CRD, 5%, and One Night StandsIn 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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