Securitisations are better? I beg to differ

23 Mar 2015 | Richard Kemmish


A response to The Cover's article,'Rabobank's RMBS is cheap to Dutch conditional pass throughs'

Hi Bill,

I don't for one moment disagree that Rabobank is a fantastic credit and a well-run bank. Or for that matter that these are the most pristine of Dutch mortgages. About as good as it gets in the securitisation market.

But your claim that the best of the securitisation market is better than a pretty decent covered bond? Sorry, no.

Firstly, let's look at the credit quality. Rabobank is a great credit but this is a non-recourse instrument, Rabobank would not be allowed to support it if it failed.  So that isn't of much relevance. In fact, could Rabobank's high quality count against them? In extremis, I personally believe that the regulator would be more likely to insist that a G-SIB with multiple funding sources - and therefore no reliance on this particular instrument to fund their day to day activities - actually does what they are supposed to and steps away from the structure.

Of course being a good credit means Rabo are more likely to survive a downturn and continue to be around to service the mortgages. But under the resolution directive almost all banks will survive as operating entities even if they go around defaulting on their debt. And this is Holland, where high quality back-up servicers are ten-a-penny.

Then there are the assets. Again securitisation is about risk transfer, covered bonds about recourse. We tend to think about recourse in terms of the financial claim against the covered bond originator but in practice their obligation to maintain the pool at pristine levels is far, far more important to the credit quality of the bond.  Look at any society which has seen a disastrous downturn in their mortgage market and guess what? The cover pools of the covered bonds are pristine, those for securitisations are bruised and bloodied. This isn't because of issuer choice - in some cases the issuers have used both instruments and have at the same time a failing securitisation and a pristine covered bond on their hands - but because of the rule book. They have to top up the covered bond, they have to step away from the securitisation.

So much for the theory, what about in practice? No, I'm not going to resort to the old 'no defaults in 200 years' argument, I'm simply going to look at the rating transition matrices for the covered bond market and for the securitisation market over the course of the crisis. No comparison. Not even close.

But it isn't all about credit. You imply that the economic structures of the bonds, a 'pass through' and a 'conditional pass through' are the same. Spot the difference? The conditions under which the covered bond becomes a pass through security are very, very remote - more remote than just an issuer event of default. It can be a pass through, like the securitisation but as in so many cases, in covered bond land the absolute worst case, economic collapse, mad-max scenario is that your security is no better than a prime RMBS was on the day that it was launched.

I hate to bring up bad memories, and I know that this is a bit of a sore point for you securitisation-philes but there is the little point about the mark-to-market performance of your bonds during the crisis. Yes, as you so often point out, your prime Dutch RMBS were wonderful credit performers in the (non-existent) Dutch economic downturn. But did you see their price performance? Your bonds were absolutely wonderful, but the market was just so beastly to you.

Securitisation technology is highly sophisticated and very effective but if there aren't any buyers in an extreme stress scenario you have an instrument with the potential to exacerbate systemic stress. The domination of the pre-crisis ABS market by leveraged money was - surely you accept this now? - the real cause of the problem.

Would I buy a high quality RMBS for my pension fund? Absolutely yes. But only because I don't have to mark that to market.

Then there is, as you point out, the better regulatory treatment for covered bonds. But surely given all of the above points this is a justifiable reflection of its better risk characteristics. Regulators aren't in the business of arbitrary support for one asset class over another. Do you suggest that they somehow have favourite asset classes for reasons other than empirical performance?  If they give a preferential risk treatment for one asset class rather than another, it's for a reason.

All the best

Richard


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