Optimism around strong growth in RMBS and ABS at S&P conference

Market participants shared widespread optimism at S&P Global Ratings' European Structured Finance conference, buoyed by robust growth and the resilience of the European and UK ABS and MBS markets. Despite global economic challenges, issuance in these markets is experiencing strong momentum, performing even more favourably than 2023.

Panellists and attendees at the event noted that the primary beneficiaries of improving market conditions are RMBS, especially in the UK, and CLOs. "If nothing's changed in UK RMBS, I'm happy," one panellist commented. 

S&P states that despite some headlines suggesting otherwise, the asset class has held up well over the past nine months and steered clear of major turbulence.

The agency explains that the stability in the UK RMBS market has been primarily driven by factors such as low unemployment rates, tight affordability regulations, consumers' considerable - albeit hard to quantify - savings buffers, wage growth, and forbearance measures, with lenders engaging early if borrower stress arises. Additionally, UK RMBS has benefited from consumers' financial prudence and their focus on prioritising mortgage payments. 

“Most borrowers fixed their mortgages for three years or longer when a rise in interest rates became increasingly likely,” one panellist said. “Given the recent path of borrowing costs, long-term fixed-rate mortgages could come to the fore, enabling borrowers to lock in rates for longer than the current typical limit of five years.”

Panellists at the conference also emphasised the importance of monitoring the emergence of hybrid products, such as combinations of repayment and interest-only mortgages or interest-only mortgages with an equity release plan. “Even though these products aren't particularly popular yet, partly because advice is thin on the ground, they are garnering increasing attention,” said one.

The momentum is also impacting other asset classes across the board, including the ABS sector, which is already booming.

In terms of credit risk, S&P says: “Panellists agreed that the slight deterioration over the past 18 months constitutes a normalisation, after a period of exceedingly benign conditions. Affirmations and upgrades accounted for most rating actions year to date.”

They continue: “ABS benefits from low unemployment rates in Europe and supportive structural features, including tight triggers and the relatively short average life of transactions. Most consumers continue to prioritise paying off debt, a trend that started during the COVID-19 pandemic and hasn't reversed since.”

Additionally, the commentary notes: “Risk exposure in auto ABS transactions will remain lopsided, with battery electric vehicles most exposed to residual value risk. That said, a potential decline in demand for internal combustion engine vehicles could eventually constitute an inflection point that would see residual value risk shift away from electric vehicles. Government subsidies could play a key role in this transition.”

S&P highlights that government subsidies could be pivotal in supporting this transition and, in the long term, non-traditional collateral, including data centres, solar projects, salary sacrifice auto schemes and buy-now-pay-later financing, may become more prominent in the ABS market. “For now, however, scarcity and regulatory restrictions prevent a more significant pick-up.”

Signs of CRE recovery signal stability for CMBS
The CMBS sector presents a different narrative, as it is one of the few areas exhibiting signs of stress, though some signs of stabilisation are beginning to emerge. Panellists have observed that value declines are exhibiting indications of moderation across all CRE sectors.

S&P says: “More forward-looking surveys of investor sentiment also herald improvement, and recently subdued activity means there are close to record levels of ‘dry powder’ in CRE globally. The UK market could recover faster than the rest of Europe. This is partly because value corrections materialised more quickly but also due to the better political stability from having recently installed a new government.”

The commentary underscores that loan refinancing has been challenging due to rising rates and tighter lending standards, but it also points out that there have been few loan enforcements, and only one CMBS loan rated by S&P is in special servicing, suggesting that the CMBS market, though impacted by broader CRE challenges, is not facing severe distress.

Selvaggia Cataldi