Securitization: All bets are off as ECB takes hold of ABS
Securitization made serious advances in Europe last year, even if the numbers do not show it. Supply has broadened and the product has been embraced by the continent’s higher powers. But looking ahead there is no escaping the long shadow of the European Central Bank, which, for good or ill, is going to shape the entire market for the next 12 months and beyond. Tom Porter reports.
If issuance statistics were the only thing to go by, 2014 would be remembered as a typically restrained post-crisis year for securitization in Europe. Nearly €60bn ($74.8bn) was placed with investors, barely creeping over 2013’s total. Another “this is the year” that never was.
But numbers, believe it or not, do not always tell the whole story in the capital markets. You could tell future generations of ABS bankers that 2014 was the year euro CLOs hit €14bn. You could tell them that multi-loan and multi-borrower CMBS made a comeback, that UK issuers nearly tripled their 2013 RMBS volumes, and that Crédit Foncier de France got rid of a full stack of mortgage-backed bonds. And they would still only want to hear about when the ECB started buying.
On November 21 last year, some seven years after a twisted form of the securitization technique brought the global financial system to its knees, Europe’s central bank started buying ABS. Because of the myriad questions the plan throws up — the move is far from universally welcomed — it is sometimes easy to forget just how important an endorsement it is.
“Within the ABS sector we tend to say ‘thank you very much but it’s still not enough’,” says Gordon Kerr, head of EU structured finance research at rating agency DBRS in London.
“But if you think about the way investment allocations happen, you’ve got people up top who aren’t specialists looking across products with money to put to work. So a vote of confidence from someone like the ECB allows them to go out and consider allocating some money to this sector.”
In public relations terms, 2014 couldn’t have gone much better for European securitization. The ECB’s executive board member Yves Mersch delivered the keynote at the Global ABS conference in June and called for a rethink of the product’s regulatory treatment, with the conference’s return to its pre-crisis home in Barcelona hinting at new optimism. It came just days after the ECB and Bank of England had issued a joint paper that forcefully argued the same over 28 pages.
Many bankers remain sceptical. Actions speak louder than words, after all, and the ECB only has soft power when it comes to the regulations they say are the single biggest drag on issuance levels.
But despite 2014’s activity failing to drag overall volumes out of the stagnant pattern of the past few years, there are reasons to be cheerful, says Kerr.
“Everyone has focused on the bigger numbers, which are falling primarily due to RMBS,” he says. “When you get away from RMBS a lot of the other markets have come back and started to show some real interest from investors. The one thing most people seem to overlook is the success that the auto market has had, for example.”
Auto ABS issuance has grown every year in terms of distributed volume since it restarted in 2010, helped by exemplary asset performance and an unerring buyer base. Transactions backed by French, Italian and Scandinavian collateral spiced up the Germany-dominated fare last year, while a giant £1bn ($1.57bn) UK deal from Volkswagen also caught the eye.
Even before the ECB announced it would be investing, non-core spreads in particular experienced a virtually uninterrupted rally from January onwards, which helped a range of more off-beat trades to market.
Italian banks sold either previously retained or brand new RMBS at ever shrinking spreads, Banif found plenty of demand for a Portuguese SME ABS and a securitization of mortgages extended to high net worth individuals in London stood out in a run of quirky portfolio acquisition trades in sterling.
“The one thing that changed through 2014 was the outstanding performance in the secondary market for most asset classes,” says Aaron Baker, an ABS analyst in BBVA’s research team in London. “That is helping originators’ deal economics, but at the same time we’ve got deleveraging and less of a requirement for wholesale funding from core banks.”
Core banks will be slightly less excited than periphery peers about further spread tightening in 2015 from a funding perspective. But the squeeze will bring one unique benefit of securitization into play for a broader range of originators.
“For core Europe more and more of the conversations we have are about full capital structure sales,” says Olivier Renault, head of structuring and advisory at StormHarbour Securities, London.
“Securitization as a funding tool is not competitive against covered bonds. If spreads stay tight or continue to come in, more banks will be able to sell entire portfolios and get capital relief. That is something that was not on the agenda a year ago, but has been the topic of more and more of our conversations recently because of the leverage ratio.”
An even broader range of transactions from an even broader range of jurisdictions and issuers will have access to the market in 2015.
But the ECB joining the market as an investor has made ABS analysts’ job forecasting volumes for 2015 particularly tough. Bank of America Merrill Lynch’s team, for instance, has estimated volumes could rise nearly 40% this year. But more than ever before that number is subject to revision, in either direction.
Like it or not, the ECB is now playing God in ABS. Which bonds it is able to buy, and how aggressively it does so, will determine the course of issuance for the next 12 months and beyond.
The ECB needs €1tr across covered bonds, ABS and its targeted longer term refinancing operation programme. BAML’s analysts also estimate the ECB might need to buy around €500bn of ABS over two years to hit its target, once the likely contributions of the other two are taken into account.
The central bank hit the ground running in covered bonds, buying up €500m to €600m a day in the first few weeks. Bankers fear that in the smaller and less liquid ABS market, the ECB will have to participate heavily in primary deals to get the size it desires, squeezing out private money in the process. That effect was already evident in the ECB’s very first primary investment: Delta Lloyd’s swapless Arena RMBS trade at the end of November.
Even so to get anywhere near Bank of America Merrill Lynch’s €500bn, there would have to be an unprecedented rise in primary market activity, or the ECB would have to buy a whole lot of retained bonds.
Some estimate that spreads could halve again from here, which could potentially mean Dutch RMBS issuers like Delta Lloyd paying single digit spreads over three month Euribor for two year seniors. Great for issuers, bad for investors.
“The ECB will not buy more than 70% of an issue,” says Renault. “So if they want to buy, say, €400bn of ABS, you need private investors to buy approximately €180bn. You wonder who that is going to be because it is not going to be the insurance companies or the banks.”
Unique selling point
The Solvency II, Basel III and Liquidity Coverage Ratio regulations penalise securitization against other forms of debt such as covered bonds.
But covered bonds cannot offer capital relief, and this is one area where some are predicting there will be a meaningful pick-up in activity for ABS.
“You should be gauging the overall success of the market in the longer term as one that returns to being a funding product for European banks, which means the success of mezzanine,” says Kerr.
The ECB has said it will only buy riskier tranches if they come with guarantees, and a flat refusal from countries like Germany and France has left the European Investment Bank as virtually the only candidate left to provide them.
Mezz sales should be much more attractive for issuers to place this year. The ECB-driven spread rally will see to that, even if the central bank can’t find a way to buy the tranches directly. There is also no shortage of buyers willing to take on that risk in return for the juicy yield it offers, many of them from the US.
Securitization bankers fear they know exactly where this is going to end up. The ECB will struggle to achieve its size target, and in trying to do so will drive investors out of the market and have only a modest impact on issuance.
But their product is capable of giving capital relief at a time when European banks, and by extension the economy as a whole, could really profit from it. With some luck on the regulatory front and some care from the ECB, more issuers should be calling on it to help free them from old assets and start originating new ones.