January 10, 2013 3:50 pm

RMBS ‘comes in from the cold’

It’s official. Mortgage-backed debt, which just a few years ago was branded toxic after its role in the US subprime crisis, is safe again – or at least some of it is.

Central bankers and regulators meeting in Basel this week gave residential mortgage-backed securities – backed by the mortgages on people’s homes – a formal stamp of approval by allowing highly rated forms to be included in liquidity buffers that banks will have to hold to prevent future financial turmoil.

Their inclusion marks a breakthrough for bankers who have been lobbying for lighter regulatory treatment for a range of securitisation instruments. Although blamed for the subprime crisis, when poorly crafted versions of such deals turned sour, securitisation is seen by many as essential in a functioning financial system.

“This is securitisation coming in from the cold,” says Simon Gleeson, partner at Clifford Chance. “There is still the widely held view among central bankers that this [the crisis] was all the fault of securitisation and anything that is done that is positive for securitisation is letting the side down.”

“Finally regulators have publicly said not all mortgage-backed securities are bad,” says Alexander Batchvarov, international structured finance strategist at Bank of America Merrill Lynch Global Research. “But the biggest impact is political and reputational.”

Originally, regulators’ plan was for the “liquidity coverage ratio” – a gauge of banks’ easy-to-sell assets – to be focused on government bonds, cash and central bank reserves. Now 15 per cent of the buffer can be filled with equities, investment grade corporates and, significantly, certain mortgage-backed securities.

The decision to broaden the definition of high-quality liquid assets reflected fears about crimping banks’ ability to lend to the economy, as well as different ways of thinking about what “safe” assets are in the post-crisis world.

“There is a general desire to diversify what can be defined as liquid,” says Marjan van der Weijden, head of European structured finance at Fitch Ratings. “We have seen markets go in swings and roundabouts in terms of what is liquid. Sometimes even sovereign debt is not always liquid.”

But analysts question whether Basel’s change in stance will have any meaningful impact on issuance of securitised products.

The Basel announcement is a “recalibration” of the rules, which gives banks a greater range of assets to play with, says Huw van Steenis, banking analyst at Morgan Stanley. But, fundamentally, he says it will not lead to a jump in issuance.

For a start, there are tight restrictions on what counts in the pool. Only triple A and double A-rated securities are allowed and since the new rules exclude “walkaway mortgages”, where borrowers who have defaulted cannot be chased for more money if they give up the property, most US RMBS will not qualify. The rules also exclude many European jurisdictions.

Even if some RMBS now have a seal of approval, there are other disincentives for banks to drive the sector’s revival. Post 2008-09, lenders are now required to keep some “skin in the game” by holding a junior piece of mortgage-backed securities.

Added to that, the “haircut” – the discount applied when assessing their value – employed under the new Basel rules is much bigger for RMBS than for similarly rated corporate bonds.

Proponents of RMBS in Europe are upbeat. They say regulators have in the past unfairly tarred all securitisation products with the same brush, been too influenced by data that applied to poorly performing US deals and too swayed by politicians.

They argue that as RMBS allow banks to parcel up property loans in securities that are then sold on to investors, they are not just an important funding option for banks but also aid the functioning of the wider mortgage market.

“Given the previous direction of the regulators, this is a resounding positive,” says Dipesh Mehta, research analyst at Barclays, pointing out that losses on European RMBS stand at just 0.2 per cent. “RMBS at senior level is almost bullet proof in an Armageddon scenario.”

Banks can also raise money more cheaply in other ways.

In the UK, for example, banks are able to borrow from the Bank of England under the Funding for Lending scheme. The European Central Bank’s injection of cheap loans to eurozone banks under its longer-term refinancing operations has also removed the need for some banks to issue RMBS – although some are using securitised products as collateral when borrowing ECB funds.

There are other, more fundamental issues at play. “We’re not out of a recession in Europe so basically funding needs are not really there,” Mr Batchvarov says.

Moreover, even after this week’s move, global regulators have yet to fall in love with securitisation, while other hurdles still need to be overcome. Under current proposals it would not make sense for insurers to hold securitisation products, for example, given Solvency II capital requirements.

“This decision will have been taken through gritted teeth,” Mr Gleeson says. “But that makes it even more important . . . Like all reconciliations it is going to have its rough patches.”

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