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Securitization and the real economy: will the ECB’s plan succeed?

ECB building
By Tom Porter
26 Sep 2014

With the European Central Bank due to provide more details for its ABS purchase programme this week, GlobalCapital invited market participants to discuss with the ECB how it is hoping the purchases will benefit the market and the real economy, how they should be implemented and what may be left behind when the ECB exits as a buyer.

The European Central Bank has turned to the once vilified practice of securitization in an attempt to achieve its stated goal of increasing the flow of credit to the real economy in Europe. Implicated in the financial crisis because of its misuse in markets like US subprime mortgages, securitization has long carried a stigma in Europe and has been saddled with some crippling risk weightings by regulators.

Top ECB officials have come to the defence of the asset class in recent months, publicly proclaiming the superior performance through the crisis of the vast majority of European ABS and publishing a joint paper with the Bank of England calling for a revival of the market.

Now the ECB has put its money where its mouth is. Its president, Mario Draghi, announced on September 4 that the central bank would purchase a broad range of asset-backed securities backed by loans to the private non-financial sector, alongside a third covered bond purchase programme.

GlobalCapital invited market participants to discuss with the ECB how the central bank is hoping its purchases will benefit the market and the real economy, how they should be implemented and what may be left behind when the ECB exits as a buyer.

Participants in the roundtable were:

Ian Bell, head of the secretariat,
Prime Collateralised Securities
Ulrich Bindseil, director general,
market operations, European Central Bank
Rob Ford, partner, portfolio manager,
TwentyFour Asset Management
Richard Hopkin, managing director,
head of fixed income, AFME
Matthias Lais, structurer, Commerzbank
Stefan Rolf, head of asset backed securitization,
Volkswagen Financial Services
Neal Shah, managing director, Moody’s
Peter Wölfle, director, Commerzbank
Stefan Ziese, head of conduit finance, Commerzbank
Fabrice Susini, global head
of securitization, BNP Paribas
Tom Porter, European securitization editor, GlobalCapital (moderator)

GlobalCapital: The European Central Bank has stated that it wants to revive the securitization market in order to help improve access to funding for small and medium-sized enterprises. Is securitization the best tool for increasing SME lending in Europe?

Stefan Ziese, Commerzbank: The short answer is probably no, but that isn’t as negative as it might sound. It’s one of several tools, and it is situation-dependent. We believe there are a number of banks out there that would like to do more securitization in order to optimise their regulatory capital, as opposed to obtaining liquidity, and in that kind of environment, securitization can make a contribution. You cannot say it is the single best tool in the strict sense of the word simply because of how diverse the universe of SMEs is in Europe. It cannot replace a number of different instruments for funding the SME sector.

Ulrich Bindseil, ECB: There is potential for the SME ABS market but if you look at it in the past, even before the crisis, it was a small market relative to total SME lending in Europe. So it is relevant, but only one among a number of instruments to activate SME lending, which from the central bank perspective is an important element of the transmission of monetary policy.

Ian Bell, PCS: The answer is yes but not in the straightforward way that some people think. Most people think if we have a lot of SME securitizations we will have a lot of SME lending. What is really constraining the flow of money to SMEs, other than the dire macroeconomic situation the European economy finds itself in, is bank capital. Therefore in order to create a situation where money may flow to SMEs it is essential to improve the capital position of banks, and there is no doubt that the best way to do that is securitization.

Peter Wölfle, Commerzbank: Securitization is a means to transfer the risk of the underlying pool to the market, so it is not in itself a means to increase SME lending. Clearly the view is once you have transferred the risk that you free up equity in order to be able to continue lending to your corporate clients. For German banks in general, but in particular for Commerzbank, there is no capacity constraint in lending to our SME clients. We are keen to grow our SME portfolio even without transferring risk via securitization, which we use primarily to manage our regulatory and economic capital.
Rob Ford, TwentyFour Asset Management: One of the problems is that there are no tools for increasing SME lending in Europe. If securitization can act as a catalyst for increasing SME lending then automatically it is the best tool. I think there is an understanding — if not backed up by a willingness — from the banks that they need to lend more to the SME sector. At the same time there may not be a desire from the SME sector to burden itself with debt given the difficult economic situation.

Richard Hopkin, AFME: What securitization can deliver for SME loans is actually a lot more than securitization can deliver for other asset classes. SME loans by their very nature tend to be riskier assets, and therefore banks are required to hold larger amounts of regulatory capital against them than they do against more commoditised forms of lending like residential mortgages, for example.

Wölfle, Commerzbank: Whether it is the best tool for the ECB is a different question. It’s certainly not within the mandate of the European Central Bank to steer monetary policy. We understand that the purpose of the measures that they have announced is to incentivise banks to stimulate lending to the real economy, but it should not be the objective of the ECB to assume the default risk of an SME portfolio or other ABS asset classes.

Stefan Rolf, Volkswagen Financial Services: Securitization is a very good funding tool in general. It is definitely key to providing funding to the real economy as the chain goes down to the regular consumer but also to SMEs. If you think about our leasing business, for example, it provides predominantly SMEs with attractive leasing conditions. As long as the underlying business model is sustainable and the securitization is properly done, that offers all the security you need as an investor.

GlobalCapital:  The ECB has widened its asset purchase programme beyond SME ABS to include RMBS, other forms of securitization involving loans to the non-financial sector, and a third round of covered bond buying. Was that the right thing to do?

Rolf, Volkswagen: The programme targets plain vanilla, high quality structures and by definition that includes asset classes like RMBS and auto ABS.

Ford, TwentyFour Asset Management: Personally I think it was the right thing to do. I was always under the impression that any purchase programme wasn’t going to exclude RMBS in particular. I’m mildly surprised about the inclusion of covered bonds as it’s just the next incarnation of the previous two covered bond purchase programmes. But who does that play to the most? The Germans and the French. With the exception of auto ABS, there isn’t really a lot of German or French securitization out there. It’s a way of making the whole purchase programme process more inclusive across Europe.

