Lending vs AAA RMBS ReduxHow is he funding this? A thin layer of capital plus "a loan from a major bank at Base+2%".
Blimey. Base+2 is 7%. The same as 3-month Libor plus 1.25%. A great deal for my friend-but you wonder about the bank when it could much more simply invest in AAA mortgage-backed bonds at up to twice the spread, whilst using less capital. Transaction costs, legal costs, the level of due diligence and credit work required, higher Basel II capital charges...what is this bank thinking of?
FOOTNOTE SEP 08
Merrill's research published on 1-9-08 states:"We think the investment case for European structured finance remains strong. With the liquidity premium skyrocketing, the current market presents a good opportunity for buy-and-hold investors to step in and capture the liquidity premium while still being compensated for the credit risk they are taking, in a number of SF sectors, such as the RMBS and CLO."
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An email arrived from Fitch today: "The first half of 2008 has confirmed the Italian market to be one of the most dynamic for structured issuances in Europe. This has been mainly driven by funding from the ECB via repos backed by structured notes and the question is how long it will last".
This doesn't just apply to Italy: banks in many other Eurozone countries are structuring to be repo-ready. This is the case in the UK, too: this month (Aug 08) Lloyds TSB has priced and retained Arkle Master Issuer- Series 08-2, a UK RMBS of £10bn.
The economics for banks are persuasive. As Deutsche puts it "The economic rationale for banks to use their own securitised bonds for central bank short term financing is very compelling, without exception. The ECB does not apply a penal interest rate when financing ABS collateral, and therefore the cost of financing is frequently close to EURIBOR".
Is this a positive development, or are there dangers?
The central banks are fulfilling one of their main roles, which is to ensure that liquidity is provided to the banking sector. Whilst the funding cost is attractive, they do require a haircut (risk piece retained by the bank) of at least 2%. (NB this is based on market value not par value, and the central banks review this daily.) They can also decline to fund assets in some cases, e.g. downgrades.
To address Fitch's question, "how long will it last", it would be perverse for central banks to cease repo facilities at short notice whilst there is still a credit crunch.
Our advice to banks is to get going and structure asset pools to a rated standard:
-If they just stay on the balance sheet, no more risk, capital or funding is required than the "do nothing and hope for the best" option;
-There is the possibility of Central Bank repo funding if the situation dictates;
-The route to capital markets funding proper once the markets recover is much shorter.
Even AAA-rated Rabobank has gone down this route. Bert Bruggnik, Rabo's CFO commented that they had done so "to be absolutely sure that we would not have any liquidity concerns whatsoever, and since
mortgages cannot be pledged to the ECB and RMBS can, we decided to do an internal securitisation and buy back all the notes."
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Sir John Templeton, the legendary investor, died this month at 95. He made many memorable observations on markets, such as: "'it’s different this time' are the most expensive words in the English language". More appropriate to current ABS markets is his "To buy when others are despondently selling and to sell when others are greedily buying requires the greatest fortitude and pays the greatest reward". In other words, it pays to be contrarian.
AAA-rated UK prime residential mortgage-backed bonds (RMBS) were recently trading at 140 basis points over Libor. This is 14 or 15 times the yield of mid-2007. Are things really 14 or 15 times worse? These bonds are stressed to withstand depressions, not mild downturns.
In addition, prime RMBS are not over-structured-too-clever-by-half products such as CPDOs or CDO squared.
Why would a mortgage lender lend on new mortgages when he can buy AAA RMBS of excellent quality? A new portfolio, if tranched, is typically just over 90% AAA. AAA bonds are, by definition, 100% AAA and offer a wide opportunity for diversification. And most likely a higher yield.
What about investors in general? We're in the realm of the psychological rather than the logical. If you're employed, you're less likely to be fired if you go with the conventional wisdom. That leaves the opportunity for the brave to follow Sir John's advice- or indeed Warren Buffet's version, which is "Be fearful when others are greedy, and greedy when others are fearful".
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That was the headline in the Financial Times of 14th July. Apparently, according to directors polled by Deloitte, over three quarters of directors said that credit was hard to obtain.
There does seem to be a case for funding companies, especially those which are smaller and medium-sized, in ways other than bank lending.
In my teaching capacity at the Dublin Institute of Technology, Dr Joe Coughlan and I recently completed our review of the group projects from the Postgraduate Diploma in Securitisation course. The question which the students were addressing was how securitisation technology could be used by a non-domestic bank wanting to fund Irish companies. The research and presentations showed that either of both of a CLO of loans to corporates or a trade receivables securitisation programme could be a valuable and profitable strategy.
The logic could be extended to many other countries.The UK, as the Deloitte study indicates, is a prime target.
Who is going to put this in place? The structuring and funding are not the hard parts-RHF could organise these. The difficulty is the origination. This might sound counter-intuitive when, as noted above, "credit is hard to obtain". However, it's difficult to get in front of the right customers without an existing relationship and, preferably, a known and trusted name. "No-one ever got fired for buying IBM" was a well-known dictum in the 80s.
What we need is an introducer/stakeholder-either
* A recognised bank which wants to break into new markets
* A respected firm such as an insurance broker
* Accountants or other high-profile advisors
Suggestions appreciated-there is a real business opportunity here.
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An interesting enquiry from a factoring company: they are currently putting together for a corporate customer a EUR100m transaction based on trade receivables.
The interesting part is that the customer is currently funded via an Asset-Backed Commercial Paper conduit at a far lower rate than the factor will be charging him. So why is this customer keen to pay more for his funding?
The answer is certainty of funding-with the 40% decline in the ABCP market the corporate is more interested on certainty of funding (the factoring company is the subsidiary of a pretty strong bank) than on saving basis points.
The nature of the enquiry from the factoring company? What other corporate customers in the same position might consider having some availability of funds from the factoring market. It's good to find someone who is keen to lend in current markets!
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