With 2006 drawing to a close and yet another record year of European securitization issuance expected, the market has definitely grown up. Analysts say that maturity can best define the European securitization market in 2006.
"After several years of financial experimentation, during which ABS was looked on, by many, as an exotic technique, or was not fully justifiable from an economic point of view, 2006 saw securitization become a fully-integrated funding tool," Societe Generale analysts said. "In 2006, securitization as a funding tool has been integrated within most bank asset sectors. Project finance and private equity businesses will likely also rely on securitization in 2007."
According to SG analysts, 2006 was driven by low funding costs and greater integration of securitization into operational businesses. The fairly stable interest rate environment and narrow credit spreads have supported lower costs of funding. A maturing market also meant more confidence in ABS credit risks and ratings assigned by the agencies, leading to more stability.
As far as securitization becoming fully integrated to operational businesses: "Originators and/or sponsors rely on securitization for their financing through regular issuance," SG analysts stated. "Both of these points are strengths for securitization, and we expect these elements to remain stable going into next year."
There has been no real change in terms of asset class dominance. Although RMBS remains at the top of its game, the CMBS sector has also seen volumes steadily climb and is displaying signs of more maturity. On the pure ABS side, the market has witnessed a gain of up to 20% overall, although the credit card sector has not seen any of this growth, mainly due to consumer credit weakening in the U.K., ABN Amro sources said.
RMBS has shown more stability in growth. Specifically, in the U.K., the increase has mainly been boosted by buy-to-let issuance that is, in turn, driven by growth in originations. The market has also seen an increase in non-conforming RMBS deals.
"The bulk of issuance has come from the established players," said Steve Curry, head of ABS at ABN Amro. "However, we have seen a couple of major U.K. high street banks issue securitizations for the first time. In addition, new mortgage platforms have been set up by investment banks and we expect to see increased issuance off these platforms in 2007."
While RMBS volumes maintained market dominance, CMBS also continued to come into its own, again showing aggressive volumes in 2006. According to SG, CMBS new issuance volumes reached 46.6 billion ($61.8 billion) equivalent in mid November. Sixty-nine new transactions have been structured so far this year, a figure very close to that of last year, which tallied 68 new deals compared with 40 deals in 2004. Germany emerged as a dominant payer in this market with its several divestiture programs and refinancing of real estate loans that will both continue to impact market volumes in 2007.
ABN's Curry said that there has also been a trend of issuing relatively esoteric deals that are not repeatable but that have offered investors access unusual asset classes. London's Arsenal football club used securitization to help pay for its new stadium (ASR, 7/10/06), while the private equity firms that bought car rental firms Europcar and Hertz both issued large deals to fund the acquisitions. Eurazeo acquired Europcar's from Volkswagen and the European business of the Hertz group was acquired by Dubilier & Rice, Carlyle Group and Merrill Lynch Global Private Equity from U.S. carmaker Ford Motor Co. last December. These deals involved multiple jurisdictions and were the first time car rental businesses have been securitized in Europe in the public market. This year also saw the 355 million securitization CRC Breeze that funded the acquisition and completion of 39 wind farm projects in Germany and France.
In keeping with its maturing stature, the European ABS market has not seen any big swings in volume by region, even though deals have come out of yet-untested jurisdictions. The emerging markets of Central Europe have definitely been more active in 2006. Although there was a lot more volume coming from certain regions aside from Russia and Turkey, these other countries are relatively small in comparison and are unlikely ever to reach a significant scale of issuance, Curry said.
From a geographical perspective, the year has been defined similarly as in the past. According to ABN Amro, the U.K. still dominates overall market issuance with Germany and Spain both growing to cover more significant shares. Italy has seen its market share drop but sources at the bank said it was still too early to unveil a specific figure since the market was still pricing deals.
In the Netherlands, origination levels have been down in comparison to the knockout year the country saw in 2005. Meanwhile, in Italy the consolidation drive meant less of a funding focus for many of the country's banks.
"In 2007 we expect to see continued growth in the Italian securitization market as those banks under new ownership implement best practice portfolio management techniques," ABN's Curry said. In some cases, additional risk concentration will drive this." ABN Amro this year consolidated with the Italian bank, Banca Antonveneta.
For the German structured finance market, capital relief has historically been the main securitization incentive but funding has become much more prominent, reflecting the greater disintermediation of banks in the credit economy. According to Deutsche Bank analysts, this has resulted in a change in the deal mix.
