Tuesday, February 23, 2010

ECB to start lending covered bonds?

Original posted in FT Alphaville by Izabella Kaminska:

Here’s an interesting story from this week’s issue of The Cover, a trade publication focused on the covered bond market.

According to the weekly title, the European Central Bank may soon begin lending out the covered bonds it purchased under its €60bn programme to help secondary market liquidity.

The Cover article says that the industry is particularly keen on this because, while the ECB’s programme may have helped kick start issuance in the primary market, it didn’t necessarily improve secondary market activity at all. In fact, according to the author of the report, it may even have hampered liquidity.

The problem being that a general lack of bonds in the market was heightened by the ECB purchases. Without supply freely available, market makers became reluctant to go short. Bid-offer spreads inevitably widened, and liquidity suffered more.

Dealers made their feelings known in a letter to the director general of market operations at the ECB Francesco Papadia, dispatched via the AFME/European Covered Bond Dealers Association (ECBDA) back in October.

As The Cover highlights, here’s how they suggested at the time that lending of purchased bonds by the ECB could alleviate the situation (our emphasis):

The ECB and the NCBs “buy-and-hold” strategy has taken an enormous amount of Covered Bonds out of circulation. Covered Bonds are also being posted as collateral with the ECB in enormous quantities. The ECB and NCBs opening up and lending out purchased bonds would help to alleviate the situation on the repo side which could lead to more mixed flows and therefore improvements in liquidity.

Which sounds to us like much of the new supply the ECB’s purchase programme generated simply went straight for use to the ECB’s liquidity window.

In that case it’s probably worth remembering what’s been happening to respective country bond-spreads since then. Because as the dealers themselves noted back in October:

October has proven to be much slower in terms of new issuance and some recent deals may have struggled with oversupply in the market. Dealers also witnessed certain new issues particularly from Spanish
jurisdictions now trading wider in the secondary market.

Which perhaps sheds some light on the following statement from the ECB’s head of market operation analysis Michel Stubbe back on February 17?

As Reuters reported:

While issuance resumed quite well after the ECB announced last summer it would buy 60 billion euros ($82 billion) worth of covered bonds, the central bank sees possible trouble ahead in the sector, the ECB’s head of market operations analysis division told an IFR covered bond conference. “We are not so sure everything is going better,” Michel Stubbe said. “Further homework is needed in order to maintain the momentum.”

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