Part of the ECB’s strategy to help ease banks off the supply of emergency liquidity — as announced on Friday — includes toughening up the criteria on collateral being pledged for its repo transactions.
As the bank stated, the ECB will only accept securities rated by at least two different providers from March 2010 onwards:
The Eurosystem will require at least two ratings from an accepted external credit assessment institution for all ABSs issued as of 1 March 2010. In determining the eligibility of these ABSs, the Eurosystem will apply the “second-best” rule, meaning that not only the best, but also the second-best available rating must comply with the minimum threshold applicable to ABSs (see the press release of 20 January 2009). As of 1 March 2011, the second-best rule and the requirement to have at least two ratings will be applied to all ABSs, regardless of their date of issue.
So what’s going on here?
First, as Barclays Capital analyst Reto Bachmann noted on Monday, it seems probable the ECB is implementing the directive to prevent so-called “rating shopping” and “methodology targeting” by issuer banks. But then ABS investors have long been aware of such practices, meaning they themselves have nearly always insisted European ABS bonds are rated by at least two agencies in any case.
For those bonds that do not already fulfill the criteria, it is unlikely the ECB’s changes will prove overly challenging for issuers or banks , says Bachmann. The window to meet the deadline, for example, is fairly accommodating (our emphasis):
For deals that arrangers are currently working on, two alternatives present themselves: either issue the bonds before 1 March 2010 with a single rating or issue them thereafter with two ratings. In the latter case, arrangers would have over three months to secure a second rating for their structure, something that would seem to be eminently feasible, even though it would result in a slight increase in costs, as rating fees would have to be paid to a second agency. As presumably intended by the ECB, it may also result in a slightly less “funding-efficient” structures, but we would not expect the effect to be substantial in the majority of cases.
Things do get a little trickier when it comes to outstanding deals, many of which feature structures designed and fixed specifically to suit one methodology or the other.
However, these are unlikely to be large in number, according to Bachmann, and only a few are likely to become ineligible. What’s more, the deadline here is an even more accommodating 15 months away.
In which case you might wonder what the ECB is actually trying to achieve with this ratings rule? Bachmann offers the following interpretation:
… the ECB’s press release apparently has a further objective: it seems to want to align the rating requirements it imposes with those investors have insisted on for years in order to nudge originators further in the direction of relying on public issuance for funding, rather than on retained issuance repo’ed with the ECB.
We are not optimistic that this will have much an effect for now: the cost of funding in the European ABS, including RMBS, market may simply be prohibitive. Instead of placing bonds with the European ABS investor base, originating banks may either elect to fund in other asset classes or simply shrink their loan book, with the latter clearly not conducive to an economic recovery in Europe.
In fact, with regard to this wider objective, the ECB’s stricter criteria may well have the opposite of the desired effect: the fact that ABS is being singled out for this stricter eligibility requirement will do little to restore investor confidence in the asset class, and the fact that ABS eligibility criteria are being tightened further only plays into the widespread worries that the ECB will eventually make a mistake and force many repo’ed ABS bonds out of its facility and onto the secondary market.
The announcement is also likely to fuel the equally widespread fears of further regulatory crackdowns on the asset class. All of this is bound to reduce investor appetite for ABS, making a primary market recovery less, not more, likely. Then again, it is difficult to see how the ECB could diffuse such fears while simultaneously tightening its eligibility criteria (indeed, as so many other market commentators, we expect the ECB to continue with its apparent plans to tighten ABS eligibility criteria slowly and carefully for the time being).
In short, it might all end up being more trouble than it’s worth.
Related links:
Trichet on the ECB’s rubbish assets - FT Alphaville
The return of widening sovereign credit spreads - FT Alphaville
Does the ECB/Eurosystem have enough capital? - Maverecon