More favourable capital treatment alone will not fix Europe’s ABS problem
New origination to provide private-sector assets for QE will only result from further regulatory clarity
The ECB’s desperate push to jumpstart European securitization in advance of any potential future private-market quantitative easing (QE) will be taken to the IMF spring meetings this weekend, when the eurozone’s central bank, together with the Bank of England, will argue for more lenient capital treatment for high-quality ABS.
Many detect a growing urgency in the ECB’s strident commentary. “What is key is that action is taken soon,” Yves Mersch, member of the executive board of the ECB, insisted in a recent speech in the City of London.
“Investors will not simply grin and bear higher risk weights – they will simply put their money elsewhere, and fund growth in other asset classes where investment may not be, from a macroeconomic perspective, as desirable.”
There is a strong sense that the central bank’s enthusiasm for a revived ABS market has a lot to do with its need for sufficient private-sector assets to be generated in Europe in advance of any potential private-market programme of QE.
|Yves Mersch, member
of the executive board
of the ECB
Mersch was understandably at pains to dampen such speculation after his speech. “QE is a theoretical concept,” he said. “There is a long way between theoretical agreement and implementation, and there is also conventional room for movement. “We need a plan B for a fat tail event and we should have a much shorter time lag between an event and response than if nothing had been announced – that was the purpose of the announcement. We are not only preparing for unconventional measures to address a tail risk. But conventional measures are intact too.”
The central banks are well aware they face a tight deadline in reviving European securitization given the steady evaporation of the European ABS investor base since 2007.
“The pressure to resolve these issues around capital treatment is baked in with the phase-in of CRD IV and the expectation that the leverage ratio will go up,” notes one industry expert.
“I am optimistic, but the jeopardy is that in the interim the market decommissions. It is not easy or inexpensive to maintain the infrastructure needed to invest in ABS and the outstanding stock of ABS is running off at an alarming rate. If by the end of next year there isn’t visible evidence that the run-off is going to be replaced, a number of investors will simply say that this market is too small for me to care about.”
However, simply defining low-risk and high-risk instruments and attaching different risk weightings to the two will not be enough on its own to entice banks back to the ABS origination table. Regulators need to be under no illusions as to what drives banks to issue.
While having securitization as another funding tool is helpful, it is never going to be cheaper than a covered bond, and it is barely going to be cheaper than senior unsecured – and the latter will qualify as resolvable debt under the European Bank Recovery and Resolution Directive (RRD) where ABS will not.
“Unless ABS funding becomes cheaper than other forms of secured and unsecured funding – which is not particularly likely – bank enthusiasm for ABS issuance will only increase if securitization becomes an efficient source of capital and leverage relief,” says Allen Appen, head of FIG DCM, EMEA at Barclays.
“With enactment of the RRD and looming requirements for European banks to maintain stocks of bail-in debt, the utility of securitization is diminished for no more complex reason than that it is not eligible to be bailed in.”
What will drive securitization issuance in Europe is, therefore, relatively straightforward. It is what it has always been – off-balance sheet treatment.
“For the securitization market to have a bright future, it must be possible for banks to use the market as a means of transferring asset performance risk so that applicable assets can be removed from the regulatory balance sheet,” says Allen. “Current regulation does not preclude asset de-recognition, but neither is it particularly apparent how to complete a transaction that would achieve this result.”
One challenge is meeting the strict true-sale eligibility criteria for high-quality issuance. Old-style triple-A securitization relied on step and call maturity shortening mechanisms to make itself attractive to investors.
However, a transaction now looking to qualify as a deconsolidating asset cannot use this approach as it calls into question whether a true sale has actually taken place.
To qualify they will now likely have to be structured as pass-through securities to maturity – say, to year 12. And the likelihood of the regulators regarding a pass-through security with a 12-year payment window as a sufficiently liquid asset for the LCR is surely far from certain.
Thus, while making old-style ABS liquidity eligible could help to drive spreads in, it will not necessarily achieve the desired policy outcome of increased issuance.
While all these developments are clearly positive for the industry, there is still a long way to go before ABS becomes the engine of credit that the regulators finally realize it can be.
“If it becomes clear that the necessary capital required to sustain expanded asset origination can be sourced from capital markets, banks are likely to originate assets more expansively,” says Barclays’ Appen.
“Notwithstanding the fact that existing regulation provides for asset de-recognition through securitization, before banks engage in this activity on a large scale, they must be convinced that regulators are indeed supportive of this outcome.”