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					Andreas Jobst / John Kiff

                                                 Capital markets-based funding in
                                                 German banking – securitization and
                                                 covered bonds

As banks struggle to secure sufficient           being hampered by legacy problems. The          (Figure 2). As opposed to U.S. private-label
long-term funding in the wake of the re-         collapse of interbank markets and the per-      residential mortgage securitization, the
cent crisis there is a risk of a vicious feed-   ceived role of securitization in the global     German securitization market has not ex-
back loop into the real economy as banks         credit crisis led to serious doubts about       perienced a situation that calls for a fun-
curtail credit to offset declining net inter-    counterparty risk in unsecured funding          damental rethinking of certain modes of
est earnings. In terms of capital markets-       and structured finance techniques aimed         securitization. The performance of German
based funding, European banks have re-           at the unbundling, transforming, and re-        securitization through the credit crisis has
cently been switching away from senior           distributing of credit risk. In particular,     proven very resilient –both at the collat-
unsecured to covered bonds, while secu-          in some markets, most notably the U.S.          eral and product level – which can be
ritization volumes remain fairly marginal.       private-label mortgage-backed securities        explained by several structural factors be-
However, concerns are being expressed            (MBS) market, by substituting securitiza-       yond traditionally conservative loan origi-
with regard to the potential impact of           tion for intermediated lending facilitated      nation standards with high equity par-
covered bonds on issuer balance sheets           excessive risk-taking to a point where the      ticipation under the same credit law as
and on the efficacy of bank failure resolu-      inability of issuers to gauge actual default    non-securitized loans (see table). For in-
tion frameworks and deposit guaranty             risk and the flexibility of asset managers to   stance, most securitization structures in
schemes. Hence, a broad range of funding         subvert investment mandates intensified         Germany have been more closely associat-
tools, including securitization, is needed to    the potential of systemic vulnerabilities to    ed with the funding needs of the real
help banks cope with considerable refi-          credit shocks (Jobst, 2010).4)                  economy, which is reflected in the domi-
nancing need going forward.                                                                      nance of small and medium enterprise
                                                 While the German securitization market          (SME) loans and car lease receivables as
Doubts about counterparty risk                   performed very well during the credit           the main collateral types, rather than
                                                 crisis, issuance placed with final investors    speculative transactions aimed at regula-
German securitization volumes have always        has since tailed off, as it has elsewhere       tory arbitrage. Despite the relative resil-
been small compared to that of other                                                             ience of the German securitization market,
forms of capital markets-based funding                                                           the retention of transactions for collater-
such as unsecured and covered bonds (see                                                         alized lending far outweighed the actual
Figure 1).2) Furthermore, in the wake of the     Andreas Jobst, Volkswirt, International Ca-     placement until recently.
financial crisis, whereas covered bond issu-     pital Markets Department, und John Kiff,
ance has remained fairly steady, securitiza-     Senior Financial Sector Expert, Monetary        Focus on non-mortgage assets
tion volumes and unsecured bond issuance         and Capital Markets Department, beide In-
have declined significantly. In fact, more       ternationaler Währungsfonds, Washing-           Moreover, securitization has become ever
recently, this reflects a more general trend,    ton, D.C.1)                                     more focused on non-mortgage assets as
with European senior unsecured bond issu-                                                        structural underpinnings of real estate fi-
ance decreasing by eleven percent in the         Während sich Banken in der gegenwärti-          nance – which makes up a considerable
first half of 2011 relative to a year earlier,   gen Krise insbesondere den Covered Bonds        share of bank balance sheets – are stacked
while covered bond issuance rose by 19           zuwenden, bleibt das Verbriefungsvolumen        up against securitization in Germany. As a
percent.3) In addition, most of the 2008–09      weiterhin gering. Mit Blick auf die Bilanzen    result of a combination of a conservative
securitization issuance was not placed with      der begebenden Institute sowie Banken-          credit culture and mortgage underwriting
