While private securitization markets in Europe have virtually shriveled up, banks and other issuers can still turn to a rich uncle: central banks will accept their RMBS paper as collateral for repo financing.
Although the European Central Bank (ECB) and the Bank of England (BoE) repo structures have been open for years, "the credit crisis has made everyone aware of how it works and what collateral is eligible," said Christopher Greener, senior analyst at Societe Generale. Since last August, the facilities have become a very popular outlet.
The exact usage numbers are not clear, since the ECB remains "rather coy" about publicizing them, Greener said. However, as of the end of September 2007, ABS pledged with the Eurosystem had reached 215 billion ($333.10 billion), which then represented 17% of all outstanding collateral. At that time, the ECB announced it had identified a total amount of 700 billion in ABS transactions as eligible for the program.
The construct is functioning as a sensible stopgap measure and safety valve, at least until the mortgage market readjusts to the changing demands. ECB spreads are lower than those in the financial markets, so banks can use them to obtain cheap funding and create liquidity.
"The central bank discount rates reflect quality as measured by the rating assigned to the asset. Skittish investors, who have lost faith in the rating agencies, would insist on deeper discounts," said James Croke, an attorney with Orrick, Herrington & Sutcliffe.
The BoE is also ready to pump up liquidity for its members. It recently announced that it will increase the time periods available, by initially offering one-year repo financing, which it may agree to extend out a further two years.
Its terms are much more punitive, though. It too will swap ABS for gilts, which can then serve as quasi cash, but at a considerable haircut. Compare the ECB's 2% discount with the BOE's 13% slice. Moreover, if there is no readily observable market for the securities - and there rarely is these days - the Bank tacks on another 5%. If the collateral emanates from the issuer, it adds another 5%, and chalks up a further 3% if it is not in sterling.
"Those haircuts can easily mount up to 25%," Greener said. "But even getting 75% is acceptable, if you need to use the bonds on your books to raise cash."
The ECB also imposes restrictions on its repo lending. Only the most senior RMBS notes qualify as eligible collateral, and the borrowers must be ECB members. Although the terms are intended to be favorable, to help generate liquidity, they are still more onerous than those the private market used to offer.
"In the past, you would have been able to sell right down the capital structure, and receive a higher rate, because you would have sold the notes at par," said Phil Adams, research analyst at Royal Bank of Scotland.
Beggars cannot be choosers. "The liquidity crisis in Europe is even more severe than in the U.S., and provides no realistic rates for financing," Croke said. To make matters worse, the expense of borrowing has been artificially increased, due to exceptionally high Libor rates. So the ECB has become the only viable game in town. "Everything on the market is now used as ECB collateral, and on a large scale," said Michaela Ulrici, an attorney with NautuDutilh in Amsterdam.
Some banks in the Netherlands continue to package recent deals, such as Rabobank, ING and ABN AMRO. Rabobank, for example, has indicated that it does not need the funds immediately, but at least will have the 30 billion from its deal on hand to use as collateral.
Since before the credit crunch, Spanish banks in particular have been using the ECB repo scheme for their own originated mortgages. The country's property boom has generated substantial RMBS transactions. "Again, we have no precise information as to who is participating, but there is a sense in the market that the Spanish have been using that originated paper for the past nine months," Greener said. Of course, the U.K. is the country in Europe most active in securitization, but it does not enjoy the ECB access.
With such generous terms, why is the ECB financing not even more popular? One could argue that the system may not endure, and may not remain reliable for long-term, synchronized funding. If a bank is originating 25-year mortgages, and its funding plans only last a few months, the liabilities would not be well matched. But issuers today are still basing their transactions on repo funding as an "actual plan, rather than just getting to the finishing line and finding they can't sell them," Croke added. "They realize they can't yet sell them in the capital markets, but know in the back of their minds they may be able to place the deals with permanent financing when markets come back." Many, who have active operations in place for constantly originating assets do not want to shutter their programs, as long as they can keep them going.
Ulrici remains optimistic that "everyone will jump back into the market, as soon as spreads become more acceptable." She regards the current repo funding as a kind of "repackaging," for altering the assets that are taking up room on the balance sheet into a more useful liquidity tool. She predicted that the European market for public deals will revive. "Arrears here are still below 1%, and there is no real subprime problem," Ulrici said.
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