Barcap ABS Future in Europe - Mar 2009[1]

8/8/2019 Barcap ABS Future in Europe - Mar 2009[1]

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Please see analyst certification(s) and important disclosures starting on page 5.

The future of ABS in Europe

Securitisation Research 13 March 2009

In this note, we update our outlook on the future of the EUR1.1trn European ABS

markets. We look at challenges in the short term but also consider the longer-term

viability of the market. The European ABS markets have been largely dysfunctional

from early autumn 2007. Since then primary issuance placed with investors has largely

ceased and the focus has shifted solidly onto central-bank liquidity facilities and trading

in the secondary market. The market continues to face a number of different and inter-

connected challenges, which will determine its prospects in the short term.

Technicals: Over the last year and a half, technical factors such as the SIV and ABCPunwinds have had a significant negative impact on secondary spreads up to year-

end. However, in the first 6-7 weeks of 2009, other technical factors have actually

resulted in spread tightening. Despite more recent widening since then, as illustrated

in Figure 1, the tightening was mostly due to the re-classification of ABS assets on

banks balance sheets. This re-classification has also partly reduced the need for

forced selling after year-end 2008. Furthermore, issuer buybacks have also been a

positive in the secondary market, albeit one that is difficult to quantify. The recent

widening confirms that the positive technicals that caused the spread tightening in

the first 6-7 weeks of the years in question did not have a lasting impact.

Figure 1: AAA UK Prime RMBS secondary spreads

0

200

400

600

800

1,000

1,200

1,400

1,600

Sep 06 Dec 06 Apr 07 Jul 07 Oct 07 Feb 08 May 08 Aug 08 Nov 08 Mar 09

Avg (LHS)

1st Jan 2009

Source: Barclays Capital

Fundamentals: As the economic slowdown has spread from the US to the rest ofthe world, declines in GDP growth, increases in unemployment and declines in

house prices have taken place at impressive speeds. The continuing problems faced

by banks and the capital markets have led to a lack of new lending for both

consumers and businesses alike. This is still having a second-round impact on the

real economy, further extending the slowdown. Over the last six months this hasled to a marked increase in delinquencies in our mortgage pools, with defaults and

losses expected to follow suit. We expect increased defaults and losses on the

Hans Vrensen, CFA+44 (0)20 7773 3502

[email protected]

www.barcap.com

Widening confirms that

positive technicals in

first two months of

2009 did not have a

lasting impact

Deteriorating

fundamentals will lead

to increased defaults

and losses


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2 Securitisation Research Barclays Capital

underlying collateral pools to come in late 2009 and 2010, as a result of further

deteriorating fundamentals.

Structurals: There is an increasing trend of structural deal features failing in EuropeanABS. This is partly due to counterparty failings, triggered by some of the technical and

fundamental factors mentioned above. However, one could argue that the breakneck

speed of the markets issuance in the period from 2005 to 2007 might have resulted in

some deal structures not being fully reviewed by all parties. Inconsistencies betweenthe offering circular and the transaction documents are also emerging in some cases.

Also, the modest fees which servicers and trustees were able to negotiate in that

environment might make it difficult to allocate adequate resources to address current

and upcoming problem situations on behalf of investors. Some of these issues are more

fully described in our publication,Structural surprises in European ABS. It does seem

that the structured part of structured finance is not always working as expected.

Policy uncertainty: The myriad of government policies announced over the last sixmonths has been partly successful, but some uncertainty remains around the

implementation and details of some of the programs. Especially, some forms of

government assistance for business and consumer borrowers could ultimately havea negative impact on bond holders. For example, due diligence requirements for

ABS investors might be more stringent compared to equally complex bank bonds.

But even more so, the uncertainty around the UK banking bill that came into effect

on 21 February 2009 has brought into question the legality under this new act of

the true sale of securitisations in the UK and how the bill in effect might overwrite

contract law in securitisations.

Of course, central bank liquidity provision to banks through repo of ABS (and other

assets) has been hugely successful over the last 18 months, providing banks with a

useful source of funding. Based on ECB and BoE disclosures, we estimate that there is

about EUR700bn in ABS with central banks. If we add a further EUR300bn for Q4 08

that we estimate was posted with the ECB, this adds up to EUR1trn. This is about the

same amount of ABS notional as has been placed with investors since the markets

inception. Of course, there is likely some overlap, as the ECB accepts existing ABS as

collateral, as long as it meets its criteria. In general, the negative public and political

sentiment relating to ABS is likely to limit any positive policy bias towards ABS. In our

view, the long-term viability of a market that is half placed with investors and half

placed with central banks can be legitimately questioned as it seems unrealistic to

expect central banks to provide funding to ABS in this way in the long term.

