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Solvency test

Could regulation coming out of Europe ultimately restrict mortgage availability? Paul Thomas reports

Mortgage experts fear Solvency II could have an adverse effect on the securitisation market, which could result in mortgages becoming more expensive and harder to obtain.

Solvency II sets out rules for how much capital insurers have to hold against various assets, depending on their risk and duration.

There are two ways the capital requirements can be decided. The first is called the standard formula, which has set parameters for how much capital insurers should hold for certain asset classes. As it stands, insurers will be required to hold 7 per cent of the market value of each securitisation asset they hold for each year of duration compared with just 0.7 per cent for covered bonds.

Alternatively, insurers can devise their own internal models that must be signed off by the local regulator. However, this approach would be costly and may be viable only for the biggest insurers.

This month, Fitch Ratings warned that the punitive capital charges for holding securitisations could put off insurers from investing in this type of asset class. This could have serious consequences for the mortgage market as insurers account for about 20 per cent of all investment in mortgage-backed securities.

The Association for Financial Markets in Europe, which lobbies on securitisation issues, recently conducted a survey of 27 insurers across Europe about the effect the proposed capital charges would have on securitisation.

Thirty-three per cent of respondents said the new rules would stop investment altogether while the remaining 67 per cent said they would dramatically reduce allocation of funds to the securitisation sector.

Worryingly, of those who said they would withdraw from the securitisation market, a fifth said they would not return. Of those who said they would return, 63 per cent said it would take more than a year and about one-fifth said it would take more than three years.

Securitisation is a key source of funding for lenders so the loss of such important investors is likely to affect mortgage availability and pricing.

London & Country associate director of communications David Hollingworth says: “This will have a knock-on effect in terms of expansion in the mortgage market. If you push up the cost of funding, then it will also result in more expensive mortgages. It looks quite gloomy.”

The Council of Mortgage Lenders has also raised concerns about the effects the proposals might have on mortgage lending.

CML spokesman Bernard Clarke says: “Lender requirements to hold capital are already bearing down on mortgage supply and measures affecting securitisation could reinforce this. It looks like another example of the effects of regulation having a cumulative effect in restricting mortgage availability.”

Some believe lenders could alter their funding models to place more emphasis on raising money through retail deposits.

John Charcol senior technical manager Ray Boulger says: “You could find banks will favour funding through savings deposits, which means savers will benefit as lenders battle to get in deposits. However, this will mean borrowers will lose out by way of increased mortgage rates.”

The fact that holding securitisation assets on balance sheets is more heavily penalised than holding other assets, such as covered bonds, which are similar to mortgage-backed securities except the originator retains all of the underlying assets, indicates the European Commission sees RMBS as being more risky.

In fact, research from Standard & Poor’s shows less than 5 per cent of UK RMBS transactions have been downgraded since the financial crisis compared with about 45 per cent in the US.

AFME argues the rules unfairly put the European market in the same category as the US market and has urged the European Commission to reconfigure the capital charges.

AFME securitisation division managing director Rick Watson says: “Much of this calibration has been based on a misperception of the sector as being high risk and badly performing. This reputation is undeserved since the performance of European securitisation has been very good.

“We urge policymakers to conduct further analysis using more appropriate calibrations for assessing securitisation capital charges that properly reflect the economic risks of the investments.”

Despite most commentators predicting dire consequences as a result of this proposal, there are people who believe the effects will not be so devastating.

Citigroup Global Markets head of European securitised products research Gordon Kerr says: “Securitisation will be impacted but not as massively as some of the doomsayers claim because the larger insurance companies will create their own internal models, which will allow them to lower the capital charges on securitisation.

“This will still be penal but less so than if they adopted the standard approach. They will still invest in securitisation, even if it is less than before.”

Kerr also believes insurers will make up for their lack of investment in RMBS by investing in covered bonds.

He says: “There would be funding concerns for the market but you could probably make up for the fall in securitisation activity in covered bonds, even though it may not be as attractive to insurers.”


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