European RMBS deals could see more price tightening as the market moves toward a full implementation of Basel II. According to results from the European Securitization Forum (ESF) working group issuance forecast survey, although survey participants believe that Basel II has already been priced into the market, the new accord could still have the effect of increased demand for ABS products. This, in turn, should drive spreads tighter, especially the senior tranches in the capital structure.
The ESF survey asked member participants about Basel II and its effect on the pricing of securitization transactions. According to figures reported by the Royal Bank of Scotland, banks represent roughly 50% to 60% of European ABS investors versus approximately 20% in the U.S. Thus, Basel II rules hold strong implications for ABS demand, especially in Europe.
"We see RMBS pricing at eight basis points to 11 basis points; that leaves significantly more room for tightening in the future," said Rick Watson, managing director and head of the ESF. "The reason that we have not seen any gapping in spread at the beginning of the year is because the whole framework won't kick in until 2010 - so we are seeing gradual implementation of capital benefit."
How the pricing challenges that lie ahead will affect the market can be best illustrated with the classic covered bonds versus RMBS debate. RBS analysts said in a report, for example, that they expect prime RMBS volumes will decline as issuers find these assets more attractive to keep on the balance sheet and fund using cheaper methods, such as covered bonds or unsecured financing. "We have already seen a move to these in U.K. markets with HBOS, Bradford and Bingley and Northern Rock, among others, announcing these structures, and wider use of covered bonds is expected in other markets such as Spain, Netherlands and Italy," RBS analysts said.
But ESF's Watson noted that the risk transfer benefits and better collateral efficiency of RMBS against covered bonds will provide an incentive for banks to continue issuing RMBS. Many banks, he said, have merged their covered bond and RMBS facilities - quite a few of the ESF members said that both products are handled by the same origination desk.
He added that banks looking for capital relief would likely see a decline in RMBS issues. However, for banks looking at securitization as a means to reduce funding costs, the incentive will still be there. Furthermore, for issuers that are not banks, like Kensington Mortgages, the Basel II debate means little except from an investor point of view.
For bank investors, the new accounting rules no longer provide as much of a capital advantage for purchasing covered bonds and unsecured bank notes. Returns on risk adjusted regulatory capital will likely favor ABS purchases over covered bonds and unsecured bank paper.
Robust year expected
Overall, survey participants said they are expecting another record year in ABS issuance. Issuance volumes are expected to grow by 16% this year to 530 billion ($690 billion) from the 456 billion issued in 2006. The highest volume sectors are expected to be RMBS, CMBS and CDOs - no surprise there, as these were the highest growth sectors in 2006. But Watson noted that survey participants did expect a surge in public auto loan issuance. Auto deals in Europe have typically been funded via conduits in the past.
According to RBS analysts, auto loan-backed and lease-backed pools growth is expected as more banks look to securitize these portfolios and there is further growth by captive issuers.
Last year, the same number of transactions was completed as in 2005 but the transaction sizes were larger, contributing to an increase in volume. "We expect that, as banks securitize, poorer quality loans will likely make their way into the portfolio, due to higher capital charges imposed by the new regulatory regime," RBS analysts said. "Supply from captive auto finance companies will also contribute to the growth, but we see specialty lenders also rejoining the fray."
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