ABS Trading in Stable Range, CLOs Weaken on back of Rating Agency Downgrades…ABS Trading in Stable Range, CLOs Weaken on back of Rating Agency Downgrades…

ABS Trading in Stable Range, CLOs Weaken on back of Rating Agency Downgrades…

Dynamic Credit European ABS Market Update 1 May 2020

Tim Jansen v2Tim Jansen1 May 2020 at 12:00

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European ABS Market Update

Global equity markets continued the recent upward trend amid optimism that the economy in some parts of Europe and the US were beginning to reopen. We continue to cheer news of flattening of COVID-19 curves coupled with hopeful announcements coming from pharmaceutical companies developing potential treatments. Unfortunately, a vaccine allowing for a return to “normal” likely remains at least 12 months away. As shown in Japan, Singapore, and now Germany, premature easing of lockdown restrictions can result in secondary infection clusters and transmission rates reversing the downward trend. On a more positive note, New Zealand announced that COVID-19 has been “eliminated” in the country and moved to ease into a less restrictive lockdown. Energy continues to experience elevated volatility as optimism over reopening conflicts with dwindling storage capacity, with June WTI settling in the low double digits and international benchmark Brent around $20.

In terms of fundamental credit performance, we continue to see credit rating agencies reacting significantly faster this time around compared to the financial crisis as they downgrade ABS transaction citing worse than expected performance or reflecting counterparty exposure following servicer downgrades. Having received a number of post-March investor reports from a wide cross-section of country and asset types, we see an increase in arrears. Risker deal types, including non-performing loan and subprime auto transactions, are likely to experience more material deterioration in credit performance which can result in impairments to mezzanine positions. In CLO markets, over 1,000 mezzanine CLO tranches have been placed on watch for ratings downgrade by multiple rating agencies, which contributed to more negative sentiment relative to other asset classes.

While equity markets rallied last week, most ABS traded in a stable range with senior and shorter duration bonds trading better and more credit sensitive and longer duration positions were flat to wider on low trading volumes. The ABS primary market is still technically on hold with only one VW Bank auto deal closed via private placement. In the CLO primary market, banks are trying to sell existing warehouse exposures from their balance sheet. The first CLO deals were placed since the beginning of the COVID-19 outbreak, including some without non-investment grade tranches. In the secondary market, CLOs weakened after rallying the previous two weeks as the market digests the elevated risks of loan defaults and rating downgrades amid heavier selling volume. Below is an overview of the one week spread change in various ABS segments, compared to investment grade and high yield corporate credit as of April 24, 2020:

abs-trading-stable-range-clos-weaken-rating-agency-downgrades table1

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Tim Jansen v2
Tim Jansen

Tim Jansen is a member of the Portfolio Management team for the Diversified Loan Fund. He joined Dynamic Credit in 2017. He has been investing in a broad spectrum of cash and synthetic credit products in Europe for over 10 years in the role of Portfolio Manager at several leading asset managers, among which NNIP, MN and Robeco. Tim began his career at Aegon Asset Management and holds a master's degree in Econometrics from Erasmus University Rotterdam.