Global ABS 2024: KBRA's Day 1 Recap
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Securitization

Global ABS 2024: KBRA's Day 1 Recap

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KBRA reviews day one of Global ABS 2024, which opened on June 4 to a record more than 5,000 registered attendees

The Global ABS 2024 conference, held in Barcelona on June 4-6, opened to a record of more than 5,000 registered attendees — including over 2,000 issuers and investors — as well as a full programme. The conference is celebrating its 28th anniversary as the largest annual European structured finance conference and is hosted by the Association for Financial Markets in Europe (AFME) and conference organiser Invisso.

Judging by the strong attendance and KBRA’s very active meeting calendar, the industry event reflected the momentum of European securitisation markets so far in 2024. New transaction issuance started the year positively, as highlighted in KBRA’s quarterly issuance report. Further, investors arrived at Global ABS with a promising view of the months ahead, as noted in our updated survey.

Day one panels featured market updates on asset-backed securities (ABS), collateralised loan obligations (CLOs), commercial mortgage-backed securities (CMBS), nonperforming loans (NPL), and more. Other discussions included broader topics such as regulation and synthetic risk transfer (SRT) securities, including several plenary sessions and a keynote from Benjamin Weigert, Deutsche Bundesbank’s Director of General Financial Stability. Below we provide a recap of some of the opening day’s panel topics:

Global ABS Markets

One of the opening panels looked at securitisation markets across the globe, comparing the differences between various countries and regions. The dominant part of the conversation focused on the US market, given its relative size and activity, but there was also plenty of discussion about Australian markets. Outside the regulatory differences that exist between the different regions, panellists covered the increasing role of private securitisations as the significant risk transfer (SRT) market continues to expand. It was noted that nonbank lenders continue to be dominant users of the European securitisation market. Also, standardised, transparent, and simple (STS) verified transactions have shown strong growth in the past 12 months.

One speaker characterised the current state of the market as “positive nervousness”, meaning that things are going well, but investors are nervous because it is going so well. Investors are active in the market and migrating into new asset classes but remain cautious about future spread widening. A panel member cited a lack of development in the triple-A investor base, which is key to the growth of the European market. A more diversified and growing base of investors is needed, according to the panellist, who added that conduit financing has shown growth, highlighting the alternatives used by banks.

Also mentioned was the uncertainty over collateral performance, given the rise in interest rates and its impact on collateral. As the discussion came to a close, panellists were asked for their wish list for the remainder of the year. There was hope for a soft landing and minimal disruption from the upcoming elections, as well as continued expansion of the securitisation market, both in terms of investors as well as new asset classes. Other items included the desire to lower the regulatory burden and for consistency in the use of environmental, social, and governance (ESG) reporting and disclosure.

Consumer ABS

The session started with a recap of the consumer ABS sector’s historical issuance, highlighted by the surge in 2022 and a strong showing in 2023. It was noted that while 2024 had a reasonable start, it was not expected to achieve the levels seen two years ago. For bank issuers, the use of the securitisation market is just a part of the funding mix, with many having a preference to fund consumer lending via other means, such as general bank funding. These issuers were also more likely to consider securitisation to help liquidity. For nonbank issuers, however, the market plays a more important role, offering them the ability to scale up.

Panellists also discussed the introduction of artificial intelligence (AI)-based credit scoring to help underwrite lending. The boundaries between underwriting and originations have blurred, according to the panel. AI-based financial technology companies are now targeting near prime credit scoring. The availability of open banking in the UK provides data to help train AI on the behavior of borrowers, including where and how much they spend, and help predict the borrowers’ default probability.

On the topic of performance, panellists noted the resiliency of European consumer borrowers. There has been a slight deterioration in performance, but this deterioration remains well below expectations. Further deterioration is expected in the near future as increased interest rates and the higher cost of living begin to impact borrowers.

