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Draghi asset-backed bond stimulus seen choked by red tape

‘The ECB takes every possible measure to make sure that purchases are done prudently’.

Mario Draghi’s plan to stimulate Europe’s economy by buying asset-backed securities is underwhelming investors, with purchases bogged down by bureaucracy and paperwork.

Since the European Central Bank president started the program seven weeks ago, 1.8 billion euros ($2.1 billion) of debt has been acquired. At this pace it will take eight years to reach even one tenth of his 1 trillion-euro target for balance sheet expansion.

The reason for the slow progress is that it takes as long as five days for ECB officials to approve purchases and asset managers hired to buy the debt are required to compile lengthy documents detailing the investment case for each bond. It’s fueling speculation Draghi will initiate a quantitative easing program buying government bonds when the bank’s Governing Council meets on Thursday in Frankfurt.

“The lengthy and drawn-out approval process has made the purchase program slower and much less effective than it could be,” said Tracy Chen, a Philadelphia-based money manager at Brandywine Global Investment Management, which oversees $60 billion of assets, including European ABS. (LMAMX) “The lack of aggression is disappointing.”

ABS Revival

Draghi targeted asset-backed debt because he said it would stimulate Europe’s economy by allowing banks to transfer risk to investors and encourage lenders to offer more credit to companies.

“The ECB takes every possible measure to make sure that purchases are done prudently, to minimize risks and to avoid crowding out investors,” according to a statement from the ECB. “Certainly at the start of such a program quality comes before quantity.”

The ABS market has shrunk more than 40 percent since 2010 as regulators cracked down on the debt they blamed for deepening the financial crisis. While sales of 81 billion euros last year were up from 74 billion euros in 2013, they remain far short of a market peak of 524 billion euros in 2006, according to data compiled by JPMorgan Chase & Co.

In anticipation of the ECB buying up swathes of the market, the average extra yield investors demand to hold ABS compared with benchmark rates fell to a seven-year low of 70 basis points in October, according to Barclays Plc. The spread has since widened to 77 basis points.

“Draghi gave no specific target for ABS purchases but he raised expectations with his continued positive comments,” said Steven Harrison, a London-based money manager at Cairn Capital Ltd., which oversees more than $14.2 billion. “Many people in the market believed we would see large scale purchases, but that hasn’t materialised.”

Bond Returns

The ECB is no stranger to the ABS market, holding about 300 billion euros of the securities as collateral for loans to European banks. Even so, it has shown caution in making direct purchases of the debt and has submitted conservative bids, said Ope Agbaje, a securitized products analyst at Neuberger Berman Group LLC, who said it’s too early to write off the purchase plan.

“The ABS program has been slow to take off, but it’s too soon to be too negative,” said London-based Agbaje. “We need the ECB to be more aggressive, so far it has been a price taker rather than a price maker.”

The slow pace is a sharp contrast to a similar program for covered bonds it started a month earlier. The bank has acquired 31 billion euros of covered notes, an average of 2.6 billion euros a week compared with 256 million euros for ABS.

Quantitative Easing

After weeks of argument about quantitative easing in speeches and interviews, officials have just a few days left before their Jan. 22 policy meeting. Its staff presented policy makers last week with models for buying as much as 500 billion euros of investment-grade assets, mostly sovereign bonds, according to a person who attended a meeting of the Governing Council.

That could further stunt the effectiveness of the asset-backed debt program, according to Srikanth Sankaran, head of European credit and ABS strategy at Morgan Stanley in London.

“Broad-based QE would likely be supportive for risk assets, but the risk for ABS is that given the lower pace of purchases, when another asset class is added in size, ABS may no longer be in spotlight,” said Sankaran, “This may delay a revival in primary ABS activity which is needed because it can have a more direct and targeted impact on bank lending and the real economy than QE.”

New Issues

Reigniting the new-issue market, which has declined to less than a quarter of its pre-financial crisis peak, is required for Draghi to achieve his goal of using ABS to help free up banks to lend. The ECB has bought Dutch, Italian and Portuguese ABS since starting its program on Nov. 21, according to Brandywine’s Chen. It purchased 48 million euros of the securities last week after a pause over the holiday period.

“It was always going to take time for the buying process to be refined between the asset managers and the ECB,” said Dipesh Mehta, a director of securitization research at Barclays in London. “Some investors are likely to have been underwhelmed with the numbers to date, but launching a purchase program in December when the market is much quieter was always going to be difficult.”

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