Your SlideShare is downloading. ×
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
The Covered Bond Report Issue 2
Upcoming SlideShare
Loading in...5
×

Thanks for flagging this SlideShare!

Oops! An error has occurred.

×
Saving this for later? Get the SlideShare app to save on your phone or tablet. Read anywhere, anytime – even offline.
Text the download link to your phone
Standard text messaging rates apply

The Covered Bond Report Issue 2

1,541

Published on

The May issue of The Covered Bond Report. Visit www.coveredbondreport.com to register for news, analysis and data.

The May issue of The Covered Bond Report. Visit www.coveredbondreport.com to register for news, analysis and data.

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total Views
1,541
On Slideshare
0
From Embeds
0
Number of Embeds
1
Actions
Shares
0
Downloads
16
Comments
0
Likes
0
Embeds 0
No embeds

Report content
Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
No notes for slide

Transcript

  • 1. The CoveredTHE COVERED BOND REPORT Bond Report www.coveredbondreport.com May 2011MAY 2011WWW.COVEREDBONDREPORT.COMNUMBER 2 Measuring up? Labels and limits in quest for covered bond ideal CBIC Small banks Asia Takes transparency lead Weighing pros and cons Playing it, Safe?
  • 2. An equation that always works. Even in troubled times, thePfandbrief is an especially sound investment with a tried and tested market infrastructure.In Germany and abroad, investors appreciate its first-class quality and the yield pick-up.Attributes it owes to the stringent German Pfandbrief Act and a strong interest group thatensures the Pfandbrief stays the benchmark on the Covered Bond market.For more information, go to: www.pfandbrief.org simply pfandbrief simply goodAareal Bank + BayernLB + Berlin Hyp + Bremer Landesbank + Commer zbank + CORE ALCREDIT BANK + DekaBank + Deut sche Apotheker- und Är ztebank +Deut sche Hypo + Deut sche P fandbriefbank + Deut sche Schif fsbank + Dexia Kommunalbank + DG HYP + DKB + Düsseldor fer Hypothekenbank + DVB Bank +Eurohypo + Hamburger Sparkasse + Helaba Landesbank Hessen-Thüringen + HSH Nordbank + IKB Deut sche Industriebank + Kreissparkasse Köln +LBB Landesbank Berlin + LBBW + Münchener Hyp + NORD/LB + Postbank + SaarLB + Santander Consumer Bank + SEB + Sparkasse KölnBonn + UniCredit Bank +VALOVIS BANK + WarburgHyp + Westdeut sche ImmobilienBank + WestLB + WL BANK + Wüstenrot Bank = ASSOCIATION OF GERMAN PFANDBRIEF BANKS
  • 3. The CoveredBond Report CONTENTS32 Cover Story LABELS & LIMITS 32 The measure of an asset class As covered bonds become an increasingly important pillar of the new global financial architecture, the need to define and delineate the asset class increases. A labelling initiative has been embarked upon to this end. But can the needs of regulators and investors be squared with those of issuers? By Neil Day5 FROM THE EDITOR 3 First things first MONITOR 4 Legislation & regulation 14 Market 17 Ratings Q&A: DEXIA 20 Dexia rebuilds for a brighter future Gone are the days when Dexia sat atop the covered bond market. Its recent history has ensured that it now trades at the wide end of the French sector. However, the funding team is confident it can convince investors that the credit deserves better and a Eu1bn five year20 Dexia Municipal Agency benchmark on 11 May produced encouraging results. Neil Day spoke to the team about the challenges they face. May 2011 The Covered Bond Report 1
  • 4. The CoveredCONTENTS Bond Report24 SUB-JUMBOS: 24 Jumbos: lowering the bar Growing acceptance of benchmarks being less than Eu1bn carries advantages for issuers old and new, and the leading index provider is being lobbied to follow the trend. But could this lowering of the bar result in the loss of privileged status for jumbos at the European Central Bank? By Maiya Keidan ANALYSE THIS: COVERED VERSUS SENIOR 29 Bail-in fears unheeded Bail-in fears are said to have driven investors from senior unsecured into covered bonds, but, according to Deutsche Bank head of covered bond research Bernd Volk, spreads for some jurisdictions fail to reflect this.40 ASIAN DEMAND: IN TRANSIT 40 Specially packed for Safe & Co. Covered bond issuers have long sought to sell their wares to increasingly wealthy Asian investors. But although the identities and behaviour of the biggest Asian players are, in the words of one banker, the bond market’s “worst kept secret”, the extent to which they want to buy covered bonds is unclear. Recent successes have nevertheless suggested attitudes could be changing. By Neil Day SMALL BANKS: REASONS TO BE FEARFUL? 44 Small banks size up pros and cons Some small financial institutions in countries exploring covered bonds for the first time have expressed concerns about being put at a disadvantage. But while bigger banks may have natural advantages in the asset class, mature jurisdictions suggest that these can be overcome or need not be a concern. By Neil Day44 FULL DISCLOSURE 48 Stockholm & Paris2 The Covered Bond Report May 2011
  • 5. FROM THE EDITORFirst things first W alk before trying to run. The wisdom quoted by Washington consultant Bert Ely, with regard to the development of a US cov- ered bond market, is advice that appears to have been taken on board by the covered bond market and those who regu- late and support it lately — albeit after they had already set off at quite a trot. While covered bonds have been put centre stage in the laws and regulations of a rebuilt global financial system, rules governing just what they need to do to qualify for this leading role differ from country to country. The labelling initiative being undertaken by the Eu- ropean Covered Bond Council with the support of the European Central Bank is not new, but has taken on renewed importance given the prominent role covered The Covered bonds are being given under Basel III, Solvency II and a variety of other regulatory overhauls. A push for greater Bond Report transparency from the Covered Bond Investor Council has only given the initiative further momentum. www.coveredbondreport.com Coming up with a template for what a covered bond is — or at least, one that deserves preferential treatment — would be hard enough even without having to take Editorial Managing Editor Neil Day into account the varied structures that have already been +44 20 7415 7185 developed. The Basel Committee on Banking Supervi- nday@coveredbondreport.com sion faced a similar challenge in coming up with a glo- Reporter Maiya Keidan bal compromise that somehow balanced local differences mkeidan@coveredbondreport.com across a range of areas — and even after its December framework was announced the debate over implementa- Design & Production tion still rages. Creative Director: Garrett Fallon Senior Designer: Sheldon Pink But however difficult it might be — and whether the differences are down to natural national idiosyncrasies or Printing vested interests — a way of delineating the varied struc- Wyndeham Grange Ltd tures and legislations in the covered bond market will have to be found, even if it risks alienating some quarters Advertising Sales of the market. ads@coveredbondreport.com Neil Day, Managing Editor Subscriber Services subs@coveredbondreport.com The Covered Bond Report www.coveredbondreport.com May 2011 Editorial editorial@coveredbondreport.com The Covered Bond Report is a Newtype Media publication Measuring up? 25, Finsbury Business Centre Labels and limits in quest for covered bond ideal 40 Bowling Green Lane London EC1R 0NE +44 20 7415 7185 CBIC Small banks Asia Takes transparency lead Weighing pros and cons Playing it, Safe? May 2011 The Covered Bond Report 3
  • 6. MONITOR: LEGISLATION & REGULATIONLegislation & RegulationLEGISLATIONCanada launches consultation after re-electionA consultation paper released by Canada’sDepartment of Finance on 11 May wasgreeted with enthusiasm by Canadianmarket participants, who said that it wasa positive outcome after several months oftalks with the government about the de-velopment of a covered bond framework. The consultation comes after the govern-ment committed to introducing legislationin its March 2010 budget. Canada’s Con- Finance Minister Jim Flaherty:servative government was re-elected earlier Plans announced in March 2010 budgetin a general election earlier this month. “It’s very positive and a welcome devel-opment for any Canadian covered bond “Canada’s adoption of a legislativeissuer,” said a funding official at a Canadi- framework should cover? Does the pro- framework for covered bonds will be aan bank. “This is something we have been posed framework strike the appropriate welcome development for issuers and in-working through with the Department of balance between the interests of cov- vestors alike,” he said. “Strengthening andFinance for several months. ered bondholders and other creditors of clarifying investor rights in covered assets “The next step is legislation, which we banks, both secured and unsecured? upon an issuer’s insolvency should bringbelieve should give Canadians a more lev- Canada’s position into line with otherel playing field in Europe.” countries that have adopted legislative The Department of Finance said that a ered bonds should be standardized by frameworks.”legislative framework will benefit Canadians. the framework to create a robust, deep Palmer said he found interesting the “The legislation will create a more and liquid market? proposed scope of eligibility criteria forrobust product that will retain investorconfidence in periods of market instabil- “The more modest scope of permitted assetsity by providing legal certainty and settingminimum standards for covered bonds,” will simplify the process”it said. “It will also help financial institu- covered assets and issuers.tions diversify their sources of funding by of the covered bonds registrar and what “Cover pools for legislative coveredincreasing investor interest in Canadian entity should perform this role? bonds would be limited to residentialcovered bonds.” The funding official said he was mortgages, unlike the recent US proposal The volume of Canadian covered pleased to see all the points that had been that would open up the US covered bondbonds outstanding doubled last year, ac- discussed over the past several months ad- market to other asset classes, like autos,cording to the Department of Finance. dressed in the consultation document, in- credit cards, and student loans,” he said.Almost all of the growth in the Canadian cluding the matter of existing structures. “Finance suggests that the more modestmarket has come from the country’s banks “There was a vested interest in codi- scope of permitted assets will simplify theselling US dollar denominated covered fying existing structures in the proposed process and permit a more rapid imple-bonds, mainly to US investors. This year legislation,” he said. “Investors who hold mentation of a legislative regime.”National Bank of Canada and Caisse Cen- existing paper, the last thing they want is Other market participants agreed thattrale Desjardins de Quebec launched their to be uncertain about what’s happening the covered bond legislation should notfirst covered bonds. with their outstanding structures.” face problems moving forward. The consultation paper deals with a “It should not be a terribly controver-range of issues including asset segrega- Canada, Canadian issuers have restricted sial piece of legislation, aside from thetion, eligible assets, and overcollaterali- their cover pool to mortgages insured by standard discussion of trying to balancesation, for example. The Department of the interests of retail depositors,” said theFinance said that it is specifically seeking Aaron Palmer, a partner at Blake, Cassels funding official.feedback on three general questions: & Graydon, also welcomed the consultation. The consultation ends on 10 June.4 The Covered Bond Report May 2011
  • 7. MONITOR: LEGISLATION & REGULATIONCIBCECBC acts after CBIC transparency pushThe European Covered Bond Council transparency standards even ahead ofhas been surveying its members for their the release of the data lists and had madeviews on transparency standards pro- progress on the topic. At a plenary sessionposed by the Covered Bond Investor of the ECBC in Stockholm at the end ofCouncil, which could form part of a la- March Grossmann unveiled an updatedbelling initiative being supported by the version of a part of the association’s web-European Central Bank. site where market participants can find The ECBC sent out the survey a week comprehensive information on coveredafter a meeting in Frankfurt on 29 April bond legislations and links to issuer data.focussing on labelling and featuring many “We have already done some work onof the association’s members as well as our own part, with the comparative data-European Central Bank officials and in- base website and looking into what dif-vestors, including Covered Bond Investor ferent issuers provide in terms of infor-Council representatives. mation,” said Grossmann. “We welcome At a plenary meeting of the ECBC at that investors have now put their ideas onthe end of March Michel Stubbe, head the table, which will enrich our on-goingof the market operations analysis divi- dialogue.sion at the ECB — speaking as an expert “If you speak to different investors youwithout prejudging any decision of the get different answers as to what they re-ECB governing council — had suggested quire, but now the CBIC’s transparencythat any covered bond label could involve standards provide us with something of“value-added services”, such as transpar- a consensus on what is the ultimate wish-ency about products. He added that a label list to work with. Now we will be meetingcould be “a big resource saver” for inves- in the technical issues working group totors and regulators. Andreas Denger: see how we can address this.” The ICMA Covered Bond Investor “Most of this can be provided The CBIC proposals are the fruit of aCouncil unveiled its plans for the trans- relatively easily” working group that has sought to identifyparency standards at the ECBC plenary the key information covered bond inves-and then released its data lists in April, The publication of the proposed trans- tors require, said the Council, which op-detailing information it believes issuers parency standards begins a consultation erates under the auspices of the Interna-should provide to investors. period that will close on 30 June, and the tional Capital Market Association. The voluntary transparency standards CBIC is aiming to have the standards fi- “It is expected that the informationset out three categories of information the nalised in September. required would be available on a regularCBIC expects from issuers: general issuer basis (e.g. a half yearly update) to meetdata; cover pool data; and explanations as “Providing consistent investors’ transparency and informationto how key concepts are defined. “It’s not just new covered bond in- data should favour needs,” it said. “Beside the quantitative information provided via a spreadsheet,vestors who are raising questions about issuers” some qualitative information is requestedtransparency,” said Andreas Denger, sen- to explain the figures and make the dataior portfolio manager at MEAG Munich “The CBIC believes that transparency more comparable.Ergo Asset Management. “Traditional standards are a milestone in the roadmap “The CBIC believes that issuers shouldbuyers also have also increasing needs for towards a better transparency regime in consider these qualitative elements andcomparable and standardised information Europe,” it said. ensure a certain degree of consistency,on the issuer, collateral pool characteris- Ralf Grossmann, head of covered most urgently at national level.”tics and key definitions. bond origination at Société Générale and General issuer information required “We believe that most of this informa- chairman of the working group, told The under the proposals includes sectionstion can be provided relatively easily by all Covered Bond Report that the ECBC had on: balance sheet data; wholesale fundingissuers.” been co-operating with the CBIC on the breakdown; customer loans; margin cal- May 2011 The Covered Bond Report 5
  • 8. MONITOR: LEGISLATION & REGULATIONculations; and the legal status of covered the suggested data twice a year, it wouldbonds — whether they are repo eligible, make the market significantly more trans-and UCITS and CRD compliant. parent and comparable, with the extra in- The cover pool data standards require formation on issuers’ strengths and weak-issuers to detail cover pool composition nesses feeding through to prices moreand eligibility criteria, with a breakdown consistently.of the types of assets in the cover pool and “At the end of the day, this would helpallowed as collateral. Some examples are: investors and other market participants to form an opinion on individual issuers ble assets? and their covered bond programmes in- dependently of rating agencies,” he said. house prices to the current OC. “However, we would warn readers of the danger of basing their judgements of cov- soft or hard bullet structure? ered bonds on excessively ratio-driven Issuers are then required to explain analysis.key concepts underlying the data in the “The key question is ultimately allprevious two sections. They are required, about the long term intrinsic value of thefor example, to describe how NPLs are de- cover assets, which in turn is ultimatelyfined, how LTVs are calculated, and how subject to the economic developments.residential and commercial loans are de- And last but not least, we believe that thelineated. value of covered bonds also depends on The CBIC said that it hopes national the sustainability of the issuer’s businessassociations will take the data lists into model and lending standards.”consideration when developing their own Grossmann said that the ECBC surveynational templates. Associations in Ger- Ralf Grossmann: and working group would be looking atmany and Sweden have already developed “Some items probably sensitive what data is already included in standard fi- for the stock market”standardised ways of calculating some of nancial reporting by issuers and what is not.the key concepts in the CBIC’s proposals. “There are also some items that will “The CBIC is well aware that not all Bank of England that for UK issuers take probably be sensitive to the stock mar-jurisdictions or issuers will be in a posi- in covered bonds as well as asset backed ket, perhaps,” he added. “For example, iftion to provide all of the requested data,” it securities, which were seen as the original we would all disclose our margins in theadded. “Nonetheless, the CBIC invites all main target of the central bank’s new re- mortgage business, that would probablyissuers to be as accurate and comprehen- quirements. By chance, on the same day as bring the equity analysts in. And alsosive as possible in filling in the data list. the labelling meeting, the ECB introduced some of the information probably needs “Providing consistent data and trans- to be approved by auditors or by internalparency for their covered bond products “We would warn compliance.should favour issuers and their respec-tive jurisdictions in increasing investors’ against excessively “These are all things we need to take account of. The national delegations andconfidence in their product. To accom- ratio-driven analysis” associations will play a pivotal role in de-modate the differences between markets termining what can be produced in what JÖRG HOMEYand jurisdictions and deviations from time-frame and by the different countries.the data list which potentially could oc- loan-by-loan information requirements We are now doing our homework.”cur, additional remarks in the data list at for commercial mortgage backed securi- Feedback to the ECBC’s survey was re-the ‘Additional comments’ section could ties and SME securitisations, but it has not quested in time for a meeting of its techni-be given.” yet imposed any such requirements in the cal issues working group scheduled for 27 Some market participants have noted field of covered bonds. May.that the CBIC requirements are not as Jörg Homey, covered bond analyst at See cover story for more on the labellingstringent as those being introduced by the DZ Bank, said that if all issuers provided initiative6 The Covered Bond Report May 2011
  • 9. MONITOR: LEGISLATION & REGULATION “The market will still prefer Eu1bn deals because they are more liquid” page 26GARRETT-MALONEYUS Bill passes subcommittee intactAttempts to address concerns surround- sued relative to the size of a bank’s bal-ing the US Covered Bond Act of 2011 are ance sheet.set to take place ahead of a full hearing of Garrett pointed out that the bill givesthe House Financial Services Committee, regulators the ability to set such limits,after its Capital Markets & Government but Campbell said that he would preferSponsored Enterprises subcommittee any limits to be statutory.passed the bill with only two “non-con- Garrett and Maloney had already saidtroversial” amendments on 3 May. that they are open to exploring avenues The amendments were put forward by to address ways in which such concernsthe sponsors of the bill, Republican Scott among members of the committee, theGarrett, who chairs the subcommittee, Federal Deposit Insurance Corporationand Democrat Carolyn Maloney, follow- and others might be addressed throughing a first hearing of the bill on 11 March. changes to the bill before it is discussed However, John Campbell, a Republi- by the full House Financial Servicescan Representative from California, said Committee.that he was “not thrilled with this bill or “We have reached out to – and theythis concept”. have reached out to us – to the regula- “I have concerns about this because of tors and specifically to the regulator thatthe way that covered bonds work, because you referenced as well, to try to hear whatof the substitution of collateral issue,” he their concerns are and understand thatexplained. “So you’ve got this pool of they have the concerns, some of whichmortgages upon which Wall Street loans you listed there,” said Garrett. “And whatmoney to the bank and then if one of we’d like to do is to continue the dialoguethose mortgages goes bad the bank has between now… and the full commit-to take a good mortgage out of the bank tee markup, and keep involved all thoseand put it in the pool and then the bad folks.” John Campbell: “not thrilled withmortgage goes over into the bank. This appeared to satisfy Maxine Wa- this bill or this concept” “So if you have a situation like we had ters, the ranking Democrat member ofin 2008 where a lot of things are going the subcommittee, who had also citedbad, then the Wall Street loans on this, concerns about the bill. amendment” and Garrett’s as “really to-they have to be covered by the bad loans Proponents of covered bonds had tally non-controversial”. However, Gar-going into the bank and good loans com- feared that the FDIC might seek to have rett said that his amendment, amonging from the bank going into this pool. an amendment tabled, potentially intro- other things, “conforms [sic] the FDIC’sTherefore, potentially — which is why ducing an overcollateralisation limit so authority to recover losses through exist-the FDIC has concerns with this — be- low as to render covered bonds unwork- ing law” and “clarifies how the cover poolcause it potentially creates a problem for able. is treated during the FDIC’s exclusivitythe security of that bank and for eventu- “They will go on saying that they period”.ally the FDIC and potentially even tax- like covered bonds,” he said, “but only The bill was passed by voice vote andpayers if you have a bad situation.” on their own terms. They are trying to Garrett said it would be “favourably re- He said that while the two amend- get away with the argument that it must ported to the full committee”. He alsoments improved the original version of be possible for these things to happen said that there could be progress on cov-the bill, he was not prepared to support and for them to be happy, but the real- ered bonds in the Senate.the legislation yesterday. He suggested ity is that it’s going to be very difficult to “I’m optimistic about this actually get-two limitations be placed on issuance, square their requirements with what the ting over to the Senate as well,” he said.one limiting the extent to which good market currently needs.” In mid-March Democrat Senatorloans can be substituted for bad, and The two amendments were not dis- Charles Schumer said that he was con-another placing an absolute cap on the cussed in any detail, with Maloney de- sidering introducing a covered bond billvolume of covered bonds that can be is- scribing hers as “basically a clarifying in the Senate. May 2011 The Covered Bond Report 7
  • 10. The CoveredBond ReportThe Covered Bond Report is not only a magazine, but also awebsite providing news, analysis and data on the market.Did you know that The Covered Bond Report has its own databaseof benchmarks?Did you know that we link directly from bond data to relevant coverage?Did you know that we include price guidance, book sizes anddistribution statistics?Did you know that you can run league tables by country and currency?To register for trial access to The Covered Bond Report, visitnews.coveredbondreport.com or contact Neil Day, Managing Editor, atnday@coveredbondreport.com. And don’t forget: if you are an investor incovered bonds you can qualify for free access to the website.