final investors, but instead “retained” by is-   und Einlagensicherungssysteme fordern           practices, loan books are more cost effec-
suers to post as collateral against central      die Autoren eine breitere Nutzung von Fi-       tive to fund with deposits and Pfandbriefe
bank repo facilities. However, the market’s      nanzierungstools, um den wachsenden Fi-         (covered bonds). Although structural con-
dependence on central bank repos has             nanzierungsbedarf abzudecken: Gerade in         straints associated with the Pfandbrief
tailed off somewhat since 2009.                  der Verbriefung sehen sie einen alternati-      model have limited the diversity of mort-
                                                 ven und flexiblen Finanzierungskanal, um        gage products, mortgage securitization
Going forward, the recovery of both secu-        eine stabile Kreditversorgung in einem          has been sporadic and mainly motivated
ritization and unsecured debt markets is         Banken-dominierten Finanzsystem sicher-         by regulatory capital relief.5)
                                                 zustellen – nicht anstatt, sondern zusätz-
1004 / S. 22 · 19 / 2011   Kreditwesen           lich zu Pfandbriefen. (Red.)
Against this background, German securiti-       Figure 1: German bank capital markets-based medium- and long-term funding
zation volumes have historically been           (billion euros)
small using a synthetic securitization plat-       500
form.6),7) While in most other countries, se-      450
curitization is driven by cash transactions
on mortgage assets, there have been only
four German cash residential mortgage-
backed securities (RMBS) transactions              300
since 2000, one of which was done using            250
the True Sale International (TSI) platform.8)      200
Only in 2003 was the trade tax (Gewerbe-           150
steuer) law, a major obstacle to true sale         100
securitization in the past, amended by the          50
Act to the Support of Small Businesses
(Gesetz zur Förderung von Kleinunterneh-                      2005             2006            2007          2008            2009            2010
men und zur Verbesserung der Unterneh-
                                                           Senior Unsecured      Covered Bonds    Securitization (Placed)   Securitization (Retained)
mensfinanzierung), which exempts special
                                                 Source: Dealogic and Deutsche Bank
purpose vehicles (SPVs) purchasing certain
receivables originated by banks in (true
sale) securitization transactions from in-
come tax. Also in 2004, value-added tax         covered bonds (Kiff et al., 2011). Cover                financial intermediaries, and savers. During
(VAT) on receivables servicing was re-          bonds rated “AA-/Aa3” or higher will be al-             periods of market stress, covered bonds
moved.9)                                        lowed to count towards the liquidity cov-               provide the time-tested funding backstop,
                                                erage ratio (LCR) under the proposed Basel              albeit mainly for investment-grade banks
General resilience to stress events             III liquidity requirements while securitiza-            (rated “BBB-/Baa3” and better). In con-
                                                tions are excluded. Also, Solvency II assigns           trast, for lower-rated banks, securitization
In any case, German mortgage funding is         a lower capital charge for covered bonds                may be the best funding option, because it
very much bank deposit-based, with capital      compared to other non-government and/                   isolates the credit quality of the collateral
markets-based funding (which amounted           or unsecured assets. Furthermore, covered               from that of the issuer and provides issuers
to about 20 percent of outstanding loans)       bonds will likely be exempted from resolu-              with more flexibility regarding collateral
comprised mostly of Pfandbriefe. These on-      tion-related “bail-in” initiatives that will            assets, security design, and payment struc-
balance sheet obligations are viewed as ul-     subject unsecured senior debt of failed                 ture than do covered bonds. For example,
tra-safe investments because they are se-       banks to forced write-downs or conversion               eligible Pfandbriefe cover pool assets are
cured by a dedicated (“cover”) pool of          into equity.                                            restricted to mortgage-, public sector-,
loans, with the issuer being fully liable for                                                           ship- and aircraft-backed loans.
all interest and principal payments. Hence,     However, on an even playing field, covered
if the issuing bank defaults, Pfandbrief in-    bonds and securitization should be viewed               Systemic problems under stressed
vestors get preferential access to the pool     as complementary rather than competing                  conditions
of high-quality assets, according to statu-     funding vehicles. During normal times,
tory laws that also ensure the high quality     they both increase the range of available               Nonetheless, it is also important to recog-
of the loans, and substantial overcollater-     financial products, benefiting borrowers,               nize that both products create systemic

