Thursday, January 21, 2010

The Time for Government Intervention in the European ABS Market Has Passed

Original posted on Structured Credit Investor:

The need for government intervention in the European ABS market has passed, according to panellists at a Fitch-hosted conference in London this week. Improving investor appetite, increasing confidence in the performance of existing European transactions and the re-emergence of a primary market were listed as positives for the sector.

"There was a time and a place for government intervention in the European ABS market, but that time has passed," said Robert Liao of Citi's European securitisation market team. "We don't want to create an artificial environment for ABS. If anything, we need constructive statements from governments and consistency between the support they provide to financial products. At the moment, governments are sending mixed messages about the implied quality of an investment by either supporting or not supporting a sector."

This view was shared by Ian Stewart, head of securitisation at Lloyds Banking Group. He commented that there was a time when more government stimuli would have been helpful, but now that investors are moving back to the market of their own accord, direct government intervention is not necessarily needed.

Graham Page, head of credit at RZB, noted that it would be good, however, to see new ABS deals properly distributed - in other words, without a US bank buying a large proportion of the notes. "If, during 2010, there were around four to five new deals issued a month, I think investor demand could easily meet supply," he said. "However, if that moved to four to five deals per week, I'm not sure that the investor base could swallow it: I'm not entirely sure of what the investor base is."

Notwithstanding the fact that many macroeconomic indicators are pointing to stabilisation in the European structured finance sector, Fitch's structured finance analysts continue to believe that the sector's recovery is fragile and vulnerable to external shocks. "Unemployment is still rising in many European countries and the risk of significant payment shock remains as interest rates begin to increase, particularly as we move into 2011," said Ian Linnel, head of EMEA structured finance at Fitch. "These factors, combined with the fact that many re-financing markets remain illiquid, mean that the scope for further deterioration in European structured finance asset performance remains."

This is reflected in the fact that outlooks for ratings in certain sectors have deteriorated as the effects of the global credit crisis continue to flow through. Fitch says rating changes are likely to still be focused on junior classes, but some criteria changes (for example, in respect of Dutch NHG-backed mortgages) and worst performing deals could mean that ratings further up the curve are affected.

"Prime European consumer ABS and RMBS has performed robustly during the credit crisis, although it is recognised that a major contributing factor to this stable performance has been the very low interest rates, so a sudden rise could have negative consequences," said Page. "Other potential brakes to a recovery in the ABS market could be declining sovereign risk, as exemplified by the recent rating actions on Greek ABS, and it remains to be seen what - if any - affect the various support measures undertaken by some governments (e.g. Italy) will have on the RMBS associated with these regions."

"Governments, regulators and central banks potentially hinder a recovery in the sector due to the lack of clarity in their views," added Liao.

The CRD's 5% ABS retention rule - which is to be applied to all new European primary ABS issuance from 2011 - was also discussed at the conference. Certain panellists expressed their scepticism over the introduction of the rule, suggesting that European regulators were introducing it as a result of European bank losses from recent vintage, 100% originate-to-distribute US subprime RMBS transactions.

Panellists also indicated that the retention rule would not necessarily affect bank business models, but expressed concern over its consequences for non-bank originators. Gerard Breen of the structured finance prudential risk division at the UK FSA argued that the ABS retention rule comes as part of a package of measures, noting that - in and of itself - it will not singlehandedly create alignment of interests between investors and originators.

"We are aware of the retention rule's limitations, such as the fact that 5% retention can, under certain circumstances, be factored into the economics of a transaction by the originator. However, we are also aware of its benefits: as part of a larger package of measures, it discourages the 100% originate to distribute model, helps address the potential misalignment of incentives, and introduces some kind of balance sheet constraint."

He concluded: "The key to its success will be its implementation, and we are currently discussing the details surrounding this."

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