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Still in the Race: European ABS Picks Up Speed, But Might Get Derailed
Asset Securitization Report--SourceMedia (July 30, 2010)
Europe has ridden into the summer months in the same state of uncertainty that has set the course for the last 18 months.

However, securitizations have not fallen off the bike yet. Market sources said that a growing interest from the buyside has been enough to elicit a steady cadence in primary issuance this summer.

In fact, over the last few months, published reports have indicated that some banks have even started to build up teams in anticipation of renewed securitization activity. At the same time, issuance volumes in the sector have picked up markedly from 3Q09, while origination activity for repo purposes has leveled off.

In the past months, there has been a spate of senior securitization hires. Among the latest senior appointments is Jennifer Wallaert, who was hired as a managing director in the securitized products team at UBS. She is responsible for northern-European fixed-income securitization. Wallaert follows Mark Graham who joined UBS in May from Deutsche Bank to be head of securitized products for the EMEA debt capital markets team.

Morgan Stanley hired Cecile Houlot, who will join the bank from JPMorgan next month as a managing director and head of securitization and structured solutions.

Deutsche Bank created a new position - head of European RMBS - for which it has hired Alex Maddox. Maddox was previously head of securitized products in Europe at Citadel Investment Group and had also established Lehman Brothers' European mortgage trading desk.

Coinciding with the surge in hirings has also been a growing pipeline of primary issuance.

According to a recent report from KfW, ?28 billion ($35.27 billion) was publicly placed in Europe's securitization market over 1H10, three times the amount placed in all of 2009.

This is likely reflective of returning investor confidence. In fact, despite continued volatility and uncertainty surrounding regulatory proposals, the European Central Bank's (ECB) restrictive monetary policy has made securitization more attractive to investors, KfW reported.

The jump in volume also shows that financial institutions are now more willing to participate in the securitization market.

"Banks are once again showing a strong interest in securitization as a means of easing the burden on their equity capital and of making their refinancing less dependent on the ECB," said Gunther Braunig, a member of KfW's managing board.

European primary ABS issuance remains relatively robust. Covered bond and senior financial issuance have revived following their virtual shutdown in May, as have primary ABS markets, albeit with placement limited to senior bonds of vanilla assets and placement predominantly via "club" syndications and private deals.

Still, the new-issue market remains primarily defined by Jumbo reverse enquiry trades that are symptomatic of a lopsided investor base in which a handful of investors are willing to pay up for size - the placement of œ3 billion ($4.62 billion) FOSSM 2010-3 and ?1 billion ($1.28 billion) SAEC 7 - clearly standing out as such examples, market analysts said.

Also, investor-placed issuance remains almost exclusively restricted to auto ABS, as well as prime RMBS from the U.K. and the Netherlands.

However, recent prints from credit card ABS platform Penarth, along with more off-the-run issues from both the Notting Hill Housing Group and the Tesco CMBS, point to appetite for some interest in other sectors developing.

Downshift in Public Market Action

For the most part, however, a return to the more broadly syndicated markets is likely still some way off.

* Cars Alliance remains an outlier in this respect, but pricing was some ways back from secondary levels and, therefore, in our opinion, unlikely to herald a flurry in fully syndicated issuance," Deutsche Bank analysts said.

To be sure, much of the activity that the market has seen has been limited to the private placements. This level of momentum hasn't caught on to the same extent in the public front primarily because investors might still be showing a level of skittishness over the uncertainty created by the changing regulatory environment and Greece's derailment, although fundamentally the sovereign debt crisis did not impact securitization.

Yet the hefty number of refinancings facing the market - a recent Bank of England report estimated $5 trillion of term funding maturing in the next three years - means that banks might have to increasingly consider the capital markets as a funding source.

According to Deutsche Bank figures, next year the U.K. is set to have œ250 billion maturing. This is in addition to a portion of the œ165 billion SLS facility.

"In this respect, U.K. prime RMBS investor-placed issuance has so far this year exceeded the combined redemption of both investor-placed and retained RMBS," analysts at the bank said. "For the first time since 2007, RMBS is a net source of funding in the U.K. Provided the volumes can be maintained, they will be in line with redemptions although the retained hump in 4Q11 represents a challenge."

