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New Regulations Could Hurt European Securitization Market

Despite a boost in activity in February, securitization remains deeply unfashionable in Europe the market could be further shrunk by new regulations.

FEBRUARY WAS AN EXCEPTIONALLY ACTIVE MONTH for European securitization. First, CQS Management, the $11.2 billion, London-­based multistrategy hedge fund led by CEO Michael Hintze, unveiled a new asset-backed securities fund. Then U.K. holiday company Center Parcs launched a £1 billion ($1.6 billion) whole business securitization in which fund managers made up 63 percent of investors. If these events indicate that the market still has some life, they’re also anomalies. In many ways, securitization is deeply unfashionable in Europe. Hit by economic and regulatory fallout from the financial crisis, asset- and mortgage-backed securities have a small investor base that could shrink even further once Basel III and the European Union’s Solvency II directive come into force. About 80 percent of new issuance stays on bank balance sheets — a sharp contrast from the heyday of 2005–’07, when outside investors bought the vast majority of it, according to the Association for Financial Markets in Europe. But with senior unsecured debt off-limits for many banks, securitization has proved to be a versatile funding tool, and issuance is steady. “Securitization for banks in the euro zone can be used to access public term funding markets or as a tool for repo lines with central banks or other market counterparties,” says Damon Mahon, London-based head of European ABS syndicate at Royal Bank of Scotland Group, lead manager of the Center Parcs deal. The biggest investor is the European Central Bank, which accepts a range of securitization as collateral for its vital loans to euro zone banks. As of December 2010 the ECB held €480 billion ($635 billion) worth of securitized products. That sum — about 24 percent of all collateral posted with the central bank — has swelled thanks to the ECB’s long-term refinancing operations. After injecting nearly €500 billion of liquidity into euro zone banks in December, the ECB announced a similar infusion on February 29. Its lending role is “a boost to overall issuance, illustrates that it is happy with the product and is in a sense a vote of confidence in it,” says Robert Plehn, head of securitization at Lloyds Banking Group in London. Although European issuance has plunged compared with 2007 and 2008, it’s in line with 2006 levels, AFME reports. Last year the total reached $508 billion, a slight drop from $515 billion in 2010. (The Securities Industry and Financial Markets Association has only released the figures in U.S. dollars.) Since 2006 residential-mortgage-backed securities have accounted for more than 50 percent of the market; U.K. and Dutch banks made several $1 billion-plus issues in the past year. Also prominent in 2011 was Spain’s Banco Santander: It launched three offerings worth more than $3 billion apiece, according to Dealogic, all of them U.K.-mortgage-backed securities. Low default rates and comparatively narrow spreads for issuers have helped. In a February report rating agency Standard & Poor’s noted that just 1 percent of structured-finance securities outstanding since mid-2007 had defaulted; on more than 70 percent, ratings held steady or climbed. Meanwhile, spreads on triple-A-rated RMBS floating-rate securities with a maturity of three to five years are typically fewer than 150 basis points over LIBOR, compared with about 500 basis points in 2009.  No wonder looming rule changes leave securitization pros frustrated. Continental European politicians and regulators tend to treat securitizations more harshly than covered bonds, Lloyds’ Plehn says: “This misalignment of treatment clearly will push agnostic investors away from securitization and into covered bonds.” The two main problems are Basel III, which doesn’t allow securitizations in bank liquidity buffers, and the EU’s Solvency II, which will impose capital charges on insurance companies. These regimes don’t take effect until 2013 and 2014, respectively, but they’re already influencing investor behavior, Plehn contends.

But some investors immune to the changes are seeking good returns. Due to amass $200 million by early April, CQS’s ABS Alpha Fund builds on the firm’s $2 billion ABS Fund, which posted an annualized net return of 29.3 percent from its October 2006 launch through the end of 2011. “The ECB’s substantial support for the wider market is reassuring for investors and has been one factor which has helped bolster European ABS appetite in early 2012,” says Alistair Lumsden, CQS’s chief investment officer for ABSs.  •  •

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