03/16/2012

Europe’s Bad-Bank Managers Reverse Roles

Several “bad banks” in Europe have started buying structured products.

RBS and Standard Chartered Bank already are picking up some positions, sources said, while a number of institutions including Nationwide Building Society consider similar moves.

In each case, the investments appear to be coming at the urging of managers charged with the unwinding of holdings that lost value during the credit crisis. Rather than routing the purchases directly into their bad banks, however, those individuals are pitching the investments for so-called liquidity books, which are meant to satisfy regulatory needs or to ensure access to cash for parent operations even in a market downturn.

Industry players don’t see the distinction as particularly important. Indeed, many bad-bank managers formerly ran liquidity books containing large amounts of structured products and are itching to return to more active buyside roles — and they’re the ones driving the investments.

Banks’ liquidity portfolios largely were purged of asset- and mortgage-backed bonds following the market crash, even as some kept buying through other units. The case for a return to those instruments rests partly on European Commission plans for a capital-requirements directive that would guide implementation of the Bank for International Settlements’ Basel 3 rules. A version of the directive released last week mentioned for the first time that the commission might allow the most liquid home-loan securities to count toward banks’ liquidity coverage ratios. Industry participants now are expressing confidence that the addition will stick though the document’s finalization in June 2013.

“This is an extremely positive development for the market,” one trader said. “Having covered bonds and ABS as widely defined as possible and included in the liquid-asset buffer . . . creates demand for those assets from banks, creates a more liquid asset and a stronger new-issue pipeline.”

RBS’ initial purchases likely were confined to mortgage bonds. Other banks have looked at covered bonds backed by home loans, along with asset-backed paper. It appears that the most willing buyers are institutions that already are well on their way to meeting Basel 3 reserve requirements, and thus have a strong measure of their ability to trade in and out of positions.

That said, most bad banks in Europe still aren’t buying. With some $100 billion of legacy positions left to unwind, they remain focused on holding investments to maturity or selling opportunistically as prices rise. Commerzbank, for example, has sold billions of dollars of holdings this year.

Many banks also have been selling structured products held in their core portfolios, in part to lessen the amount of capital they would have to hold against certain types of positions under Basel 3.

One buysider said he is skeptical that the purchases are taking place, arguing that the bad banks could be overstating market demand in a bid to drive up interest in their own asset sales. “That sounds like someone is talking their book,” he said. “If you were a bad bank, you’d want people to think there is a huge wall of demand out there.”

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