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ABS under the microscope

Part of the Alternative View series

By Niek Swagers

February 2020

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ABS under the microscope

Asset-Backed Securities (ABS) offer an opportunity for investors to enhance the return and

diversify the risk of their portfolio. This white paper provides insights into this asset class. What

are ABS, how are ABS structured and what are the characteristics of the European ABS market in

particular? This analysis can help investors to better understand the asset class, including its

opportunities and risks.

What is an ABS and how is an ABS structured? ABS are loans (‘securities’) that are covered (‘backed’) by a specific

collateral (a pool of ‘assets’). The underlying loans, such as residential mortgages or credit card loans, are often split

into different risk tranches. The losses on the pool of assets are first absorbed by the higher-risk tranches but these

tranches also have a higher return potential. The availability of the characteristics of the underlying loan portfolio

makes it possible for investors to perform in-depth risk analyses. This gives investors the opportunity to select an ABS

that corresponds with their risk and return preference.

The risk profile of ABS is characterized by their variable interest payments (floating rate coupons). This makes the

interest rate risk of an ABS substantially lower than for sovereign or corporate bonds. Depending on the overall

interest rate hedging policy, the short duration can make ABS an attractive investment in a scenario of rising interest

rates. Another feature of an ABS is that the credit risk is not caused by countries or companies, but predominantly by

consumers. Because of this exposure to consumer risk, ABS offer an attractive opportunity for risk diversification

within the fixed income portfolio.

The euro-denominated ABS market is very diverse in terms of the underlying collateral. For this reason, the different

market segments are defined according to the type of underlying loans. The majority of the market consists of

Residential Mortgage-Backed Securities (RMBS) and Consumer ABS (securities backed by car loans, credit card loans

or student loans). The United Kingdom, Spain and Italy are strongly represented as issuers of European ABS and most

securities have a high rating (from A up to AAA). However, within segments of the market the distribution over

countries and ratings differs strongly. This helps to create an ABS portfolio that is well-diversified over segments,

countries and ratings and that meets the risk-return preferences of an investor.

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Contents

1. Introduction to ABS ................................................................................................................................................. 4

1.1 Credit crisis ..................................................................................................................................................... 4

2. Structure of ABS ...................................................................................................................................................... 5

2.1 Pass-through and pay-through ....................................................................................................................... 5

2.2 Distribution of the risks and returns of a pay-through ABS ........................................................................... 6

3. Risk profile of ABS ................................................................................................................................................... 7

4. Characteristics of the ABS market ........................................................................................................................... 8

5. Conclusions ........................................................................................................................................................... 11

Appendix 1 – Residential Mortgage-Backed Securities (RMBS) ..................................................................................... 12

Appendix 2 – Commercial Mortgage-Backed Securities (CMBS) ................................................................................... 14

Appendix 3 – Consumer ABS .......................................................................................................................................... 16

Appendix 4 – Collateralized Debt Obligations (CDO) ..................................................................................................... 19

References ..................................................................................................................................................................... 21

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1. Introduction to ABS

ABS are loans (‘securities’) that are covered (‘backed’) by a specific collateral (a pool of ‘assets’). In general, the

underlying pool of assets are loans from one category and one jurisdiction, for example residential mortgages, car

loans, student loans or credit card loans. These underlying loans are stand-alone harder to sell to another buyer

because the loans can vary with regard to format, interest rate and other agreements that have been made between

the provider of the loan and the borrower. Banks provide the underlying loans to lenders, but may want to sell them

to other investors in order to free up capital on their balance sheet.

The process of combining loans and issuing one or more new securities is called securitization. It is also possible to

split these new securities and create different risk tranches in the process. The risk of a tranche is predominantly

determined by the degree of protection for losses, in other words the degree of credit risk. The losses on the

underlying pool of assets are first absorbed by the higher-risk, or subordinated, tranches. This creates a lower credit

risk for the lowest risk, or ‘senior’, tranche. Rating agencies are able to give a credit rating for different risk tranches

of an ABS based on the large set of historic performance data of the underlying collateral. These risk tranches make

the underlying loans more attractive for investors because they can buy the tranche that suits their specific risk-return

preferences.

