The European Central Bank will start covered bond purchase this month and ABS later this quarter.
The ECB’s purchases will extend to both the primary and secondary markets. As previously announced on September 4, the ECB will purchase both senior and guaranteed mezzanine bonds.
Senior bonds must be eligible under the ECBs current collateral framework. The bonds must be investment grade rated by at least two rating agencies; they must be secured by claims against non-financial private sector entities in the euro area, of which a minimum share of 95% is euro-denominated and of which a minimum share of 95% are resident in the euro area.
Purchases will also include junk bonds (or debt rated BBB-’) from Greece and Cyprus. In this case the ECB will waive the investment grade rating requirement. These bonds will instead be required to have the second best rating achievable in that country; have minimum credit enhancement of 25%, and having investor reports and modeling in standard third-party modeling tools as assessed by the ECB.
The criteria for mezzanine bonds will be published at a later date.
The bank could purchase as much as 70 billion in the coming 12 months, according to researcg published by Barclays. However, the ECB has addressed initial concerns that it would become the sole buyer of ABS by restricting its purchases to a maximum of 70% of a tranche (30% on the case Greek of Cypriot ABS). For fully retained transactions, the ECB may purchase but only if there is some participation by other market investors.
The Barclays chart below shows outstanding European ABS volume.
In its report, Barclays described the plans as “positive,” but stated that the 70% threshold "is somewhat higher than we expected (our expectation was 20-50%) and maximization could result in a considerable crowding out effect unless primary market issuance picks up substantially."
The ECB's purchases are expected to push spreads on these assets tighter. However if funding costs fall far enough to make issuance more attractive to banks, the returns might not be so appealing for investors. For example, ABS investors polled by Barclays stated that 40 basis points over Euribor was the lowest entry point they would consider to invest in Italian residential mortgage backeds or securitizations of loans to small and medium sized enterprises. By comparison, the ECB’s long term refinancing operation provides funding to Italian banks at a spread of 15 basis points, according to Barclays.
“We think that in practice the central bank will target a lower participation in a given bond, which would reduce the risk of crowding out. It would also have the advantage that it would keep the capacity to remain the buyer of last resort in such bond, in turn increasing investor confidence in the investment,” stated Barclays.
There remains doubt over whether this latest effort by the ECB will be enough to revive the securitization market. Barclays today restated its position that it does not believe the purchase program, on its own, will be enough to rebuild the European ABS market, “which relies on banks’ ability to place mezzanine bonds at economically viable spread levels.”
The success of ECB’s ABS program is therefore linked to the ECB;s mezzanine purchases, according to Barclays. “The central bank was noticeably quiet on that point today,” stated analysts.