Welcome to the end-of-year edition of the STS Newsletter by PCS, keeping stakeholders up to date about market and regulatory developments in the world of STS.
As ever, we very much welcome any feedback on this Newsletter.
In this section, we will focus on specific numbers in 2022 before going, in section 3., to a broader analysis of what transpired in 2022 in the STS securitisation markets.
Please note that, differently from most year-end commentaries, we have focused on number of deals rather than volume of issuance. The reason for this is not that numbers have a greater explanatory power than volume but rather that they have a different and complementary explanatory power.
Many research firms and other commentators provide the volume numbers and it seemed of limited value to just do the same. By focusing on numbers, PCS hopes to shed not a better light but a different light on the year.
(All numbers are as of 12th December 2022 and so comparisons with 2021 are not exactly on the same basis. PCS only expects very few additional STS deals by year end though..)
(Hover over the sections for legends)
Europe-wide STS transactions went from 206 to 177 and term true sale transactions went from 125 to 99.
Last year’s comparison showed a misleading steep decline in EU true sale STS deals. This, as we explained at the time, was the result of legacy ABCP transactions achieving STS in 2020 and therefore falling out of the figures in 2021. This year’s decline has however nothing misleading about it. Publicly placed STS true sale transactions decreased (from 79 to 75) in 2022, for reasons we explain below.
Looking at the UK alone adds little to change to this downbeat analysis. UK STS transactions were at 18 for both years.
As RMBS shows a slight increase and consumer loan numbers remain almost identical, the victim of the lower number of public European STS transactions is the auto sector. Last year’s asset class story had been the emergence of autos as the dominant product in number, overtaking RMBS, the previous holder of the title. This year saw its percentage of deals drop back, almost back to sharing the top spot with mortgages.
This is consistent with other market data showing that auto issuance (STS and non-STS) in 2022 was €12.5 bn. This is not only a meaningful climb down from 2021’s €16.7 bn issuance but is also the lowest auto public issuance since the GFC1PCS is grateful to BAML for its non-STS numbers.
As for last year, non-bank/non-captives grew as a percentage of issuance at the expense of captives. The best guess though is that this is not so much a reflection of long-term trends as much as the subdued market for new cars due to supply issues. When (if?) Europe’s industrial supply chain problems are solved, it is reasonable to expect a rebalancing of the auto securitisation mix.
To be clear though, this is a relative decline for autos. RMBS issuance in the EU (STS and non-STS) is also down 21 % in volume. Even CLOs (not an STS product) went from €39 bn in 2021 to €25 bn in 2022. Placed securitisations Europe wide fell from €125 bn to €88 bn.
Not a lot of evolution in the jurisdictional distribution except for the decrease of Germany relative to the other countries. This though seems to be primarily the jurisdictional mirror image of the decline in auto issuance, long associated with that country.
The number of synthetic/OBS transactions notified to ESMA as STS went from 15 in 2021 to 32 in 2022. The comparison is misleading to some extent since synthetic/OBS securitisations could only be STS as of April of last year. The comparison is therefore of part of a year vs a full year.
However, the incorporation of synthetic/OBS transactions within STS has clearly been a success and PCS anticipates that it will continue to grow as an STS asset class in 2023 and beyond.
Asked what he had found the most challenging part of being a prime minister, Harold Macmillan is reported to have answered: “Events, dear boy, events…” And how 2022 has proved him right.
When PCS looks back at its prediction section in last year’s End of Year Newsletter , there is a certain sense of pride that we had been so extraordinarily prescient. Our predictions were spot on .… or rather would have been if the year had ended on June 1st. Thereafter, not so much.
Any attempt by the writer to escape footballing metaphors in this season is as lost a cause as that of an astronaut escaping the gravitational pull of a black hole beyond its event horizon. So .…
The first part of the year, until June, looked good for European securitisation as a whole and especially STS. The withdrawal of central bank liquidity was bringing traditional originators back to the market after long absences, especially in RMBS, including in the UK. The approaching January 2025 deadline for the final implementation of Basel III was also leading originators to eye “full-capital-stack” securitisations to achieve capital relief.
The previous year had been very positive for securitisation as a whole (with issuance of € 125 bn) but not so good for STS in relative terms. This year looked like the year STS would play some catch-up on CLOs and non-STS RMBS (such as BTL and NC loans).
Synthetics were going strong to add to the upbeat outlook.
Then Ukraine was invaded, followed by a panic over energy supplies, followed by an acceleration of inflationary pressures, followed by increasingly dire predictions of central bank rate hikes; the whole wrapped in a deep fog of uncertainty.
As a result, the second half of the year saw something of a collapse in public issuance. It must be noted that this was not a panic, nor was it a dead stop. Deals did get done, albeit with reduced demand, albeit often on a pre-placed basis with a small investor group.
