The first two months of the year saw a handful of European originators launch tenders to buy back their structured finance bonds.
Whether this will extend into March and beyond depends on a number of factors, not the least of which being how banks decide to use the €529.5 billion ($705.8 billion) take-up in the European Central Bank's three-year Long-Term Repo Operation (LTRO) last Feb. 29.
Along the same lines, expectations of more liquidity-boosting operations of this nature could raise the prospect of additional buybacks, but some sources question whether we will see another rash of them.
Five originators have repurchased a total of about €2.1 billion in securitizations via public tenders since the beginning of the year. (See table below.) This excludes the covered bonds and Tier 2 bonds that have been part of a few offers. Three of the tenders are Spanish, one is Dutch and another Portuguese.
The liquidity provided by the ECB's previous LTRO on December 22 for â‚¬489 billion and the ability to use ABS collateral for the February one no doubt helped fuel this flurry.
But sources said there were other motives too, which the LTRO facilitated but did not create.
One is the capital gain an originator books in buying back a consolidated securitization that is trading below par.
"If the deal's structured at Libor plus 10 or 15, and at the same time you can get the LTRO at 1%, then there is not much difference in funding cost," said Alexander Batchvarov, international structured finance strategist at BofA Merrill Lynch Global Research. With that part of the equation more or less equal, an originator that has consolidated a securitization at significantly below par - as these issuers have in recent tenders - can realize a "huge capital benefit," Batchvarov said.
He added that all the banks that have launched tenders this year consolidate the deals that have been targeted, which include RMBS and SME loan ABS.
The reason that banks might want to improve their capital position in the short term is to help them pass the next round of stress tests by the European Banking Authority scheduled for July. The EBA has boosted banks' required ratio of Core Tier 1 capital to 9% by mid-2012, from the 7.5% originally envisioned.
Spanish banks are struggling to meet this requirement on top of the tough real estate provisioning plan that the Spanish economy minister announced in early February and that they must implement by the end of the year. These demands may explain why three of them launched tenders in February.
Indeed, via e-mail a press official from Banco Mare Nostrum said that there were accounting advantages to their recent tender, as well as the possibility that the re-purchased notes would be used as collateral for ECB funding.
Neither Catalunya Banc nor Banco Popular Espanol returned requests for comment.
Originators buying back their bonds may also be looking to restructure or reissue part of their securitization program, said Steve Curry, founding partner at Bishopsfield Capital Partners. "It can be quite helpful to get bonds back in order to collapse the structure and take the collateral for new transactions," he added, saying that Banco Santander bought back a deal to snap up collateral that was then plowed back into a new transaction. This helped in the pool's seasoning mix.
While issuers have their reasons, investors have their own to tender their bonds.
Apart from the repurchase by Lloyds Banking Group of Dutch RMBS issued off the Candide program, the success rates in the past five European buybacks have been underwhelming. Many players have been surprised that a good number of bondholders want to hold on.
"There are some investors who can't sell their bonds for various reasons," said Robert Plehn, head of asset-backed solutions at Lloyds Bank. For example, he added, there may be investors holding the bonds in a banking book at a price that is higher than the tender price, and they may think the bonds are money-good. By selling at the tender price they would be taking a loss they do not want to recognize and so do not participate.
Participating in this scenario can have a dangerous cascade effect. "Once they've crystallized that loss, they'll need to mark similar bonds to the same price," said Dipesh Mehta, vice president at Barclays Capital. The resulting domino of write-downs would obviously be damaging to a financial institution. "That's what happened at the peak of the crisis," Mehta added.
Plehn said that certain investors might also have their bonds tied up in repo operations with third parties. These could be banks or potentially hedge funds or other investment funds.
Another reason for nonparticipation could be that investors simply want to keep the bonds. The senior tranches of prime European ABS have performed well, and none of the notes that were bought back this year had collateral performing anywhere close to distressed levels. "They may have bought it at a discount" said BofA Merrill's Batchvarov. "Why take the hit if I think the bond is money-good and will pay back?"
The Mare Nostrum official added that the notes it re-purchased were of strong quality with low-delinquency collateral and, as a result, it made sense that some investors would want to keep them even at the offered price.
Nevertheless, while their numbers have fallen short of expectations in most offers, there are investors who have tendered their bonds.
With Spanish and Italian product, some bondholders might have tendered as a way to cut exposure to the more beleaguered eurozone economies, regardless of how the collateral has actually been performing.
The question of whether or not an originator will exercise the call of its bonds can also play a major role.
Most European RMBS have a call option, but if an originator indicates that it will not call the bond and launches a tender, there is a strong incentive for investors to participate.
An originator can mar its reputation if does not follow through on what it has suggested it will do. On the other hand, if it has no plans to come back to the securitization market, the issuer may not have any scruples about toying with investors' expectations.
"Here there is a big distinction between repeat issuers and those looking to get out," said Mike Nawas, a founding partner at Bishopsfield Capital Partners. With securitization going through such a rough patch, he added, "it's important to appreciate that dynamic in Europe."
Nawas added that investors would be keen to get out of a bond that has a step-up coupon that has been agreed to before the crisis.
Market players no doubt still remember quite vividly the case of Northern Rock's roundly criticized behavior with its Graphite synthetic ABS bonds. According the Alphaville blog of the Financial Times, the bad bank told investors in June that it would not call â‚¬519 million in bonds and then announced a tender at a discount. After buying back â‚¬282 million worth, to the dismay of those who had tendered, the bank announced that it would call back the remaining bonds at par. Players said that as a bad bank owned by the government, the issuer no longer felt the need to play nice with market investors.
Following the results of these recent tenders and February's LTRO auction, players are now turning their attention to whether further buybacks make sense.
Barclays' Mehta said he wouldn't be surprised if there were more tenders coming from Spanish, Portuguese or Italian banks. The Greek banks, he added, would probably like to, but cannot get their hands on enough liquidity to make it feasible.
As Spanish banks face the extra provisioning for real estate assets on top of the EBA's capital ratio requirement, Batchvarov said they will remain under the most pressure for capital, but he didn't rule out other banks doing it.
Whether it will be more than the occasional tender remains to be seen.
Plehn said he believed the buybacks were likely to slow down following the most recent LTRO, although there could be an uptick if the ECB announces another round. He added that institutions might continue to do this if they are long-funding and driven more by the "profit-capital accretion objective."
The overall outlook for structured finance on the continent may also influence the prospect of more tenders, said Nawas. "If issuers see a strong likelihood of positive changes in Basel III and Solvency II, they might buy back deals to position themselves for the return for the market." Although, of course, in that scenario investors may take a similar view and therefore be loath to sell back their notes.