IFR Securitisation Roundtable 2015

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

IFR: At some point quite soon the ECB is going to stop buying ABS. Given that – looking at the Covered Bond Purchase Programme versus the ABS Purchase Programme – there’s been a huge differential in what they’ve been buying, and of course we’ve all seen the impact it’s had on covered bonds sending it into negative territory in core markets. Traditional Pfandbrief investors in Germany are screaming blue murder because there’s no value and they’re actually quitting the asset class. There are different dynamics at play within the securitisation market, so just to put a wrap on the ABSPP, when it stops does anyone really care? Alex Batchvarov, Bank of America Merrill Lynch: In six months or so the total volume of purchases, I think, is €6.3bn or €6.4bn. Does it really matter? It’s a fraction of the market. Where it could have mattered significantly is if the ECB had initiated the ABS Purchase Programme to address retained transactions and priced them accordingly. You can’t want to buy a retained Triple A at 30bp over when that same Triple A with a 10% discount can be put through the TLTRO at 5bp over – actually, it’s 5bp flat not even 5bp over. There is a lot to be desired in terms of the ABS Purchase Programme. The issues I think that we are going to face going forward are twofold: ABS is a self-liquidating instrument, so even if the ECB decides to hold them over a few years, the €6bn will become €3bn, then €2bn, then zero. Covered bonds and the ECB are focusing on the five to seven-year maturity, and in a way it was meant to push out the maturity curve for covered bond issuance. You have to hold them for maybe three to five years, or you have to liquidate them. That is when it’s going to get very interesting in the covered bond market, because when is a big group of investors who are lost and frustrated going to come back? Actually, it’s much easier to come back to covered bonds as an investor than to come back to ABS. Simple regulation does not require you to set up any kind of specific framework to analyse them, and to tick boxes and prove you’ve done due diligence, which is the case for ABS. Once the relative value dynamics start changing, there will probably be investors. On the other hand, it may be a great idea: you sold to ECB at minus 15bp and you buy back at plus 10bp. Who knows who is going to take that loss? Scott Dickens, HSBC: We should be clear as well: these purchase programmes were supposed to be a short-term measure. They’re not the long-term solution. The key is to get the right regulatory framework and all of the right long-term structures in place to get a functioning market. In some ways it distorts the market; it’s been good for the secondary market trading desks. If I was going to focus on one thing, it would be the regulatory framework across banks, insurance companies, asset managers to make sure we encourage asset liability matching and make sure that these assets are going to those most able to hold them at the right price. IFR: We’ve mentioned it already but the other area I wanted to touch on very briefly is the US, which is going gangbusters. Pat, do you have any sense of why on earth the US market has recovered so quickly and it’s just so busy. Alex Batchvarov, Bank of America Merrill Lynch: The US needed the securitisation market. The US banks are a much smaller part of the economy, as I already stated, and so you have a lot of specialist lenders – the auto companies, the unsecured consumer lenders, equipment leasing companies etc that all fund themselves through the securitisation market. It was always very different than Europe in that way and so it was much easier to restart. The infrastructure was there and there was a bigger buyer base there. Here you had the SIV buyer base that went away. You always had more of a real-money buyer base in the US that bought ABS and that understands ABS. There’s a huge industry there so it was just much easier to come back. That being said, the regulators and

IFR: Welcome to IFR’s Securitisation Roundtable, which I’ve called “The Great European Securitisation Debate”. I wanted to touch on two broad areas: how the policy area is evolving in Europe and where the market is today in terms of where the flow is, touching also on the differentials between issuance in the US and Europe. Alex: what’s your read of the market in Europe today? Alex Batchvarov, Bank of America Merrill Lynch: The European securitisation market is gradually declining. We continue to see net negative supply as a result of low issuance and the amortisation of existing product. There are a few bright spots here and there, such as the revival of UK issuance, but we haven’t seen a significant pick-up in European issuance. In that respect the European Central Bank’s ABS Purchase Programme has not really initiated or prompted more supply in the European market. In terms of spreads, the market has contracted materially from last year and the year before, which is more related both to where other sectors are and limited supply. The relative attractiveness of the market remains; to a large degree that was enhanced by the distortions introduced by the ECB’s Purchase Programmes, which significantly compressed spreads on covered bonds. The next wave is compression of spreads of multinationals, agencies, and regional governments, leaving the European securitisation market behind with quite attractive spread levels. We are seeing some crossover with the US, where with the exception of private-label mortgages all sectors of the market have recovered and we are seeing very active developments. Pricing in the European securitisation market is influenced by where the US is because a large portion of the European buyers are US investors. It’s also influenced by dynamics within Europe hence driven by the ABS Purchase Programme, by all the other QE initiatives which the ECB has initiated. When we talk about spreads and issuance, we cannot forget that there are other funding sources and in that respect ABS in Europe is not the most advantageous funding source for banks. Actually, if you want to use ABS, you’ll probably use it for the TLTRO where you can get funding at 5bp and a very advantageous advance rate, and then fund the rest with deposits or other forms of a debt. From that perspective, we are probably not going to see material recovery in eurozone securitisation until some of these other funding sources – and the lack of a level playing field across funding instruments – are addressed. The main stumbling blocks continue to be the regulatory framework in Europe. IFR: Oldrich, what’s the key essence of this product? Is securitisation about funding or risk transfer? Oldrich Masek, JP Morgan: During the crisis: it was very focused on funding. To Alex’s point, I agree that you can never look at securitisation in isolation; the other markets just make it much more favourable as issuance forms. The one bright spot has been the re-introduction of risk transfer as seen in full capital structure securitisations, where you’re getting capital relief, real economic risk transfer and funding. That’s playing well into the wave of raw material disposal. If there’s any unique source of volume for the next 12 to 18 months, it’ll be the repackaging of portfolios that are becoming unstuck. IFR: The other point that Alex made is the fact that ABS spreads in look very tight but on a relative value basis they look quite attractive. Is that how people should look at this, Arun? Arun Sharma, Credit Suisse: In a perfectly functioning market that’s the way it would work but regulations around the capital investors have to hold and bank liquidity buffers prejudice ABS in the way that skews that equation towards covered bonds and away from even prime ABS products. We are in all honesty suffering from that. Clearly there have been some moves to level that playing field, but I think that in an ideal world they would go further. IFR: Scott, when you go to din

