Structured Credit: Peripheral euro-zone ABS: a liquidity-driven rally
European asset-backed securities (ABS) markets may not be as attractively priced as they were immediately after the financial crisis, but they can still add useful diversification of credit risk and they may still even offer some value.
For Neil Tijn, ABS fund manager at Cervus Capital Partners, European ABS still appeals, and he sees appetite from domestic, US and Asian investors. “Even though spreads have come in, on a relative-value basis ABS still makes sense, especially for these markets,” he says. “ABS still offer a pick-up to government bonds and high-grade corporates. The only thing in the trade-off is less liquidity and a bit more credit work.”
In fact, things may have been too good. Decent performance paired with shrinking markets and sizeable fund inflows, has led to something of a supply-demand imbalance, particularly in non-core markets. While ABS spreads across Europe have been tightening, new issuance outside the UK, Netherlands and Germany is likely to remain moribund.
“Many investors are still worried about what is happening in Italy after the elections and the deleveraging process in Spain is still very much ongoing and uncertain,” says Tijn. “There are some developments that will add more stability to the market – the bank clean-up in Spain is making some progress, for example – but it is still very early days for ABS out of the periphery to be issued in any meaningful way.”
Shammi Malik, ABS trader at Stormharbour Securities, argues that excess liquidity has already created a bubble.
“There is a massive dislocation between ABS bonds and fundamental assets, which is sowing the seeds for another crisis,” he warns. “We have seen Greek MBS moving from yields of 25%-plus in Q1 2012 to today’s levels of around 14%, depending on the issuer.
This is a massive tightening, and while a large part is just the beta of the market, it is also because investors remain confident that politicians will continue to bend and amend the rules to ensure that Greece does not exit the euro and receive additional funding.”
It is not just Greece that has seen spread tightening in the euro-zone periphery. Senior Italian MBS trade at yields of 2-3%; tier-1 Spanish senior MBS trade 75bps inside the 10-year government bond yield. Portugal and Ireland paint a similar picture, trading at yields of 6% and 5.5%, respectively, virtually on top of their respective sovereigns.
“That is staggering when you look at the list of problems,” says Malik. “The ECB has only dealt with the symptoms of the European crisis – high sovereign bond yields – not the main causes.”
Nonetheless, Malik still feels that technical factors – supported by the Federal Reserve’s QE programme and the ECB’s outright monetary transactions (OMT) promise – will continue to support asset prices in the short term. While a re-escalation of the euro-zone crisis could “quite easily” occur though Italian (or German) elections, Spanish regional politics, a downgrade of Spain forcing it into a full-scale OMT assistance programme, or some non-compliance out of Greece, Malik says, with so much liquidity around any weakness on these fronts will likely be viewed by investors as an opportunity to add more risk.
“The biggest beneficiaries will continue to be higher beta Euro-peripheral MBS and ABS issues as the core Europe-versus-peripheral Europe compression trade continues,” he concludes.
Tijn also sees (relative) value in southern Europe, albeit very selectively and informed by strict bottom-up credit analysis.
“We have invested in a couple of Italian leasing deals where the duration is still something that is not extremely long and the credit analysis can be done in a clean way, and also some seasoned Spanish RMBS deals and Portuguese auto loans,” he reveals.
“These are deals where you can get comfort from the seasoning, the leverage within the structure, and sufficient credit enhancement to offer protection for any deterioration or first losses that you can think of.”