Furthermore, the Pfandbrief market has          Figure 2: German placed private-label term securitization (million euros)
demonstrated general resilience to stress        35,000
events and enjoyed official support during
the recent crisis.10) For example, the Euro-     30,000
pean Central Bank actively supported the
market from June 2009 to June 2010 with
its 60 billion euro covered bond purchase        20,000
program. Also, some German bank bailouts
involved large Pfandbrief issuers,11) leading    15,000
to perceptions that the authorities are          10,000
prepared to support the Pfandbrief
brand.12)                                         5,000

A confluence of regulatory developments                       2005          2006        2007          2008        2009          2010        2011
– actual and potential – in the wake of fi-
                                                                              Autos   CMBS       RMBS     Other ABS      CDOs
nancial crisis further supports the recent
                                                 Source: Deutsche Bank
trend toward post-crisis prominence of

                                                                                                                  Kreditwesen     19 / 2011 · S. 23 / 1005
Capital markets-based funding in German banking – securitization and covered bonds

Table: U.S. private-label versus german mortgage loan securitization business                                     w w w. i m f . o r g / e x t e r n a l / p u b s / c a t / l o n g r e s .
models                                                                                                            aspx?sk=25031.0.
                                                                                                                  Jobst, Andreas, 2010, “Managed Collateralized Debt
                    United States (private-label)                 Germany                                         Obligations (CDOs),” in: Cont, Rama (ed.) Encyclope-
                                                                                                                  dia of Quantitative Finance (Chichester, UK: John
                    Break-up of the value chain and               Loan origination and servicing remains          Wiley & Sons Ltd.), pp. 1113–5.
                    commission-driven origination and             with the financial institution.                 Jobst, Andreas and John Kiff, 2011, “Financial Sector
 Credit             servicing (quantity rather than quality;                                                      Assessment Program Update – Germany: The Future
 origination        moral hazard problems).                                                                       of German Residential Mortgage-Backed Covered
                                                                                                                  Bond and Securitization Markets,” Technical Note,
                                                                  Securitized loans are subject to the same
                    No regulation.                                                                                June 20 (Washington, D.C.: International Monetary
                                                                  credit law.
                    Low credit standards: high loan to            Traditionally conservative loan origination     Kiff, John, Surti, Jay and Andreas Jobst, 2011, “Cov-
 Credit quality     value, interest-free teaser periods,          with high equity participation (e.g.,           ered Bonds and Asset Encumbrance,” ECBC Fact
                    exotic payment options.                       mortgage loans).                                Book 2011, European Covered Bond Council, pp.
                                                                  Securitization part of ongoing balance          Schöniger, Sandra, 2007, “Overview of the German
 Funding            Securitization of third-party originated
                                                                  sheet operations (with seasoned loans           Securitisation Market,” in: Deutsche Bank (ed.)
 purposes           loans (off-balance).
                                                                  only)                                           Global Securitisation and Structured Finance 2007
                                                                                                                  (London: Globe White Page), pp. 263-6.
                    Separation of risk between securitizer        First loss position usually retained by         Schönwälder, Pia, 2011, “Covered Bond Report,”
 Risk sharing
                    and investor (principal agent problem).       securitizer.                                    BayernLB Investment Research, Covered Bond Re-
                                                                                                                  search, July 28.
                                                                                                                  Volk, Bernd, 2011, “EUR Liquid Credit Weekly,”
                                                                                                                  Deutsche Bank Global Fixed Income Markets Re-
problems under stressed conditions, which                  the effectiveness of bank failure resolution           search, July 7.
also impact unsecured funding. The main                    frameworks and deposit insurance pro-                  Wookey, Jethro, 2008, “After 200 Years, It’s Come to
impact of securitization gone wrong is                     grams could be adversely impacted.13) For              This,” Euromoney, November.
through investors, as was so clearly evi-                  example, in the new banking resolution
dent during the recent credit crisis. For                  framework, depositors will continue to be              1) E-mail: and The
covered bonds, the extensive legal protec-                 treated as subordinated to Pfandbrief in-              views expressed in this article are those of the au-
tions granted to debt holders present po-                  vestors. This may increase moral hazard,               thors and should not be attributed to the Interna-
tential vulnerabilities for the issuer’s un-               because authorities – recognizing the sys-             tional Monetary Fund, its Executive Board or its
                                                                                                                  management, or to the Bermuda Monetary Author-
secured creditors, including depositors. In                temic relevance of this important funding              ity.
this regard, depositors will have a smaller                channel – might find it difficult to resist            2) Securitization transactions involve the transfer of

