There remains value in certain European ABS sectors despite their risk profile, said panelists at the Association for Financial Markets in Europe’s (AFME) and the Information Management Network’s Global ABS 2011 conference being held in Brussels this week.
These remarks were made at the panel called Assessing the Relative Value of Securitization in Today’s Funding Environment.
To prove this point, Ganesh Rajendra, head of European securitization research at Deutsche Bank, cited the total returns that Granite triple-B paper has posted year to date. However, he said that from a glass-half-full perspective, the depth of the European ABS market “is really not that significant.”
He added that if one looks at the market’s issuance profile, it remains in the defensive asset classes. There also has been no meaningful activity in non-bank paper and there remains $1.2 trillion in retained paper, which he called a “misuse of liquidity.” This also demonstrates that the market is “not completely out of the crisis.”
However, he said that it can be argued that the securitization market in 2006 and 2007 is a broken model, which is now being replaced by a more “genuine” one.
Covered Bonds vs. ABS
The panel also discussed securitization versus covered bonds as a financing alternative. Both methods, according to panelists, are used by issuers as ways to diversify their sources of funding. However, certain investors cannot buy ABS due to regulatory considerations.
On the issuer side, Head of Structured Securitization at Lloyds Banking Group Robert Piehn said there are instances on the margin where securitization becomes a more efficient and cost-effective funding tool versus covered bonds. This is why, at least on the margin, there has been some movement away from covered bonds, he said.
Additionally, panelists noted that some investors have expressed concern over the covered bonds’ linkage back to the issuer, increasing the risk of downgrades and raising concerns over the sector’s stability.
Katherine Frey, managing director in EMEA structured finance at Moody’s Investors Service, said that at the moment 50% of the banks underlying covered bonds that the rating agency rates are either on review for downgrade or have a negative outlook.
There is a direct link to the covered bond’s and the underlying bank’s rating, she said. In a previous report, Moody’s has said that currently about 25% of the covered bonds that it rates can experience a downgrade if the underlying bank rating is lowered by a notch.
ABS, on the other hand, depending on the sector has a more stable outlook in terms of rating migration. However, Frey said that it is exposed to operational risk, which can be caused by servicer migration.
Panelists also mentioned that the European investor base is expanding with the entry of U.S. investors, both Europe-based and U.S.-based.
However, Europe-based U.S. investors have less restrictions in terms of their investment decisions. Even if the parent company providing the money is an American firm, U.S. investors based in Europe are treated like offshore companies buying securities and therefore are not subject to U.S. securities laws. This is why they have shown interest in some of the more esoteric asset classes.
On the other hand, U.S.-based investors buying European collateral are limited to U.S. dollar-denominated tranches in European transactions.
Meanwhile, Rajendra said that pre-financial crisis, the buyside comprised mostly bank investors who were highly dependent on ratings. Currently, there is a movement toward the de-linking of a deal’s rating from investment decisions.