Robin Hood Finance Blog2010-03-10T09:27:35ZRichard SeniorCopyright 2010, Richard SeniorSPHPBLOG"European Banks Need To Raise €240bn A Year" • the central banks continue to tighten their criteria for repo lending. The Bank of England has declined to renew its Special Liquidity Scheme (SLS). £287bn of collateral, mostly mortgage-related, was posted and £185bn of funding provided. According to Deutsche Bank, [says Euromoney], SLS swaps [i.e.repos] will begin coming due in earnest in June 2011, with between £10bn and £25bn of maturities each month until January, 2012.
• The Council of Mortgage Lenders has warned of a “huge funding gap”.
• Governments themselves have huge borrowing needs. The UK’s £198bn of Gilts issued in the last year neatly matched the amount bought by the Bank of England using money it created out of thin air under “quantitative easing”. Next year’s government borrowings will have to be funded by real buyers!
• Banks are under pressure from regulators in respect of liquidity matching.
Given all of this, it is reasonable to state that securitisation will have a significant role to play in terms of the banks and indeed the mortgage markets. And that there will be some excellent buying opportunities for those investors sated with Gilts. So long, that is, as the buyers have the expertise to meet the requirements of the Capital Requirements Directive (see Feb 8 2010 blog entry). ]]>http://www.robinhoodfinance.com/blog/index.php?entry=entry100301-1435182010-03-01T00:00:00Z2010-03-01T00:00:00ZCRD, 5%, and One Night Stands In the context of securitisation, it is currently being used to describe the EU’s Capital Requirements Directive (CRD), and its requirement that originators of securitisation deals retain at least 5% of the risk. The idea is that banks in the bad old days (up to mid-2007) were building or buying up assets and flogging them off in tranches to naive and unsuspecting investors, then doing it again, rather like a series of one night stands.
That this analysis is superficial in many ways need not concern us here. The new rules come in on 1-1-11, so we need to know what they are and what they mean.
The first point is that originators have to retain 5%. Which 5%? There are two basic variants: the first loss (equity tranche), and three variants of a vertical slice. This is where the originator shares pro rata with the investors. Common sense tells us that it’s better to share the losses than take the first hit, and recent analysis by Fitch puts some numbers on this. The extra capital charge on a vertical slice can be as low as 9bp, and in most cases significantly below 1%. The question arises as to whether an originator could actually sell 95% of an equity piece, but even then the additional equity requirement would not normally be onerous.
So will this kill the market? Unlikely, since the benefits of term funding and asset/liability matching are still there. And investors will be looking for highly-rated assets with a decent yield.
The other main requirement in the CRD states that bank investors must perform thorough due diligence and stress tests, both up front and continuing. And convince the regulator that these have been performed properly by competent people. Otherwise the investor gets hit with an additional capital charge.
Some banks already have such a capacity. Many do not. Those that get in competent people, either as employees or outsourced, will have a distinct advantage come 2011. They would be well advised to start the process now. ]]>http://www.robinhoodfinance.com/blog/index.php?entry=entry100208-1102012010-02-08T00:00:00Z2010-02-08T00:00:00ZABS vs Gilts Nine months ago you could buy really solid AAA UK RMBS at between 60-70% of face value. I and some others pointed out this outstanding buy opportunity at the time. Now the price is 90-100. Has the buying opportunity gone, or is there still value to be had?
An institution such as an insurance company or pension fund which invests in fixed income could be expected to have put a lot of money into Gilts or other sovereign bonds in the last couple of years. The income might be poor, but you couldn't be blamed/fired for being risk averse. But there are now good reasons to look again at ABS:
-Sovereign risk. Taking Ireland as an example, Fitch rates the sovereign at AA-. But you can buy Irish ABS which is still AAA, three notches higher. (Sovereign risk is not the same as country risk). The UK could well be downgraded in the medium term. ABS offers a good yield at a higher rating than many governments are or might be.