The panel explored the new products and trends in the market, including the growth in buy now, pay later lending and the product’s potential to be securitised. It was noted that some retailers have already started the practice on their own instead of using third-party lenders, making use of their own balance sheet. As a result, they could still come to market, but will be dependent on their own balance sheet management. Subscription products for phones, laptops, and others have yet to reach the securitisation market, but there have been ongoing discussions with a number of these originators about their potential. The panel also pointed to other more esoteric products, focussing on hybrid lending to innovative small business lending, to name just two. There was even the suggestion of smart meters and more. In general, panellists were positive on the potential securitisation aspect for these numerous products, although regulation will be a key driver to adoption.

Buy now, pay later regulations were noted as a welcome support for the potential for the product to make its way to the securitisation market. It is currently an unregulated product and regulators, having noticed the increased activity, have taken the step of publishing a consultation. Regulators also note a high level of delinquency (around 25%) in this market. In 2023, the UK’s Financial Conduct Authority reviewed current practices and subsequently put in place support for good and sound guidelines such as the improvement of due diligence process. Panellists noted that any regulation would likely be similar existing consumer duty regulations. In the EU, there is talk about reviewing AI underwriting and decision-making as well as increased standardisation.

Exploring Private Securitisations: Using ABS to Finance the Real Economy

This year’s conference included dedicated areas in the main conference hall. The first of these was a discussion on the private securitisation market, where bank representatives led attendees through a private securitisation transaction used to support the financing of a corporation. It was explained that the transaction offers the issuer funding diversification, which could help the efficient management of their trading operations.

There is limited data on the breadth and scope of the private securitisation market, but the presenters noted how STS verification can help to provide the market with some detail of the sector’s true scale. The vast majority of the STS private securitisation market is focused on trade finance and corporate credit facilities. Attendees were told that the auto finance market also makes use of private securitisations, mainly in the form of asset-backed commercial paper.

CLO Market Overview

The CLO panel began with an overview of the status of the market, highlighted by the strong start to 2024. Refinancings and resets, for example, have returned to levels seen in 2021. The main drivers of the increase in CLO activity are the attractive yields, call options, and redemptions. The recycling of this cash goes back into the CLO market. This is then supported by the ongoing resilience of leveraged loan fundamentals. Panellists questioned whether the level of activity in the CLO market is likely to last. The consensus view was that 2024 would be a strong year; however, the panel also noted that the availability of loan collateral is challenging.

The broadly syndicated loan market has seen some activity via the repricing of originally private market deals. However, mergers and acquisitions as well as leveraged buyout activity needs to pick up in order to generate new loans for use in CLO transactions. It was noted that rates have stabilised somewhat, which should help activity. However, a challenge remains with the valuation gap for some assets.

The panel also considered how the European market is faring compared with the US. While refinancing activity is higher in the US, one panellist noted that region is seeing stronger spread compression in the secondary market. Meanwhile, Europe has potentially more collateral available. One panellist cited three distinct CLO “profiles” at the moment: seasoned deals from 2018, mid-life CLOs from 2021, and recent transactions. The market is looking at each of these differently and seeing value in different parts of the capital stack, depending on the profile, the panellist said.

The panel noted that captive equity and risk retention vehicles had kept the CLO market alive over the last few years, providing affiliated managers with the flexibility to issue when needed. However, there has been some revived interest from third-party equity this year, which should hopefully continue. Finally, the panel discussed middle market CLOs, pointing to typical issues with the product, such as lack of availability of ratings on the underlying collateral, FX risk, and a general lack of collateral. However, the broad consensus was that we would see the first European middle market CLO this year.

Recent Developments in European CLOs

The two speakers focused on four main topics: (i) maturity amendments, (ii) the reclassification concept, (iii) restructuring, and (iv) the latest UK Securitisation Regulation developments.

Concerning maturity amendments, the speakers noted its typical restrictions, including the requirement that the other terms of the underlying obligation remain substantially the same, the maturity date does not extend past the maturity date of the notes, and the requirement to satisfy (or at least improve) the weighted average life (WAL) test. On credit amendments, some managers had been taking the approach of abstaining from voting on the amendments. Investors have been increasingly requiring a positive or negative vote. In some cases, a requirement may be built in such that, if unapproved amendments are made, the asset must be sold out of the deal within a certain period of time and, failing that, held at a haircut.

