In Europe, daylight saving time may not end until the last week of October; nonetheless the continent's asset backed securitization market may have already suffered through its darkest hour. Investors have cautiously returned, and investment banks are restructuring and refinancing in order to make amends. Ratings agencies are back on the ball, and the EU is mulling new regulations in order to prevent a repeat of the crash.
"We think the negative news is over," said one investment director at an Edinburgh-based firm. "We saw Northern Rock and thought to ourselves that a bank run is as bad as it can get. We can tell ourselves it should not have happened and focus on the past, or we can get a lot more rigorous and start taking up a lot more offers."
The director added that while confidence is returning, there is still an underlying current of trepidation. Not only have buyers had to contend with Northern Rock's problems but investor confidence has also been rocked by the near-collapse of Germany-based banks IKB and Landesbank Sachsen Girozentrale. Nonetheless investors now look keen to seize the opportunity created by investment banks selling off mortgage backed loans at a discount.
"We're glad [the banks] are getting a haircut and taking some losses," added another market player. "There's no point in holding loans that are eating into capital. You've got to offload that."
Indeed, a common occurrence in the European market is the selling off of loans in order to clear balance sheets. "We are accepting discounts on some assets in order to clear the balance sheet," said one analyst of his bank's latest activity. "CLOs are being restructured in order to lighten the load. SIVs are still selling assets, but we are watching for a forced disposal."
The analyst added that spreads continue to tighten, with some triple-A's pricing in the 30 basis points range, down from the 50 basis points to 60 basis points range seen recently, and the mid-40 basis point levels of two weeks ago. However, his bank is more than happy to go slow, he added, as "it's a bit dangerous to try to go too far." His bank, like many others is also restructuring personnel in light of the slow market conditions. Many origination teams, for example, aren't doing much and haven't been for six months or so.
A staff member at a European investment bank's human resources department added that his bank didn't have the same "hire and fire," mentality as firms in the U.S., but he admitted that heads would eventually roll. "One of the problems is that some guys just aren't pulling their weight," he said. "When it was busy, we hired more people than what we needed, so now, of course, we will be trimming a bit."
Others are looking at more innovative ways to move forward. BNP Paribas, for example, has announced a new research committee, called "Asset-Liability Management and Institutional Investment Management," along with financial research body, EDHEC Risk and Asset Management Research Centre.
The committee is intended to lead to a three-year research program that will examine "dynamic allocation strategies" in asset liability management in order to "formulate an integrated ALM model," the bank said in a statement. The research will then be distributed to European financiers through EDHEC's website and at their conferences.
"Taking into account the structure of liabilities and their financial risks allows investment solutions to be optimized in accordance with an environment that is specific to each investor," said Francois Hullo, sales director for France with BNP Paribas Investment Partners. "We therefore felt that it was important to accompany academic research in these areas and to enable our institutional clients, who are increasingly aware of this new challenge, to benefit from it."
Across the Atlantic
Oddly enough, analysts at Dresdner Kleinwort have pinpointed beneficial news from the commonly perceived source of Europe's present angst: the United States. "Credit sentiment is slowly improving [in Europe], particularly on the back of encouraging U.S. non-farm payroll data report; 110,000 jobs were created in September and August's negative figure has also been revised upwards," the analysts said in a statement. "As a result, a U.S. recession scenario seems less likely and structured credit markets have benefited."
The analysts added that the U.S. economy appears to be "resilient on recession grounds," despite the continued weakness in its housing sector. Furthermore, commercial paper volume rose by $13 billion last week, and the decline in ABCP is also slowing.
"Whilst money market funds are slowly coming back to the CP market they remain very selective, preferring financial to asset backed CP due to the latter's allocation to structured finance," they said. But despite the positive news, Dresdner Kleinwort has seen little activity, including low levels of trading in the European secondary market last week.
Indeed, one commercial paper investor said that his firm would only do deals on a "very selective basis." Such deals, he said, needed to be structured with a strong focus on liquidity risk, as well as a pre-agreed repo transaction in place and reassured commercial paper. "In August, the market was too in shock, and in September, we were too cautious," he said. "Now, it's October and we intend to still be selective into the first quarter of 2008."
Stuck on SIVs
A recent IMN conference in Paris on SIVs and ABCP had a common grievance: movers and shakers in the sector were noticeably absent. Ratings agencies and investors were out in force, but there seemed to be few people around qualified to answer the questions of the latter. The question many wished to ask was: What will happen with the SIV overhang? Will they continue selling assets or will there be a forced disposal? The answers are just now coming to the surface.
SIVs and money market funds are very likely responsible for the "significant chunk" of investors who have "evaporated," according to analysts at Deutsche Bank. "From what we can tell, the improvement in ABCP rates has been insufficient thus far to re-establish the economics of many bank conduits and, especially, SIVs, many of which are currently restructuring in order to survive," they explained in a report.
The Deutsche Bank analysts added that SIV restructuring or recapitalizations usually happen with an orderly unwinding rather that incremental investing, and as these vehicles slowly wind down, the primary market is likely to remain at a standstill. "We believe the use of repos have been far more widespread than otherwise publicly announced," they said. "Indeed, the language of many SIVs normally allow for repo financings, with certain vehicles also having committed, but likely undrawn, repo agreements in place."
In addition, Fitch Ratings reported that the average sale price of SIV assets in recent weeks was 98.7% and that repos are commonly being used to replace portions of commercial paper. Fitch also stated recently that the cap on repo amounts is normally 20%.
CLO Rally
According to Markit, the European cash leveraged loan market has jumped in the last four weeks, and analysts at Deutsche Bank believe the CLO model is going to remain competitive with its tighter liabilities and more accommodating fee structures, at least in the near term.
Analysts at the Royal Bank of Scotland confirmed that CLOs are being sold at a discount, and with reduced management and arrangement fees. "This allows arranging banks to convert their warehouses into balance sheet CLOs, thus crystallizing mark-to-market losses in order to free capital that can be used to buy fresh leveraged loans, at current price levels, and structure new CLOs in the coming months, hopefully at a more attractive arbitrage," they noted.
Time for a Change?
While market players continue to restructure and adjust to the current conditions, it wouldn't be Europe if the government didn't say it knew how to do it better. France's minister of Economy, Finance and Employment, Christine Lagarde, recently wrote in the Financial Times that those involved in securitization should prepare themselves for more regulations, particularly in order to heighten transparency.
Lagarde said that Basel II reforms had served the continent well, but she added that the Basel committee "should be tasked with coming up with new standards and the EU should formalize these standards in a directive," in order for European structured finance to remain competitive on a global scale.
Last week, other European finance ministers announced reviews of financial practices in the securities market. Fernando Teixeira dos Santos of Portugal, the EU presidential country, said he is laying down a "road map," that will chart new changes for 2008. Italy's finance minister, Tommaso Padoa-Schioppa is pushing for an independent review board.
Lagarde also suggested that ratings agencies should develop new procedures that would include external monitoring and avoid internal conflicts of interest. "Europe must give serious thought to submitting ratings agencies to the oversight of market regulating authorities," Lagarde said, "as is the practice in the U.S." Her comments have already earned the support of the President of France, Nicolas Sarkozy and Germany's chancellor, Angela Merkel.
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