The European securitization market saw the return of regular new issuance with approximately €75 billion ($98.2 billion) distributed to end investors year-to-date. However, the uptick in primary volumes is still dwarfed by the retained securitizations that remain on issuers balance sheets.
At their recent structured finance conference in London, the Royal Bank of Scotland (RBS) estimated that the outstanding European ABS universe is at €2 trillion, of which €1.1 trillion represents bank-retained ABS that have been structured since the start of the crisis.
The actual amount of borrowing against this retained ABS is considerably lower, however. In 2009, the average aggregate borrowing at the European Central Bank (ECB) window was €750 billion with ABS on average representing around 25% of the aggregate posted collateral, according to RBS. At the end of October, aggregate borrowing at the window was down to €500 billion.
RBS projected that over 60% of this borrowing was being undertaken by Portugal, Spain, Ireland and Greece. The play out of the latest sovereign saga will therefore be a significant influence on the short-term fortunes of the ABS market.
Ireland Bailed Out
With the announcement of an €85 billion rescue package, Ireland became the second Eurozone country in the last six months to request an emergency rescue. Although the terms of Ireland's package reduced the risk of any immediate haircuts on sovereign debt and senior bank debt potential for further volatility extending to ABS should not be discounted.
"The lack of any provisions that would require senior bondholders in Irish banks to share the burden of bank rescues suggests that that the European Commission (EC) has realized that bailing-in senior bank bondholders could have severe negative repercussions for access to funding in capital markets for other European banks and could have brought on the much-feared contagion the announced Irish rescue package was supposed to forestall," Barclays Capital analysts said.
But, while the risk of haircuts has decreased substantially for Irish bank senior debt, haircuts remain likely for junior debt. Irish Finance Minister Brian Lenihan said in a broadcast interview that the government needs to impose "big haircuts" on banks' junior noteholders, according to a Bloomberg report. This backdrop of uncertainty and the push for private investors to share the burden of future bailouts has seen senior bonds on Irish banks drop sharply.
Haircuts imposed on junior bank paper will have a negative effect on ABS because they increase the chance of non-calls in RMBS deals. Barclays analysts explained that call risk in European RMBS arose, not exclusively but also, in connection with bank bailouts.
"Specifically, the EC disallowed calls of bank capital securities issued by bailed out banks and routinely extended such a call prohibition to ABS transactions from bailed-out originators," explained Barclays analysts. "Only once the originator proposes and the EC accepts a workout plan does it seem ABS calls are again made on time."
If junior debt holders are forced to accept haircuts in the case of the Irish bailed-out banks, it is likely that these Irish RMBS bonds will not be called, at least until the bailed-out sponsors have submitted and the EC has accepted a detailed work-out plan where affected institutions eventually wean themselves off of government support.
And the issue of non-calls isn't just a problem for issuers from sovereigns that have succumbed to bailouts. According to Jean-David Cirotteau, a director and credit analyst at Societe Generale, the non-call issue is crucial for those originators with a high portion of non-amortizing loans, for certain U.K. and Dutch deals and, to a lesser extent, Italian pools that sometimes include a bucket of interest only loans.
"We find that, thanks to an improving liquidity situation, a majority of originators have been willing to protect their securitization franchise by exercising these calls, that is for publicly-placed deals of course," he stated. "Retained structures, which are in many cases mobilized at the ECB, do not enjoy the same status, highlighting the remaining difficulties of banks in Europe in general."
U.K. prime and Dutch RMBS markets, where the primary market has opened fairly convincingly, will likely remain those most insulated against extension risk that is reflected in the pricing of bonds. But the situation regarding Portuguese transactions is very different. No calls from public deals have been exercised so far.
"This is the case both for domestic national banks and domestic branches of larger international groups (Santander or Barclays, for example), which should raise some questions at some point," said Cirotteau. "The situation does not look like it will improve. We believe that this is also due to the emergence of the Portuguese covered market to which originators/issuers are more favorable and would be keener at protecting in the future."
A primary market re-opening for a jurisdiction would mitigate non-calls, but with no immediately accessible primary market the odds of extension become higher, thus making the primary market more challenging, explained analysts at Deutsche Bank.
"The issue of [European Union (EU)] bailouts didn't start and stop with Greece and no one believes it will end with Ireland," said James Frischling, president and co-founder at NewOak Capital. "More bad news is expected to come and the cost of borrowing by these countries will continue to increase. As the borrowing costs become problematic, the outcome may be that other countries are also forced to seek a bailout or to restructure their debt."
He emphasized the importance of the EU trying to stay ahead of the curve. Greece, Ireland and perhaps next in line Portugal are, by all accounts, manageable when compared with the larger European economies, Frischling said. It is the concern that the contagion might spread to Spain or Italy, he said, that is far more alarming to the European debtholders.
The Portuguese government has denied that it needs an EU-led bail-out. Nevertheless, speculation is growing that Portugal is struggling to cope with its vast public debt and it can potentially be the third country to need financial support.
"As with Ireland, public government denials do very little to calm the markets," said Mark O'Sullivan, director of dealing at Currencies Direct."It's the bond markets that reveal all and as confidence fades away and yields rise, a bailout becomes inevitable - you cannot outrun the markets."
If Greece's RMBS trajectory is anything to go by, the latest sovereign problems will be reflected in the performance of securitized products as well. Ireland's latest woes will lead to further downgrades (following downgrades in Ireland, potentially also rating agency criteria revisions) and a continuation of deteriorating fundamentals in Irish RMBS and increasing implied credit risk for Irish transactions, say market analysts.
Another concern, RBS analysts said, is the risk that some of the stock of retained bank paper is forced into the markets as domestic ABS ratings fall out of compliance with the ECB repo liquidity criteria.
"Determining the precise amount of legacy ABS held by 'bad-banks' or other holders strategically axed to exit the positions is difficult," Henderson Global Investors analysts said.
RBS projected the outstanding pre-3Q07 ABS universe to be around €700 billion.
What percentage of this is not with strategic long-term holders is hard to determine and, in any case, most of these bonds are money good and amortizing considerably over the next two to four years.
"We question the desire (or ability to absorb the capital hits) of these holders to dispose of such assets at material discounts to par," Henderson analysts said. "We expect that a steady flow of selected disposals will continue to occur into market strength, helping to keep spread levels elevated but unlikely to result in substantial market re-pricing."
