The European Central Bank’s program for buying asset-backed securities has directly and indirectly led to spread compression among securitizations, according to analysts at Bank of America Merrill Lynch.
This is good for originators that can either issue or re-sell retained deals at lower yields.
But it also risks pushing away investors who want higher returns, particularly those that have to factor in the steeper capital requirements that face securitizations versus other kinds of instruments.
As part of its asset backed securities purchasing program (ABSPP) launched in November, the ECB is buying portions of senior tranches and encouraging market investors to join in.
Under the assumption that a regulated investor is looking to maximize its risk-adjusted return on capital (RAROC) and has no preference among instruments, BofA analysts found in a report this week that some kinds of European securitizations are a tough sell right now.
In the table below, the analysts compared the current spread on a several securitization asset classes to three other spreads. One is the spread on the underlying target asset (in the case of some RMBS they used covered bonds as a substitute for the underlying target asset or collateral).
The second is the spread that an insurance company subject to the capital requirements of Solvency II would need to earn on that asset class to match its return on the target asset.
The third is the spread that a bank subject to BIS 3 ERBA (Bank for International Settlements External Ratings Based Approach) would need to earn on that asset class to match its return on the target asset.
While Solvency II and BIS 3 ERBA have not been implemented yet, investors tend to factor in future regulatory changes in their investment decisions.
What BofA analysts found was that spreads on some deals should be wider — in some cases far wider — to make them attractive vis-à-vis their underlying assets.
This not only shows how pricey securitizations are for regulated investors when capital requirements are baked into the yield, it also puts the economics of doing certain kinds of securitizations into doubt.
“If the required spreads of the ABS tranches is this much wider, then the securitization of the respective underlying asset will be economically impossible, given the base equation of any securitization — that yield of the securitized assets should be sufficient to pay all securitization expenses including interest on the securitization tranches,” the analysts wrote.
Dutch RMBS Tight to Banks
As part of ABSPP, ECB has been buying between 200 million and 300 million of securitization tranches since November of last year.
While this is relatively paltry — there was more than 150 billion in securitization sold in European last year — there is not much supply out there as secondary activity has waned.
This has helped compress spreads, along with the ECB’s announcement on January 22 that it would buy up to 60 billion of a range of assets every month for the following 19 months in an effort to reverse deflation.
BofA analysts said that Dutch RMBS — which is eligible for ABSPP — was, for the first time, trading at yields below that of comparable bonds issued by Dutch banks. RMBS spreads had shifted below that of bank debt in the case of Italy after the ECB announced ABSPP last September, and the same thing happened in Spain following the Jan. 22 announcement.
“We expect the question as to whether ABS should trade inside the origination bank’s senior debt to come up more often in the future,” the analysts wrote. They believe this shift from the norm makes sense given that QE is reducing the liquidity premium a bank’s vanilla debt tends to enjoy over its securitizations.