutdown are forcing investors to rethink how active they want to be during this time. Add rate volatility into the mix and it is no surprise that things are looking somewhat less rosy.
Although more than 20 15-Gs were filed ahead of this week, the market was quiet on Monday and Tuesday. An ABS syndicate banker told GlobalCapital that they weren’t “surprised at all” that many deals didn’t price earlier this week.
“The dynamic felt like some of the larger accounts were sitting back on some of these deals and dictating the spread,” they said. “The market is very crowded. Everyone is trying to get out at the same time, and there is certainly a lot more volatility in the macro. We are seeing a pretty big backdrop in rates.”
Despite the volatility, US ABS primary was busy this week ahead of IMN’s ABS East conference in Miami. Issuers were keen to fulfil fourth quarter funding plans before the event kicked off. It’s usual for the market to be active before and after large industry conferences, but these added rate volatility and geopolitical risk incidents have created an unpleasant surprise for issuers with deals in the pipeline.
The three-year US Treasury yield ended Monday at 4.87%, up from 4.80% on October 13. It was up to 5.03% by Wednesday’s closing. The two-year yield also climbed 5bp from October 13 to October 16 to 5.09%, ending Wednesday at 5.19%.
Starting on Wednesday, 17 issuers rushed to ABS primary, bringing more than $9.79bn new issue volume to the market as of Thursday afternoon.
“Maybe people just think that rates are going to continue to go up — and so why not just try to get [the deals] done now,” a head of fixed income at an investment firm told GlobalCapital.
Wider spreads
Even with a busy primary schedule, new deals are still getting done around initial price thoughts, but secondary spreads across the board continue to widen.
Over the past month, triple-A prime auto seniors were 8bp-11bp wider, while subprime auto two-year triple-As were 20bp wider, according to Deutsche Bank’s securitization report from this week.
Subprime auto double-A and single-A classes were wider 30bp and 40bp month on month respectively, with credit card and equipment ABS seniors also seeing 7bp-13bp and 5bp-19bp widening respectively.
“I wouldn’t say that we are seeing a retrenchment, but in our view, some of the air is coming out of the balloon,” Rich Barnett, capital markets partner at investment firm Castlelake said about spreads widening compared with summer. “We believe things are slowing down. Deals still appear to be oversubscribed, but not on the same magnitude as three or four months ago.”
Considering how busy the primary market is at the moment, the spread widening is still “within a very manageable range”, according to the banker.
Bank of America researchers predicted ABS spreads would be rangebound but biased wider over the near term in this week’s report, citing macroeconomic concerns about rates, the Fed and geopolitical risks.
Although current spread widening is not alarming investors, broader risks are still contributing to a slowly creeping investor fatigue.
“None of those factors are huge standing alone, but when you combine them all you get investors a little bit more nervous to put money to work right now,” the head of fixed income said.
Risk appetite softening
The risk appetite in the ABS market was making a comeback before October, but increasing rate volatility and geopolitical risk may steer investors back to high quality paper.
Many issuers, including Affirm, were able to issue down to double-B tranches for the first time in a year, pointing to an improvement in risk appetite. But that trend might start to slow down in the fourth quarter.
“Given where we are at this point in the year, I don’t think people will want to be in an aggressive position heading into the year end,” Barnett said. "We may see people start to take their profits and be a little bit more conservative.”
Deutsche Bank researchers said in their weekly report that they continue to like high quality, short weighted average life ABS in the face of higher rates and potentially weakening consumer fundamentals.
Softening of risk appetite is not reflected on spreads yet, but spread widening is a bigger risk for subtranches than senior ABS paper, according to market participants.
“Even a small chance that this all affects spreads makes people want to sit on their hands, because no one wants to buy a deal or a handful of deals and then [see that] all of a sudden spreads blow out,” the head of fixed income said.