KfW-sponsored SME CLO and RMBS platforms are making way for cash CMBS, such as the private equity refinancing of multifamily assets, RMBS and hybrid' CLOs like ABN Amro's Amstel program (see below), which securitize equity-like exposures to SMEs. This trend is expected to continue in mortgages, and Deutsche Bank analysts expect the continued growth of specialized non-bank lenders will drive cash RMBS volumes going forward.
As the European market matures, investors have become more comfortable with a wider variety of assets - there is a general acceptance of ABS being an asset class to invest in.
Hans Vrensen, head of the Barclays Capital European securitization research team, said that investors generally had fewer restrictions on their asset allocations. Therefore, they are able to buy a wider range of securitization product. "The performance of European ABS asset classes from a ratings points of view and otherwise has been very good," Vrensen stated. "The stability of the ABS sector is allowing people to move into new areas, such as lower rating categories and new, emerging asset classes."
According to Barclays' second annual European investor survey, investors are still looking to grow their portfolios albeit at a slower rate than indicated at the end of 2005. The survey showed overall growth in investor demand for European ABS for 2007 is expected to be approximately 30%.
Growth for individual sectors is expected to be higher, with 44% in CMBS and 39% in CDO/CLO and SME CLO. Growth expectations for other sectors are slightly lower, but still very respectable, with 28% in RMBS and 21% in consumer ABS.
Basel II
As has been the case for the past years, Basel II also emerged as a major theme again this year but ABN's Curry said that in 2006, the upcoming accord has been more prevalent in structuring rather than just talk about how it will affect structures.
"This was the year that we saw the first real signs of action being taken to prepare for Basle II," he said. "Structures began to reflect both the existing and the new regulatory environment."
ABN Amro in November priced Amstel Corporate Loan Offering 2006 (ACLO 2006), a y10 billion partially funded synthetic balance sheet CLO. This transaction is the sixth CLO in the Amstel program but it was the first in which notes referencing part of the un-rated first loss' (equity') have been offered. All classes of rated notes were over-subscribed.
"We've seen institutions that have historically held onto the first loss pieces become much more receptive to distributing this type of risk reflecting the considerably higher capital charges under Basle 2," Curry said. "It is a theme that will heat up as we go in 2007."
Market opens
to more trading
Secondary trading has picked up over the course of 2006, according to Barclays survey results. With 11% of ABS assets bought in the secondary market, this accounts for approximately 28 billion for the Barclays survey respondents. They account for 25% of the overall universe, and also represent approximately 25% of secondary trading. Based on that, Barclays estimated a total European ABS assets acquired via secondary trading at approximately 112 billion, an increase of 53% from last year's estimate of 73 billion.
On a scale of one to 10, with 10 being the most important, a majority of 79% respondents scored secondary market liquidity seven or higher, up from 67% last year, the survey indicated.
"There is more pricing information available and additional cash flow modeling that make deals easier to trade," Vrensen said. "Secondary market trading might attract new and different type of investors. Therefore, going forward we expect to see more investors with a more active trading mentality."
Pricing stability
For 2007, ABN's Curry said he expected more double-digit growth overall for European securitizations and supply outweighing demand is unlikely. This year has primarily been defined by tighter spreads across asset classes with some widening seen among triple-A RMBS paper in the rush to get deals done by the close of the market this year. It is likely, Curry said, that this trend in pricing will continue.
"If you look at the top end of the capital structure, a consistent theme over the past three years has been an absence of volatility - the market has been relatively stable with spreads trending downward consistently," Curry said.
Historically, European deals paid a premium but as the market matures so have pricing levels shifted to reflect the growing knowledge of the market. The market over the past five years has remained relatively consistent story on individual asset classes and geographical story. Curry said that looking further down the credit curve at junior and mezzanine risk, the trend is also lending itself to narrower pricing spreads. "We will see more of this type of paper (Jr. and mezzanine) available going forward because of Basel II," he said. "We have more investors seeking yield and more players issuing in the market hence the supply and demand balance will likely lead to further spread compression."
Up to now the market has enjoyed a near spotless record with just one or two problems. "If you look at the outstanding issues, many investors are expecting the spotless record to continue," said Phil Adams, a director of securitization research at Barclays. "But a return to more historical level of arrears and losses shouldn't come as a big surprise and we expect deal structures to withstand these."
However, analysts caution that investors should maintain an optimistic outlook on the market and not sell on the back of one or two negative credit reports - if investors start to pull then the market may potentially see some widening next year.
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