Come September, if investors' fears have ebbed away, issuers will likely begin to tap into the market more aggressively to fill the market's significant refinancing needs.

It is certain that the recent market activity has not been enough to temper the effects of the euro zone sovereign debt crisis completely.

This also does not reflect the upcoming regulatory issues such as the Committee of European Banking Supervisors (CEBS) recently releasing guidance on CRD II as well as the Basel Committee on Banking Supervision proposing amendments to the Basel II market risk framework.

ECB Paper Could Derail Pricing

Where spreads are headed and any potential widening are also still very much dependent on the capacity of real money funds to absorb legacy books. At the moment, ABS is cheap and attractive for buyers searching for yield.

"Illiquidity is not the point because investors should assess that separately before buying," Deutsche Bank analysts said. "This more or less raises the question of the size of the long-term investor base in the euro zone."

At the forefront of the legacy assets issue is the recent expiration of the biggest European Central Bank (ECB) one-year program with an auction last month that saw ?4 billion of one-year paper repaying.

Although the ECB has extended its three-month and six-day facilities with unlimited cash tenders until September, a total of only 171 banks asked for fresh funds, the ECB said. The ECB will still be lending commercial banks a total of ?131.933 billion for three months.

Some European banks are now considering options outside the ECB repo program. "The market is now split into banks that cannot afford to let go of ECB money, particularly southern European banks that have predominantly rolled from one year into the six-day and three-month options," said Olivier Renault, head of structuring and advisory, StormHarbour Securities. "But the better banks are not finding the three-month trade at 1% appealing and have opted not to roll money into these programs."

The weaker banks continue to face an interbank market that is closed to them and, as a result, have opted to access the private placement market, which requires banks to pay much higher spreads. For now, however, these banks are borrowing as much as they can.

"Indeed, despite the relatively smooth winding down of 12-month money from the ECB, retained issuance, particularly from peripheral jurisdictions, is unlikely to cease any time soon," said Deutsche Bank analysts. "Overall, 1H10 witnessed ?38 billion of ABS placed with investors - a number in line with our EUR 60 to 80 billion forecast for the year - although in a historical context equating to a volume similar to 1998-99 levels."

The more stable banks will probably find other funding sources, such as total return swaps, more attractive. Renault said that there are banks refinancing collateral to fund via total return swaps or, in rare cases, these financial institutions might even consider selling off a block of assets to a private buyer.

"We are seeing banks secure refinancing on collateral to access collateral through repo or total return swap, and, given the current terms of repo financing, a number of banks are seeking alternative financing options," Renault said. "We see more banks opt for selling a block of assets or doing a total return swap."

However, opting for a whole sale is of course trickier as the assets were originally packaged under the loose guidance set by the ECB at the start of its repo operations. This can make it less attractive to a private buyer.

The ECB does not care what type of assets are included, but it wants to make sure that the transaction is a true sale and that the asset has that triple-A rating, although these pieces wouldn't pass the scrutiny of regular market investors, he said.

Instead banks might find that they are better off unwinding the deal to create a new and cleaner transaction. However, there continues to be a big differential between what banks are willing to sell at and what investors are willing to pay.

"When you buy a government bond and you get 5% yield, you wouldn't look at a securitization that garnered a lower return," Renault said. "Banks need to realize that they are in a new world and either readjust the spreads at which they lend to make up for the higher costs on the funding level or just wait for securitization to come back at tighter spread levels."

ECB Begins to Pull out of the Race

The shift in ECB policy could also be behind the recent jump in securitization. The central bank is set to implement more onerous requirements that require that from 2011 assets seeking eligibility as repo collateral will now need to have two ratings.

Renault explained that to get a second rating, some banks are ramping up their securitization teams. "It's certainly enough to keep the market busy as we are talking about hundreds of transactions," he said.

