Regulators are close to the final version of the implementation of minimum due diligence requirements under the European Capital Requirements Directive Rule 122A.
However, Societe Generale analysts said that originators already have strong incentive to keep portfolios clean and, in many cases, the performances of securitized pools are better than those from the originator’s balance sheet.
Rule 122A requires European credit institutions that invest in structured finance securities to know what they own. It laid out explicit penalties if a European credit institution does not obtain sufficient data regarding an ABS to satisfy regulators that the buyer fully understands the security.
According to the Securities Industry and Financial Markets Association, Rule 122A applies to all securitized exposures, which broadly include all cash and derivative instruments that are credit-tranched. Certain types of transactions are scoped out, such as those based on an index, syndicated loans, purchased receivables or credit default swaps where these instruments are not used to package and/or hedge a securitization.
The failure by either investors or issuers to meet the requirements of Rule 122A will result in their holding more capital against a security. The deadline for retention measures to be applied is January 2011.
SocGen analysts argued, however, that the originators’ involvement in European ABS structures should be considered as a "de-facto skin in the game."
"One reason for this may be the cherry picking of assets under the securitization eligibility criteria," analysts said. "For a new loan to be added to the securitized pool, it must already be seasoned. Therefore, there is already a bias for good selection. This commitment from originators therefore already achieves what the retention ratio is being implemented for. Why implement an additional cost then? "
European auto ABS transactions, for example, only refinance the senior classes of the pool while the subordinated risk is retained by the originator. These deals have been very popular in 2010 based on low extension risk and good historical performances.
In the new FCT Compartment 2010, a German auto ABS from Peugeot Group’s captive bank Banque PSA Finance, the base case gross loss probability is 3%. The stressed level for the 'AAA' tranche is up to 14.5%, which is almost five times the assumed base case and 8.5% for the 'A' level i.e. almost three times the base case, according to the Standard & Poor's presale report.
"There are other parameters used in the modeling as loss severity, e.g. time to recovery, and it is clear that these are also very conservative," SocGen analysts said.