To address the current uncertainty, we need a strong and clear signal from regulators

and lawmakers that they are committed to continue to work with the ESF, banks and

the rest of the industry to restore securitisation as a funding channel. Of course, thevarious degrees in which different European countries have tapped into securitisation

makes a coordinated policy response on an EC level difficult, as some countries have

much more at stake than others.

Ratings pressure: The number of downgrades in the first two months of 2009 has beenstrong and we expect further downgrades to come through during the rest of the year.

Even if rating agencies leave their existing models in place, they will be re-visiting some

of their assumptions, typically based on historical data, with the recent, unprecedented

decline in economic activity and asset values. Rating agencies have also seen a wide

range of new regulatory proposals from many different agencies, both European and

US. The revision of model assumptions and methodologies, together with significant

regulatory pressures, is likely to increase the breadth and speed of rating downgrades.

Legal deal structures

not always working

as expected

Despite significant

policy announcements,

much uncertainty

remains onpolicy impact

Large amount of

issuance placed with

central banks provides

useful funding, but

raises questions on

long-term prospects

Need clear government

commitment to assist in

restoring thesecuritisation market

We expect the breadth

and speed of

downgrades to increase


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Barclays Capital Securitisation Research 3

Selling pressure: Ultimately, potential further rating downgrades, are expected totrigger increased capital reserve requirements for banks ABS holdings. Given that

banks have become the largest ABS investor category again, we see significant

pressure for further forced selling by banks, some of which might be unable to meet

capital reserve requirements. Of course, any changes in the interpretation or

(temporary) relaxation of these capital reserve requirements by local regulatory

agencies should help alleviate this pressure. However, the lack of a significant inflowof buyers is expected to hamper further spread tightening for some time to come.

Emerging trends from our roadshow

With this rather bleak outlook for our markets future, we want to share some of the

feedback from our recent Europe roadshow. As in previous years, we presented our

2009 securitisation annual to our existing European ABS investor client base. In this

context, we met with almost 70 clients in 19 cities and 10 countries over the last seven

weeks. In general, we observe the following trends with existing investors. First, most

are returning to their core competence and focus on their home jurisdiction, which is

easier to get approved by senior management and risk departments. In general, Spanish

investors are bigger buyers of Spanish RMBS and Dutch investors are focused on DutchRMBS, etc. Buybacks are likely driven partly by this and it may result in less portfolio

diversification. Secondly, most investors have re-focused their attention on closely

monitoring their existing portfolio (with the helpful assistance of their risk colleagues)

and are not re-investing (most of) the cash prepayments on their existing ABS holdings.

So far, this is certainly consistent with the overall outlook. But there were also a number

of other more positive things going on below the surface. In particular, we are seeing

some green shoots of new investor activity, especially with UK and Dutch pension funds

and insurance companies. A number of UK and European fund managers are

attempting to raise capital for distressed debt and ABS funds. Some are also increasing

existing ABS mandates or increasing the percentage permitted to be allocated to ABS.

Although limited in size, these initiatives are likely to be the start of a slow revival that

can be expected to unfold over time. Given previous false starts last year by some

investors, when further spread widening killed some of the new initiatives, we expect

any increase in buying activity to be cautious and slow, especially on the higher-rated

tranches. However, in the subordinated tranches, we could see a quicker recovery if

hedge funds are able to pick up any heavily discounted portfolios in size from highly

motivated (bank) sellers.

The second positive trend emerging from our roadshow is that a significant number of

investors seem to have committed to investing time and money in stress testing after

the publication of our own series of stress-testing analyses across most actively-traded

European ABS sub-sectors. Many mentioned that they had signed up to third-party

cash-flow model providers and were keen to share experiences on the use of these

systems. Some who had previously invested in the development of in-house modelling

and data infrastructure also admitted to now switching to these same third-party cash-

flow model providers. Most are well aware of the shortcomings of these models, but our

view is very positive on this development. We believe that the more widespread use of

third-party cash-flow models will allow investors in future to further expand their

discussions on their model assumptions, which many of them already shared with us.

These types of discussions should allow buyers and sellers to bridge more easily the bid-

ask spread, resulting in more effective secondary trading.