It's also worth noting that some of the banks that are doing the new securitization hires had previously disbanded their securitization operations. "We did see some banks keep teams intact but in the cases where they didn't you are beginning to see some rehiring of securitization people," said Steve Curry, founding partner of Bishopsfield Capital Partners. "The hire into MS and UBS - which recently brought in a new head of ABS - doesn't come as a massive surprise since these teams were effectively dismantled but houses like Deutsche Bank, which only scaled back operations which are now rehiring, may be an acknowledgement that they expect things to happen."

The July 23 publication of "stress tests" on European banks, intended to reassure markets worried that some banks might be hiding losses on government bonds and other debt from financially troubled countries such as Greece, Portugal and Spain has served to stall the momentum in the market.

"That in itself puts a bit more of a break on the repo situation, and it's likely that the ECB will wait until the market is in a slightly more confident mood before it pushes banks to begin considering other liquidity measures," said Curry.

If the ECB were to make a move right now to put paper back into the market it would more than likely push spreads out.

According to UniCredit analysts, the largest part of securitized exposure since last July is made up of retained RMBS deals (?154 billion), which are mainly related to tranches from the Netherlands (25%), the U.K. (23%), Italy (24%) and Spain (8%).

"Retained exposure today contains largely non-senior, hardly-sellable tranches, some refinancing of maturing transactions, as well as exposure related to higher fundamental risk for which the primary spread is relatively wider and public issuance hardly feasible economically," UniCredit analysts said.

Curry said, however, that there is some appetite for legacy assets placed with the ECB repo program, particularly those assets that have been placed under the new underwriting criteria. Some investors, he said, are quite happy to do the work on secondary paper for more yield.

The question the market needs to answer is if investors were given enough opportunity to see primary deals would they bite? The answer is likely yes. "Investors haven't been closed to securitization," Curry said. "To a certain extent much of the reduced appetite is due to the fact that the SIVs are no longer part of the market. But the buyers left have said that they are willing to look at some asset classes - prime RMBS in particular. In some cases banks may find a smaller universe of investors still looking to buy into the securitization market for the right asset class."

The expected hefty volume of ABS amortization - UniCredit estimated more than ?40 billion in 2010 and 2011 - and distorted wholesale funding options are certain to pressure European issuers to at least consider the market.

"With prolonged high volatility, dismal securitization activity is furthermore accompanied by declining primary activity elsewhere on credit markets, thus from a pure funding perspective, securitization still has a reason to exist," UniCredit analysts said. ASR

Stress Test Results Give Little "Stress" to European Banks

The idea of undergoing a stress test comes across as a much-needed safeguard to ease investor fears that the European banks with which they do business have sufficient capital to deal with future " stress" scenarios.

But this is why the fact that all but seven banks undergoing the European Union-wide stress test at the end of July passed should have come as great news.

This is not the case, market analysts say. They agreed that the tests did not go far enough. For instance, tests for a potential sovereign default scenario - such as the one unfolding in Greece at the moment - were not included.

Royal Bank of Scotland (RBS) analysts said that early market reactions to the bank stress results were somewhere between lukewarm and outright skeptical.

Before the results came out, UniCredit analysts said that the stress tests had a good chance of being a non-event and that it was widely rumored that even some of the worst positioned banks - e.g., German Landesbanken and Spanish cajas - would get a "pass."

"In our view, it appears to be great ballyhoo, politically orchestrated with respect to the scope of the test and details of the release to make sure that (a) no relevant institution fails the procedure, and (b) investors still believe that the scenarios are vigorous enough to be reliable indicators of the strength of the institutions," UniCredit analysts said.

The problem, according to analysts, is that banking book exposures were stressed by computing the incremental capital required assuming an only four-notch downgrade to the assets, while worst-case trading losses were calculated generally assuming a 60% widening in spreads (or up to 80% for 2006/2007 ABX 'AAA' vintages), explained RBS analysts.

Property market stresses under the adverse scenarios also don't go far enough. The U.K. commercial real estate prices, for instance, were stressed to fall 10% in each of 2010 and 2011, RBS analysts said. However, property derivatives are currently already pricing in a capital decline of around 7% to 8% for U.K. CRE next year.

"Such 'stresses' do not look punishing by any measure; indeed, we'd argue that this degree of stress certainly does not capture a '[Lehman Brothers]-like' fallout," said RBS analysts.




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