The U.K. government plans to implement its Asset Protection Scheme by April 2009. However, it has yet to unveil the scheme's full details.
Nonetheless, market players are hoping that this step will lead to a more stabilized banking system and better spreads for securitizations.
"In our view, the new scheme is a useful tool to provide stability to the constrained environment, and the plan will help to restore urgently needed confidence on primary and secondary markets as well as to the whole U.K. financial system," Unicredit analysts said. "Spread stabilization on credit markets, including the ABS sector, might be the consequence if the scheme is applied."
The scheme is part of a comprehensive package provided by the U.K. Treasury. The scheme provides government protection against future losses of the riskiest assets held by large U.K. banks. ABS assets such as cash RMBS, CMBS, CLOs and CDOs are eligible for the scheme.
According to the U.K. Treasury, banks will receive protection for a proportion of their balance sheets so that the healthier core of their commercial business is able to continue to lend to creditworthy businesses and households.
Protection is provided to the extent that credit losses exceed a "first loss" amount of 10% of the protected exposure, which still has to be borne by the protected institution.
Ian Linnell, head of structured finance for EMEA at Fitch Ratings, said that the inclusion of the 10% residual exposure encourages the banks to manage the assets prudently and fulfill the servicing role effectively. This alignment of interests will limit losses to the U.K. taxpayer and support the ratings on these securities.
"The asset protection scheme is designed to kick-start lending by removing toxic loans from banks with a taxpayers' guarantee," said Salim Nathoo, head of securitization at Allen & Overy. "The scheme will no doubt go a long way to helping stabilize and strengthen the financial markets, as it will help reduce uncertainty and give greater confidence in the future creditworthiness of businesses."
The protection provided by the government will cover the remaining 90% of any credit losses that exceed this first loss. The first loss piece ensures that participating institutions fulfill an appropriate servicing and portfolio management process.
To participate in the scheme and receive protection, banks need to pay a fee and are legally required by the U.K. government to provide lending to households and businesses, which could provide a renewed flow of assets available for securitization.
"Although the securitization markets remain closed at the present time, such an increased flow of assets could be used for the purposes of the government's proposed guarantee scheme for asset-backed securities," said Stuart Jennings, structured finance risk officer for EMEA at Fitch. "The guarantee scheme offers the chance for a revival of primary structured finance issuance to investors."
Banks Already Using Scheme
The Royal Bank of Scotland is one of the first banks to queue up for the scheme. The bank announced that it would insure £325 billion ($452 billion) of assets through the facility.
The bank will pay the U.K. government £6.5 billion to insure the £325 billion of assets, equivalent to a 2% fee, according to market reports. RBS will assume a first loss piece of £19.5 billion, 6% of the total pool of assets being covered, and also retain exposure to 10% of losses on the remainder of the pool - for a total potential exposure of £50 billion.
Standard & Poor's said that the RBS capitalization should be strengthened by its planned entry into the scheme, which will be crucial given the expectation of a material rise in credit risk across RBS' key markets.
More recently, Lloyds Banking Group announced its intention to participate in the scheme. The bank has agreed to take insurance through the scheme on £260 billion par value of its assets, with an expected value of £250 billion net of impairments and provisions, an average mark of 96%. Lloyds will bear a first loss amount in respect of the covered assets.
The amount of the first loss will be up to £25 billion, or 10% of the carrying value, compared with the 6.5% first loss for RBS. Lloyds also faces a steeper fee; at a £15.6 billion premium, it represents a 6.2% fee for use of the scheme.
"Participating in the government's Asset Protection Scheme substantially reduces the risk profile of the Group's balance sheet," said Eric Daniels, group chief executive at the bank. "Our significantly enhanced capital position will ensure that the Group can weather the severest of economic downturns and emerge strongly when the economy recovers. We believe that this is an appropriate deal for our shareholders."
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