Back to the future of securitisation? Learning from the past to boost the economy…

Securitisation 101 – the basics

Securitisation is a financing technique by which income-generating assets are pooled and sold to a specially created third party, which uses them as collateral to issue securities and sell them in the financial markets.

Securitisation is a useful tool used by a wide range of stakeholders in the financial industry:

  • Banks use it to free some capital, hence increase their lending capacity (banks use securitisation to remove the assets (loans) from their balance sheet, which allows the release of regulatory capital),
  • Investors use it to capture yield premiums over similarly rated debt products, to trade pooled assets that would be difficult to trade on their own and finally to invest in products with specific payoffs matching their needs.

Securitisation is considered as an efficient and powerful funding mechanism for the real economy.

Securitisation can take many shapes:

  • Traditional products
    • ABS (asset backed securities): securities whose collateral is mainly composed of mortgage loans (MBS, CMBS); non-mortgage securities can be composed of various assets (e.g. automotive loans, credit cards receivables … or even future returns on assets such as planes or copyrights).
    • CDO (collateralised debt obligations): securities whose collateral is mainly composed of bonds (CBO), loans (CLO) or even ABS.
  • Synthetic i.e. use credit derivatives to transfer only the credit risk of the asset pool and not the asset themselves.
  • Re-Securitisation i.e. when a pool of securities, issued by an SSPE in earlier securitisations, is bought
    by an originator and securitised again.

The European securitisation market – the context

To understand the rationale behind the STS (Simple, Transparent and Standardised) Regulation framework, we need to look back almost 20 years ago. Back then, US issuance volumes were close to €1bn per year and European volumes were insignificant.  In the years before the crisis, investors’ appetite led to a quick growth in American issuances (EU iss. rose too, but on a smaller scale), which peaked at almost €3bn in 2003.

Progressively, high quality underlying exposures became rare, and the market struggled to satisfy investors’ appetite. The “solution” came from complex structures, based on lower quality exposures. Investors – driven by market euphoria- kept buying, even though they didn’t have the tools and knowledge to properly assess the risks involved. When the crisis arrived in 2007-2008, US sub-prime RMBS massively defaulted and investors’ portfolios suffered. Default rates in some securitised products were particularly high and investors realised that they had underestimated the risks involved in such products; especially the opaque and complex ones…

This shed a negative light on the entire securitisation market. Both US and EU volumes collapsed. But, as always after crisis, US volumes recovered quickly but remain very low in Europe, cutting access for the European economy to an interesting source of funding.

 

Historical issuance in €bn. Source AFME

The new regulatory framework at a glance

Desperately trying to find new ways to boost economic growth, the European Commission re-opened the case of the securitisation market in 2015. Gathering feedbacks from consultations with national regulators and lobbyists, the EC decided to review the securitisation regulation with the aim to resume the market.

This gave birth to a new regulatory framework made of two texts: the Simple Transparent & Standardized Regulation (STS) and the Securitisation Prudential Regulation (SPR). The regulations will be applied from January 2019.

The framework pursues three clearly identified goals:

  1. Promote securitisation to boost the economy
  2. Harmonise and standardise securitisation market across the EU
  3. Protect investors and manage systemic risk

The transparency/reporting requirements are particularly interesting, as they lead to new disclosures towards investors and regulators as well as to the creation of data repositories.  Reports should be sent before the sale and regularly during the life of the product. Once the product has been sold to investors, originators/sponsors/SSPE are still due to send monthly (ABCP) / quarterly (other sec.) reports, which include a precise set of information. Besides, the Regulator defined a list of significant events for which special reports should be sent.

The most appealing measure as impacting directly the P&L is the link to Securitisation Prudential Regulation. Indeed, capital cost for investors of these simpler, more transparent and standardised products are reduced vs. current method and other securitised products.In practice, risk weights floors and caps have been redefined. Some STS securitisations (both ABCP and term sec.) will benefit from lower (10% vs. 15%) risk weights floors.

Senior tanche 5y maturity

Credit quality step 1 2 3 4
Non STS risk weight 20% 30% 40% 45%
STS risk weight 10% 15% 20% 25%

 

Significant risk weight differences (example on the SEC-ERBA method)

STS Criteria for Term securitisations

Becoming STS is not easy as pie, 20+ stringent criteria are to be assessed (even more if we consider the variations per types of products).

