Confidence returns but banks hold fire on ABS issuance
A more conciliatory tone towards the securitization industry from regulators and a rehabilitation of the product among many investors means optimism in the securitization market is at its highest since 2007. But will issuers take advantage when cheaper and simpler alternatives such as central bank funding are available? Hugh Leask investigates.
European structured finance finds itself in a precarious place. It is caught between a squeeze on issuance that has driven some banks and other financial institutions away from wholesale markets towards cheap central bank funding, while the still-uncertain regulatory backdrop is keeping many issuers and investors from returning to the market.
Yet, there is a real sense of optimism that the market has turned a corner following the problems it faced in the aftermath of the financial crisis. The region’s CLO market — largely shut in the years following the crash — has enjoyed an impressive resurgence this year, while commercial mortgage-backed securities are also seeing renewed interest. At the regulatory level, the stigma attached to securitization appears to be receding, with the European Central Bank reducing its haircuts on ABS and lawmakers talking up the role SME ABS has to play in funding the real economy.
So has securitization reached the point where issuers and investors will start to return?
“ABS and CLOs are something that banks should use more in order to refinance the real economy,” says Cedric Perrier, executive director, securitization and covered bond syndicate at Natixis in Paris. He reckons the product can help banks with deleveraging, offloading lending and streamlining balance sheets.
A recent report published jointly by the three pan-European regulators — the European Securities and Markets Authority, the European Banking Authority and the European Insurance and Occupational Pensions Authority — suggested today’s securitization market bears little resemblance to that of 2007. The report noted major issuers and counterparties have either merged or withdrawn from the market, while certain more complex products such as asset-backed commercial paper, collateralised debt obligations and synthetic securitizations have either declined sharply or disappeared altogether. At the same time, most of today’s deals are underpinned by more “real economy” demand components, such as housing, autos and credit cards, rather than being linked to more edgy investor speculative purposes, such as synthetic CDOs.
With this backdrop, Europe’s structured finance market is much healthier than 18 months ago, says Bob Paterson, head of ABS syndicate, structured securitization at Lloyds Bank in London. He says that the market then was dominated by a few prime UK and Dutch RMBS issuers, and a handful of German auto names.
“As spreads have come in on the plain vanilla assets — residential mortgages, cards, autos — you’ve seen more issuance in CMBS and CLOs,” Paterson says. “That’s been feasible because the funding costs have come down to a level where it makes sense for everybody. We’re getting a broader variety.”
With most plain vanilla ABS spreads having pulled in well inside of 100bp — too tight in fact for a number of buyers — some investors have now begun looking at other, higher yielding assets, such as CLOs or commercial real estate. The problem, according to market practitioners on the frontline, is that not enough prospective investors have made that migration.
More accounts needed
Perrier says that while the market may be more diversified from an issuer point of view, with a wider spectrum of asset classes on the table, on the other side of the fence there is still a very limited, though increasing, number of accounts able to participate effectively in the market.
Some bank treasuries and asset managers that fled securitization following the 2008 crisis are slowly returning, Perrier explains, but many are only returning to plain vanilla consumer ABS. It remains much more of a challenge to tempt buyers back to the more complex corners of the market, such as CLOs, even at the triple-A level. Despite this, CLOs have seen a big resurgence in 2013, with €4.5bn worth of new issuance volume emerging across 13 deals so far this year.
“CLOs are going up in terms of volume, which is good. We are back now to more plain vanilla CLOs — there are no more synthetic, exotic CLOs. But in terms of the investor base it’s true that it is still relatively limited,” says Perrier, whose firm was arranger in Haymarket Financial’s Hayfin Ruby II SCA CLO and 3i Debt Management’s Harvest VII CLO earlier this summer.
Market pros point to a series of factors hindering the expansion of the investor base. Traditional pre-crisis CLO buyers, such as SIVs and other leveraged funds, have disappeared, while bank treasuries and asset managers have a limited capacity in how much new paper they can buy. Other components of the ABS investor base, such as insurance companies and pension funds, traditionally stuck to plain vanilla assets and they have continued to do so post-crisis. Many of these buyers remain spooked by the looming Solvency II regulation, which slaps on higher capital charges for even the safest ABS asset classes.
Rob Ford, partner and portfolio manager at TwentyFour Asset Management, explains that much of the demand in the pre-crisis market had been driven by leverage, which has largely disappeared and is unlikely to return in any meaningful way.