Discussions on the reclassification concept referred to assets that do not meet the eligibility criteria on the issue date, but that the manager still wants to keep in the transaction. In some cases, these can be reclassified as “collateral enhancement assets” or obligations and, rather than being sold out of the deal at market value, the equity funds the market value of the asset. Any cash flow subsequently generated by the asset is directed to equity holders’ accounts rather than the rated debt.

On restructuring, the speakers noted that managers have typically had the ability to participate in a restructuring vote. However, managers are increasingly seeking the ability to reinvest principal proceeds that have built up in the transaction into the restructuring.

Next up was the UK securitisation regulations, where speakers noted that not much has changed. However, the panel said that UK investors are able to rely on a more principles-based reporting regime, whereby they are required to assess whether the information being provided was sufficient for their purposes. However, investors do not need to insist on strict reporting templates. On risk retention, there has been a helpful clarification that existing hedging arrangements that were put in place to hedge portfolio risk as part of a prudent risk mitigation strategy do not violate the prohibition on hedging the retained interest.

Finally, the speakers referred to the recently published IOSCO report on Leveraged Loans and CLOs Good Practices for Consideration. They noted that there was useful advice in there with regards to manager conflicts of interest, due diligence and disclosure requirements, as well as manager valuation policies.

Plenary: Market Outlook & Performance Review

The first plenary session of the conference covered ABS performance over the past year and expectations for the next 12 months. According to the panel, issuance this year has been strong with approximately €60bn placed so far this year — the highest volume at this point in the year, since the global financial crisis. The major contributors to this have been the CLO and UK RMBS markets. Both markets have been supported by refinancings, but in the RMBS market there have also been some debut issuers. Added to this, there have been some esoteric assets such as data centers, and the potential for solar transactions and others such as bridge financing. Furthermore, the SRT market remains robust, keeping investors and issuers very busy so far this year.

According to panellists, performance over the past year has been stronger than expected given the elevated interest rate environment and related repricing. Some sectors have experienced weaker performance such as an increase in consumer ABS arrears, and some UK legacy non-conforming deals. Also, there have been some loan defaults among high loan to value loans. However, the panel noted that, broadly speaking, performance was in line with expectations a year ago. Part of this positive performance was put down to stronger underwriting standards over the past 10 years, pandemic savings and fiscal support.

In terms of what could possibly disrupt the current market, it was noted that there are some potential clouds on the horizon. In particular, geopolitics risks impacting the markets with elections coming up in short order; Europe goes to the polls next week, the UK shortly after. This is followed by the US in the autumn, where there is the greatest expectation of potential disruption. However, it was also noted that these geopolitical issues extend beyond elections as war rages in some regions still. These areas could have a knock-on impact as they elevate energy prices again, which could raise the prospect of challenges to the fight against inflation. Interest rate cuts are being pushed out further and further, which has a heavier impact upon collateral performance the longer they remain elevated.

Lastly, panellists were asked their expectations going into Global ABS 2025. It was noted that there will likely be an increase in esoteric asset classes, regulations will remain unfit for purpose, and that asset performance should be fine, overall, barring any major black swan type of event.

Global Market Securitisation Regulation

The regulatory panel is a constant fixture of the conference, but every year there are fewer attendees as the market reflects the lack of changes. The panel covered a number of still important topics, but overall, they were very positive on the prospect for change. It was noted there have been an increasing number of political voices in support of change to improve the capital markets in Europe and this includes the use of securitisation. Until now, the call for change had been met by a lack of political will.

Panellists highlighted the need for greater flexibility, in particular on the investor side of things. The principles-based approach of the UK was recognised as a positive step, and upcoming consultations should present an opportunity to suggest further adjustments. The panel focused on due diligence requirements, which are viewed as too prescriptive and not fit for purpose. Proportionality is determined to be needed to support the market and help to diversify the investor base, the panellists said.

Risk retention was also discussed, particularly the differences between the treatment in the US versus Europe. Here it was noted that the UK and Europe are in alignment with regards to the quantum, although the US remains very different in its treatment with greater flexibility. One panellist noted that after the global financial crisis, regulations put in place were broadly similar, but they function in a different way. The detailed nuances between Europe, the UK, and the US have produced very different outcomes.

