Alexander Batchvarov, md, head of international structured finance research at BofA Securities, discusses the burgeoning European esoteric securitisation sector with SCI

Q: How would you describe European investor appetite for esoteric securitisations currently?
A: We have a situation on the market, where corporate spreads are moving very tight and at present high yield spreads are in the 300bp area in Europe. Investors seek beta, but also keep an eye over their shoulders – ECB reaction function is of concern. 

With rates beginning to back up elsewhere, the demand for floating rate exposure is strong and can only rise. Investors will want more leveraged loans exposure and the corporate conditions are ripe for more leveraged loan supply, given that M&A and LBOs are picking up.

With esoterics, it is a bit tricky. These bonds are sometimes a little more difficult to assess and may not offer economies of scale for investors; i.e. supply of a given sector may be rather sporadic.

So, demand is definitely there, but it is dependent on asset class, issuer and sector.

Q: In which ways are market conditions ripe for esoteric and first-time issuers?
A: Market conditions are good for first-time issuers. On the one hand, the banks have more liquidity than they can handle, so they issue little ABS paper, if at all. On the other hand, the investor demand is there and, in the absence of the low hanging fruit (e.g. repeat bank issuers), investors will assess and eventually take the investments that are on offer (e.g. debut issuers, debut asset classes).

Whether the supply will materialise remains to be seen. Let’s not forget the regulatory hurdle: for US versus EU investors, there are different standards of due diligence (broadly defined versus very prescriptive, respectively); the same can be said about the issuers (e.g. just compare the disclosure template requirements) and the same can be said about the products (the standards for due diligence and disclosure for RMBS and mortgage covered bonds are significantly different).

A first-time issuer and a first-time asset class issuance would take more time to reach EU investors than US investors.

Q: What, if anything, has changed to create these conditions?
A: There are contradictory conditions at the moment.

On the one hand, we have strong investor demand for beta, along with demand for floaters. On the other hand, there are barriers to issuers and investors reaching out to the ABS market. 

It is, quite frankly, a balancing act between the two for esoteric ABS.

Q: How much of a yield pick-up do rare deals generically provide versus more traditional issuance?
A: There is no rule of thumb or an indicative average spread pick-up for esoteric deal pricing. It will depend on the reference point (for example, is the esoteric deal comparable to consumer or corporate ABS) and on the dominant investor base (for example, a preference for shorter duration investment by banks versus long duration investments by insurers).

It will also depend on whether the asset class is new for just some (geographically constrained) or all investors. Rental car ABS have been present in the US for a while and offer a pick-up of about 65bp over prime auto loan ABS; if such a deal were to be done in Europe, it may end up with a higher pick-up than that because of newness or a lower pick-up because of scarcity. Timeshare ABS offer similar pick-up over credit card ABS in the US; the former product will be fairly new, if offered in the EU now, and the latter is of limited supply in the EU, so the spread differential in the EU may be potentially bigger than in the US.

Q: How do you see the esoteric/first-time issuer segment evolving, in terms of potential new assets, jurisdictions and beta trades?
A: We should see more products coming into the market. There is certainly more demand for esoterics, especially in the ESG space: solar panels, water treatment plans, wind turbines and EV loan ABS. In that space, there is a real money pull from investors and a verbal push from regulators, as far as sustainable ABS is concerned.

Q: What is driving the supply/demand imbalance in the European securitisation market at the moment?
A: There are certainly constraints on both sides of the market, both demand and supply, and the reasons for that are multiple. The EU has the most restrictive and costly regulatory framework for securitisation anywhere in the world and among all fixed income instruments, despite the stellar historical performance of the EU securitisation market since its inception about 30 years ago. 

The cheap and easy liquidity that ECB has offered the banks has certainly reduced their funding needs. The most favourable treatment offered to covered bonds makes them a preferred funding instrument for banks over RMBS; the shift from RMBS to covered bonds is evident in, for example, the Netherlands, a historically strong MBS jurisdiction. The restrictions on EU insurers and pension funds have largely taken them out of the securitisation market. 

Q. Is this situation likely to change in the coming months?
A: Let’s call these small changes. A new asset class here or there (rare issuance of insurance premium ABS or a rare mortgage type), a debut issuer (we have every year a few in CLOs and there was recently a debut issuer of salary loan ABS in Italy) or ESG-defined collateral.

Even if this happens all together, it will not lead to a material change in the EU securitisation market.  For that to happen, we need to see a change at the top that the market has been asking for many years now and which found the most visible and detailed expression in the list of recommendations for fixing the EU securitisation market drawn up by the High Level Forum on CMU (SCI 21 July 2020).  But that is not in the cards for 2021, if at all. 

The recently adopted ‘quick fixes’ for synthetic and non-performing loan securitisation are anything but fixes. Depending on how they are implemented, they may turn out to be two steps backwards in the future for the one step forward made by the market in recent years.

Angela Sharda