The Basel Committee’s inclusion of RMBS in its Liquidity Coverage Ratio is the first major reprieve for the ABS market since the financial crisis and the first sign that regulators’ antipathy towards all securitisations is on the wane.
Crucially the Basel amendment has shown there is a way around the market’s chicken-or-egg dilemma, in which liquidity would only return to the market after regulators were less punitive towards securitisations, but regulators would only be less punitive after the market could demonstrate quality and liquidity. Instead the Basel Committee has shown regulators are willing to take the first step.
But the ABS market should not begin its victory dance yet.
The Basel Committee’s new definition of high quality liquid assets for liquidity coverage ratios includes certain RMBS, rated AA or higher, with a 25% haircut. The regulator did not go as far as giving the asset class parity with covered bonds, which are subject to a 15% haircut, and instead put RMBS in a new level 2B category, which includes unencumbered equities and low-rated corporate bonds. The 2B assets are not allowed to exceed more than 15% of a bank’s total level one and two LCR assets, whereas the limit for 2A assets is 40%.
ABS market practitioners have long argued that the exclusion of ABS from LCR buckets has eviscerated the bank bid for securitisations, inhibiting the market’s full recovery. This latest LCR framework, if replicated in its current form by the European Commission, is unlikely to materially change the bid for securitisations.
For starters, regulators have kept other asset classes, such as auto ABS, credit card and consumer ABS, excluded from liquidity buckets, despite those asset classes demonstrating resolute underlying performance and, in the case of autos, greater liquidity over the past couple of years.
There is still a chance that the European Commission will expand the list of eligible asset classes beyond RMBS in CRD IV, perhaps using the Prime Collateralised Securities label as a criterion for eligibility. The ABS market should continue to lobby European lawmakers to deviate from the Basel LCR revisions and to legislate according to regional conditions – not global parameters.
But banks will also have to weigh the benefits of meeting the LCR requirement through buying RMBS with the capital cost of holding those securitisation positions, after the Basel Committee increased proposed risk weightings for all senior bond securitisations rated triple-A down to triple-B in December. The risk weight for a triple-A rated senior tranche securitisation with a one year maturity, for instance, went up from 7% to 20%.
Some bank treasuries may look at RMBS more closely as an investment option. But many had already started to buy primary deals in greater bulk in the expectation that regulators would amend the LCR. Banks were often the largest buyers of auto ABS and RMBS deals in the second half of 2012.
Now the returning bank treasuries need to reconsider the returns on capital under the new Basel risk weightings, which could inhibit an immediately stronger bank buying.