1.1 Credit crisis

The credit crisis of 2008 gave ABS a bad name. The mortgage market in the United States was said to be one of the

main causes for the credit crisis. A large proportion of the mortgage loans that were granted in the US before the crisis

were sold to investors as ABS. A significant part of the underlying mortgages were related to consumers with a low

income, or even no income at all. These mortgages are typically referred to as subprime mortgages.

At the time, the rating agencies underestimated the risk of these subprime mortgages. First of all, the decline of the

housing market turned out to be stronger than expected . Moreover, it turned out that the willingness and the

possibility of homeowners to pay, was also significantly lower than estimated. Contributing to the subprime mortgage

crisis was the fact that homeowners in the US could simply hand over the keys of their house to their bank in order to

free themselves from their mortgage-payment obligations. When the value of the house is lower than the value of the

loan, this is an attractive feature for homeowners to release themselves from their mortgage debts. As a consequence,

these specific US subprime mortgage-backed securities suffered large losses, because many underlying mortgage

loans defaulted.

ABS were also often included in money-market-type products due to their strong credit quality and the variable

interest payments. After the rating downgrades of US subprime ABS, many forced sales of other ABS took place as

well. The low liquidity of the overall financial markets and the large number of forced sales resulted in a decline in the

value of European ABS. But the credit losses on European ABS remained very limited due to the high quality of the

underlying loans (the collateral) of these European ABS. Despite the drop in value, interest payments and repayments

on the European ABS investments continued. After a while, the prices of the European ABS therefore recovered.

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2. Structure of ABS

An ABS is a combination of underlying loans into one new loan, which in turn is split up into different risk tranches.

When banks provide a loan to consumers and companies, they are normally limited in their ability to provide new

loans. In order to free up capital, a selection of outstanding loans of a similar type can be combined and then resold

as new packages of loans (i.e. an ABS) to investors.

ABS are created through a process called securitization. Individual loans are brought together by the lender in a Special

Purpose Vehicle (SPV), which is established specifically for this goal. In practice, this happens by selling individual loans

that are on the banks’ balance sheet to the SPV. The capital that is required for the purchase of the loans by the SPV

comes from the participants in the ABS (the investors). The SPV is therefore the owner of the ABS. Future cash flows

are no longer owned by the original provider of the loans (the bank) but by the investors in the ABS. The risk and

return of the underlying loans are therefore passed on by the bank to the ABS investor.

Figure 1: Illustration of cashflows of ABS with mortgage loans as collateral

Source: Aegon Asset Management.

2.1 Pass-through and pay-through

The ABS market differentiates between two types of structures for paying out the coupons and loan repayments (cash

flows) on the underlying assets to the ABS investors: a pass-through structure or a pay-through structure.

In a pass-through structure, every bond represents a proportional share in the underlying pool of assets. In this case,

investors have the right to a proportional part of the cash flows that come from the underlying portfolio. The pass-

through structure issues only one type of bond whereas a pay-through structure issues multiple types of bonds. These

Bank

Special

Purpose

Vehicle

Investor

Mortgage loans (incl.

collateral)

with interest payments

Money

ABS bond with interest

payments

Money

Borrower

Interest payments

(with collateral) Money

6

different bonds within the same ABS structure are called ‘tranches’. Tranches can differ in their creditworthiness

(senior, mezzanine, equity), interest compensation, maturity profile, etc.

Figure 2: Illustration of pass-through and pay-through structures

Source: Aegon Asset Management.

2.2 Distribution of the risks and returns of a pay-through ABS

The SPV typically issues different ABS bonds that vary strongly in their risk and return profile. Often, the goal is to issue

a senior tranche with an AAA rating. In order to achieve this, so-called mezzanine tranches with a subordinated

position (and therefore a lower rating) are also issued, as well as an equity or first-loss tranche. In terms of yield

potential, the equity share has the highest return, but it must also absorb the first losses. These losses occur when the

underlying loans are not repaid. If the losses are so high that the equity tranche no longer has any value, then the

remaining losses are absorbed by the mezzanine tranches (the subordinated positions). Only when these mezzanine

tranches are fully written off, the senior tranche (AAA loan) needs to bear the residual losses. Therefore, the lower

the rating of a tranche, the earlier the tranche has to absorb losses.

