This unprecedented squeeze creates some food for thought for credit investors and fund managers.
The ‘Targeted Long Term Refinancing Operations’(TLTRO) announced by the ECB are expected to further reduce European ABS new issuance in the second half of 2014 in the non-financial sectors of consumer loans, auto loans, credit cards and SME ABS.
Spreads will naturally tighten, particularly in the secondary market, as an already present supply/demand imbalance is exacerbated, explained Matthias Wildhaber, co-manager of the JB ABS fund at Swiss & Global.
Mortgage backed paper (RMBS), CLOs and commercial mortgage backed paper (CMBS) do not qualify but according to Wildhaber, spreads will tighten as well in reaction as they could be brought into the plans next year.
“The ECB is doing preparatory work for a program to buy ABS directly and cannot start buying immediately but when they have done all the work it will be easier for them and everybody else to buy ABS,” he said. Wildhaber said it will likely take until early next year for the ECB to be in a position to buy directly.
“For investors it makes sense to buy now because there is still a lot more tightening to come through,” Wildhaber said.
Rathbones fixed income manager Bryn Jones concurred that the spread tightening story has further to run still. “The ‘free money for longer’ should mean banks can get funding at very cheap levels for the next few years, meaning a more stable profit line for the banks and hence tighter credit spreads,” he said.
“Also the ECB is crowding out the issuance of debt as they can fund themselves cheaper with the ECB, meaning supply is reduced and with more structural demand for credit, spreads will tighten further,” Jones added. “This is also true in the ABS space, and if the ECB actually come out and directly support the ABS market this will support asset prices and lower yields further,” he continued.
One notable advantage for credit funds which has developed according to Jones, is that the further tightening of spreads means that for some, the generating of long/short strategies becomes less expensive.
Regulatory changes aimed at simplifying the asset class and improving transparency are on the cards and as they materialise ABS could gain further new traction with banks and insurance companies, again supporting the asset class. “The market is rather thin and banks will be further incentivised to retain ABS on their balance sheets,” said Hermes Fund Managers’ Filippo Alloatti.
At present plans for the ECB to expand to buying up RMBS in a similar way to the Bank of England has done in the past are not confirmed, but such a move could have a big impact if it does happen.
Alloatti said that while it is not a prediction, he considers it a possibility that the ECB will move to buy up RMBS directly at some point in the first half of 2015, perhaps alongside the introduction of quantative easing.
With all this being factored in, there is potentially a narrow but attractive buying window for ABS, and RMBS in particular, but credit investors will have to move quickly to take advantage.
