The good news for the European Central Bank is that the volume of ABS paper European banks will be repoing with it in 2009 will fall. The bad news is that this is not because of its revised and supposedly tighter collateral rules that are due to come into effect in February. It is for a far more straightforward reason banks are running out of assets to repo. There will be an easing in the use of the ECBs repo scheme in 2009 as banks are starting to exhaust their available collateral, says a European RMBS expert. And the worrying corollary of this is that they will likely do all that they can to squeeze more challenging assets into the scheme, hoping that the ECB will accept collateral that traditional ABS investors have rejected.
People are now looking at other, less obvious asset classes for repo trades, confirms the global head of structured finance at a London-based bank. It would be easier to get such assets past the ECB than it would to get it past other ABS investors. This is because as long as a deal adheres to the collateral rules it should be accepted.
The ECB perhaps has less flexibility in the portfolio profiles it accepts as repo collateral than other investors do, says Stuart Jennings, European structured finance risk officer at Fitch Ratings in London. We are therefore seeing more complex collateral such as development loans, loans to high-net-worth individuals with borrower optionality or loans for second homes being included in trades. Fitch itself has suggested that the risks involved with such collateral may not be compatible with a triple-A level of credit risk, but repoed deals can be structured down to the single-A level and only require one rating.
The ever-present question of just how the enormous volume of ABS paper now sitting with the ECB will be unwound will become additionally vexing if it grows to include assets that ABS buyers would not have looked at even in the good times. Experts believe that there is a total of 1 trillion assets that could be repoed under the ECB scheme and a lot of banks do still have collateral that they havent repoed yet. But the boundaries may be pushed by those that do not.
In a recent interview with Euromoney magazine, ECB president Jean-Claude Trichet explained that the bank always has an exit strategy in our minds in terms of managing down its balance sheet. But if that strategy involves selling securities back to the market when buyers return it is imperative that the central bank does not make this job harder than it already will be by accepting collateral that will be very difficult to shift later. The first question that investors will ask if and when the ECB begins to unwind its positions is have these deals been correctly structured with the right rating and the right collateral?, warns the global ABS head. If they have not then no one will buy them.