European securitization industry lobbyists have long argued that the market is misunderstood — rather than the complex, murky market that the financial crisis helped demonise in the US, in Europe it has traditionally been a more vanilla form of funding and balance sheet relief, they say.
To help lobby for better regulatory treatment of the market, the industry has pitched the idea of “simple, transparent and standardised” securitization as a way of encouraging European politicians to overcome those crisis-era characterisations of the market.
But casting the market as a simple and straightforward financing used mainly by banks is at odds with the reality of market trends.
The renewed interest of private equity firms in arbitrage possibilities for warehoused portfolios, the interest of investment banks looking to serve that business, and the growing use of securitization as a niche, private, bespoke funding tool point to a market that is anything but standardised — even if the collateral pools are as transparent as can be.
Behind closed doors
This year has already seen a raft of private synthetic securitization deals from banks looking to clean up their balance sheets and reduce risk weighted assets in the expectation of new, more punitive credit risk weights from the Basel Committee.
While balance sheet relief is often touted as one of the benefits of a functioning securitization market, it is rare to find these deals in the public market.
Just one significant publicly syndicated balance sheet relief trade has been closed this year — Obvion’s €1bn Purple Storm Dutch RMBS deal, which closed in July this year. Capital relief trades face tricky accounting hurdles, and must attract the attention of a narrow and highly specialised investor base for junior ABS exposures.
The synthetic securitization market can appear more complex than publicly syndicated balance sheet relief deals. The trades are private and often bilateral, with little information circulated beyond the investors being shown the deal. While it is not the side of the market that lobbyists arguing for better regulatory treatment for ABS would like to promote, it is booming. At least 28 trades were closed last year.
Funding alternatives
On the funding side of the market, industry lobbyists argue that securitization is the means by which banks can finance the origination of loans that help the real economy — mortgages, auto loans and consumer loans.
But for banks at least, there are cheaper alternatives. Even without the Bank of England’s Term Funding Scheme, offering four year funding at little over the base rate, UK and European mortgage lenders have preferred to take funding in the covered bond markets, or through retail deposits. European insurance companies have shown more interest in buying whole loan portfolios, rather than RMBS paper, because of punitive Solvency II risk weightings. Banks have been happy to sell those portfolios rather than go through the expense of structuring a securitization deal.
Based on this dwindling public issuance — on Monday, Bank of America Merrill Lynch reaffirmed a long standing trend of quarterly public ABS issuance falling, year on year — the industry’s argument that the instrument is a straightforward funding tool falls a little flat.
Private equity fuel
This is where the role of the securitization market as a more exotic instrument, ready to lock in a funding arbitrage for private equity comes in.
Private equity firms such as Cerberus and Blackstone have been monitoring spreads in the asset class while sitting on large portfolios, acquired from bank sellers as far back as two years ago. The summer rally in spreads has now made the securitization route an attractive way to fund these portfolios, of legacy UK buy-to-let loans, and Spanish reperforming mortgages, acquired at a steep discount in 2014.
Another deal of this kind could soon surface, from the portfolio of Dutch mortgages acquired from Rabobank subsidiary RNHB by CarVal investors and UK-based debt recovery specialist Arrow Global. It would be a classic private equity arbitrage deal — a bank looking to deleverage its balance sheet offloads hefty mortgage exposures to a private equity firm that can refinance the portfolio attractively, when the time is right.
Syndicate banks are acutely aware of the future direction of travel for securitization. Rather than picking up slim fees in regular, programmatic standardised deals from issuers such as the captive auto finance companies, the real money is in the bespoke, one-off trades to leverage portfolios for private equity firms. More and more banks are retooling their business for these deals, rather than betting on an upswing in cookie-cutter flow issuance.
There is nothing wrong with being a complicated market, if it is fit for purpose. While banks have a raft of cheap funding and balance sheet tools, securitization’s strength lies partly in its suitability for financing more challenging portfolios. That's a very worthwhile niche to fill, and the better the terms of financing for the private equity firms, the higher their bids will be for other legacy assets.
But it is at odds with the stories that industry lobbyists have been telling European policymakers. Better to be honest, and say that it is a complicated market, and that's OK.