The European Central Bank (ECB) published adjustments of risk control measures for newly issued ABS.
The ECB intends to limit repo collateral to triple-A rated bonds and will no longer accept collateral that is backed by other ABS, a change that could limit future repo restructurings.
The ECB said that the changes will contribute to the restoration of a properly functioning ABS market.
Under the previous terms of the ECB eligibility criteria, banks could come up with riskier transactions in terms of structural features and collateral quality than were typical in the pre-crisis public European securitization market.
Fitch Ratings noted that European banks have increasingly included assets that they had previously passed over for securitizations for ECB repo restructurings.
"The previous eligibility criteria had left the door open for banks to securitize more risky, less liquid or data limited assets for ECB repo purposes," said Stuart Jennings, EMEA structured finance risk officer at Fitch. "It is possible that the pool of eligible assets will contract as a result of the new 'AAA' rating threshold, as certain portfolios of this type may not be capable of achieving a 'AAA' standard."
However, over the lifetime of the ABS, the collateral can be downgraded to a minimum rating of single-A and still remain eligible. The ECB changes related to ABS repo collateral take effect on Feb. 1.
The ECB has opted to maintain its requirement for a single rating at the triple-A level from an accepted external credit assessment institution (ECAI) despite market speculation that it would make a move to require two ratings to address potential rating shopping.
Jennings warned that the post-August 2007 trend toward less credit enhancement, with originators only needing to meet the credit enhancement requirements of one rating agency rather than two or more, will continue.
Furthermore, the rating agency warned that reliance on a single rating will accentuate transition risk when the structured finance sector reopens and moves back to the pre-August 2007 publicly syndicated market model and away from the current ECB repo-driven model.
"Specifically, the public market has traditionally required two or more ratings," Jennings said. "Therefore transactions that have been posted with the ECB may require significant restructuring before they can be transferred to a wider investor base."
Besides the limitation of eligible ECB-repo ABS collateral to triple-A rated bonds at issuance, the ECB also limits restructuring efforts of ABS bonds for ECB repo reasons. "In our view, the restrictions for ABS collateral have mainly been made to keep collateral quality sustainable in the long run," Unicredit analysts said. "Nevertheless, the allowed rating migration scope to a single-A from triple-A could be questioned under the aspect of sustainability."
While the latest changes are an encouraging sign that the future ABS market stage could shift beyond the current dislocation in primary issuance that is defined by the lack of public issuance and a heavy reliance on repo activity, these shifts will do little toward market restoration in the short term.
"The majority of securities placed with the ECB have been 'AAA'-rated anyway, and few, if any, have been CDOs of ABS," Jennings said. "What the criteria update does do though is draw a line in the sand for future issuance, safeguarding the future risk profile of the program."
Unicredit analysts expect restructuring efforts to experience a final hype before March. "Then, ABS portfolios outstanding on bank balance sheets can no longer 'disappear' in transactions restructured for ECB repo reasons," they said.
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