Evaluating the Impact of New Securitization Regulations and Basel III on New Issuance

At several times over the last year, we have sounded the alarm that the long-term negative impact on bank financing activity coming from the virtual vise that recent accounting rule changes, new securitization regulations and the impending implementation of Basel III liquidity standards is enormous.

As market data continues to accumulate, now we can see what the future may look like.  Last week the Financial Times ran an article describing how the “hang over” associated with the residual effects of a continuing over-abundance of subprime mortgage product is starting to be proven out by the continued slow recovery of the new issuance market for securitisations.  This, in itself, is an important observation.

However, also displayed in this article was a graph depicting just how far the bank issuer market in Europe has swung over the past 9 or 10 Quarters.  Whereas, in the heady days of the early to mid 2000’s, European banks, just like their US counterparts, were placing 90% or better of their securitisations off the balance sheet and, as result, freeing up valuable capital for other lending opportunities.  Now the game has changed.

The recent spate of legislation and regulation has delievered a strong, perhaps fatal blow to off-balance sheet structures, as investors, skittish about how secure their claims might be in an off-balance sheet structure, are staying away from more traditional financings. 

In their place, covered bonds have become the darlings of the issuance community but what the below chart reveals is a truth that we have always known.  There is clearly a limit to how many covered bonds can be issued and, unlike true off-balance sheet securitisations, this upward limit is directly tied to the capital base of the bank issuing the covered bonds. This fact was never more evident than in the  following chart:  Euro Securitization Recovery Lags osp 6-11

Clearly, the chart shows a trend away from off-balance sheet financing among the European banks that had tradtionally relied on securitisation to sustain their business models.  Essentially, by bringing these asset “back on the balance sheet” the banks are reducing their leverage.  Some may view this as good thing.  We do not; especially when we see such a dramatic reduction in leverage. 

What seems to be driving these trends is a combination of the new regulations themselves, issuer uncertainty as to how many of these complex regulations will affect their activities and, perhaps most importantly, uncertainty among investors who have little faith in their abilities to count on new off-balance sheet structures receiving the arm’s length protections from regulatory recourse that structured finance investors had come to take for granted for more than 25 years.

If the regulators of the global structured finance markets wanted any empirical evidence about how their new regulations are being received in the “real world”,  look no further than this chart. 

We would suggest that a similar chart of the US market would probably look worse.  However, the euro market view is bad enough.  For the last two quarters nearly as much securitised assets have been kept on the balance sheets of european issuer banks as have been moved off their balance sheets. 

We see this trend as unsustainable and something which should sound an alarm with both European and US regulators that something needs to be done very soon.  That something should include a return to most of the time-tested structural techniques and regulations that supported the securitisation markets for so many years.

About markferraris
Managing Principal Orchard Street Partners LLC

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