“We have an investor base now with the same sort of people as before, minus the SIVs and the leveraged investors, but also a handful of larger investors from the real money sector, and a number of agile buyers from the hedge fund community, which includes those from the US, who have been able to play in the more distressed and difficult-to-analyse parts of the marketplace,” Ford says.
“Some of those real money investors have been able to overlook the mismatch between their desire for longer maturities and the typically shorter dated investments that characterise the ABS market,” he explains. “The returns they have been able to get from shorter dated assets have been more attractive than they were at the tight yields pre-crisis.”
Perrier, meanwhile, sees difficulties for insurance companies and bank investors stemming from the assortment of regulatory measures — such as Solvency II, Basel III and ECB repo — that have been stacking up in recent years.
“Banking treasuries — it’s good to see them back again, but for them buying ABS is not worth the same in terms of capital charges and repo,” he adds. “If the regulation can help enlarge the investor base, that would be very helpful, as issuers will be ready and willing to consider RMBS because the levels have tightened in the secondary market and it’s becoming more competitive compared to other funding instruments.”
The US model
Emmanuel Issanchou, head of European structured credit and solutions at Natixis in London, says regulation has limited the leverage and the availability of credit offered by banks, and this will push Europe towards a more disintermediated economy similar to that of the US.
“This is where securitization definitely comes into play,” Issanchou explains, pointing to more private equity and non-bank lender sponsor-backed securitizations appearing in the European market. “Banks are constrained, or gradually pulling away from areas of the economy. So the securitization market is key to financing, not only the deleveraging, but also the new lending landscape.”
Issanchou explains that credit funds are buyers of those portfolios being disposed of by banks in the deleveraging process, and one way to finance those acquisitions is through securitization. “More non-bank lending platforms are emerging, and this is the evidence of that disintermediation happening. Securitization is a powerful tool to make this disintermediation happen efficiently, provided regulators encourage the investor base to grow.”
Recent developments point to a shift in tone from regulators towards securitization, and that is providing the industry with a sense of optimism.
In July, the ECB lowered the repo haircuts for senior ABS from 16% to 10% and broadened the range of ABS assets eligible for the facility, while at the same time raising haircuts for retained covered bonds by between 8%-12%. This levelling of the playing field between ABS and covered bonds chimed with comments by ECB chairman Mario Draghi in May that securitization could provide a potential source of funding for small-to-medium enterprises against a backdrop of widespread bank deleveraging in Europe. At the same time, the Commission has requested the European Insurance and Occupational Pensions Authority to re-examine the way Solvency II capital charges are calibrated to ensure potential long term financing routes are not cut off.
“There’s no doubt that regulators now recognise the importance and significance of securitization as a funding tool,” says Ford. “Also, they probably recognise, though they may not admit it, that in some of the early statements and regulatory changes they overreacted, based on a misperception of the benefits of what securitization is and a comparison with products in the US.”
Ford reckons there will always be a stigma around ABS. But he adds: “People increasingly understand, as they look at the performance of the underlying assets, that there is a difference between jurisdictions — and most European jurisdictions have performed extremely well, even in the periphery.”
Perrier says that regulation is heading in the right direction, but warns that the rules as they are drafted — whether Basel III, Solvency II or the ECB haircuts — are still much more favourable to covered bonds than to ABS. This continues to limit the number of potential players in the market.
More help needed
“We need to have more support from regulators, helping enlarge the investor base, and then people will be ready to move forward because the costs at the end are much more competitive than they used to be.”
Perrier reckons securitization will remain mostly vanilla. “I don’t think we will go back to the very complex or synthetic products again because investors are telling you that the mandate they have from their clients is really, really defensive,” he explains. “So they are not allowed to go into too much complexity. They want to be able to have a bit of liquidity in the secondary market for their book.”
Ultimately, however, despite the more conciliatory tone towards the industry from regulators, and a rehabilitation of the product among investors, market pros say the supply of cheap central bank funding available will likely hold many issuers back from tapping the ABS market.
Many point to the sharp drop in UK prime RMBS — a cornerstone of European structured finance and previously one of the most buoyant sectors of the post-crisis market — since the introduction of the Bank of England’s Funding for Lending Scheme.
Ford says securitization supply will stay low while central bank funding measures are in place. “However, those major banks that have been regular users of securitization will continue to issue sporadically, to ensure that they remain in the sights of their investor base until the opportunities to use securitization as a more mainstream funding tool return,” Ford adds.