Hopkin, AFME: This was the only way to get the programme to any kind of meaningful size, because RMBS is the bulk of the securitization market in Europe and SME issuance has been very low in recent years.

Wölfle, Commerzbank: In theory they could have focused on SME ABS only, but I think the market size and the volume of SME ABS in Europe is simply too small given the objective that the ECB is pursuing. So if you agree that the ECB should purchase asset-backed securities, then it is probably necessary to also include other asset classes where you have much larger volumes, in particular RMBS, but also consumer ABS.

Neal Shah, Moody’s: I’m sure the ECB would have liked to focus entirely on SME ABS, but that just wouldn’t be practical given the current size of that sector. If it said it would only be buying SME ABS it would have to wait for more to be structured and that can take a long time. SME ABS is a tiny portion of the overall market and the vast majority of the paper currently outstanding in that sector is from Spain, so it would not provide a very wide effect geographically either.

Bindseil, ECB: By including other asset classes we haven’t reduced the absolute importance of SME ABS, we have just added more to the programme. The rationale behind this was that the total market size increases significantly if you add these other types of ABS. If we can reactivate markets for banks to originate additional ABS then regardless of what they originate and place in the market you are contributing to bank funding, possibly bank capital release and you are also contributing to more liquidity in the market. There are various positive effects that you can enhance by adding those other classes.

Bell, PCS: You do not need to do securitization of SMEs in order to fund SMEs. What you need to do is securitization of any assets that you’ve got in order to generate more head room in your balance sheet, in order to be able to lend to SMEs. By widening the scope of any programme beyond SME ABS, the ECB has given itself the possibility of helping with the mezzanine tranches to solve the capital problem. They really need to get those mezzanine tranches out and make securtization into a capital tool again, and the best way to do that is a wide programme rather than a narrow one.
Bindseil, ECB: There should also be a portfolio rebalancing effect. If you buy, for example, RMBS you can contribute to investors moving to other asset classes as substitutes. The other objectives Mario Draghi mentioned at his press conference, like lengthening the Eurosystem balance sheet, and the liquidity injection, they are achieved no matter what type of ABS you buy.

Ziese, Commerzbank: It seems to me that the covered bond market currently has fewer issues than the securitization market and the RMBS market also has fewer issues than the securitization market as a whole, and therefore one probably could have restricted the programme to SME ABS. Ultimately the question RMBS specialists need to answer is whether they currently have a real need for ECB help. Our understanding is that, for instance, the Funding for Lending scheme in the UK very much alleviated the need for UK banks to use the RMBS market, so that’s one reason why maybe the most important function for the ECB purchases is indeed the SME market. But that doesn’t mean it’s necessarily a problem to include RMBS and covered bonds.

GlobalCapital:  Should ABCP be included in the purchase programme?

Ziese, Commerzbank: It depends on the circumstances. ABCP plays a very different role in different countries. It’s always a matter of how you combine different instruments but certainly it does play an important role, especially in Germany. In the case of SME ABS we are talking about an indirect instrument where banks give loans to companies, securitize the loans and refinance the loans through securitization. The ABCP market is really the way to fund these companies directly because you fund the receivables on their balance sheet. Understandably the primary target of the ECB venture is bonds but ABCP could make a contribution.

Shah, Moody’s: It’s true that ABCP does provide an important source of funding for certain assets like trade receivables, which are more match funded and less often funded by long term asset-backed issuance. ABCP issuers target money market funds and that is not a traditional component of the asset-backed investor base, so it would allow for access to a wider group of investors. It would be positive for ABCP, there is no doubt about that.

Bindseil, ECB: ABCPs are not eligible collateral. We expressed in some sense our views on ABS suitable for central bank operations in the eligibility criteria for collateral, so if that is taken as a starting point for the purchases, then ABCPs would not qualify.

GlobalCapital:  Would it be a more direct way
of helping SME funding?

Ziese, Commerzbank: It’s certainly a more direct way than buying SME bonds, but again it’s complementary. It’s not a competition. Very small companies do not have enough receivables on their balance sheets to economically do securitization through an ABCP conduit. But for larger ones that’s attractive, so to the extent that the ABS market has more pricing pressure that would certainly be directly beneficial to those companies.

Hopkin, AFME: ABCP is a slightly different animal from term ABS. Users of ABCP programmes tend to be the corporate clients of banks, so the link with corporate funding is perhaps more direct with ABCP than with term ABS. Supporting ABCP through the ABS purchase programme would be very much a positive for that side of the market, which has also languished somewhat in recent years. Outstanding volumes in ABCP are down considerably on what they used to be. But the ECB’s job is not to explicitly be a friend of the ABS markets or a friend of the covered bond markets, or of any other market for that matter. Their job is to transmit monetary policy.

GlobalCapital:  By broadening the programme beyond SME ABS the ECB has given up any explicit focus on SME loans. While you all thought that was a necessary move, it does raise the question of how exactly this purchase programme will help SME lending. Ulrich, are you aiming to free up capital at banks and rely on them to use that on SME lending, or are you hoping the price of doing SME ABS will be lowered, so that it makes it more attractive to originate SME loans? Or is this just an attempt at broad QE?

Bindseil, ECB: You cannot separate those effects. You make securitization more attractive for the originator by driving down yields. This reduces average funding costs of banks, and in particular funding costs associated with SME lending. This makes new loans more attractive as well. So the price dimension is there. If governments can agree on contributing to mezzanine tranches then also capital release can be supported directly, and that would add to the effects of the programme.

Ford, TwentyFour Asset Management: I think they’re trying to do all of those things. They’re trying to encourage a securitization mechanism that allows lenders to originate loans, which cost capital, which they can then securitize, which then releases capital if it’s done all the way down through the capital structure properly. I think it’s fair to say the central banks have gone a long way to fixing the short to medium term funding problem.

