The ECB said that, after a review of its risk framework, it would accept lower-rated asset-backed securities (ABS) into its funding programme and reduce the cost of lending against the securities.
The move represents a return from a dark place for mezzanine tranches of ABS, which were widely vilified during the financial crisis for the huge losses they incurred.
Borrowers, who will see lower interest rates, will also be pleased, but for issuers of debt the new rules do not come without a cost, particularly for those who have become inured to drinking from the ECB tap in exchange for covered bonds.
“There is concern, particularly in Germany, that the ECB is carrying too much risk on its balance sheet, which means that major relaxation of collateral requirements is not politically achievable,” says Christian Schulz, a London-based senior economist at Berenberg.
“For that reason, they have balanced their decision by tightening requirements for some non-SME-related assets, in effect giving with one hand and taking away with the other.”
Haircuts for AAA-rated securitization bonds will decline to 10% from 16%, the ECB says, while provisions for bonds rated BBB plus or minus will fall to 22% from 26%.
In addition, for transactions that comply with loan-level reporting requirements – autos, consumers, leases, RMBS and SME ABS – the minimum rating requirement for eligibility will drop from AAA to A-, overcoming eligibility issues caused by the generic rule that securitizations must not be rated higher than their domestic sovereign.
Despite headlines suggesting the contrary, haircuts on all covered bonds have not been increased to offset the impact of the ABS changes. In fact, many covered bonds haircuts will also decline.
However, the central bank has introduced a retention add-on charge for covered bonds, meaning that issuer retained bonds posted to the ECB incur an additional 8% haircut for AAA to A- rated bonds and a 12% hit on BBB-rated securities.
“While this may seem like a victory for ABS, we must remember that ABS bonds, whether distributed or not, are only as good as retained covered bonds in haircut treatment,” says one industry analyst.
It will be no mean feat if the ECB succeeds in boosting confidence in the ABS market. The market has retreated into a pale shadow of its former self in the recent period, with year-to-date issuance in Europe running about a 10th of the level in the US.
However, amid an ongoing analysis of the impact of the change, one group which seems likely to benefit is Europe’s SMEs, which will attract more loans from ABS-related bank funding than from mortgage-focused covered bonds.
“If the ECB manages to create a bigger market for ABS, the impact will be to drive down borrowing costs,” says Berenberg’s Schulz.
“But this change is not a big gun – the most important impact of SME borrowing is the central bank’s outright monetary purchases [policy] and the work of public investment banks and European development banks, which are able to bypass the commercial banking sector.”
The German government, through state development bank KfW, recently lent the Spanish Development Bank €1 billion for lending to SMEs, says Schulz.
The SMEs that face the most acute funding problems are those based in Spain and Italy, which pay around 200 basis points more than their German counterparts, according to Berenberg estimates.
Part of the additional cost is justified by the impact of the poor economic climate, but banks in the periphery are also trying to de-risk their balance sheets by restricting credit to SMEs.
Policymakers in Frankfurt have recognized that if the ECB is to succeed in enforcing austerity in peripheral countries, it must be accompanied by private investment, and accepting ABS as funding collateral goes some way towards encouraging that.
However, it is not envisaged that the central bank will expand its balance sheet by buying ABS outright or trading on the secondary market.
“What the ECB is trying to do is to show its commitment,” says Schulz. “It wants to give the message to banks in these countries that ‘if you lend to SMEs we are with you, and we will do what we can to make sure it pays off’.”
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