SCI 6th Annual Pricing, Trading & Risk Seminar 7th December 2012, London

On 7th December 2012, over 100 industry delegates attended the annual Structured Credit Investor (SCI) Pricing, Trading and Risk Management Seminar. There were a wide range of panellists from Fund Managers, Investment Banks, Law Firms, Rating Agencies, Industry Associations and Traders.

As with last year, Richard Hopkin [RH], Association for Financial Markets in Europe (AFME) kicked off proceedings with an update on the regulatory environment which still remains a key component towards the re- emergence (or decline) of the ABS market.

There were several reasons to be optimistic as he pointed out:  Bank CRD IV Liquidity Buffers – may now include some securitisation structures which is a positive sign for industry.  Solvency II – capital charges still high for securitisations but the European Insurance and Occupational Pensions Authority (EIOPA) will be re-visiting again.  Rotation of Rating Agencies now only applicable for Re-securitisations.  Prime Collateralised Securities initiative (PCS) launched (detailed further below).  ABS performance still very good, losses are minimal - not all securitisations are US Sub-prime!

RH stated that the argument is still strong that securitisation funds the real economy, and AFME is using strong evidence to support its core strengths.

Potential Bad news still lingers over the Industry:  FSB – “Shadow Banking” - 5 work streams – 14 January 2013 market response date and AFME working hard to lobby.  AFME / industry does not have a lot of time to respond to all the regulation proposals and volume is high.  Must encourage non-bank investors to return due to banking lending decreasing.

RH reiterated that “over-regulation is damaging the market” and concluded by stating that Basel III and new risk weightings for ABS due in January 2013 whilst negative perceptions still exist with EU policy makers.

General themes / comments from the remaining roundtable sessions are listed as follows:

Regulation impacting investors’ appetite for ABS

Originators in EMEA still have to think about Risk Retention rules, increased transparency requirements, and the costs around extra administration including swaps and collateral. At the moment, whilst the capital charges to hold securitisation positions versus covered bonds is significantly higher, the question was asked, where is the incentive for insurance firms to invest in this asset class?

Mark Hale (CIO, Prytania) said increased regulation is resulting in a decrease in structured finance collateral managers and the better ones will survive and provide investors with better returns.

Arrangers Roundtable – trends for 2013

Several Arranging Bank panellists agreed that there is a continuation of de-leveraging of banks and lack of a private market funding requirement due to ECB/LTRO funding availability. However, more investors are in the market looking for yield.

Expectations for 2013 in terms of issuance were again quiet, but 2014 should pick up with the “re-financing wall” needing to be plugged which should see demand for new structures.

There was common agreement that there would be no return of re-securitisations for some time (if at all) in order to safeguard industry reputation. These were seen as too complex, high risk and too highly correlated and financial engineers with the Investment Banks had been considered to be generating deals for the sake of fees and bonuses. Policy makers are glad to see the back of these transactions.

PCS – Ian Bell, Head of PCS Secretariat

The PCS (Prime Collateralised Securities) Initiative takes the best practices which already exist in the ABS market and tries to standardise transparency for “real economy” ABS issuances of the highest rating and quality. Its real aim is to encourage those investors who left the market since the crisis began to return and not just to label higher quality ABS.

Why set it up now? – IB makes the following observations:

1. Firstly, market participants realise post –Global Financial Crisis that the world is now very different and growth and credit availability will not go back to pre-crisis levels. 2. Secondly, the industry has also realised that for the next decade the market will be driven by regulation and not market forces. 3. Thirdly, regulators were seeing securitisation as the bad guy of the crisis and all the subsequent regulation was believed to have been a knee-jerk reaction to this. It was argued that the new regulations were driven through in haste and could be viewed as dangerous for recovery prospects. But slowly, things are starting to change and securitisations are again beginning to be viewed as an important tool to kick-start the European economies.

The PCS was born to enable policy makers and originators (mainly banks) to see eye to eye on the return of high quality real economy ABS transactions.

The first PCS was issued and arranged by Santander in November 2012. PCS labels are geared towards the highest rating issuances only and for “real economy” ABS initially (auto/consumer loans, RMBS, credit cards, leases and SME loans). The overall goal is to increase transparency, improve standardisation helping to ease regulatory pressures and to provide loan level data as well as on-going performance throughout the life of the transaction.

At the moment, holding PCS as an investor does not give better capital allowances therefore no two tier market has developed at present. However, with investors wanting better capital treatment for PCS and EU policy- makers only willing to provide this when more deals are issued under PCS, it would be easy to see how both sides could stall with both sides looking at each other to take on the initiative. The reality is that both investors and policy makers need to work together on the beginning of a long road back to recovery of the European ABS market.

CLO European Issuing Prospects

What can the European market learn from the US market of late?

2012 new issuance in the US is approaching upwards of $50bn which is close to pre-crisis levels, driven by:

 Larger investor appetite for loans  Better economic recovery  Central bank intervention, increasing liquidity and driving down spreads.  Equity expectations are lower than in the EU.

For the European markets, where the economies are still “kicking the can down the road”, they are seen to still suffer from:

- Private/shadow ratings versus public in the US - Less diverse portfolio opportunities and lack of leverage loan supply and primary issuances - Liability spreads not tight enough to make an arbitrage work

How do we get European CLOs up and running again?

1. Panel agreed it wasn’t “skin in the game” risk retention regulation that is hampering potential for new deals, it is just lowering potential volumes. 2. Lower equity return expectations are required. 3. David Matson (IKB) believed the CLO arbitrage will be there within next 12 months. 4. Need for an increase in the supply of primary/secondary loans for diverse CLO portfolios.

Overall, future structures will be very different - “CLO 2.0” will have shorter reinvestment periods benefiting investors and lower leverage. AAA investors will have at least 45% equity beneath to absorb greater losses.