ECB Tightens Repo Criteria for Covered Bonds

Stricter rules for the eligibility of covered bonds used in the European Central Bank’s (ECB) repo facility are unlikely to significantly depress collateral postings, because the new ABS rule affect few issuers, according to Standard & Poor's and Bank of America Merrill Lynch.

The ECB announced on Nov. 28, that covered bonds with cover pools containing external ABS are no longer repo-eligible, eligible covered bonds must now also be compliant with the capital requirements directive (CRD), UCITS compliant or offer a comparable protection to the one under the CRD compliance criteria. The revised repo eligibility for covered bonds also includes a two-year grandfathering period, starting from Jan. 2013.

CRD-compliance requires eligible collateral must be EU public sector credits/guarantees; or non-EU public sector credits/guarantees must be rated at or greater than double-A minus. The UCITS 52(4)-compliance requires that the covered bond must be issued by a credit institution which has its registered office in an EU member state and the credit institution must be subject to special public supervision by virtue of legal provisions protecting the holders of the bonds. The UCITs directive also requires that the covered bond holders’ claims on the issuer must be fully secured by eligible assets until maturity; and the covered bond holders must have a preferential claim on a subset of the issuer’s assets in case of issuer default.

According to a Nov. 26 report from BofA Merrill, the changes will mainly impact non-European covered bonds and Spanish covered bonds, which are neither CRD nor UCITS compliant. French covered bonds non CRD-compliant.

Karlo Fuchs, analytical manager for S&P's covered bond ratings, said that the majority of covered the ECB holds is via the repo framework, where they get it as collateral.

The ECB set up a direct covered bonds purchase program. It ended its second covered bond purchasing program in October. The program, said Fuchs was underutilized, with less than the EUR 40 billion ($52.2bn) purchased. “When the first covered bond purchase program was around, banks needed the funding but nobody was giving it due to fears of market-to-market losses,” he said. “The ECB program provided a backstop for those fears and negative secondary price performance vanished and helped to revive the market.”

But the second program was launched in the same timeframe when the ECB offered its three-year long-term repo operation (LTRO) and  the Outright Monetary Transactions (OMT) program. Under the OMT, unveiled on Sept. 6 the ECB purchases the bonds of countries like Spain if they apply for a European Union bailout.  “Banks have liquidity and they rather take the LTRO than the comparatively more expensive covered bond funding,” said Fuchs.