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European ABS Market Update

Global equity markets lost momentum last week, as outlook warnings resurfaced US-China tensions, and continued deterioration in economic data outweighed optimism over lifting social distancing measures in many countries. Q1 GDP numbers showed a contraction of 3.5% in Europe and 4.8% in the US, with Q2 expected to be far worse. While consensus is that there will be an initial bounce in Q3, in the absence of a vaccine or herd immunity, we don’t expect to see pre-pandemic levels of economic activity for years. There was no new major news on the fiscal or monetary policy fronts, but we expect both to remain in the wings pending the progress (and likely setbacks) in the reopening process.

In terms of fundamental credit performance, we have started to see the first real effect of the pandemic crisis on consumers. Looking at the first 21 UK RMBS deals that report monthly for which data is available (GBP 15.5 billion of mortgages), the proportion of loans that have been granted COVID-19 payment holidays is as high as 14.1%, with ten transactions seeing a 10%+ proportion of payment holidays. In several CMBS deals, senior borrowers have received numerous requests from tenants for rent deferrals or for renegotiation of tenancy agreements. In these deals, approximately 75% of rent due in April was collected. In leveraged loans, S&P adjusted their recovery rate expectations from 73% to below 60%, which will compound losses from expected rising loan defaults.

In a slow week with thin trading volumes, spreads in the European ABS secondary market remained generally consistent to slightly tighter week- over-week. The market appears to be in a holding pattern awaiting a direction based on fundamentals. Senior and low duration bonds continue to trade well, while buyers and sellers remain far apart on more credit sensitive bonds. The ABS primary market remains on hold, providing technical support to spreads. In the CLO primary market, three low leverage deals with short non-call and reinvestment periods were placed. In the secondary market, CLO BWIC supply was noticeably lower than average with an elevated DNT percentage.

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 May 1, 2020:

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