A Small Step to Unlock Credit for the Club Med

This month the European Central Bank will start to buy euro-denominated asset-backed securities (ABS) and covered bonds in an effort to revive a market that has been sharply impaired since the financial crisis. The move, which aims to boost the credit available to the economy mainly in those countries where banks are busy buying public debt, has been criticized by Germany and France, which see this new thing as the latest attempt by the ECB’s boss, Mario Draghi, to help his fellow Southern Europeans.

ABSs are financial securities that take revenues from loans, leases or credit card debts and bundle them up for sale to investors. Data from the Association for Financial Markets in Europe show that in the first six months of 2014 a total of 114.3 billion euros ($127 billion) in securities were issued, a hefty 30% increase over the same period in 2013 (about 87 billion euros or $109 billion) but still a fraction of the 512.7 billion euros ($642 billion) of ABSs issued in the US in the same period and much less than what was issued in Europe in 2008 (818.6 billion euros or $1 trillion) when the market hit its peak. Although provisional, these figures show a market that has yet to recover from the financial crisis–when some of these securities spread toxic subprime mortgages across investors and markets–and one that may greatly benefit from ECB support.

“This is the ECB trying the next thing,” said Gordon Kerr, who runs structured-finance research for Europe at DBRS, a rating agency. “They have been accepting the ABS collateral in repurchase agreements for the last seven years and now they are trying to restart the real economy funding source. The difficulty there is how banks will behave and whether they still need to raise capital or they are able to transmit the ECB credit to the real economy.” Created in 1976, and originally called Dominion Bond Rating Service, DBRS is the fourth largest rating agency in the world.

Securitization, used by banks as a funding tool to transfer risky assets off their balance sheets, can become a way to create room for credits for small and medium-size companies.

At present, the ECB will buy only highly rated securities–the most senior ones. If member states agree to provide credit guarantees on the ABSs, as the ECB has asked for,  it would also be able to buy more junior debt. In principle this will help expand the breadth and size of the ABS markets, but it faces opposition from Germany and France.

“There are concerns that these warranties will become a support for something, such as the ABS market, that in their view contributed to the financial crisis. Since the financial crisis there have been bad feelings toward the securitizations,” Kerr said.

But there is also a political issue. “The larger countries see this as an asymmetric decision in favor of the Club Med, mainly Italy,’’ noted Carlo Favero, a finance professor at Bocconi University in Milan.