Risk Retention-Germans Go Over The TopI was put in mind of this when I heard what the Germans are proposing on retained risk in ABS deals. The benchmark is 5%: see http://www.robinhoodfinance.com/blog/in ... 208-110201
That in itself was pretty much a made-up number. Now the Germans propose 10% for their own banks. This will put their banks at a distinct disadvantage, and slow the flow of credit, but heigh-ho, it looks tough and macho and will no doubt play well with the electorate short term.
Oh for rules based on evidence rather than knee-jerk reactions. I'll drink to that!
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Just seen in the trade press that Kroll Bond Ratings has announced its management structure.
Kroll's plan is to do more in-depth work than the usual-suspect rating agencies. There is certainly room for this in the post-crisis world, where the problems with ratings on structured products were exposed.
There is also a real market opportunity in Europe for providing the level of analysis required under CRD 122a, i.e. investors must demonstrate a thorough and comprehensive understanding of the assets, risks, structural features etc. in any investment, and run models for stress testing.
Mind you, these are European requirements, and Kroll looks like an organisation with a US focus. We made multiple attempts several months ago to contact the relevant people at Kroll to discuss European opportunities, but were stonewalled. Let's hope they are better at communicating with their new customers!
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The BIS stated in its annual report (published 28th June 2010) that banks are "highly leveraged and still appear to be on life support". So they need to get either capital up, assets down or both. Since capital is in short supply, and the more there is the lower the return, the smart money is on a reduction is assets.
Accompanied, presumably, by the usual guff from banks about lack of demand for loans. Investec has just done some research around the increase in demand for asset-based finance (a portmanteau word for factoring and leasing) "as it predicts businesses will continue to struggle to secure mainstream forms of credit from banks".
The Bank of England in its latest report says that bank leverage has come down-from an astonishing 30 times at the end of 2008 to 19 times now. The Bank also points out that, in addition to leverage, funding itself will be a problem: banks have been funding £12bn a month, and should be doing twice that to fund the £750-800bn which the BoE calculates they need to fund by the end of 2012. A further reason why lending will be squeezed.
So where's the funding for the companies which are vital to any economic recovery? There is a real opportunity for cash investors such as funds, foreign banks and Islamic institutions to get a decent yield on money out to good companies. This could be via trade receivables and supplier financing at the short end, and loans and leasing at the longer end. The mechanisms are feasible and flexible.
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The ECB writes in its June Stability Review:
"Despite some improvements, euro area securitisation markets remained dysfunctional for both supply and demand-related reasons.
On the supply side, the profit-generating potential of securitisation has not been sufficient yet, since spreads over LIBOR for various asset-backed securities (ABSs) still exceeded levels that would ensure that a transaction would at least break-even from the issuer’s perspective."
A bit odd. If ABS can be issued at Libor/Euribor+150 for the AAAs, say, the cost to fund on 90%+ of an RMBS book is about 2.2%. If a bank has standard variable rate mortgages at 4%, that still leaves a healthy spread. Spreads on car loans would be even higher.
The ECB also says that "ABS spreads remained significantly above the level where securitisation would provide a cheaper source of funding than the money market." Well, it depends what value you put on term funding. If Northern Rock had not borrowed nearly a quarter of its assets on the money markets, but securitised more instead, it would probably never have needed a bailout!
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According to the IFR, ABS repoed with the ECB was €467bn at the end of 2009. That's an awful lot of funding. The ECB is trying to get banks back to funding in the market by tightening its criteria:
• ABS issued from 1-3-2010 must have two AAA ratings to be eligible. The earlier requirement was just one A- rating
• No ABS of other ABS (this is really the dreaded “CDO squared” and other horrible constructions)
• Provision of loan-level information. This is in part for transparency for the ECB itself, and in part to force the market to adopt such standards as a norm
• No synthetic exposures
• No FX swaps or over 20% liquidity support from the arranger-a lesson from Lehman!
There are several implications:
• Banks need to start getting away from reliance on Nanny ECB and start issuing in the “real” market. They have been loath to do so since it has been hard to issue at a price they like. However, there is obviously demand at the right price-witness the secondary market rally in the last year- so banks will have to swallow hard and issue
• A lot of existing issues will have to get a second rating in order to achieve this before the ECB requirements tighten to require two ratings on 1-3-2011
• Banks are under increasing pressure to beef up capital ratios, and also hold liquid assets. The match funding provided by ABS issuance is very helpful here
On the other side, banks as purchasers will have to have, according to SIFMA “...a thorough understanding of all structural features of a securitisation transaction that would materially impact the performance of their exposures to the transaction”.
So we have more banks which need to issue, an ECB reluctant to play Nanny any longer than absolutely necessary, and some banks which will be unable to buy very much ABS due to capital and liquidity constraints, or their own negligence in not having competent people and procedures to meet the “thorough understanding” requirement.
ABS funds, anyone?
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