Selling pressure on

banks is likely result of

ratings downgrades,

unless capital reserve

requirements

are relaxed

Some common trends

from European

roadshow meetings:

return to home country

and re-focus

on surveillance

Some new investors

coming in, especially UK

and Dutch

pension funds and

insurance companies

Investors committing

more to in-depth and

stress-testing analytics


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4 Securitisation Research Barclays Capital

The future meeting the challenges through bold reforms

In our view, the future of the European ABS markets will depend on how the sector

meets the above challenges. The ultimate impact of policy initiatives, once finalised and

implemented, will also depend on how pro-actively the sector embraces reforms. In this

respect, the industry group European Securitisation Forum (ESF) and others have made

some good progress in working with the wide range of government and regulatory

agencies. In particular, the recently announced standard reporting formats with their

mandatory fields and published list of committed banks is a great step forward.

However, despite this progress, we believe that bolder action is needed. In private

conversations, many investors seemed to agree with us that public disclosure of loan-

by-loan data on the collateral pools, material transaction documents and standard data

templates are not just nice to have, but essential to meet the new legal requirements

that investors might face. We support S&Ps presidents suggestion that the market

should have public access to the same data as the rating agencies. Of course, easier-to-

use third-party cash-flow models and other databases, which would allow a wider range

of investors to benefit from the improved analytics fuelled by loan-by-loan data and

standard data formats, are also essential. The wider adaptation and expansion ofstandard data formats for post-issuance reporting will also help boost efficiency in

third-party cash-flow and other analytical systems.

Public disclosure of transaction documents, if and when material, is probably required

by law in most European countries. As circumstances change, what was perhaps not

material at the issuance date of the bonds can easily become material once a swap

counterparty fails or a liquidity facility is not renewed. Clearer guidelines and standards

for servicers and trustees with regard to providing public access to the relevant

transaction documents might avoid legal issues later.

Legal counsel might be able to help in thinking about ways to implement changes in

disclosure standards, even for existing transactions. In fact, the American SecuritisationForum (ASF) has provided the industry with some useful guidance, partly through its

RESTART project, as to how to interpret legal transaction documents for existing

transactions to avoid further unnecessary and harmful legal actions. A similar initiative

from the ESF in Europe would also provide huge benefits, in our view.

We believe that more standardised legal structures that are easier to understand are

essential for any new primary issuance, while at the same time providing essential legal

protections for investors as well as issuer efficiency. This might not include master-trust

structures, with their large number of triggers and bond tranches, as well as uncertainty

around the sponsors willingness and ability to maintain the trust with loan substitutions.

Given the negative political sentiment regarding securitisation and banks in general, we

believe it is essential for industry groups, like the ESF, to help the industry overcome as

many of the current challenges for existing bonds as possible and implement bold

reforms. Focus on the revival of new primary ABS issuance in the short term,

government-guaranteed or otherwise, might delay any of these solutions and reforms.

In the end, investors do need to take responsibility for pressing for these reforms

through their industry representation. Given the current role of the ECB and BoE, we see

a leadership role in this respect for central banks as well. Of course, all of this will take

hard work and might in some cases even require cumbersome legal actions. New

investors will only continue to come into the sector if and when ABS can prove that it

has performed in line with expectations, despite all the challenges it faces.

Some progress has been

made in meeting

challenges, but bolder

action is needed

Loan-by-loan data

should be made public

and will allow for

improved analytics

Public disclosure

of material

transaction documents

For existing issuance,

guidance and standardsmight avoid legal issues

More standardised and

easier-to-understand

legal structures

essential for

new issuance

Reforms need to be

aimed at current

challenges not only

new issuance

Leadership from

investors and central

banks is needed


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Securitisation Research Analysts

5 The North Colonnade

London E14 4BB

Hans Vrensen, CFA

Head of European Securitisation Research

+44 (0)20 7773 3502

[email protected]

Anca Gagea

Consumer ABS

+44 (0)20 7773 9874

[email protected]

Mark Nichol

Commercial Mortgage-backed Securities

+44 (0)20 7773 4503

[email protected]

Dipesh Mehta

Residential Mortgage-backed Securities

+44 (0)20 313 42139

[email protected]

200 Park Avenue

New York

NY 10166

Glenn Boyd

Head of US Securitisation Research

+1 212 412 5449

[email protected]

Joseph Astorina

Subprime MBS, Consumer ABS

+1 212 412 5435

[email protected]

Ying Wang

Subprime MBS

+1 212 412 2512

[email protected]

Elena Warshawsky

Subprime MBS, CDOs

+1 212 412 3661

[email protected]

Wei-Ang Lee, CFA

Subprime MBS

+1 212 412 5356

[email protected]

Priya Misra

Agency MBS

+1 212 412 2099

[email protected]

Barcap ABS Future in Europe - Mar 2009[1]

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