Andrew DennisAberdeen Asset ManagementAndrew Dennis is an investment manager in the EMEA credit team of Aberdeen Asset Management, which he joined following Aberdeen’s acquisition of SWIP in 2014. Prior to joining SWIP’s fixed-income team as a sector specialist in structured finance, he worked for UBS with responsibility for the development of the structured finance business, with roles across structured finance variously leading research, syndicate, trading and sales. He has also worked in DCM in roles in emerging and developed markets based in the UK and the US. Alexander BatchvarovBank of America Merrill LynchAlexander Batcharov heads international structured finance research at BofA Merrill Lynch, encompassing securitisation, residential and commercial real estate financing, property derivatives, covered bonds, CDOs and consumer credit in EMEA, APAC and LatAm. He has held this position since Oct 1998, and has also served as a head and a co-head of global mortgages and other structured finance between 2007 and 2010. Before joining Merrill Lynch in 1998, Batchvarov worked at Citibank and Moody’s in New York. Marjan van der WeijdenFitch RatingsMarjan van der Weijden is head of Fitch Ratings’ European structured finance group, responsible for assigning and monitoring credit ratings on ABS, RMBS, MBS and CDOs. She manages the London, Paris, Milan, Frankfurt and Madrid-based staff; oversees criteria, research and analytical development; and interacts with a variety of market participants, particularly investors. Before joining Fitch, she spent five years at Rabobank in various roles, and worked in the securitisation group in its London branch before joining Fitch in 1999. Scott DickensHSBCScott Dickens is global head of structured capital markets at HSBC, joining the bank in 2004. He is responsible for the origination, structuring and execution of infrastructure/project bonds, credit-linked, whole business, RMBS, ABS, CMBS, structured covered bonds and managed and balance sheet CLOs. He was recently appointed global co-head of the infrastructure finance group with responsibility for associated project and export finance, leveraged acquisition finance and DCM businesses. A 25-year market veteran, Dickens began his banking career as a project finance professional with Bank of America. Arun SharmaCredit SuisseArun Sharma is head of European residential mortgage asset finance at Credit Suisse. Before joining Credit Suisse in 2014 Sharma worked at Barclays Investment Bank, which he originally joined in 2005, latterly as head of FI ABS structuring. He has executed transactions in a wide range of asset classes across a variety of European jurisdictions. Patrick ConnorsDeutsche BankPatrick Connors is head of EU Asset Finance & Portfolios at Deutsche Bank. Before joining the team in London in 2008, Connors was on the Deutsche Bank securitisation team in New York.  Prior to that, he was with the Citigroup ABS team in New York. He has securitisation experience in a wide variety of asset classes and industries. Prior to business school, he spent four years with PricewaterhouseCoopers in Chicago. Oldrich MasekJP MorganOldrich Masek heads EMEA Securitised Products Origination for JP Morgan. He has been with the bank for 19 years, including four years in New York and the last 15 in London. During that period, he has held numerous leadership positions in structured finance and structured credit both globally and regionally. Prior to rejoining ESPG in 2010, Masek built and managed JP Morgan’s global structured solutions business. He has over 24 years of experience in corporate finance, structured finance and derivatives. Anna BrunettiReporter, IFR Keith MullinIFR Editor-at-Large, Moderator To see the digital version of this roundtable, please click here. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com