This second half can itself be divided in two. From June to October, the driver of reduced issuance was entirely price volatility. An originator was reluctant to go to market with initial price talk at 60 bp to find that it was having to pay 90 bp on the day of pricing. On the other side of the equation, an investor was reluctant to buy at 60 bp to find that the same paper would be trading at 90 bp at the end of the year, forcing a mark-to-market loss. So both stayed away.
By October, the macro-economic outlook for Europe dimmed and credit concerns began to creep in – especially for less “top end” issuers. These credit concerns fed into investor expectations on price and resulted in deals being postponed or pulled by originators not willing to pay the new spreads.
Although, in itself, a fairly trivial observation, it is important to see what happened to STS securitisation as part of what happened to securitisation; and what happened to the latter as part of what happened to fixed income generally. The increase in spreads seen in STS securitisations broadly reflect increases seen in the whole fixed income market in 2022 (with somewhat of a timing lag for securitisation both on the increase and the decrease).
As securitisation volumes dropped in 2022, covered bond issuance hit an all-time high at €210 bn for benchmark issuance and probably about three times that for overall issuance.
For years now, the regulatory community has deflected responsibility for the weakness of the European securitisation market away from an inappropriate regulatory framework to the monetary policy of the central banks. This led them to predict (or strongly imply) that tighter monetary policy would lead to a growth in issuance. This year has proved them partly right. There was growth in issuance. It is just that all of it was in covered bonds. PCS invites regulators and policy makers to draw the correct conclusions from the data and focus on fixing the regulatory framework.
Policy makers have been concerned by the number of deals going to the private STS market as against the public market. First, the numbers for this year indicate that this is not a trend. Last year saw 79 public transactions against 127 private ones. In 2022 so far, 75 public deals compete with only 102 private ones.
But also, PCS has seen a number of deals scheduled for public distribution that were “privatised”. This includes technically public securitisations that were, however, pre-placed with a very small group of investors as well as private transactions with banks. In all cases PCS has dealt with, these “privatisations” reflected concerns of price volatility (see above) and never over the regulatory burden of private versus public disclosure.
When limiting the types of securitisations eligible for inclusion in regulatory liquidity coverage ratio pools under the CRR and confining them to the lowest category (2b), banking regulators have cited the alleged illiquidity of this product. Similar considerations are adduced under Solvency II to punish STS securitisations held by insurance companies.
However, one key feature of 2022 has been to demonstrate these concerns are misplaced. Secondary trading in 2022 was the highest since the GFC at €60 bn. More anecdotally but powerfully indicative, in the dark week of the UK’s mini-budget meltdown, when the bid for the 30-year gilt vanished, £4 bn of asset-backed paper traded in the secondary market without a hitch.
The myth of the illiquidity of the asset-backed market was further debunked in a paper by Risk Control that PCS urges regulators and policy makers to read, and which may be found here.
With regards to Solvency II, PCS continues to be puzzled by the assertion that the Solvency II calibrations are fit for purpose when the capital requirements for having an illiquid pool of whole mortgages on the balance sheet remains lower than the capital required to purchase a highly liquid AAA rated senior tranche of a securitisation benefiting from substantive credit enhancement of the same pool of mortgages.
Predicting the future has always been somewhat of a quixotic endeavour but today we suspect it is positively delusional.
In this section, we try to identify the events and phenomena that are likely to be important in determining the course of the STS market. But if it is prediction you seek, honesty forces us to advise that a quick trip to the local supermarket to purchase a chicken followed by some judicious toying with the bird’s entrails is as likely to yield an accurate result. This is the world we live in. “Events, dear boy, events…”
Central bank policy is likely to continue to reverse the quantitative easing of the last few years. This leaves banks with substantial amounts of TLTRO, TFS and TFSME cash to repay and replace by other types of funding. As we saw above, much of that funding is going to be through covered bonds. But strategically minded banks will be inclined to avoid putting all their funding eggs in the same basket and should seek to issue some securitisations.
The role of non-bank lenders is likely to continue to grow. These players cannot access covered bonds and have credit ratings too low to access non-equity financing at a commercially viable rate.
The final implementation of Basel III deadline of January 2025 will be one year closer in 2023. This will require banks, if they wish to preserve their lending envelopes, to raise meaningful new capital or reduce risk-weighted assets (RWAs). The latter, short of portfolio sales, can only be achieved by securitisations – whether in traditional or synthetic format.
Finally, the price volatility of 2022 has left a decent size overhang of transactions which were originally scheduled for this year. Should volatility abate and spreads land in an acceptable place, those postponed securitisations could result in a strong recovery in early 2023.
Fears of recession are growing. A meaningful economic slowdown in Europe could negatively impact securitisation in two ways.
First, credit concerns could push up spreads to levels that make it impossible or deeply unattractive for issuers to come to market. In particular, there is the impact of high spreads on the securitisability of pools generated in lower interest rate environments – “underwater pools”. These can be securitised, of course, but only if the originator takes a “loss on sale” impact to its P&L.