Wölfle, Commerzbank: If ECB were to purchase newly printed ABS without any conditions on the bank to make further loans to the real economy, then it may have a limited impact. Then banks may just use this to lay off risk to the central bank or to others providing credit protection. So far it is not clear to me how the ECB wants to incentivise banks to make additional loans when they purchase asset-backed securities or — similarly — when they provide funding via TLTROs, which is a funding programme.

Rolf, Volkswagen: If you look at where the problems are, like, for example, in the southern peripheral countries, then it appears that there is definitely a lot of stimulus needed. But we were able to securitize our auto lease receivables, which primarily fund SMEs, throughout the crisis. That goes to show that some of the major sectors with vanilla structures don’t have problems, so it is difficult to believe that liquidity alone will make much difference to quite a large portion of the market.

GlobalCapital:  Will it help you extend cheaper loans to your real economy customers?

Rolf, Volkswagen: I definitely see a spread compression in the market. That is the short and medium term effect. Can we pass it on to our clients? Of course we can. Is there also a risk involved in lower spreads? It depends on how far they come in. There are fund managers who are paid a management fee for their work and they can’t sustain their returns with eroding spreads. They have to look at investment opportunities on a relative value basis so it might have an adverse impact on the investor base of some sectors.

Bindseil, ECB: You can also contribute to capital release by buying only senior tranches because the overall deal economics of placing both tranches in the market is improved by making the senior tranche more attractive. We think we will have capital release even if we as the ECB do not go ourselves into the risk taking associated with mezzanine tranches, and guarantees do not become available. We also provide long term funding to banks via this operation.

Hopkin, AFME: I have heard from our members that the very fact that ECB has made this announcement has already prompted a number of investors who had left the market immediately after the crisis to think about coming back, and even encouraged investors who hadn’t been investing before to prick up their ears and think again about this. The positive signal from the ECB is not to be underestimated.

Ziese, Commerzbank: We believe banks are currently more seeking to optimise their capital usage rather than to obtain additional liquidity. This whole venture only adds value if paper goes to market that otherwise would not go to market. Potentially of course the impact could be that it goes to market at a lower price than it otherwise would, although I would suggest that if we look at the numbers, what has happened with this significant volume of retained SME securitizations that we have seen in the last two or three years, especially from Italy and Spain, it doesn’t strike me that the issue there is pricing. The issue has been whether you can find willing buyers of volume.

Hopkin, AFME: Another thing I have heard anecdotally is that there are investors out there increasingly willing to look at the mezzanine risk and one area where the ECB does perhaps need to exercise caution is not to intervene in such a way as to depress spreads so much that it cannibalises private sector demand.

Bell, PCS: There are a number of things that may have been in their minds. One of them of course is that the purchase of senior tranches is just QE — that it is about helicopter money drops and not necessarily about helping the SMEs or increasing lending to the SMEs. And it well may be that the reason the programme’s extended to outside the SME securitization space is simply because it’s really about QE.

GlobalCapital:  How will the ECB define simple and transparent or high quality?

Bindseil, ECB: The Eurosystem has a lot of experience with ABS because we have accepted this asset class as collateral for a long time. When we were designing that framework and changing it over the last few years we always had simple and transparent transactions in mind. This is not a concept we will be completely reinventing for the purchase programme.

GlobalCapital:  Are the criteria likely to be different from those for repo then?

Bindseil, ECB: They may not be identical, but there will be a relationship with the criteria for repo. An outright purchase programme is a different operation but it is natural to take what you already have in the collateral area as a starting point. We have the loan level data, and the simplicity concept in the sense that we don’t accept, for example, multiple layer structures. Our experience gives us orientation for the outright purchase programme.

Fabrice Susini, BNP Paribas: There is one key element that I think is underpinning the thinking process of the ECB. That is moving from defining an asset class as high quality by definition, which was probably the starting point 12 or 18 months ago, to something which is more about defining elements of quality that can be applied across asset classes. So you could have an RMBS which is not ticking the right boxes, and it won’t qualify as quality securitization, just as you could have a CLO that does tick the right boxes and so does qualify as high quality. That is a more constructive way to define high quality. Rather than judging transactions simply by the branding they are wearing, you judge them by the intrinsic elements of quality embedded in them, like quality of underwriting, for example.

GlobalCapital:  Do industry standardisation initiatives like PCS have a big role to play?

Bell, PCS: We hope that simple, high quality securitizations are defined, using as an anchor some of the concepts that PCS has discussed and talked about over the years. One of the most important is the distinction between what we would call structural integrity and pure credit risk. We hope that they make that distinction. Because otherwise what’s high quality beyond the tautology of a bond that pays? So you need to look at structural integrity, which is very much the kind of thing that PCS focuses on, as a prerequisite of credit quality. Then of course some kind of ‘pure’ credit analysis because you can have a highly structurally sound transaction ruined by simply bad lending. So an analysis that makes that distinction is key. We also very much hope that they use as a guide our conceptual analysis of what went wrong in the crisis, and either use our criteria or use a subset of our criteria.

Rolf, Volkswagen: The TSI label requires hard undertakings on origination, underwriting, risk management and collection procedures, which in our mind is a very strong message. Because at the end of the day securitization can only be as good as the underlying core business. And it is reflected by a high degree of trust in those transactions. The label is only worth as much as the quality of the underlying business.

Shah, Moody’s: The ECB, with the Bank of England, put out the discussion paper a couple of months ago, I guess that will probably form the basis of it. Industry participants will also have an input on that as well. While we don’t know exactly what it will be, I think we have some guidance around what they will term high quality.

Ziese, Commerzbank: A few things are pretty obvious. I suppose to some extent it follows the principle, ‘I know it when I see it’. It’s a bit like that with high quality securitization. If it’s highly granular, if the assets are delivered to the European Data Warehouse, these are probably good indications that you have high quality, but there will always be a debatable grey area. We think standardisation initiatives like PCS or TSI do have quite a significant role, simply because anything that gives the market more comfort that there is standardisation on a high quality level will help. Let’s not forget that quality labels and certification have played a major and beneficial role in manufacturing for more than 100 years. Why should they not matter in finance?

