Under Basel II, banks could lower capital charges by investing in rated securitization structures rather than by directly holding a comparable pool of unsecuritized assets, said Fitch Ratings in a new report exploring the quantitative impact of the Basel II capital charges on securitization structures. The focus was on particular product lines like credit card asset-backed securities (ABS), commercial mortgage-backed securities (CMBS), and residential mortgage-backed securities (RMBS).
In the report published last week, Fitch evaluates the amount of Basel II capital that banks must hold on an unsecuritized pool of assets in comparison to holding a securitized structure of these same assets. "Looking ahead, we may see banks looking for opportunities to reduce their Basel II capital requirements by investing in credit card ABS, CMBS, and RMBS markets," said Stuart Jennings, managing director in Fitch's European structured finance team.
Basel II appears to have little impact on the decision to securitize corporate debt and residential mortgage assets (i.e. through CDO and RMBS transactions). However, Basel II seems to establish fairly strong capital incentives for banks to securitize commercial mortgages and credit card receivables (i.e. through CMBS and credit card ABS structures). In its research Fitch evaluated what impact the new capital accord would have over a range of portfolios representing different underlying assets and risk levels - including RMBS, credit card ABS, CMBS, and CDOs of corporate debt.
A bank holding both rated and unrated positions within the same securitization structure would apply the ratings based approach (RBA) to the rated tranches and the supervisory formula to the unrated exposures. However the bank holds less capital on rated securitization tranches than on tranches that do not have an external rating from a recognized credit rating agency. In certain cases, Fitch also found that RBA generated much lower capital requirements than the supervisory formula on the same securitization position, which could provide incentives for banks to target the rated portion of the securitization market.
According to analysts, the differences in capital charges between the RBA and supervisory formula were most pronounced for the credit card ABS and CMBS transactions. "The supervisory formula generates approximately three to four times as much capital as the RBA across the same securitization structure on all but one of the credit card ABS and CMBS deals evaluated in this study," reported analysts. For the lower risk and medium risk CMBS portfolios the supervisory formula charges across the entire securitization structure were 3.8 times higher than the corresponding RBA charges for the same structure. The supervisory and RBA capital charges are better aligned in the case of CDO and RMBS deals, according to analysts. They also found that in the majority of these structures the supervisory formula resulted in no more than 1.5 times as much capital as the RBA and in less capital than the RBA on the lower risk RMBS transaction evaluated in the study.
The ultimate effect of Basel II on the securitization markets will depend in a large part on how banks identify and respond to these new regulatory capital incentives. "The impact of Basel II on a bank's decision to securitize a portfolio of assets will depend on a complicated interplay of factors, including, for example, the inherent default risk and recovery rates of the underlying assets, the type of asset or product being securitized, the tranching of the resulting securitization structure, and the features or conventions of the structuring process, such as excess spread and reserve funds," said Kim Olson, managing director with Fitch.
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