Global ABS Conference Recap – Day 2
BARCELONA, Spain--(BUSINESS WIRE)--Jun 6, 2018--Day two of the Global ABS Conference in Barcelona shifted away from the more mundane regulatory and policy discussions (as discussed in our ) to a greater focus on capital market topics (See Figure 1). At a high-level, market sentiment seemed mixed among conference goers, with differing views on where spreads would go over the next 6-12 months. However, most agreed that shortening duration and moving up in quality makes the most sense in the current environment, given the flat yield curve and heightened volatility.
Many of the investors we spoke with felt that given recent market volatility and spread widening seen during Q2, spreads were more likely to tighten over the next 6-12 months, driven by strong investor demand. Meanwhile, just as many investors felt that unfavourable technicals, caused by central bank tapering, would push spreads marginally wider by year-end. In these uncertain times, however, no one seemed to have much conviction either way.
Below we give a quick recap of some of today’s panel topics.
ABS Growth and Liquidity Outlook
Day 2 kicked off with a panel discussion focused on the health of the European ABS market. The panel was primarily made up of CIOs and portfolio managers, who all agreed that we’re in the late stages of this historically long credit cycle, based on late stage indicators such as stretched asset valuations, weaker credit fundamentals, tight spread levels, and high consumer confidence. That said, since central banks have made it expensive to sit on cash, many of the panelists thought that at this stage of the credit cycle it was prudent to remain invested, but to de-risk portfolios by shortening duration and moving up in quality. The panel also touched on ABS supply expectations, with all the panelists forecasting a marginal year-over-year increase in European ABS new issue volumes. One panelist pointed to the strong up-tick in U.K. RMBS supply, which has likely been a result of central bank tapering. Panelists expectations called for a gradual growth in European supply over the next few years, but no one expected there to be a “tidal wave” of issuance any time soon.
The European CLO Market Outlook in 2018
The panel kicked off with a discussion about CLO credit fundamentals, focusing on how credit quality has deteriorated over the past 12 months, due to higher loan leverage, weaker loan covenants, and more equity friendly structures. However, no one seemed to be overly worried about credit or believed the loan market would turn south in 2018. On the demand side, the panelists see increased capital inflows from Asia, as well as a number of U.S. investors entering the European CLO market. Increased demand in the space should be met with increased supply as most of the panelists forecasted €25+ billion of new issue supply in 2018, versus around €20 billion in 2017.
Finally, the panel discussed relative value, noting that nothing looks historically cheap within the CLO capital stake. One panelist thought that CLO equity presented the best risk/return profile, even as equity returns continue to get squeezed due to rising rates. Meanwhile, others found CLO AAs attractive, given that spreads have widened 30-35bp to L+135 in recent months and trade 50bp wide of AAA-rated paper, despite a trivial increase in credit risk.
Market Liquidity Challenges: The Traders’ Roundtable
Made up entirely of traders, these panelists had a more pessimistic view of the market. Most felt that investors were anxious given elevated market volatility and historically tight spread levels. One trader noted that at current levels, there is probably more risk to the downside than the upside and felt it was prudent for investors to take more defensive positions. The panel was generally negative on spread levels, given central bank tapering and the flatter yield curve. In terms of trade ideas, panelists thought CLO AAA/AA/BBs and consumer ABS mezzanine tranches appeared to offer the best relative value. That said, they noted that it was wise to be at the shorter end of the curve when possible. Meanwhile, one of the more outside-of-box trade ideas included buying Australian and Irish RMBS, which appear attractive relative to U.K. and Dutch mortgage bonds.
Brexit Update and Impact on ABS Markets
While Britain’s exit from the EU is fast approaching, the form and consequences of Brexit remain largely speculative. Regarding the former, one panelist noted a spectrum of forms Brexit may take, ranging from a hard crash out of the EU to a free trade agreement, with the optimistic scenario being an equivalence recognition between the EU and Britain. The consequences for the ABS market remain unclear, particularly regarding legacy transactions and the potential need to seek approval from noteholders to change deal documentation. Several panelists noted that they had already seen changes in how deals are currently being structured, and there is heightened interest among investors for deals backed entirely by UK assets. One panelist noted that while spreads blew out immediately after the Brexit vote, since then they have progressively moved in. However, the panelists agreed that “what keeps them up at night” is the concurrently evolving European regulatory framework coupled with lingering concerns over unanswered questions regarding the post-Brexit EU-Britain relationship.
CMBS Trends: What is Coming to Market and What is Holding it Back?
The panel began with an encouraging statistic. There have been five public European CMBS deals over the past six months, making 2018 the strongest year for issuance since 2015. Several reasons were given for the increased CMBS activity, including a generally positive European macroeconomic backdrop, a “wall of money” asset managers have at their disposal and, above all, relative value as compared to CLOs, which have seen spreads tighten across the capital stack. One panelist provided an overview of the recent deals, noting the diversity of jurisdictions and underlying collateral across the five deals, which possibly portends issuer confidence to show new products to investors in the near future. The panelists proceeded to discuss privately placed and synthetic CMBS transactions, noting that the market for these products has remained quite active over the previous three years and is expected to remain so. Despite the encouraging recent deal flow, several issuance constraints were discussed, including a limited asset supply and investor base, as well as little EU regulatory endorsement. However, the panelists were fairly optimistic regarding issuance over the rest of the year, with predictions of increased issuance from continental Europe and Ireland, as well as agency deals.
Credit Risk Transfer for Capital Relief
How do banks decide whether to utilise a synthetic or traditional securitisation to mitigate credit risk? The panel began with synthetics being credited for their ease of implementation, whereas traditional securitisations offer excess spread. The panelists proceeded to discuss the pre-and post-crisis investor profile, noting that before the Financial Crisis there was a broader range of investors, while now there are different classes of investors depending on risk preference, ranging from pension funds seeking standardised products to specialised investors that focus on transactions backed by alternative assets. The investor base for U.S. Agency transactions was also discussed, with pension and sovereign wealth funds opting for the top of the capital stack, hedge funds further down the stack, and asset managers that migrate down the curve as they become more familiar with the product. The panel concluded with a lengthy discussion on the challenges for market participants, including banks, investors, issuers, and rating agencies. Data adequacy was identified as the primary challenge, particularly for synthetic transactions, where there is often scant data provided on collateral. However, the discussion ended on a positive note, with one panelist identifying new technologies that may ease data collection and thus facilitate an expanded market for securitisations.
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Kroll Bond Rating Agency
Brian Ford, CFA, +1 (46-731-2329
Structured Finance Research
Matthew Horner, +1 646-731-2477
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SOURCE: Kroll Bond Rating Agency
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PUB: 06/06/2018 05:49 PM/DISC: 06/06/2018 05:58 PM