  • 11. MONITOR: LEGISLATION & REGULATIONAUCTIONSDanish offer daily move in Basel bidThe Association of Danish Mortgage “And if we do a refinancing on a dailyBanks (Realkreditrådet) is proposing a basis, we would do refinancing on aboutmove to daily auctions to refinance ad- 220-240 days,” said Hjortshøj-Nielsen, “andjustable rate mortgages as one of various in that case we could only lose half a percentoptions it is exploring in a bid to win bet- of our funding on one day. That’s much lesster treatment for its system under Basel III than a retail bank has the risk of losing.when the new framework is implemented “So we would very much like to use thein the European Union through CRD IV. argument that if you actually refinance on The possibility of having “day-to-day” a daily basis it would be as safe as if youauctions was raised by Peter Engberg Peter Engberg Jensen: “We have a have retail deposits. We are going to useJensen, chairman of the Association of system with low liquidity risk” that argument in the NFSR debate.”Danish Mortgage Banks and Nykredit Arnth Jensen said that a Europeangroup chief executive, at its annual meet- The Danish mortgage banks also believe Commission proposal for CRD IV is ex-ing at the end of last month. that such a move would help their case with pected just before or after the summer “We are discussing such a proposal with regard to the NSFR as well as Liquidity holidays, with discussions in the Euro-the Danish Mortgage Banks’ Federation and Coverage Ratios under Basel III. Accord- pean Parliament to follow.public authorities,” he said, “with a view to ing to Henrik Hjortshøj-Nielsen, head of “If we can prove that they are liquidimplementing it in due time for us to dem- group treasury at Nykredit, a possible move then we think that will help us argue ouronstrate to the European authorities that we to daily auctions is just one of three options case,” she said. “It’s a long way before wehave a system with low liquidity risk which being explored and prepared for. actually know what’s happening but it’sshould fall within the Next Stable Funding Nykredit Realkredit, which has very important that we are fighting.”Ratio under the Stable Funding rules.” three auction dates, is reweighting its A move to daily auctions could, how- Currently, Danish issuers hold up to sales so that within the next two years ever, carry disadvantages for the Danish.three covered bond auctions a year — in the March, September and December “There is an advantage in trying to getMarch, September and December, with the auctions will be of equal size, and it is investors’ interest at certain times of yearlargest concentration being in December. considering introducing a fourth auc- by having big liquid auctions, and havingThe December sale issued 96% of Danish tion. The mortgage bank has also pre- big liquid bonds is actually advantageouscovered bonds until 2009, but the associa- pared to bring its auction dates forward for investors,” said Hjortshøj-Nielsen. “Sotion agreed to further distribute refinanc- a month, because in order to satisfy the you could argue that on average we woulding auctions and to refinance new loans at LCR institutions have to be financed 30 have higher funding costs by spreading itother times of year after the Danish central days forward. out. That is the risk.”bank, Danmarks Nationalbank, raised con-cerns over the reliance on a single auction. “That moved quite a few bonds,” saidAne Arnth Jensen, managing director ofthe association, of the move away fromhaving only the December auction. “Thatwas a good first step.” However, the central bank is under-stood to be keen on spreading the auc-tions even further. “The Danish central bank has beenagainst these very large auctions,” saidGustav Smidth, senior analyst at Dan- Denmark’s Nationalbank “has beenske Bank. “It tends to put the country’s against these very large auctions”finances at risk if an auction happens tocome at a bad time for the market. So thisis all a result of the crisis. May 2011 The Covered Bond Report 9
  • 12. MONITOR: LEGISLATION & REGULATIONCRD IVStick to LCR limits, says Basel memberA member of the Basel Committee on considered as liquid under the new regula-Banking Supervision has said that the tion more popular, and assets that are notEuropean Commission should stick to considered as liquid assets less so.the limits placed on covered bonds in the “This can shift demand to sovereignBasel III framework when implement- bonds, covered bonds and high qualitying it through CRD IV — although he corporate bonds and away from less liq-said that they could play a greater role in uid assets, such as other bank bonds, se-countries lacking Level 1 and 2 assets. curitised assets and lower quality corpo- Speaking at a European Covered Bond rate bonds. All this can have implicationsCouncil plenary meeting in Stockholm at for credit spreads and investors’ returnsthe end of March, Lars Frisell, chief econ- Frisell: Basel III “a global compromise” on particular market segments.”omist at the Swedish Financial Supervi- Wellink said that the prospects forsory Authority and member of the Basel shortage of Level 1 and 2 assets. He said that term funding could improve if the liquid-Committee, said that the Basel III frame- Denmark and Sweden were “pretty close” ity of long term paper improves relativework represented a “global compromise”, to qualifying for special treatment on this to short term paper.and that “it was an achievement to get an basis, adding that it would be “absurd” to “This could be stimulated by transpar-explicit role for covered bonds at all”. punish countries that had kept government ent, collateralised and straightforward Under the Basel Committee’s frame- debt low. asset structures,” he said. “For these rea-work, covered bonds can be included in sons covered bonds have become popularLiquidity Coverage Ratios as Level 2 as- “It’s hard for them to recently, although we are not sure on thesets, meaning that they can constituteup to 40% of LCRs and face haircuts of see differences precise impact on unsecured investors. In the first quarter Eu100bn of coveredat least 15%. The ECBC and others have between RMBS and bonds was issued in Europe and observ-been campaigning for improved treatmentof covered bonds in LCRs, with a Danish- covered bonds” ers expect this asset class to grow further. “The recognition as liquid assets inGerman initiative calling for certain cov- “My main advice is not to worry too the LCR supports the issuance of coveredered bonds to be treated as Level 1 assets, much,” was his advice to Danish con- bonds.”on a par with sovereign bonds, which do cerns about the impact of Basel III. He then raised the prospect of MBS innot face the same limits and haircuts. Frisell pointed to the way in which the future being included in the LCR. “It is important that the Commission Australia is planning to cope with such “As you probably know, MBS securi-stands by this agreement,” he said, add- a situation as a model. The Reserve Bank ties are not recognised in the LCR buff-ing of the 40% limit that the EU would of Australia will have a new committed er,” said Wellink. “Increased transpar-“have to live with that” and “same thing secured liquidity facility that banks can ency and market liquidity, for instancewith the haircut”. use to meet the LCR, and this could be through market quotation, would in- Frisell said that there had been “candid” secured on covered bonds. crease the likelihood that MBS securitiesdiscussions within the Basel Committee would be recognised as liquid assets.”about covered bonds, where it had been MBS in LCRs? The shortfalls in liquid assets thatnoted that covered bonds, too, had suffered Nout Wellink, chairman of the Basel some countries are facing were also ad-during the crisis, and that it was at times Committee, highlighted how Basel III dressed, with Wellink highlighting howdifficult for non-European members to see will boost demand for covered bonds in “tailor-made” solutions were allowed bywhy covered bonds might deserve special a speech in mid-April, and also discussed the new liquidity regulation.treatment given that “it’s hard for them to how the chances of mortgage backed se- “For instance, the Reserve Bank ofsee differences between RMBS and covered curities being recognised as liquid assets Australia has established a liquidity facil-bonds in their own country”. could be improved. ity to help local banks meet the LCR re- However, Frisell said that there remained “The LCR will change the relative prefer- quirement,” he said, “while Denmark in-plenty of time for carving out a role for cov- ences for banks to hold certain asset classes,” tends to give special treatment to coveredered bonds before the final implementa- said Wellink, who is president of De Neder- bonds; the possibilities to do so will be fle-tion of Basel III for those countries facing a landsche Bank. “It will make assets that are shed out over the observation period.”10 The Covered Bond Report May 2011
  • 13. MONITOR: LEGISLATION & EGULATION “It’s easier for the big banks given that rating agencies have linked approaches” page 46SOUTH AFRICARBSA prohibits coveredThe Reserve Bank of South Africa has possible use in South Africa.prohibited the issuance of covered bonds However, the Reserve Bank said that:by banks in the country, saying that they “Since a covered bond structure in termsare potentially “materially inconsistent” of which covered bonds are issued by awith the mission of its bank supervision bank will in essence subordinate the in- Coovadia: “covered bonds provide adepartment (BSD). terests of depositors to the interests of the useful tool” The Banking Association South Africa covered bond holders, a covered bondhad been lobbying for covered bonds, but structure is regarded by the BSD as pos- engaging the banking regulator on thisthe RBSA revealed the decision in a guid- sibly being materially inconsistent with aspect,” Cas Coovadia, BASA managingance note in late May, informing banks the objectives, duties and responsibilities director, had told The Covered Bond Re-that it has a “policy not to allow the use imposed on the BSD in terms of the pro- port in early May.of covered bonds and similar structures visions of the Banks Act, 1990 (Act No. “Covered bonds provide a useful toolby banks in South Africa”. 94 of 1990 — the ‘Banks Act’).” to lengthen the term of bank funding The central bank said that the mission The central bank added that it would whilst at the same time add to the stockof the BSD is to “promote the soundness of “continue to monitor and appropriately of liquid assets in a country that has lim-the domestic banking system and to mini- consider all relevant international devel- ited options to meet the new internation-mise risk through the effective and efficient opments related to covered bonds”. al banking legislation.”application of international regulatory and The move comes in spite of lobbying Some market participants had, how-supervisory standards and best practice”. from The Banking Association South ever, already raised objections to the The guidance note acknowledges the Africa, which had been in talks with the push for covered bonds. Andrew Canter,position covered bonds are given under Reserve Bank. chief investment officer of FuturegrowthBasel III and their use in other jurisdic- “Covered bonds are not yet offered Asset Management, for example, had saidtions, suggesting that these prompted re- in South Africa and we, The Banking that covered bonds would prejudice ex-cent enquiries it has received about their Association South Africa, are currently isting creditors. MOODY’S Better LCR treatment credit positive Moody’s would view any inclusion of minimum 15% haircuts that Level 2 assets troubled issuer meaning that access to, covered bonds in Level 1 assets for li- – which covered bonds fall under accord- and costs of, refinancing for existing pro- quidity coverage ratios as credit posi- ing to the Basel Committee on Banking Su- grammes is reduced. tive, the rating agency said after a Ger- pervision’s proposals – for covered bonds man finance ministry representative was meeting certain criteria. reported as saying that covered bonds Moody’s said that, if implemented, meeting certain criteria should be treat- the initiative would be credit positive as it ed as high quality liquid assets for the would reduce investor losses arising as a purposes of LCRs. result of refinancing risks. The rating agency said that an article “If some covered bonds have the ben- in Recht der Finanzinstrumente in March efit of an exemption from the 40% cap, this quoting state secretary Jörg Asmussen exemption will materially increase and sta- supports an initiative by the Association bilise the potential investor base for these of German Pfandbrief Banks (vdp) and covered bonds and reduce yields,” said Association of Danish Mortgage Banks the rating agency. “Prospective covered (Realkreditrådet) aimed at gaining better bond issuers with access to a strong inves- treatment of covered bonds under Basel tor base, able to fund at low yields, will be Asmussen: Supports Danish-German stance III. This would remove the 40% cap and more willing to refinance the assets of a May 2011 The Covered Bond Report 11
  • 14. MONITOR: LEGISLATION & REGULATIONREGULATED COVERED BONDSUK promises enhancements, clarityThe UK Financial Services Authority and creditor’s residual unsecured claims after re-HM Treasury launched a review of the alisation of collateral or recoveries under aUK covered bond framework in April, guarantee would be subject to bail-in. As in-which they said aims to make UK cov- ternational negotiations about bail-in pow-ered bonds more attractive to investors ers progress, the authorities should considerand to allow UK issuers to compete on a carefully the mechanisms by which creditorslevel playing field. could call upon any guarantee forming part The review had been flagged in the of a covered bond arrangement in respect ofUK budget in March. the original unsecured claims.” “Making sure banks and building so- The RCBC’s Fielding welcomed this.cieties lend to families and businesses “There has been a misplaced worryis vital for sustaining the recovery,” said Mark Hoban: “Review that in the case of a bail-in the assets inMark Hoban, Financial Secretary to the demonstrates the government’s the cover pool could in some way be re-Treasury, on announcing the review. “To- commitment” claimed,” he said, “but the consultationday’s review demonstrates the Govern- makes it crystal clear that the segregationment’s commitment to supporting the of assets in a bail-in, the secured creditor’sUK’s growing covered bond market. The as funding instrument for UK banks.” rights to collateral, is not in question.”review will bring out the strengths of the Claus Tofte Nielsen, chairman of the However, market participants saidUK’s covered bond regime and help lend- Covered Bond Investor Council and that it was unclear how the review mighters raise the funds they need to lend.” senior portfolio manager Norges Bank affect the levels at which UK covered Investors and issuers reacted posi- Investment Management, said that bonds trade.tively to the review, saying that it should the transparency improvements being “The rules are really positive, but thestrengthen the UK product. sought are aligned with the CBIC’s trans- spread impact is hard to quantify,” said “We welcome the recognition of the im- parency initiative (see separate article). Frank Will, senior analyst at RBS. “Theportance of covered bonds as a funding tool UK has already performed well, but there’sand the statement of intent to build upon Bail-in angle covered probably a little bit of room to perform bet-the strengths of the existing framework, as As well as the framework governing cov- ter and this is a step in the right direction.well as ensuring their attractiveness to in- ered bonds, the consultation document “However, I don’t think it’s a game-vestors.” Chris Fielding, Regulated Covered discusses how covered bonds should be changer. It will probably do more for wid-Bond Council executive director, told The treated in a bail-in scenario, with the au- ening the investor base and engenderingCovered Bond Report. “We appreciate eve- thorities noting that bail-in powers are more confidence in UK products.”rything said by the Financial Secretary with an important issue for many investors.regards to the flexibility covered bonds of-fer and how they can complement unse- “If a bail-in power were introduced into the UK’s Special Resolution Regime UK review proposals:cured funding and securitisation.” (SRR) for failing banks, the power would Buy-side market participants were also be subject to the same creditor safeguardsencouraged by the government’s move. that apply more generally within the SRR, “We welcome the joint initiative by including the safeguard that protects cov-the FSA and HMT to review the UK cov- ered bond holders,” says the consultation.ered bond regulation and are supporting “In addition, the UK believes that, in thethe authorities in their effort to make exercise of any bail-in powers, securedthe current framework even better,” said creditors’ rights to collateral should notGeorg Grodzki, head of credit research be over-ridden, and that the claims of cov-at Legal & General Investment Man- ered bond holders in relation to the assetagement. “LGIM believes that covered pool of a covered bond, including under abonds could become an important asset guarantee which forms part of the coveredclass for long term institutional investors bond arrangement, should not be affected.and play an increasingly significant role “This would mean that only a secured12 The Covered Bond Report May 2011
