European Securitized: High Rates Have Uneven Impacts

In the U.K. and Europe, varying asset classes are responding differently to rising interest rates. European asset-backed securities and residential mortgage-backed securities (RMBS) are performing well amid this monetary-tightening cycle due to their reduced exposure to duration risk.

However, the fundamentals of some collateral have weakened since 2022, particularly affecting portfolios tied to floating-rate loans, with increased arrears observed in lower-quality borrower pools, notably in U.K. nonconforming and Irish reperforming loans. In contrast, fixed-rate mortgage markets in France, Spain, the Netherlands, and Italy are maintaining robust performance, supported by stable affordability.

Investment strategies currently favor mezzanine tranches of RMBS from Spain, Italy, and the Netherlands while prioritizing senior tranches in deteriorating collateral scenarios. Furthermore, appealing value is found in first-pay tranches, which offer wider spreads and benefit from strong structural protections despite weaker collateral.

The U.K. and European job markets remain strong, bolstering support for homeowners. Similarly, fixed-rate consumer and auto loans have sustained affordability, resulting in only minor default increases, further enhanced by quick deal deleveraging.

Consequently, mezzanine tranches of European auto loans and consumer loans are attractive due to their compelling yields and fast maturity profiles, ensuring quicker credit enhancement increases for these potentially vulnerable assets.