14 February 2013

Risk.net: Banks hunt for asset-backed securities as liquidity swap market stagnates

Lloyds Bank is one of a number of banks sourcing assets from smaller institutions to meet demand from insurers. Banks are sourcing illiquid assets from other financial institutions to use as collateral for liquidity swaps with insurers.

Lloyds Banking Group is one of a number of banks that are looking to third-party assets to meet demand from insurance companies that are keen to undertake liquidity swaps as a way to increase the yield on their liquid assets.

The volume of liquidity swaps has fallen over the past year as the supply of suitable illiquid bank assets has lessened and the need for banks to undertake such trades has declined. But insurers are still looking to conduct these trades as low interest rates continue to put pressure on their investment returns, say market participants.

Larger banks are seeking illiquid assets from third parties that are keen to increase their own liquidity coverage, but which may not be an attractive counterparty in a liquidity trade with an insurer.

Lloyds Bank is currently in discussions with a number of insurers for liquidity swaps using assets sourced from a third party. Deepak Seeburrun, director, insurance, in the financial institutions solutions group at Lloyds Banking Group in London, says: "The clients I'm facing don't have to look for Lloyds' assets so I can source other assets from the market through my trading desk so long as my clients are happy with the given assets. It could be retail mortgage-backed securities issued by other banks, for example."

The relaxation of Basel III liquidity rules this year and the impact of the European Central Bank's long-term refinancing operation are cited as other reasons for the slowdown, alleviating the urgency for banks to acquire liquid assets to meet regulatory requirements.

The amount that banks are prepared to pay has also decreased over the past year, making the trades less attractive for insurers. The spread over Libor that insurers could earn on liquidity swaps was typically as high as 150 basis points, depending on the structure of the trade.

Others say long-dated swaps could still form part of broader funding strategies. BNP's Taylor [senior structurer in secured funding, credit structuring] says liquidity swaps are becoming a strategic transaction. "There are potentially fewer going on but will frequently be of a strategic nature. Due to widespread bank deleveraging, there are no longer large portfolios of illiquid securities available, rather banks will look at non-traditional sources of collateral such as loans. This requires collaboration across divisions, increased complexity and further due diligence by the insurance client, a burden that results in structures necessarily being executed in a good size."

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