European Central Bank considers cheaper loans

London: The European Central Bank is looking at ways to make it cheaper for financial institutions to borrow against about 1 trillion euros (Dh4.6 trillion) of asset-backed bonds, three people familiar with the matter said.

The ECB is considering lowering the discounts it applies to asset-backed securities when taking them in as collateral for loans, said the people, who asked not to be named because the talks are at an early stage. Bonds that have better weathered the financial crisis would be given a lower so-called haircut than others, meaning banks would be able to borrow more.

“It doesn’t make sense to apply the same haircut to a two-year bond backed by auto loans in Germany as a mortgage-backed security from a peripheral country,” said Christopher Schumann, the head of ABS trading at DZ Bank AG in Frankfurt.

The proposal would help lenders at a time when they’re under pressure from more stringent capital rules as well as German objections to the ECB’s plan to buy government bonds, most of which are held by banks. The continent’s financial institutions have mainly used asset-backed securities as a way to build their reserves for central bank funding, according to the Association for Financial Markets in Europe.

An official at the ECB in Frankfurt declined to comment on the proposed plan.

Liquidity rules

The ECB is also pushing global banking regulators to relax draft liquidity rules so that lenders can use some asset-backed securities and loan debt in a buffer they must hold against a possible credit squeeze, according to three people familiar with those talks.

The ECB, backed by the Bank of France, considers a draft version of the liquidity coverage ratio, or LCR, as a potential obstacle to efforts to combat the euro-area debt crisis by curtailing lending and making it harder for central banks to implement their monetary policies, said the people, who couldn’t be identified because the discussions at the Basel Committee on Banking Supervision are private. They said the ECB is opposed by some other Basel members, including US regulators.

“As central banks have relaxed their rules” during the euro region’s debt crisis, “the LCR has become more and more out of sync with central-bank reality,” said Jesper Berg, senior vice president at Nykredit A/S, Denmark’s biggest mortgage bank.

Collective shortfall

The 212 largest global banks would have had a collective shortfall of 1.76 trillion euros at June 2011 in the assets needed to meet the LCR, figures published by the Basel committee show. The ratio is scheduled to take effect in 2015.

The ECB applies two levels of discount to ABS issues posted as collateral, skimming it off the amount it lends to banks.

The haircut is 16 per cent for bonds rated by two firms at the equivalent of at least A-, Standard & Poor’s seventh-highest investment-grade rank. If the debt has one A- rating and one lower grade, down to as low as BBB-, then a 26 per cent to 32 per cent discount applies. The discounts compare with 0.5 per cent to 13.5 per cent for investment-grade government debt.

The ECB’s plan recognises the strong performance of European asset-backed bonds in the financial crisis, the people familiar with the proposal said. Another reason for the policy, they said, is that from December the ECB will require banks to supply more detailed information on assets underpinning some ABS, improving disclosure on the quality of the collateral it takes on.

Shrinking spreads

A combination of low defaults, strong appetite from investors seeking assets perceived to be a haven and few sales combined to send relative yields on the most popular European ABS, those pooling prime UK home loans, to the lowest in more 4 1/2 years on Monday, according to JPMorgan Chase & Co.

The extra yield investors demand to hold five-year UK residential mortgage-backed securities narrowed to 95 basis points more than the euro interbank offered rate, the least since February 2008 and down from 100 basis points a week earlier, JPMorgan data show.

The accumulated default rate for European ABS since 2007 is 1.02 per cent, compared with 13.8 per cent for deals that pool US assets, S&P said in a June 29 report.

There were 981 billion euros of ABS eligible for central bank loans at the end of 2011, according to the ECB. About 351 billion euros had been used to obtain funding, making it the second most-popular type asset used for collateral after corporate and other loans.

Declining sales

European asset-backed bond sales fell to 43.4 billion euros this year through August 27, from 50.7 billion euros in the same period of 2011 and compared with a record 509 billion euros in all of 2006, JPMorgan data show.

Elsewhere in credit markets, Southern Copper Corp plans to issue its first bonds since 2010. Hertz Global Holdings Inc. is said to be planning a sale of about $1.45 billion in bonds and as borrow much as $500 million in loans to finance its $2.6 billion purchase of Dollar Thrifty Automotive Group Inc. JPMorgan analysts said collateralised loan obligation sales this year may exceed their forecast of $30 billion.

The US two-year interest-rate swap spread, a measure of debt market stress, narrowed for the fourth day, declining 0.15 basis point to 17.90 basis points, the lowest level since May 2011. The measure decreases when investors favour assets such as corporate bonds and widens when they seek the perceived safety of government securities.

Credit swaps

The Markit CDX North America Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, fell for a second day, declining 0.72 basis point to a mid-price of 100.3 basis points, according to prices compiled by Bloomberg.

Credit swaps typically fall as investor confidence improves and rise as it deteriorates. The contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Southern Copper, the largest producer of the metal in Peru and Mexico, may sell 10- and 30-year debentures next week, according to a person with knowledge of the transaction, who asked not to be identified because terms aren’t set.

The miner last sold debt in April 2010, issuing $1.5 billion in a similar two-part offering, according to data compiled by Bloomberg. The company issued $400 million of 5.375 per cent, 10-year notes to yield 162.5 basis points more than similar-maturity Treasuries and $1.1 billion of 6.75 per cent, 30-year bonds at a relative yield of 212.5 basis points, Bloomberg data show.

Hertz funding

Hertz has obtained a $1.95 billion bridge financing commitment from Barclays Plc, Bank of America Corp. and Deutsche Bank AG, the company said in a regulatory filing. The loan and the bond sale will replace the bridge debt once the acquisition has obtained regulatory approval, according to a person with knowledge of the transaction, who asked not to be identified because the terms are private.

The loan may add to Park Ridge, New Jersey-based Hertz’s $1.4 billion debt due March 2018, said the person. The piece pays interest at 2.75 percentage points more than the London interbank offered rate and will have 1 percent floor, Bloomberg data show.

The S&P/LSTA US Leveraged Loan 100 index rose to the highest level since May 2011, adding 0.06 cent to 95.19 cents on the dollar. The measure, which tracks the 100 largest dollar- denominated first-lien leveraged loans, has climbed from 91.8 on June 5, the lowest since January 6.

CLO Sales

Two CLOs, which invest in loans backing leveraged buyouts, were sold last week, bringing this year’s total to $24 billion, according to a JPMorgan report from August 24. Blackrock Inc and Goldentree Asset Management LP raised $416 million and $590 million, respectively.

“The pace of CLO issuance looks set to meet or exceed our” projection for $30 billion, JPMorgan analysts led by Rishad Ahluwalia wrote. A total $12.9 billion of the funds were raised last year, down from a record $104.7 billion in 2007, according to Wells Fargo & Co.

Leveraged loans and high-yield, high-risk, or junk, bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at S&P. CLOs are a type of collateralised debt obligation that pool high-yield, high-risk loans and slice them into securities of varying risk and return.

In emerging markets, relative yields widened 2 basis points to 319 basis points, or 3.19 percentage points, according to JPMorgan’s EMBI Global index. The measure has averaged 369 basis points this year.

Bonds of Caracas-based Petroleos de Venezuela SA, or PDVSA, were the most actively traded dollar-denominated corporate securities by dealers yesterday, with 72 trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.