CREFW-Fall2015

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CRE Finance World Autumn 2015
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Potential Jurisdictional Differences Will Significantly
Influence Investor Decisions
One topic causing consternation among many market participants
at the recent conferences was just how much the treatment of the
constituent assets differed across jurisdictions. Currently, both the
EU and U.S. versions of the rule include corporate bonds as level
2B HQLA. The EU regulation includes certain RMBS, auto loan
ABS, small to mid-size enterprise (SME) loan ABS, and consumer
loan ABS as level 2B HQLA, whereas the U.S. regulation does not.
Interestingly, the Canadian rules recognize the credit quality
and liquidity that comes from their government-sponsored
guarantee on their Canada Mortgage and Housing Corp. (CMHC)
residential mortgage bonds as level 1 assets, while U.S. agency
MBS is classified as level 2A under the U.S. rules. Based on our
conversations with institutional investors, most are surprised and
concerned about that decision. There are over $7 trillion in agency
MBS outstanding (including in collateralized mortgage obligations
[CMOs]), making it the third-largest bond class available to
investors (U.S. Treasuries and U.S. corporates are the two largest).
Also, average daily trading volume suggests that agency MBS is
the second-most-traded fixed-income product after Treasuries,
and has been for at least the past 10 years. It is understandable
that U.S. regulators may want to distinguish between an implied
and full-faith-and-credit guarantee by the government, but there
may be an unintentional effect on the global bond ecosystem
if investors begin to trade out of the $7 trillion agency bond
market en masse and into the limited number of other potential
alternatives, which would be the $12 trillion U.S. Treasury market
or the less liquid, but still large, $8 trillion corporate bond market.
This is especially true for domestic bank investors, who are
currently the #1 holder of Agency/GSE-backed securities, and
have increased their holdings since 2009 (see appendix).
Beyond the issue of deciding what is liquid and high-quality, there
are valuation haircuts that are applied to HQLA (although generally
not to level 1). On this issue, the EU regulations apply a 25%-35%
haircut to their qualifying RMBS/ABS securitizations. This is below
the 50% haircut for some other 2B HQLA, suggesting that the
EU regulators may be recognizing that securitized products can
help support their financial institutions and play a role in funding
economic growth.
While not yet fully implemented, these levels, which include
some bond products and exclude others, are already becoming
a key factor in influencing bank investment demand as opposed
to assessing credit risk and liquidity relative to yield. Based on
conversations with institutional investors, a covered bank may
invest in an EU SME loan ABS or auto loan deal versus a U.S.
collateralized loan obligation (CLO) or auto loan deal based solely
on the preferential regulatory treatment.
Further, it appears that commercial mortgage-backed securities
(CMBS) are excluded in all jurisdictions from qualifying as HQLA.
This exclusion is likely playing a role in the limited reemergence
of floating-rate shorter-duration CMBS, as that market has not
seen the same recovery achieved in fixed-rate CMBS. In Europe,
CMBS does not meet several of the 14 criteria recommended
by the BCBS-IOSCO task force to be classified as a “simple,
transparent, and comparable” securitization. These include: nature
of the assets (assets backing CMBS transactions typically are
heterogeneous, not homogenous), consistency of underwriting
(CMBS underwriting standards can and sometimes will vary by
loan circumstance, e.g. acquisition or refinancing, stabilized versus
non-stabilized property), and redemption cash flows (the majority
of principal cash flows in most CMBS depend on refinancing or
sale of the assets at maturity). In addition, CMBS do not meet
other “high-quality” securitization (HQS) guidelines published
by the EU Banking Authority (see endnote), which include a
credit risk criterion that limits maximum obligor exposure to 1%.
We suspect that some of these parameters may be due to poor
performance that came from some more transitional floating-
rate CMBS pools, which usually contain three to 30 transitional
properties. The 1% restriction may unnecessarily restrict the
market from utilizing products such as single-borrower CMBS,
which was the first type of U.S. CMBS deal to re-emerge after the
financial crisis, and currently remains a significant portion of the
U.S. market (about 33% of 2015 issuance year to date through
July). So, it is somewhat ironic that the transparency achieved in
single-loan CMBS is excluded by regulatory rules that take comfort
in diverse ABS pools.
Average Daily Trading Volumes: How is Liquidity Being
Measured?
Any comprehensive measure of market liquidity requires many
variables, such as bid/asked spreads, spread volatility, total
outstandings, the ability to transact in times of market stress
(such as right after the financial crisis), trading volumes etc.
Unfortunately, all of those variables are not publicly available ,
which creates a challenge for regulators to analyze and implement
a national classification system consistent with other different
international markets. In charts 1 and 2 we compiled average daily
trading volumes for various fixed-income products.
Basel III’s Recent Liquidity Guidelines