pool of unencumbered (and possibly lower                   calls for the bailout of a covered bond is-            the risk associated with portfolios of credits into
quality) assets to fall back on in the event               suer that gets into difficulties. However,             off-balance sheet special purpose vehicles funded
                                                                                                                  with the issuance of one or more „tranches“ of se-
of a default. Weaker recovery rates on un-                 this risk is mitigated in the German case to           curities. Tranche holders are paid in specific order,
secured senior unsecured debt could in                     some extent by strong Pfandbrief legisla-              starting with the „senior“ tranches (least risky)
turn result in heavier reliance on covered                 tion that ensures that the bonds are well              working down through one or more levels to the
bonds, whose privileged position (regard-                  over-collateralized.14)                                „equity“ tranche (most risky). In contrast, covered
                                                                                                                  bonds are on-balance sheet debt obligations se-
ing the seizure and foreclosure of collater-                                                                      cured by a dedicated reference (or „cover“) portfolio
al assets) only further weakens unsecured                  In any case, promoting securitization as an            of assets, with the issuer being fully liable for all in-
debt credit strength and so on. The impact                 alternative and flexible funding channel to            terest and principal payments. In the case of Ger-
of this structural subordination may also                  Pfandbriefe contributes importantly to en-             man covered bonds (or Pfandbriefe), all obligations
                                                                                                                  related to the bonds are backed by an exclusive
be amplified by rising levels of over-collat-              suring a stable and comprehensive supply               claim on the cover pool that is recorded in the cov-
eralization required to maintain the bonds’                of credit in a bank-dominated financial                er register.
high credit ratings. Also investor prefer-                 system amid rising regulatory challenges               3) Issuance in 2010 came close to the 2006-07 pre-

ence for covered bonds could make fund-                    and large refinancing needs of German                  crisis peaks, and 2011 European volumes are looking
                                                                                                                  even stronger with 131 billion euros worth of
ing via unsecured senior debt more costly                  banks over the next five years (about 250
                                                                                                                  benchmark bonds (more than 500 million euros) is-
(and, thus, delay the exit from current cri-               billion euros annually until 2015).                    sued in the first six months of 2011 (Schönwälder,
sis support measures).                                                                                            2011; Volk, 2011).
                                                                                                                  4) Private-label securitization products comprise

Furthermore, to the extent that covered                    References                                             those not issued or backed by governments and
                                                           Engelhard, Fritz, and Michaela Seimen, 2010, “The      their agencies, that is, excluding those of govern-
bond funding replaces unsecured funding,                   AAA Investor,” Barclays Capital AAA Research, No-      ment-sponsored enterprises (e.g., Fannie Mae and
                                                           vember 11.                                             Freddie Mac in the United States), and public sector
                                                           Engelhard, Fritz, Harju, Jussi, and Michaela Seimen,   entities (e.g., Canada Mortgage and Housing Corpo-
                                                           2011, “The AAA Investor,” Barclays Capital AAA Re-     ration in Canada).
                                                           search, June 11                                        5) For example, such constraints tend to preclude

                                                                                                                  the offering of prepayment options, because they
  Beilagenhinweis                                          European Banking Authority (EBA), 2011, “Stress
                                                           Test Summary Report,” available at http://www.eba.     can undermine asset-liability matching and result
                                                          in breaches of over-collateralization conditions. Al-
  Dieser Ausgabe liegt ein Prospekt des                    wide-stress-test-results.aspx.                         most all Pfandbrief issuance is in the form of fixed-
  C.H. Beck Verlages, München, bei.                        International Monetary Fund (IMF), 2011b, “Germa-      rate bullet maturities, but Pfandbrief regulations
                                                           ny: Financial Sector Stability Assessment,” Country    stipulate that cover assets must always exceed out-
                                                           Report No. 11/169, June 20 (Washington, D.C.: In-      standing securities, and sudden shortfalls could re-
                                                           ternational Monetary Fund), available at http://       sult from prepayments.

