At the start of 2009, the formula that would save securitization began with government intervention. Six months down the line, the U.S. and European markets have seen some results. For Europe, the story has naturally been fragmented or on a country-by-country basis where some governments pledging more support than others.
However, unless Europe takes the plunge to deal with the "toxic" asset overhang, something that the U.S. seems more willing to deal with, no real strides can be made toward truly restoring the market.
On a more positive note, what Europe, particularly the U.K, has offered the market is more forward-looking solutions. The U.K. launched its Asset-Backed Securities Guarantee Scheme in April, allocating £50 billion ($75.9 billion), or E57 billion, to guarantee property securitizations. Under the scheme, the government will guarantee the timely payment of all amounts contractually due under the issued RMBS. This will effectively cover 'AAA' credit risk. Fitch Ratings said it had received feedback from investors indicating they are generally willing to take on good-quality credit risk of U.K. prime RMBS.
The second guarantee attempts to mitigate extension risk, which seems to be the primary concern of investors currently as prepayment rates have dropped lower than the level at which transactions initially priced. Investors will have the opportunity to utilize a put option that allows them to sell RMBS back to the issuer. Issuers will also be able to call notes after a certain date as well. Both options will be backed by a government guarantee.
"There are many differences between this scheme and the one that the U.K. Treasury previously announced," said Marco Angheben, director at the European Securitization Forum (ESF). "The main difference is that its purpose is to create conditions for the market to restart on a stronger footing rather than providing funding for banks." The markets have yet to fully factor in the effect of these measures, but market participants see an opportunity in the short term.
How many lenders will apply remains to be seen, since it's a little bit premature to determine what impact the scheme will have on volumes. Additionally, it is limited in that the mortgages that are eligible are the ones generated after January 2008. "Will lenders have the critical mass necessary in order to use the scheme?" Angheben questioned.
He added that some of the mortgages might also have been used in alternative programs, and generally banks look at a number of funding alternatives. At the moment, the scheme is available only for banks and building societies. However, Angheben said that there are other financial institutions that could also consider using the scheme if it becomes available.
Different from TALF
The U.K. government scheme is different from the U.S. Treasury's Term ABS Loan Facility (TALF) initiative in that its goal is to provide support for new mortgage lending. In the U.S., there are a number of programs aimed at strengthening banks' balance sheets while improving the discovery process and fair valuation of assets. "In the U.K., the initiatives have focused more on providing guarantees for legacy securities held on balance sheet and on guarantees for actual new issuance," said Douglas Long, executive vice president of business strategy at Principia Partners. "In some respects, it is a slight reverse to the situation in the U.S."
According to data reported by Societe Generale, the participation ratio for TALF reached 76% in the third round, which is the best result to date. The size of a number of deals rose, and the range of asset classes grew, with the launch of first-time equipment and student loan deals as well as SBA loans. And like previous sessions, the May session was dominated by auto and credit card ABS.
"We believe that this constitutes the first signs of a recovery in the U.S. ABS primary market, although it is far too early to estimate what the full-year issuance figures will be," said Jean-David Cirotteau, SocGen securitization research analyst. "The various measures by the U.S. government and the Fed are starting to heal the ABS market. The high rate of return for TALF investments - particularly in comparison to other credit investments - and the good performances of the underlying portfolios are drawing in investors. As a result, the liquidity premium is gradually disappearing."
However, Cirotteau believes that the resurgence in the U.S. may be more difficult to replicate elsewhere. "The U.S. has a genuine investor base that has fully integrated ABS products into their investment processes," he explained. "The same cannot be said of Europe, so it may prove more difficult to achieve a recovery on this side of the Atlantic."
While the TALF initiative is seen as fundamental for a recovery of the market, it cannot stand alone. "It highlights that there are good things about leveraged structures that we saw before, but only if there is control, regulation and confidence in diligently managing these types of operations," Long said. "Initiatives need to be two-pronged. They must allow for a quick reduction in the large asset overhang and secondly stimulate new issuance."
The variety of initiatives is aimed at addressing one or both of these challenges. It appears, at least in the U.S., that some headway is being made on the new issuance front in terms of the TALF program and PPIP. "I do believe more needs to happen to address legacy assets, and this needs to be done in a consistent manner. It's not enough unless the drive to change at an operational level happens at the same time," Cirotteau said.
Long explained that people getting involved in TALF and the PPIP will kick-start liquidity in the short term, but funds or banks looking for a long-term, sustainable business will have to consider using proven administrators with strong and transparent management and systems in place. They should also look at developing an internal scalable platform to support long-term growth and implement a unified and robust infrastructure that can handle the increasing numbers of investments, portfolios or business entities.
In Europe, some players argue that this lack of government-provided leverage via a TALF/PPIP-like program is inhibiting a more orderly U.S.-style asset unwind - one where buyers return hurdles that can more easily be matched with acceptable seller write-downs.
"In direct contrast to the U.S. ABS market, the European market continues in our opinion to face the twin challenges of a lack of substantial depth in bid-side liquidity and an unwillingness to sell down at distressed levels," Deutsche Bank analysts said.