  • 15. MONITOR: LEGISLATION & REGULATION “You have to decide between two objectives”page 37AUSTRALIAAussies press on despite limit let-downThe Australian Treasury has set an 8% Analysts noted that the draft legisla-limit on the amount of assets that can be Australia’s Treasury could hold tion did not deal with minimum liquid-encumbered by covered bond issuance in second consultation ity requirements or the maintenance ofdraft legislation, disappointing covered a minimum overcollateralisation level.bond proponents, who have blamed the Fitch said it believes that these issues willAustralian Prudential Regulation Au- be addressed through consecutive draftsthority for the restrictive stance. and result in a future rating of Australian Some market participants criticised covered bonds of up to triple-A.the limit, saying that the government S&P said that unlike under coveredhad been swayed by APRA, which had bond legislation in other jurisdictions,previously said that covered bond issu- eas such as asset quality (<80% LTV for special purpose vehicles (SPVs) envis-ance was prohibited as it was counter to residential loans), third party asset monitor aged in Australian structures do not pro-the Banking Act 1959 that is now being and maintenance of the cover pool are all vide a guarantee of the ADI’s obligationsamended by the government. welcome as a means to ensure the Austral- to covered bond holders. “An 8% limit will be inadequate for those ian covered bond is best of breed.” “The exposure draft refers to the ADI’sADIs that could and should be making use debt obligation as being ‘secured against’of covered bonds,” said one. “It’s a bit silly re- “APRA is clearly an the pool of assets and the explanatoryally, but it came at APRA’s insistence.” on-going opponent memorandum refers to the bondholders’ The restrictive proposals come af- right to enforce a charge,” said the ratingter APRA in February excluded covered of covered bonds” agency, “but neither document stipulatesbonds from its initial eligibility criteria for “There is flexibility through Regulation how any ‘security’ will work or be enforced.liquidity buffers under Basel III, when it to see how an 8% limit works in practice “If the intention is for the SPV tosaid that no asset classes met the required and then seek amendment if required,” he grant a third party security, the mecha-standards to qualify as Level 2 assets. added. “However, much of the detail has nisms for enforcing and applying pro- “APRA is clearly an ongoing opponent been left to APRA Prudential Standards ceeds from the security interest held onof covered bonds, despite having said that and we look forward to working construc- behalf of bondholders will need to beit was only the Banking Act that caused tively with APRA and the Government in explicitly dealt with, for example, in thetheir prior objections,” said a market par- the development of those standards.” programme-specific documentation.”ticipant. “This is just the latest manifesta- S&P also said that the exposure drafttion of their attitude to covered bonds.” A solid first step, but no more does not appropriately tackle funding He was also disappointed by the discre- A consultation on the exposure draft fin- and refinancing alternatives followingtion afforded APRA in the exposure draft, ished on 22 April and although this was insolvency.which allows the regulator to impose ad- originally expected to result in a version “We believe that it does not explicitly pre-ditional requirements on ADIs. Critics that could be presented to parliament, the clude the SPV from addressing maturity mis-said that this could create uncertainty for launch of a second consultation round matches following an ADI’s insolvency – fornot only issuers but also investors regard- before that is understood to be possible. example, by incurring new debt or creatinging the levels of overcollateralisation that In the meantime observers said that security over the cover pool assets in favourmight be permitted, for example. while the country is progressing positive- of other lenders,” it said. “We anticipate that However, Commonwealth Bank of ly towards a viable covered bond frame- the relevant programme documentation andAustralia chief executive Ralph Norris work, it needs to address several issues structure of a covered bond issuance wouldwas reported to have described the 8% where uncertainties remain. specify any mechanisms or frameworks bylevel as “a good number”. Fitch considered the draft as being “a which the SPV may incur new debt or source Australian Securitisation Forum chair- solid first step”, adding that this was par- funding to meet any liquidity needs.man Stuart Fuller said: “The relatively light ticularly true with respect to segregation “In addition, the proposed frameworkhanded approach is to be welcomed as is of assets. However, a lack of clarity in does not discuss matters concerning thethe protection afforded to unsecured ADI several areas of the proposed framework eligibility of the cover pool for repurchasecreditors through an 8% cap. Provision to led UniCredit analysts to declare the arrangements with the Reserve Bank ofprotect covered bond investors in key ar- draft “no more than a first step”. Australia.” May 2011 The Covered Bond Report 13
  • 16. MONITOR: MARKETMarketEUROSResurgence in prospect after supply ebbA record surge in covered bond issuance night, when only four benchmarks hadthat ran from January into March eased hit screens. As The Covered Bond Reportto a trickle throughout April and the first was going to press the European Centralhalf of May, with Eu96.3bn being issued Bank appeared to be at loggerheads within the first three months and only a fur- the European Commission and Ecofin,ther Eu18.4bn up to 19 May, according to apparently rejecting the latter bodies’figures from Crédit Agricole. suggestion of a “soft restructuring”. However, the primary market gained “Looks like people are having troublerenewed momentum in mid-May, with with the whole Greece story again andissues from CIF Euromortgage, Bayer- again and again,” said one banker.ische Landesbank and Eurohypo hitting Dhiren Shah on Credit Suisse’s cov-the market on the same day. Market par- ered bond and SSA syndicate said that theticipants suggested the trio’s deals could slowdown was attributable partially to a re-herald a second wave of supply. newed focus on senior unsecured issuance. “I would expect this could last until “There was so much covered bond is-the summer break now,” said a German suance at the beginning of the year” saysfund manager. “But I’d expect, after how Shah, “and hardly any senior. Now we’rewell the market held up at the beginning seeing more senior than at the beginningof the year in the face of heavy supply, of the year and fewer covered bonds.that things should go OK.” “Banks are diversifying their funding.” In spite of the market having been Stéphane Bataille, head of origina-quiet for some time, the few deals that tion and syndicate, DCM at Landesbankdid hit the market in the wake of two Baden-Württemberg, was positive aboutlong weekends in April showed it to be the covered bond market as a whole, inopen. BPCE SFH, for example, launched spite of the brief slowdown.the first deal after a two week hiatus and “Yes, April was subdued, but with allmet with a strong reception for what was the holidays it’s not surprising,” he said.the first obligations à l’habitat bench- “On the positive side, we’re seeing themark in euros, a Eu2bn issue. covered bond investor base expanding, Market participants cited several rea- with more and more senior investorssons for the quiet period alongside the switching to covered, and even clients Vincent Hoarau: “Everyone is prettyholidays. Vincent Hoarau, head of cov- who had been traditionally very active well advanced in their funding”ered bond syndicate at Crédit Agricole, prior to the crisis now returning.”said that most issuers were in a “wait-and-see mode”. iBoxx spreads against swaps “At the beginning of the year most of 350the European covered bond issuers front- Spain 300 UKloaded massively and logically the paceof the supply decelerated significantly 250 Italy Basis pointsover the months of March and April,” he 200 Netherlandssaid. “Everyone is pretty well advanced in 150 Canadatheir funding programmes — well above 100 France60% for most of the tier one European Scandinavia 50frequent borrowers.” Germany 0 Dexia analysts on 18 May pointed 0 10 0 0 1 10 0 1 1 -1 -1 -1 -1 -1 -1 -1to the latest concerns about the fate of n- p- ar ar ay ul an ov ay a e M -J -M -M -J -M -N -J -S 04 -Greek debt as a possible explanation for 04 04 04 04 04 04 04 04the lack of issuance in the preceding fort-14 The Covered Bond Report May 2011
  • 17. MONITOR: MARKETDOLLARSSpareBank 1 last but tightest in Nordic quarterThe focus of dollar covered bond issu- Bank 1 Boligkreditt, told The Coveredance turned from Canada to Scandinavia Bond Report.as the first quarter turned into the sec- Thor Tellefsen, senior vice presidentond, with three Nordic issuer hitting the and head of long term funding at DnBmarket at the tail-end of March and Spare- Nor, said that the funding achieved on itsBank 1 Boligkreditt issuing in May. 144A deal was in line with that achievable As The Covered Bond Report was go- in euros.ing to press, the only other issuer with “We are the only Nordic issuer thatconcrete plans to tap the US market was has been able to twice issue $2bn five yearCredit Suisse, which had roadshowed deals, which is very good,” he said. “Andahead of a dollar debut. while there are some key investors in the Market participants suggested that any US that participated in both transac-lack of supply in the second quarter was tions, we saw a widening of the numberno reflection of any dissatisfaction with of smaller investors that were involved,the asset class among US investors. Indeed with some 55 to 60 accounts in the booka banker said that it could only serve to and more than 90% of the bonds sold inhelp any potential issuers, with secondary Arve Austestad: ”We had been looking the US.”paper tightening. at US for some time” The other Scandinavian to issue was A Swedbank Hypotek $1bn five year Nordea Eiendomskreditt, the Norwe-fixed rate benchmark launched in late gian issuer of the Nordea group. It soldMarch — alongside a $1bn three year SpareBank 1 Boligkreditt to price its a $2bn three year split into fixed andFRN — had tightened from 71bp over $1.25bn five year inside its peers, at 62bp floating rate tranches at 42bp over Li-Libor to the low 60s by mid-May, while over mid-swaps. bor. Crédit Agricole sold the only othera $2bn five year fixed rate deal came in “We had been looking at the US mar- dollar covered bond in the period tofrom 66bp over to the high 50s over the ket for some time, but we felt that the dif- mid-May (see obligations à l’habitat ar-same interval. ferential to Europe was too large,” Arve ticle for more), which was also a float- Indeed the tighter levels enabled Austestad, chief executive officer of Spare- ing rate note. KOREA KHFC eyes second pooling deal Korea Housing Finance Corporation Korea, and indeed Asia, after Kookmin rea’s Financial Supervisory Service to this could launch its second covered bond Bank sold a $1bn issue in 2009. KHFC, end. Korea has no covered bond law, but in June or July as the country’s banks a government institution, pools collateral KHFC issues under the law governing the are showing a renewed interest in taking from Korea’s banks in its issuance. Its first institution. advantage of the funding instrument. issue was backed by mortgages originated “The KHFC Act authorises KHFC to KHFC launched its first, $500m five by Standard Chartered First Korea Bank, issue mortgage backed bonds,” said year issue in July 2010. That was led by Shinhan Bank and Woori, although its Moody’s in a pre-sale report ahead of BNP Paribas and Standard Chartered, forthcoming issue is open to all its mem- KHFC’s debut. “These are dual recourse and the new issue is mandated to those bers, which also include Kookmin Bank, obligations that represent both (i) a claim two banks as well as Nomura. The issuer Korea Exchange Bank, Industrial Bank of on the general assets of KHFC and (ii) a is understood to be considering issuing in Korea and Hana Bank. priority claim on the residential mortgages dollars again or turning to the Japanese Korea’s banks nevertheless remain which are designated to secure payment yen market. keen to be able to issue on a standalone of the mortgage backed bonds, which are KHFC’s debut was only the second basis, according to market participants. segregated and managed separately from covered bond to have been issued out of They have been in discussions with Ko- the other assets of KHFC.” May 2011 The Covered Bond Report 15
  • 18. MONITOR: MARKETFRANCEGrand Départ for obligations à l’habitatNew French covered bond legislation in- told The Covered Bond Report that thetroduced to bring its common law cov- issuer had been working on the US dollarered bonds under dedicated legislation project for a couple of months.was inaugurated shortly after the Au- “The dollar market opened up lasttorité de Contrôle Prudentiel (ACP) on year and there have been many issuers28 March gave the go-ahead for issuance that have chosen to go to the US dollarby granting authorisations to potential market as well as euros,” she said, “andissuers. we thought that, being the biggest home A stepping stone to the new instru- loan lender in France, it was a logicalment was put down on 30 March when next step to diversify our investor base byCrédit Mutuel Arkéa Covered Bonds going to the States.”sold a Eu1bn 10 year issue accompanied The issuer held a roadshow starting inby a letter to investors committing to the week of 21 March, just ahead of thetransforming the issue into obligations à expected approval from France’s Autoritél’habitat. de Contrôle Prudentiel (ACP) on 28 “This first step will be followed by the March for Crédit Agricole to issue obli-transformation of the company itself,” gations à l’habitat and convert Crédit Ag-said the issuer. “We undertake to seek all ricole Covered Bonds to Crédit Agricole HSBC, Natixis, Santander and UniCreditnecessary internal decisions to transform Home Loan SFH. priced the Eu2bn five year benchmark atCrédit Mutuel Arkéa Covered Bonds into “We didn’t want to launch the deal 63bp over mid-swaps.a SFH, which shall be renamed: Crédit before our bonds could be issued as obli- Rather than merge the two issuers ofMutuel Arkéa Home Loans SFH.” gations de financement de l’habitat,” said BPCE that had previously issued outside The deal was priced at 90bp over mid- Fedon. “It would have been more com- a dedicated legal framework — Banquesswaps by leads Crédit Agricole, DZ Bank, plicated to say that we are issuing a con- Populaires Covered Bonds and GCEJP Morgan and Crédit Mutuel Arkéa. tractual covered bond but will soon be Covered Bonds — the group created a “We are very pleased with the result operating under a legal framework. new issuer, BPCE SFH, to issue under theas the issuer only has one outstanding “We wanted to be able to go to inves- legislation.benchmark,” said a syndicate official at tors and provide them with clarity on “We priced very close to the two oldone of the leads. “More and more people what covered bonds they are buying.” curves,” said the syndicate official at onenow are getting comfortable with buying BPCE gave the new product a home of the leads. “For me, the success of thisthe name and are keen on this kind of launch on 3 May, issuing the first obliga- transaction is an indication that the newrare exposure (French residential home tions à l’habitat in euros. Danske Bank, law will make them trade better.”loans in Brittany). “This is a very positive signal looking BPCE SFH finds a home in French covered bond landscapeforward. The change into OH will obvi- Cover pool: pledge of Eligible Home Loansously speed up the process of penetrationof the name into the investor base.” Crédit Agricole Home Loan SFH Eligible Regional Home Bank #1launched the first obligations à l’habitat Loansproper on 13 April, debuting its new issu- Obligations deer in the dollar market with a $1.5bn three Eligible Regional Secured Financement de Home Loans l’Habitat Investors Bank #nyear 144A floating rate note. Lead manag- Loans (OFH)ers Barclays Capital, Citi, Crédit Agricoleand Merrill Lynch priced the FRN at 75bp Eligible Assets BPCE Replacementover three month dollar Libor. Securities Capital Nadine Fedon, chief executive officer, Guaranty and solidarity systemCrédit Agricole Home Loan SFH, and of Groupe BPCE Derivatives (swaps)global head of funding, Crédit Agricole, Source: BPCE SFH Investor Presentation – April 201116 The Covered Bond Report May 2011
  • 19. MONITOR: RATINGSRatingsFITCHInvestors fear senior subordinationEuropean investors are concerned about It noted that planned resolution regimes How concerned are you that bankan increased use of covered bonds, ac- would make structural and legal subordi- senior unsecured creditors willcording to a survey conducted by Fitch, nation an even more important issue. become increasingly structurally subordinated as banks increasealthough the rating agency said that it “Holders of bank senior debt are un- the use of secured funding toolsbelieves that for the majority of “sound derstandably concerned about the growing such as covered bonds?banks” there should be no material threat use of covered bonds, given that these have Not at all concerned because the access toto unsecured creditors from the trend. a preferential claim over selected bank as- this additional funding source lowers the default risk of the bank:13% In its latest quarterly European senior sets,” said Bridget Gandy, co-head of Fitch’sfixed income investor survey, released in EMEA financial institutions group. Very concerned because higherearly May, Fitch found that 87% of respond- However, Fitch said that legal constraints asset encumbranceents were concerned about an increased use limit how high much issuance can rise, ref- increases the loss given default forof secured funding by banks, which could erencing “regulatory limits on banks’ use of unsecuredlead to structural subordination. secured funding and availability of qualify- creditors: 16% “Within this sample 16% described ing assets”. It also said that broad risk aver- Moderately concerned: 71%themselves as ‘very concerned’ as higher sion should fall as economies recover, which Source: Fitch Ratingsasset encumbrance increases the loss would make unsecured funding cheapergiven default for unsecured creditors,” relative to secured funding.said Monica Insoll, managing director in “Fitch would expect to see an equilibri- The rating agency said in a report inFitch’s credit market research group. um being reached, which, for the majority March that although in extreme cases Fitch said that it believes covered bond of sound banks, is unlikely to be a material covered bond issuance could be a “curse”,issuance will only continue to grow, citing threat to the status of unsecured creditors,” it was in general benign, and in most casesinvestor risk aversion and regulatory incen- said Gerry Rawcliffe, managing director in well below levels that might give cause fortives as the primary reasons for the trend. Fitch’s financial institutions group. concern. MOODY’S ‘Incomplete’ data stokes cédulas worries Some Spanish covered bond issuers are there continues to be discrepancies be- slowly but steadily we are running out of not complying with Bank of Spain dis- tween different issuers’ published data.” reasons to maintain our sympathy. closure requirements introduced in De- Moody’s said that inconsistencies in “Currently, we see a market with a cember 2010, resulting in discrepancies reporting made comparisons of pro- large share of troubled issuers, in combi- in data between different institutions, grammes a challenge. nation with a claim against a pool of as- according to Moody’s. “Some of the areas where data pres- sets, which – put nicely leaves some open The rating agency said that it had been entation is inconsistent include (i) the in- questions and a cover pool that turns out to hopeful that the law, Circular 7/2010, clusion of securitised loans in cover pools; have massive inconsistencies with regards would lead to greater disclosure through (ii) the amount of collateral relative to the to total size available as well as eligible el- its requirement for extra information in an- covered bonds issued; and (iii) the defini- ements. Spain, please, please, please give nual reports on the assets backing cédu- tion of an ‘eligible’ asset,” said Moody’s. us a reason to regain trust in Cédulas!” las. However, the rating agency said that UniCredit analysts described the in- Moody’s nevertheless noted that it does important data continues to be obscured. accuracies as “shocking” and said that not expect the reporting inconsistencies to “Although the new law (effective De- they undermined a sector that is already affect ratings and said that it acknowledges cember 2010 significantly improves facing several challenges. that making data consistent across a wide the disclosure requirements of Spanish “Regular readers of our research range of issuer is “an onerous challenge” covered bond issuers in their annual re- might know that we have a certain pen- and that Spain has set “an extremely high ports,” said Moody’s, “the fact that some chant for the Spanish market, despite the standard” in disclosure, which had im- issuers are not yet compliant means that points mentioned,” they said. “However, proved “markedly” in recent years. May 2011 The Covered Bond Report 17
