Esoterics to the fore as US ABS finds new highs

By any measure, 2024 was a stunning year for the US ABS market, with issuance volumes already reaching record levels by October. Auto ABS, as is standard, accounted for a larger portion of issuance than any other sector. But perhaps the most eye-catching corner of the market was esoteric ABS.

Among other feats — such as Subway’s record-breaking $5bn whole business securitization — it was the year digital infrastructure matured into a benchmark asset class of its own. And 2024 also witnessed the surprise return to form of aircraft ABS.

Moreover, esoterics also accounted for a greater increase in volumes than any other part of the market. Broader non-mortgage ABS volumes were up from $267bn in 2023 to $324.6bn by the end of November, according to data from Finsight, and esoteric ABS issuance was up from $77bn in 2023 to $110.2bn by the end of November 2024.

The previous biggest year ever for US ABS was 2021, with $294.3bn of issuance. That year, esoteric ABS totalled $103.7bn.

Yet investors have been more than willing to soak up this year’s exceptional levels of issuance — and this dynamic should continue.

“As a relative value play, ABS is in a strong position compared to unsecured corporate debt,” says Elen Callahan, head of research and education at the Structured Finance Association. “In ABS you can get credit card or prime auto loan triple-A ABS paper, for example, at pick-up of 5bp-10bp versus double-A corporate paper. ABS spreads have tightened, but corporate unsecured spreads have tightened even further.”

Within this, esoteric paper often provides higher yielding paper. With investor risk tolerance staying strong in the wake of the US election, the sector should be in a good position to continue to capitalise.

“Absent significant developments in credit markets, we expect origination and issuance volumes to remain strong in 2025,” says Dan Kosinski, an ABS and CLO manager at Medalist Partners. “While traditional asset classes such as autos should continue to lead the way, esoteric sectors such as aviation and data centres should provide an increasing share of total issuance in ABS.”

In the first 11 months of 2024, esoteric ABS accounted for 33.5% of issuance — up from 28.8% in 2023. Only in 2021 did esoteric ABS enjoy a larger share, at 35.2%.

This does not take into the account the vast amounts of private ABS deals being priced that do not show up in issuance statistics or in rating agency reports. These deals can also offer a spread pick-up over traditional public ABS, says a managing director at one ABS investment firm, saying this is where he sees value in the market.

“There is an unrated market full of deals that I would categorise as mostly static assets,” says the MD. “These are newer asset classes and rating agencies just don’t have any way to analyse them.”

One development that showcased the strength of the esoteric sector in 2024 was the comeback, in the final quarter, of the once beleaguered aircraft ABS sector.

After Russia invaded Ukraine in early 2022, the sector virtually collapsed, with many aircraft stranded in Russia. Like this year, fixed income markets more broadly were dealing with tighter monetary policy.

According to Jeff Stern, a partner in Reed Smith’s financial industry group: “2022 and 2023 were two very challenging years for structured finance as a whole because of steadily rising interest rates. It was impactful to the economics of individual transactions but also to the willingness of institutional investors to deploy capital when the notes they bought could decline in value for no other reason than the shifting rates environment.”

But as the rates outlook eased, so the fundamentals of the aircraft sector improved. Strong demand for travel after the Covid-19 pandemic was beyond the manufacturing capacity of the likes of Boeing and Airbus, leaving aircraft owners in a strong position. A viable option is for these aircraft to be leased and the receivables to be securitized.

“We’ve seen aircraft ABS issuers come back this year and I think that will continue into 2025,” says Nicholas Rogers, head of non-traditional ABS origination at RBC. “There’s a significant pipeline of bank-financed aircraft and markets have improved, suggesting a larger year for issuance ahead.”

Until the middle of 2024, most market participants had been forecasting the return in earnest of aircraft ABS issuance to public markets in 2025. But markets have been so strong that the comeback was brought forward.

After just four aircraft ABS deals totalling $1.8bn in 2022 and 2023 combined, there were nine deals totalling $5.2bn in the first 11 months of 2024, with most coming after the summer. More are expected.

“I expect that we will see a rash of transportation finance deals for aircraft and vessels in the coming years,” says Stern. “We are entering a replacement cycle for a number of airlines.

“Although aircraft production has of late dealt with a number of challenges, as has been widely reported, I nonetheless anticipate a material uptick in aircraft purchases over the next two to three years.”

The sector causing most excitement among ABS bankers is digital infrastructure, particularly data centres, as the securitization market steps up to fund a surge in demand related to the computing needs of artificial intelligence.

Like many sectors, data centre ABS enjoyed its biggest ever year in 2024, with 19 deals worth $8.6bn by the end of November — compared to just three deals totalling $1bn in 2022. The pick-up in issuance came after new data centre leasing activity in the US had increased by 82% between 2022 and 2023, according to a T Rowe Price blog published in September citing numbers from DataHawk.

So impressive has the growth been that, for some market participants, the asset class is moving from the fringes of esoteric ABS and should be seen as a standalone segment of the market.

“Digital infrastructure has become a big story this year,” says Mike Nowakowski, managing director and head of structured products at Conning Asset Management. “It’s no longer emerging, it’s here to stay.

“There’s a critical mass of issuers, enough to call it a benchmark sector within esoteric ABS.”

Indeed, as the digital infrastructure sector gains in prominence, Nowakowski says that the market will begin to see price tiering between issuers — like other benchmark sectors within ABS and broader securitization markets as a whole.

“There’s already some tiering between issuers in the digital infrastructure space, similar to the subprime auto sector where there are tier one, two and three names,” Nowakowski says. “I expect to see differentiation in the fibre space between legacy telecom providers who are playing catch-up versus more pure-play fibre companies who have been at it for some time.”

Within digital infrastructure there has been a lot of merger and acquisition activity, which has brought some of the more previously prolific ABS issuers in-house to larger companies. Theoretically, this may reduce their reliance on securitization as a funding tool.

However, Rogers believes that these issuers’ new owners may still use securitization as a funding source to avoid straining their corporate unsecured offerings.

One of the largest of these M&A deals was Verizon’s $20bn purchase of Dallas-headquartered telecoms firm Frontier Communications in September 2024. Before Verizon announced its purchase of the company, Frontier had priced two securitizations: the $750m FYBR 2024-1 in June 2024 and the $1.6bn FYBR 2023-1 in August 2023.

“Depending on the depth available in corporate bond markets for your name, raising more than you used to could push your spreads higher,” says Rogers. “It varies name by name, but I expect we will continue to see ABS issuance, even from some of these acquired players in digital infrastructure. For other acquisition targets, it’s still an open question and the jury is out. Once the M&A closes and some of the bridges are refinanced, we’ll see how this plays out.”

Although there are plenty of reasons for caution heading into 2025 — not least the potential for US Treasury yields to keep rising again — the mood is largely one of optimism. RBC’s Rogers says that, for now at least, things are looking bright.

“There are certainly things that could complicate or derail the market, and several events in the economic calendar, but I think issuers are planning for the best in many respects,” he says. “For today it looks like the party can continue.”