Hopkin, AFME: We do need one definition. It will be good to have a core definition and then modular supplements to that because different people need different things from a definition of high quality securitization. A central bank might want certain things and an investor might want different things, so it is complex and when you try to draw these lines, it does raise difficult issues.

Matthias Lais, Commerzbank: In the joint paper with the Bank of England a number of criteria are mentioned and I would guess they will focus on these criteria. In the joint paper they published along with the Bank of England they only focus on true sale transactions, so our understanding is that high quality securitization can only be a true sale securitization and not a synthetic deal, which in our view is the wrong approach.

Ford, TwentyFour Asset Management: The European Commission has asked the EBA to go away and come up with a definition of high quality. We expect something from them in about a month’s time. It’s pretty certain that will be the benchmark, whatever it turns out to be.

GlobalCapital:  Does the ECB need to worry about creating a two tier market with its definition of what is high quality and what is not? Will most investors be willing to buy paper that is by default low quality?

Ford, TwentyFour Asset Management:    They do have to be careful that they don’t create a cliff effect. On the other hand, that doesn’t mean that anything which doesn’t qualify is bad. Think about CMBS for example. It’s unlikely that CMBS is going to get included. That doesn’t mean that all CMBS is bad. I think we all know that some of the structures around the conduit lending commercial property market prior to the crisis were wrong, but that was really about deal structuring. Clearly some of the loans lost money. But guess what, property prices go up and down. Commercial property is much more volatile in the event of a recession.

Bell, PCS: Yes there is that risk of creating a two tier market. But at the end of the day, people need to remember we had subprime and we had CDO squared. We cannot get away from the fact that some parts of the securitization universe performed incredibly badly and that we need to be able to separate the stuff that performed incredibly well, European RMBS, European auto loans, from the stuff that did incredibly badly. On investor appetite, what we’ve been seeing is that a lot of investors are actually quite desirous for yield so they like the fact some paper is not defined as high quality. Why? Because they get a legitimate pick-up to buy it.

Susini, BNP Paribas: I’m not a strong believer in the cliff effect. We have to be realistic about what the objectives are, and that would be a small price to pay to get the market going. Do we want to withhold everything, and stay in limbo just because we may have some sort of cliff effect with the 5% or 10% of the market that won’t qualify? Triple-A ratings are the principal element that supposedly distinguish between quality and non-quality in securitization at the moment. Nobody is saying we should abolish the triple-A, just because if something is triple-A that means something else is not triple-A.

Ziese, Commerzbank: I don’t believe that a ‘high quality’ label will be earth-shattering in that sense. If you have an investor perfectly capable of analysing the risk who thinks something without the high quality label is still a great deal, the investor is still going to buy it. But there may be some investors who make the easy choice of saying they will only buy high quality paper — and if it really is high quality, why shouldn’t they?

Shah, Moody’s: By having differing standards you could have a two-tier market between everything that is high quality and everything that isn’t. You could end up targeting different investor bases for each of those and that will lead to some kind of tiering in the market, the demand for the high quality stuff will end up being higher and the pricing will be better. When we’re looking at things from a credit perspective we do assign the same credit risk assessment to different asset profiles if they meet certain standards. A CMBS can end up with the same rating as an RMBS if it meets the same standards of quality, so any criteria that is put in place should not be completely rigid and should allow for future developments in the market.

GlobalCapital:  How much ABS is available to buy? How much will the ECB need to buy? There was a leak just before the announcement that suggested the figure would be €500bn over three years, is that realistic?

Ford, TwentyFour Asset Management: €500bn is a very significant number within the context of the ABS market or even the ABS and the covered bond markets combined. Just to put it into context, the UK bought £260bn of Gilts, so this would be almost double that. There are a lot of retained deals out there. We don’t know whether they will meet the ECB’s chosen eligibility criteria for purchases. But there are already a number of rules for funding via the ECB’s repo operations and it wouldn’t surprise me if there was a copy and paste of those sort of regulations to meet some of the criteria for purchases. If the ABS bonds the ECB are currently repoing are likely to be eligible for the purchase programme then there’s probably about €500bn of that sitting there, yes.

Rolf, Volkswagen: The amount of €500bn, when compared to the overall volume of the market, is quite a challenge. I don’t think buying in the secondary market will be sufficient, so if the ECB intends to buy larger tickets they will have to buy in primary.

Susini, BNP Paribas: First of all it’s the absolute amount of the purchases. If the amount is too small it will look ridiculous so I expect it to be a large amount. The key second element for me is how they deploy it. It needs to be commensurate with what the market can support in terms of new issuance, and leave enough room for private investors.

Shah, Moody’s: There is around the €800bn-€900bn mark in terms of targetable securities. Some €500bn of purchases would be very large given that scope. I think that one of the key benefits here, independent of the size, is the positive endorsement of the segment. To me there are two consequences of a purchase programme. One is to provide additional liquidity into the banking space by providing another funding source, but when you think about it the banks are fairly awash with cheap liquidity right now. Having another source of liquidity, while helpful, is not really a solution to the problem. What is more important is the capital benefit securitization can provide, compared to other funding sources.

Bell, PCS: Unless the ECB’s terms are so good that there is suddenly a huge increase in volume, we are looking at a new issuance market this year of probably somewhere between €70bn and €90bn. And some of that presumably is going to investors. Half of it is already done, but even if the ECB buys half of it, you know you’re looking at small numbers in terms of primary. In secondary assuming the ECB doesn’t buy at incredibly inflated prices then it’s unlikely that a lot of investors will want to sell. Investors are actually incredibly desirous to buy, not to sell. But then it depends on price. If the ECB’s willing to offer 50bp more than anybody else, then everybody’s going to sell. But I can’t see that happening. The repo transactions are a much bigger target, if people are willing to sell them.

Bindseil, ECB: In terms of outstanding ABS, including retained ones, the nominal value is around €700bn if you use the collateral criteria. We trust origination will increase over time as prices change and the deal economics become more attractive for originators.
As the ECB president said in the press conference, the plan is for the ABS and covered bond purchases, added to the TLTROs, to move the balance sheet back towards 2012 levels.

