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"If this goes ahead and it does not kill securitization then it will just make it very costly. That cost will be transferred to borrowers and result in lower GDP growth"
Alexander Batchvarov, Merrill Lynch |
The strained relations between Europe’s securitization industry and its regulator hit a new low in July with the European Commission’s announcement of its latest plans to address the perceived failings of the market. The EC had earlier announced that as part of its proposed changes to the European Capital Requirements Directive (CRD) any originator of a securitization would be required to retain 15% of its risk-weighted assets on its balance sheet. Not surprisingly, this went down like a lead balloon with the market. "They are taking a hammer to kill a cockroach," complained Robert Plehn, head of securitization and covered bonds at HBOS, at the Global ABS conference in June. "It is completely arbitrary. On the one hand they want you to keep assets and on the other hand they want you to sell them to get capital relief."
Following the negative reaction, the EC agreed to look again at the proposal. But as far as the market is concerned, what they have come back with is far, far worse. The new plan, announced in early July, is for originating banks to be compelled to keep a 10% vertical slice of any credit risk transfer product – and to add insult to injury the industry was given just two weeks to consult. The argument is that the change will protect investors, who will be required to obtain an explicit commitment from the originator of the product that it will retain 10% throughout its lifetime.
This goes against the most fundamental driver of securitization – risk transfer. In order to achieve capital relief for meaningful risk transfer under the CRD, originators have to demonstrate that they have transferred 95% of the risk of the assets – something that would become impossible. "This proposal goes against the heart of Basle II," explains Alexander Batchvarov, international structured finance strategist at Merrill Lynch in London. "The idea is to keep regulatory capital commensurate with the risk banks keep. I am not sure what this is going to achieve."
But the EC argues that – much as architects should be condemned to live in the houses that they design – originators should be forced to hold on to assets that they originate. "If you originate the debt and hold it, you can be much more flexible if the borrower runs into trouble. If it is packaged into a security there is very little flexibility," argues one source supportive of the move.
But it is hard to see this proposal as anything but a death threat for the industry. "If this goes ahead and it does not kill securitization then it will just make it very costly. That cost will be transferred to borrowers and result in lower GDP growth," warns Batchvarov.
This CRD proposal feeds into the wider perception that the European regulator wants to see an end to off-balance-sheet treatment of any kind for securitized assets. The fact that banks could completely sell down the risk of loans they originated is at the heart of the entire sub-prime crisis as it is deemed the root cause of shoddy and negligent origination. This was certainly a contributory factor in the US sub-prime ABS CDO market failure, but securitizers in Europe feel that they are now being made to pay the price for problems in a US market with insufficient rules.
There is also a widespread belief that the EC has an agenda to punish the securitization market for what has happened over the past year. "Why is this [the CRD change] applicable just to securitization? If this is addressing weaknesses in the originate-to-distribute model then it should be applied to other assets classes as well – funds, private equity, loans, infrastructure. It is not fair to just apply it to ABS. It is punitive," complains Batchvarov.
One of the arguments that the industry has put forward to illustrate the ineffectiveness of the CRD proposal is that most originators in Europe hold on to the first-loss pieces of their securitizations, so it won’t make much difference.
However, many did not – and Northern Rock was widely lauded for its Whinstone Capital trades that involved it selling off residual loss pieces from its RMBS master trust deals. And the argument holds little sway with the regulator. "If most banks already hold on to the first-loss piece of their securitizations, as the industry is suggesting, then they should not have a problem with this proposal," points out one observer.
It is no surprise that the securitization market in Europe sees itself as being punished by over-zealous regulators for a problem that it did not create. And by restricting securitization to on-balance-sheet trades, funding options for European mortgage originators will be fewer and more costly. "If people think that the German Pfandbrief model is more valid than the securitization model, they should just look at what happened to the German banks," says Batchvarov.