European Pros Pin Hopes on Prestige Brand
>Officially launched during the Global ABS confrence in mid-June, the initiative of prime collateralized securities (PCS) could provide the stimulus to issuance for which European players have been waiting.
Indeed, it appears the project has triggered an emotion that had all but disappeared from the industry: optimism.
But sources said that it will be regulators that will shape, if not determine, the project's success. A big gauge of that success is whether this prestige brand will woo mainstream investors who either abandoned the market during the crisis or always kept their distance.
Transactions that carry the PCS label will have to follow a set of criteria (see box), one of which involves a link to assets that are part of the productive economy, such as housing or small and medium enterprises. "An investor wants to be able to tell the board that I'm financing the real economy of Europe and not a trading desk," said Ian Bell, the head of the PCS Secretariat, which will run the brand's operations, including granting the labels and monitoring the transactions.
The PCS organization also includes an association and a board. Bell expects the Secretariat to start issuing labels in Q4.
Part of the impetus behind PCS is to give a collective name to the asset classes that performed well through the crisis and are still associated with either segments of the European market that fared badly or, more ignominiously, the villainous subprime deals from the U.S.
Bell said that even after a couple of years of efforts to educate more mainstream investors, many believe that losses were dramatically higher than they actually were in the asset classes that are eligible for PCS. "People are still startled when you tell them losses on European RMBS are only seven basis points," he said, referring to all tranches. "PCS is a way to crystallize this reality."
Rob Ford, a partner at London-based TwentyFour Asset Management and a member of the PCS working group, says the initiative is a way to identify the strengths of securitization.
While earning a PCS stamp requires two ratings, players are quick to point out that it is not an alternative to ratings.
"Credit ratings and PCS do two very different things," Bell said, adding that investors in higher-quality European ABS and MBS now have three sources of information to help with their decision. They are the rating, which seeks to convey a probability of default; the credit research notes, which speak to the risk/reward of investing; and PCS, which reflects the origination of real economy assets, the simplicity of the structures and the transparency of the transactions.
"PCS will be another bit of information that can be used in conjunction with a rating," said Douglas Long, executive vice president of business strategy at Principia. "However, it's not a replacement for doing your homework."
But players still hope that those investors who would likely farm out some of the due diligence on structured deals might be persuaded by the label to either return or make a first-time visit to the securitization camp.
"Every time I analyze a deal, I do all the credit work," said Ford. "But the CIO of the large pension fund, looking at the macro-picture, he doesn't know one mortgage deal from another. PCS is a simple way of communicating so that investors can make the macro-decision."
In a recent report, Barclays Capital analysts said that the PCS label is superfluous for investors already familiar with the market, as they are well versed in the relative credit strength at the top of the capital structure of most European asset classes.
But the idea is to expand the investor base. To be sure, some key ingredients appear to be already in place to bring back large European investors such as insurance companies and pension funds.
Long said that structured credit as a whole is cheap today given the risk to return when compared with other products, and existing deals have seen considerable maturity extension. What's more, the fact that they tend to be floating rate, which was once a downside for buy siders with a long-term horizon, should now heighten their appeal. "Rates have only one way to go," Long added.
He said that compared to transactions in the pre-2007 era, securitizations are much better structured, and these assets can once again meet the needs of insurance companies and pension funds - but only if regulators fix capital rules so that the capital to be held for these assets is tied more closely to credit risk and an institution's ability to monitor it on an ongoing basis.
Many players echo this view that PCS's success hinges on regulation.
The analysts at Bank of America Merrill Lynch certainly see it this way, and in a recent report they predicted that PCS is likely to achieve a lighter regulatory treatment than that currently faced by ABS and MBS in Europe. And they are willing to attach concrete figures to their predictions as well.
"Judging by the recent statements by different regulatory bodies in light of the launch of the PCS, we believe that the probability of positive changes [has] increased, and we assign 70%, 30% and 50% probability of potential favorable changes in...LCR [liquidity coverage ratio under CRD4], Solvency II and ECB repo, respectively, within the next 18 months."
This is a marked shift in BofAML's tone from just a few months ago, and the views of other players appear to have similarly brightened.
In the case of the CRD4 liquidity coverage ratio, at present the only eligible assets are sovereign, supranational, high-grade corporate and covered bonds that meet certain criteria. "Theoretically it might be argued that a subset of the ABS market should be included," said Ford. Including PCS deals in this would be "of paramount importance for the future growth of the securitization market," BofAML said.
Players also argue that the higher capital charge for securitizations under Solvency II vis-a-vis other paper has led many insurance companies to cut down on their ABS and MBS holdings or pull out altogether.
Barclays analysts have similarly pointed out that regulators appear to be softening their previously negative stance on ABS, a possible result of the developing PCS project.
Officials from the European Commission did not return requests for comment on this article. At last month's Global ABS conference, Nadia Calvino, the deputy director general for mergers at the EC's directorate general for competition, said that she agreed in principle with these types of initiatives, provided that they are transparent and manage conflicts of interest.
Proponents of PCS hope that regulators will see the benefits of lightening the regulatory treatment for this class of deals.
"If we don't show regulators that securitization has changed or highlight the good bits of securitizations, then they aren't going to do anything to change what they've currently got in place," said Ford. "Some CDOs and CDOs-squared and synthetics went a step too far, and the risk of those products wasn't fully understood. But that doesn't mean that the senior tranche of a high-quality RMBS should be tarred with the same brush."
Bell said the PCS organization wasn't explicitly targeting certain regulations. "We don't have a shopping list at the moment because these regulations [such as CRD4 and Solvency II] haven't gone through in final form."
He also said that PCS could still take root even without explicit support in the regulations. "I wouldn't say that regulators absolutely have to come on board for it to be a success," Bell added.
However successful PCS is in luring new or former securitization investors into the fold, Barclays pointed out that all holders of this branded paper will face "cliff risk." That is, they would bear the pain of non-compliance and the resulting removal of the PCS label. This would particularly sting if regulatory treatment for PCS-certified deals was favorable or if these deals experienced smaller haircuts in repo eligibility, Barclays said.
The certification process for PCS will be handled by a group of vendors that will check to see that the transaction meets the stipulated criteria. Bell said these vendors will have long, robust track records in data checking. In terms of payment, seed capital will cover the ongoing surveillance cost and other expenses for the first 18 months to two years of the PCS label while issuers will pay only for the vendors. After that, issuers will need to foot the bill for PCS and surveillance costs. Bell pointed out that the organization is nonprofit. As a result, growth in the number of transactions should automatically lead to lower fees.