We highlight below the main criteria for term securitisations to comply with in order to be eligible to the STS label. The criteria should guarantee a high standard of quality in the product structure as well as a clear presentation of the risks involved for investors. They don’t mean that these securitisations are less risky than Non-STS.

Simplicity

  1. True Sale : The ownership of the underlying exposures should be transferred to a Securitisation Special Purpose Entity (SSPE). This excludes synthetic securitisations from the label, as only the credit risk is transferred in such processes (using derivatives).
  1. Representations and warranties: The seller shall provide representations/warranties that the underlying exposures are not in a condition which can affect the enforceability of the sale.
  1. No active portfolio management of exposures: The underlying exposures shall meet predetermined eligibility criteria and can’t be actively managed. This excludes most CLOs (managed) from the STS label.
  1. Homogeneity: The underlying exposures should be homogeneous in terms of asset type. They should be contractually binding and enforceable obligations with full recourses to debtors, with defined periodic payments. The exposures should not include transferable securities.
  1. Ban on re-securitisation: The underlying exposures shall not include securitisations.
  1. Ordinary course origination: The underlying exposures shall be originated in the ordinary course of the originator’s (or original lender’s) business. They should respect same standards as similar exposures that are not securitized. The originator shall have expertise in originating exposures of similar natures.
  1. No exposures in default: At the time of transfer to the SSPE, exposures:  should not be in default and should not expose to credit-impaired debtors.
  1. One payment done: At the time of transfer, debtors shall have made at least one payment.
  1. No dependence on assets sales: Repayments of holders of the securitisations should not depend on the sale of assets securing the exposures.

Standardisation

  1. Risk retention: The same retention (5%) obligation as all securitisations shall be respected.
  1. Hedging of IR and FX risks: Rates and currency risks shall be hedged and hedging measures shall be disclosed.
  1. Compulsory use of rates benchmarks for interest payments
  2. Principal receipts passed to investors: No substantial amount of cash shall be trapped in the SSPE, principal receipts from the underlying exposures shall be passed to investors via amortization of positions. This should be done according to the seniority of the securitisation position. Automatic liquidation of the underlying exposures at market value is not allowed.
  1. Documentation shall include early amortization events or triggers for termination of the revolving period: The required events are:  (a) a deterioration in the credit quality of the underlying exposures to or below a pre-determined threshold; (b) the occurrence of an insolvency-related event with regard to the originator or the servicer; (c) the value of the underlying exposures held by the SSPE falls below a pre-determined threshold; (d) a failure to generate sufficient new underlying exposures that meet the pre-determined credit quality
  1. Documentation shall clarify obligations, duties and responsibilities of the servicer
  2. Documentation shall include definitions, remedies and actions relating to delinquency and default of debtors
  3. The transaction document shall include provisions to facilitate the resolution of conflicts

Transparency:

  1. Historical data on default: The originator, sponsor and SSPE shall provide access to data on default and loss performance for similar exposures to those being securitized. Data shall cover 7 years for non-retail exposures and 5 years for retail exposures.
  1. External verification: Exposures (a sample) should be externally verified prior to issuance of the securities.
  1. Cash flow model: The investors should be provided with a liability cash flow model, both before pricing and on an ongoing basis.
  1. General transparency: The securitisation shall respect transparency requirements applicable to all securitisations.

To conclude… a good initiative … but it will take time to bear fruit 

At this time, it is difficult to estimate the actual boost to the securitisation market that will be provided by this regulatory pack. Criteria go in the right direction but they pile up into a long list, which will probably prevent any quick market response in 2019.

However, securitisation stakeholders should anticipate the arrival of the new requirements/ STS label. The regulation is broad and will impact several teams (front, back, IT, risks, compliance). Ultimately, the first banks/ investors to be ready will theoretically be able to capture new market share/higher yield.

 

Sources:

European Parliament: Common rules and new framework for securitisation: http://www.europarl.europa.eu/RegData/etudes/BRIE/2017/608777/EPRS_BRI(2017)608777_EN.pdf

Basel Committee Consultation: https://www.bis.org/bcbs/publ/d304.pdf

STS regulation: http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32017R2402&from=EN

Regulation amending Regulation no 575/2013 on prudential requirements for credit institutions and investment firms: http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32017R2401&from=en