IFR Securitisation Roundtable 2015: Part 3
IFR: It works for the covered bond market, right? So you’ve got the Pfandbrief Act in Germany and we all remember the controversy when Commerzbank did an SME pass-through that they weren’t allowed to call a ‘Pfandbrief’ so it ended up being called a ‘structured covered bond’. It would appear to me that’s potentially what policymakers are looking to replicate with securitisation.
Oldrich Masek, JP Morgan: I think that’s the difficulty with the nomenclature of ‘high quality’. It’s such a subjective interpretation. That’s going back to basics of: “this bond is triple A, so it must be good; I’m not going to lose any money, right?” I think we have to be quite careful about that.
I think the covered bond analogy is a very good one, where there is this market sense and broad belief that you will not lose a penny in covered bonds. As we move into conditional pass-through covered bonds, you’re getting much more into asset risk.
You don’t have the same disclosure requirements. Chatting with investors where they look at covered bonds versus ABS, it’s just a completely different paradigm in terms of the level of diligence. I think this comes back to the point of some markets are just fostered, and branded, and made to feel better.
Alex Batchvarov, Bank of America Merrill Lynch: And bailed out when necessary.
Oldrich Masek, JP Morgan: Yes, bailed out, bailed out when necessary. So, I think there is a negative to the concept of high quality. Yes, it brings it back into that realm of everything’s great, but there are different risks and you don’t want people just to rely on that nomenclature.
IFR: They’re also excluding short-term assets from the label.
Alex Batchvarov, Bank of America Merrill Lynch: My understanding is that there is an effort in the regulatory community to restore the multi-seller conduit ABCP, and it is fair to say that to a large degree multi-seller conduits actually fund SMEs. They have a relatively short, small-duration mismatch of assets and liabilities, and it’s probably a good, well-functioning market.
We shouldn’t have destroyed it in Europe, but I think there is an effort to restore it. I doubt it will be as part of STS (Simple Transparent & Standardised); it’s probably a parallel. The concern many market participants have is that STS securitisation was not properly replicated in Type 1 and other securitisation treatment under Solvency 2; that for me was the biggest disaster.
It wasn’t a disaster that some asset classes were not in Type 1; the disaster was that the differential between Type 1 and Type 2 was enormous. The second disaster was that there was no reference of Type 2 assets to the underlying credit, so you end up having a regulatory capital requirement for a senior tranche of Type 2 securitisation that is a multiple of the capital for the underlying portfolio; these are things that don’t make sense.
Generally everybody I’ve spoken with says STS is a good idea, but of course it depends how it’s implemented. When it comes to the base elements, simple structure, transparency, some form of standardisation and disclosure, that’s probably fine; I don’t think anybody will have a problem with that.
Things become much more complicated the moment you start putting in qualifying credit criteria for high-quality securitisation. We know very well that big chunks of the SME markets performed very poorly so what credit criteria would you put?
At the same time, we know that the majority of the leveraged loan market performs very well, but it’s totally excluded. Where do you draw the line for SMEs? How do you differentiate between your quality criteria for RMBS-qualifying STS and quality criteria for covered bonds? If you put everything at 80% LTV, you end up with cannibalisation of products, given that the comparable regulatory treatment is not there.
The final point I want to make is that there is, in my view, a good focus on disclosure but to some degree that focus is misguided because it’s only for securitisation. That disclosure has to be for everything. I don’t know how anybody can argue that you can price and analyse a CoCo but you cannot analyse a securitisation.
Secondly, disclosure isn’t coming from the securitisation pool; disclosure is coming from the bank. We all know that the European Data Warehouse is doing a great job but they’ve had a very hard time getting that standardisation, equalisation, and consistency of disclosure and so on.
The regulators need to focus on harmonisation, standardisation, and disclosure for the banks and on a broad level across the system, and that will naturally flow into the same aspects of disclosure for securitisation, but you cannot want one thing and not have the other.
