Having undergone a significant repricing of risk in the structured credit markets following the liability-driven investment (LDI) crisis in Q3 of 2022, it does feel somewhat like the ‘calm before the storm’ on the credit fundamentals side.
In our view, this provides an attractive buying opportunity for investors in structured credit. Year-to-date, spreads for most asset-backed securities (ABS) tranches have tightened. Looking at UK non-conforming as an example, AAAs have tightened 30-40bps from mid-100bps to low-100bps. Across investment-grade mezzanine tranches, the re-pricing has been more in the order of 50-70bps.
From an issuer’s point of view, as pricing has improved, so has the motivation to come to the market when compared with the beginning of the year. The result has been an increase in the volume of new issues – and at the current run rate, the European ABS market is on course for approximately €60- 65bn of issuance this year.
As we have discussed previously, the outlook for credit fundamentals appears challenging, with rates and inflation causing strain on consumers’ finances. The one saving grace underpinning the relative stability in credit fundamentals right now is the encouraging labour market data we are seeing across the countries in which we are invested.
Post-Covid unemployment numbers remain low – and this provides support for the types of consumer products – mortgages, car loans, credit cards – that make up much of the European securitisation market.
As pricing has improved, so has the motivation to come to the market when compared with the beginning of the year.
Looking at 90+ days arrears in residential mortgage-backed securities (RMBS) across multiple countries, we can see there has not been a deterioration across most markets (see chart). In this, however, we note that it is not unusual for performance in ABS structures to hold up while the economic cycle turns.
This is due to a number of factors. First, there is the conservative nature of the origination of the underlying assets; then there is the diversification of the collateral pools, which make up a vast number of underlying loans to consumers. Finally, on top of this, structures are designed to withstand significant stresses – far exceeding what we are seeing currently.
The robustness of structures and the continuing performance of collateral is corroborated by recent actions by rating agencies, with more tranches being upgraded than downgraded so far in 2023. Nevertheless, the risks have been well flagged and while investors may be attracted by higher spreads and higher returns, they would still do well, in our view, to exercise caution.