On Sept. 7, 2023, S&P Global Ratings held its sixth European Structured Finance Conference in London. Wayward markets, persistently high inflation, and looming loan maturities for some borrowers set the tone of this year's edition.
S&P Global Ratings President Martina Cheung and Cian Chandler, Managing Director and Chief Analytical Officer at S&P Global Ratings, delivered the opening remarks and gave an overview of the current market, before handing the stage over to the first of six panel discussions.
European Securitization Market: Outlook Broadly Positive
- Matthew Jones, Head of Specialized Finance, EMEA, S&P Global Ratings
- Kate Galustian, Managing Director, Head of European ABS, BlackRock
- Taher Miah, Capital Markets Associate Director, LendInvest
- Janet Oram, Head of Asset-Backed Securities, USS Investment Management
- Rachelle Rijk, CFO, Obvion
- Andrew South, Managing Director and Head of Structured Finance Research – EMEA, S&P Global Ratings
All panelists and, as an impromptu poll revealed, two-thirds of the audience felt somewhat positive or very positive about the future of the European securitization market. Both bank and non-bank sellers are closing transactions, regulatory conditions have stabilized, and most borrowers, particularly mortgage holders, seem to be dealing with inflation and higher interest rates for now.
"We have a lot more visibility on credit performance than we did a year ago," Andrew South said. "Even though mortgage borrowers experienced payment shocks over the past 12 months, there have not been any big, nasty surprises." Accordingly, the ratings impact has been benign. In the past 12 months, S&P Global Ratings only lowered 1.0%-1.5% of its ratings on European securitizations.
That's not to say there aren't any obstacles and credit pressures will continue. The long period of low interest rates means that some structured products are perfectly attuned to a low-interest environment but might not be as good a fit for current conditions. Europe's subdued green and social securitization market is another pain point. Sustainable issuance volumes are still low, and panelists identified the ongoing lack of transparency, standards, and clarity as the main reason for the muted uptake.
The session ended as it began: on a positive note. Most panelists expected that issuance will increase by 10%-20% in 2024. As Matthew Jones put it: "'Uncertain' is not high up on the list of words I would use to describe the outlook for the European securitization industry. Despite incoming credit and economic headwinds, I believe the future for our industry is bright."
RMBS: Shifting Sands
- Vedant Thakur, Director, RMBS, S&P Global Ratings
- Alastair Bigley, Senior Director, RMBS, S&P Global Ratings
- Doug Charleston, Partner, TwentyFour Asset Management
- Steve Harrison, Director, Debt Capital Markets, Together
- Paul Wilde, Group Treasurer, Shawbrook
Credit performance in the owner-occupied space did not deteriorate materially. Performance in the buy-to-let (BTL) segment has also been strong, which is in line with the prime segment. The exception are some legacy transactions, whose underlying loans are floating-rate and have seen a surge in mortgage payment after successive rises in the Bank of England base rate.
Panelists agreed that a peak-to-trough house price correction of 5%-10% is in the offing in the U.K. The reason for the limited decline is the resilient job market. There are caveats, though. One, only a small number of borrowers with mortgages granted in the last two to three years have reached their reversionary rates so far. And two, solely looking at average house price variations may be, at best, misleading, given the wide regional discrepancies.
In terms of issuance, the return of prime high-street lenders to the primary market is welcome and signalizes a well-functioning, diverse, and healthy residential mortgage-backed securities (RMBS) market. Investors, however, are particularly concerned with navigating the ever-evolving space of large, challenger, and small banks, while paying particular attention to sponsors' track records and their attitudes toward the RMBS funding channel.
CLOs: Quietly Optimistic
- Rebecca Mun, Director and Lead Analyst, S&P Global Ratings
- Sandeep Chana, Director, Structured Credit, S&P Global Ratings
- Roger Coyle, Partner, Fair Oaks Capital
- Michael Curtis, Head of Private Credit Strategies, Fidelity International
- Michelle Manuel, Co-Portfolio Manager, Investec
Recent collateralized loan obligation (CLO) issuance has been muted in Europe and the new issue loan pipeline remains thin. Even so, there are indications of green shoots ahead.
After a post-financial-crisis high in the fourth quarter of 2022, CLO spreads have tightened sufficiently that reset and refinancing activity is likely to pick up. The proportion of 'CCC' assets in CLO portfolios is stable, while the number of obligors on CreditWatch negative is low. The European CLO market is in reasonably good shape, with robust fundamentals and stable ratings.
Among the main challenges in the medium term will be corporate downgrades and weaker companies that haven't dealt with their loan maturities. The number of assets maturing in 2023 and 2024 may be limited, but the respective issuers' credit quality is low. As Michael Curtis put it: "Downgrades will hit, and hit pretty hard, in the coming quarters." S&P Global Ratings expects an uptick in the European speculative-grade default rate over the next year.
Yet, not all CLO managers are deleveraging transactions as fast as they could be after the reinvestment period. So-called "you snooze, you lose" loan provisions mean that some managers are moving into longer-term amended loans, even if the CLO documentation may not allow them to consent to such a maturity extension.
Depending on the scenario--an increase in interest rates or a deterioration in the economy--some corporate sectors will be more affected by downgrades than others.
