Analysis - Banks to profit as investors eye assets leaving ECB
By Sinead Cruise and Laura Noonan | February 23, 2013 12:00 AM EST
Asset-backed bonds, banished to the vaults of the European Central Bank (ECB) in return for emergency cash, are back on investor wish-lists, giving banks a fresh shot at profits that could spur lending to the real economy.
Banks used to make billions of dollars from selling these special bonds - typically secured against slices of European mortgages, car loans and credit card debt - but the 2007 credit crisis slashed their values, killing off demand.
With few buyers, banks rushed to post these unloved assets as collateral at the ECB in exchange for cash at the peak of the financial crisis in 2008 and more recently in its 2012 longer-term refinancing operations (LTRO).
But those banks that feel strong enough to repay the ECB and take back asset-backed securities (ABS) and similar collateral may be handsomely rewarded by money managers crying out for secure income in a world of rock-bottom sovereign bond yields and uncertain stock markets.
"There is certainly sufficient demand to absorb whatever reasonable supply might come along after LTRO," Edward Panek, head of securitisation at Henderson Global Investors, said.
"It is becoming an easier sell because we're starting to see clear water between the worst of the crisis and where we are right now."
Once liquidity returns, banks will feel more comfortable about slicing up loans into new securities, feeding them to the market and using the proceeds to make new loans, alleviating a dearth of lending that has bedevilled consumers and companies.
"We are seeing more private deals being struck on transactions that were done for ECB liquidity - we've been reversing those deals into the market," said Jim Ahern, global head of securitisation at Societe Generale.
"ABS are becoming an increasingly important capital markets funding tool for the real economy, particularly in Europe."
In the meantime, regulatory efforts to tackle some of the root causes of the 2007 collapse, such as weak credit analysis and poor transparency, are slaking fears about these assets and the way banks create and sell them.
While German bunds, British gilts and U.S. Treasuries are offering paltry returns, AAA-rated UK and Dutch five-year bonds backed by residential mortgages (RMBS) offer respective spreads of 60 and 90 basis points over London's interbank offer rate (Libor) and its Euro equivalent, Euribor.
"You can get 5-6 percent internal rates of return on investment-grade commercial mortgage-backed securities. That's a great deal compared with the other options out there," said Patrick Janssen, head of ABS at M&G Investments.
Investors seeking higher income are even mulling ABS from countries worst hit by the euro zone crisis, as economies show signs of stability after months of tough austerity measures.
Spreads on AAA-rated five and six-year Spanish RMBS bonds have tightened to Euribor plus 350 basis points (bps) from 640 bps in December 2011, JP Morgan data shows. That trumps the 3.8 percent yield on Spanish five-year government debt.
Italian and Irish RMBS are trading at about 270 and 380 bps, against December 2011 spreads of 600 and 1,600 bps respectively.
ECB data shows that banks had parked 352.7 billion euros worth of ABS in its vaults by end-2012, after the scramble for cash from two LTRO operations in January and February last year.
To make sure this collateral was worth at least as much as the cash lent against it, the ECB demanded markdowns on ABS values, known as haircuts, ranging between 16 and 32 percent.
Now, thanks to the revival of interest in these bonds, banks that can afford to repay the ECB loans are broadly getting back collateral valued far more highly today than when it was posted.
Banks have repaid 150 billion euros of the 489 billion euros borrowed in January 2012. On Friday, 356 banks announced they would repay 61.1 billion euros of the 530 billion euros they drew from the second LTRO in February 2012.
"The reason to offload would be that some of the bonds have rallied ... you get rid of the bonds and you post some gain to the profit-and-loss account," said a capital markets executive at one of the banks that has taken advantage of LTRO money.
Banks have already chalked up profits on their trading books by marking their ABS to the new market prices, but real sales would allow them to turn a paper gain into real cash.
Specialist credit investors and distressed-debt funds have been buying ABS for several years to take advantage of the low prices, but more conservative buyers who had their fingers burned in the credit crisis are returning, too.
It is hard to estimate how much money could be funnelled into the market from these types of funds, but against such low sovereign bond yields, the ABS revival is certainly grabbing attention, fund managers say.
"We have credit and rates funds that ... don't want to use a cash fund or super-short government bonds as it yields them nothing, so they choose to buy this paper," said Christian Holder, a director in the fixed income team at BlackRock.
"If you are not a leveraged investor, this asset class has delivered you a nice return. You have all your money back."
(Additional reporting by Owen Sanderson; Editing by David Goodman)