GlobalCapital:  How much time will you need for the programme?

Bindseil, ECB: That has not been specified but it is not a short term programme, we want to see markets develop, it is not a matter of a few months but a longer period. You also need time to build up volumes. The TLTROs will be taking place over a period of two years, and if we have a total sum in mind that includes the TLTROs then the purchase programmes will have to be on that horizon or longer.

Shah, Moody’s: What the market needs in the long term is the introduction of additional real money investors. Right now there is a lot of uncertainty over what the level of capital relief will be. And under different regulations there is an inconsistency as to how they deal with capital relief, and there is a perception that the levels are just too high. So the size and length of the purchases doesn’t necessarily completely matter, it’s whether all these components and particularly the regulatory treatment can be resolved as well.

GlobalCapital:  So where should the ECB be shopping in a market where investors complain there is not enough for them to buy? Should they be buying in primary, secondary, or will they target transactions already on repo at the ECB?

BIndseil, ECB: In past purchase programmes we bought in the primary and secondary markets. This has to be decided but if you want to achieve volume perhaps you should not restrict yourself to one or the other. It has to be decided how to approach the retained transactions, but if you exclude them you obviously reduce the immediately available volume.

Ziese, Commerzbank: I assume the ECB has no interest in buying ABS which can come to market without the ECB. I also assume the ECB has no interest in chasing private investors out of the market because they drive prices down so far that private investors lose interest. What we need the ECB to be is a back-up in case transactions are being structured that would find it difficult to go to the primary market. There could always be individual examples where buying primary works. If it’s obvious that a primary deal can go to market with 30% or 40% more demand, there’s nothing wrong with buying in the primary market, but I don’t believe the ECB should be systematically buying primary issues.

Bell, PCS: It’s very, very important that the ECB does not set up a programme where it can and will buy the entire issue. Because if it does that, then the market will just collapse because nobody’s going to do a road show in seven different countries to 75 different investors when they can put in one phone call to Frankfurt and get their senior notes sold.

Shah, Moody’s: The problem with the ECB buying in primary is the issuance volumes are just not very high. For the exercise to have meaningful size issuers would have to start creating a lot more deals, which obviously takes time, and you need other mechanisms to be in place to be able to get into that market. If the ECB is looking to do this in any reasonable volume they are going to have to look at the secondary markets as well.

Ford, TwentyFour Asset Management: If they buy secondary I think it could be concentrated on retained deals for the most part. They’re not going to be buying €5m or €10m clips of the stuff I buy for my portfolio every day from the standard London-based investment banking community. They’re just not going to be in that market. They’re going to be talking to originators at a bigger level, and taking down €100m or €500m clips of stuff that’s either already been structured and retained or in the future structured with them in mind.

Hopkin, AFME: I think they’re going to have to go into retained deals because that’s a big chunk of the market unfortunately, that’s the historic legacy we have at the moment. There are challenges around that, because deals that have been structured to retain are not always priced to market.

Susini, BNP Paribas: The benefit of buying repo transactions is that it will be quick to execute, much quicker than waiting for the primary market to grow in volume. But are all these transactions ticking the right boxes in terms of quality? There is also a lack of diversification in those transactions, they tend to be concentrated in certain jurisdictions, from certain banks and with the same type of assets. You wonder whether that will have a big impact in terms of quantitative lending or encouraging new transactions.

Wölfle, Commerzbank: As long as they do not interfere into the normal market activity then of course they should buy in secondary. If you’re just purchasing entire transactions in the primary market, like for instance retained deals, then they have no reference price and they may influence the market price. If that’s what they want to achieve, then they should buy primary, but I don’t think that’s their mandate. So I could see both, in the secondary market as well as in the primary market.  

Susini, BNP Paribas: What will be interesting, though, is to see if buying in secondary will mean the programme is somehow built to prompt banks to resume market-making activities.
Rather than putting €100m in the market by directly buying a primary transaction, if you make €100m available for market-makers, provided there are some conditions attached to it, then you have a multiplying effect in terms of liquidity, where more than €100m would be provided to the market.

Bell, PCS: I’d like to see them buy some primary, 30% or 40% maybe of each issue would be good, not good for investors but it will be good for the market. But what I care about is reviving the European securitization market. The ECB quite rightly cares about a whole lot of other things. QE is one of them, interest rates, monetary policy, so in terms of my narrow view, I think buying in primary is good and I don’t really care very much about them buying in secondary because I don’t see that as having much influence either way on the securitization market.

GlobalCapital:  How will the purchases affect the thinking of issuers? Will the price and liquidity benefits be powerful enough for them to increase issuance quickly?

Rolf, Volkswagen: I don’t see a major deviation from our funding strategy. We are continuously working with investors. We are established as a frequent issuer. That might require a bit of a premium to the cheapest possible funding, but accepting market price also was one of the major reasons why we were able to issue throughout the crisis.

Lais, Commerzbank: It all depends on the pricing. There are investors out there at the moment, so it’s not a problem to place a transaction at the market price. So for me the ECB is just one large new investor that may lower the price slightly and that may increase issuance a little, but that’s a German issuer point of view. For Spanish or Italian issuers it may make a much bigger difference.

Susini, BNP Paribas: Draghi’s announcement translated immediately into spreads tightening for existing transactions in the secondary market, so we can expect that it will lead to increased issuance because the tightening may incentivise more issuers to come to the market.

Bindseil, ECB: We definitely hope to see increased issuance. We have evidence from some markets that with the current levels of yields origination is again attractive. We will enter markets in a number of countries where the deal economics will be improved and there we hope for a pick-up in volume.

