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ECB, BOE Talk on Securitization Needs Regulators' Support

online.wsj.com | April 9, 2014

By Richard Barley

The power of central bankers' proclamations has never been greater: European Central Bank President Mario Draghi stopped the euro-zone crisis in its tracks with just 23 words in July 2012. But it will take more than words if Europe is to revive its securitization market. Regulators are still fighting the last crisis.

A clear push is on to bring securitization in from the cold and boost credit availability. The ECB's Yves Mersch has been a vocal supporter; at the Bank of England, Andy Haldane and Clara Furse have also been speaking out. The two institutions plan to present a joint paper on the topic for the International Monetary Fund's spring meetings this week. But while the securitization market is active, it is a pale shadow of its former self. Public issuance of bonds in 2013 was €76.4 billion ($104.8 billion), down 10% from 2012 and just 16% of the volume issued in 2006, data from the Association for Financial Markets in Europe show.

Strides have been made in improving the structures of securitization. There is greater transparency, and the complex structures that brought down the financial system are a thing of the past. A regulatory consensus is building around support for so-called high-quality securitizations: relatively simple structures with well-understood underlying assets that provide funding to the real economy, such as auto loans. Riskier structures such as collateralized debt obligations, or CDOs, or commercial-mortgage-backed securities (CMBS) aren't in the high-quality bucket.

But regulation still looks punitive. Take Solvency II, the new rules that will govern insurers. Even with the lower capital charges proposed by the European Insurance and Occupational Pensions Authority in December for higher-quality structures, securitizations are at a disadvantage. For a triple-A prime U.K. residential mortgage-backed security (RMBS), the charge is 4.8 times that for a triple-A corporate bond, and is even slightly higher than for double-B rated "junk" bonds. Insurers will surely prefer to put their money in corporate bonds rather than securitizations. But insurers are vital in broadening the investor base for securitization beyond banks.

True, the track record for some forms of securitization is appalling. From mid-2007 to the end of the third quarter of 2013, 21.6% of U.S. RMBS defaulted, according to AFME. But the default rate for European RMBS is just 0.1%. For securitizations of loans to SMEs—the hot topic for central bankers eager to get credit flowing to parts of the economy beyond their reach—it is 0.4%, AFME says. This performance is impressive given the depth and severity of the euro-zone crisis.

The risk is that regulators are calibrating their rules based on data that fail to reflect the European experience; Mr. Mersch has notably likened this to setting the price of flood insurance in Madrid based on the experience of New Orleans. The current regulatory proposals might have helped avoid the last crisis. But regulation needs to reflect securitization in its current incarnation, not the market's past sins.

 

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