Market participants have cautioned against reading too much into a pick-up in European RMBS issuance noted by Standard & Poor’s last week, suggesting that tough conditions, regulatory disincentives and the attractions of covered bonds could stymie a continued recovery forecast by the rating agency.

S&P reported that European issuance of residential mortgage backed securities, excluding retained deals, neared Eu30bn in the first half of 2011, 20% more than in the first half of last year. The rating agency said improving collateral performance and recovering investor sentiment could be partly responsible for the moderate revival in new RMBS issuance in the past year.

“As RMBS issuance has slowly returned, there has been some shift in post-crisis transaction structures,” said S&P, using the example of standalone transactions, which it said have gained traction.

The rating agency said that whereas most UK prime RMBS have traditionally been in the form of master trusts, six standalone UK prime RMBS transactions were placed with investors in the year to 7 July, 2011, compared with only eight in 2005 and 2006 combined.

However, market participants noted that the increase noted by S&P was from a low base. Boudewijn Dierick, head of structured covered bonds at BNP Paribas, was more sceptical about the return of the RMBS market.

“Because the amount of issues in H1 2010 was relatively small, it does not need a huge amount of deals more to get a 20% increase,” he said, “but it is indeed a good sign.”

“The Dutch and UK markets are still the only active RMBS markets,” he added.

S&P acknowledged any recovery was limited to the UK and the Netherlands, which together accounted for 95% of placed RMBS issuance in H1 of 2011. S&P said this trend will probably continue throughout 2011 and 2012.

The rating agency said that the sovereign debt crisis in Europe could cause the collateral performance and ratings on RMBS transactions in peripheral EU countries to deteriorate.

“A recovery is still divided between core and non-core,” said S&P credit analyst Mark Boyce. “Non-core countries are still feeling the pain more from the recent deteriorations.”

Dierick also contrasted the recovery in the UK and the Netherlands with Italy and Spain – the two other European markets that were the most active pre-crisis.

“The big difference is that, for example, we have seen one or two Italian deals but that’s it,” he said, “while pre-crisis Italy was quite important.

“Spanish RMBS was also really big and we haven’t seen those either, although that’s more linked to the sovereign problems and the state of the housing market in Spain, for example.”

Paolo Binarelli, CDO portfolio manager at P&G SGR Alternative Investments, said the Italian RMBS market is currently illiquid.

“It hasn’t been a very liquid market since a couple years ago, as the bulk of outstanding bonds is made of legacy paper and the number of new issues has been very limited since the end of 2010,” he said. “I’m not expecting that under current conditions issuance will improve, though of course anything could happen.

“I think eventually they will probably try a non-public way of issuing – probably through finding funding with the ECB.”

Binarelli added that covered bonds were more viable because issuers could access the market more swiftly, thus enabling them to act during a brief market upturn, and because their investor base included international and domestic investors.

“RMBS is much harder as the domestic market for Italian RMBS is almost non-existent,” he said. “Those transactions are usually placed in other jurisdictions.

“It’s going to be quite hard at the moment to find demand in Europe for Italian RMBS, unless there is support from a big foreign player, but I don’t think that will happen.”

Regulatory shackles of RMBS remain

Market participants agreed that better regulatory treatment would lead to an improvement in the outlook for RMBS.

Back in April Simon Collingridge, managing director, structured finance, at S&P, asked delegates at an IIR securitisation conference if they felt that covered bonds were disproportionately favourably treated in regulation and almost everyone agreed (click here for coverage). Four months on, Collingridge told The Covered Bond Report that nothing has changed from a regulatory perspective.

“CRD IV indicated favourable treatment for covered bonds,” he said, “whereas structured finance seems to be quite heavily treated in things like Solvency II.

“I think investors forget that not all covered bonds are created equally and that there is actually a higher degree of transparency with RMBS.”

Respondents to a poll on The Covered Bond Report run after the conference were roughly evenly split on whether or not there is an unjustified regulatory bias in favour of covered bonds over ABS. Of 70 voters, 39 said that there is such a bias while 31 disagreed – although The Covered Bond Report’s readership might be more inclined to considering any favourable covered bond treatment appropriate.

BNP Paribas’ Dierick said it is very difficult to get investors to acknowledge RMBS because of the regulatory treatment they face.

“Not necessarily for insurers or pension funds,” he said, “but for bank investors, in all their investments they take into account whether it counts as liquid assets.

“If it doesn’t, then it’s more difficult for them to invest in.”

The European Securitisation Forum (ESF) and lobbyists have approached the European Banking Authority (EBA) seeking better treatment for the asset class, but Dierick said that the question of exactly what will be considered liquid assets will have to be left to the EBA to outline in more detail.

S&P’s Collingridge said that he sees no reason why, from a credit perspective, prime RMBS, for example, should not be considered alongside covered bonds in liquidity buffers in CRD IV.

“If you look at the credit performance of RMBS over the last three years it has been very robust indeed,” he said. “The European market is very different than the US as its default levels and downgrades in Europe were much better.”

Like S&P, Binarelli at P&G SGR had an ultimately positive perspective on the asset class, arguing that it is well supported by its strong credit fundamentals.

“It is an important funding tool and will find support in the future,” he said, “so there is no expectation that this sector will be left alone or abandoned

“Probably we need some time to get through all this uncertainty and volatility, but the credit is not worsening – if an investor is holding a bond he just needs to wait for a better time.”