-Rating stability. Yes, in spite of what sensationalist journalists might write, Standard and Poor's points out "between mid-2007 and the third quarter of [2009], more than 98% of our 'AAA' ratings outstanding on European residential mortgage-backed securities (RMBS) and consumer asset-backed securities (ABS) remained AAA".
-Risk diversification. What it says on the tin.
-Quantity of sovereign debt. A lot of governments have an awful lot of money to raise. This might impact on the price of sovereign bonds currently held.
We are recommending to institutional investors that they look carefully at the benefits of investing a proportion of their money in ABS. This obviously involves having a thorough knowledge of ABS to find the right bonds, and avoid the wrong ones. Which is where we come in.]]>http://www.robinhoodfinance.com/blog/index.php?entry=entry100114-1059182010-01-14T00:00:00Z2010-01-14T00:00:00ZKeynes and Liquidity But what is liquidity? The ability to sell for cash at any time? For there to be real liquidity, there has to be a real buyer at the end of the chain, not just pass-the-parcel traders.
Keynes was characteristically cutting about this in the General Theory, now over 70 years old: "Of the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of “liquid” securities. It forgets that there is no such thing as liquidity of investment for the community as a whole."
Don't we have central banks as lenders of the last resort? The Bank of England lent £61.6bn to RBS and HBOS at the height of the crisis. This could not have been avoided by forcing these banks to put more gilts in their balance sheets. Mind you, central bank intervention doesn't help to bale out governments issuing vast quantities of debt. Printing money and buying gilts, plus forcing banks to buy more than they would otherwise buy, does.]]>http://www.robinhoodfinance.com/blog/index.php?entry=entry091217-0947462009-12-17T00:00:00Z2009-12-17T00:00:00ZConsultants vs Employees Seen from where I sit the answer is simple-get in the consultants!
Here's why: -We have loads of experience. My colleagues and I have all personally structured many deals, and run departments in big banks; -We just get paid for our time, and don't have any claim on the bonus pool; -We're not part of the headcount, so easier to bring in as & when required to get a specific job done; -We're not part of the hierarchy, so do not get involved in office politics; we're just there to make things happen.
]]>http://www.robinhoodfinance.com/blog/index.php?entry=entry091201-0816512009-12-01T00:00:00Z2009-12-01T00:00:00ZBarclays Protium-One Way To Deal With Toxic Assets Barclays sold $12.3bn of assets to a new, unrelated entity in the Cayman Islands. Not only did they transfer the assets, they also lent the majority (but importantly not all!) of the funds to purchase them, and transferred the staff to run them, effectively creating a new fund management entity.
Chris Lucas, the Barclays FD, is on record as saying that they weren't trying to change their risk profile. So why did they do it? Step forward our old adversary "Fair Value Accounting". If they left the assets on the trading book, there is a fair chance of taking a big hit if market prices fall. If they put them into banking book, they are to some extent protected from the vagaries of "Fair Value", but can't sell as freely as if they were on the trading book.
The Protium deal should mean that the bank is protected from the whims of "Fair Value", but the assets can still be freely managed. And the bank gets a predictable income stream over 10 years.
What about other banks? This type of approach could make sense to anyone who has toxic assets. We're already in discussions with one.]]>http://www.robinhoodfinance.com/blog/index.php?entry=entry091109-1755452009-11-09T00:00:00Z2009-11-09T00:00:00ZSecured Commercial Paper Facility The BoE has announced that the number of firms benefiting from the SCPF to date is-nil. Zero. Not a single one.
Why is this? One reason may be that the original concept was fairly academic. It wanted to fund via commercial paper conduits, presumably because they are already there. But conduits can fund themselves cheaply by issuing in US dollars and swapping via the spot-forward market anyway. The BoE also insists on a rating. But getting ratings on small pools of receivables is labour intensive. So why wouldn't an arranging bank just stick with bigger customers. Which is what has happened to date.
