"Banks are turning to assets that they chose not to securitise previously, when investors were still buying, because alternative funding sources were available and there was a strong flow of newly originated more 'plain vanilla' assets to securitise," says Stuart Jennings, Structured Finance Risk Officer for the EMEA region. "Banks may have preferred not to tap such portfolios in the past as either they saw limited investor appetite for the profile of the assets, or they may have deemed them too problematic or costly to securitise in terms of limited data availability, legal concerns, systems issues or enhancement levels."
"Transaction sizes are also increasing to large sizes of tens of billions of euros or pounds. This is an apparent recognition that banks will have to continue to tap central bank funding for the foreseeable future. They are therefore readying themselves with retained transactions which can be quickly utilised for repo funding when needed," Jennings adds.
The agency emphasised that the securitisation of more esoteric assets, as well as the volume of transaction sizes, presents particular issues in terms of credit analysis. While such collateral may often be seasoned, other issues may outweigh this positive. For example, in RMBS, the collateral may consist of loans that offer borrowers a high degree of optionality or might involve mortgage borrowers who earn in a different currency to the currency in which the loans are denominated. Other assets may present data issues. For CMBS, banks have been reviewing commercial mortgage books and some are contemplating granular portfolios for securitisation that were previously considered to have too many data hurdles. Development loans are also being considered which have historically been excluded from CMBS. The degree of incremental risk involved in some cases may result in a transaction which Fitch does not deem compatible with a 'AAA' level of credit risk.
Meanwhile due to the changing nature of transactions, the extent of counterparty risk is also increasing. The types of swap and other hedging instruments used in European structured finance have often been of a somewhat less liquid and esoteric nature, including balance-guaranteed swaps and swaps which effectively provide extra credit enhancement to transaction structures.
"Where there are problematic elements within collateral, such as borrower optionality, originators may seek to address these risks by covering it in hedging instruments, for which the originator itself is often the counterparty. This, as well as larger deal sizes, mean more swaps that are less liquid, where the ability to find a replacement will be slim, especially in the current times of crisis when there may be a struggle to replace the counterparty of any type of swap," adds Jennings. "The frequent involvement of the originator in providing such swaps means that there is an erosion of the effective isolation of the structured finance transaction from the risk of the originator. Also, in the event that the originator has to find collateral to post in the event of downgrade, this could present extra liquidity strains for the originating financial institution, at a time of increased financial stress."
In response to growing risks within many structured finance transactions, both in the nature of the collateral being securitised, as well as the extent of counterparty risk involved, Fitch is currently developing two new criteria reports. The first addresses the topic of rating ceilings and outlines circumstances where the maximum structured finance rating that can be obtained within a structure will be capped, as a result of the nature of the underlying risks. The second is a revision to Fitch's counterparty criteria and will address mitigants that might be adopted to minimise the risks associated with counterparty exposure and reduce the potential instability that this might bring to structured finance ratings or indeed an originator's rating. (Fitch's financial institutions and structured finance groups work together to assess significant counterparty risk positions in structured finance and the extent to which these might impact both the structured finance ratings and the ratings of the financial institutions themselves.) The two criteria reports are expected to be published in the next few weeks.
