Buying into Securitisations

Securitisations are making a comeback and presenting an excellent investment opportunity along the way. With the EU examining ways to recover from the financial crisis and banks (such as Societe Generale) looking at novel methods to decrease their counterparty risk, securitisations are looking attractive to buy for investors due to the low yield environment driven by excessive quantitative easing in Europe, USA and Japan.

2008: bankers handling CDS² 

This interest may be at odds with the negative sentiment culminating in the financial crisis of 2008 when the US mortgage market exposed the dangers of packaging and reselling large volumes of dodgy Alt-A (borrowers with patchy record of repayment) and sub-prime (borrowers with No Income No Jobs or Assets) loans.

However there is an added factor that makes securitisations attractive, besides obtaining a higher interest for buying into the new raft of securitisations. It is looking likely that the European Central Bank will guarantee, at least implicitly, certain securitisations. Having initiated the Outright Monetary Transactions (OMT) scheme to successfully support the periphery Eurozone countries and given €1,019billion in low-interest loans to banks across the EU, the ECB  has demonstrated its commitment to finding a long-lasting solution to the economic depression in Southern Europe. Therefore, a commitment from the ECB to guarantee, in some way, securitisations would add to their appeal.

Traditionally in continental Europe banks are the providers of credit to European business. Yet the financial crisis resulted in banks withdrawing lending to European businesses and households, with amplified effects in eurozone periphery countries like Spain, Italy and Greece. For example, by December 2012 outstanding bank loans to Spanish businesses had dropped by 25% from January 2009. The void created by European banks unwilling to lend is already partly being filled by European corporate debt markets, which remain underdeveloped by USA standards. In the USA it is capital markets, not banks, which are the major sources of credit for American businesses. However there is a divergence in European capital markets, with companies raising funds from them being predominantly from Northern Eurozone countries such as Germany, France, and the Netherlands. For these countries, they not only can obtain cheap bank loans but the yields on their corporate bonds are low. Conversely, companies from Southern Eurozone countries face much higher bank interest rates and only the largest companies can access capital markets.

This divergence has led to discussions among EU policy officials about using securitisation as a method to get credit flowing again in the Eurozone by packaging loans to small and medium-sized enterprises in the periphery and selling them to global investors. The ECB want to effectively play the role of banks in supplying funding for SMEs as well as the role of markets in providing the mechanisms for sufficient liquidity in the securitisation asset class.

There are several reasons to invest in these SME loan securitisations:

1. Higher interest rate than other asset classes;

2. Supported by the ECB;

3. Before the financial crisis, Europe had a burgeoning market for SME loan securitisations. For example, in 2006 there were 34 issues worth €46billion in total, with 15 issues originating from Spain. Therefore there is a track record of success in this asset class;

4. Global regulators in the USA and EU have approved residential mortgage-backed securities as a product banks can utilize when constructing liquidity buffers, which is a sign of support for securitisations;

5. SME loan-backed securitisations have a low default record; and

6. The ECB has launched the European DataWarehouse to bring transparency to the pools of loans underpinning asset-backed securities and restore confidence in the market. A second initiative aimed at increasing transparency in the securitisation market is the Prime Collateralised Securities initiative, which awards kitemarks to high quality asset-backed securities (including SME loan-backed securitisations). These initiatives should address some of the issues with SME loan-backed securitisations, such as problems standardising these small business loans and worries about the ease of buying and selling such securities.