In Europe, there are several areas of improvement being considered — in particular, a greater clarity on the functioning of the regulation. Plus, an exploration of the consistency of collateral to help improve the facilitation of cross-border European collateral transactions. Further, there needs to be an examination of the changes needed. For example, are just minor tweaks needed, or is there a need to make larger changes?

Overall, the panellists agreed that there is a need to improve the functioning of the markets. Going forward, one panellist suggested that the market should be viewed globally from a regulatory perspective and should look to align across markets to allow greater movement of capital between regions: for example, to allow Asian, Australian or US investors easily invest into a safe and regulated market in Europe and vice versa. There is a need to improve the consistency of the securitisation markets across the globe to help facilitate this cross-border investment.

Auto ABS

As one of the largest and steady issuance markets in Europe, the auto ABS sector panel offered attendees an insight into the state of the market. The discussion opened with the collateral side, where vehicle sales and valuations are starting to normalise. Vehicle purchases have increased 19% in Europe, but remain below pandemic levels. Of note is the decrease in electric vehicles (EV) as a share of the market, currently around 12% of new vehicle sales.

The panel noted that used car prices have been declining, especially EV prices. Used petrol vehicle prices remain up, about 20% since COVID, albeit down from peak levels. Meanwhile, EV prices have collapsed to roughly 20% below pre-pandemic prices. The impact of this has led some rating agencies to apply a valuation stress if there is a large proportion of EVs in a pool. One panellist stated that while new vehicles are better for performance, there is less mezzanine issuance available.

On the topic of issuance, a panellist stated that approximately €9bn has been issued so far this year and they expect the total issued to rise to €25bn by year-end. Of this total, two thirds of the issuance to date has come from auto manufacturers. The topic turned to the global nature of the auto market, with Australian issuers finding a home within European and US investor portfolios. The banks in Australia have largely exited the auto financing market and as a result, the private lending market has grown dramatically. The nonbank lenders make use of the securitisation market to fund their business, and they are currently issuing AUD10bn a year — with 80% of the issuance bought by investors outside of Australia.

SRT issuers have also been active with their use of auto lending as collateral. This has greater appeal among some investors due to the increased yields over the mezzanine tranches of cash securitisations. One panellist stated the strong performance of auto collateral in their view makes mezzanine tranches of either SRT or ABS a great investment.

SRT Market Overview

Despite being a market that is largely private and esoteric, this was one of the best attended panels of the day with standing room only. The panel noted the appeal of the market as one which offers investors yield and a steady pipeline of supply in Europe. The market is expected to continue to grow in Europe, but attention has been focussed on the potential for the US market to grow. However, it was noted that there is a long lead time to a first-time issuer and the regulations in the US have not been finalised. As a result, the US market is unlikely to see an explosion of deals. Instead, the panellists feel there is likely to be a steady growth as increasing numbers of issuers find their feet. Further, as the market in the US is more conservative, there are thicker tranches and the pricing is not as appealing. As a result, many investors will continue to focus their attention on Europe. It was noted the prospect for issuance growth in the US has led to investors eying the SRT market in Europe.

Panellists highlighted the partnership element of the market — with investors and issuers working together, rather than in competition. One panel member even raised a strong example of this, where an investor had the document language adjusted to where it was originally strongly to their own advantage. The panel mentioned that the risk of a deal going bad in that way was not helpful to the market. As it is a regulated market, a bad experience in one transaction could taint the whole of the market in the eyes of the regulator.

The panel noted SRTs’ sustainability challenges, most critically being the lack of loans that would potentially meet the level of sustainability at the current moment. Further, the use of proceeds approach is an additional reporting burden that could also extend an already lengthy process to create a transaction. However, it was noted that the bilateral nature of the product did allow investors to create unique transactions that could potentially meet their own criteria.

European Residential MBS

KBRA’s Kali Sirugudi spoke on this panel focused on the RMBS markets across Europe. The panel noted the elevated activity in the RMBS market with an approximately 60% increase in issuance compared to last year. A large proportion of this has come from the UK. Nonbank lenders have been helping to grow the market as they continue to issue with new issuers every year. The RMBS market still remains the sector of choice for retained transactions, but these have been diminishing in 2024 versus prior years. In Ireland, the big banks are coming back to the market, but they are doing so mainly via portfolio sales or SRT transactions. However, there remains some activity in the re-performing loan sector in Ireland.

