December 19, 2017 / 11:28 AM / 3 months ago

Fitch: EU SF Capital Charges Less Severe, but Mask Risks

(The following statement was released by the rating agency) Link to Fitch Ratings' Report: European Securitisation Framework: Calculation Approach and STS Label Drive Capital Charges here LONDON, December 19 (Fitch) Final European securitisation rules will see a smaller-than-expected increase in capital charges for bank investors, but will not fully distinguish between all risks, Fitch Ratings says. The new rules, signed by the Presidents of the European Parliament and the European Council on 12 December, following the approval by both the Parliament and the Council earlier this year, aim to boost securitisation as part of the Capital Markets Union plan. They set out capital requirements for banks investing in structured finance (SF) securities, and establish the criteria for Simple, Transparent and Standardised (STS) deals. Most provisions will apply from January 2019. The new rules give more prominence to the Securitisation Standardised Approach (SEC-SA), which can be used before the External Ratings-Based Approach (SEC-ERBA) is applied, subject to certain restrictions. As a result, the increase in capital charges is less than it would have been under the original European Commission proposal, based on the Basel III securitisation framework. Investment-grade tranches of STS deals will attract only a slightly higher capital charge. The increase for non-STS investment-grade tranches is still substantial, but will be smaller-than-expected. These findings are based on Fitch's calculations for its rated portfolio of European SF transactions, outstanding as of December 2016, and compared to the currently applicable ratings-based approach. As we have previously noted, Fitch's loss expectations support the preferential capital treatment for STS transactions. However, SEC-SA is a simple formula-based approach that allows risk weights to be calculated from basic information about the tranche and the underlying asset pool quality. It does not address variations in country risk (which can cap SF ratings under Fitch's methodology), and assumes performance variation between, but not within, broad categories of loans. For example, unsecured consumer loans have the same underlying pool risk weight as auto loans to retail customers, despite the lower loss rates associated with auto loan deals. Furthermore, SEC-SA does not consider structural features, such as counterparty risks (which can also cap Fitch's SF ratings) or interest rate mismatches. The final regulatory rules do address some of the consequences of using the SEC-SA approach; for example, they require the use of SEC-ERBA for the calculation of capital charges for all auto loan and lease transactions. However, the potential effect of heightened country risk remains unaddressed. In practice, SEC-SA will be more applicable to higher-rated tranches (which bank investors tend to buy), rather than lower-rated tranches. Investment-grade tranches from some countries (namely Portugal, Spain, Ireland and Italy) and sectors (unsecured consumer loans, SME CDOs and Prime RMBS) will see a significant relative benefit from the final rules, allowing the preferential application of SEC-SA compared to SEC-ERBA. Fitch's full report "European Securitisation Framework: Calculation Approach and STS Label Drive Capital Charges", including our methodology, is available at or by clicking the link above. Contact: Eberhard Hackel Senior Director, Structured Finance +49 69 768076 117Fitch Deutschland GmbH Neue Mainzer Strasse 46-50 60311 Frankfurt am Main Marina Nebrat Analyst, Structured Finance +49 69 768076 260 Mark Brown Senior Analyst, Fitch Wire +44 203 530 1588 The above article originally appeared as a post on the Fitch Wire credit market commentary page. 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