Toxic, tainted and demonic: the securitisation market is still reeling from the labels attached to it at the height of the 2007-08 subprime crisis.
But while the unravelling of the bundles of bad debt that were issued at the heart of that crisis continues to be felt, certain parts of the European securitisation market are tempting investors back.
Demand for European residential mortgage-backed securities, household mortgage loans that are packaged together as securities and then sold on to investors, has been steadily growing in the secondary market, with US and more recently Asian buyers attracted to the debt instruments.
Allen Appen, head of European financing solutions at Barclays Capital, says it has taken time for the stigma attached to many European securitisation deals since the financial crisis to recede and for investors to realise that mortgage loans from Dutch and British markets have in some cases performed better than other funding instruments.
While some European investors have been unwilling to return to the European RMBS market, a few large US banks, some of which were active before the crisis, “are now hugely acquisitive and driving the secondary market,” Mr Appen says. More recently there has been interest from large Japanese banks.
The scale of US investor appetite can be seen in the frequency and size of dollar tranches in the new issue market, says Gareth Davies, head of European asset-backed securities and covered bond research at JPMorgan. Relative to US securitised products, the UK and Dutch markets offer more attractive value for investors, he says.
A three-year UK, dollar-denominated RMBS transaction would print at about 140 basis points over Libor, the benchmark interbank borrowing rate, compared with its nearest US equivalent credit card-backed securities trading at nearer 14bp. In the US, some of the securities at the heart of the financial crisis – bonds backed by home loans struck during the boom years of the past decade – have rallied sharply this year. Amid rising hopes for US economic recovery, they have benefited from investors’ voracious appetite for yield while official benchmark rates remain very low.
But growth of the European securitisation market, and RMBS in particular, is still heavily constrained. Proponents argue that regulators have “tarred all securitisation products with the same brush”. They say the problems coming out of the US crisis related to bad loans and not to the products themselves.
Recent regulations, moreover, have encouraged banks to hold more covered bonds, a form of ultra-safe debt backed by mortgages or public-sector loans as well as guarantees from the issuer. Covered bondholders are expected to get more favourable treatment, ranking more highly than other creditors should a bank collapse, under so-called “bail-in” rules.
Rick Watson, head of capital markets at the Association for Financial Markets in Europe, says regulation such as Solvency II also disincentivises insurers to buy any securitised products due to accompanying punitive charges. He says there continues to be “a misunderstanding about the differences between various securitisation products and the risks they carry”.
Work is under way on a labelling scheme that would help investors identify the highest-quality securitisation products.
Rebranding efforts aside, there are more fundamental issues. The eurozone sovereign debt crisis threatened to bring the region’s banking system to its knees in the second half of last year, with many banks facing severe liquidity issues and unable to raise funds in the public markets.
Since December, the European Central Bank has injected more than €1tn into the banking system. The move helped avert a liquidity crisis, triggered a market rally and helped to open up the public debt markets for covered bonds and senior unsecured debt for some banks.
The ECB’s offer of cheap, three-year money under its longer-term refinancing operations also allowed banks to refinance maturing debt. But with hundreds of European banks loaded up on cheap ECB money, the problem now is that there is not enough supply of either covered bonds, senior unsecured debt or securitisation products to meet demand from cash-rich investors.
Peter Nowell, head of ABS trading at BNP Paribas, says that banks in places such as Germany and France are able to use securitisation but are choosing not to because they can tap cheaper sources of funding. For many banks in Spain and Italy, meanwhile, securitisation remains too expensive and they would rather use their loans portfolio as collateral to tap the cheaper ECB money.
In the short term, the LTRO and the way regulation is governing how banks operate means 2012 is likely to see steady, but not an explosive, level of RMBS issuance.
Andrew South, senior credit analyst at Standard & Poor’s, says that from a ratings and credit performance perspective, certain classes of European ABS have held up well since the 2007-08 crisis, with relatively few defaults. But he is cautious about the securitisation market this year. “With so much ECB funding available, how many eurozone banks will actually have an incentive to use securitisation in the short term?” he asks.
(Additional reporting by Nicole Bullock in New York)
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