Investors in 262 billion euros ($347 billion) of Dutch residential mortgage-backed securities risk being penalized by new bank liquidity rules, even as the securities prove among the safest home-loan bonds globally.
The notes won’t be categorized as liquid assets under regulations approved last week by the Basel Committee on Banking Supervision because the underlying mortgages have an average loan-to-value ratio of 95 percent, a quirk of the Dutch housing finance system, where borrowers take on more debt because they can use tax deductions in place since the 19th century. The rules only allow banks to apply securities where the ratio is less than 80 percent, according to committee documents.
Excluding Dutch bonds, in which defaults are close to zero, shows the flaws in trying to apply global standards for banks after more than 27 nations spent four years crafting regulations to prevent a repeat of the 2008 global financial crisis. While lenders won concessions such as a delay in meeting requirements and an expanded list of eligible assets, including equities and riskier corporate bonds, Dutch issuers could face higher funding costs as investors demand larger premiums to hold the debt, according to Union Investment GmnH fund managers.
“It’s a problematic situation because we have always stated LTV is not a good proxy for determining credit risk,” said Dipesh Mehta, a London-based securitization analyst at Barclays Plc. “I’m even more skeptical in this case because Dutch RMBS is one of the best performing sectors and it’s being put at a disadvantage.”
Regulators struggled throughout 2012 to revise the rules until central bank chiefs agreed on a range of assets that banks can hold to meet a so-called liquidity coverage ratio, or LCR. That measure, a key component of a package of capital and liquidity measures, known as Basel III, means banks must have enough easy-to-sell assets to survive a 30-day credit squeeze.
The LCR ratio has two categories of assets. Level one comprises cash and bonds issued by governments, central banks and multilateral agencies. Level two includes highly-rated covered bonds and corporate bonds as well as residential mortgage-backed securities, although there are strict limits on their use.
Mortgage-backed securities included in the calculation should be widely traded in repurchase agreement transactions and have a track record of price resilience under stressed situations, according to the document. The securities will also face a discount, or haircut, of 25 percent, and the notes must have a minimum rating of AA, the third-highest investment grade.
This could include bond deals tied to U.K prime mortgages, where performance has been as good as with Dutch mortgages.
“It seems a pity that the Basel committee hasn’t set out clearer criteria for the residential mortgage-backed securities that can count towards the” liquidity coverage ratio, said Patricia Jackson, head of prudential advisory at Ernst & Young LLP in London. “The Basel criteria could have covered number of tranches, information disclosure and how loans have been originated.”
U.S. government-backed mortgage securities receive more preferential treatment with debt-guaranteed by U.S.-owned Ginnie Mae counting the same as Treasuries, which carry no discounts. Fannie Mae and Freddie Mac securities also can be fully counted up to a cap.
U.S. deals not backed by the government, the type of debt blamed for fueling the financial crisis, may be included, although a provision stating the loans needs to be full recourse will hinder this.
“While we welcome the inclusion of highly rated RMBS- backed securities rated AA or higher as an extremely positive development” for U.S. private label RMBS, there are a few conditions that will make it difficult to meet, Credit Suisse Group AG analysts led by Chandrajit Bhattacharya wrote in a Jan. 10 report.
Dutch transactions could be excluded as lenders in the country offer higher loan-to-value ratios because homebuyers can claim tax relief on interest payments for 30 years. Deductions have existed in the country since at least 1893.
Banks in the Netherlands are the largest issuers of residential mortgage-backed securities in Europe after British rivals, which have 275 billion euros of the notes, according to JPMorgan Chase & Co. data.
Cumulative defaults on Dutch home loans packaged into securitizations reached 0.4 percent at the end of September, according to Moody’s Investors Service data. That is similar to the 0.30 percent on U.K. prime mortgages, and compares with 2.85 percent on Spanish mortgages where the average loan to value ratio is less than the 80 percent limit.
“I really wonder who made this list, and where the LTV cap came from,” said Frank Erik Meijer, head of asset-backed securities at The Hague-based Aegon Asset Management, which oversees 220 billion euros of assets. “LTV is already taken into account by the rating, so a AAA from a Dutch RMBS should be as safe as a AAA UK prime RMBS transaction, hence, as liquid.”
Investors currently demand 103 basis points above the euro interbank offered rate, or euribor, to hold a five year senior bond backed by Dutch home loans, the lowest spread on a European bond of that kind after the U.K. The spread on senior Dutch RMBS has narrowed from as high as 425 basis points in Jan 2009, which is also the highest level reached by the U.K. comparable securities, JPMorgan data show.
Banks account for about 45 percent of the investor base in Dutch mortgage-backed securities transactions, said Max Bronzwaer, the Heerlen-based treasurer at Rabobank Groep’s mortgage unit Obvion NV, which issues the securities under its Storm and Strong issuance programs.
“We will be discussing with regulators and policy makers to get appropriate consideration for Dutch RMBS,” said Bronzwaer, which has been arranging securitization transactions for Obvion during the last 10 years. If the wording is not changed, “it would become for banks inefficient to buy Dutch RMBS, which ultimately would mean less demand and less funding opportunities for us in the Netherlands, which is quite an important issue because we have a funding gap of about 300 billion euros.” A funding gap is the portion of the loans that can’t be financed with deposits so lenders issue debt.
Defaults on Dutch mortgage-backed securities remain at low levels even as the unemployment rate rose to seven percent in November, the highest in at least 12 years. House prices, which declined more than 15 percent since its peak in 2008, will continue to decline by up to 25 percent by mid-2014, according to Fitch Ratings estimates.
House prices may weaken because of changes to the tax regime that could limit the deductions for borrowers, in addition to deteriorations in the economy, the ratings company said in a Dec. 17 report. As of January 2013, tax deductions are restricted to mortgages with durations of 30 years or less, and to those being amortized on at least annuity basis, according to a Dec. 13 prospectus of a Delta Lloyd’s mortgage-backed securities deal issued under its Arena program.
“Spreads for Dutch RMBS are already higher than the U.K, so combined with the new law in the Netherlands it’s a disadvantage for Dutch banks,” said Alexander Fagenzer, a Frankfurt based fund manager at Union Investment, which manages 179 billion euros of assets, including Dutch mortgage securitizations. “If finally confirmed that wording it can prompt investors to demand a premium spread.”
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