The flip side is of course that the lower rated risk tranches offer a higher potential return (yield compensation).

Depending on the assessment of the possible losses on the underlying portfolio, the AAA tranche will be equal to 60%,

and in some cases even up to 92%, of the value of the underlying portfolio. Figure 3 illustrates the return of an risk

tranche as a function of the potential losses on the underlying pool of mortgages. Losses in the pool will affect the

return of the tranches following a so-called ‘waterfall’ that will hit the lowest rated tranches at first and the highest

rated tranches at last.

Pass-through

structure

Liabilities Investments

Mo

rtga

ges

Par

tici

pat

ion

s

AAA ABS bond

Pay-through

structure

Liabilities Investments

BBB ABS bond ABS equity share

AA ABS bond

Mo

rtga

ges

Par

tici

pat

ion

s

7

Figure 3: Illustration of losses depending on tranches

Source: Aegon Asset Management.

In fact, an ABS structure looks similar to that of a bank. A bank has shareholders who absorb the first losses. When

the shareholders are written off, the holders of subordinated bonds are next in line. When they are also written off,

the normal bondholders will follow, and ultimately the saving deposits can be liable too. The advantage of an ABS

investment, compared to an investment in a bank, is the availability of the characteristics of the underlying loan

portfolio for risk analyses. The balance sheet of an ABS is therefore often more transparent than banks’ balance sheet.

The individual underlying loans in the ABS can be analyzed one by one. Relevant data can include information about

the age, income and other debts of the borrower. Based upon on detailed information at the level of the individual

loans, it is possible to carry out solid research on the creditworthiness of an ABS.

Scenario analyses are used to determine under which scenarios an ABS is likely to meet its obligations for interest

payments and principal payoff. In the ABS market, the investor can thus make a well-informed choice about the

desired risk-return profile. For example, the investor can choose a safer investment by purchasing the AAA tranche,

but if the investor has a strong opinion on the underlying value and the expected economic scenarios, a lower-rated

tranche can also be selected. The potential return of this tranche is higher because this tranche will absorb potential

losses earlier. In this way, ABS investors can select the risk tranche that suit their specific risk-return profile.

3. Risk profile of ABS

Investing in ABS entails a number of risks that often correspond to the risks of other fixed income investments.

Therefore, we will now focus on the typical differences in interest rate, credit, concentration and liquidity risk of an

ABS.

ABS are characterized by their variable interest payments (floating rate coupons). The maturity of the euro-

denominated ABS market with residential mortgage loans as collateral (i.e. residential mortgage-backed securities)

has been on average 3.16 years.1 The floating rate coupon is often the 3-month Euribor rate including a spread as

1 Barclays Capital Euro ABS Floating Rate Note Index, as of 31 January 2020.

ABS equity share

AAA ABS bond

AA ABS bond

Possible loss on mortgage pool

Ret

urn

8

compensation for the credit risk.2 As a result of the quarterly update of the Euribor rate, an ABS has a similar short

duration. By contrast, sovereign and corporate bonds often have fixed interest payments (fixed rate coupons). This

makes the interest rate risk of an ABS substantially lower than for sovereign or corporate bonds. However, in

combination with interest rate swaps, ABS can be used as part of the interest rate hedging portfolio of institutional

investors such as pension funds and insurance companies.

Another feature of an ABS is that the credit risk is not caused by countries or companies, but predominantly by

consumers. For example, the degree to which a consumer is able to meet his or her mortgage obligations determines

the credit risk for an mortgage-backed security. The credit premium or spread above the Euribor rate provides

compensation for this credit risk. If the spreads for ABS rise, then the value of an ABS declines. The relative level of

the spread reflects the assumed credit risk of the ABS. Because of their exposure to consumer risk, ABS offer an

attractive opportunity for diversification within the fixed income portfolio, especially when the portfolio only consists

of sovereign and corporate bonds.

