The European securitization market has been stuck in a holding pattern, thanks largely to regulatory uncertainty, and it is likely to remain so through next year.
In their 2013 outlook report, Barclays Bank analysts characterized this limbo-like state as one of "fragile equilibrium."
Should regulations continue to weigh on the markets, there is still potential for change around the edges. The Bank of England's Funding for Lending Scheme (FLS), for instance, looks as if it will sap some energy from ABS volumes if it keeps providing cheaper funding, although the price differential between this program and securitization funding is currently razor thin. And there's upside risk to issuance as well, fueled in part by the initiative to brand top-tier deals prime collateralized securities (PCS).
Launched in the summer, the PCS Secretariat published the rule book of criteria only last November, with the first deals expected to follow shortly.
The chance that European securitization will feel even more pain is possible as well, with ratings downgrades looming and the ever-present danger of more shocks from the Eurozone crisis.
Primary Issuance
Market participants said that overall issuance volumes in European ABS and MBS will probably look similar to this year, with at least one contrarian voice - Citi Research - seeing an uptick in CMBS.
"Across mainstream core Europe, excluding the U.K., issuance will probably be relatively unchanged from this year," said Rob Ford, a partner at TwentyFour Asset Management.
Barclays forecast roughly €50 billion ($65 billion) in public securitization issuance next year, a slight decline from the €52 billion the bank projected for 2012 (see chart at left). Despite the funding competition posed by the FLS, U.K. prime RMBS is still expected to lead among asset classes, with projected issuance of €12.5 billion. In the year through October, Barclays estimated that there had been €48.7 billion in total public issuance.
The last few years have seen issuance more or less holding still (see table, p. 27), with a larger portion being retained for Central Bank funding, as opposed to being bought by investors.
The anticipated damping effect that the FLS will have on U.K. RMBS volumes could subside as the year wears on, according to Andrew South, head of research for European structured finance at Standard & Poor's. "The FLS window will close in January 2014, and I expect the effect of it to slowly get less and less throughout 2013, because as you get closer to the end of the window, people think about using private sector funding again," South said. He added, however, that its impact will still be felt at the beginning of next year.
How much FLS will eat into U.K. RMBS volume depends on how much better its terms are for originators. Ford pointed out that recent spread tightening in RMBS - itself an effect of FLS - is getting closer to the point where the pricing competitiveness is marginal. Next year, "the cost differential between FLS and securitization will be scrutinized more carefully by management," Ford said, adding that banks will also want to remain in touch with their RMBS buyers.
But something else will keep issuance in check. Low origination volumes - afflicting asset classes throughout Europe. In the case of the U.K., gross mortgage lending totaled £12.9 billion ($20.7 billion) in October, up from £11.4 billion in September and 4% higher than October of last year, according to the Council of Mortgage Lenders. Although this late-year springtime for mortgages could be an early sign of FLS's success, it is still well below the averages of a few years ago. "U.K. prime RMBS issuance is down 80% from the peak, but when you look at mortgage origination, it's down a similar percentage," South said.
Ford questioned how powerful the impact of FLS could be with U.K. banks already flush after having rebuilt their liquidity positions during and after the crisis. "Banks aren't going to compromise on credit quality," he added, saying that if they do, they would have to beef up their capital buffers. "The capital requirement for lending a 90% LTV mortgage is a hell of a lot higher than the requirement for lending a 75% LTV mortgage," Ford said. And borrowers who can put 25% down in the U.K. are uncommon.
One asset class that sources said will help pick up the slack from less U.K. RMBS is Dutch RMBS. Observers are optimistic that certain developments in this arena - such as the establishment of the Dutch Securitisation Association (DSA) in November and the debut of a dollar tranche in a Dutch RMBS earlier this year - will continue bearing fruit next year.
The DSA is an effort to boost transparency by providing detailed reporting and documentation for deals, including loan level data. In a release, the organization flatly stated the causes of today's limp market: "Uncertainty in respect of future regulatory guidelines and the demand for more clarity in respect of transaction structures and underlying collateral are the main causes for the reduced appetite for securitization transactions by investors." The organization also aims to create a more unified standard for Dutch RMBS, something that has been lacking so far.
The growing presence of U.S. investors, which first made their mark with U.K. RMBS, may extend to euro tranches in core assets, particularly for global asset management firms domiciled in the U.S., Ford said. Still, the percentage and overall volume of dollar-denominated tranches in U.K. RMBS actually fell this year from 2011.
Barclays' analysts expect that non-euro issuance will remain active in 2013, with not only U.S. dollar tranches, but also paper denominated in Australian dollars and Japanese yen, which saw deals this year.
Observers are expecting issuance in whole business securitization and auto ABS in Europe as well, sectors that respectively churned out about €9.3 billion and €9.6 billion in publicly placed paper during 2012, according to Barclays.
CMBS: Revival or Stagnancy?
