No more size anxiety about the ECB
Some market commentators seem to think the European Central Bank's ABS purchase programme is not the real deal, because it will be limited in size by the low volume of placed securitizations and the difficulty of pricing off-market deals. One research team estimates the ECB might buy €40bn over three years. But this seriously underestimates the potency of the ECB’s move.
The ECB, according to Reuters, wants to spend €500bn on ABS and covered bonds. Draghi did not comment on this number, but said that the Targeted Long Term Repo Operations and purchase programme combined should return the ECB’s balance sheet to 2012 levels, meaning a €1tr expansion.
This commitment naturally sent the market off to the races. But scepticism still seems to linger over just how the ECB will spend the money.
The ECB gave up on the second covered bond purchase programme after spending less than half of its intended €40bn, and the market has shrunk further since then. Placed ABS issuance is only €250bn, with €38bn issued in the European primary market last year. So how is the ECB supposed to deploy €500bn?
This worry is misplaced. The ECB has hinted that it will buy retained deals — structures which are simply held on the originating bank’s balance sheets —in both asset classes meaning huge volumes of assets that can be newly structured (a hefty €864bn in repo-eligible euro-denominated ABS is ready to go). Credit Suisse’s banking team estimate €2.4tr of eurozone bank assets could be eligible for the programme.
A swift look at the European securitization market in 2007 and 2008 should show that this isn’t idle chatter. Although the public market shrivelled and died, nearly €1tr of retained ABS was issued in 2008 (along with goodly chunks in 2007, 2009 and even 2010). Rabobank alone structured a €50bn deal in late 2010.
The ECB, some argue, cannot price these securities. Draghi, for what it’s worth, is sure that the ECB can.
"The ECB knows very well how to price and how to treat the ABS that’s accepted,” he declared last Thursday.
But even if it cannot, this is not vital.
If a buyer representing 10 times the annual public issuance of a market suddenly joins that market, pricing should rightly go out of the window. The concept of a real price derived from a model or a market comparison becomes a joke — it would only be real in another world where the ECB was not ready to buy the market.
And if revitalising securitization is part of the aim, then an explicit goal of the programme has to be moving the price. To put a spring in the market’s step, the ECB’s strategy needs to be the opposite of that employed by a normal investor — it wants to move the price as much as possible as it deploys its €1tr balance sheet expansion.
Another objection occasionally raised is that the ECB wants any ABS it buys to be simple and transparent — giving us the handy acronym STABS (hat tip to Bank of America Merrill Lynch). Lots of legacy deals, the theory goes, will be ineligible under the new rules.
But this too ignores the experience of the last few years. The ECB’s ABS repo rules were repeatedly toughened between 2009 and 2011, before being slackened off again, while rating agencies adopted far more conservative assumptions about swaps in structured finance and covered bonds.
Deals were restructured and restructured again. Swaps were removed or collateralised, new subordinated loans were added, deal documents sprouted new annexes and exemption clauses. It was expensive, and a lot of issuers were late to make their amendments, but there was no big disaster.
Simple and transparent, for the new ECB programme, very likely means nothing more than using a pass-through structure with no swap and submitting loan level data to the ECB’s European DataWarehouse. This standard will cut out a lot of solid deals (especially if it is applied to the covered bond market) but issuers will step up to it when there’s a strong incentive to do so.
Gripes about the limited size of the ABS and covered bond markets are misplaced. The last six years have shown that issuers will gladly ask how high whenever the ECB tells them to jump.