The European Commission's interpretation of Basel III rules for requiring banks to hold enough liquid assets to meet cash-flow needs for up to 30 days initially penalized RMBS.
However, European banks might come back as major RMBS buyers if the asset class becomes eligible for Basel liquidity requirements, as proposed in the newest version of the implementation draft of CRD IV put out by the Commission.
In this most recent draft of the CRD IV, European Union (EU) banks would have to hold a proportion of their portfolio in the form of liquid assets. CRD IV, which was published by the European Commission in July 2011, translates Basel III provisions into law in the EU.
Liquid assets are defined to include cash held with central banks, sovereign bonds issued by EU member states, transferable assets that are of extremely high liquidity and credit quality and transferable assets that are of high liquidity and credit quality.
Neither of the terms in "transferable assets that are of extremely high liquidity and credit quality" and "transferable assets that are of high liquidity and credit quality" were defined, but the European Banking Authority (EBA) has now been explicitly tasked with reporting to the European Commission by mid-2013 on suitable definitions for these terms, explained George Gooderham, counsel for the structured finance group at Linklaters. "In other words, we don't yet know what will and what won't count as a liquid asset," he said.
The initial draft framework for liquidity-eligible assets published in 2009 explicitly excluded securitizations.
A draft of CRD IV published in January this year referred to carve-outs for "asset-backed" instruments, but the reference was largely interpreted by industry participants as referring to certain covered bonds outside of the traditional covered markets.
Gooderham explained that the Council of the EU is reviewing the latest draft of CRD IV and making its comments. By June 30, the EBA will be reporting to the Commission on the appropriate uniform definitions of extremely high liquidity and credit quality of transferable assets.
According to the Commission, the EBA report must also look at other categories of central bank eligible assets, such as RMBS of high liquidity and credit quality and other non-central bank eligible but tradable assets such as equities listed on a recognized exchange and gold.
"While any claim of official endorsement of securitized credit is of course premature, we believe senior ABS/RMBS of sufficiently high quality will ultimately be allowed as eligible assets for bank liquidity portfolios, a view we have long held," Royal Bank of Scotland (RBS) analysts said in an ABS strategy report in March. "Any such ultimate inclusion will significantly deepen the buyer base for such asset-backed bonds, as bank liquidity books are reincentivised to invest in the asset class directly."
For inclusion, RMBS will need to prove that they exhibit sufficient liquidity, price stability and credit quality stability and that they meet this "high liquid and credit quality" requirement.
Barclays Capital analysts noted in a March securitization report that determining which assets will be eligible will likely require a blueprint such as the one defined under the Association for Financial Markets in Europe's (AFME) Prime Collateralized Securities (PCS) initiative. The PCS initiative is a proposed blueprint for an official standard for "qualifying ABS."
"The inclusion of ABS (or lack thereof) within the 'liquidity credit requirement' was a key risk for the future of the ABS asset class, and while this is not a confirmed inclusion, this is certainly a step in the right direction," Barclays analysts said in the report. "Although we have certain reservations about the PCS initiative, this direction is still extremely welcome."
European market analysts believe that the proposed revision of CRD IV is a signal that regulators are softening their view on securitization and that policymakers have decided that RMBS can still play an important role in bank funding, since favorable treatment under liquidity requirements would serve as a powerful endorsement of securitized mortgages as investments.
"The potential of its inclusion as an eligible asset has raised hopes of deepening the investor base, as it is believed that bank liquidity books will look to once again invest directly in the product if it is eventually confirmed by the EBA as an eligible asset," according to a March securitization weekly report by Deutsche Bank Securities analysts.
RBS calculated that before 2007, banks and their off-balance-sheet vehicles (such as SIVs, conduits, etc.) made up approximately 85% of the securitization investor base. Current primary syndication data, according to RBS, suggests that bank investments in new securitization issues have declined to around 40%.
"The inclusion of, say, senior vanilla ABS/RMBS in the liquidity framework will of course significantly increase the natural bank buyer base," said RBS analysts. "It would likely encompass many treasury liquidity books in addition to the few bank investment portfolios currently active in the asset-backed market, reversing the trend in buyer profiles evident since the 2007 crisis."