Words cannot rid securitised debt of 'bad boy' image in Europe

By Anil Mayre and Anna Brunetti

BARCELONA Spain (Reuters/IFR) - Six years after mind-blowingly complex securitised debt brought the global financial system to its knees, the bankers behind the market are wary of official efforts to rehabilitate it in Europe.

In the years leading up to 2008, when loans were transformed into bonds, many were repackaged again and again, acquiring triple A ratings despite links to U.S. sub-prime mortgages, and earning the nickname "toxic sludge".

Yet the European Central Bank (ECB) and Bank of England (BoE) say they want to revive more straightforward asset backed securities (ABS) in the hope of ramping-up lending to credit-starved businesses and rebooting the regional economy.

Attendees at the industry's annual meeting in Barcelona say it will take more than positive words to overcome their pariah status in Europe and worry that official efforts to exclude the riskier parts of the market will make it unworkable.

"Don't confuse words with action," James Hewer, a partner at PwC's structured finance team, told delegates at a meeting far more low key than those before the crisis, when bankers supped cocktails and, one year, danced to the Gypsy Kings.

Delegates are cheered by the calls for a revival of the moribund market from London and Frankfurt but skeptical it can be a meaningful driver of economic growth unless the regulatory clamp down triggered in the wake of the crisis is eased.

Bankers want regulators globally to reduce the amount of capital that lenders, who create the debt, and insurance companies, who could buy it, must set aside in case the bonds lose their value, as in 2007.

To facilitate that, the ECB and the BoE want to create a new category of "high-quality" asset-backed securities that would have lower capital charges. The definition is still being worked out but it would include loans to businesses and exclude sub-prime mortgage securities and exotic derivatives.

Bankers worry, however, that such a definition might end up being too narrow and would make securities falling outside it untradeable, shrinking an already shallow market and further deterring investors who like to have a deep supply.

To get the market going, the ECB has signalled that it might buy "simple and transparent" securities itself but bankers argue such assets are thin on the ground because banks have already parked them with the central bank in return for cheap funding.

“You do have an investor base out there, but a large part of it disappeared because of the Bank of England and the ECB themselves,” said Gordon Kerr, head of Structured Finance Research, DBRS.

The ECB's decision last week to offer further cheap funding to banks via "targeted longer term refinancing operations" may also discourage banks from issuing asset backed securities if they can get funding cheaply from Frankfurt, delegates said.

TARRED WITH SAME BRUSH

The transformation of mortgages, business loans and consumer debt into securities that can be sold on to investors makes economic sense because it gives banks a source of funding and frees up their balance sheets, in theory reducing lenders' risk.

It also enables companies to tap capital markets directly. Car companies who provide finance to customers, for example, can repackage those repayments and sell them on to investors.

Used recklessly, however, securitisation can be catastrophic.

The repackaging of mortgages given to risky U.S. borrowers fuelled the last financial crisis because they were not valued correctly and were bundled into a suite of products whose riskiness was not reflected in the ratings assigned to them.

So lucrative was this financial wizardry for Wall Street that some mortgages were created just to enable more securitisation.

Securitisation experts in Europe argue they are being blamed for the sins of their U.S. peers. European asset backed securities are traditionally simple and transparent. Their default rates held up well during the crisis, coming in at around 1.4 percent between mid-2007 and the first quarter of 2013 compared to 17.4 percent in the United States.

U.S. authorities did not clamp down as hard on the securitisation industry, where it is a bigger source of funding for the economy than in Europe, and the market there has had more of a recovery with $2.2 trillion worth of securities issued in 2013, around two-thirds of the pre-crisis annual rate.

The market in Europe, where issuance levels are under half the pre-crisis annual rate, is also constrained by the different ways in which information on securitised debt is disclosed across Europe, making it difficult for investors to get a clear overall picture of what they are buying.

Indeed, the biggest problem will be trying to get investors on board rather than giving banks more incentives to take part.

Janet Oram, a director at asset manager Blackrock, warned that with the new goodwill being shown to the market from regulators, bankers would have to tread carefully.

"We can't afford to take a step wrong," she said.

(Additional reporting by Eva Taylor in Frankfurt and Sarah White in Madrid; writing by Carmel Crimmins; editing by Philippa Fletcher)