Given how long the securitization market had been lobbying for some form of ABS to be eligible for the liquidity coverage ratio (LCR, the recent announcement by the regulators that this was to be the case has drawn a fairly muted response. On the evening of Sunday January 6 the Basle Committee announced that its definition of high-quality liquid assets had now been divided in two – an upper tier of sovereigns, central banks and public-sector enterprises deemed 2A securities and a new category of 2B securities that includes certain residential mortgage-backed securities rated double-A or higher at a 25% haircut. These 2B securities cannot account for more than 15% of total high-quality liquid assets.
Before this the most recent pronouncement by the Basle Committee on the industry had been the revisions to the Securitization Framework in mid-December. This announcement detailed two revised approaches to calculating securitization capital charges that will remove the reliance on external ratings. Both will result in higher risk weights and capital charges across the board for securitization positions held by banks – with junior tranches particularly hard hit.
Regulatory schizophrenia
According to JPMorgan, a generic five-year triple-A RMBS would see its risk weight rise from 7% to 58% under the new proposals. Although the assessment of liquidity eligibility and capital weightings are clearly very separate things the industry could be forgiven for a fair amount of bemusement as to whether the Basle Committee thinks that securitization is now a safe and liquid asset class or not. “It is simply schizophrenic to increase risk weightings on securitizations in the same month as deeming parts of the asset class of sufficiently high quality and liquid enough to be included in liquidity buffers,” declares one exasperated ABS banker.
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| Stefan Ingves, chair of the Basel Committee |
The changes to the LCR are, nevertheless, critical to the survival of securitization in Europe and have been a rare piece of good news for an industry that has at times seemed to be held responsible by the regulators for all of the financial sector’s ills since 2007. “This feels like two steps forward and one step back,” says David Covey, head of European ABS strategy at Nomura in London. “LCR inclusion is a big deal and a very positive development – bank demand for ABS might have shrivelled up otherwise.” The industry had lobbied furiously for triple-A securitizations to be eligible for liquidity buffers – even initiating a kitemark scheme, the prime collateralized securities (PCS) scheme, in order to make it easier for regulators to spot high-quality bonds. It is, however, illuminating to note that there was no mention of the PCS in the Basle Committee’s January announcement.
Diversifying liquidity buffers
The market will now be boosted not only by banks that had previously ceased buying RMBS returning to the market but also by others that are keen to diversify the make-up of the liquidity buffers that they have already built up.
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| Allen Appen, head of financing solutions, Barclays |
“There is likely to be a reduced need for banks to issue term debt as the pressure to expand liquidity buffers has diminished, and this will suppress supply of ABS and covered bonds,” says Allen Appen, head of financing solutions at Barclays in London. “Banks that have already expanded and perhaps over-built buffers through programmatic issuance of term debt and deposited proceeds with central banks and/or invested in lower-yielding sovereign and supranational obligations in compliance with previously applicable asset eligibility criteria, will seek to swap into the now expanded range of higher-yielding Level 2 assets, including ABS. The amounts involved are material and this additional demand for ABS has the potential to drive spreads tighter still.” There was little immediate sign of movement in RMBS spreads on the news, however. “I would not have expected a major move in market prices on this announcement,” says Covey. “Given how well bid the market is now, it is hard to say that the recent tightening is due to the news about LCR eligibility – the market may simply be catching up with the rally from December in other assets. The effect on the market should be considerable, but more in the long run.”
He adds that the decision had also been well flagged. “The potential for some ABS to be included became more apparent in March last year when the ECB became more vocal in its advisory role on CRD IV, and on the liquidity rules specifically,” he says. “Their involvement seems to have been a major catalyst for change.”
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| Triple-A RMBS spreads in Europe. Source; Markit |
Appen is quick to emphasize that developments around the LCR do little to address the European securitization market’s biggest problem – lack of supply. “The changes that are now effectively in place will provide a significant boost to the market but there is unlikely to be a sudden and material increase in issuance,” he says. “There will be continued distortion from too little supply relative to demand until there is a coordinated and sustained withdrawal of official liquidity.”
Pet hates
Now that its primary goal has been achieved – even if only in part – the European securitization industry will likely turn its lobbying firepower on the Securitization Framework risk-weighting proposals in an attempt to get them watered down. “The risk-weighting issue will attract withering resistance,” says one banker. “It feels like a punitive attempt to lash out at two of the regulators’ pet hates – ABS and the rating agencies. But there is an increasing awareness that constant meddling in the banking system with a very obvious political agenda is not helpful.”
