The ECB demand translates into spread compression on ABS and reduces the spreads of covered bonds to below pre-crisis levels across all European countries. Scope Ratings expects that the low spreads will partially mask the different credit risk levels of the individual issuances. In fact, Scope Ratings sees much wider differentiation of credit risks than the credit spreads would indicate. Investors will therefore need more transparency and information to take investment decisions. This will be a key theme for both the securitisation and covered bond markets in 2015.

ECB-driven spread compression of European securitisations creates technical conditions supporting issuance volumes. Low spreads also make securitisations a viable tool for the optimisation of banks’ balance sheets via regulatory risk transfer. For leveraged loan CLOs, it may also drive structural innovation and the resurgence of multi-currency transactions.

The credit outlook for European structured finance and covered bonds is positive in 2015. The performance of most asset classes will be supported by low interest rates, improving refinancing and credit availability and modest economic growth in the European Union. However, spread compression may erode general risk awareness, making it more difficult for investors to discriminate between transactions.

Covered Bonds: In the new environment, more collateral transparency is necessary
Scope Ratings expects covered bond issuance to sustain a strong momentum in 2015. Investor demand remains high as existing investors seek to reinvest their holdings in covered bonds. In addition the ECB is using the covered bond purchase program (CBPP3) to support liquidity for banks and to create a stimulus for the economy.

Even though demand is high, covered bond benchmark redemption volumes continue to exceed new issuance in the European covered bond market. In 2014, the net supply was a negative EUR 53bn and it will probably remain negative in 2015. In Scope Ratings’ view, the scarcity of new mortgage collateral and the availability of other funding sources are currently the main reasons for the limited covered bond supply. In particular, the surge in issuance of AT1 and similar capital instruments provides banks with funding that needs to be deployed, further reducing the incentive to issue covered bonds.

SME CLOs: ECB action and promotional lending will boost issuance volumes
The lower cost of funding for SME CLOs combined with more favourable lending conditions for banks will support the increase in SME CLO volumes in the coming year, particularly in peripheral countries such as Spain. Modest economic growth in 2015 will also support the availability of quality SME obligors, the lack of which has constrained the production of loans for securitisation to date.

Taking the example of Spain, Scope believes that the performance of SME CLO securitizations will improve in 2015, because SMEs will benefit from slow but positive economic growth and better access to credit. In addition, Scope expects that the performance of future Spanish SME CLO securitisations will not be determined by the performance of real estate and construction since new lending in these sectors will be scarce, with strong underwriting scrutiny.

Leveraged loan CLOs: multi-currency CLOs and bank-affiliated managers to return to the market
Scope Ratings expects European CLO issuance volumes to sustain their momentum in 2015 and to exceed the EUR 15bn anticipated for 2014. Scope foresees a rebound in multi-currency CLOs in 2015 because managers need the diversification benefits of including USD and GPB loans in their portfolios. In addition, tighter spreads on European CLO liabilities now make it possible to absorb the extra costs raised by currency hedging strategies.

Bank-affiliated managers and the large US managers who are able to comply with European risk retention rules will likely re-enter the European market in 2015. The latter will be attracted by the possibility of leveraging the scalability of their credit platforms. This happened in 2014 when Sankaty or, more recently, Halcyon issued transactions in Europe.

Download the complete “Structured Finance and Covered Bonds Outlook 2015”