A sector that has been very quiet this year - indeed since 2007 (see table below) - CMBS is expected by at least one player to make something of a comeback.
Analysts at Citi expect CMBS issuance to hit €8 billion in 2013, a huge leap of 116% over a €3.7 billion estimate for 2012. "Office loans in major European business hubs such as London, Frankfurt, Paris, etc. collateralize the majority of relevant maturity CMBS deals," the analysis said in a report. "Good office locations and strong DSCR performance should be easier to refinance."
Citi analysts estimated that about 38% of the €20.6 billion of CMBS loans maturing during 2013 are re-financeable. The cost of issuing CMBS is around 19%-33% cheaper than the average loan margin of around 350 basis points at press time, according to the bank.
Citi said the forecast revival in European CBMS could echo what has already happened in the U.S., where simpler, stronger structures have brought investors back.
Others are more skeptical. "Because spreads on securitization have come in so much you can begin to entertain the idea that maybe CMBS is economically feasible again," said S&P's South. "But I don't think we're quite there yet."
Barclays likewise sees poor prospects for CMBS issuance next year. Analysts there forecast issuance of between €1.0 and €2.0 billion next year, a drop from the €2.7 billion so far issued this year. The 2012 figure included the Dutch deal Utrecht Funding, which came out of the default of legacy transaction Opera Finance Uni-Invest and was therefore bought up by existing noteholders. As a result, this deal is not included in the privately placed issuance figure in the table on p. 26.
Ford said that the kinds of CMBS that have any chance of a comeback next year are "hybrid" transactions. "I think you might see some CMBS go back to their U.K. roots, which is really hybrid corporate bonds," he added. "That's how a lot of commercial property got financed here, 10-15 years ago, before the innovation of U.S.-style, investment bank-led conduit funding programs."
Regulations in the Way
The pact of activity in the market will hinge on how much progress is made in the area of regulations.
"The main two regulatory negatives for the market in Europe are Solvency II and CRD IV, the European implementation of Basel III," said S&P's South. "They affect the incentives respectively of insurance and bank investors."
Solvency II defines the capital charge for different financial instruments held by insurers. Observers are hopeful that the final rule will not be as punitive as it is in its current form. As it now stands, ABS is considered a highly illiquid instrument. "AAA-rated ABS would attract a capital charge 10 times greater than AAA-rated floating rate covered bonds with the same duration," Barclays' analysts said. For AA-rated ABS, the multiple differential with covered bonds is 18 times.
But the rule has been changed before, and its final implementation date is constantly getting pushed back, giving players cause for at least a modicum of hope. It is now slated for implementation in January 2014, but a number of observers say it could be pushed as far back as 2016.
The other major regulation in the works, CRD IV, covers banks. Some have said this rule could pose an existential threat to the market, because in its current draft form, it does not include asset-backeds in a bank's liquidity coverage ratio at all. Essentially, securitization is not considered a liquid asset in these regulations. But, as with Solvency II, players are growing hopeful that the final version will not be as punitive to ABS and MBS as it is currently drafted. Although slated for implementation this January, CRD IV looks likely to be delayed.
All this regulatory uncertainty, while an obstacle to renewed activity, is still preferable in the eyes of many to the certainty of having ABS and MBS receive the kind of harsh treatment they do in the current forms of Solvency II and CRD IV.
PCS to the Rescue?
Players hope that regulators will at least look more kindly on deals carrying the label of PCS, a brand designed for transactions that meet certain criteria.
South said that PCS will potentially be one way of distinguishing certain securitizations that may end up with a regulatory treatment more favorable than the way the rules are currently drafted.
The first deals tagged PCS are expected out shortly. Although the initiative was launched last summer (see ASR 7/12), the rulebook was released only in November 2012.
The label will be stamped on transactions that fulfill certain criteria, such as meeting specified reporting standards; involving assets directly tied to the "real" economy; and holding at least two ratings. In addition, only senior tranches are eligible.
This project and those of the DSA as well as the recently initiated European Data Warehouse are designed to make deals more palatable to investors. The question, though, is whether they will work even if the final versions of regulations are as punishing to securitization as they are now crafted.
Ratings Trouble
On the ratings front, there is a specific threat next year looming from Moody's Investors Service.
The agency said in November that ratings actions on banks, as well as current and proposed changes to its methodology, could lead to more downgrades, especially in deals from peripheral countries. The eroded strength of counterparties, methodology updates made in June and deteriorating collateral performance were all likely to show up in structured finance ratings actions by the end of 2012.
But next year might see a slew of other actions - in all likelihood downgrades - stemming from proposed methodology changes to capture the effects of a swift decline in sovereign creditworthiness and from potential changes in how Moody's links structured deals to their swap counterparties, accounts banks and eligible temporary cash investments. This round of rating actions is slated to be completed by the end of 2Q 2013.
