ECB affects surprise that banks dump their junk on it

ECB Concern Over Liquidity Scheme

By Paul J. Davies, Norma Cohen, and Anousha
Financial Times, London
Thursday, May 15, 2008

http://www.ft.com/cms/s/0/8e338cc8-22ce-11dd-93a9-000077b07658.html

The European Central Bank on Thursday voiced its "high concern" at growing evidence that banks are exploiting its efforts to unblock the frozen funding markets by using its liquidity scheme to offload more risky assets than it envisaged.

Yves Mersch, a governing council member, said the ECB was now "looking very hard at whether there is not a specific deterioration of collateral" which the central bank is accepting in return for funds.

He was speaking amid signs of some banks creating low-rated assets specifically so they can be traded for treasuries at the European Central Bank.

Central banks have become important in providing funding for difficult to sell mortgages on what is intended to be a short-term basis while securitisation markets remain frozen.

The Bank of England recently created a facility for UK banks to access funding for mortgages and the Financial Times has learnt that almost L90 billion ($175 billion) worth of bonds are being created to be placed there -- almost twice the L50 billion in­itially expected when the scheme was launched only three weeks ago.

But the ECB, which is proud of having always had in place the same system to support bank liquidity, accepts a far broader range of collateral than other central banks. It now appears to have some worries about what is being used by banks.

On Thursday, however, speaking at the International Capital Market Association in Vienna, Mr Mersch said the type of collateral now being accepted was "a matter of high concern."

His comments come as banks, whose main centres of operations are not within the eurozone, are structuring new bonds based on assets other than mortgages in order to gain access to ECB funding.

The ECB's main mortgage-bond exposures so far are believed to be from Spanish, Dutch, and some UK deals, but the central bank publishes few details on the collateral it holds.

However, this week Glitnir, the Icelandic bank, is in the process of clearing the use of a E890 million ($1.37 billion) collateralised loan obligation (CLO) for funding at the ECB. Similarly, Lehman Brothers recently structured a E1.1 billion CLO, which it is expected to use for ECB funding.

Meanwhile, Macquarie Leasing, a unit of the Australian bank, has done a securitisation of Australian motor loans, which will have a euro-denominated slice so that the investors who buy the deal can use it at the ECB.

Investment bankers who work in securitisation say that their main business is structuring bonds that are eligible for ECB liquidity operations. Some analysts have concerns about whether the bonds being created will ever be saleable if markets recover.

"There is moral hazard ... and we are not in the business of taking over the market," Mr. Mersch said. "That means there must be an exit strategy."

The importance of central bank involvement in supporting securitisation markets has been shown again in the UK, where the Bank of England's Special Liquidity Scheme has already attracted almost twice the level of demand originally anticipated.

According to debt market sources, the banks planning to use the scheme are the UK's eight largest lenders.

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