Recently, the ECB and the Bank of England published a joint paper calling for the return of securitization markets in Europe (see below). This goes completely against the grain of the latest Basel accord which has started imposing much higher capital requirements for holding securitized paper. The media called it “bringing back the toxic sludge” (see story). What’s going on here?
With the Eurozone banking system on its back (see post), someone else needs to provide corporate and consumer credit. The central banks want to see the securities markets (shadow banking) take on that role. Some are outraged because securitized products are viewed to be one of the key causes of the financial crisis. However this is the case of “throwing out the baby with the bath water”. It was a specific asset class, namely US subprime mortgages, that did most of the damage. But the media and many regulators have been applying the term “toxic” to all securitized credit.
ECB/BOE: – Despite the low issuance and the modest take-up by investors, most European structured finance products performed well throughout the financial crisis, with low default rates. According to an analysis by Standard & Poor’s, the cumulative default rate on European structured finance assets from the beginning of the financial downturn, July 2007, until Q3 2013 has been 1.5%. Some asset classes such as consumer finance ABS, SME Collateralised Loan Obligations and RMBS have experienced default rates well below this average and the performance of European structured finance products has also been substantially better than US peers.2 By way of comparison, ABS on US loans experienced default rates of 18.4% over the same period, including subprime loans.
The goal here is to get investor capital to the borrower without materially expanding the balance sheets of EU commercial banks (who are undergoing deleveraging). One of the obstacles to growing this business in Europe (and to some extent in the US) is the so-called Risk Retention Rule which was implemented in 2011. It requires that the structured bond issuer retains some “skin in the game” by buying a part of the origination (usually part of the most junior tranche). It’s less of a problem for bank issuers, but creates barriers for independent managers who are not well capitalized. And since the ECB wants non-bank issuers to step up, this rule will cause some difficulties. Given the declines over the past few years in European ABS and other securitized credit product issuance, it will be a while before private securitization can materially supplement bank credit.
Enjoy:
THE IMPAIRED EU SECURITISATION MARKET