  • 20. MONITOR: RATINGSCOUNTERPARTY CRITERIA‘Danger’ in new S&P proposalsStandard & Poor’s held a comment peri-od ending on 4 May on new proposals to Adjustments to the maximum potential covered bond ratingchange its criteria for assessing counter-party and supporting party risk in cov- STEP 1 STEP 2 STEP 3ered bond transactions, after in January Number of derivative Weighted-average rating on derivative Covered bond issuer counterparties counterparties credit ratingsuspending application of previously an-nounced criteria to the asset class. AAA to A A- to BBB- However, analysts have warned that >10 derivatie No adjustment No adjustment AAA to AA-the new proposals could result in S&P counterparties BUCKET 1 andonce again putting all the covered bonds No adjustment Minus 1 notch A+ to Ait rates on negative review. <30% single counterparty The proposed criteria consider three concentration Minus 1 notch Minus 2 notches A- to BBB-factors: the number of derivative coun-terparties; the weighted-average rating of <10 derivatie No adjustment Minus 1 notch AAA to AA- counterparties BUCKET 2the counterparties; and the credit rating or Minus 1 notch Minus 2 notches A+ to Aof the covered bond issuer. >30% single “The proposed criteria would apply an counterparty concentration Minus 2 notches Minus 3 notches A- to BBB-adjustment of zero to three notches down-ward to the maximum potential covered Source: Standard & Poor’s 2011bond rating, as determined by the 2009ALMM criteria,” said S&P. “The proposedcriteria would have a rating floor that isthe higher of the covered bond issuer’s “This procedure will add more uncertaintyICR plus one notch or the lowest rated to S&P’s ratings”counterparty’s ICR plus one notch, to theextent that we consider credit enhance- “danger” in the proposal because S&P This means that it has the potential to reachment to be sufficient to support that rat- makes any downward adjustment to a AAA with three notches to spare. However,ing, according to the 2009 ALMM criteria. covered bond rating after all other steps if under S&P’s new proposals it should face “In our view, derivative counterparty in the process are taken. a one notch downward adjustment, thisrisk may be mitigated by both the cov- “In the original S&P rating method- would not be absorbed by the three notchered bond issuer’s obligation to repay ology, market participants could easily leeway; it would be cut to AA+.the bonds and the counterparty’s com- find out the relevant issuer rating levels “Any potentially unused notches of up-mitment to pay under the derivative ob- necessary to retain a AAA on the cov- lift of the covered bonds on top of the is-ligations, if that counterparty is different ered bonds,” he says. “The suggested suer rating are disregarded,” says Eichert.from the covered bond issuer. Further- approach is to incorporate the counter- “This procedure will add more uncertain-more, given the importance of covered party criteria adjustment at the very end ty to S&P’s covered bond ratings.”bond funding to an issuer’s overall fund- of the process.” He expects S&P to put all covereding strategy, in our view, issuers are mo- For example, an A+ rated issuer in bond programme ratings on negative re-tivated to manage their programmes to S&P’s covered bond category 1 and with a view, as it did when introducing its newmaintain access to this funding.” low ALMM score can achieve an uplift of covered bond rating methodology at the Florian Eichert says that there is a seven notches for its covered bond rating. beginning of 2010. Don’t forget to visit our website at www.coveredbondreport.com18 The Covered Bond Report May 2011
  • 21. MONITOR: RATINGS “They are now broadening their remit” page 42QUARTERLY OVERVIEWMoody’s to ignore laggards in timeliness bidMoody’s will no longer wait until all issu- Average Cover Pool Losses by country: mortgage backed covered bondsers have provided it with data before pub- 35% 33%lishing its quarterly monitoring overviews 30% 30%so that it can publish them on a more 25% 23% 21% 20%timely basis, the rating agency said when 15% 15% 16% 15% 15% 13%releasing its latest such report in April. 10% 10% 9% 10% 11% 11% 10% 7% The rating agency has hitherto waited 4% 4% 5% 7% 5% 5% 6% 4%7% 5% 3% 3% 3%until it has the relevant data from all is- 0% Denmark Finland France Germany Greece Italy Ireland Netherlands Norway Portugal Spain Sweden United Kingdom (UK) UK (Pass-through)suers before releasing the overviews, butthis has resulted in a time lag of around sixmonths between publication date and the Collateral risk Market riskinformation contained in the overview. Source: Moody’s Investor Services “Going forward, Moody’s aims to pub-lish its covered bond performance data on deal-specific performance overviews on a “While we doubt that Portuguese covera more timely basis,” said the rating agency. first-come, first-served basis. pools have less credit risk than Swedish“This applies both to the more detailed indi- covered bonds,” said another covered bondvidual deal-specific performance overviews Portuguese biggest losers analyst, “(as suggested by a lower averageas well as this monitoring overview report.” The quarterly report, which gives key nu- collateral score), it seems plausible that This means that the overview will be merical credit measures used by Moody’s for Portuguese cover pools have less credit risk more than 180 transactions, recorded several than Irish and Greek cover pools.”“Spain has improved changes in the market since the prior quarter. The collateral risk components of Ireland’s slightly” Michael Spies, covered bond analyst at DZ Bank, said that although the aver- and Greece’s expected loss figures were 11% and 10%, respectively. Spain’s was 16%, andpublished closer to the period the infor- age expected loss across all Moody’s rated its market risk 21%, giving the 37% total.mation relates to, even if this comes “at covered bond programmes, at 23%, was “Spain and Greek cover pools get al-the cost of completeness”, in Moody’s stable, there were notable changes in the most worst scores in case of overall ex-words. The rating agency said it will not measure for individual countries. pected cover pool losses,” said the analyst.delay publication “to accommodate issu- “Portugal is… seen fundamentally worse “Regarding Spain, we highlight that theers that are less responsive”. over the last six month,” he said. “Here the an- collateral score refers to the whole mort- The next overview will therefore be for the ticipated average cover pool loss has risen to gage book and not only eligible collateral.”first quarter of 2011, even though the latest 28%. Spain has improved slightly on the other The highest expected loss scored as-related to the third quarter of 2010, meaning hand (by two percentage points to 37%).” signed by Moody’s to mortgage backedthat the rating agency will skip a publication Portugal’s 28% cover pool losses fig- bonds was 44% for Ireland and 40% fordedicated to the fourth quarter of 2010. ure came from a 23% market risk meas- Greece. Norwegian issues recorded the Moody’s said that it will also publish ure and 5% collateral risk. Credit lowest market risk score, at 10%. Cover pools expected to suffer the biggest losses Issuer Cover type Collateral Risk Market Risk Cover Pool Losses Marfin Egnatia Bank S.A. Mortgages 6.0% 38.7% 44.7% Bancaja Mortgages 22.4% 22.4% 44.8% CatalunyaCaixa Mortgages 23.1% 22.2% 45.3% EBS Mortgage Finance Mortgages 9.4% 36.8% 46.2% Banca March Mortgages 23.2% 24.6% 47.8% Anglo Irish Bank Corporation Ltd. Mortgages 32.2% 16.5% 48.7% OTP Mortgage Bank Mortgages 15.5% 34.8% 50.3% Mortgage and Land Bank of Latvia Mortgages 19.2% 42.1% 61.3% HSH Nordbank Ship loans 67.0% 5.6% 72.6% Bre Bank Hipoteczny Mortgages 42.0% 30.7% 72.7%Source: DZ, Moody’s May 2011 The Covered Bond Report 19
  • 22. Q&A: DEXIA20 The Covered Bond Report May 2011
  • 23. Q&A: DEXIADexia rebuilds fora brighter futureGone are the days when Dexia sat atop the covered bond market. Its recent history has ensured that it now trades at the wide end of the French sec- tor. However, the funding team is confident it can convince investors that the credit deserves better and a Eu1bn five year Dexia Municipal Agencybenchmark on 11 May produced encouraging results. Neil Day spoke to the team about the challenges they face.Q Why did you decide the time was right to come with your Q People were expecting a five year deal at the start of the week, latest benchmark? even if that had not been officially announced. Was that whatA Cécile Van De Moosdyk, group head of long term fund- you had thought would be the right maturity the previous ing, Dexia: There were several factors. We do not, of course, week? And was placement in line with your expectations? decide on the timing alone; we need the market to be sup- A Van De Moosdyk: Since we have discussions on a regular portive, so we monitor the market and look at whether it is basis with our investment banks and also directly with the the right time to issue in a particular currency. investors we visit, we knew there was significant demand for We have also been engaging in a lot of communications this maturity. We wanted to leave it open until it was certain with investors in Europe until very recently so we felt that it that this was the maturity with the most demand, but we al- was the right moment in this respect, as well as in terms of ready had a good feeling for five years. market conditions. We were working on this transaction from the middle of A Eudes: We had nice feedback from central banks, for exam- the previous week and we decided that the right market ap- ple. As usual in this kind of maturity, we saw fewer insur- proach would be to announce the transaction on the Monday ance companies but more asset managers and bank investors. morning in order to be ready to go relatively fast if market There was nice demand from Germany and Austria for this conditions were positive after Dexia’s Q1 results were an- maturity, but we were also pleased to see a nice return on the nounced to the market. marketing investment we have put in during the past couple of months in Scandinavia, Austria and the Netherlands whenA Olivier Eudes, head of Dexia’s long term funding desk in we launched the transaction. Paris: You also have to bear in mind that the primary market, especially for covered bonds, was very calm for one or two Q How did the execution, which people said was better than weeks, with Easter and the Royal Wedding. After that we saw expected, compare with any expectations you might have limited supply in the market, so we felt that this was another had for the deal? reason why it was the right time to firm up a Dexia MA trans- A Eudes: We are pleased with the execution. In terms of the final action — the second benchmark for Dexia MA this year after spread [91bp over mid-swaps], we are happy with the result. the 10 year we launched in January. We had a constructive discussion about where the right May 2011 The Covered Bond Report 21
  • 24. Q&A: DEXIA spread whisper should be, taking into account the secondary MA’s cover pool and that we have limited peripheral Euro- market and the recent transactions we have seen in the mar- pean exposure — quite the opposite: we have a lot of France ket On this basis we took IoIs at the mid-90s. Thanks to the and Belgium in the cover pool. strong and quick feedback we saw in this project, with more It is of course taking some time to work on this message and than Eu1bn of demand coming in at this level, we decided to come improve our levels, but we are relatively confident that quite quickly to open a book at the 93bp area. we can prove to investors that central government risks are very Seeing the flow of concrete orders coming in once more remote in terms of the cover pool of Dexia Municipal Agency. after we did this, reaching Eu2bn, we had enough flexibility to tighten the spread a little bit, and to get the right balance On M&G: “Overall it had a between the spread for the issuer and the spread for the in- vestors. The spread to the issuer was right because we have positive rather than negative a limited new issue premium compared with the secondary impact” market, and the spread for the investor was right because we feel that with this kind of level and taking into account the Q Do you give any commitments with regard to peripheral demand we saw, we expect to see a performance on the sec- exposure in your cover pool going forward? ondary market. A Van De Moosdyk: Yes, because what we explain is that the cover pool is made up of assets that are originated by DexiaQ How do you feel about the way in which you trade wide of entities themselves within the new Dexia strategy. Regard- other French names? ing Spain, Dexia Sabadell is indeed in the Dexia group, butA Eudes: There is indeed a spread for Dexia MA. This is the this is one of the entities we have to sell according to the EC result of the recent history of the Dexia group, and the job of restructuring plan agreed with Dexia. It’s the same for Italy. our investor relations is to explain and re-explain the French So we are communicating based on figures as of today, but we law, the new business model of Dexia, and the very strong also explain that the share of French and Belgian assets will quality of the assets on the cover pool of Dexia MA. The increase, whereas other exposures will decrease in the future. strategy we decided to apply for 2011 in terms of our global funding programme, at group level and for Dexia MA in par- Q M&G made some claims about your cover pool in an ticular, is to work towards an improvement in our spreads. opinion piece critical of covered bond transparency that received widespread coverage, despite it containing inac-A Van De Moosdyk: The other reason why our spread is differ- curacies. How much of an issue was that for you? ent to other obligations foncières issuers followed the shock A Van De Moosdyk: We did not experience a negative impact from the sovereign crisis in Europe, Dexia being perceived as on the trading level of our covered bonds. On the contrary, more involved than others. There has been a sort of misinter- this gave us the opportunity to communicate again on the real pretation of any relationship between the sovereign crisis and risk exposures of Dexia Municipal Agency. M&G itself re- the fact that Dexia MA has public sector assets. So this is also leased a communication a few days afterwards regarding their part of the communications with investors that we are do- misunderstanding of Dexia MA’s cover pool. So maybe we can ing, explaining that we do not have sovereign bonds in Dexia say that overall it had a positive rather than negative impact Spread Landscape of French Covered Bonds Dexia MA’s primary market activity 1999-2011 120 in EUR bn CRH BNPPCB CIFEUR CFF 15.3 DEXMA BPCOV ACACB 2011 target: 100 EUR 5 to 7 bn 12.1 Currency diversification 80 9.9 9.1 8.7 9.1 ASW Spread 60 8.5 8.0 7.1 6.8 6.5 40 20 3.2 2.5 0 -20 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 0 5 1 0 15 to date Modified Duration As at April 29, 2011 Source: UniCredit Research Source: Dexia22 The Covered Bond Report May 2011
  • 25. Q&A: DEXIA because we were able to discuss in even more detail the true perspective. Of course, we need to have investor support, es- picture of Dexia MA. pecially in those countries where our coming to the market is relatively new or is a comeback after a period of absence, forQ What do you make of the Covered Bond Investor Council instance in Australian dollars. transparency initiative? Regarding US dollars, we have never issued in the US mar-A Eudes: Dexia MA is one of the issuers that already provides a lot ket for Dexia MA. It’s correct that we have set up a US MTN of information on a very regular basis, releasing all the colour programme, which would allow us to access the market if on the cover pool each quarter. But indeed, we have received the conditions were favourable. request for comments on the CBIC proposals and we will par- We’ve been a relatively active issuer in the Swiss franc ticipate in this work on transparency. We are considering how market, including in 2011, and this is one of the non-euro we can improve. It’s a win-win situation for everybody. markets that we might return to. And we’ve also been road- showing in the UK, in order also to approach sterling longQ Are you happy with the way your market profile is develop- term buyers. ing this year? Longer dated issuance has been a feature of the sterlingA Jérôme Gyss, director, investor relations, Dexia: I would market — is that something that makes it particularly at- say that throughout the very numerous investor meetings tractive to you? that we have had over the past month — and we have been visiting many places in most of Europe — what we sense is a A Van De Moosdyk: Yes, it’s interesting for us, because we have greater degree of comfort among investors in both the Dexia long dated assets in Dexia MA. In the latest instance we is- story and in the financial instrument that we offer. sued in five years, but we are keen to issue longer. We are in This is clearly linked to the drastic change in our funding that respected interested in the sterling market’s possibilities strategy, coming from being a mass issuer in the years 2009 for longer dated issuance. and 2010 to a much more modest issuer, with a very standard product, the Dexia MA obligations foncières, notably. That, A Gyss: We have begun to educate UK investors regarding the we believe, is a very good stepping stone to start the second Dexia MA credit. The French SCF framework is not always part of our funding programme for the year. easy for UK investors to understand, especially for those coming from an RMBS background, so there is a lot of work On spreads: “The result of the to do there, both in terms of the legal framework under which recent history of the we operate, and of course explaining to them what the assets within the cover pool are. Of course in the UK there aren’t Dexia group” really any public sector backed covered bonds, so there is a lot of work to do in terms of explaining what the public sectorQ What can we expect in terms of issuance in the rest of the entities are, what kind of risk they represent, and how dis- year? tinct this risk is from central government risk, for instance.A Van De Moosdyk: We have been communicating on the dif- Discussions in that respect have been very constructive, ferent programmes in order to make this very clear to the in- with UK investors keen to better understand Dexia MA. vestor base. Regarding Dexia MA’s programme, we have communicat- ed three to a maximum of four benchmarks denominated in Dexia MA’s asset breakdown by country euros for 2011.This means we will come back to the market as at December 31, 2010 with one or two transactions — if market conditions allow Luxembourg Sw itzerland Spain it, of course. 6.2% 0.3% 0.1% Italy Germany We have also indicated that Dexia MA will achieve its target 10.3% 1.0% by diversifying its investor bases as much as possible, by issuing Belgium United 10.6% Kingdom in currencies other than euros in 2011 and the coming years. 0.9% Regarding Deutsche Kommunalbank Deutschland, we have also said that they will issue euro benchmarks this year. Sweden 0.5% They have already issued one and, if market conditions allow, Greece 0.6% they could execute three or maybe four transactions this year. Others Austria 0.4% 2.4% United States 0.3% Iceland 0.2%Q You mentioned other currencies — what do you have in France Portugal 0.2% 68.2% Finland 0.1% mind? Dollars has been very active and Aussie dollars, Japan, Canada, where you have issued before, has been reopened. Source: Dexia Ireland < 0.1%A Van De Moosdyk: Those are among the markets that we would like to approach as far as it is possible from a market May 2011 The Covered Bond Report 23
  • 26. SUB-JUMBOS: LOWERING THE BAR Jumbos: LOWERING BARRIERS24 The Covered Bond Report May 2011
