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Securitization no longer a dirty word in Europe, but volumes lag pre-crisis peak

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Securitization no longer a dirty word in Europe, but volumes lag pre-crisis peak

The crisis-scarred securitization market is just a fraction of its former size in Europe and is unlikely ever again to scale the heights reached in the 2000s. Yet as the continent's regulators look to reinvigorate the market, experts say the toxic reputation it acquired after the crisis is in many ways undeserved.

Securitized bundles of mortgage debt were a key contributor to the global financial crisis, as losses on subprime U.S. lending triggered worldwide contagion. Securitization — which involves the parceling of loans linked to commercial property, mortgages, car loans and credit cards into tradable bonds — gained additional notoriety in Europe after a succession of highly leveraged commercial property financings, structured on the eve of the financial crisis, wiped out investors when real estate prices collapsed.

Now, however, the European Commission is eager to revive the market for asset-backed securities as a way to encourage nonbank lending, as well as freeing banks themselves to lend more, given that they tend to hold far more loans on their balance sheets than peers in the U.S., where securitization is commonplace. It set out a new regulatory framework to this end in May, with an emphasis on promoting transparency and simpler structures than those seen in pre-crisis days.

And despite the reputation it acquired during the crisis, securitization is not a problem in itself, experts argue, saying it still has a legitimate role to play in global financial markets — so long as it is not abused.

"Let's get the story straight. Securitization was widely blamed for the financial crisis, but that's not an accurate diagnosis," said Anastasia Nesvetailova, director of the City Political Economy Research Centre at City University of London.

Around "for many years" pre-crisis, and used constructively other than during the subprime fiasco, securitization should not be a "dirty word" as long as market participants are using it responsibly, she said in an interview. It can be a useful way for companies to manage debt, and public squeamishness is unwarranted given the number of pension funds that still have exposures to harmless securitized products, she added.

"When the models developed for prime mortgages were suddenly applied to subprime paper, and more financial products were invented on top of those, that was the problem," Nesvetailova said. "Many aspects of the financial system are problematic, but securitization by itself isn't."

Seeking revival

In Europe, the securitization market remains alive, if not kicking at nearly the rate seen on the eve of the crisis, according to data compiled by the Association for Financial Markets in Europe. From a total of €818.7 billion of securitized issuance in 2008, volumes plunged under €200 billion in 2013 and have rebounded only slightly since, to just shy of €240 billion in 2016 and €109 billion in the first two quarters of 2017.

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In the U.S., by contrast, 2016 issuance totaled nearly €1.8 trillion, and issuance in the first two quarters of 2017 amounted to €825.2 billion.

Given that regulators are "obsessed" with ensuring a more transparent market free from the complex "double, triple-layered securitizations that we saw at the height of the market," securitization's bad reputation "is no longer justified," said Barbara Casu Lukac, professor of banking and finance at Cass Business School at the University of London.

Even so, there is still a lack of a "deep investor base" for securitization, she said in an interview, pointing to two main causes: "Investors are still very reluctant [to invest in securitized debt]. And because banks have been deleveraging so strongly since the crisis, there's not that surplus on their balance sheets that they can readily securitize."

And Nesvetailova noted that the potential for market disruption still exists, not least because of the possibility of human error, for example misjudgment by rating agencies about the creditworthiness of bonds underlying a securitization.

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Of the €109 billion in 2017 issuance, roughly three-fifths comprised residential mortgage-backed securities, or RMBS, while just over half (€120.2 billion) of the 2016 issuance was RMBS. U.K.-based collateral accounted for nearly half of second-quarter RMBS issuance in Europe, thanks in part to the country's thriving residential property market.

CMBS still constrained

By contrast, the commercial mortgage-backed security, or CMBS, market remains virtually dormant in Europe, with €3.7 billion of issuance in 2016 and just €0.3 billion in the first two quarters of 2017.

CMBS issued in the peak years of the property boom in the mid-2000s resulted in some lengthy restructurings and legal battles after the collapse of the real estate market, and have fallen out of favor as a result. By the end of 2008, U.K.-based CMBS holders were owed in excess of €77 billion, according to data compiled at the time by Barclays, but many deals had run into trouble as property values tanked. High-profile cases include the securitization of debt against Plantation Place, a landmark London office building, and properties owned by care home firm NHP.

But according to recent research from Bank of America Merrill Lynch, there have been €4.3 billion of losses to date on the €294.7 billion of CMBS issued in Europe between 1995 and 2017, and it is predominantly loans securitized at the peak of the property boom, between 2005 and 2007, that are the problem. Where CMBS is starting to be used again, leverage is more conservative, at around 60% to 65% loan-to-value, down from the 75% or more that was commonly seen before the market imploded, the report adds.

But while European regulators have been eager to revive RMBS, they have taken a far more conservative line on CMBS, including where prospective investors are concerned, said Peter Cosmetatos, CEO of the European arm of the Commercial Real Estate Finance Council.

"Regulators have slapped very high capital charges on CMBS for European insurers using the standard formula under Solvency II," he said in an interview. "Insurers should be the primary buyers for this kind of debt."

When used properly, CMBS can be a useful form of exposure to commercial real estate for investors, and regulators fail to understand that the performance of CMBS against wider commercial property lending has generally been good, Cosmetatos argued.

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