Ford, TwentyFour Asset Management: I think it will lead to increased issuance in the future but it’s going to take some time. I don’t expect the ECB to buy €200bn before Christmas. There might be stuff from the retained buckets that they decide to do, but I don’t expect to see a whole wave. When I say it will take time I’m possibly thinking a year or more in terms of a gradual build-up. But if they are trying to improve the transmission mechanism of lending from the banks into the economy, then ultimately they’re going to do that through a process where banks will issue SME securitizations to be bought by the ECB, which means there will be more new issuance. One leads to another.

Bell, PCS: Adding a large chunk of demand to the senior end doesn’t change the basic situation, unless it makes senior spreads tighten in much further than they have so far. If they do go tighter you may get issuers who were going to print a senior unsecured bond at 100bp doing triple-A ABS at 80bp instead. If you’re looking at spreads coming in so strongly that capital trades are now starting to stack up from an economic point of view, then you could have some real impact on issuance numbers. But if this ends up being only a senior funding programme, doesn’t bring spreads in that much and competes with the TLTROs, then it is hard to see how it is going to move the dial at all.

Shah, Moody’s: It depends on how they structure it. Adding another source of liquidity will not spark things off on the issuance side, but the potential capital benefit or the knock-on impact on mezzanine spreads — that could. If all those things align then it will have a significant positive impact on issuance, but just by the ECB purchasing some degree of senior paper it will not have a dramatic impact straight away.

Ziese, Commerzbank: The ECB has suggested it is willing to buy mezzanine tranches if they’re guaranteed. That is really what the big pricing driver is because the mezzanine area is where any measurable risk transfer takes place. If it’s guaranteed then the total price depends very much on what the price of that guarantee is. If I’m an investor the price I’m asking for is going to be much, much lower if I have that guarantee, but then that guarantor will also want to have some money for the guarantee.

Bell, PCS: The other thing is if banks want to free up some balance sheet, they need to sell the whole capital stack. Now that’s hard to make work because at the price people are willing to buy the equity, the economics just aren’t usually favourable. But if you are going to sell the whole stack what you really care about is your all-in costs. So if senior spreads come in really strongly, 75%-90% of your deal is much cheaper, and all of a sudden you’re in a position where that capital trade starts to make sense. If the spreads don’t come in hard to allow those capital trades to work, then it could end up being just another cheap funding tool and the TLTROs look like a much better cheap funding tool.

Hopkin, AFME: In many ways having the ECB as a player and supporting liquidity could have a very powerful effect. If correctly structured it could support market-making by banks, by rebuilding confidence and sending positive signals to the wider non-bank investor base.

GlobalCapital:  So the ECB’s backing could be just as important as the actual buying itself?

Hopkin, AFME: Yes, exactly. Especially when you consider what happened in the financial crisis. There was a loss of faith in securitization and a lot of the losses that investors took were really mark to market, they weren’t credit losses. Investors left because secondary market trading seized up and there were no buyers. If the ECB could act as some kind of cornerstone to support market-making then that would be a big positive.

Ziese, Commerzbank: I’ve always been of the opinion that the primary benefit of this ECB action is, where it is necessary, to give investors a degree of comfort and remove a certain stigma from ABS. There is a symbolic value of this action that can help certain segments of the ABS market in Europe, and it is this influence on the thinking of investors that I would consider to be most beneficial.

GlobalCapital:  How does the ECB maintain a properly priced and liquid market with itself as an investor? Should it be a sole investor or a co-investor?

Shah, Moody’s: When it did the covered bond programmes it was a co-investor. It has stated its aim to maintain that degree of third party pricing, so I would expect something similar this time.

Bindseil, ECB: We want this market to live on and become more active, and therefore we would prefer to buy alongside investors in order to not crowd out investors and be the only buyer.

Rolf, Volkswagen: It might make sense to be a sole investor on private tranches in order to avoid a crowding out. If it comes to buying more problematic assets it might be a good idea to be a co-investor to encourage real money demand.

Ziese, Commerzbank: Of course co-investment would be preferable because that by definition means there are a lot of private investors already involved. As market participants our interest in this matter is to have a functioning private market. We don’t want to replace the private market with the ECB for good. So, for me, if the ECB were a sole investor that would simply show that the paper could not find private investment, at least not at the price that is offered. As a European taxpayer, or indeed someone working at the ECB, I would probably take comfort from the fact that I’m not the sole investor but a co-investor with private parties.

Ford, TwentyFour Asset Management: They need to be a co-investor with the public market. I think they need to say we will buy between X percent and Y percent, let’s call it 35% to 50% for argument’s sake. What you can’t have is a central bank that says it’s going to be the buyer of first and last resort. That will kill the public market.
I think they need to be doing that on a vertical slice basis down through the capital structure at least to investment grade. That is the only way that you will get issuers to come back to the market and think about selling mezzanine tranches into the market rather than retaining them.

Hopkin, AFME: Our members are very strongly in favour of co-investment, it comes back to this point of not cannibalising private sector demand. You don’t want to be the sole investor because then you will just drive investors away. Co-investment is very important.

Susini, BNP Paribas: It can only be a co-investor in the primary market. That is for the ECB’s own benefit as it justifies their pricing, but it is also for the benefit of the market.

Wölfle, Commerzbank: To avoid crowding out investors ECB should as a general rule act as a co-investor in primary deals only and in exceptional situations purchase in the secondary market.

GlobalCapital:  Can they do enough size to have the price impact they want, without crowding out at least some investors?

Shah, Moody’s: Right now you have a high degree of demand for a very small amount of supply. Adding a large new investor to that will have an impact on pricing. You saw that effect immediately after their announcement, in both ABS and covered bonds. I think they hope this will increase issuance and also increase the investor base coming into the securitization space as well, so that the ECB itself will end up being a small but meaningful component in the market.

Ford, TwentyFour Asset Management: I do think the result of the purchases could be quite binary. There is the potential that whatever they decide to put in place ends up killing the market rather than revitalising it if they do it wrong.
I have to be positive and believe that they will do the right thing, and then I think we will come out of this in five years’ time with a healthier, better functioning ABS market.

GlobalCapital:  How about the pricing of retained issuance?