1006 / S. 24 · 19 / 2011   Kreditwesen
6) Since 2001, 15 partially-funded synthetic residen-
tial mortgage-backed securities (RMBS) transac-
tions have been issued via KfW‘s Provide securitiza-                                              Ihre
tion platform.
7) In a „cash“ securitization, a special purpose vehi-

cle (SPV) buys the loans outright (i.e., a „true sale“).
In a synthetic securitization, credit derivatives are
used to transfer the risk associated with the loans
from the bank‘s balance sheet to the SPV. The pro-
ceeds from the sale of securities are used to buy liq-
uid high-quality collateral to fund contingent pay-
ments on the credit derivatives, and pay interest
and principal on the securities.
8) There have been 14 TSI-certified securitization

transactions going back to 2005, seven of which
were auto loan-backed ABS, and two each of con-
sumer loan-backed ABS, commercial mortgage-
backed securities, and collateralized loan obliga-                                          lädt ein zur
tions (CLOs) backed by loans to small- and medium-
sized enterprises (SMEs).
9) The VAT exemption applies only if servicing rights

are retained by the lender, as is typically the case in
                                                           57. Kreditpolitischen Tagung
Germany. In addition, the Refinancing Register was
introduced in 2005 (Schöniger, 2007); prior to that,              am 4. November 2011, 11.00 – 13.00 Uhr,
mortgage transfers had to be recorded in the re-
spective land register, which was expensive and had           im Hermann J. Abs-Saal der Deutschen Bank AG,
to be done for each individual loan (amounting to
thousands in a typical securitization transaction).
                                                                   Junghofstraße 11, Frankfurt am Main,
10) If the reference asset portfolio fails to generate

sufficient cash flows, or if its market value drops
                                                                          Empfang ab 10.00 Uhr
below the notional value of the issued securities,
covered bond investors have an unsecured senior
claim on the bankruptcy estate of the issuer. The
only covered bond issuer bankruptcy was in 1883 -
the Austrian issuer Böhmische Bodencredit. In that         „Der Euro, die Märkte, die Banken –
case, the failed bank‘s covered bond obligations
were transferred to another bank two years later,           wie weit reicht die Solid(ar)ität?“
interest payments were reduced, and the bonds re-
deemed in full in 1901 (Engelhard and Seimen,
2010; Engelhard et al., 2011).
11) However, these bailouts were not related to
                                                                                      Dr. Jürgen Stark
funding problems caused by covered bonds but
large investment losses from cross-border expo-                     Mitglied des Direktoriums, Europäische Zentralbank,
sures.                                                                               Frankfurt am Main
12) The banks in question included Allgemeine Hy-

pothekenbank Rheinboden AG (October 2005), Düs-
seldorfer Hypothekenbank (April 2008), Hypo Real                                         Gerd Häusler
Estate (October 2008), and Euro Hypo AG (May
2009). For example, in the case of Hypo Real Estate,
                                                              Vorsitzender des Vorstands, Bayerische Landesbank, München
the covered bonds were seen as being sufficiently
collateralized, but there were questions regarding
the ability to liquidate it in the wake of the Lehman                      Prof. Dr. Jan Pieter Krahnen
Brothers bankruptcy (Wookey, 2008).                                  Lehrstuhl für Kreditwirtschaft und Finanzierung
13) Greater transparency about the underlying as-
                                                                         Fachbereich Wirtschaftswissenschaften,
sets, as evidenced by the recent start of regular dis-
closures of the cover pool composition by Pfand-                 Johann Wolfgang Goethe-Universität Frankfurt am Main,
brief issuers, can reduce these systemic concerns.                        House of Finance, Frankfurt am Main
14) In some countries, such as Germany, covered

bond legislation imposes a special law principle
and/or regulatory caps on issuance with a view to-
wards protecting (retail) depositors and/or represen-
                                                                                Nachgefragt zur Sache
ting the interests of (retail) depositors. However,                                          Philipp Otto
current regulations falls short of imposing covered
bond issuance caps, which could benefit both co-
vered bond holders and unsecured creditors. These           Teilnahmegebühr: 120,– Euro zzgl. MwSt.       Anmeldeschluss: 24. Oktober 2011
limits can preserve the economic value of full re-
course to covered bond investors in the event of is-
suer insolvency. Also, they reduce the risk of rising                                  Fritz Knapp Verlag
                                                                     Sandra Gajewski . Postfach 11 11 51 . 60046 Frankfurt am Main
cover pool dilution if covered bond issuance increa-
                                                                             Telefon 0 69/97 08 33-20 . Telefax 0 69/7 07 84 00
ses faster than total liabilities (as a smaller pool of           E-Mail: . Internet:
assets is available to meet unsecured credit claims)
and/or unencumbered assets on the balance sheet
decline in credit quality.

                                                                                                                  Kreditwesen     19 / 2011 · S. 25 / 1007

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