Last week the European Banking Authority (EBA) released the preliminary results of its analysis of financial instruments that it believes will be liquid enough to be eligible for inclusion into bank liquidity buffers.
The results, which showed the liquidity ranking of covered bonds was almost equal to government bonds, led to speculation that covered bonds could be elevated from a level 2 asset in Basel III’s liquidity coverage ratio rules to a level 1 asset.
In contrast, the liquidity of the securitization market was ranked alongside equities at the bottom of the EBA’s table.
That summary fails to address some key points about both markets and makes the EBA’s choice of what it analysed for the results look questionable.
By concluding that covered bonds include liquidity to rival their sovereign counterparts, the EBA seems to have missed the fact that the covered bond market regularly faces liquidity bottlenecks.
The very different results for the two asset classes will mean that even more investors will flock to covered bonds and some may now wish to avoid ABS.
But ABS is a very heterogeneous product and each individual sub-sector shows quite idiosyncratic and distinct characteristics. Had the EBA looked at it differently, it may well have come to different conclusions.
Research by Bank of America Merrill Lynch suggests that if the EBA had looked at plain vanilla triple-A rated RMBS and senior car loan ABS — the largest sectors in the ABS market and excluded other securitizations, it would have come up with a more positive result for the market.
The analysis also showed that if the EBA had examined the market over the last three years instead of the last five, it may have even reached the conclusion these securitizations were more liquid than covered bonds.
Bid/offer spreads, which are a crucial indicator of liquidity, were tighter in the RMBS and auto ABS markets than they were in the covered bond market. This is because covered bonds were more closely correlated to the government bond rout that accompanied the sovereign debt crisis.
Such results are so vastly at odds with the original EBA analysis that one must now question the validity of the regulator’s verdict.
Policy makers and the ABS industry would like to see a revival of the securitization market, but so far they have not managed to convince regulators.
If only they had as good a dialogue with the EBA as the covered bond industry has, we would not now be digesting liquidity scores that for ABS fans must be hard to swallow.