Thursday, March 4, 2010

Structured Credit Ups and Downs

Original posted on Structured Credit Investor:

Regulatory change continues to impact the vitality of the securitisation market, but at least the parameters of that change are becoming clearer as the year progresses. Within these parameters, new structuring ideas are beginning to be discussed.

"The substance of regulatory change is pushing back on the vitality and robustness of the securitisation market, but I'm encouraged that at least some uncertainty is gradually disappearing," James Croke, partner at Orrick noted at a seminar held at the firm's offices last week. "The eventual outcome should spur the development of the technology and legal tools to enable the market to create better credit products. I'm optimistic about transaction flow this year: we're already seeing some interesting ideas being bounced around."

Martin Bartlam, partner at Orrick added: "The problem with regulatory regimes is that they typically herd everyone towards the same state of mind in terms of risk - for example, liquidity was not considered as a factor previously. The forthcoming changes will help deal with some of these issues, but the danger remains that if there is something wrong with the underlying model, it could hurt everyone. Capital requirements are ultimately likely to be greater than necessary, but this isn't an unexpected response and they could be refined over time."

He pointed to the EU's CRD 2 initiative, which is expected to be concluded this year, as an example of regulatory progress. "However, the market still needs more clarity around what investor 'due diligence' means and how 'skin in the game' should be measured, as well as what exactly constitutes a resecuritisation (as potentially any tranched deal could qualify) or significant risk transfer. One possible outcome of such stipulations is that a different market for 'non-credit institutions' could develop."

Croke identified the Basel Committee's liquidity risk management proposals and FAS 166/167 as the most significant regulatory changes impacting the US ABS market, suggesting that there is potential for an entity to exploit the tension between the proposed rules and the ability of corporates to raise finance. For instance, the consolidation of ABCP conduits and other managed vehicles under FAS 167 removes the impetus for the supply-side to finance assets in this way.

It will also be interesting to see how the market reacts to the FDIC's recent ANPR (SCI passim), according to Croke. "If sellers can still demonstrate a sale under FAS 166/167, the FDIC will allow the safe harbour to remain. It's a technical problem, but I'm not sure that this is such an attractive fix."

He explained that there is a 45- or 90-day period following an insolvency, during which the FDIC can step in and potentially disrupt cashflows. "It will be difficult for lawyers to give an opinion on bankruptcy remoteness in such a situation. It feels more like an enhanced form of secured lending, but perhaps this will become part of a new market paradigm."

The US government was described as having a "strong lever", especially in terms of mortgage securitisation, and so has included a number of policy objectives into the ANPR rule. Two objectives were highlighted in particular.

First, the compensation limitations for servicers and other counterparties involved in a securitisation. In some cases, compensation will be paid over a five-year period, depending on how the deal performs.

Second, all mortgage loans will need to be seasoned for 12 months before they're securitised. However, given that many US banks are retreating from asset warehousing, this stipulation could create an opportunity for third parties to hold loans for the duration of the seasoning period.

Meanwhile, Basel's liquidity proposals were described as signalling a "fundamental shift" for the financial system in that they require banks to hold significantly more permanent capital. Any payment obligation that a bank may be called to make within 30 days, including payment obligations on instruments issued under a consolidated securitisation, will generally need to be 100% collateralised by either US government securities or significantly overcollateralised amounts of certain high credit quality corporate or covered bond obligations.

"Obviously this will make short-term funding more expensive for banks and thus is a significant disincentive to financing assets in that fashion. I doubt that many corporate clients are fully aware that this financing route may dry up, given that corporate commercial paper is contingent on back-up facilities," Croke continued.

The ABCP sector is also being impacted by the resecuritisation rules under Basel 2. Programmes with partial sponsor support will be classed as tranched exposure and thus count as resecuritisations, while a liquidity facility on a single pool of diverse assets won't be. Consequently, bank investors will either be reluctant to buy CP that isn't fully supported or some form of tiering could emerge between supported and non-supported issuers.

At the same time, SEC rules for money market funds have also changed and now stipulate that they have to hold shorter maturities, including a 30% allocation of government assets maturing in 60 days or less or ABCP maturing in seven days or less. Croke indicated that these new requirements could prompt issuers to begin tailoring product specifically for this segment.

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