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The ECB’s ABS purchases may be over before they’ve begun

By Tom Porter
11 Dec 2014

Since making its decision to purchase asset backed securities, the policy message from the European Central Bank has floated somewhere between credit easing and quantitative easing. One won’t work, and the other should have nothing to do with ABS.

Back in June, when ABS purchases were still at the "intense preparations" stage, ECB president Mario Draghi’s message was squarely aimed at improving credit conditions in the real economy. Buying these simple, real and transparent products would feed through into lower rates for businesses and individuals.

A few months later the market grew impatient and demanded a number. Draghi caved and said a €1tr balance sheet increase, spread across ABS, covered bonds and the targeted long term refinancing operations (TLTROs).

With that number now the target there is an easier way to get there, which is the sovereign bond buying the vast majority of market participants expect to see in the first quarter of next year.

Some think sovereign QE could be announced at the earliest opportunity on January 22, when judging by the pace so far, the volume of ABS in the ECB’s portfolio could still be less than €2bn. The ECB has acquired just €601m so far, versus €21bn of covered bonds.
If sovereign bonds are thrown into the mix at that stage, could the ECB pull back from ABS entirely?

Cut and run

It would certainly be a lot less hassle. The ECB has made its statement. It likes ABS, everybody else should like ABS, and regulators should encourage more people to buy ABS with more favourable capital treatment. Besides some potentially awkward conversations with the four asset managers it hired on two year contracts to run the purchase scheme, a cut and run wouldn’t be a bad option.

It is not the ECB’s job to revitalise the ABS market, though curiously it does seem to feel the need to keep reiterating that this is the intention. There are precious few people in the market that are happy to see it there.

When asked why the ABS volumes were so low at his press conference last week, Draghi replied that the ECB did not want to crowd out private investors. That was perhaps a nod to the exact effect it has had in the covered bond market.

And he has banks convinced. Those that loaded up on ABS in anticipation of selling it to an aggressive, price taking ECB have been selling in recent sessions as the pace of purchases has proved disappointing, which is one of the main reasons spreads have barely tightened since the ECB started buying.

While caution from the ECB will make ABS purists smile, it again raises the question of what exactly the ABS purchases are for. With sovereign bonds about to become the tool of choice for QE, the answer can only be credit easing.

But do banks need more cheap liquidity? Analysts expect banks to offer a resounding no to that question at the next round of TLTRO bids this week, with most expecting take up to be around €150bn of the €317bn still on offer. With €290bn of LTRO repayments due by February, that could mean the ECB’s balance sheet contracting.

To paraphrase Royal Bank of Scotland’s Alberto Gallo (who estimates the December TLTRO take-up at just €120bn), there is only so much free beer you can drink, despite a wealth of anecdotal evidence to the contrary from anyone who has been to a City lunch in December.

Low hanging fruit

There is also only so much ABS you can structure when you are not originating any assets. The ECB's programme will eventually increase ABS issuance if purchases continue. There is already a healthy pipeline of previously retained ABS on its way to market from periphery lenders, particularly smaller ones without covered bond programmes which can offer more attractive funding.

But that is low hanging fruit. The consensus among ABS analysts is that supply could be 50% higher in Europe next year. But if the ECB is buying a big chunk of that increase, it hardly counts as a revival, and much of it will not be backed by newly originated assets.

Lower spreads are not much use in anything but the very short term, particularly in an asset class with a very small group of increasingly yield-starved investors that are disproportionately penalised for holding securitizations instead of competing forms of debt.

If the ECB is to hit the QE button early next year, it will have a good opportunity to call a halt to the slow-moving ABS purchase programme without losing face. It could feasibly keep its promise of not crowding out investors by keeping the pace of buying low, while offering an implicit liquidity backstop that might tempt some new investors into the asset class.

But pulling out altogether would not be the worst option either.

By Tom Porter
11 Dec 2014