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European ABS Market Update
With the number of COVID-19 cases passing 13 million, the world continues to adjust to life with the pandemic in the background for the foreseeable future. While Western Europe and parts of Asia progress toward a semblance of normalcy, we continue to see an acceleration in the number of daily new cases in many areas like (Latin) America, Eastern Europe, and India. This aligns with the easing of lockdown measures we continue to see across Europe since the beginning of July as some countries have now opened external borders. However, the macroeconomic picture remains difficult as ECB President Lagarde described expectations of a complicated economic recovery using the words “sequential and restrained.” This aligns with our continuing view that the global recovery will be halting and uneven, with potentially a very long path towards pre-pandemic levels of economic activity.
On the monetary policy side, the ECB has increased the Pandemic Emergency Purchase Program (PEPP) to EUR 1.35 trillion, which may be upsized even more given the long road to recovery. The impact of this support has led to investment grade bonds within the scope of the program that have seen significant growth in volume as companies continue to raise cash in the most active quarter for primary issuance on record. While high yield spreads have also benefitted, the fundamental credit story is challenged as we continue to see deterioration with two new major European defaults: Hema, the Dutch retail chain and Matalan, a British retailer. We also observed the first broadly publicized European case of a (high yield) borrower shifting pledged assets away from creditors into a separate uncovered entity under control of the private equity sponsor. While it remains to be seen if this is the beginning of a trend, it highlights the disparity in the ability of high yield versus investment grade borrowers to raise cash as we remain in a challenging period for corporates (and individuals).
European ABS issuance remains subdued with only two deals in the pipeline. European issuance is 30% below June 2019 YTD levels. While the pace of primary supply could partially recover in the second half of 2020, as spreads have recovered significantly from the depths of March, this is unlikely to happen before September and subject to COVID-19 developments over the next 2 months. In the absence of new issue supply, European ABS secondary spreads ground slightly tighter over the last few weeks on the back of the current supply/demand imbalance. BWIC activity has remained healthy and trade execution remained robust with most bonds trading. The level of DNTs has been in the low single digits for core European bonds, with peripheral bonds somewhat higher between 10 and 20 percent.
In terms of fundamental credit performance, we see more and more transactions reporting on the impact that COVID-19 has had on the collateral pool. We have begun to observe significant dispersion across jurisdictions (and even between originators). Dutch RMBS have reported less than one percent of loans on payment holiday on average, Spain is close behind at less than 2 percent, while UK RMBS levels are significantly higher at just above 15% on average. To be fair, this is partially due to the discrepancies in loan hardship documentation requirements, but it highlights the need for detailed credit analysis and a conservative approach towards credit selection despite strength in bond prices.
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 July 10th, 2020:
Dynamic Credit Partners Europe B.V. (‘Dynamic Credit’) is a registered investment company (beleggingsonderneming) and a registered financial service provider (financieel dienstverlener) with the Dutch Authority for the Financial Markets (Autoriteit Financiële Markten). This document is intended for informational purposes only and is subject to change without any notice. The information provided is purely of an indicative nature and is not intended as an offer, investment advice, solicitation or recommendation for the purchase or sale of any security, financial instrument or financial product. This communication is a summary only, it may not contain all material terms. Any offering that may be related to the subject matter of this communication will be made to you pursuant to separate and distinct documentation (Legal Documentation) and in such case the information contained herein will be superseded in its entirety by any such Legal Documentation in its final form. Dynamic Credit may in the future issue, other communications that are inconsistent with, and reach different conclusions from, the information presented herein. Dynamic Credit cannot be held liable for the content of this document or any decision made by a third party on the basis of this document. Potential investors are advised to consult their independent investment and tax adviser before making an investment decision. An investment involves risks. The value of securities may fluctuate. Past returns are no guarantee for future returns.
Tim will be happy to answer any questions you might have.
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.