Proposed bank capital rules are likely to both benefit and crimp the securitization market, potentially making highly rated transactions less attractive while having uneven effects on different asset classes.
The Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. issued a three-part proposal for comment in early June that, as written, could reshape the securitization market. In particular, big banks are likely to be less incented to hold highly rated ABS on their books, since the proposed rules would set a risk weight floor of 20%.
Jason Kravitt, a partner at Mayer Brown, said that the banks will likely instead opt for lower-rated assets that provide higher returns. "If the amount of capital is the same for 'AAA' assets as for assets further down the credit spectrum, banks will invest down the credit spectrum," Kravitt said.
Alok Sinha, principal and leader of Deloitte & Touche's banking and securities practice, disagrees. He noted that Basel I already sets a 20% floor, and U.S. banks currently adhere to that standard. "So we don't expect significant change in behavior or appetite to hold highly rated securitizations due to the recent guidance," he said.
Nevertheless, as Kravitt pointed out, the biggest U.S. banks have been simultaneously running Basel I and the advanced approach under Basel II, and awaiting the significantly lower capital charges under the latter. Basel II applies a 7% risk weighting for highly rated securities, resulting in a capital charge of 56 basis points compared to 160 basis points under Basel I and the proposal."All the big banks have already been running both models, with the thought of converting to Basel II in the near future," Kravitt said, adding that the 20% floor would put U.S. banks at a competitive disadvantage, at least for now, to European competitors who currently adhere to Basel II requirements.
The banking regulators' proposal does not uniformly amend risk weights to different types of assets backing securitizations. Bill Springer, counsel at Bingham McCutchen, said that could be a factor impacting banks' decisions about whether to securitize assets or hold them on their books, since some securitizations may become more or less economical to pursue. On the other hand, Springer said, the proposal's potentially heightened due diligence requirements may make it harder for new esoteric products or smaller issuers with fewer resources and less experience to enter or stay in the securitization market.
"In esoteric sectors with few or no established issuers and less certain cash flows and historical data, it may be harder for new players and new products to efficiently enter into the securitization market," Springer said. - John Hintze