The euro-denominated ABS market has a relatively large exposure to southern European countries. Particularly, Spain

and Italy represent a large portion of the ABS universe. This can lead to a higher concentration risk. Compared to

government and corporate bonds, ABS have a higher liquidity risk, i.e. the risk that an investment cannot be quickly

bought or sold at a reasonable price. Although the European ABS market is smaller than the market for government

and corporate bonds, in practice the ABS market typically offers sufficient liquidity to trade fast. If we compare

mortgage-backed securities with direct mortgage investments, the liquidity risk of these mortgage-backed securities

are lower.

4. Characteristics of the ABS market

The market for ABS is relatively large within the overall bond market. The market for investment-grade sovereign

bonds from the Eurozone had a size of around €6,584 billion, and the market for investment-grade corporate bonds

from the Eurozone was around €2,134 billion.3 The size of the outstanding euro-denominated ABS market (investment

and non-investment-grade) is around €1,190 billion and can be divided into different subcategories.4

The ABS market is very diverse in terms of the underlying collateral. For this reason, the different market segments of

ABS are defined according to the type of underlying loan of the ABS.

2 In the ABS universe there are also underlying loans with fixed interest payments (fixed rate coupons). These are often converted into a variable interest payments by using interest rate swaps. 3 Barclays Capital Euro-Aggregate Government Index respectively Barclays Capital Euro-Aggregate Credit Index, as of 30 September 2019. 4 AFME Securitisation Data Report Q3 2019, via https://www.afme.eu/reports/data/details/AFME-Securitisation-Data-Report-Q3-2019. ABS from multinational and pan-European regions that are quoted in euros are included in these and other calculations in this paper.

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The most important market segments in the euro-denominated ABS market are securities that are backed by:

• Mortgages to individuals: Residential Mortgage-Backed Securities (RMBS)

• Mortgages to companies: Commercial Mortgage-Backed Securities (CMBS)

• Loans to individuals (often for the purchase of a car): Consumer ABS

• Mix of different forms of underlying loans: Collateralized Debt Obligations (CDO)

• Loans to medium and small-sized companies (with collateral): Small and Medium Enterprise CLO (SME CLO)

Source: AFME (2019), as of 30 September 2019.

The figure above shows the relative size of these five sectors. It shows that RMBS (ABS with residential mortgage loans

as collateral) account for the largest part of the market. This segment is much bigger than CMBS (ABS with mortgage

loans on commercial real estate as collateral). The market segment Whole Business Securities (WBS) is not shown in

this pie chart because WBS accounts for a very small portion (5%) of the ABS market and predominantly exists in the

United Kingdom.5

The next two figures show the breakdown of the outstanding euro-denominated ABS market by country and rating.

Nearly 93% of the rated bonds have a high rating (from A up to AAA). In the pie chart showing the country distribution,

United Kingdom is in first place. Spain and Italy, which are generally seen as riskier, are also strongly represented with

a combined 23% of the market. Large European countries such as Germany and France play a lesser role in this market.

5 WBS are securitizations whose interest payments are made from (future) cash flows from a company, business unit or a group of them. Unlike the other ABS market segments, this concerns the securitization of ‘operating assets’ instead of ‘financial assets’. Examples of such operating assets are future cash flows from airports, harbors, pubs or royalties.

60%

20%

13%

7%5%

Figure 4: Sector distribution of outstanding European ABS market

Residential Mortgage-Backed Securities(RMBS)

Consumer ABS

Collateralized Debt Obligations (CDO)

Small and Medium EnterpriseCollateralized Loan Obligations (SMECLO)

Commercial Mortgage-BackedSecurities (CMBS)

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Source: AFME (2019), as of 30 September 2019.

An important part of the market for pay-through ABS is the Collateralized Debt Obligations (CDO) market. This includes

various market segments, whereby the differences are especially dependent on the type of debt that serves as the

underlying pool of assets for the CDO. Within this CDO category are Collateralized Loan Obligations (CLO),

Collateralized Bond Obligations (CBO) and Collateralized Mortgage Obligations (CMO), among others. In this market,

however, only CLO and CBO are normally placed under the category CDO, while CMO are often categorized in the

Mortgage-Backed Securities (MBS) market. When discussing the ABS market segments, we follow this market

convention.