Wölfle, Commerzbank: There’s no market price for most of these, but clearly there’s a large stock of retained deals, especially from banks in the peripheral countries. Normally the ECB would value them with their own internal models. Often on these retained deals you have off-market coupons, so if the ECB would decide to buy those transactions at fair market spreads or close to fair market, then the originator may have to post a loss on selling them. It is unlikely that the banks would sell at a loss because then you achieve exactly the opposite of what you wanted to achieve.
Therefore one has to look at this deal by deal. So, at the spreads on a tranche, at what spread you will purchase the retained deal, and then at what impact that has on the balance sheet, on the P&L of the institution that is originating.

GlobalCapital:  There are very few mezzanine bonds that carry guarantees, and certain national governments have already made clear they don’t think it is their job to guarantee ABS. Does the ECB have to buy mezzanine to have any meaningful impact on bank lending, and if so how difficult will that be to execute?

Bindseil, ECB: The way the possibility of buying mezzanine tranches was announced kept it flexible, in the sense that if national governments or EU institutions come up with a workable approach to it, then that will help. If it doesn’t happen then it doesn’t happen, and still the programme would be effective. But it wouldn’t have been decided if there hadn’t been the belief it would contribute to the effectiveness of the programme.

Susini, BNP Paribas: I don’t see it as a necessity. The issue for banks is not so much about the liquidity of the position but about the capital costs. So do we need the ECB to buy them just for the sake of the liquidity that would be in the system naturally? And then if the guarantees from KfW or the EIB, or whoever, persuade investors to buy certain tranches, then should the ECB bring liquidity to those investors?

Rolf, Volkswagen: We would shy away from getting our mezzanine wrapped with a guarantee because it would increase our funding costs. It is not black and white. With our deals we can always retain such portions or place it with investors that are seeking a higher yield. I think the broader support is more important on the funding side really.

Wölfle, Commerzbank: If as an originating bank you only sell the senior tranches of a securitization transaction, then it is generally for funding purposes. While you still transfer some of the default risk in the underlying pool to the investor, the main default risk of the portfolio is still retained by the originating bank. With respect to SME portfolios in Germany you see mostly synthetic securitization. Here the focus is not on funding, but on releasing regulatory capital and that you achieve by transferring the risk of the mezzanine tranche and not so much the senior tranche.

Lais, Commerzbank: I absolutely agree. Funding is not a problem for banks, especially in Germany. So if this programme is to have any effect, then it should be on the capital side and therefore the ECB should purchase mezzanine tranches if they want to achieve this effect. But I’m not sure if it’s the job of the central bank to purchase that kind of risk.

GlobalCapital:  Banks have had cheap funding for years while the flow of credit to the real economy has been stagnant. Why should this version of cheap funding make any difference?

Bindseil, ECB: As I mentioned before, lower yields on senior paper can give more issuers the ability to place non-guaranteed mezzanine tranches into the market. We can contribute to make capital relief transactions more likely, just by buying senior tranches, because you affect the overall deal economics positively. The originator can increase the mezzanine tranche yield and thereby support demand.

Wölfle, Commerzbank: I expect the ECB will not purchase mezzanine tranches without guarantees. It will buy senior tranches and then they’ll push European institutions such as the EIB or EIF to provide coverage on mezzanine. Perhaps you could also help to release capital by just buying senior at low spreads. If the ECB starts purchasing in the secondary market and pushes spreads down on senior tranches, that may ultimately lead to more attractive opportunities for banks to place mezzanine tranches, so it may be an indirect effect.

Shah, Moody’s: To make a difference, either the ECB has to buy mezzanine bonds or the regulators have to look at the capital levels, it’s really got to be one or the other. Just purchasing senior will not add a huge amount as of today. It is possible for the EIF or EIB to give a guarantee on deals on an ad hoc basis but in terms of the existing stock very few have guarantees. Even for new deals there isn’t a public guarantee mechanism in place, so a supranational agency or a national government would have to put that in place.

Hopkin, AFME: I’m not sure that it’s the role of the ECB to take that sort of risk but for securitization to make a meaningful difference we do have to restore the risk transfer function. Investors somewhere need to be found for the mezzanine tranches because otherwise you won’t achieve significant risk transfer and you won’t get reg cap relief.

Ziese, Commerzbank: If, as we believe, issuing banks are currently more driven by capital restrictions than liquidity restrictions, then it will be more important to place mezzanine. So the next question is what needs to be done to move the mezzanine risk at prices that are acceptable?

Rolf, Volkswagen: There are always options for getting guarantees, but every single risk comes at a price. From the funding cost perspective, the question then is, is it really beneficial to put a guarantee on top? I can’t really comment on whether banks will be trying to offload assets from their balance sheets for capital reasons, but certainly from a funding perspective it might not be sensible to have a guarantee.

Hopkin, AFME: There is some private sector demand for mezz out there but it needs to be at the right price. Perhaps a co-investment programme with an institution from the public sector would work. I don’t think it would be the ECB, it might need to be somebody else, but a co-investment programme at the mezzanine level would do a lot of good.

GlobalCapital:  What should the securitization market in Europe look like in five or 10 years when, hopefully, the ECB has exited the market as a buyer? Will this boost be enough to preserve a stronger market once it has gone?

Ziese, Commerzbank: I very sincerely hope that in five years’ time we don’t need the ECB supporting the securitization market. If we still need the ECB then I would be very worried. My hope would be that certainly within three years the market is up and running as private participants need it to be and want it to be.

Shah, Moody’s: Attracting new investors is the key, and to do that you need to make the price attractive or you need to make the associated costs of investing manageable. As of now the capital charges are quite high for investors, particularly further down the capital spectrum. If you look at the traditional investor base, the structured investor base has disappeared, then you look at the real money investor base, asset managers, banks, insurance companies. Given the capital levels it’s clearly particularly prohibitive to invest in subordinated and mezzanine paper. We are in a position where unless those levels are lowered or the pricing becomes so low across the board that it’s attractive for other reasons, it is very difficult to imagine the investor base growing to the level the market is hoping for.

