The European securitization industry’s push to obtain better regulatory treatment for its products has been predicated on the argument that it is a simple, vanilla product that, as a funding and capital relief product, pushes credit through to the real economy.
Looking at the current state of the primary market, however, it is hard to see this in action.
Traditional bank originators, issuing the kind of vanilla funding transactions that regulators had in mind when thinking about STS, are largely absent from the market — cheap central bank funding schemes have proven a far more attractive option for banks, however large their credit card, mortgage or SME books.
But high levels of demand for yielding assets, of which structured finance, unlike many other markets, still has plenty, has driven renewed investor interest in the market, driving spreads in some asset class to their tightest levels seen since the financial crisis.
Private equity firms have been quick to sniff out cheap financing opportunities for legacy portfolios acquired in the aftermath of that crisis. Non-performing loans, re-performing loans, and complex mortgage portfolios are being securitized and bought by investors that are crying out for yield and willing to absorb the more complicated deal structures that are on offer.
Coupon caps, tranche specific liquidity facilities, zero coupon tranches, repurchase rights, limited reps and warranties and other structural bells and whistles all have a function for issuers — but makes getting involved in ABS murkier and more complex for non-specialists.
Activity is also booming in the private ABS market — where issuers can construct bespoke transactions behind closed doors to suit their own needs. Similarly, synthetic securitizations are also resurgent, with as much as €94bn notional of these trades sold in 2016, according to a Deutsche Bank report on Tuesday.
On the sell side, banks are shifting their approaches to better cater for private style deals, rather than the vanilla flow ABS transactions, simply because the fees for financing and arranging portfolio transactions are much greater.
None of this is inherently bad — where there is both a need for yield and the assets and willingness to meet it, trades will happen. There is also something to be said for how private equity firms can help banks deleverage their balance sheets — which European regulators have urged them to do — and have the expertise to manage those portfolios and exit them successfully.
But the distance between what the industry says the market is (a simple funding tool to help credit flow to the real economy), and what it currently is (a way for private equity firms to leverage investments and boost profits) is growing.
The danger is that this will further slow regulatory progress, which the industry undoubtedly needs. Some European politicians have already blasted the European market for its supposed role in the financial crisis, and the increasing role of private equity firms in the market will not help soften their view of the industry.
Europe does need an appropriately regulated securitization industry, with appropriate risk weights, for when the music stops on cheap central bank funding. Perhaps only then will the importance of a functioning securitization market become clear — which is why progress on STS is crucial sooner, rather than later.