  • 27. SUB-JUMBOS: LOWERING THE BAR Growing acceptance of benchmarksbeing less than Eu1bn carries advan- tages for issuers old and new, and the leading index provider is beinglobbied to follow the trend. But could this lowering of the bar result in theloss of privileged status for jumbos at the European Central Bank? By Maiya KeidanS  ub-jumbos accounted for 25 out of 90 benchmark cov- ered bonds issued from January through April of this year, according to figures from Credit Suisse. Compared with 2009, this represents a major increase, as only sev- en issues of at least Eu500m but less than Eu1bn madeit to market last year, in a year when 83 Eu1bn-plus deals came. “It’s gone from being negligible to being a very significantportion in the overall market in no time at all,” says RichardKemmish, head of covered bond origination at Credit Suisse. Bankers say that sub-jumbos gained popularity when themarket was challenging and Eu1bn deals were difficult toachieve. Then, Eu500m transactions came to the rescue. However, as market sentiment has recovered, the rise in is-suers choosing to launch sub-jumbos has had less to do withany difficulties in reaching a billion. “We’ve seen a very robust market this year,” says Jez Walsh,global head of covered bond syndicate at Royal Bank of Scot-land. “With the exception of probably a couple of names, formost issuers, achieving a billion has been very straightforward. “That’s a dynamic that’s certainly changed from some of thedifficult periods last year. Any issuer who has the need or capac-ity to do a billion can do it.” At the same time, Walsh, along with other market partici-pants, acknowledges that Eu500m deals allow greater participa-tion from smaller issuers. “Now you have issuers such as NIBC and Aktia,” he says.“They’re among the issuers who don’t have the funding needs todo billion-sized deals. “They do Eu500m issues, which are very well supported bythe investor base.” The Netherlands’ NIBC Bank, for example, launched its de-but covered bond benchmark in March, a Eu500m three yearissue backed by residential mortgages through LandesbankBaden-Württemberg, Natixis, NIBC and RBS, which was pricedat 105bp over mid-swaps after attracting Eu1.1bn of demand. Ralf Grossmann, head of covered bond origination at So-ciété Générale agrees that the advent of sub-jumbos has helpedsome issuers, from a size as well as a market perspective. “Obviously the size of the deal has to correlate with the over-all size of the issuer,” he says. “A Eu500m deal might be a loteasier to place than one billion; there might be less executionrisk involved. May 2011 The Covered Bond Report 25
  • 28. SUB-JUMBOS: LOWERING THE BAR anced asset-liability management profile,” he says. “That’s the major advantage. It’s of course easier to have your payments on several dates than one bullet. He says that the financial crisis brought such issues to the fore. “I think the rise in popularity of Eu500m deals is because li- quidity risk has become even more of an important factor since the crisis,” says King. “Everyone started suddenly looking at li- quidity risk in covered bond programmes. “Regarding Basel III requirements, you have to hold liquid assets for upcoming maturities, so the larger the covered bond the more you have to hold. And remember you also have the net stable funding ratio.” He adds that the introduction of a leverage ratio will also affect refinancing needs in the medium term. “Lower growth rates on the asset side reduce the need for large issues on the refinancing side,” he says. Small = illiquid? However, King points out that changes to the nature of supply are only possible if the demand side is willing to accept such an evolution. “On the other hand, if investors do not like these issues, it would actually be a huge disadvantage though we haven’t seen this problem in the primary market so far,” he says. Indeed not all market participants are jumping aboard the sub-jumbo bandwagon. Some market participants still fear that Eu500m deals are less liquid, but Grossmann is confident that these naysayers are growing fewer, and even slowly being won over. “There are really only a small number of investors who Frank Will: “The market will still prefer Eu1bn deals don’t like transactions of less than a billion because they be- because they are more liquid” lieve they’re less liquid,” he says, “but the truth is the liquidity is pretty similar when it comes to trading. There’s also nothing to “If the market is accessible with Eu500m, we’ll see more is- say these investors won’t change their minds.suers in the market,” he adds. “This is good for investors, too; “We have to keep in mind that secondary market liquidity isthey’ll have a choice.” more limited overall than it used to be before the crisis, but you can buy and sell Eu500m as you can Eu1bn.” ALM reinforces trend The hardest part of getting sceptics to accept sub-jumbos isIt is not just the smaller issuers hitting the market with Eu500m convincing them that the smaller transactions are as liquid — ordeal either, according to Grossmann. nearly as liquid — as billion-sized deals, say market participants. “There has also been an increase in the number of larger is- King also points out that while investors have reason to be scep-suers doing deals of less than a billion,” he says. “We’ve even tical about the liquidity of smaller issues, even liquidity in theseen Eu500m deals coming out of Germany.” jumbo segment is not comparable to where it was prior to the Eurohypo, for example, which has traditionally been one of financial crisis.the largest issuers in the covered bond market, sold a Eu500m “Unfortunately, there are still investors in the market who won’t10 year transaction in March via Commerzbank, Deutsche, buy deals of less than a billion,” says King. “We’ve spoken to manyHSBC and LBBW. investors and they say it’s still less liquid, but I do think investors These bonds of less than a billion are advantageous to the is- would get used to it if the number of these issues increased.”suer from a regulatory perspective. Rating agencies have said that Kemmish at Credit Suisse, says that factors other than thesmaller individual deal sizes can improve asset-liability match- “blunt” size measure determine liquidity.ing, which can lead to lower required overcollateralisation. “If every other single detail is the same, then yes, the smaller “The main reason why Eu500m deals are better for issuers is deals are less liquid, but the other details are very rarely thebecause of asset-liability management reasons,” says Grossmann. same,” he says. “Take the extreme case of two bonds: both have Landesbank Baden-Württemberg senior credit analyst Jan King a book of Eu800m, one prints Eu500m and one prints Eu1bn.agrees that the smaller bonds offered are beneficial in this respect. The Eu500m one is probably going to be the more liquid bond “The advantage for issuers is that they get to have a more bal- because there’s demand for it. It’s the correct size.26 The Covered Bond Report May 2011
  • 29. SUB-JUMBOS: LOWERING THE BAR “If you print Eu1bn on an Eu800m book, you’ll never see anyliquidity in that.” But others say that the absolute size of a deal can make a dif-ference to the way it trades. “Smaller deals are more difficult to offer,” says Walsh. “Ona Eu1bn deal, even if he hasn’t got the bonds, a trader will stillmake you an offer. “With a Eu500m deal, given there are a lot fewer bondsaround, it’s quite difficult to actually offer. However, the bid willstill be there and to my mind that’s the most important thingwhen we consider liquidity.” And RBS senior analyst Frank Will says that in general themarket will still prefer Eu1bn deals because they are more liq-uid than Eu500m trades. A German fund manager says that widening the “benchmark”net from Eu1bn-plus deals to anything above Eu500m would onlymake his life more difficult, irrespective of any difference in liquid-ity between the two. He says that his credit team would struggle tokeep track of every issuer and focusing on only the more regular— which would typically be the larger issuers able to do Eu1bndeals — is therefore the best strategy for him to pursue. Index reflectionsAnother problem associated with the rise in sub-jumbo issu-ance is that statistics related to Eu1bn-plus deals less accuratelyreflect the state of the covered bond market. This is particularlytrue in relation to their exemption from indices. “Indices are essential,” says King at LBBW. “In general, if youwant to have a picture of the market, you should include these Lucette Yvernault: iBoxx change to Eu500mdeals as well.” “a completely different strategy” In light of this trend, iBoxx has been asked to lower itsminimum size requirement to Eu500m for benchmark coveredbonds. Credit Suisse’s Kemmish told a plenary meeting of the In an effort to estimate the impact of iBoxx potentially lower-European Covered Bond Council at the end of March that the ing its minimum size, LBBW’s King created a hypothetical newmarket related issues working group he chairs had discussed index composition including Eu500m deals as well. He foundthe potential change with the leading index provider. that the weighting in such an index of Hypothekenpfandbriefe “When you look at the reasons for the whole jumbo defini- would increase by 0.8 percentage points and of cédulas hipoté-tion in the first place, most of them have fallen away, really,” he carias 1.1, while Austrian covered bonds’ weighting would rise bysaid. “Perhaps the only outstanding point which is still relevant 0.5. By contrast, France’s weighting would fall by 1.5 percentageis that jumbo trades qualify for the various indices, in particular points through its current covered legal category and 0.5 in itsthe iBoxx index, which is the most important one of them. covered structured. “I think it’s a good idea if iBoxx accepts Eu500m issues,” says “The ECB might reconsider RBS’s Walsh. “For me, more and more investors buy sub-jum- this jumbo rule and recreate bos — in fact there are not many that won’t buy Eu500m deals these days, even though there’s a clear preference for larger one category” Eu1bn issues because of liquidity. “It will mean that traders will have to provide iBoxx with “Now, iBoxx have a cut-off of Eu500m for senior unsecured quotations on the bonds,” he adds, “so that will if anything en-and ABS, so we are an anomaly already.” hance the liquidity of the transactions. So, I think that’s also Kemmish said that several members of the market related something you can look at as a positive.”issues working group felt that this should be addressed. Grossmann says that the potential iBoxx move would repre- “On the back of that, we had a meeting with the people who sent the company following a trend, not leading one.administer iBoxx,” he said. “They have gone to their technical “We already see Eu500m deals on a regular basis,” he says.committee and are now out consulting with a view to, at some “It’s much more common than it used to be even 12 months ago.stage, change the cut-off to Eu500m.” iBoxx is just following the market.” May 2011 The Covered Bond Report 27
  • 30. SUB-JUMBOS: LOWERING THE BAR In the ECB’s courtSome market participants say that even if iBoxx does include Vdp seeks revitalisationsmaller issues, this would not necessarily validate the argument The Association of German Pfandbrief Banks (vdp) isthat they have equivalent liquidity to Eu1bn-plus issues. working with dealers to implement a successor system to “I thought that they wanted a big minimum size in order to market-making aimed at revitalising the jumbo Pfand-qualify it as a liquid index,” says Lucette Yvernault, global port- brief in the eyes of investors and central banks.folio manager at Schroders, “and if that’s what they want they “As we all know, market-making stopped after Leh-should confine themselves to only large issues and not tackle man and since then the whole industry on a Europeanthe smaller ones in the market because there is less liquidity in level has been struggling to find a new standard and itcovered bonds that are less than a billion in size. turned out to be difficult to find a solution,” Jens Tolck- “By the same token, if they want to be an index provider for mitt, vdp chief executive, told The Covered Bond Report.anybody and everybody and they change the criteria for how they “So in Germany we decided to try to find a solution on awant to compete in the market, then they could go for Eu500m. German level to get something going and create some-But it’s a completely differently strategy because so far they claim thing that others may join later, if they think it is feasible.their index is liquid only. If they change it to Eu500m, well, that “The reasons for the initiative are to restore the frame-doesn’t look like a very liquid proposal to me.” work investors were promised when they bought a Jum- Whether or not iBoxx makes the change, questions about bo Pfandbrief,” he adds, “and to secure the special treat-the definition of what is a liquid benchmark have raised re- ment afforded jumbo covered bonds by central banks inlated questions about the way in which the ECB differentiates their liquidity operations. We don’t want to be asked inbetween differently sized transactions. Under its existing col- order to develop something, but want to be pro-active.”lateral framework, “jumbo” covered bonds face less punitive Tolckmitt said that there are two elements to the new project.haircuts than “traditional” covered bonds. “The first is that we will have minimum standards as the “There’s no reason why the ECB should differentiate betweenEu1bn and Eu500m,” says Kemmish at Credit Suisse. “You can “We will concentrate our effortsby all means differentiate between this bond and that bond, butnot on the basis of an arbitrary cut off point of Eu1bn. on prices for investors” “Whether you call it a benchmark, a jumbolino or whatever, ter- basis for Jumbo Pfandbrief that will require price quotationminology is just not that important. Is there room for the concept of syndicate banks to Pfandbrief investors,” he said. “Theof a benchmark if you have the concept of a jumbo? Possibly not.” difference between the old system and the one we want to The ECBC has already moved to describing Eu500m issues introduce is that we will concentrate our efforts on prices foras “benchmarks”, rather than using the term “jumbolino”, which investors, instead of giving prices to the street, too.had become common parlance. “The second element is that we want to replace the Could such considerations mean that the ECB has to look at other fixed bid/offer spreads of the old system – which weremeasures when determining if some covered bonds should get prefer- too tight – with market transparency. This means showingential treatment in its collateral framework? ECB officials have previ- spreads of different Jumbo Pfandbriefe on a daily basisously stated that the market should work to improve liquidity in its to give investors a feeling for where the market is andflagship products with previous jumbo standards having fallen away. whether a price is in line with overall market pricing.” “Overall there are other factors that are important in deter- He said that this would be average prices quotedmining liquidity, but how you measure them or how you define once a day.them is extremely difficult,” says Kemmish. “Whether it’s some- “What we are currently testing is whether this systemthing to do with post trade reporting or pre-trade price report- works,” said Tolckmitt. “We’ve really just started out oning on the vdp proposal. this and it will take a little time to be sure what works.” “I’m not convinced by the proposal to have a daily price,” he The Markets in Financial Instruments Directive (Mifid)adds. “I’m not really sure how it will work because it could be has also been putting transparency on the agenda.manipulated fairly easily, whereas post-trade reporting would “We have known for a year that the EC intends towork and would be much more difficult to manipulate.” extend the post-trade transparency regime that you have Grossmann feels that the ECB discussion is far broader than already for equities under Mifid to the bond markets,”the one surrounding iBoxx that could have negative implica- said Tolckmitt. “That agenda would have helped perfect-tions for the covered bond asset class. ly to move on with this. “The ECB should follow, yes, in a certain logic,” he says. “My “However, we didn’t want to have to wait the extra twoconcern is that the ECB might reconsider this jumbo rule and to three years until it is implemented in national law, butrecreate one covered bond category. to revitalise the former market-making now. Therefore “I would like to keep it as it is, but I think this is very linked our initiative is supposed to be a bridge closing the gapto a political discussion and given that the ECB is not a homo- from now towards Mifid.”geneous block, a consensus can change overnight.”28 The Covered Bond Report May 2011
  • 31. ANALYSE THIS: COVERED VERSUS SENIORBail-in fears unheeded Bail-in fears are said to have driven investors from senior unsecured into covered bonds, but, according to Deutsche Bank head of covered bond re- search Bernd Volk, spreads for some jurisdictions fail to reflect this. And he argues that even forecasts of heavy supply cannot justify tight senior- covered spreads.M  any senior bank bond in- with senior bonds (based on spreads as at tial claim) is sufficient to fully pay back vestors have been driven mid-March). investors (after impairments and refi- into covered bonds by How did we arrive at this conclusion? nancing costs). Cédulas investors would concerns about the po- We estimated issuer default prob- in this scenario thus have a 100% recov-tential impact of bail-ins, which have abilities from the traded prices of sen- ery — or, to put it in simple terms: theycome to the fore in light of the German ior unsecured bonds. This allowed us to would suffer no losses.Bank Restructuring Act, the European establish a pricing link between senior However, given that we wanted to ex-Union discussion paper on bank resolu- unsecured bonds and cédulas. We as- amine whether cédulas are cheap versustion regimes in January, and a significant sumed a recovery of senior debt in case senior unsecured bonds, we preferred tohaircut of unsecured creditors in the case of default of 37.7%. This assumption was consider an — in our view — extremelyof the failure of a small Danish bank. extracted from the senior unsecured conservative scenario and were willing However, in numerous cases, such bond prices of defaulted banks based on to stress test our hypothesis of cédulasas Spain’s Santander and Banco Bilbao Moody’s statistics. cheapness.Vizcaya Argentaria, spreads between We can think of numerous possi- Our pretty tough stress test assump-covered bonds and senior bonds are rela- ble scenarios regarding cédulas in the tions were as follows:tively tight. Examining the relative valu- event of a bank default. A positive and 1. Cédulas are issued up to the maximumation between the cédulas and senior un- indeed quite likely scenario is that the limit allowed given the legally stipu-secured bonds of Santander and BBVA, cover pool (eligible mortgage loans and lated minimum overcollateralisationwe found that three to five year cédulas other loans in the mortgage book on of 25% in relation to the volume ofshould be at least 80bp tighter compared which cédulas investors have a preferen- registered eligible mortgage loans. Santander senior unsecured credit spread and implied default probability curves obtained from traded bond prices 160 16% Bond: Probability of Default 140 14% Credit Spread (bp) Default Probability 120 12% 100 10% 80 8% 60 6% 40 4% Stripped Spreads 20 BondCurve 2% 0 0% 0 1 2 3 4 5 6 7 0 1 2 3 4 5 6 7 Years to Maturity Years to Maturity Source: Deutsche Bank, Bloomberg May 2011 The Covered Bond Report 29
