By Andrew Lennox, Lead Portfolio Manager at ECM Asset Management
As we have discussed regularly in our weekly pieces, many of the current proposals for the regulatory treatment of securitisation, whether it be for banks or insurance companies, are still informed by the dark days of the credit crisis when Asset Backed Securities (ABS) was widely, and largely erroneously in the case of Europe, held up as the cause of many of the problems in the financial system. Such overly negative views of securitisation have led to unreasonable treatment of the asset class in new and proposed regulations, in turn resulting in a stalling re-emergence of ABS. As can be seen from the table below from the Basel Committee’s December 2012 proposal, the capital charges that banks face are significantly higher than those in the current framework.
This past week alone, securitisation emerged poorly in the European Banking Authority’s draft report on Liquidity Coverage Ratio (LCR) which aims to address past issues of inadequate liquidity positions of banks. Whilst covered bonds are a clear winner, considered to have liquidity similar to that of government bonds, ABS scored 4.38 out of a possible 5 (1 being the best, 5 being the worst). The obvious outcome of such a score will be banks’ appetite for holding ABS will be curbed as far as the LCR is concerned.
However, in some respects, the tide appears to be turning and recent weeks provide some good examples of the steps being taken to place ABS back on a more level playing field versus other asset classes, and therefore provide hope that a more meaningful market will be allowed to return in the coming years. There have been strong indications coming from the Basel Committee that the risk weights will be revised down and the December 2012 proposal will likely not be implemented. We can expect are-worked proposal to emerge in the coming months.
Basel Committee – Revised Securitisation Framework
In addition, the lower haircuts for posting ABS as repo collateral with the European Central Bank, which were proposed in July, came into effect on 1st October. Eligible senior-ranking ABS with a single A or higher rating now receives a 10% haircut as opposed to 16% previously.BBB-rated bonds have gone to a 22% haircut, previously 26%-32%. Indeed, Mario Draghi picked up on this topic in his monthly press conference, taking the discussion over eligible collateral a step further, commenting: “We are certainly ready to consider accepting the mezzanine tranche of ABS as collateral…”
Whilst all of the above are moves in the right direction for the rebuild of the asset class, ABS industry participants are fully aware of how long it can take for such consultations and discussions to come to any conclusions and come into force. Until then, and so long as financial institutions are receiving cheap sources of funding from central banks, such as the Bank of England’s Funding for Lending Scheme, we continue to expect the ABS market to slowly reduce in overall size.