For pay-through structures within the Consumer ABS sector, the classification by the Association for Financial Markets

in Europe (AFME) is used. CLO and CBO are listed in this case under Consumer ABS instead of under the CDO sector.

Please note that for CDO it is not necessary that the cash flows from the underlying assets exactly match the cash

flows of all tranches together. It is also possible that reinvestments of cash flows on the underlying pool take place

only during a specific period and that the CDO is amortized at a later time.

In addition to their exposure to United Kingdom, Consumer ABS and CDO have a relatively high exposure to countries

from southern Europe. In particular, the subcategories Consumer ABS and Small and Medium Enterprise Collateralized

Loan Obligations (SME CLO), loans to small and medium-sized companies, consist predominantly of loans from Spain

and Italy. In the appendices, we give a more detailed picture of the different subcategories and their underlying

distributions across countries and ratings.

26%

14%

12%11%

10%

10%

5%

12%

Figure 5: Country distribution of outstanding European ABS market

United Kingdom

Netherlands

Spain

Italy

Pan-Europe

France

Belgium

Others

53%

32%

9%4%4%

Figure 6: Rating distribution of outstanding European ABS market

AAA

AA

A

BBB

< BBB

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5. Conclusions

ABS is an asset class with specific opportunities and risks for investors to consider when entering this market. The

figure below gives an overview of the identified opportunities and risks of investing in ABS. The appendices contain a

more detailed overview of the composition of the individual market segments in the euro-denominated ABS market,

including their unique opportunities and risks.

ABS with a floating rate coupon can, in combination with interest rate swaps,

be used as part of the interest rate hedge portfolio.

From a return perspective (spreads), ABS can be attractive compared with

sovereign and corporate bonds.

Due to their short duration, ABS are an attractive investment in a scenario in

which the interest rate rises (due to the floating rate coupon of ABS). This

also depends of course on the applied interest rate hedging policy.

ABS offer risk diversification in a fixed income portfolio, as the credit risk is

moreover based on consumers than on countries and companies (for

example in the case of Consumer ABS).

Opportunities

ABS are less liquid and are often viewed as more complex.

ABS have a reinvestment risk in the case of accelerated repayments.

Within specific segments of the market, ABS have a high share of non-

investment-grade loans or loans without a rating. This can be mitigated by

investing in ABS sectors with higher ratings.

The euro-denominated ABS market is characterised by a relatively large

exposure to countries such as the Netherlands, Spain and Italy, but this risk

can be mitigated by investing only in tranches with a high rating.

Risks

12

Appendix 1 – Residential Mortgage-Backed Securities (RMBS)

RMBS are financial instruments backed by an underlying portfolio of residential mortgage loans as collateral. With a

market share of €593 billion (around 60% of the total), RMBS account for the largest portion of the euro-denominated

ABS market, as shown in Figure 4. Through the process of securitization, this loan portfolio is turned into an investable

RMBS. RMBS are typically bonds of which the principal is paid off during its term. Also, almost all RMBS tranches have

a floating rate coupon.

The portfolio underlying a RMBS often contain a diverse selection of mortgages (e.g., spread over regions). This has

historically provided relatively stable returns. Figure 7 shows that the Netherlands is the biggest issuer of euro-

denominated RMBS, with a total of €147 billion outstanding. United Kingdom takes a second place with €138 billion,

followed by Spain with €95 billion.

Source: AFME (2019), as of 30 September 2019.

25%

23%

16%

14%

8%

6%

4%4%

Figure 7: Country distribution of outstanding European RMBS market

Netherlands

United Kingdom

Spain

France

Italy

Belgium

Ireland

Others

13

Table 1 shows the characteristics of the euro-denominated RMBS market. We have used the data of the Barclays

Capital Euro ABS Floating Rate Note Index to represent the RMBS and the overall ABS universe.6 Within this universe,

almost all RMBS have a pay-through structure (using risk tranches). The average coupon and yield for RMBS are

respectively 0.12% and 0.08% per 31 January 2020. The average duration and life of the bonds in this segment are

respectively 1.47 and 3.25 years. With respect to the rating, RMBS have an average rating of AA+, which is the same

as the overall ABS universe. Approximately 95% of the RMBS market relates to senior tranches (in contrast to 5%

subordinate tranches). The Netherlands and Spain are the largest issuer, covering around 52% respectively 23% of the

total Euro RMBS market in the index.

