The volume of residential mortgage-backed securitizations in Europe will fall significantly as a portion of overall asset-backed securitization, as a result of the imminent introduction of the Basel II capital adequacy rules, according to securitization experts. Attention is focused more than ever on the impact of the new risk weightings on securitization in Europe ahead of publication of the new rules at the end of the month. In particular, market participants say the new rules dramatically reduce risk weightings for single- to triple-A rated notes from an average of 50% to closer to 20% and therefore disincentivize banks from securitizing higher quality assets.
Indeed, Halifax Bank of Scotland, one of the largest RMBS issuers in the U.K., is more likely to keep mortgage assets on its balance sheet in their entirety after Basel II, said Gavin Parker, associate director of securitization. "Issuing RMBS is more expensive than covered bonds, but currently makes sense from a capital relief perspective; under Basel II those capital relief advantages largely disappear," said Parker. "It would no longer be cost-effective to issue subordinated or mezzanine tranches," he added.
Parker pointed out, however, that investor diversification is a key reason to continue issuing RMBS alongside covered bonds, as the two investor bases are quite separate. "The average size of our RMBS transactions is £4 billion versus E2 billion for a covered bond," he said. Parker declined to quantify the possible reduction in RMBS issuance, saying it would depend entirely on the market's reaction to Basel II in terms of price tightening.
Analysts at top sell-side firms expect European RMBS issuance, which was close to 60% of the E204 billion in asset-backed new issuance over the last 12 months, to drop considerably, although nobody is willing to quantify the hit it will take. "It is quite likely that RMBS supply will drop and we expect a trend towards riskier assets being securitized," said Birgit Specht, head of asset-backed research at Dresdner Kleinwort Wasserstein in London. Similarly, Ronald Thompson, head of asset-backed research at Royal Bank of Scotland in London, expects to see the slack in RMBS issuance being taken up by securitizations of other assets, such as higher loan-to-value mortgages in both the commercial and residential sectors, consumer and auto loans, and unsecured corporate lending.
One large continental ABS investor said he would not be surprised to see RMBS fall to 30% of ABS issuance by the end of the decade. He pointed out the lower risk weightings that would depress issuance by banks would also increase demand for highly rated paper from bank investors, with the consequence that RMBS spreads would be squeezed from both the supply and demand side.
Some investors, however, might also drop out of the market, observed William Ross, head of asset-backed securitization research at ABN AMRO. "Typically a lower risk weighting is associated with tighter spreads on the securitized product, so it is possible a lot of RMBS deals would fall out of the eligible asset space for investors looking for spread rather than liquidity," he said.