There remains a concern in Europe over investor appetite for mortgage-based products, Cirotteau said. The European Central Bank's (ECB) announcement that it will start directly purchasing covered bonds highlights the problems of this asset class. "The measure should support covered bond prices and liquidity, although ABS participants are still wondering about the feasibility of the U.K. RMBS guarantee scheme," Cirotteau said. "It is clear that the ECB scheme will have a more direct impact. Indeed, we have been advocating for some time that the ECB could and should purchase ABS paper directly, perhaps through open market operations. This could provide a floor for prices in certain ABS asset classes, though direct purchases by the ECB seem unlikely at this stage."
But Long said that even with the ECB purchasing ABS assets, though it would certainly provide some quantitative easing, it does not get investors back in the market.
Preparing for Down the Road
Being prepared and able to meet the demands that are being placed on them by regulators, internal management and investors is the best preparation structured finance market participants on both side of the Atlantic can make to take advantage of the changes happening in the market.
The current environment has effectively mandated that anyone managing structured finance portfolios needs a robust and sophisticated operation to support the portfolio management, risk oversight, reporting and accounting needs. Previously, this really was limited to businesses that were mandated externally to have such strong operations. Those involved in structured financemust be able to really understand investments and manage their portfolio initially and on an ongoing basis.
For instance, Long said that market participants have to prepare for the PPIP mandates for risk control, operational infrastructure, initial and ongoing deal/portfolio monitoring; Basel II securitization framework requirements; accounting requirements and ongoing changes from the International Accounting Standards Board and Financial Accounting Standards Board. "From an internal perspective, the challenge is to find ways to easily disseminate data across the enterprise in a consistent way," he explained. "Having such a controlled and flexible structured finance operation allows structured finance participants to adapt to market changes and quickly capitalize on new opportunities."
What this means is that participants should be introducing an integrated approach for their investment management activities with the required risk control and oversight functions that run from operations through to accounting. This preparation, said Long, was core to any regulatory and investor requirements.
Participants also need to present a clean and consistent view of their portfolios with the required detailed level of valuation, cashflow and performance data - irrespective of the data source. "And not just on an initial investment decision - but more importantly on an ongoing basis," he said. "Integration into overall risk function is key but extends beyond integration into an organization's enterprise risk calculations. With structured finance portfolios, the unique challenge is to additionally perform consolidated risk surveillance (across all structured finance portfolios - on and off balance sheet) and be able to present and manage to the portfolio diversification and risk limits mandated by the business."
The Importance of Keeping Order
In the current economic environment, having the best handle on their structured finance portfolios will also give participants the best chances of survival and prepare them for any market pickup. The evolution of the market has likewise brought up new issues on the asset servicing front.
The market changes have highlighted a number of general problems with the way structured finance portfolios were managed previously. The overriding theme is that managers must be able to understand the asset and its associated risks and have the ability to prove they have full control of the portfolio and be able to assess the investment's value both up front and then on an ongoing basis.
The U.K. scheme, for example, requires issuers to adhere to the ESF designed RMBS Issuer Principles for Transparency and Disclosure, Version 1, issued in February 2009. "Importantly, this plan will i mprove transparency and consistency for pre- and post-issuance disclosure," said Rick Watson, managing director of Securities Industry and Financial Markets Association and ESF.
Angheben said that 14 U.K. lenders that issued RMBS have endorsed the principles representing 70% of cumulative issuance. These 14 institutions plan to start issuing new transactions from their 19 RMBS programs from the end of this year according to the new industry standards.
In continental Europe, however, only a handful of Dutch entities have endorsed the principles, and it still remains a challenge to get a broader consensus. One reason is that the continental housing market has not declined as sharply as in the U.K.
Another reason is that there are still a number of market players experiencing issues with their IT systems because of the recent spate of mergers dominating the continent in the past few years. These IT systems are, in some cases, not fully integrated, and it takes time with substantial costs involved to merge them. "It could be potentially that those who do move to endorse the principles are at a competitive advantage to the ones that are not using the post-issuance template," Angheben said. He suspected that the major players on the continent will move to implement the principles almost all at once, as happened in the U.K.
"In Europe there are more issues with respect to data consistency across the geographical regions than in the U.S. - but industry bodies like the ESF are working to standardize this, e.g., the standard issuer report templates," Long said.
The mandated requirements being placed on business units managing structured finance operations and portfolios are absolutely the same on both sides of the continent. And while the road to recovery is pock-marked with many bumps, issues such as standardization of reporting standards have really found some momentum.
"Our business model has always been to really provide this standardized operating environment - this means having the strong backbone that banks, asset managers/administrators and other specialist managers need but with the ability to tweak it so it can meet the unique deal structuring, operating and disclosure guidelines of any type of structured finance business," Long said. "The market is validating a lot of the work we have been doing for years.
"Another key differentiator and continued driver for us is the way we integrate front office deal data and cashflows into risk, operations and accounting," Long said. "People often manage this integration manually, which creates operational risk and ongoing administration challenges. With Principia you can just plug in the CUSIPs and it flows the factors and cashflows through the entire operation, allowing control of incorrect or late information coming from the deal."
He added that Principia is working with all the leading data providers such as Intex, Markit, Standard & Poor's and Lewtan.
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