Table 1: Characteristics of RMBS within Euro ABS index

Benchmark Rating Duration Maturity Coupon % Yield % Senior Subordinated

Total ABS index AA+ 1.39 3.16 0.38 0.04 95% 5%

RMBS AA+ 1.47 3.25 0.12 0.08 95% 5%

Source: Barclays Capital Euro ABS Floating Rate Note Index, as of 31 January 2020.

6 The Barclays Capital Euro ABS Floating Rate Note Index is a smaller universe than the AFME data report that is used for the pie charts in this paper. The reason for this is that the index, amongst others, require an investment-grade rating (AAA-BBB), minimal remaining term, and minimal nominal value for every ABS. Whereas the AFME data report includes all European ABS.

RMBS typically provide relatively stable returns due to the diversity of the

mortgage pools.

Almost 50% of the RMBS have an AAA rating and 85% are investment grade

(≥ BBB).

RMBS is the largest ABS market segment, and therefore more liquid than

some other market segments.

Opportunities

Relatively large exposure to Spain, Italy and Portugal.

Diversification benefits are possibly limited due to already-existing exposure

to direct mortgage investments in the fixed income portfolio.

Risks

14

Appendix 2 – Commercial Mortgage-Backed Securities

(CMBS)

CMBS are securities backed by an underlying portfolio of mortgage loans for commercial real estate as collateral.

CMBS is a relatively small part of the euro-denominated ABS market, accounting for €48 billion (5% of the total market)

as shown in Figure 4. Like RMBS, CMBS are typically bonds whereby the principal is repaid during its term. Also like

RMBS, the majority of CMBS have a floating rate coupon. The portfolios underlying CMBS have a less diverse collection

of mortgage loans than RMBS. Like RMBS, CMBS often have no pass-through structure, but rather a pay-through

structure (using risk tranches).

Figure 8 shows that the largest issuer by far of CMBS is United Kingdom with €37 billion. In other countries CMBS is a

less popular way of securitizing these type of loans. A total of €3 billion is issued by multinational pan-European

countries. France is the third largest single market with €2 billion outstanding.

Source: AFME (2019), as of 30 September 2019.

The Barclays Capital Euro ABS Floating Rate Note Index as of 31 January 2020 does not contain CMBS. Therefore, we

cannot have a closer look at the characteristics of this sub category with the Euro ABS index. This also shows that

CMBS is quite rare in euro-denominated countries.

77%

6%

5%5%

2%

5%

Figure 8: Country distribution of outstanding European CMBS market

United Kingdom

Pan-Europe

France

Italy

Germany

Others

15

CMBS is a risk diversifier if the fixed income portfolio does not already

contain direct exposure to commercial mortgage loans. Opportunities

Large exposure to United Kingdom. CMBS are often issued in British pounds,

making currency hedging often necessary for euro-denominated investors.

Relatively less stable returns due to a more concentrated pool of mortgages

(as compared to the RMBS segment).

Almost 25% of the CMBS subcategory is non-investment-grade (< BBB rating).

Risks

16

Appendix 3 – Consumer ABS

Consumer ABS are backed by an underlying portfolio of all kinds of consumer loans. The most common consumer

loans in this category are car loans and credit card loans. Another well-known type are student loans. Figure 4 has

shown that the Consumer ABS segment accounts for €200 billion (around 20% of the total market) of the euro-

denominated ABS market.

Car loans have, just like mortgages, collateral and a repayment scheme. However, the repayment scheme of a car loan

is in general of a shorter duration and the borrowed amount is lower than that of mortgages. For these reasons, the

life of an ABS on car loans is, generally speaking, shorter than that of other ABS. Another difference with mortgages is

that the value of the collateral declines relatively quickly, whereas the collateral of mortgages generally rises in value.

ABS on car loans are normally created with a pay-through structure (using risk tranches).