ABS: New Avenues Ahead
- Doug Paterson, Director EMEA ABS/RMBS, S&P Global Ratings
- Gordon Beck, Director, Securitised Products, Barclays
- Matthew Mitchell, Senior Director, Structured Finance, S&P Global Ratings
- Maddi Rowlatt, Portfolio Manager, Challenger Investment Management
- Dylan Setterfield, Head of Forecast Strategy, cap-hpi
So far, high inflation and rising interest rates have had only a limited negative effect on the credit performance of asset-backed securities (ABS). Panelists and the audience agreed that small and midsize enterprises (in particular, exposures in the construction industry, including its supply chain) and near-prime consumer loans will be hit hardest. The strong labor market remains a key mitigant for credit performance.
From a country perspective, the U.K. will likely experience the largest performance deterioration, as borrowers grapple with rising interest rates. France and the Netherlands should be less affected, since households' largest debt service commitments, including mortgages, are predominantly fixed-rate for the entire term.
In securitizations, negative carry, resulting from rising interest rates, and the reduction in excess spreads have led to the emergence of new structural features. Servicing fee reserves, off-market swaps, and notes with below-market coupons that are sold at a discount have become increasingly common in new issues.
After significant increases during the pandemic, second-hand vehicle prices are now falling. That means some financing, originated when prices were at their peak in 2021 and 2022, could face higher residual value risk as its matures over the next two to three years.
Electric vehicle ownership will clearly continue to grow, as manufacturer competition increases and prices fall, with implications for the composition of auto ABS collateral pools. While attractive from a total cost of ownership perspective, the electric vehicle market still requires a significant infrastructure investment to increase the number of fast chargers and become more appealing to consumers.
Panelists expected issuance volumes in the ABS primary market will slightly increase in 2024. New asset classes, including data centers and solar ABS, will drive growth in the U.K. and Europe.
CMBS: A Mixed Bag
- Mathias Herzog, Director, CMBS, S&P Global Ratings
- Ope Agbaje, Director, Credit Research, BlackRock
- Svetlana Ashchepkova, Associate Director, Corporate Ratings - EMEA Real Estate, S&P Global Ratings
- Carenn Chu, Associate Director, CMBS, S&P Global Ratings
- Rob Hughes, Head of Structuring EMEA CRE Finance, Citi
Investors' appetite for commercial mortgage-backed securities (CMBS) is currently limited. The investor base in the CMBS sector continues to shrink, with fewer active players in the secondary market.
The outlook differs across S&P Global Ratings' rated CMBS universe, which spans five underlying real estate types. Demand is still strong in the residential and logistics sectors, where any value declines will likely be driven by high interest rates. Offices, on the other hand, might see an increase in vacancy rates, even though the "working from home" pendulum is swinging back. This stands in stark contrast to the healthcare segment, where vacancy rates are comparatively low because of beneficial demographic trends. Higher for longer interest rates will continue to weigh on valuations in retail, especially in the U.K. Overall, the probability of CMBS loan defaults in 2023 and 2024 is high, given the heightened refinancing risk.
Rising energy efficiency requirements and, with that, an increase in operating expenses could pose another challenge. "If you're a borrower and you have to meet these requirements, you might be in trouble," Carenn Chu said.
Other risks include tenant defaults, refinancing--especially for borrowers without any pre-existing banking relationships--and the increasing number of loan extensions. Tight credit conditions mean that many properties are currently sold at a 10%-20% discount to their peak values, although this is still far from a fire sale.
Blockchain In Finance: Go Innovate
- Andrew O'Neill, Senior Director, Global Analytics & Methodologies – Structured Finance, S&P Global Ratings
- Thomas Bohner, Founder & CEO, Credix
- Mathew McDermott, Global Head of Digital Assets, Goldman Sachs
- Nick Philpott, COO, Zodia Markets
Blockchain is making waves in financial markets. Some corporates use stablecoins--cryptocurrencies whose value is pegged to another asset class--to move large sums of money across borders, asset tokenization is spreading fast, and previously cut off geographies are now able to access global capital markets.
The panel agreed that public blockchains are the way to go. Unlike private blockchains, which are controlled by a central authority or organization, public blockchains are open to anyone, provide scalable access, and are more transparent than their private counterparts.
Even so, it will take a few years until blockchain becomes an inherent part of financial markets. Issues around control, privacy, and security mean that the technology, which is still in its early stages, isn't ready for the mainstream yet.
Central bank digital currencies--digital versions of cash--might turn out to be a gamechanger in that regard. They help set the regulatory and legal framework for digital currencies and could accelerate blockchain adoption among institutional investors.
Meanwhile, the crypto industry in the U.S. is under increasing pressure after several crackdowns by the Securities and Exchange Commission (SEC). The negative effect on the wider adoption of digital assets is limited, though. "The SEC has a clear objective about what they want to achieve. Is it doing permanent damage to the digital asset ecosystem in the U.S.? Probably not," Nick Philpott said.
Writer: Kathrin Schindler.
This report does not constitute a rating action.
|Primary Credit Analyst:||Arnaud Checconi, London + 44 20 7176 3410;|
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