Fitch: European Structured Finance Outlook Improves in 2016

An improved macroeconomic landscape, consumer confidence and a more competitive lending environment will continue to support improving asset performance in the European structured finance (ESF) market next year, Fitch Ratings says.

We have changed our asset performance outlook for ESF to Stable/Positive in 2016 from Stable in 2015, as credit flows are now complementing the macroeconomic recovery in most European countries. The asset performance outlooks for several individual markets have improved, mostly in relation to residential and prime commercial mortgages, as GDP growth and lenders' greater appetite to underwrite loans to solvent borrowers cause arrears to decrease and prepayments increase.

We think these trends can continue, although they are not universal, particularly where economic recovery has stalled or is sluggish. For example, three-month-plus arrears including defaults are still rising in Greek and Italian RMBS deals, as recovery cash flows remain very weak and loan resolution is extremely slow.

The increase in residential mortgage prepayments is striking. The simple average annualised prepayment rate rose to 8.4% in 3Q15 from 6.5% last year for the five largest European RMBS markets. These include France and Italy, where borrowers are prepaying fixed-rate mortgages by refinancing them with floating-rate products to take advantage of low rates, and where we estimate that refinancing transactions represent 20%-30% of new credit flows for housing. We think the figure is as high as 60%-65% in Ireland and the Netherlands, where there is strong competition among lenders to offer better credit terms to borrowers.

Prepayments have also come back to the commercial property loan market, with many loans originated in 2014 already refinanced.

Performance remains robust in consumer sectors including auto loans and credit cards, which are posting historically low charge-offs, and in SME and post-crisis high-yield CLO deals.

The overall credit performance of securitised portfolios supports our stable rating outlook for 2016. The proportion of Fitch's ESF ratings with Stable or Positive Outlooks has risen to 95% from 89% last year, with most of the improvement accounted for by affirmations and upgrades.

Rising prepayments are usually positive for bonds backed by granular portfolios, as credit enhancement builds up. But where portfolios consist of loans to a few large borrowers (such as CMBS and corporate CLO deals) they may constrain ratings by increasing obligor concentration risk.

Ratings in 2016 may be influenced by Fitch's proposed criteria changes for UK RMBS ratings. If implemented in their current form, a large proportion of Stable Rating Outlooks in UK prime, non-conforming, and buy-to-let deals would probably move to Rating Watch Positive ahead of transaction-specific rating actions. This would affect about 18% of all ESF Rating Outlooks.