  • 32. ANALYSE THIS: COVERED VERSUS SENIOR2. Other loans in the mortgage book to which cédulas investors also have pref- erential claim are pledged away (for instance, by means of ABS issuance). This means that the legally stipulated minimum overcollateralisation rep- resents the full safety net for cédulas investors. “Another factor toconsider is the future supply of covered bonds”3. In the event of issuer default, there are cover pool losses in value due to credit and market risk. We got the es- timate regarding cover pool loss from Moody’s cédulas performance over- view (based on data as of 30 September Bernd Volk: “Relative value for covered bonds in numerous cases” 2010). However, we highlighted that the cover pool loss used by Moody’s re- fers to the total cover pool and not only BBVA offer at least 80bp spread compres- spread for the instrument with the much the eligible pool. In our view, the credit sion potential versus unsecured bonds, higher recovery value. However, even quality of the eligible mortgage loans even under extremely conservative as- taking into account all uncertainties re- is higher than the average credit qual- sumptions. In our view, the same funda- garding the insolvency remoteness of ity of the whole mortgage book, which mental value for covered bonds versus voluntary overcollateralisation, swap again highlights the conservativeness senior bonds applies also in the case of counterparties or whatsoever, a signifi- of our approach. other countries where covered bonds cant difference in expected recovery val- The recovery value we calculated is trade close to senior bonds — particular- ue was not only our assumption for themore than twice as high as the recovery ly in the case of numerous Italian covered calculation, but is also the key character-value assumption for senior unsecured bonds, for example. istic (or better, the definition) of coveredbonds. Moreover, the following argu- Admittedly, one probably does not bonds.ments again suggest that our approach need to be a genius to agree on the re- While details might be very differentwas very conservative: sult based on our assumptions. Using from one country to the other, excluding1. Our scenario implicitly involves the the same probability of default but sig- for a moment price distorting political acceleration of cédulas, which is likely nificantly different recovery values will intervention, there should be relative val- only in the absence of liquidity. of course suggest a significantly tighter ue for covered bonds versus senior bonds2. We believe it is reasonable to conclude that there will likely be only a few buy- European bank redemptions - senior, covered and government guaranteed ers of defaulted unsecured bonds in 800 this environment. The realised senior Gov GTD 700 unsecured recovery could therefore be Covered 600 Senior materially lower than the recovery rate of 37.7% that we have used. 5003. We have assumed that the part of the 400 mortgage book that is not part of the 300 eligible pool is pledged away. This 200 would also be a significant drag on the 100 recovery value for senior unsecured 0 creditors. 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Overall, as mentioned above, we con- Source: Deutsche Bankcluded that cédulas of Santander and30 The Covered Bond Report May 2011
  • 33. ANALYSE THIS: COVERED VERSUS SENIORin numerous cases. Generally: “You cannot put a pricetag on safety.” Transfer this old saying toinvesting in covered bonds versus seniorbonds and relative value seems obviouswhen both products are trading tight toeach other. Supply plays both waysWith Eu115bn of new issuance of eurobenchmark covered bonds and $16bn(Eu11.2bn) of dollar benchmark coveredbonds as of 16 May 2011, there has beenrecord issuance in 2011 year to date. Despite the fundamental value in cov-ered bonds versus senior bonds that was “Covered bond supply (intentions) are likely to remain high” “Where senior was, there covered shall be”confirmed by our quantitative valuation,another factor to consider is the futuresupply of covered bonds. Large supply orsupply intentions of covered bonds maycause spreads to remain wide. Given that senior, covered and gov-ernment guaranteed paper are used in-terchangeably for term funding it makessense to look at total European bank termfunding redemptions. Total bank bond redemptions (sen-ior, covered bonds and state guaranteedbonds combined) of more than Eu3.2trin the next three years is a quite substan-tial number. In fact the near Eu700bn runrate per year is similar to the record issu- particularly given further increases in the case of banks with weakening creditance we saw in 2009. the overcollateralisation requirements profiles, senior investors may realise that Given the on-going investor concerns of rating agencies), in our view, this is their claim is becoming worth progres-regarding burden sharing in the case of not the case for the majority of issuers sively less — potentially also via issuerssenior bank bonds, regulatory privileges of covered bonds. The most obvious protecting covered bond ratings withfor covered bonds in Basel III and Sol- example is Italy, where covered bonds higher overcollateralisation. Moreover,vency II, and banks’ interest in reducing account for less than 2% of domestic political support for senior bondholders,funding costs, it seems likely that banks banking system assets. while probably continuing for some timewill try to shift even more refinancing On-going high supply of covered longer due to contagion concerns, it mayneeds to covered bond issuance. Hence bonds in turn leads to increasing subor- not be sustainable forever.covered bond supply (intentions) are dination of unsecured creditors. Hence, Overall, while we are not convincedlikely to remain high. while high supply of covered bonds may that covered bonds are a silver bullet for While there are factors that may act keep the spread between senior bonds a financial system stuck in crisis, it seemsagainst a significant further increase in and covered bonds tight in the short to difficult to argue that covered bondssupply (for example, at least some issu- medium term, it may increase the differ- are not cheap versus senior at the tighters may run out of eligible collateral, ence in fundamental value. Especially in spreads many have traded at recently. May 2011 The Covered Bond Report 31
  • 34. COVER STORY: LABELS & LIMITS32 The Covered Bond Report May 2011
  • 35. COVER STORY: LABELS & LIMITS The measure of an asset class As covered bonds become an increasingly important pillar of the new globalfinancial architecture, the need to define and delineate the asset class increases.A labelling initiative has been embarked upon to this end. But can the needs of regulators and investors be squared with those of issuers? By Neil DayF  or all the enthusiasm with which issuers, regulators tory of creating products that are not really useful except for and investors have embraced covered bonds lately, those that are creating them. And you have a lot of creative they have yet to agree upon what should constitute people out there who would like to be more busy than they a covered bond. And in a world where regulators are are today! keen to dot every “i” and cross every “t” — after so- “Too much dependence on ratings turned out to be dangerousphisticated financial instruments created in the years before the and is not a solution going forward. It’s quite natural that if thecrisis failed to live up to their descriptions —boundaries need to authorities are going to give preferential treatment to a product,be clearly drawn. the same authorities should also “My starting point is that if “The private sector has a well define the product, make sureyou are introducing new regu-lations where you mention the known history of creating products quality standards are met, and be observant towards attemptswords ‘covered bond’ — the that are not really useful” at unwanted regulatory arbi-bail-in discussion, ECB hair- trage, which are inevitable.”cuts, Solvency 2, Basel III liquidity buffers — then you need Market participants say that this is particularly importantto define what a covered bond is, what it should include,” says given the privileged status that covered bonds are set to enjoy,Claus Tofte Nielsen, chairman of the Covered Bond Investor such as lower haircuts with central banks, eligibility for liquid-Council and senior portfolio manager at Norges Bank Invest- ity buffers, exemption from bail-ins, and preferential treatmentment Management. in Solvency 2. Any failing in such a pivotal asset class could He argues that market forces alone cannot be left to deter- therefore have far-reaching consequences in the new global fi-mine what is and what is not considered to be a covered bond nancial architecture.that enjoys preferential treatment. “If you look at the position it is being afforded by the regula- “You cannot leave it up to the private sector to define that,” tory authorities, the covered bond looks like the holy grail ofsays Tofte Nielsen. “The private sector has a well known his- rescuing the banking system,” says a German fund manager. “If May 2011 The Covered Bond Report 33
  • 36. COVER STORY: LABELS & LIMITSwe do have a failure as a result of what is in some cover pool it should not be so broad as to be ineffective. It could, he added,then I’m not sure the market will distinguish between what is be “a big resource saver” for investors and regulators.behind all the different countries and types of issuance, and the A meeting between the ECB, ECBC members, and other in-whole thing could come tumbling down. terested parties, such as the CBIC, followed on 29 April, and the “You therefore really have to have a high level of detail in project is now centre stage. As Antonio Torío, chairman of thedetermining what a covered bond is, and that is why I really European Covered Bond Council, told The Covered Bond Re-strongly support the labelling idea.” port: “The covered bond labelling initiative is at the top of the ECBC agenda, and together with the transparency initiatives Calling time represents key milestones in the roadmap for the regulatorySuch thinking has crystallised in the form of the labelling ini- recognition of the value of the asset class. The ECB has beentiative that is being handled by the European Covered Bond closely following the progress of these initiatives.Council, with the European Central Bank acting as, in its ownwords, a “catalyst”. “We are ready to play a role of Michel Stubbe, head of the market operations analysis divi-sion at the ECB — speaking as an expert without prejudging catalyst at the ECB”any decision of the ECB governing council — expanded upon “The covered bond labelling initiative, led by the ECBC, isthe institution’s support for the initiative at a plenary meeting of further reinforcing the cooperation among covered bond stake-the ECBC at the end of March. He underlined the wide range of holders in order to consolidate the nature of this asset classchanges the European financial markets are undergoing in their based on three pillars: quality, transparency and liquidity.”structure and supervision, and said that covered bonds were af- The possibility of addressing the transparency aspect throughfected by many elements of this. incorporating the CBIC transparency standards in any labelling “The covered bond market is really at the intersection of is being discussed (see article in Monitor: Legislation & Regula-these many different directions of financial reform,” he said, tion), while possible moves towards post-trade price transpar-“both from the issuer perspective and the investor perspective.” ency are being worked on at the ECBC to improve liquidity. He said that it is very important that this is addressed in a The industry is not embarking on the labelling initiativeforward-looking way. solely from a technical perspective. At stake is potentially better “We believe that the labelling initiative is indeed a good basis treatment than that on offer under existing central bank repoto carry forward this continuous improvement of the covered operations.bond market in line with the challenges to come,” said Stubbe. Various comments from the ECB have been taken as sug-“We are ready to play a role of catalyst at the ECB to make sure gesting that covered bonds meeting meaningful labelling crite-that the industry makes good progress.” ria could see their lot improve. For example, further comments Stubbe said that a label must create a boundary between from the ECB’s Stubbe at March’s ECBC plenary:what is and what is not a covered bond. He said that it would “If then it appears that with experience the label really makesalso involve “value-added services”, such as transparency a difference, this would have to be taken into considerationabout products — something being addressed by the Covered when reviewing collateral frameworks,” he said. “But only if aBond Investor Council through national data templates and label really makes a difference, in particular with regard to li-the ECBC through its comparative website — and post-trade quidity.”transparency. This is one half of what some market participants under- Stubbe said that while a definition did not have to be narrow, stand to be a “carrot and stick” approach from the ECB in its self-declared role as “catalyst” in the labelling initiative. ECBC essential features: But while lower haircuts in the ECB collateral framework would clearly represent the carrot, what stick is the ECB seen - to be wielding? - No-one has mentioned covered bonds facing worse treat- lic supervision and regulation; ment than the status quo, but the industry is, of course, lobby- - ing for the asset class to receive better treatment under Basel III. nancial assets in priority to the unsecured creditors of The European Commission is yet to come up with its final plans the credit institution; for CRD IV, which will mark the implementation of the Basel III framework in the European Union, and efforts for covered bonds to be treated more like sovereign debt in the model’s li- quidity buffers continue. - The essentials A previous ECBC-led initiative to come up with a definition of a covered bond did not ultimately claim to do so, but rather ended34 The Covered Bond Report May 2011
  • 37. COVER STORY: LABELS & LIMITSup with the “essential features” of a covered bond (see box). “These common essential features should be understood as UCITS 22 (4)the ECBC’s minimum standards for covered bonds,” said theCouncil. - The essential features came with explanatory notes and were,according to the ECBC, “intended to be read independently” -from other definitions or interpretations of covered bonds. Themost often quoted of these — and that which has provided abackstop definition of covered bonds in the absence of better al-ternatives carrying any legal weight — is UCITS (Undertakingsfor Collective Investment in Transferable Securities) Article 22(4) (see box for ECBC summary). - In turn, covered bond treatment under the Capital Require-ments Directive is based on UCITS 22 (4), but narrows down Source: ECBCthe range of assets eligible and adds certain criteria for them(see box). However, no definition has yet been arrived at that is more and commercial mortgages, the bill would allow cover pools todetailed and to the satisfaction of those in charge of doing so. comprise home equity loans, auto loans or leases, student loans,This is attributed to the difficulty of finding a definition that credit or charge card receivables, and small business loans —covers all those bonds that instinctively should be included — and even leaves open the option of the Treasury Secretary add-although differences over just what should qualify have also ing further categories.hindered progress. Some market participants have warned against allowing is- suance backed by such a broad range of assets. Among them is “The diversity of structures Jens Tolckmitt, vdp chief executive, “One of the big advantages today in Europe — and this is something that we want to make sure of by creating a label — is market shows that that we have a more or less genuine asset class,” he says, “and it opinions vary” is genuine because it is based on similar types of high quality assets all over Europe. And obviously if you had a big market “The diversity of structures launched in the covered bond coming to this global covered bond market and defining assetsmarket shows that opinions vary as to how the issuer’s interest in a totally different way, that would certainly be a certain dan-in low funding costs can be combined with investors’ interest in ger for the genuine asset class we know in Europe.the highest possible level of security while at the same time pro- “That does not mean that we would not in Europe be abletecting the interests of other, unsecured creditors,” says Bernd to differentiate ourselves from this kind of emerging market inVolk, head of covered bond research at Deutsche Bank. covered bonds. But obviously there is a certain interest — and An example is the use of mortgage backed securities in cov-er pools. While most participants would rather these were not According to the CRD, covered bonds benefitnormally included in cover pools — including the ECB, accord- from privileged credit risk weightings only ifing to an opinion published last year — the number of covered they fulfill the following requirements:bonds using MBS as a means to transfer collateral from one part -of a banking group that originates mortgages to another thatissues covered bonds has only increased. A waiver allowing is-suers to do so was extended temporarily under CRD III. Diversity an asset?The question of how broad the asset class should be allowed togrow — or at least that part that enjoys preferential regulatory – Exposures to institutions;treatment — is one that countries in the process of drawing upcovered bond legislation are also faced with. Such jurisdictionsinclude Australia, Canada and the US. The latest iteration of draft US legislation — the UnitedStates Covered Bond Act of 2011, introduced by Republican must meet certain minimum requirements regardingCongressman Scott Garrett — envisages covered bonds backed mortgage property valuation and monitoringby a wider range of assets than are used in any country that al- Source: ECBCready has a market. As well as public sector debt and residential May 2011 The Covered Bond Report 35