If we don’t have a standard definition of delinquency across the banking system, we cannot replicate it in securitisation across Europe, so the data availability and all these kinds of issues are a bit misguided.
The final point here is related to how we set up the capital. What happened in the last few years? The rating agencies tightened the criteria, the attachment points increased, the thickness of the tranches increased. We made these things safer, but at the same time the regulatory capital went up across the board, so we have a double whammy.
What happened in the covered bond space? The exact opposite: we allowed for double counting of support, so we have a Triple A covered bond, which has half the regulatory capital for a Triple A bank, but that’s not the senior secured obligation of a Single A bank; that’s a senior secured obligation of a single-A bank, so we are actually having multiple benefits.
We do not have the same level of requirements; we do not have the same level of due diligence requirements, and the rating agencies in many respects had to relax their rating criteria for covered bonds by the introduction of these multiple obligations of the banks.
Not to mention the complexity now we have across rating agencies in terms of covered bond rating methodologies, which I dare say are not widely understood in the market and the structures are not widely understood in the market.
We need to take into account all these aspects when we are talking about how we calibrate high-quality securitisation or STS securitisation capital and how we calibrate the capital for the non-STS securitisation. As Arun mentioned, we don’t want to create this massive cliff which Solvency II created.
Marjan van der Weijden, Fitch Ratings: There are a couple of things I want to highlight. An interesting observation is when Alex said: “rating agency criteria look for more credit enhancement”. We actually looked at it and it’s true credit enhancement has gone up, but it’s not necessarily always driven by the rating agencies; it’s often also been driven by investor demand.
That’s a nuance there. The discussion on transparency and the availability of loan-level data and what to do with that is dear to my heart. Being at a rating agency, we constantly try to get as much data as possible, but I often say to the team: “keep it simple; don’t look at everything in the greatest detail if it doesn’t really make a difference because you lose the bigger perspective because the risk might be somewhere else.”
I think, undoubtedly, that the availability of loan-level data in a better-quality format, which is still work in progress, and more standardisation in terms of ongoing investor reporting is a good step forward. I think it’s where Europe definitely was lagging the US. I don’t think it’s necessarily the biggest driver in understanding the product, but I think it’s going to help the secondary market and liquidity of the product, because it’s better and we are better able to compare.
I don’t think that standardisation of definitions is going to be achieved on all fronts; we simply have too many jurisdictional differences so I think we need to be realistic about what’s achievable there but we can certainly make more effort to explain exactly what each definition means.
If it is different, then at least make sure the difference is understood. There’s also a role for us as rating agencies. We need to explain a lot; we need to make sure we explain it in simple terms, maybe lose some of the acronyms. We need to go back to basic concepts.
IFR: Who should bear the burden of providing the STS label? The ECB and Bank of England have proposed that that should come from self-certification. Do you think that could be a helpful way to do it, or do you think that that will recreate the risk that we saw before the crisis?
Alex Batchvarov, Bank of America Merrill Lynch: When we talk to investors, generally their view is that the self-certification route may not work, so you need another party to provide the compliance stamp. But things get very complicated once you go beyond the simple, transparent, and standard criteria, once you get into credit criteria.
For example, one of the requirements is that the bank does not change its underwriting practices. Who can give a certification that the bank has not changed the practices? And how? Then you have another set of issues that you have to report a level of detail which you don’t report anywhere else, so how many mortgages are on payment holiday, how many of the repossessions were done on an agreed basis and how many of them were forced, etc?
Who is going to provide the certification? You suddenly fall back into the situation of rep and warranties because nobody else can do it. Do I have rep and warranties from the originator? Yes. Is this the end result? This reminds me of the rep and warranties that a covered bond has perfect asset liability management.
That’s a question about how this whole process is going to evolve. I think we’re ending up in a situation where we are replicating the work done by the rating agencies, by legal counsel, potentially the auditors, the accountants and so on. I’m not sure how they’re going to bring this together, but there seems to be a direction of travel. The European Commission recently said it – they do not want self-certification; they want third-party certification.
