Investors have proven slow to return to the European securitization market. The limited appetite has been matched by a lackluster amount of securitization supply that market analysts said has created an imbalance in secondary and primary securitization pricing.
The greatest concern for securitization buyers continues to be the uncertainty created by several unknowns that could still impact the ABS market down the line.
In a recent report, the European Central Bank (ECB) suggested that deteriorating macroeconomic conditions, including rising unemployment and low consumption, have subdued the issuance of loans and weakened the performance of collateral qualifying for securitized products, which impacts ABS origination activity. The ECB also reported that alternative funding sources - ECB repo, covered bonds, deposits, increased structuring cost (e.g., swaps) - are also behind the limited public supply.
Appetite for securitization paper has been further suppressed by the impact of rating agency changes to counterparty risk. On Jan. 18, Standard & Poor's put 1,981 structured finance tranches in Europe, the Middle East and Africa, or the EMEA region, on CreditWatch negative based on its changes.
According to Barclays Capital analysts, the vast majority (97%) of the affected tranches are currently rated triple-A and double-A, but some lower-rated classes were taken on review as well.
Meanwhile, Societe Generale analysts said that that new requirements being revised by the rating agencies that limit operational risks in the event of counterparty difficulties, which will ultimately be positive for the market, also complicate the process of structuring and achieving the highest possible ratings for new issues.
According to a report by UniCredit analysts, banks and real money accounts comprise roughly 80% of today's investor base while insurance activity is limited to roughly 10%. Only huge, specialized insurance accounts seem to be active.
"However, some insurers might as well be investing in securitization via their own investment fund vehicles," analysts wrote. "While former real money accounts are returning, completely new players have also entered the European market."
Most primary investors are located in the U.K. with a focus on U.K. RMBS, Benelux and the European Union (EU), with the buyers primarily chasing after Dutch RMBS, and auto paper. Within the EU, nearly all countries are represented, including France, Spain, Italy and Germany. It is noteworthy that regional demand differs for different asset classes.
"For example, the ECB found that German securitizations attract a sizeable interest among foreign investors," UniCredit analysts said. "German auto deals were mainly bought by investors from Germany (40%) and the U.K. (23%). Also, French investors accounted for approximately 14%. The remaining countries accounted for less than 10%. Some issues are also targeting overseas investors [for example] U.S. investors [mainly purchasing] U.K. RMBS. Currently, an AUD tranche is offered to Australian accounts with respect to a U.K. prime RMBS."
In terms of the sell side, low demand for refinancing and fairly wide spreads at issuance are likely to continue to keep these buyers away from the market.
Investors have learned their lessons from the financial crisis and are now scrutinizing products more carefully, showing increased appetite for tested structures and collateral that are less complex and more plain vanilla. They also closely look at structural risks - including sequential payments, non-amortizing reserve accounts etc.
"Granularity and prime quality are key with respect to the underlying portfolio," said UniCredit analysts. "A good track record and high-quality originator reputation is very much favored by today's investors as well, which underlines why recent issuers such as Skipton or Veneto Banca needed to pay some pick -up in comparison to other frequent issuers." They added that issuance is too expensive and uneconomic for junior debt and "second pay," longer-dated senior bonds lack demand.
On the secondary market, real money end accounts like funds, banks, and asset managers are all active buyers, particularly of senior debt. However, bids or mezzanine are limited mainly to specialized fund investors, hedge funds and strategic investors. Such accounts are also active in non-prime asset classes within the CDO/ CLO and CMBS sectors.
"The number of secondary bids has increased, while secondary markets have become completely sold out," UniCredit analysts said. "The sell side is very limited. Sporadically, there are strategic sellers due to rating constraints, regulatory changes or other risk limitations. Performance-driven forced selling is relatively infrequent. With limited sellers, it has become difficult to source paper in attractive sizes."