Two years ago the European Central Bank and Bank of England published a joint report berating regulatory incentives that cause ‘undue overreliance’ on covered bonds in preference to securitizations.
Two years before that, in 2012, Fitch published a report showing that realised losses in the European ABS market were negligible. Despite that, regulations continue to incentivise issuers and investors to stick to a uniform secured funding model with covered bonds at its heart.
This was underlined by a report published on Tuesday by De Nederlandsche Bank (DNB) which showed covered bonds had become a larger source of funding for Dutch banks than the securitization market. The central bank said that total outstanding securitizations had fallen by 22% to €58bn last year, while outstanding covered bond supply grew to €61bn. Dutch ABS that was placed with real investors amounted to just €5.5bn, some 50% below levels seen in 2014 and the lowest level seen since 2009.
The sharp decline in ABS supply was due to “ill-repute, stricter rules governing securitizations and weakened credit growth”, said the DNB. More pointedly, it blamed the prudential treatment of securitizations “notably capital requirements which are more onerous for investors compared with covered bonds”. The DNB also berated the poor treatment of securitizations in bank liquidity buffers.
The DNB’s report comes two years after the ECB and BOE said prudently structured, high-quality ABS tranches provide the same credit protection as covered bonds, both being backed by virtually equivalent collateral. The report suggested high-quality ABS markets would be revived if risk weights were cut towards levels seen in covered bonds and if securitizations got better treatment in bank liquidity coverage ratios. But as the DNB reports shows, nothing has changed.
Though the covered bond market has so far proved exemplary, providing access to almost all types of issuer in some very challenging times, this does not mean the market will continue to function in the same way in the future.
The psychology of any market is such that if only one part of it becomes tainted, the whole sector risks coming unstuck. Overreliance on any one asset class at the expense of any other is never a good idea.