Illiquid assets

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GLOBAL INVESTOR 1.15 — 58 European securitization From illiquid assets to profitable investments To foster economic growth, the European Central Bank needs to revive the securitization market. This market is currently down to 25% of precrisis volumes or only 14% of US issuance in 2013. Improved transparency, the clearing of bank balance sheets and improved regulatory rules are expected to provide a catalyst for the securitization market going into the second half of 2015, offering attractive yield opportunities for investors. Illustrations: Frida Bünzli
GLOBAL INVESTOR 1.15 — 59 In the aftermath of the financial crisis, the European securitization market collapsed. New issuance in European securitization decreased by more than 75% compared to volumes in 2008 and has not recovered since then. Primary market activity in 2013 was below EUR 200 billion, corresponding to only 14% of US issuance over the same time period (see Figure 1). The lack of a functioning securitization market is a major disadvantage for European banks, the economy and investors. Regulatory-forced deleveraging and its negative impact on lending and economic growth could have been better mitigated, in our view. For the European Central Bank (ECB) to be successful in fostering economic growth, the current pool of assets for Quantitative Easing (QE) might prove to be too narrow, so that the issuance of securitized investment products based on high-quality assets – so-called Qualifying Securitization (QS) – needs to pick up in order to broaden the ECB’s investment base. As the ECB is pressuring interest rates and yields into negative territory, banks are in need of margin expansion. If structured correctly, this can be achieved by QS and align the banks’ need to earn profits with the ECB’s need for economic growth and the investors’ need for attractive yield opportunities. To make the securitization market grow in Europe, it must become economically attractive for banks. So far, the maths have not quite worked out, mainly due to regulatory rules with respect to securitization that result in a lack of “capital relief” for the banks (see box on the risk capital treatment of different loans and securitizations on p. 61). Given their need to remain exposed to the part of the securitized assets with the highest risk, to which a risk weight of 1,250% is applied, the transaction simply lacks economic appeal for the banks. ECB as an asset-backed securities buyer In 2014, the ECB released details of its asset-backed securities (ABS) purchase program, which was followed by the release of a legal act enabling implementation of the purchase program with actual purchases having started. The ECB has appointed four executing asset managers for the purchase program. The asset managers will conduct the purchases on behalf of the Eurosystem and undertake price checks and due diligence prior to approving the transactions. The program will involve the purchase of senior tranches and guaranteed mezzanine tranches of loans originated in the euro area. Greek and Cypriot ABS will also be included in the purchase, albeit with tighter provisions. The combined size of the ABS purchase program and covered bond purchase program will reach EUR 1 trillion. Several other measures have also been taken in the meantime to facilitate the development of the securitization market in Europe. Among them, we would highlight the changes to Solvency II > Turning an illiquid asset into an investment opportunity takes time The ECB is in the middle of a multiyear process to regain investors’ and market trust, as well as to foster economic growth. In our view, the basis for regaining investor trust – including the ECB as an investor – was provided by the comprehensive asset quality review (AQR) and the stress test carried out by the ECB and the European Banking Authority (EBA). In October 2014, following a yearlong analysis of over a million pieces of data, the ECB and EBA published the much-awaited results of the AQR and stress test. The AQR exercise covered 130 banks within the Eurozone’s 18 countries, with total assets of EUR 22.0 trillion accounting for around 82% of total banking assets under the European Single Supervisory Mechanism (SSM). The EBA stress tests covered 123 banks across 22 of the 28 EU countries, including banks from the UK and the Nordic region. Overall, 25 of the 130 banks failed, with an identified capital shortfall of EUR 24.6 billion. More specifically, 13 banks were identified to face capital shortfalls totaling EUR 9.5 billion. We believe that the ECB/EBA announcement struck the right balance between being too harsh and being too lenient, notably highlighting areas of vulnerability for some of the examined banks. Despite not forcing them to take immediate action, the ECB made it very clear that the adjustments would become part of its ongoing supervision of capital requirements as it continues to forge ahead with the agenda of improving the quality of European banks’ balance sheets. More importantly, we believe that the process toward a European Banking Union has significantly contributed to increased disclosure and transparency, which is building the basis for a greater investor attraction toward banking assets. 01_Primary market activity of European and US asset-backed securities New issuance of asset-backed securities (ABS) remains subdued in Europe compared to the US. The European market is, however, forecast to pick up during the course of the year following the launch of the ECB’s purchase program. Source: AFME, Credit Suisse in EUR bn 2,500 2,000 1,500 1,000 500 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 Total European ABS placed Total US ABS placed European ABS placed in % of US ABS placed (rhs) 100% 80% 60% 40% 20% 0%
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Illiquid assets

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