"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).
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The ugly phrase is “skin in the game”. Allegedly coined by Warren Buffett. Quite what the nature of the game is, or what might be the potential fate of the skin in question, is not made clear. This colourful if vague phrase means, I believe, retained risk.
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.
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The ABS market overreacted. Markets often do-retail investors have been seen time after time to buy near the top of a market (greed) and sell near the bottom (fear).
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.
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Central banks and pundits alike keep repeating the mantra that banks should increase their holdings of liquid assets. That no doubt suits governments which have an awful lot of debt to flog over the next few years.
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.
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There's been a lot of stuff in the press recently about banks such as RBS and HBOS losing 'vital' staff in the securitisation, structured finance or other areas due to limitations on pay and bonuses.
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.
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