In an ABS on credit card loans, the underlying portfolio consists of credit card receivables. The cash flows from

individual credit card receivables can fluctuate strongly from month to month. By combining thousands of credit card

receivables into one portfolio, a more moderate and stable cash flow can be created. A key feature of a credit card

loan is that it is a revolving credit, i.e. no standard monthly repayments are due. In addition, credit card loans by

themselves have no collateral. If debtors fail to pay, the recovery percentage is low. ABS on credit card loans are

generally as pay-through structured.

In the case of ABS on student loans (also called Student Loan ABS, or simply SLABS), the collateral consists of loans for

students to finance their education. There are two types of student loans, loans guaranteed by the government and

private loans without any form of guarantee. The latter type of student loan therefore has a higher interest rate. The

cash flow profile of SLABS are not very stable because students are limited in how much they can pay back during their

studies (and are often exempted from the obligation to pay back during their studies). So, the repayment speed will

often increase after completion of their studies. In the United States, SLABS make up a significant part of the ABS

market, but this is not the case in Europe. For the very limited number of SLABS within the euro-denominated universe,

a pay-through structure is used. These are all US loans from a single issuer (Sallie Mae, the largest private American

lender of student loans), whereby the ABS are quoted in euros. SLABS don’t have any direct collateral, but in the US it

is common that parents act as co-signer. This increases the chance of repayment in the event that students cannot

meet their payment obligations.

Figure 9 shows that the largest issuer for this type of ABS is Italy with a total of €56 billion outstanding. United Kingdom

and Germany take a second and third place with €47 respectively €37 billion, followed by Spain (€21 billion) and France

(€19 billion).

17

Source: AFME (2019), as of 30 September 2019.

Table 2 shows that the average coupon and yield for Consumer ABS are respectively 0.18% and -0.16% per 31 January

2020, which is lower than for the total ABS universe. Consumer ABS can be broken down into two previously-

mentioned subcategories, car loans and student loans. This reveals that student loans have a positive yield of 0.94%

whereas car loans are contributing to the overall negative yield for the Consumer ABS category. The average duration

and life of the two categories are respectively 0.21 and 1.89 years, which is lower than for the overall ABS market. It

is noteworthy that the remaining maturity of car loans is short in comparison to student loans. Student loans are often

exempted for repayments during their studies which explains the longer maturity of these loans. With respect to

ratings, this market segment has an average AA+ rating, which equals the total universe. Around 96% of the Consumer

ABS market are senior tranches (note that students loans are even 100% senior tranches). Within the Consumer ABS

market, car loans are strongly concentrated in Germany (56% of the outstanding car loans in the index). The Euro ABS

index contains only one student because as noted earlier, student loans are more common in the United States.

Table 2: Characteristics of Consumer ABS within Euro ABS index

Benchmark Rating Duration Maturity Coupon % Yield % Senior Subordinated

Total ABS index AA+ 1.39 3.16 0.38 0.04 95% 5%

Consumer ABS AA+ 0.21 1.89 0.18 -0.16 96% 4%

Car loans AA+ 0.40 1.80 0.18 -0.23 95% 5%

Student loans AA- 2.60 6.22 0.01 0.94 100% 0%

Others AA 0.59 1.68 0.20 -0.08 96% 4%

Source: Barclays Capital Euro ABS Floating Rate Note Index, as of 31 January 2020.

28%

24%18%

10%

10%

10%

Figure 9: Country distribution of outstanding European Consumer ABS market

Italy

United Kingdom

Germany

Spain

France

Others

18

Due to the short duration, Consumer ABS (and in particular car loans) are an

attractive subcategory in a scenario of rising interest rates (due to the

floating rate coupon). This depends of course on the interest rate hedging

policy that an institutional investor has applied.

Around 50% of this market segment has a rating higher than AA.

Diversification potential within a fixed income portfolio due to direct

exposure to consumer risk (instead of credit risk of governments and

corporates).

Opportunities

Relatively large (but spread-out) exposure to Germany, Italy and Spain.

Around 16% of the universe does not have a rating.

Credit card and student loans have no direct collateral, or the collateral

declines quickly in value.

Student loans are less common in Europe so concentration risk needs to be

considered.