  • 38. COVER STORY: LABELS & LIMITS lack of a covered bond framework in Korea make for a compli- cated structure and many traditional market participants said that it simply was not a covered bond. Among those deeming the transaction worthy of considera- tion as a covered bond was Moody’s, which along with Standard & Poor’s assigned the deal a triple-A rating. Volker Gulde, vice president, senior analyst at Moody’s, says that the qualification necessary for treatment as a covered bond by Moody’s are simple. “We need direct recourse to the issuer first and foremost, and then a segregated pool of assets, so we’ve two ports of call as an investor,” he says. For Moody’s, the key determinant of whether or not an asset type can be incorporated into the rating agency’s covered bond analysis is how quantifiable its risks are. “For as long as we can assess the credit risks stemming from the assets, there shouldn’t be a restriction on the types of assets,” says Gulde. “For example, Kookmin includes credit card receiv- ables and is a Moody’s-rated covered bond, and rightly so.” Meanwhile, Moody’s has been less impressed by Germany’s Schiffspfandbriefe. Last year the rating agency revised its rat- ing methodology for structured finance transactions backed by “For as long as we can assess the credit risks stemming from Bert Ely: “walk before trying to run” restriction”that is what I understand also from other countries — to keep shipping loans, which led it to take a more conservative viewthe asset class of covered bonds as genuine as possible.” on cover pools comprising such assets. This resulted in it cut- He argues that there are qualitative differences between the ting the uplift above issuer ratings that Schiffspfandbriefe cantypes of assets that make up the backbone of the European mar- achieve from two notches to one.ket — public sector debt and mortgages — and those envisaged This has had concrete consequences for HSH Nordbank, theunder the draft US legislation. only issuer so far of a benchmark Schiffspfandbrief. Its shipping “One reason is that these asset classes are long term assets, backed issuance is rated A2, one notch above the issuer’s A3 rat-and it’s always convincing if you have assets that are at least ing, compared with the Aaa ratings it enjoys from Moody’s forlong in their maturity as the outstanding bonds,” he says. “Sec- its mortgage and public sector backed covered bonds.ondly, these are asset classes — as well as by the way, ships and Even some traditional German investors, who are happy toaircraft — where you have actually an asset to back the loan, afford the Pfandbrief special treatment in several respects, areto secure the loan that you grant as a bank, which is from my cautious about Schiffspfandbriefe — and even more so regard-point of view one of the key characteristics of the asset classes ing Flugzeugpfandbriefe, which have yet to be issued but arechosen so far. possible under the Pfandbrief Act. “You have a safety net around these assets that give inves- “I was not happy to see Flugzeugpfandbriefe in the Germantors in covered bonds the safety to have a direct claim on these Pfandbrief law,” says one. “And not even ships.”assets, and you cannot say that for other asset classes, and espe-cially those that are being discussed in the US.” Time to decide Meanwhile in the US, opinions differ as to how best launch a US covered bond market. Bert Ely, a financial institutions andIt is not only in jurisdictions where legislation is pending that monetary policy consultant in Washington, says that the USthe question of appropriate asset classes has been an issue; this should “walk before trying to run”.much is clear from an on-going argument over whether or not “My sense is to start off with just a few typical classes of as-Asia’s first covered bond was a covered bond at all. sets — mortgages of all types and public sector loans,” he says, In 2009 South Korea’s Kookmin Bank sold a $1bn five year “before trying to broaden covered bond eligibility to other as-deal backed by a mix of residential mortgages and — never be- set classes.”fore included in a covered bond — credit card receivables. The But others — in some cases the underemployed struc-36 The Covered Bond Report May 2011
  • 39. COVER STORY: LABELS & LIMITS Jens Tolckmitt: “You have to decide between two objectives”tured finance bankers referred to by Tofte Nielsen — con- it is a high quality instrument for investors to buy into as a sub-tinue to push for a broad range of asset classes. Some pro- stitute for government bonds that they will continue to hold asponents of this approach also suggest that the covered bond a safe haven during a crisis. Or you can create something to re-initiative will gain broader political support in Washington finance a larger part of the balance sheet but which will attract aif it is seen to be supportive of more parts of the consumer totally different investor base that will not necessarily stay withfinance market than just mortgages — and indeed mortgage the product if times get tough.”finance remains perhaps the fiercest battleground given thatFannie Mae, Freddie Mac and the Federal Home Loan Banks Will it add value?retain their cheerleaders. Not everyone is convinced that a label will make a big difference Meanwhile, north of the border, Canada’s Department of to the fate of the covered bond market.Finance has restricted eligible assets under proposed legisla- “I’m not sure about the need for trade or government bodiestion to residential mortgages only. Again, the reason for this to be active in this field,” says Georg Grodzki, head of credit re-appears to be partly political in nature, with market partici- search at Legal & General Investment Management. “Investorspants anticipating that it will smooth the passage of the law are perfectly able to analyse and differentiate covered bonds(see Monitor: Legislation & Regulation for more on the Cana- without official labels for some or all of them.dian proposals). “Given that even credit rating labels are largely ignored these The vdp’s Tolckmitt notes that when discussing the potential days I can’t see other labels adding any value and wouldn’t mindshape of US legislation, he is not being critical, but merely giv- if the initiative is abandoned.”ing recommendations on how the US can achieve its targets as He argues that any label should not be a short-cut for inves-he understands them to be. tors or could mislead them. “My understanding is that the US wants to create a stable “Investors need to take full responsibility for their analyses andfunding instrument that works in times of crisis, but the draft decisions,” says Grodzki. “It should be down to investors to decidelaw gives the impression that they are planning to introduce which legal frameworks provide sufficient clarity and protectiona funding instrument that covers a larger part of the balance and if issuers offer sufficient disclosure and collateral quality.”sheet,” he says. “And I think that you have to decide between But other investors say that while there is validity to this linethese two objectives. of thought, there are advantages to having a label. “You can either achieve a stable funding instrument, because “Yes, you can always make the argument that investors can May 2011 The Covered Bond Report 37
  • 40. COVER STORY: LABELS & LIMITS Ships in Hamburg: HSH Nordbank Schiffspfandbriefe face limitssimply make up their own minds,” says the German fund man-ager. “But for me it is rather sensible to have some market guid- “I would strongly disagree withance — particularly for the kind of new, less well educated in- anything that led to differentvestors we are seeing — so that they really know what is in thepackage that they have bought into. “We are still introducing investors to the market,” he adds,“particularly in countries like Australia and the US. Maybe thebig ones understand more than they did a couple of years ago In the past, not everyone has been satisfied with the waywhat a covered bond is and what its typical features are. But the in which different regulators have interpreted UCITS. Forrest? I’m not sure about that.” example, when the first UK structured covered bonds were He says that a label would help in this respect. issued, some market participants in more traditional juris- “It’s really about getting the market more mature, more edu- dictions disagreed with the FSA’s interpretation of UCITS’cated, and this can be strongly supported by an official label say- requirement for special supervision of covered bonds. Whileing: ‘This is a covered bond,’” says the fund manager. “Everybody this was mainly the result of the different fundamental legalneeds to do his own homework and make his own judgement systems in the UK and on the continent, and the introduc-and all that, but at least you would have some kind of guidance tion of Regulated Covered Bond legislation made it a mootand a framework that could lead people to some extent.” point anyway, some market participants say that there could And while the labelling initiative is now connected to the be similar problems with labelling if there is no EU-wideCBIC’s proposed transparency standards, the former is by no harmonisation and control.means a pre-requisite for the latter. “I would strongly disagree with anything that led to different Just how a label is implemented could also have in impact national labellings of what a covered bond is,” says one investor.on how useful investors find it. One analyst says that his un- “The whole idea would then be useless.derstanding of current thinking is that this would involve some “I would strongly advise that the ECB and ECBC lead thekind of self-certification, with the ECBC verifying that the la- way in ensuring that there is a proper uniform labelling.”belling standards have been met. Another market participant However, a market participant involved in discussionssays that he expects labelling to be implemented at a national around the labelling project says that issues of potential li-level, much in the same way that compliance with UCITS is ability and compliance may mean that such wishes cannot bedetermined by national regulators. practically met.38 The Covered Bond Report May 2011
  • 41. The CoveredBond ReportThe Covered Bond Report is not only a magazine, but also awebsite providing news, analysis and data on the market.Are you a covered bond investor?Then you could be receiving free daily news bulletins fromThe Covered Bond Report and access to its coverage of the market as wellas its proprietary database of new issues and cover pool data links.If you would like to gain complementary access toThe Covered Bond Report’s website and to receive freecopies of The Covered Bond Report’s magazine, contact Neil Day,Managing Editor, at nday@coveredbondreport.com or visitnews.coveredbondreport.com to register*.*Investors directly linked to covered bond issuers may not qualify for this offer.
  • 42. ASIAN DEMAND: IN TRANSIT German pavillion, Shanghai Expo 201040 The Covered Bond Report May 2011
  • 43. ASIAN DEMAND: IN TRANSIT Covered bond issuers have long sought to sell their wares to increasingly wealthy Asian investors. But although the identities and behaviour of the biggest Asian players are, in the words of one banker, the bond market’s “worst kept secret”, the extent to which they want to buy covered bonds is unclear. Recent successes have nevertheless suggested attitudes could be changing. By Neil DayW  hen Svenska Handelsbanken subsidiary There also been some buying of cédulas by Asian investors.” Stadshypotek launched a Eu1.5bn five The cédulas hipotecarias market has been the most volatile year at 31bp over mid-swaps in early covered bond sector where deals have still been feasible this May, the Swedish borrower sold 26%, or year, but Barcelona’s La Caixa in mid-April was able to place Eu390m, of the deal into Asia — prob- 12% of a Eu1.25bn five year issue (i.e. Eu150m) into Asia whenably the largest amount into the region any covered bond issuer it accessed the market in mid-April at 195bp over mid-swaps.has achieved in one go since the onset of the financial crisis. This coincided with central bank distribution of 12.8%. “The central bank participation [34%] and Asian participa- A banker at one of the leads noted that the unusually hightion were notable,” says Edward Markham, syndicate manager Asian share came on the same day that Chinese premier wasat Goldman Sachs. “The issuer has been doing a lot of roadshow reported as having told Spanish prime minister Jose Zapaterowork in the region and that clearly paid off.” that China would invest in Spanish savings banks and continue The issue was just one of several this year where Asian distri- buying Spanish government debt. That initiative was just one ofbution has crept past 10% into the teens and occasionally higher. several whereby the Chinese have made commitments to Eu-Could this be the beginning of a comeback by a regional investor rope’s weaker economies.base that dramatically scaled back any participation when cov-ered bonds were caught up in the volatility of the crisis? Brand recognition “They’re dipping their toe back in the water,” says Markham, Ted Lord, head of covered bonds at Barclays Capital, says that“but clearly they have the capacity to be a lot bigger going for- while Asian accounts are looking at a wider range of credits,ward if things go right from here.” they remain selective. The growth in the reserves of Asian official institutions tells “They tend to favour national champions from countriesa simple story that backs this up. with good businesses,” he says. “Rather than saying we are open Dhiren Shah on Credit Suisse’s covered bond and SSA syn- to all UK covered bonds, we may be open to one or two strongdicate says that covered bonds are capturing Asian investors’ UK names. Instead of being open to all Norwegian coveredattention in much the same way that the profile of the asset class bonds, they may be open to one Norwegian issuer.has been raised globally. “They’d rather diversify geographically,” he adds, “as long as “Covered bonds are getting a lot more focus from a regula-tory standpoint,” he says. “And such factors are playing a rolewith Asian investors, too. “We also saw some Asian interest coming in last year on theback of the support the European Central Bank gave to the cov-ered bond market through its purchase programme.” Pre-crisis, Asian demand was said to have been concentratedon those covered bonds that traded at the tightest levels, name-ly German Pfandbriefe and some obligations foncières issuers,and mainly public sector backed collateral. However, althoughthe amounts of covered bonds sold into Asia this year mightstill be too small for any firm conclusions to be drawn, some is-suers from outside this previously elite circle have already madeinroads into Asian money. “Initially the Asian investors were very much focussed onGerman Pfandbriefe and obligations foncières and then thenext stage was that they would only consider legislation basedcovered bonds,” says Shah. “They wouldn’t look at any form ofstructured covered bonds. “It’s been a slow transition, but they are now broadening Ted Lord: “They tend to favour national champions”their remit to look at other jurisdictions, namely the Nordics. May 2011 The Covered Bond Report 41
  • 44. ASIAN DEMAND: IN TRANSIT ra. “And the names from the pre-crisis era are still names that Dhiren Shah “They are now broadening their remit” can capture their attention. “Certain French traditional obligations foncières issuers re- main the best known brands in terms of covered bond issuance in Japan in spite of any issues they may have faced in the last couple of years. So as long as you are a tier one player and they “The reality is that the number has not increased dramatically” recognise the brand, that’s really more relevant than, for exam- ple, the underlying cover pool being public versus mortgage.” Playing it, Safe? Germany’s Pfandbrief issuers also returned to Asia in Janu- ary for an annual Association of German Pfandbrief Banks (vdp) seminar they have been running for several years. And after Thomas Sommer, member of the managing board of Westfälische Landschaft Bodenkreditbank gave a presentation on mortgage Pfandbriefe to the Japanese audience the issuer achieved 5% distribution to Asia with a Eu1bn five year mort- gage Pfandbrief at 11bp over mid-swaps in mid-May. However, according to one market participant that Eu50m went not to Japanese investors but to one Asian central bank. And a funding official at one covered bond issuer says that any pick-up in Asian interest in covered bonds should not be over- stated, with the Central Bank of Malaysia and the Bank of Korea accounting for the lion’s share of tickets.they feel very comfortable about the basic business of the bank, “The only two investors at the moment are the Central Bankbecause who wants to buy a covered bond from an issuer that of Malaysia and South Korea,” he says. “If they take Eu50m ofgoes into insolvency? Yes, they will get their money back, but your issue, that’s a nice ticket.think about all the internal headaches they’d have to go through.” “But you’re talking about concentrating on just two single Barclays Bank sold 14% of a Eu1.5bn five year Regulated accounts from the whole Asian universe. This isn’t really any-Covered Bond to Asian investors when it came to market at thing, is it?”58bp over mid-swaps in early April. He says that Safe and other accounts, like the Central Bank “It’s really a question of the name,” says Markham at Gold- of the Republic of China (Taiwan) and Hong Kong Monetaryman Sachs. “Some of the people in Asia who bought the Stad- Authority are not part of the market.shypotek issue, they decided to look at covered bonds again, “People tell you so many different stories,” says one marketbut only the best names in what they consider to be the best participant, “but my understanding is that the credit depart-jurisdictions, and Stadshypotek is arguably the strongest bank ments of some central banks are forcing these guys to invest inin the Nordic region and clearly Sweden is a strong jurisdiction zero risk weighted assets. So while they may like Germany theyin the context of all of Europe. are not buying Pfandbriefe but things like KfW and NRW Bank. “So it was a good fit for them. Likewise, if you had somebody “It’s not because they don’t like covered bonds,” he adds. “It’slike a Deutsche Bank in Germany, that would be of interest. But their management policy since the crisis to invest into govern-they are still shying away from second tier names and weaker ment risk.”jurisdictions.” Armin Peter, head of covered bond business and syndicate But despite the changes to the pecking order in the European at UBS, also says that any pick-up in Asian interest, althoughcovered bond market since the onset of the crisis, those issu- welcome, should not be overstated.ers that took the time and effort to build an Asian following “In the covered bond space there is the occasional transac-beforehand have not lost all their supporters by any means. An tion where the distribution into Asia is higher,” he says. “Butexample is Dexia Municipal Agency, which sold 16% of a Eu1bn the reality is that the number of accounts has not increased dra-five year to Asia in early May, despite its profile having changed matically.dramatically since 2007. “However, an Asian account can make a difference given that “Asian investors are once again looking at Euro FIG names,” we are normally talking about central banks who will get full al-says Marko Nikolic, head of covered bond origination at Nomu- location, which can clearly impact the distribution figures.”42 The Covered Bond Report May 2011
