Both the Bank of England (BoE) and European Central Bank (ECB) board members said last week that they are looking at possible new restrictions on the liquidity facilities they currently have on offer.
The changes will address concerns over the potential for excessive usage of securitized debt for ECB collateral as well as the programs' long-term sustainability.
The ECB plans to review its current ABS collateral criteria as the risk of abuse and refinancing dependence by some financial institutions have become problematic. The BoE has reiterated that its Special Liquidity Scheme (SLS) is intended only as a temporary measure to cope with a special situation. The Bank has also stated that the liquidity facility is intended to disappear at some point - even as early as next year should the markets return by then.
On the ECB side of the equation, it is the opportunistic behavior of some market players that has raised issues. According to Unicredit analysts, some recently structured transactions have featured less conservative pools and concentration levels that would otherwise be hard to place with investors publicly.
These deals, constructed to include an element of adverse selection, have already started to falter, as is the case with the recently downgraded Spanish transactions which were issued and retained for the possibility of posting as collateral with the ECB. Unicredit said that short-term central bank funding is, to some extent, also taking over the role of missing ABCP investors in arbitrage conduit pools and SIV pools that are no longer functioning. "We think these deals can cause problems as soon as central bank support is reduced and these transactions need to find once more their right to exist," Unicredit analysts said.
It is likely that any refinement of criteria would curtail the heavy usage of the repo facilities and could also tempt originators back to the primary market, thus creating buying opportunities for investors willing to return to the market. Deutsche Bank analysts said that investors are increasingly showing signs of interest in returning to the market. However, the problem is that, with over 90% of the ABS issued so far this year being retained by banks, there has been no real primary market activity.
The ABS Share
According to figures reported by Unicredit, ABS-backed loans currently account for 16% to 18% of the ECB's loan collateral. If the ECB moves to curtail such widespread usage, it is likely that the market will see ABS spreads widen further, creating some real buying opportunities for sidelined investors.
"It was exactly the extended central bank collateral facilities that triggered the last wave of significant spread tightening in spring," Unicredit analysts said.
Market analysts said that the changes on the ECB side would also help balance the distortions between central bank target rates and Libor rates, which are acting strongly against inflationary pressures. The original strategy of the ECB was to fight the crisis and inflation at the same time, prompting it to leave rates above crisis levels to combat inflation, while simultaneously providing banks with liquidity via more generous collateral requirements.
"The recent change in expectations regarding the potential evolution of rates in the coming months may have triggered these messages from central bankers who do not want to sound too accommodative," Societe Generale analysts said. "Although bad economic figures have hit the market, the evolution of inflation is not totally under control. But central bankers are definitely cautious about the fragile state of the structured finance market and its potential implications for the economy."
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