Risks

19

Appendix 4 – Collateralized Debt Obligations (CDO)

CDO are ABS with a very diverse underlying loan portfolio. The asset pool may contain consumer loans, corporate

loans, bonds, credit derivatives, lease contracts and even other ABS. As noted earlier, this asset class can be divided

into Collateralized Loan Obligations (CLO) and Collateralized Bond Obligations (CBO), depending on the type of

underlying debt.

With €126 billion outstanding, the CDO market covers around 13% of the euro-denominated ABS market, as shown in

Figure 4. The vast majority of this market is the CLO sector, which covers around 70%. We have not included in this

number the market segment of CLO with underlying loans to the medium- and small-sized enterprises (SME). We have

treated this so-called Small & Medium Enterprise Collateralized Loan Obligations (SME CLO) market as a separate

segment. Figure 4 shows that, with €68 billion (around 7% of the total market), SME CLO is a smaller subcategory of

the ABS market. There is also a difference between ‘regular’ CDO and structured finance CDO. The latter category can

be based on other ABS (for example RMBS) or other CDO that are repackaged into new ABS. Especially since the credit

crisis, the last category is not frequently issued anymore.

Source: AFME (2019), as of 30 September 2019.

In addition to the scope of companies (SME’s versus larger companies), another difference is that larger companies

often have a rating, whereas SME’s are often not rated. When looking at the combined universe in Figure 10, it is

striking that 85% of the CDO market consists of CDO that are backed by a pool of loans from different Pan-European

countries and that only 10% of the asset pools are solely linked to loans of a specific country, such as the United

Kingdom.

Figure 11 shows the country distribution of the SME CLO universe. Because the underlying loans of an SME CLO come

from one single country, it is easier to see which countries play an important role in the SME CLO market. Belgium,

Italy and Spain occupy the first three places with €19 billion, €17 billion respectively €12 billion. This means that these

85%

7%5%

2%

Figure 10: Country distribution of outstanding European CDO market (excl. SME CLO)

Pan-Europe

Multinational

United Kingdom

Others

20

three countries account for as much as 71% of the overall SME CLO market. Including the countries Greece and

Portugal, the Southern European region even accounts for around 85% of the market.

Source: AFME (2019), as of 30 September 2019.

28%

25%18%

9%

8%

6%5%

1%

Figure 11: Country distribution of outstanding European SME CLO market

Belgium

Italy

Spain

Greece

Germany

United Kingdom

Portugal

Others

Possibility for extra return with respect to government and corporate bonds

without having to make any sacrifice with regard to credit ratings (via AAA

and AA tranches).

Underlying loans of CDO are, in most cases, spread over many countries and

therefore diversified by themselves.

SME CLO offer risk diversification potential in the fixed income portfolio

through their exposure to medium- and small-sized companies.

Opportunities

Large exposure to Italy and Spain in the case of SME CLO.

Around 25% of the CDO market and 31% of SME CLO market have no rating.

With arbitrage CDO, there is a possible conflict of interest between the

sponsor of the CDO that invests in the equity tranche and the investors in the

more senior tranches.

Risks

21

References

AFME (2019). AFME Securitisation Data Report Q3 2019. Available at:

https://www.afme.eu/reports/data/details/AFME-Securitisation-Data-Report-Q3-2019

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Acknowledgments

The author would like to thank the Investment Strategy team of Aegon Asset Management and Herialt Mens of Aegon

Netherlands for their research on Asset-Backed Securities, which forms the basis for this paper. Furthermore, he

extends his thanks to Egbert Bronsema and David van Bragt for their contributions, which resulted in this final white

paper.

About the author

This article is written by Niek Swagers of Aegon Asset Management. The author is working as Investment Solutions

Consultant, giving advice to institutional investors about ALM, LDI, risk management and regulatory developments.

About the Investment Solutions Center

The Investment Solutions Center of Aegon Asset Management is the knowledge hub for balance sheet and investment

strategy solutions. Various experts of Aegon Asset Management collaborate on research and publications in areas

such as regulatory impact, capital optimization and asset-liability management. The joint knowledge and expertise is

used to support clients with research insights and suitable solutions. Click here for more research publications.

More information

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https://www.aegonassetmanagement.com/netherlands/about-us/contact/

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