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Where will they find the bonds

22 September 2014
Richard Kemmish

Two weeks on from the announcement of the ECB’s covered bond and ABS purchase programme we are still none the wiser. But it is interesting to look at some of the breathless reactions of the covered bond community.

‘Insane’ was a word used by some analysts, which personally I thought was a bit strong. It would have been insane if the ECB had said that they would be out in the primary and secondary market trying to buy €500bn (or at least the covered bond markets share of that amount).  Clearly this is impossible given that the programme size is thirty times bigger than what they actually managed to buy in primary and secondary last time around and that conditions in the market have tightened since then.

But they didn’t say that. We as a market inferred it given the absence in the announcement of any detail about where they were going to find the bonds. Sadly we won’t get any more detail before we all head off to Vienna for the Euromoney conference.

But if you want to find €500bn of covered bonds, ironically the best place to look would be the vaults of the ECB. Their balance sheet contains covered bonds as a result of the purchase programme, as an own investment and most of all as collateral from eurosystem banks, both for long term operations and their more old fashioned monetary policy instruments.

Is it possible that part of the ECB’s intention is to ‘term out’ the covered bond holdings that they already have? “Stop funding yourself with covered bond repos, issue them into the market and I promise to buy loads of them myself”.

If they do this it is a sign of enormous confidence in the product - when it’s a repo it gets marked to market. If the value isn’t enough the ECB, like Oliver Twist, can always ask for more. If the ECB holds it outright they are more directly long the risk, both credit and mark to market.

And, it would imply a vast increase in primary activity. The ECB might be happy to be the biggest investor in any given bond but would not want to be the only one, they presumably want secondary market liquidity as much as the next investor. In addition we know that they would be uncomfortable setting the price. Better to let the market decide the price and try not to distort relative value too much with a €200mn order. 

We all know that there is a vast shortage of covered bonds (I think we underestimate the size of the problem, a theme I will return to), perhaps a recycling of much of that repo collateral into the market could help to alleviate this?  It would certainly cheer everyone up in the covered bond community. Think of those fees.

Pity the ECB couldn’t have shared the details of the programme before we pack our bags for Vienna. But at least it gives us something to speculate about.

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