Given banks’ efforts to achieve target returns on equity, and cope with capital adequacy regulations and volatile wholesale funding markets, it is clear the deleveraging process still has a long way to run. Indeed, the latest IMF Global Financial Stability Report suggests that between September 2011 and December 2013 large EU‐based banks could lop as much as $2.6 trillion off their combined balance sheets, mostly through sales of securities and non-core assets.
Prior to the crisis, banks probably would have sought to retain these assets by securitising them. The withered market for asset-backed securities (ABS) – a product of regulators’ refusal to take a risk-based approach to the asset class – means that is no longer an option.
Insurers in particular have been a crucial source of real money demand for ABS. Under the latest Solvency II proposals though, triple-A rated securitisations will attract a capital charge 10 times greater than for similarly-rated covered bonds. And since ABS is ineligible for liquidity buffers under Basel III, regulators have also choked off demand from banks, the only other major buyer of the asset class.
While banks face little alternative but to sell assets, portfolio transactions have yet to reach the level of market expectation. That is particularly true for banks’ long-dated, low-yielding portfolios, such as their non-core but performing mortgage, infrastructure and project finance books, where firms have struggled to find strategic buyers with a cost of capital low enough to match the desired sale price.
However, there are now tentative signs that pension funds and insurers could step into the breach. For such firms, buying portfolios of long-dated, secure investments – that also offer a potential “illiquidity premium” – presents an attractive opportunity. And with regulators setting the capital charge on holding whole loans at a lower level than for securitisations, even though liquidity and protection are also lower, these portfolios will be made still more appealing.