STS ABS: Opportunities and expectations for European insurance investment portfolios

Introduced in 2019, the framework applies significantly lower capital charges to eligible securities than the former ‘Type 1’ and ‘Type 2’ charges under Solvency II, while placing stringent requirements on originators in order to increase investor confidence.

Regulators designed STS eligibility to stimulate ABS market activity, particularly in areas that promote lending to the real economy, such as mortgages and consumer lending, as well as loans to small and medium-sized businesses (SME loans). In turn, this provides European insurers the opportunity to access a structurally robust and scalable asset class once again.

Since the STS framework came into effect, supply of STS paper has grown substantially. Despite the increased administrative and reporting burden required for STS issuance, European originators appear unperturbed. In 2024, we observed c.€55 billion of issuance and consensus among market participants points to c.€60 billion of STS issuance this year which would provide even greater depth and breadth of issuers to the existing €255 billion market.

What is the opportunity?

We believe STS securitisations offer a number of potential advantages for investors, such as:

1. The yield premium – STS securitisations offer a clear yield pick-up versus other credit assets with similar risk. Typically, AAA ABS offer higher all-in yields than other defensive asset classes, as well as higher spreads compared to AAA (or lower) rated corporate and government bonds.
   
2. Reduced Spread Solvency Capital Requirement (SCR) charges – While non-STS securitisations are treated very harshly under Solvency II, STS securitisations receive much reduced Spread Solvency Capital Requirement (SCR) charges. This means insurers can benefit from the potential yield premium available in the securitisation market without incurring high capital charges.
3. Structural protections – Senior ABS are positioned at the top of the capital stack and therefore benefit from robust structural protections. Given high levels of credit enhancement for the AAA senior tranche, these positions can withstand extreme market conditions.
   
4. Liquidity – AAA ABS is the largest part of the public securitisation market, with secondary market volumes offering sufficient liquidity for daily trading. These assets are listed on regulated exchanges and have a minimum of two public ratings.
   
5. A risk diversifier – STS securitisations exhibit a low correlation with other established asset classes, which can be appealing from a portfolio construction perspective.

Investing in STS securitisations is time-intensive and requires significant knowledge and experience. There are no shortcuts, particularly for the European insurance community, which typically relies on asset managers to conduct extensive due diligence on potential investments and provide support with increasing regulatory demands.

What is the opportunity now?

Rampant inflation in 2022/23 subsequently led to rapid rises in interest rates and the halting of the European Central Bank’s (ECB) asset purchase programmes. Up until this point, the ECB had been a price insensitive buyer of continental European ABS paper which compressed spreads to artificially low levels. Since the ECB’s departure from the market we have observed normalisation of ABS spreads in continental Europe, with AAA-rated Dutch Prime RMBS and EU Auto ABS in particular trading above the 90^th percentile (based on historical spreads over the last decade). We believe this offers a good entry point into the market.