Liquidity and credit are not always best friends — Funding for Lending in the UK and the LTROs spring to mind. However, blaming liquidity alone for the lack of credit out there is obviously [expletives removed].
For one, banks can’t lend if they can’t find borrowers — although it might be unfair to blame borrowers who are seeing unappealing terms — and for two, central banks have poured a fair amount of liquidity out there with more available on tap.
The diagnosis of the problem then comes before the solution. In a recent note, UBS’s Stephane Deo and Ramin Nakisa put forward four possible explanations for the credit crunch:
(1) a volume issue, lack of liquidity, (2) a pricing issue, banks are requesting excessive return on their loans, (3) a balance sheet issue, banks ability to lend being impaired, (4) a demand issue. We argue that (2) and (3) are the main reasons for the credit crunch.
Some solutions:
We look at the US, EU and UK, and depending on the diagnosis of the source of the problem we show that solutions are different. We think there are five possible courses of action: (1) inject more liquidity, (2) make the liquidity injection conditional, (3) cut rates, (4) recapitalise, (5) implement some QE on banks’ assets, and (6) change regulation. We provide a scenario analysis depending on the diagnosis of the credit crunch and the cure proposed. One problem is that, in a number of cases the solution goes beyond the remit of central banks.
Although solutions (1) to (4) have been widely discussed, to our knowledge there is little focus on solution (5). We think this could actually prove to be the best therapy.
Worth mentioning, again, the idea that the ECB — with a 25bps refi cut increasingly priced in this week — might consider at some stage buying up securitised SME loans. A step on that rather difficult road is revamping the SME securitisation market which would improve disintermediation in the European credit market.
From Morgan Stanley:
Prior to 2007, the securitization market played an important role in financing SME lending across a number of countries. In all, transactions worth ~€175bln have been placed with investors since 2000, 60% of which were issued between 2005 and 2007 (Exhibit 1). Funding was the primary motivation for bank originators in Spain, UK, Portugal and Netherlands, while in Germany capital relief was a more important consideration. Since 2010, despite the revival of ABS issuance from a number of core countries, public securitizations of SME loans have been almost non-existent.
A functioning SME ABS market would clearly help the flow of financing to SMEs, but in our view a securitization-specific intervention can at best be part of a broader solution. A reduction in ABS risk premium requires further moderation of macro and regulatory risks, as credit risk per se is not the limiting constraint. In fact collateral performance in some countries are showing early signs of stabilization (Exhibit 2) and market access is often determined by non-collateral considerations. For instance, senior Spanish SME CLOs benefit from high credit enhancement to offset the weakness in performance but currently trade at spreads in excess of 350bp because investors still price in a premium for macro risks and linkages to the broader distress in the real estate sector. Meanwhile in core countries, investor appetite for German and UK SME transactions is strong and banks would likely be able to price new deals in the 100bp area (3yr AAA tranche); but issuers remain reluctant to tap into the market, presumably because of an already healthy liquidity situation.
Policy options to revive SME ABS should therefore be viewed in the context of the broader securitization market interventions and, more importantly, will be effective only if they simultaneously address the weak demand for credit. Lower haircuts at the ECB, lower capital requirements under Solvency 2 and a relook at the new Basel securitization framework are all steps that would eventually result in a more functioning securitization market. This in turn can support lending, not just to SMEs, but to the broader economy. In the near-term, potential guarantee and/or purchase programs for SME loans directly or senior securitized tranches would provide a positive signaling effect. However, the distribution problem cannot be addressed easily – the immediate benefits are likely to be least in peripheral countries, although the need for private funding there is the highest.
Anyway, here’s the effects of UBS’s solutions in matrix form (click to enlarge):