From January to October 2022, spreads rose inexorably for all asset classes in all jurisdictions. Senior auto paper trading at 4 bp in January was trading at 50 bp in October. Dutch RMBS that could be purchased at 11 bp in late January would cost you 65 bp by late October. Since then, spreads in the secondary have pulled back a little. A key question of 2023 will be whether spreads continue to retrace their steps and how far down they will go before stabilising, or indeed if their rising resumes.
Secondly, a recession may slow the generation of new loans. This will reduce the volume of primary assets capable of being securitised, as well as the need for financing.
If the lights do not go out over winter in the largest economy in Europe, and Russia does not resort to a nuclear attack, and China does not invade Taiwan to distract from a botched COVID policy and slowing economy, and central banks do not dreadfully overshoot on rate rises tipping the economy into deep recession, and central banks do not fail to tame inflation leading to major industrial unrest and no foolish archaeologists decide to open that tomb covered in mysterious undecipherable markings despite the terrified warnings of the local autochthonous population then ….
We think that we will see a fairly decent first half of 2023 in STS with a quieter second half. We think overall issuance will be better than 2022 but not dramatically so. We also see synthetic STS issuance continuing at roughly the same pace.
We think the UK will play a bigger role in overall issuance than it has over the last few years.
But then again, you might want to double check against that chicken liver.
On December 9th, the Chancellor of the Exchequer unveiled the roadmap to the post-Brexit reform of the regulatory framework for British finance.
Although overshadowed by more headline grabbing subjects such as the future of ring-fencing and bankers’ bonuses, proposals around securitisation were part of the package.
To summarise, since Brexit and during the post-Brexit negotiations, the Treasury kept its powder dry. Other than promising to devolve large sections of financial regulation from legislative acts, where the European Union had placed them, to regulatory handbooks drafted by the FCA and the PRA, little indication was given about the overall direction of travel. In particular, it was not clear whether UK rules would stay almost identical to those in the EU in the hope of access to the European market or whether the UK would go it alone.
Maybe it is the result of the new-new-new UK government being run by free-trade, deregulating, “Singapore-on-the-Thames” Brexiteers. Maybe it is the recognition that, having left the club slamming the door, the club trustees were not going to allow you to still use the clubhouse for free. Either way, the British government has now openly opted for the go-it-alone and make your own rules approach.
However, because the government has also – as promised – devolved most of the technical rulemaking to the FCA and the PRA, it is not clear how deeply the new securitisation rules will differ from the current rules inherited from the EU. But that will depend primarily on the views of the regulators rather than those of the politicians.
The current proposals for the UK regime unveiled by the Treasury were published in a draft statutory instrument (an application decree/level 2 instrument for our continental readers).
The draft can be found here.
There are quite a few highly technical drafting changes the implications of which are still somewhat unclear. But here are the highlights.
The definition of “securitisation” remains unchanged.
The STS regime remains in place. However, the criteria of what makes a securitisation STS have disappeared from the legislative text altogether and are now entirely delegated to the FCA to draft. Presumably, the FCA will have a consultation to determine what criteria need be met for a securitisation to achieve the STS standard.
Intriguingly enough, with the criteria for STS having disappeared from the draft legislation and, in the absence of a definition of “non-ABCP securitisation” the proposed text appears to leave open the possibility of synthetic securitisations being STS. This seems now to be in the gift of the FCA although it should be noted that so far the PRA has shown a marked reluctance to assist synthetic securitisations.
The third-party verification and data repositories regimes are kept broadly unchanged.
In line with the free-trade approach of the Treasury, an equivalence regime for STS is set out, with the Treasury deciding which jurisdictions may benefit.
In a similar vein, the exemption for the special purpose vehicle having to be in the UK is maintained. The originator and sponsor though need to be UK located. (However, the concession that allows EU STS to be treated as STS in the UK until December 2024 remains in place.)
Oddly, in our view, the text allows for re-securitisations – which are banned in the EU. However, any re-securitisation transaction will need to be pre-approved on a deal-by-deal basis.
Retention and disclosure requirements are still in place but the text seems to allow non-UK issuers to sell to UK investors provided they comply with substantially the same standards. So the total identity of standards required by the EU has been abandoned.
Bear in mind that this is merely a summary of the high points and the document is still a draft. It could change quite a lot before becoming law.
We would like to take this opportunity to celebrate the ten years of the PCS initiative and thank our readers and other stakeholders for their support through a decade of seeking, with their help, to support the European securitisation market as well as to convey our season's greetings and best wishes for the new year.
So, from London, Paris, Milan, Munich, Poznan, Amsterdam and Banholt, the Outreach Team and the Analytical Team from PCS send you Season’s greetings and wish you a happy, prosperous and, above all, healthy 2023.
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