So the poor old MMCs miss out again. The next initiative is supply chain finance. There's a lot more mileage here, but there are still inherent problems: -Big banks aren't lending as much as they should, or indeed promised. Why would they lend any more under SCF? -Everyone's simplistic illustration is a small customer selling to, say, Tesco. Under SCF the supplier gets paid up front, and the "lender" collects from Tesco in e.g. 90 days. That gives everyone a rating to cling to. But the real requirement is MMC to MMC business, where there isn't a rating. -So we need some credit insurance. But credit insurers also only want the best risks. So the unloved MMCs are left grovelling to the banks.
Incidentally, I'm constantly amazed how many capital markets firms assert that they don't rely on ratings, do their own credit work etc etc-but actually cling to ratings like a toddler to its security blanket.
What we need is either a trade receivables-type rating approach-the credit enhancement comes from the discount on purchase, not a third party-or an insurer to enter the market and grasp this opportunity in the same way as ACE and XL did some years ago in a different insurance sector when reinsurers were running scared.]]>http://www.robinhoodfinance.com/blog/index.php?entry=entry091028-1658132009-10-28T00:00:00Z2009-10-28T00:00:00ZAsset Protection Scheme-Dead in the Water? The APS was announced in the dark days of January, and was a good idea at the time. It proposed insuring hundreds of billions of "toxic" assets on the balance sheets of RBS and Lloyds (well, the bit over a 10% first loss to be taken by the banks)in return for large fees payable to HM Govt and making large lending commitments-£9b of mortgage lending an £16b of business lending in the case of RBS. Most reports state that the latter condition has been reneged on.
The world looks very different now compared to January. 3 month Libor indicates how well bank funding is working. It was then Base+75bp; it is now Base+6bp. AAA asset backed bonds have gone from 60-ish to 90-ish. Other banks have found market-driven solutions, such as Barclays' Protium, where $12.3bn of assets have been hived off into a separate asset management company. Several other banks are said to be looking at this approach.
The APS, ironically, has probably done its job by the very fact of being announced. Time to move on.]]>http://www.robinhoodfinance.com/blog/index.php?entry=entry091014-1051282009-10-14T00:00:00Z2009-10-14T00:00:00ZFSA Liquidity Rules: How ABS Can Help The FSA specifically mentions government bonds as a desirable asset to hold. This no doubt suits this government and its successor.
The problem for banks is that these are the lowest-yielding assets. So in order to make a loan, a bank has to borrow not only enough money to fund the loan, but also borrow some more to buy govt bonds. The downside is of course that the income from the lovely liquid assets is lower than the cost of funding, so the bank loses a spread-which it presumably passes on to its borrowers in the form of higher margins.
The FT estimates that UK banks will have to "increase their holdings of cash and government bonds by £110bn and cut their reliance on short-term funding by 20 per cent in the first year alone".
ABS of course involves the issuance of debt which is as long as the underlying assets, so there is no asset/liability mismatch and no reliance on short-term funding. Expect an increase in issuance once the real cost of the new liquidity rules has become clear to banks.]]>http://www.robinhoodfinance.com/blog/index.php?entry=entry091008-0955452009-10-08T00:00:00Z2009-10-08T00:00:00ZHybrid Bank Capital Scratch that same surface, however, and big problems are apparent:
*The Bank for International Settlements (BIS) issued a press release last month in which they state "The predominant form of Tier 1 capital must be common shares and retained earnings". You can't get much clearer than that. As Euroweek put it, the BIS's statement "...is the strongest indication yet that hybrids are history".
*Rating agencies are not keen either. S&P wrote back in 2006 "Owing to the unpredictable nature of some of the risks to which hybrid capital issue ratings are subject, the ratings are potentially more volatile than the ratings on conventional debt issues".
*It's not long since too-clever-by-half banks were issuing this stuff and buying back their own shares. Here's a quote from 2005 "On average, the cost of this kind capital is only 50 to 75 basis points more than senior term debt," said Erin Callan, head of global finance solutions at Lehman Brothers. "Historically, that is the all-time tightest level it has ever been." You can see why the BIS is concerned.
What sort of people were buying this overstructured and overpriced paper?
Finally, why would any rational person buy paper with equity-type risks for a yield lower than you can get on very solid RMBS paper with the highest AAA rating?