Debt funds and banks today are using EU regulations to engage in loan portfolio financing at attractive rates using securitised fund finance techniques. Post-financial crisis, the traditional fund relationship with securitised portfolios has expanded and it is fast becoming apparent that the new fund/bank partnership around this model is a very good match.
During the crisis, the collapse of products that were using securitisation gave the tool a bad press. The liquidity squeeze that spread across the system saw questionable practices uncovered and corrected through value loss across the system. In some places, securitisation models were accused of being the cause, plagued with issues so fundamental that they should be banned. That is akin to blaming splitting the atom for nuclear hostilities – in fact, securitisation is efficient, helpful and can be put to good use in the right context.
At a basic level, it is a tool for processing loan assets involving suppliers (originators), warehouses (holding vehicles), sorters, graders and packers (rating agencies, financial institutions), advertisers and traders (marketing, investor relations) and buyers (investors). What was described, around the time of the crisis, as a ‘brave new world’ all sounds rather familiar. So what of the post-crisis evolution?
Bank capital and risk-retention requirements have long been changing behaviours. Bank lending capacity has been curtailed, market participants need to deal with risk retention and banks continue to shed NPL and non-core assets. The role of funds in this space has expanded in a number of ways and managers are exploiting securitisation as a risk-sharing tool far beyond the traditional mezzanine investment role. Amongst other developments, managers seeking fund finance are able to find cheap leverage for their collateral pools by structuring loans within the securitisation regulations.
Securitisation regulations were written from the perspective of a collateralised debt obligation structure so some interpretation of the definitions is required, however, through good structuring, they can be used to enable attractively priced capital delivery to funds to finance their loan portfolio investments. By structuring fund loans within the regulations, banks can engage indirectly in these markets whilst lowering their capital obligations on the debt. Meanwhile, funds can leverage their portfolios cheaply, freeing up capital to make more investments and providing essential liquidity in the space. Ultimately, the regulations play into this hand - well-structured, tranched debt arrangements permit banks to take advantage of lower capital requirements and for obvious reasons, funds generally don’t have an issue with a ‘first loss piece’ which simply boils down to an LTV calculation.
Risk-sharing transactions have matured: they got clean, got hitched in honest partnerships with other market participants, did some health-and-safety training and got (risk-retention) glasses to correct short-sightedness. Risk-sharing between funds and banks in a fund finance context is reducing the pricing for recycling loan portfolios and assisting with liquidity generation for the real economy. Securitisation is a very important piece of this financial architecture - appropriately operated, it will have a valuable place for years to come.
Bryony Robottom, London legal director, Dla Piper
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