Changes to capital requirements for European insurers, while more securitization friendly, may still make asset backed securities unappealing to these important investors, according to a report published today by Standard & Poor’s.
In December 2013, the European Insurance and Occupational Pensions Authority (EIOPA) released the latest draft calibration of standardized capital charges for insurers' securitization holdings under the Solvency II regulatory framework. The updated proposal redefines some, but not all, securitizations as "Type A" exposures, and treats them more favorably than securitizations still termed "Type B".
Among the qualifications for Type A classification are: the securities cannot be subordinated to other tranches when it receives principal and interest after the delivery of an enforcement notice; they must be rated 'BBB-' or above at all times; provisions exist to ensure servicing continuity if the servicer defaults.
Solvency II also outlines asset-level requirements for Type A securitizations. The underlying assets must not include any credit-linked notes, swaps, synthetic securities, or derivatives other than those used to hedge foreign exchange and interest rate risk. Only residential mortgage loans, loans to small and midsize enterprises, auto loans, leases, consumer finance, or credit card receivables can back a Type A securitization and none of the loans can be in arrears for more than 90 days pior to being acquired as collateral.
The proposed capital charges for securitizations that meet all of these requirements are substantially lower than those detailed in the previous draft technical specifications published in December 2012 but, according to S&P, they neverthelss “remain high compared with other fixed-income investments and may still deter insurers from investing in the securitization market.”
For example, five-year 'AAA'-rated covered bonds and corporate bonds are subject to spread risk capital charges between 3% and 5%--five to six times lower than for Type A securitizations.
The securitization capital requirements for European insurers under the proposed Solvency II rules are also more than 10 times higher in some cases than those for global banks under the most recently-proposed revisions to the Basel securitization framework.
“Questions remain over how significant a share of future European securitization issuance would qualify for Type A treatment under the rules, without material changes to current market practices,“ S&P credit analyst Mark Boyce stated in the report.
For example, back-up servicing agreements are not the norm in most European securitization asset classes, yet one of the requirements for Type A deals is that provisions exist to ensure servicing continuity if the servicer defaults.
"There's still scope for amendments to the Solvency II standards,” Boyce said. “However, while we believe that the December 2013 calibration changes imply greater policymaker support for the European securitization market, we anticipate that unless capital requirements fall further, many insurers would shun securitization investments."