Standard & Poor’s does not want to take the blame for Europe's stagnant securitization market.
In a report published today, the rating agency today cites multiple other factors holding up issuance of asset-backed securities in the region, including continued economic weakness, low underlying credit origination volumes, bank balance sheet retrenchment, and plentiful cheap alternative funding sources.
Annual issuance of investor-placed European securitization has ranged between 60 billion ($82 billion) and 80 billion since 2010—down from a high of about 500 billion in 2006, before the financial crisis.
European regulators have argued that that stricter credit ratings are one of the market's remaining structural roadblocks. In an April report, the European Central Bank and the Bank of England wrote that "rating agencies now require far greater levels of credit enhancement to achieve a given rating" on a securitization tranche than they would have done some years ago—and that this makes securitizations "more costly to issue."
The central banks' report also cites the fact that—in some European countries—rating agencies currently limit the highest rating that they will assign to a securitization tranche, based on the respective sovereign ratings, but "not related to the underlying collateral quality."
As a result, 'AAA' ratings are generally not currently achievable in securitizations backed by underlying collateral from Italy or Spain, for example, regardless of a tranche's credit enhancement or the underlying collateral quality.
Not a surprise, this rubs S&P the wrong way. “The paper implies that this could be problematic, given that 'AAA' ratings were historically the benchmark’ in the securitization market,” analysts at the rating agency state in their report.
S&P says that its reassessment of risk for securitization reflects the riskier economic environment; it does not agree that “a shift toward lower ratings should necessarily constrain securitization.”
Rather, "requiring greater levels of credit enhancement to achieve a given rating is equivalent to assigning a lower rating for a given level of credit enhancement,” the report states. “In other words, for a given securitization tranche, the rating today may be lower than it was some years ago. We note that this situation is no different to many other classes of credit instrument."
By the end of last year, S&P had lowered its rating on about 55% of the European securitizations that outstanding as of mid-2007. This reassessment of risk was not limited to asset-backeds however the ratings agency took similar action with its rated European financial institutions, where it lowered 65% of its ratings over the same period. The same trend happened in the ratings agency European non-financial corporates ratings, where it lowered 50% or the ratings.
“This simply suggests that our opinion of debtors' creditworthiness across a wide variety of sectors has generally fallen over the past six to seven years, or, equivalently, that credit risk has generally increased, in our assessment,” said analysts in the report. “This is perhaps unsurprising, given ongoing depressed economic conditions and dysfunctional banking systems across large parts of Europe”.
Further, while credit enhancement requirements have risen for securitizations, so has the risk premia on originators' other funding options. “In that sense, the rising cost of securitization funding may not result in a relative disincentive for originators to use it,” explained S&P.
As far as the ratings agency's sovereign-related rating caps, S&P does not believe that the current inability to achieve 'AAA' ratings in some countries is not necessarily hurting investor demand. It argues that investor sentiment has evolved beyond the 'AAA' ratings benchmark, and today buyers are willing to recognize that ratings in the 'AA' and 'A' categories, “still represent very strong or strong capacity to meet financial commitments”.
The chart below illustartes how spreads in Italian RMBS have tightened even as S&P has capped ratings at the 'AA' level for Italian-related deals.
Two other examples are Spain and Italy’s covered bonds: these programs used to be rated 'AAA,' but “issuance has continued despite the fact that ratings are now lower,” said S&P.
“Investor demand for securitizations from these countries also appears to remain strong. In fact, spreads on senior RMBS from countries where 'AAA' ratings are generally no longer achievable have actually tightened substantially over the past three or four years, despite country risk increasingly constraining our senior tranche ratings.”