Rolf, Volkswagen: The first important step is to acknowledge securitization as a vital funding tool for the real economy. The second one is certainly to allow securitization to be LCR-eligible, as long as they are high quality.  Third, a crowding out of investors is certainly something that needs to be avoided. A gentle push or a stimulus to the ABS market from the ECB is certainly helpful. But if there is an erosion of spreads that goes beyond what is acceptable to bank treasuries and real money investors, it could harm the investor base and that is why it’s very important that the ECB officials who are running the programme are very sensitive to how the market works.

Lais, Commerzbank: It depends a little bit on how they do it. If they crowd out all the traditional investors, then it will take some time for even them to come back. One thing that will influence the development of the ABS market more than anything, much more than the ECB does, are the regulatory rules that are set to be finalized in the next few months.

Wölfle, Commerzbank: If the European economy starts growing again, then I’m pretty sure that we overcome the issues in the securitization market and then the ECB can exit again these programmes like the Fed did in the United States.

GlobalCapital:  Indeed. Could all the ECB’s efforts on this purchase programme ultimately prove futile if the various regulations that determine how much capital needs to be held against securitizations by different investors remain as punitive as they are now?

Lais, Commerzbank: We are still not sure what the final documents will look like so there is uncertainty about the future regulatory rules. But if the current version becomes the final version, then it will absolutely have a negative influence on the market.

Hopkin, AFME: We do need sensible outcomes on the Basel III proposals for bank investors, the Solvency II proposals for insurance company investors, and on the liquidity coverage ratio in particular. There are various other regulations out there but those are the three biggest problems.

Susini, BNP Paribas: I wouldn’t say futile, but the benefit will be very limited. For a long time people were pursuing capital market and banking regulation in a very fragmented way. The ECB has now expressed the necessity to have a holistic view, and that’s something we were pushing years ago. We’ve had different people looking at what insurers can buy, what banks can buy, what money market funds can buy, and then we have someone looking at liquidity ratios.

Bindseil, ECB: No it would not be futile because there are other effects of the programme. The ECB buying has direct impacts and it affects prices. So for a given level of regulation it still has positive effects. But we believe in ABS as an important tool and we want it to work without the ECB, so for that to happen the regulation has to change. I don’t think it’s likely that nothing more will happen on the regulatory side. There is work in the pipeline on the simple and transparent concept, for example. The ECB has always stressed the importance of regulatory treatment, particularly for banks and insurance companies that are key components in the investor base.

Hopkin, AFME: Provided we get sensible outcomes on those regulations that recognise the strong performance of European ABS, through and since the crisis, and so long as we have a level playing field in those regulations with other instruments like covered bonds, then combined with the ECB ABS purchase programme I think that could make a big difference over the medium term.

Bindseil, ECB: Things are moving in the right direction. The objective has to be adequate regulatory treatment, not an unduly favourable one, of course. The concept of simple and transparent ABS that have performed well in the past has to be recognised and risk weights adequately calibrated, that is essential for the medium term outlook for the market.

Susini, BNP Paribas: But all this has a knock-on effect and it is part of a chain. The ECB has done its bit on the liquidity side. Then you have to expect something to move on liquidity ratios. Then you have to expect something to move on Solvency II, then on the money market funds. The biggest and the most difficult part will be probably the Basel regulation, because it’s international, rather than only European.

Bell, PCS: It’s not actually regulation that’s holding back the market. What’s holding back the market today is the macroeconomic situation, bank deleveraging, and free money from the central bank. That is not going to change until, one, the AQR finally gives a seal of approval to the banks’ capital positions so there is no concern, and two, when the economy starts to improve. The economy has to start improving and the central bank has to start pulling out of the free money business. Once that happens the supply will start coming on stream and then demand will be the question. That’s why the regulation needs to be fixed before we get to that point.

Ford, TwentyFour Asset Management: There is a hole in the ability of financial markets to function if securitization is not there. With the amount of capital that banks now have to put aside for everything they do across all of their operations, without a functioning securitization market and the benefit that it brings with capital relief, I do not believe there is the capital available for an expansion of the banking market or indeed SME lending.

GlobalCapital:  The momentum seems to be behind securitization in the regulatory arena, with more revisions to capital charges under Basel III and Solvency II. Can that continue and will the ECB have enough influence over regulators to improve the situation?

Susini, BNP Paribas: Progress has been made on Basel III and Solvency II, but you have to look at it in relative terms. If they had multiplied regulatory capital by 10, and then after a lot of protest and discussion come back and say, OK, it will only be five times what it used to be, then everyone says that is a great achievement. From 10 to five is great, but the market looks at the five being very expensive, and it is a huge disincentive to invest. We should be very grateful to the ECB. They have been the first one to announce concrete measures to support the market. We should expect the rest of the regulatory framework to evolve in a way also conducive to greater support for the market.

Lais, Commerzbank: The direction is positive and the progress needs to go further. But I’m not sure to what extent the Basel committee will act on the suggestions the ECB has made.

Shah, Moody’s: The ECB appears to be very keen not to be seen as driving the discussion at the regulatory level. There has been a positive evolution on a number of fronts in terms of perception of securitization and what capital charges should look like. There seems to be a view that the performance of European collateral is different from that in the US and that is absolutely correct. European transactions have generally performed well throughout the crisis. You are seeing regulators thinking that as well now. But these things take time and at the moment there is not enough certainty or consistency between the main bodies for people to be flooding back into the marketplace. As these things get ironed out there is no doubt there are a number of investors ready to come back or ramp up their activity in the sector, but we are not there yet.

Ford, TwentyFour Asset Management: But how many revisions have we seen to Solvency II already? There will be more. How many revisions have we seen for the liquidity coverage ratio? There will be more. How many revisions have we seen to Basel III? There will be more. The ECB have put their cards on the table and well done to them. They believe in this market and ultimately everyone else will follow.    

By Tom Porter
26 Sep 2014