Another record year is set to close in the European ABS market, with some estimates putting the 2005 tally close to the $350 billion mark. While most market players are expecting more growth from certain sectors in the market, the level of growth that has set the pace over the last few years is unlikely to hold.
Spreads are a lingering topic that kicked off 2005, with early predictions that the ABS sector would maintain tightening levels through the end of this year. Howard Esaki and Sarah Barton at Morgan Stanley expect European ABS spreads to outperform corporates because of relative spread stability in the sector. According to Morgan Stanley, European ABS has outperformed corporates on a total return basis by about 0.20% year-to-date. "Next year, ABS spreads will continue to show correlation with corporate spreads, but with less volatility, in our view," said the team at Morgan Stanley. "This has been the historical pattern for the more mature U.S. ABS market, and is starting to hold for Europe as well."
Esaki and Barton predict further growth in the market - 2006 should see volumes surpass 2005 year-end figures but not at the same growth rate. "Over the past 10 years, compound annual growth of European ABS has exceeded 30% - while the market cannot sustain such high growth rates forever, we expect continued strong growth in 2006," said the Morgan Stanley analysts. The duo expected total issuance to climb another 10% to 15% next year, given the benign interest rate outlook for the U.K. and the Euro-zone. "The much anticipated housing price collapse of 2005 did not occur and we look for stable to slightly lower prices in 2006," they said in an outlook report. "We expect U.K. RMBS issuance next year to be flat to 2005."
Fraser Malcolm, head of ABS syndicate and tradings at Dresdner Kleinwort Wasserstein, said that the end of 2005 and into early next year will be a period dominated by huge primary supply that he expects will tail off in 2006. "Lots of issuance has been on balance sheet driven by risk capital relief - think Barclays Capital, ABN AMRO - that should begin to taper off in 2006."
There may be a slight tightening trend driven by a slowdown in issuance but its not exactly clear what the supply volume would be like next year, said Malcolm. "In RMBS we will start to see more triple-A funding where originators hold onto the subordinated piece as we have seen in the U.K., but we don't see a clear picture that we will continue to see the same volume of growth in 2006."
The year of CMBS
One area that has seen phenomenal growth in 2005 has been the CMBS sector - analysts at Morgan Stanley estimate that issuance this year has grown 120% from 2004 volumes. Morgan Stanley's Esaki reported that the surge of issuance in the fourth quarter would push CMBS 2005 issuance volume at nearly $55 billion, more than double last year's total. And while growth is expected to continue in 2006, the pace is expected to slow, with Esaki estimating 20% to 25% growth to $70 billion at the end of 2006. "We base this forecast on a heavy calendar, aggressive conduit lending, a low rate interest rate environment and favorable property fundamentals," he said. Malcolm at Dresdner said he expected increased qualitative tiering, which will potentially put more spread volatility into the CMBS asset class.
"CMBS has more than doubled this year and next year the volume will be even higher now that the conduits are in place, but the whole market is much bigger, 12% to 13% bigger," said Julien Mareschal head ABS trader at BNP Paribas. "We should see a very active start of the year, particularly on the secondary side."
Mareschal supports his prediction with the pricing levels the surge of CMBS deals has seen this year. While still relatively tight, the sheer weight of volume has pressed pricing levels out from the tight levels that kicked off the year in this sector. "You have tiering that disappeared in January last year with prime RMBS trading at 10 basis points, non-conforming paper trading at 10-to-14 basis points and CMBS trading at 15-to-16 basis points - there was no tiering, nothing to play with," said Mareschal. "Now we are in a situation of strong growth in some sectors and there is some good value there. Asset managers have much more choice and actually paper that you can look at that offers value for managers looking to allocate risk return."
Mareschal said he also expected an increase in the CDS market, with a pick up in European trades. Indices are another area that has been growing over the past two years that has seen little trading in the past. "We are trying to introduce a level of trading via our Euro multi-dealer index that will be launched in 1Q06. It will be triple-A initially then we'll see where we go from there."
Consumer ABS affected by debt
On the consumer side it is not clear whether there is any major growth on the horizon but Fitch Ratings analysts said they expected stable to improving performance of most European consumer ABS in 2006.
Dresdner's Malcolm said that there might be more captive auto issuance from the likes of Ford Motor Credit, General Motors Corp. and VolksWagen AG (see ASR 6/6/2005). Analysts at Fitch said that the first half of 2005 saw a significant growth in the volume of auto issuance compared to that seen in the first half of 2004, coming primarily from France, Italy, Spain and the Netherlands. There were no deals from Germany in the first half even though they were the dominant issuing country in 2004 with nearly 50% of volume. The third quarter of 2005 was very quiet with only one true auto loan transaction: Driver 2 from Germany; although Success 2005, an Austrian mixed lease pool, closed with approximately half the underlying leases being for vehicles.
So far this quarter has seen the launch of the fourth securitization from Fiat SAVA in Italy (A Best 2) and the DC Bank transaction (Silver Arrow). "Regarding general auto securitization we have seen more securitization of flexible loan products rather than a focus on pure amortizing loans," said one analyst. "Some transactions have previously excluded the balloon payments and the wide spread three-way financing products and we expect to see these more frequently included in future transactions. Competition in the auto loan market is increasing as the more credit institutions offer the products competing with the previously restricted number of specialized auto loan banks,"
On the credit card side, Fitch said that increasing consumer indebtedness may negatively impact the credit card sector but the agency did not anticipate any deterioration in performance. Delinquencies have improved over the last 12 months and while the rating agency said it expected an increase in chargeoffs, the levels should begin to taper off sometime next year. "I think next year we will see continued issuance repeat issuers - Arran and Pillar will both close before Christmas," said one market source. "In 2006 we should see at least one new U.K. originator - from the other jurisdictions it's not so clear cut but we are hoping to see levels grow again. A lot of the repeat issuers were hesitant to tap the market earlier this year because they were worried about performance levels and that fear has been dealt with."
Dresdner's Malcolm added that the recent spate of private equity deals in the U.K. should lead to an uptick in issuance on the whole business front.
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