On the performance side, the panel noted that borrowers have largely absorbed the increase in interest rates, partly due to wage growth across jurisdictions. Borrowers with a long-term fixed rate have performed very well, given the protection the long fixed rate offers. This is a feature of the mortgage markets of Germany and Netherlands. There are some pockets of rising arrears, according to the panellists, with buy-to-let not performing very well. In Europe, rents have not increased as much as interest rates. This will likely keep issuance in this sector largely on the sidelines. In the RPL market, the rise in arrears was described as modest with servicing key to ensuring cash flows have been maintained. Arrears in this sector have translated into liquidity issues rather than defaults, making structural supports key.

There was some discussion around spreads and whether they could tighten further. The panel believed that the market was starting to hit a floor. However, it was noted that covered bonds have actually had wider spreads than RMBS this year. Some panellists highlighted the pricing benefit of STS was apparent in prime transactions, but not in others such as buy-to-let. Nonetheless, the panellists were in agreement that the market was heading in a positive direction.

CLO Manager Perspectives

One of the final panels of the day included KBRA’s Gabriele Gramazio, who shared his insights on the CLO market. One panellist commented that the CLO market is a cyclical pendulum, and it has swung from an investor-friendly market to an issuer-friendly market. This year is very different to 2023 with spreads tightening, good deal flow, and a brightening outlook. Issuers have made the most of the opportunity with a surge in issuance and resets and refinancings. Having captive equity available is key to the ability to take advantage of the market. Positively, demand for third-party equity has returned to help support issuance. However, the panel noted that the arbitrage between the collateral and tranche pricing levels is currently being stretched.

The outlook for collateral performance was highlighted with discussion about lender-on-lender violence as a potential risk over the next 12 months as some borrowers are being challenged by elevated rates and margin compression. Defaults are expected to reach 4% in Europe, mostly driven by distressed debt exchanges. It was pointed out that this could be the recession that never happened. Earnings remain strong in the US and the European market has been surprisingly robust given the headwinds in the market. The European market has large exposure to the top 20 obligors which have a wall of maturities not until in 2028. Furthermore, these issuers are for the most part well rated.

Documentation and structure also entered the discussion with changes that provide managers with greater flexibility. There is new language coming into transaction documents, but most documentation questions are being solved for via pricing, rather than allowing for tighter documentation. On the collateral side, the market is starting to revert to be more sponsor friendly with covenants remaining rather light.

One issue of concern noted by the panel is that of sourcing new loans. The LBO has been slow and as a result, there have been few new loans available for the market.

Primary Authors

Gordon Kerr, Head of European Research

+44 20 8148 1020

gordon.kerr@kbra.com

Matthew Horner, Senior Director

+44 20 8148 1082

matthew.horner@kbra.com

Katherine Quirke, Senior Director

+353 1 588 1185

katherine.quirke@kbra.com

Hrishikesh Oturkar, Director

+44 20 8148 1070

hrishikesh.oturkar@kbra.com

Gianfranco Di Paolo, Associate Director

+353 1 588 1205

gianfranco.dipaolo@kbra.com

Additional Contact

Yee Cent Wong, Co-Head of Europe

+353 1 588 1260

yee.cent.wong@kbra.com

Media Contact

Adam Tempkin, Director of Communications

+1 646-731-1347

adam.tempkin@kbra.com

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§ European Securitisation: Positive Trend Continues

§ European Auto ABS Indices: April 2024

§ UK Mortgage and Housing Trends: May 2024 Update

§ Navigating European CLO Tail Risk: Mind the Amortisation Gap

§ European Significant Risk Transfer Symposium 2024 Recap

§ European CLO Manager Style Comparisons: April 2024 Update

§ Private Credit: Potential for European MM and Direct Lending CLOs

§ Irish Mortgage and Housing Trends

§ 2024 European Structured Finance Sector Outlook: Turbulence Ahead

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