When the European Central Bank (ECB) announced a dedicated purchase program for European asset-backed securities (ABSPP for short) in September 2014,
its aim was to revive Europe’s lackluster ABS market and spur both issuance and, ultimately, lending to the real economy. At PIMCO, we had always
argued that neither spread levels in core countries nor investor appetite were strangling securitized issuance – the issue is that banks have limited
funding needs and banks that need relief from capital requirements are not receiving it in the current regulatory and economic construct for
securitization. So one year since its announcement, is ABSPP worth the effort?
In our view, the answer is no. Funding for a European bank’s loan business can be sourced cheaper through other channels, such as covered bonds or
outright ECB funding, and buying mezzanine tranches that might result in capital relief for the selling bank is out of the scope of the ABSPP. In
addition, the ECB’s low risk appetite in ABS has guided its purchases primarily to select sectors in core countries, which in our view never really
needed help to begin with.
That said, we continue to believe that ABS and securitization are part of the longer-term solution to overcome Europe’s heavy reliance on banks as
primary credit channels; however, in the medium term, economics need to work for ABS to do its job.
The ABSPP construct
Beyond an initial program description, the ECB has treated most details about the ABSPP as confidential, particularly in respect to targeted sectors
and countries. The only regular information available to investors is the ECB’s publication of the weekly quantitative easing (QE) purchase volume,
which is released every Monday (see Figure 1).
As the ECB’s counterparties adhere to the ECB’s intended confidentiality, here is what we know (or assume to know):
- The Eurosystem (consists of the ECB and central banks of eurozone member states) has started to buy ABS through four dedicated asset managers, with
each manager responsible for buying bonds in an assigned sector/country. However, the ECB announced on 23 September that it plans to extend the
contract with only two of the four asset managers and to intensify direct ABS purchases via select local European central banks.
- For each purchase, these asset managers have to undergo an extensive research and approval process, with the ECB making the ultimate decision on
which bonds are eligible for ABSPP and at what price levels.
- ECB purchases are made in both the secondary and primary markets, where the participation rate – once a new issue deal has been approved – is roughly
between 25% and 30% on average.
- The ECB’s focus so far is on high quality senior tranches of auto and consumer ABS and prime residential mortgage-backed securities (RMBS) that could
match the criteria for “qualifying ABS” securities, which is a term currently in discussion to define a high quality standard for potentially better
- Since November 2014, the ECB has accumulated about €12.8 billion of ABS (as of 25 September 2015), which represents roughly one-tenth the size of the
ECB’s covered bond holdings under its third covered bond purchase program (CBPP3).
- A market segment of government-guaranteed mezzanine ABS that can theoretically be purchased from the ECB has not been successfully established so
What has the ECB’s ASBPP achieved to date?
The ECB’s intent to involve local central banks more deeply in its purchases of ABS does indicate a longer-term commitment to the ABS market; however,
the low volume of buying by the ECB relative to its covered bond purchases and to the total size of the European ABS market (see Figure 1) indicates
that there are no specific quantitative targets associated with its ABS purchases. The ECB has been extremely cautious in its ABS buying and has tried
to replicate its other QE purchase programs, such as CBPP3 and sovereign debt purchases, in its aim to target loss remoteness of purchased assets.
However, we believe ABSPP has been too selective in targeting specific sectors and countries only and fails both to support and to revive the market in
areas where it is most relevant, since neither the small and medium-sized enterprises (SME) collateralized loan obligations (CLO) market nor ABS
purchases from peripheral eurozone countries have been a focus. To date, ECB purchases have been concentrated in core eurozone countries such as
Germany, France and the Netherlands, especially in the auto ABS and prime RMBS sectors, which both needed the least support. Conversely, Portuguese and
Spanish RMBS have seen only two new deals in the primary market over the last 12 months. Figure 2 shows the divergence of sector spreads pre- and
One can argue that the ECB participation in Europe’s ABS market helps to address the negative stigma that was once associated with this asset class as
policymakers did not differentiate between the various parts of the ABS market, discrediting the whole universe as with the example of the U.S. subprime
market. As such, we see the ECB’s initiative as supportive in re-establishing ABS as an investable asset class in Europe and it also might lead to a more
favorable regulatory treatment. The ECB’s ABSPP can therefore be seen as marginally positive over the long term, but important add-ons are needed to
address the ultimate goal of creating a new transmission channel from lending to the real economy to capital markets.
Improving credit availability more broadly ought to be the ultimate goal
With funding for the aggregate European financial community arguably a diminished concern and addressed through other ECB policy tools, such as its
targeted longer-term refinancing operations and other monetary policy instruments, we think ABSPP should be refocused to more specific sectors, especially
in peripheral economies, where loan margins remain high and credit availability is scarce (see Figure 4).
With local banking institutions in peripheral jurisdictions still hampered by the financial crisis and facing the need to improve balance sheets through
capital raising and deleveraging, their willingness to take “credit” risk remains low. But the demand side of the equation seems to be improving, which
makes the argument even stronger for ABS to serve as a credit channel (see Figure 5).
If the ECB’s ultimate objective is to encourage lending to the broader economy and it truly wants securitization to reach its full potential, it would need
to take outright credit risk or subsidize structures via risk transfer for others to step in. We believe buying mezzanine tranches of ABS outright or
insuring subordinate parts of the capital structure would compress the risk premium significantly. If the ECB can create an environment for originators
with less execution risk to sell a significant part of the debt stack, which would achieve capital relief for them, the loan growth argument would start to
gain some momentum.
There have been other programs in the past, such as the U.S. Federal Reserve’s Term Asset-Backed Securities Loan Facility (TALF), the Bank of England’s
(BOE) Funding for Lending Scheme (FLS) and the U.K. Treasury’s Help to Buy: Mortgage Guarantee (HTB) scheme, through which policymakers facilitated similar
policies. The HTB scheme, for example, was an explicit mezzanine insurance program to compress risk premium and facilitate higher leverage to homeowners in
the U.K. In similar fashion, the ECB would have to increase its risk appetite to assume more credit risk and, if the current setup does not allow it, then
empower or create more institutions, such as the European Investment Fund (EIF), which are mandated to take first loss or subordinated risk.
We believe a supranational guarantee, which could enable balance sheet and capital relief to the lender and transfer the direct credit risk to the
guarantor, could also open up an effective lending channel to the real economy. The efforts started by the European Investment Bank and EIF, such as the
EIF’s Risk Sharing Instrument (RSI) to facilitate
SME lending initiatives, are steps in that direction, but the program would need a much broader scope and size of involvement by a supranational agency.
RSI, for instance, guarantees 50% of a loss on each new loan for a small fee and reduces the credit risk and capital charge to encourage lenders to extend
loans. Likewise, government agencies at the individual country level, for example Germany’s KfW Entwicklungsbank and Spain’s Fondo de Titulización de
Activos (commonly referred to as FTPYME), exist to support SME initiatives. Expanding their scope, however, would probably be necessary to increase
Securitization is a great instrument if used for funding and risk transfer (i.e., capital relief). Transparency and standardization facilitate risk
assessment by both investors and other market participants, which can lead to regulatory treatment that is on par with other capital market instruments. If
implemented correctly, we believe Europe’s ABS market could support the healing of the European economy by stimulating lending and credit availability,
especially in the periphery.