The prospect that the EU could lower the risk-weightings for banks of certain securitizations has seemingly sent shivers through the covered bond market. Perhaps the insecurity reflects a lack of conviction in the superiority of the product.
What the EU’s final position will be is still unclear, pending a trilogue between the European Council, Commission and Parliament, but the negotiating positions are set after a vote by Parliament’s Econ Committee on Tuesday.
It looks as though the cleanest and most prime securitizations might be able to reach a risk-weighting close to 5%, while the best a covered bond can do is 10%.
Covered bonds will still benefit from being far easier to buy in terms of due diligence and will get superior treatment in the Liquidity Coverage Ratio.
Securitization is used by different issuers in many ways, but viewed as a bank funding tool, it is similar to a covered bond. So, for bank issuers, it doesn’t make sense to tilt the table in favour of one or the other. The healthy position is to allow banks to diversify and use both.
You can put an identical pool of assets into a covered bond or a securitization. Buying the securitization comes with credit enhancement, hefty due diligence requirements and detailed disclosure from the issuer. Covered bonds give investors dual recourse to the issuer and the pool of assets, and protection against losses by means of overcollateralization.
Either way, done properly the credit risk is close to zero.
Securitizations are arguably more liquid during certain moments of market strain, like during the UK's mini-budget induced Liability-Driven Investment Crisis that rocked thegilt market in late 2022.
A study in February 2022 by trade body, the Association for Financial Markets in Europe (Afme), and risk analysis company, Risk Control found that “while [covered bonds] were generally more liquid in the early 2010s, since 2016, senior ABS have been consistently and generally more liquid even in the 2020 Covid-19 crisis”.
The market for covered bonds is bigger than the prime RMBS market, so having the option to sell either is clearly the way to maximise liquidity.
There’s no need for the regulators to pick winners in the bank funding market. Why not let the best funding option win?