For many years ABS has primarily been used as a funding tool for banks and other lenders. But before the financial crisis ABS had proven itself to be an efficient tool for banks to transfer credit risk to investors and get relief on the regulatory capital they had to hold against such assets. Under new Basel rules capital charges changed dramatically, particularly for mortgages, and risk transfer became less efficient for banks, as yield requirements from investors simply made these transactions very expensive. However, these capital relief transactions were still done, typically towards the end of the year, by selling junior notes in transactions backed by predominantly corporate loans, in private transactions.
Don’t let the phrase “capital relief transactions” scare you. They are no different to normal securitisations backed by a specific set of assets and cash flows, but rather than only selling the AAA (the safest and most liquid) part of the deal, the focus is on selling the mezzanine and junior (typically non-rated) bonds to investors. And similar to all other European ABS deals, the originator is aligned with the investors as they are required to retain at least 5% of the risk. As the credit risk (and yield) is obviously higher, investors will need to get comfortable with this and spend a lot of time scrutinising the origination/servicing skills of the bank, as well as the collateral and structural features of these deals. BNP Paribas closed a large French consumer transaction two weeks ago, selling the AA to non-rated bonds part of the deal to investors at yields between Euribor+80bp and 6.35%. If we compare this to, for example, the 3.2% yield on the bank’s four-year AT1s, that is not a bad yield (in euros) for junior but secured credit. Having said that, we are not going to argue that they are similar credits, as they are not and neither do they have the same liquidity profile.
As capital charges are changing with the introduction of yet another new set of Basel regulations, these capital relief transactions are becoming more interesting for banks again. At the recent Global ABS conference we had several meetings with large European issuers that are considering this kind of trade in the next six to 18 months. This is not concentrated around a single jurisdiction per se, but it is very focused on consumer and SME loans, which tend to have shorter duration and carry higher capital weights, making it an efficient asset class to securitise from a capital perspective. We have already seen a number of public transactions from the likes of BNP Paribas, Santander (multiple jurisdictions) and Lloyds, and we expect to see more of these full capital stack deals coming to the market, particularly from the European banks.
From an investor point of view, it is an interesting way to get exposure to junior risk from high quality lenders in Europe that have previously been difficult to source. We don’t expect to see a wave of these deals coming to the market, but we welcome this development and look forward to a nice diverse mix of assets to look at.