PCS maybe one of the entities or some form of transformed PCS structure to provide that but I am really concerned that we are going to get into a situation where we’re putting yet another entity which certifies what other entities have done. Where is that going?
IFR: Moving to our conclusion, three years from now, what would you like to see happen? What do you expect to happen and how does the European securitisation market look in three years’ time?
Andrew Dennis, Aberdeen Asset Management: Hopefully, in three years’ time we’ll have finished talking about regulation. In three years’ time, if we get sent 20 RFPs from pension consultants saying: “how do you deal with European ABS in this portfolio?” and it achieves a position as a mainstream asset class alongside high-yield, emerging markets, and convertibles, then I think we, as an industry will have gone a long way towards rehabilitating ourselves and being seen as a proper bond market, not just a sort of weird bunch of technicians running round with whiteboards and boxes and arrows.
Oldrich Masek, JP Morgan: What I’d like to see is the regulation resolve so that the policy debate moves up a notch to the real practical issues that Europe is facing: demographics and the other things we mentioned. There is a bit to learn, because a lot of our regulations are designed around the banking system.
Securitisation is the one tool that can actually take a lot of raw-material generation into the specialty finance sector so that they can lend. Banks are 30%-40% smaller than they were at the beginning of the crisis, so securitisation is the one way these new start-up engines of lending and enterprise growth can actually fund themselves and create real long-term value for the economy, as well as the industry.
Arun Sharma, Credit Suisse: I’d like to see a consistent and stable set of regulations. It obviously will be imperfect because everything is imperfect but I think a stable and consistent set of regulations will allow us all to grow the market in our respective ways, to talk to people – whether it’s pension consultants or bank issuers – to figure out how the securitisation market can benefit them mutually and grow the market to a more sustainable base.
Alex Batchvarov, Bank of America Merrill Lynch: I hope that what you’ve seen in the UK market this year you see more broadly across Europe, where it’s a healthy mix of bank issuance and non-bank issuance in the securitisation market.
I hope that we start seeing some new asset classes that we see in the US, like middle-market CLOs and other things develop to take the place of the banks deleveraging, and that you have this new pocket of money out there that is willing to invest and support the SME market, the middle-market loan market, maybe the auto lending market, other things in non-bank format. I hope the regulation gets to somewhere reasonable.
Alex Batchvarov, Bank of America Merrill Lynch: I hope that by September we get a comprehensive document from the European Commission about securitisation within the context of Capital Markets Union. I hope that by that time there is a review initiated on the treatment of covered bonds and other sectors comparable to securitisation, and that that whole regulatory framework is finally put in place in terms of a level playing field by the middle of 2016, which actually coincides more or less with the end of the purchase programmes by the ECB.
And then securitisation gradually takes its place as a funding and risk transfer instrument in the context of bank and non-bank funding in Europe and grows gradually into 2017 and 2018 as an integral part of the capital markets in Europe.
Scott Dickens, HSBC: I would echo that. I would like to hope that in three years we’ll be operating on a level playing field, and we can really see the benefits of securitisation as a funding and risk transfer tool, and there won’t be any impediments or bias against the product. I think that’s achievable.
There’s a lot of work to do, but I think that’s hopefully the aim of the industry and should be the aim of politicians and regulators, because it certainly has a role to play in the economy.
Marjan van der Weijden, Fitch Ratings: I hope that the European economies have recovered to an extent that we see good generation of real-economy assets, because that’s the basis of where we grow from. I would hope that cheap central bank money is no longer necessary to the same extent, or at least is not so widely available, and I would certainly echo the level playing field between securitisation and other funding instruments.
If these three things come together, then I think we have a good chance of being in a better position in three years’ time.
IFR: I salute your collective optimism. Let me close the session and thank you all for some very insightful comments.