Fixed income
European ABS: Sailing through banking-induced volatility?
4 min read 17 May 23
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At the beginning of the year, few investors would have predicted that collapses in the banking sector would trigger the next bout of volatility and lead to a significant shift in the trajectory and velocity of monetary policy. The failure of three US regional banks and the rescue of Credit Suisse by UBS, which saw CS AT1 bonds fully written down, has led investors to re-evaluate the level of risk premia required to compensate for taking subordinated exposure particularly within the banking sector. But how has the ABS market navigated the volatility?
Recent events have been a timely reminder that market stability can be fragile, and risks may emerge even in the most unexpected of areas.
“We believe ABS offers a compelling combination of floating rate instruments secured on observable, high quality, defensive collateral which offer good relative value to other fixed income markets.”
Bankruptcy remote
We believe that one overlooked facet of the recent sell-off is how smoothly the European ABS market has navigated this period of banking sector induced volatility. European ABS are bankruptcy remote in nature and the following chart demonstrates the benefit that these structures provide from a pricing and volatility perspective relative to senior and subordinated debt of the corporate issuer, in this case Credit Suisse.
Whilst the AT1 was written down and the senior unsecured bond experienced a 25% drop in price, the Credit Suisse UK RMBS was left relatively unperturbed given its financial and legal separation from the bank.
Further evidence of the protection ABS investors receive in the scenario of an originating bank default was most visibly demonstrated with Lehman Brothers during the Global Financial Crisis where its ABS programmes continued to operate whilst even their senior corporate bond investors were mired in years of litigation and illiquidity following the bank’s failure.
Less volatile
Focusing on the asset class overall, the European ABS index (which is primarily composed of AAA and AA rated instruments) has delivered positive returns in-line with Euro and Sterling corporate bonds, but with far less volatility.
Yield pick-up
ABS instruments also benefitted from rate hikes during the quarter (BoE +75bps and ECB +100bps) which flowed through into higher European ABS index rates, SONIA and EURIBOR. The following table compares the all-in yields of various ABS asset types to AAA-A rated corporates, which evidences the attractive pick-up in yield offered by European ABS.
Improving credit quality
There has been some modest evidence of collateral performance softening so far during 2023, however in our view this remains very manageable relative to ABS structural protection. The amortising nature of RMBS and consumer loan collateral continued to drive net positive ratings changes across the market during the quarter:
We believe ABS offers a compelling combination of floating rate instruments secured on observable, high-quality, defensive collateral which offer good relative value to other fixed income markets.
ABS new issuance volumes are expected to increase in the coming months following more limited primary market supply towards the end of Q1 which we believe will allow the opportunity to deploy new capital sensibly and at attractive levels.
The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.
