* Insurance proposals to keep junior ABS underwater
* Type A/type B definition to clash with other regulatory efforts
By Anna Brunetti
LONDON, Aug 22 (IFR) - Hefty capital charges on subordinated securitisation tranches proposed in the latest draft of Solvency 2 will blunt insurers’ appetite for the asset class, market participants warned this week.
Under planned rules set to be published in September by the European Commission, while insurance companies will not be heavily penalised to hold the most senior tranche of an ABS deal, lower ones will be hit by much heftier capital charges.
“Who’s going to invest the resources necessary to do sophisticated analysis to buy securitisations if they think they will be heavily penalised by capital charges?” said Steve Gandy, head of DCM solutions at Santander Global Banking and Markets.
“The cost-benefit equation is not going to work very well,” Gandy said, if compared with the relative ease of analysing and holding other asset classes such as covered bonds.
The Solvency 2 rules the commission will publish in September will place anything but the most senior tranche of an ABS deal into the type B bucket - where the starting point to calculate capital charges is 12.5% for a Triple A and 13.4% for a Double A, multiplied by the years of the bond’s duration.
“The sheer gap between type A and type B charges makes it unworkable to invest in whole ABS deals”, said Sidika Ulker, director of the securitisation unit at The Association for Financial Markets in Europe (AFME) - which is looking to respond to the commission’s draft next month, hoping to sway policymakers for future modifications.
If an ABS transaction offers bonds starting from a Triple A tranche, the risk charge for this would be 2.1%, while the charge for the immediate next tranche would jump to 13.4%, Ulker pointed out. For a five-year bond, this translates into a leap from 10.5% to as much as 67%.
Central bankers are increasingly seeing securitisation as a tool that could break the financing deadlock in the real economy by channelling new funds to SMEs and consumers.
But to achieve both goals,“banks need to be able to place junior tranches at economic levels,” not just the Triple A tranches, Gandy said, as they need to sell down the capital structure in order to transfer the risk of the underlying assets and achieve capital relief.
Instead, the commission may be setting the securitisation market for a short circuit between banks needing to sell junior bonds and insurers not being able to buy them.
“We are starting to see new interest for sectors such as SME ABS, where it will be critical to be able to sell subordinated tranches,” Gandy said. But at the unattractive costs implied in the future Solvency rules, chances are that a large slice of demand for these tranches will be cut away, he said.
“There needs to be a bias in the junior segment,” Ulker agreed, “otherwise the typical deal is not economically workable,” she said.
In SME securitisation, subordinated tranches represent a larger share of a deal as they need to provide stronger credit support to the senior classes. “But if there’s no buyer of mezzanine and junior, the economic sense of the deal is lost,” she added.
Insurers represent roughly a third of ABS investment, and have the potential to allocate large sums money in the future to the asset class or withdraw from current holdings.
But in the final Solvency 2 draft “there is a massive incentive for insurance companies to invest in the underlying loans rather than in securitisation,” Ulker said.
For an exposure to a residential mortgage with loan-to-value ratio of 75% or less, the investor would incur zero charges, Ulker said. For a mortgage with LTV of 85%, the insurer would have to put aside a one-off 0.9% charge. “One can see very clearly where the incentive lies,” she concluded.
The other critical takeaway of the Commission’s draft is that it is at odds with a widespread attempt by the industry and central banks to identify criteria to qualify entire deals, rather than single tranches, as good quality securitisation.
There are good indications that the European Banking Authority, tasked by the commission itself with defining High Quality Securitisation, is basing its work on the definition put forward by the industry group Prime Collateralised Securities, the ECB and the Bank of England.
The HQS definition is set to be disclosed in September as well, and should then allow preferential treatment to qualifying deals in terms of capital requirements in CRD IV and liquidity status in the LCR, according to what the commission has publicly stated in the past.
If this is going to be the case, the ABS market is going to be divided into insurers who have to reason in terms of tranches, and banks that are allowed to think in terms of whole deals.
“It would be extremely confusing if there were different definitions around,” Ulker said.
“Hopefully the Solvency 2 definition will be brought in line with the one that will be proposed by the EBA, at some point in time,” she said. (Reporting By Anna Brunetti, editing By Helene Durand, Anil Mayre and Julian Baker)