One of the primary reasons that the European securitization market has failed to fully recover since the financial crisis is that banks have been retaining the few deals that they issue to use as collateral for cheap borrowing from the European Central Bank (ECB). This is particularly true for lenders in peripheral countries such as Italy, Spain, Portugal or Ireland.
But in recent months some banks have been re-marketing these deals to other investors. Initially this was because spreads on these securities have tightened. Since November, there has been another incentive: the ECB’s asset backed securities purchasing program (ABSPP), in which the central bank buys a portion of the senior tranches of retained deals outright and encourage market investors to join them
For example, on Dec. 16, Italy’s Banca Popolare dell’Alto Adige sold a 199-million tranche of a residential mortgage securitization that it had previously retained. Reportedly, half of it went to the ECB itself. The originator did not confirm the ECB’s participation by press time but Bloomberg reported that 55% of the transaction was allocated to “central banks and supranationals.”
Players expect this flowback will intensify into 2015.
The re-marketing of retained deals “is actually an aspect we expect will grow into next year as the ECB may use that to generate size” in ABSPP, said Dipesh Mehta, a director of securitization research at Barclays. “It is the quickest way for them to get some purchases under their belt.”
Analysts at Bank of America Merrill Lynch similarly said in an early December report that ABSPP should generate larger and more frequent re-marketings of retained deals than the occasional transaction that has hit the market so far.
Buyer of First Resort
The ABSPP was launched Nov 21 and as of press time the central bank had purchased 788 million. It doesn’t provide a breakdown of the securities it has purchased.
The transactions that are eligible for the program are basically the same at those eligible for repos, with the exception of Greek and Cypriot ABS. The program is targeting senior tranches of deals backed by mortgages, loans to small and medium companies, auto loans, commercial mortgages, and other assets. The bank is limiting its participation in individual tranches to 70% of the volume in deals from most countries. The outliers are Greece and Cyprus, where the ECB will hold no more than 30%.
In the case of retained deals, the purchase requires the participation of outside investors not related to the originator.
The idea is to spur origination and overall demand in the European economy, which is teetering on the brink of deflation, a potentially disastrous scenario.
While peaking in 2009, the percentage of new European securitizations that are retained remains well above 50%. But the 66% figure for YTD 2014 ignores the re-sale of previously retained securitizations into the market.
Where the ECB will focus its effort remains uncertain, though many are guessing it will target banks in the periphery, the ones that are most desperate for funding and have also had the most difficulty placing their deals with market investors.
Barclays expects that the ECB will purchase between 50 billion and 70 billion in the first year of the program — about 15 billion - 25 billion in the secondary market and 35 billion - 45 billion in the primary market. Over two years, the purchases could amount to 125 billion - 150 billion.
Barclays sees the ECB favoring re-marketed deals and new issuance over secondary market purchases. More particularly, the English bank predicts authorities will try to compress the spread between the senior peripheral ABS and core country ABS. Once that differential is in the 35-basis-point-to-50-basis-point range, then a number of originators will be incentivized to either issue fresh supply or re-sell retained deals.
Such a tightening could potentially bring the yield on senior tranches of originators of peripheral countries to inside of the curve for respective government debt.
But the ECB has a difficult balancing act that participants aren’t necessarily confident it can pull off: stimulate origination by buying retained or new deals, while not crowding out investors to the point where they never come back.
There is a more hopeful scenario. Analysts at BofAML said that the tightening of yields could end up nudging market investors towards mezzanine tranches, a particularly welcome outcome for banks as the issuance of full capital structures gives them more capital relief.
Whatever happens with market investors, the ABSPP program is expected to further spur re-sales.
Figures on how much retained securitization is outstanding are imperfect — banks can retain a transaction at issuance and then turn around and sell portions of it immediately afterward. According to Barclay’s data, the number is currently in the ballpark of 480 billion.
As of mid-November, there were about 350 billion of asset-backeds functioning as collateral for ECB repo funding. But that figure does not capture all retained transactions as there are tranches not being used for repo funding. According to Barclay’s data, the total outstanding universe of retained deals is closer to 480 billion.
Getting the Boot
Players say Italian banks are the best candidates for selling retained deals.
Barclays estimates that Italian banks hold about 71 billion in asset-backeds eligible for ABSPP, with 53 billion currently serving as collateral for ECB funding.
Even before ECB launched its program, higher prices was already pushing Italian banks to sell retained deals back into the market. Investors have bought up 8 billion of Italian RMBS this year, with the bulk consisting of retained deals.
A fairly high-profile transaction — and one of the first to be reportedly purchased by the ECB — was the one from Banca Popolare dell’Alto Adige.
The 199-million deal consisted of the A2 tranche of the bank’s Voba 5 RMBS deal, rated AAA’ from DBRS and AA+’ from Fitch Ratings. Credit Suisse, Deutsche Bank and Natixis arranged the re-sale. The deal sold at a premium with a spread of 70 basis points over 3 month Euribor.
But not all re-sales have been public.
Banca Popolare itself engaged in another quieter re-sale earlier this year, selling 122.6 million in Voba 3.
The senior tranches of both Italian and Irish banks are currently trading wider than the 35-to-50-basis-point spread over core asset-backeds that Barclays argues would be a good target for the ECB. This means that they would have the most incentive to sell their retained deals.
Originators from other peripheral countries will not be as incentivized under that scenario.
Spanish and Portuguese banks, for instance, have retained senior ABS tranches that have a coupon spread of below 30 basis points, which would trigger a loss for a bank if the ECB is willing to go no tighter than 35. To make a sale economical these transactions would have to be restructured, which would basically make such a transaction a new issuance.
Hazardous Haste?
Industry players generally see a high percentage of retained deals as evidence that the European ABS market is still dysfunctional. Pushing them back into the market could bring the industry closer to a genuine recovery.
The analysts at BofAML are not alone in their view that a “true recovery” of the European securitization will only come about if a rebound in issuance takes place for both senior and mezzanine tranches and the final buyers are market investors.
But while helping with a rebound, ABSPP has the potential to scare investors away.
If the ECB moves too aggressively in snapping up these deals itself, it risks raising prices to the point where other buyers are no longer interested. And some may not come back.
What is more, even if the program goes relatively smoothly, the exit could cause spreads to rise too quickly, hurting the mark-to-market value for investors who bought during the life of the program.
To avoid this, Barclays analysts echo what many in the industry have been calling for: bringing the regulatory treatment of securitization closer in line with other financial instruments.
At any rate, one thing is clear: the balancing act the ECB must strike between stimulating banks to sale or re-sale deals while keeping prices attractive to market investors be key to ABSPP’s ultimate success.