  • 45. ASIAN DEMAND: IN TRANSIT What would really make a difference, says one issuer, would limited, mainly to insurance companies (see table).be if China’s State Administration of Foreign Exchange (Safe) “It found that only certain types of insurers, casualty insur-were to be a big player in covered bonds, given that it is the ers, were affected,” says Nikolic, “and in relation to coveredbiggest Asian account of them all. But he is not yet convinced bonds, that means that only one of the buyers we previouslythis is the case. saw has not been active in the past one and a half months since “Supposedly Safe is thinking about covered bonds again,” he the new financial year started in Japan.says, “and apparently they even participated in some trade, but “Other than that, if anything, what’s happened is that sinceI’m not so sure.” there has been very limited issuance in the domestic space, Several covered bond bankers nevertheless say definitively all of a sudden many of these investors are sitting on a largethat Safe is returning to covered bonds — even if most bankers amount of assets to deploy and they are looking for any kind ofare cautious about discussing the Chinese account for fear of triple-A rated paper they can find.”upsetting the institution. He says that this has even extended into senior unsecured “Safe has been coming back to the covered bond market,” and samurai issuance, for example a ¥140bn deal for HSBCsays one. that was the largest samurai trade since the collapse of Lehman Another says that, with the aforementioned central banks Brothers.of Malaysia and South Korea, there is a significant increase in “So the rest of the investor audience has not been affected byAsian participation in the asset class. the tsunami at all,” says Nikolic. “Traditional Asian central banks, whether they are located Indeed he says that some accounts that had not been seen inwith their office in the UK or back in Asia, are increasing the the covered bond market before have been coming in for ticketssize of their tickets, yes,” says a syndicate official. “So you can of Eu20m-Eu30m, while some old hands have returned to thecall it a trend.” asset class, albeit for Eu50m rather than Eu100m tickets, and He even argues that they never fully withdrew from the market with more questions on underlying credit stories. “They were still there during the crisis — Malaysia, Bankof Korea, Safe, etc — but the frequency is higher now, and the JAPANESE INVESTOR BEHAVIOUR POST-EARTHQUAKE Investor type Recent trend “Only certain types of insurers, Life insurance Major life insurance companies announced broad asset allocation policy for the new fiscal casualty insurers, were affected” year whereby as a whole life insurance compa- nies will increase the allocation for yen bondsticket size on average slightly higher as well.” and foreign curerency denominated bond from last year. Tends to extend duration given the low Barclays’ Ted Lord says that a wider range of Asian official interest rate in Japan.institutions could be participating, too. Casualty insurance Some selling of yen bonds were seen soon after “We have got 10 Asian central banks that are currently in- East Japan earthquake from casualty insurance sector to build more liquidity. Market stabilitycreasing their purchases of covered bonds, some after a long has helped them back in normal on investmentabsence,” he says. “And we have three more that may enter the activities recently.market for the first time within the next three months. City banks Some disaster related lending picked up. However, excessive liquidity position ermains “If you look on the map, that’s actually most of Asia.” unchangend and continue to be active in bond investment. Japan proves resilient Trust banks and Pension accounts have no direct impact from asset managers earthquake. They were are rather active in theWhile central banks and official institutions in other parts of Asia secondary market in April and took advantagecontinue to pile on the reserves, Japan has this year become an of the post-earthquake spread widening in theeven more differentiated part of the region’s investor base because credit markets to buy bonds. Becomimg more active in new issue and secondary market on theof the natural disasters it suffered on 11 March. The earthquake back of new cash inflow in the new fiscal year.and the tsunami and nuclear crisis that followed caused untold Central cooperatives All but one relatively unaffected by the earth-damage to the Japanese economy and in the wake of the disaster quake and would continue to invest in Samurai market.the extent to which Japanese investors might participate in any Central public Investment may be reduced as they are report-new international investments was unclear. accounts edly being asked to provide special loans to Today, some market participants are still sceptical about certain corporates.Japanese accounts concerning themselves with covered bonds. Regional banks On the back of continued excess liquidity, invest- ment in the new issues are very active except for “I believe the Japanese investors are more focused on their those few in Tohoku area.domestic problems now with the economy and of course the en- Regional cooperatives On the back of continued excess liquidity, invest-vironment than buying covered bonds,” says one. “They haven’t ment in the new issues are very active except for those few in Tohoku area.bought covered bonds since Lehman and why they should they Others On the back of continued excess liquidity, invest-change their mind now? I don’t believe that, unfortunately.” ment in the new issues are very active except for But a survey conducted by Nomura at the beginning of April those few in Tohoku area.suggests that the impact of the natural disasters is much more Source: Nomura May 2011 The Covered Bond Report 43
  • 46. SMALL BANKS: REASONS TO BE FEARFUL? Small banks size up pros and cons Some small financial institutions in countries exploring covered bonds for the first time have expressed concerns about being put at a disadvantage. But while bigger banks may have natural advantages in the asset class, mature jurisdictions suggest that these can be overcome or need not be a concern. By Neil Day44 The Covered Bond Report May 2011
  • 47. SMALL BANKS: REASONS TO BE FEARFUL?W  hen the House Financial Services Sub- In the euro market, examples of smaller issuers accessing the committee on Capital Markets & Gov- market with only negligible spread premiums appear to sup- ernment Sponsored Enterprises met on port the argument in favour of covered bonds being a funding 13 March for a hearing on the US Cov- instrument for all institutions of all sizes even more — mainly ered Bond Act of 2011, four witnesses through pooled issuance whereby a specialised covered bondspoke positively of the bill. One was outright hostile. issuer raises funding on behalf of a group of banks. Among various criticisms of the proposed legislation — While SpareBank 1 Boligkreditt matches DnB Nor Bo-which has since been approved after a markup — Stephen ligkreditt with triple-A ratings, Terra BoligKreditt — raisingAndrews, president and chief executive officer of the Bank of covered bond funding on behalf of the Terra-Gruppen of 78Alameda, a community bank in California, argued in his testi- local savings banks and housing co-operative OBOS — has po-mony that a covered bond market would harm the interests of sitioned itself close to the levels of its peers despite its issuessmall and medium sized banks. being Aa2 rated by Moody’s. “Unfortunately, the lion’s share of the benefits of a covered “We haven’t seen any major disadvantage,” says Kristianbond market in the US would be to help the largest banks in Fiskerstrand, funding and risk management at Terra Bolig-the US to the detriment of excellent community banks,” he said. Kreditt. On the Washington stage, Andrews wrapped himself in the However, he puts a large part of the success of the issuerflag and clearly relished the role of the underdog against the down to a focus on the strengths of the cover pool, which com-other witnesses. prises Norwegian residential mortgages. In a report last year “To cut to the chase, I’m going to speak to you today as a com- Terra achieved the lowest Moody’s collateral score of any cov-munity banker,” he said, in his opening remarks. “A banker. Not acapital market individual who’s interested in his investors.” “We haven’t seen any major Whatever one makes of his performance, and contrary tohow he might have portrayed his plight, Andrews is not alone disadvantage”in arguing that covered bonds can skew the playing field in fa- ered bond programme the agency rates, even if it has since nar-vour of bigger banks. In Australia — which has recently had a rowly lost that title.similar debate over the role of covered bonds to that underway Not every issuer is so lucky. Towards the other end of thein the US — Abacus, which represents Australian mutuals, said spectrum is Spain, where multi-cédulas — backed by individualin a submission to a November Senate enquiry that it strongly cédulas issued by several financial institutions — have experi-rejected the notion that covered bonds are pro-competitive. enced a much rockier ride. “It is unlikely that many smaller regional banks would be When the pooled issuance was pioneered a decade ago, theable to access funding through such an instrument,” it said. structures enabled small Spanish savings banks to band together Yet proponents of covered bonds have argued that such con- to issue large, liquid benchmarks and compete with their largercerns are misplaced. International Capital Market Association peers. And with spreads compressed from the top to bottom ofboard member Tim Skeet said at the hearing that small banks the covered bond spectrum, they traded very close to even thein Europe have benefited from covered bonds. biggest names. But since the collapse of Lehman Brothers only “In Europe we do have much smaller financial institutions one such issue has been launched as multi-cédulas have tradedthat have been able to tap into the covered bond market,” he said. wide of anything but Greece, Ireland and Portugal.“For instance, in Norway we have a lot of very small, regional While it is hard to foresee a scenario in which Norway’s jointsavings banks that have collectively come together and have suc- issuance could go the same way, the experience of multi-cédulascessfully competed, including a transaction that came to the US again makes arguments that covered bonds do not discriminatemarket late last year from a Norwegian bank that represented the less convincing.interests of many smaller savings banks from around Norway. “And that actually proves that you can have through the Till death do us partcovered bond instrument the ability for the smaller institu- While the question is one that smaller issuers face in the cov-tions to compete and get the same pricing terms as the larger ered bond market, it is arguably one that is imported from out-institutions.” side the asset class — although this will not necessarily win it more sympathy on the political or public vote. Specialists point Norway versus Spain out that it is the low issuer ratings that smaller institutions tendThe issuer in question was SpareBank 1 Boligkreditt and since to have that handicap them when it comes to covered bonds,then it has gone on to access the US market for a second time, given that Moody’s, Standard & Poor’s and Fitch all cap coveredissuing a $1.25bn five year deal in May. Its pricing, the equiva- bond ratings a certain number of notches above issuer ratingslent of 62bp over dollar Libor, was inside where DnB Nor Bo- in their methodologies.ligkreditt, the covered bond issuer of the Norwegian national “To be quite frank, it’s of course much easier for the bigchampion, had tapped the market in late March and only a few banks to issue a covered bond given that all the rating agenciesbasis points back from where that deal had since tightened to. have linked rating approaches,” says Karlo Fuchs, senior direc- May 2011 The Covered Bond Report 45
  • 48. SMALL BANKS: REASONS TO BE FEARFUL? goes on to issue, rather than using a special purpose vehicle Karlo Fuchs: “It’s easier for the big banks given that rating to issue securities backed by covered bonds, as was the case in agencies have linked approaches” multi-cédulas. Go up, go down While governments — much as they might like — cannot change rating agency methodologies, some market participants point out that they can at least help their smaller institutions win favourable treatment. Christoph Anhamm, head of covered bond origination at Royal Bank of Scotland, says that a way in which governments could help smaller issuers get their best shot at achieving high ratings would be by ensuring that those running cov- ered bonds post-insolvency have adequate access to liquidity — typically from central banks — to ensure favourable rating agency treatment. “If you have a system that allows each covered bond pool, or the administrator of that pool, to achieve a reasonably high de- gree of liquidity following issuer insolvency, then there will be wider room between the issuer rating and covered bond rating,” he says. “So if as a regulator or lawmaker you are concerned about your smaller sized banks being put at a disadvantage be- cause of their lower rating and the linkage in rating method- ologies, then you should consider setting up a system where liquidity is available in such a situation. “The question is always who provides the liquidity,” he adds, “how that is actually structured and what the related costs are. It’s not easy, but it’s definitely something that should be consid- ered and there are ways of working it out.” And although only triple-A ratings will allow issuers totor, analytical manager, covered bonds, at S&P. reach the heights of the covered bond market, they are — as However, smaller issuers grouping together can improve discussed in the context of Terra — by no means a pre-requisite.their chances of creating covered bonds that get the highest rat- Indeed a European survey by Fitch in February found that 88%ings by explicitly supporting issuers that pool their collateral,with the degree of support being given through guarantees or “It really depends on theequity increasing the notching upwards that can be achieved. Market participants say that this is more likely to happen banking model you have”among networks of co-operative or savings banks that have a of investors are open to non-triple-A issues.common mission and history, rather than any institutions that But Terra’s Fiskerstrand points out that rating obstaclesmight come together in a marriage of convenience. The likeli- could rise once more, with Solvency II, for example, discrimi-hood of issuance through what are also known as aggregation nating against non-triple-A covered bonds.models could therefore also depend on the culture of a particu- “We are closely monitoring changes to the regulatory envi-lar country’s banking industry. ronment,” he says. “When you look into the Norwegian market at the Spare- In the US, Ralph Daloisio, chair of the American Secu-Banken, they at least belong to the same group and work to- ritisation Forum board of directors and a managing directorgether,” says Fuchs. “And with Finland’s OP, they are all in the of Natixis, says that there is reason to believe the US could besame boat and the issuing entity also benefits from a joint guar- similarly open to lower rated covered bonds.antee mechanism. “When the US asset securitisation market was created in the “Obviously there it’s much easier from a rating perspective late 80s it was single class triple-A rated securities that wereto see that they all belong together, they are in it for the long issued — very simple, and there was no market for lower ratedrun, and you most likely also can equalise the issuer with the investments,” he says. “But over time we were able to create aother supporting banks.” more expanded menu of credit tranching alternatives. Market participants also stress that aggregation models “Drawing on that experience, I think we’ll see — if we getshould be based on issuers pooling their collateral in the cov- there — a US covered bond market that is initially accessedered bond of a single entity, ideally with a banking licence, that by the large financial institutions. But once investors become46 The Covered Bond Report May 2011
  • 49. SMALL BANKS: REASONS TO BE FEARFUL?more familiar with the technology, the structures and the leg-islative framework, and once there’s some depth and liquidity Ralph Daloisio: “I could certainly see a tiered market”created by that leadership group, I could certainly see a tieredmarket emerging.” Who needs ’em?And some market participants say that even if smaller finan-cial institutions cannot in every country take full advantage ofcovered bonds, it is impossible to say definitively that this is abad thing. At the House subcommittee hearing, as part of his argumentagainst covered bonds, Andrews contrasted the banking marketstructure in the US with that in Germany and Europe, sayingthat while the US has more than 7,000 banks, the latter have“three or four major banks and a small number of additionalinstitutions”. However, his portrait of the German banking system — wherecovered bonds are afforded as much political support as any-where else — is misleading. Despite the high profile issuance ofPfandbriefe by some market heavyweights, there is much more tomortgage finance in Germany than Andrews suggests. “The largest 20-25 savings banks issue Pfandbriefe on a moreor less private placement basis because they have the capacity,”says one banker. “The vast majority of the other 450 savings “The question is: what are you replacing?”banks don’t do Pfandbriefe, but they are still a major playerin the residential mortgage market because they’ve got otherfunding routes. “So it really depends on the banking model you have and the “Has the Pfandbrief harmed them? No. Are they at a disad- structures you have in place in a particular country,” he adds.vantage? No. Does it mean Germany doesn’t have a functioning “The question is: what are you replacing? Senior unsecured, se-real estate market? No — the market is very competitive.” curitisation or deposits?” He says that Pfandbriefe are estimated to finance only up to See sub-jumbos feature for a discussion of the trend towards15% of the total amount of mortgage collateral eligible as collateral. smaller benchmark sizes — a related issue facing smaller issuers. TERRAS INCENTIVE STRUCTURE Moody’s: “The members of the Terra Group are incentivised by gurantee obligations to pass high quality loans to the issuer” Pro-rata framework Loss Guarantee Set-off rights Guarantee First loss guarantee for the portion of Terra BoligKreditt has set-off rights against All banks participate in a 1.00% pro-rata the loan exceeding 50% LTV each bank’s commission for period of framework guarantee up to 3 years Minimum gurantee of NOK 25.000 To be used by TBK if banks fail to meet (EUR 3,138) per loan, irrespective To be used by Terra BoligKreditt, if losses their guarantee obligations, or losses exceed paid guarantee amounts, or a exceed individual guarantees and set-offs 100% of the loan is guaranteed by bank fails to meet its guarantee obligation the bank until the collateral is registered Currently EUR 480 mn Currently EUR 50 mn Currently EUR 38 mn Source: Terra, March 2011 May 2011 The Covered Bond Report 47
  • 50. FULL DISCLOSURE ECBC plenary, Stockholm (clockwise from above): Chairman and chairmen; the CBIC tries to find useful info in an investor report; auspicious conditions; Claus Tofte Nielsen enjoys the day; and, unsatisfied with their discussion at the plenary, the Association of Swedish Covered Bond Issuers tries some- thing different for its subsequent roadshow. Stockholm & Paris Paris in the springtime: Eric Busnel welcomes guests including CRH’s Henry Raymond and Terra’s Kristian Fiskerstrand to a Dexia Capital Markets conference at Hôtel Pershing Hall.48 The Covered Bond Report May 2011
  • 51. The CoveredBond ReportThe Covered Bond Report is not only a magazine, but also awebsite providing news, analysis and data on the market.The Covered Bond Report is the firstmagazine dedicated to the asset class. The CoveredIf you are an investor or issuer with Bond Report www.coveredbondreport.com March 2011an interest in covered bonds, thenyour subscription to The Covered BondReport’s magazine is free.To ensure that you receive everycopy of The Covered Bond Report,please send an e-mail to Neil Day,Managing Editor,at nday@coveredbondreport.com.Alternatively you can enter your To thedetails while registering for our lifeboats! Can covered bonds offer safetywebsite at news.coveredbondreport.com after bail-in panic?– and access to our online offering is Australia Sterling US legislation A whole new ball game UK gains home advantage The FDIC rears its headcompletely free to qualifying investors.
  • 52. Coveredbonds? Aaa/AAA covered bonds backed by mortgages Average LTV of 60.5% Match-funded structure Core capital ratio of 18.5% Largest mortgage bond issuer in Europenykredit.com/irFigures as of 17 March 2011

×