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The Covered Bond Report Issue 1


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The first issue of The Covered Bond Report, published in March. Visit us at

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The Covered Bond Report Issue 1

  1. 1. March 2011 To the lifeboats! Can covered bonds offer safety after bail-in panic? Australia A whole new ball game Sterling UK gains home advantage US legislation The FDIC rears its head The Covered Bond Report THECOVEREDBONDREPORTMARCH2011WWW.COVEREDBONDREPORT.COMNUMBER1
  2. 2. CréditAgricoleCorporateandInvestmentBankisauthorisedbytheAutoritédeContrôlePrudentiel(ACP)andsupervisedbytheACPandtheAutoritédesMarchésFinanciers(AMF)inFrance andsubjecttolimitedregulationbytheFinancialServicesAuthority.DetailsabouttheextentofourregulationbytheFinancialServicesAuthorityareavailablefromusonrequest. We offer you our World of Solutions FIXED INCOME MARKETS Choose a bank which engages its Covered Bond expertise for the sole benefit of serving its clients. Crédit Agricole Corporate and Investment Bank continues to strengthen its global market presence in Debt Capital Markets and in Covered Bonds in particular. When it comes to Debt Capital Markets and Covered Bonds, there is no better partner for issuers than Crédit Agricole Corporate and Investment Bank. January2011 January2011January2011 January2011January2011 January2011 EUR 1,000,000,000 EUR 1,250,000,000 EUR 1,250,000,000 EUR 1,250,000,000 EUR 1,500,000,000 EUR 1,000,000,000 Joint Bookrunner Joint Bookrunner Joint Bookrunner Joint Bookrunner Joint Bookrunner Joint Bookrunner 4.25% French Obligations Foncières Due 2021 3.5% Dutch Legal Covered Bond Due 2018 3.9% French Covered Bond Due 2021 2.75% French Covered Bond Due 2015 4.125% Cédulas Hipotecarias Due 2014 4% Hypotheken Pfandbrief Due 2021 DEXIA MUNICIPAL AGENCY ABN AMRO CAISSE DE REFINANCEMENT DE L’HABITAT GCE BANCO BILBAO VIZCAYA ARGENTARIA ERSTE GROUP BANK AG EUR 1,000,000,000 Joint Bookrunner 2.75% Öffentlicher Pfandbrief Due 2016 BAYERISCHE LANDESBANK January2011February2011 January2011 EUR 1,250,000,000 EUR 1,000,000,000 EUR 1,000,000,000 Joint Bookrunner Joint Bookrunner Joint Bookrunner 5.250% Covered Bond (Italian OBG) Due 2023 4.25% French Obligations Foncières Due 2023 3.25% French Obligations Foncières Due 2016 January2011 UNICREDIT SpA SOCIETE GENERALE SCF CIF EUROMORTGAGE EUR 2,000,000,000 Joint Bookrunner 3.250% Dutch Covered Bond Due 2016 ING BANK N.V. February2011 EUR 2,250,000,000 Joint Bookrunner 2.625% French Covered Bond Due 2014 CREDIT AGRICOLE COVERED BONDS January2011
  3. 3. March 2011 The Covered Bond Report 1 CONTENTS FROM THE EDITOR 3 Aim high MONITOR 4 Legislation & regulation 8 Market 11 People & institutions 14 Ratings BUY-SIDE: ICMA’S CBIC 16 The voice for investors ANALYSE THIS: COVER POOL DISCLOSURE 19 Living with the data deficits Is legal or voluntary disclosure yielding the most useful information? Florian Hillenbrand, senior covered bond analyst at UniCredit, weighs the results and recommends how investors cope with a lack of transparency. 36 16 19 Cover Story BAIL-INS 36 Room for everyone? European Commission bail-in proposals have prompted senior unsecured investors to seek the security of covered bonds, raising fears of an over- reliance on the asset class among the buy and supply sides. But proponents warn that investors have nothing to fear but fear itself. By Neil Day and Maiya Keidan The Covered Bond Report
  4. 4. 2 The Covered Bond Report March 2011 The Covered Bond Report 22 STERLING MARKET 22 UK gains home advantage Last November the first sizeable sterling UK covered bond in four years kicked off what market participants hope could become a stable source of funding. Can UK financial institutions get better results at home? By Hardeep Dhillon COUNTRY PROFILE 28 Australia winds up for delivery After years of watching from the stands, Australia’s banks are taking a run up for issuance as early as the third quarter. The banking industry is therefore hard at work ensuring the right balance is struck between issuer and investor needs in impending legislation. But could RMBS and smaller banks be dismissed cheaply? By Neil Day OBLIGATIONS A L’HABITAT 42 France’s new model The latest fashion in Paris this spring is the obligation à l’habitat. Created by bringing France’s common law covered bonds under a legislative framework, the new instrument offers a new take on an old favourite. As such, can it command couture prices? By Neil Day LEGAL BRIEF 46 US: Today’s reality & tomorrow’s potential The US Covered Bond Act of 2011 has reignited the debate over whether legislation is necessary to seed issuance and, if so, how it should relate to the Federal Deposit Insurance Corporation. Lawton Camp and John Hwang of Allen & Overy in New York examine the proposed bill and the arguments being made against it. FULL DISCLOSURE 52 Postcards from Mainz and Washington 28 42 CONTENTS
  5. 5. March 2011 The Covered Bond Report 3 FROM THE EDITOR  W elcome to the launch edition of The Covered Bond Report, the first maga- zine dedicated to the asset class. We launch at a critical moment in its history. After years of skirting the issue, the biggest market of them all, the US, is poised to make a decision on whether or not to put in place the foundations necessary for cov- ered bonds to thrive. This has thrown the spotlight on some of the funda- mental arguments surrounding the asset class, and never before have so many governments, regulators and inves- tors scrutinised the pros and cons of covered bonds in such depth. In Australia, interested parties are seeking to strike the right balance between issuers’ and investors’ needs after finally winning around public opinion. In the UK and elsewhere, investors new to the product are asking tough questions of issuers. And at a European level, the industry faces a battle to achieve what it considers cov- ered bonds’ rightful position to be under Basel III. An immediate focus of attention is transparency, a theme that runs through many of the articles in this issue. Among these is a column from the International Capital Market Association’s Covered Bond Investor Council, in which the buy-side’s agenda is laid out. If proponents of covered bonds are to win over scep- tics and doubters, to win over investors and regulatory authorities, they must engage them. Their opponents surely will. Few asset classes have come out of the financial crisis in such good shape as covered bonds, but being the least worst option is not enough. Neil Day, Managing Editor Aim high The Covered Bond Report Editorial Managing Editor Neil Day +44 20 7263 2732 Reporter Maiya Keidan Contributor Hardeep Dhillon Design & Production Creative Director: Garrett Fallon Senior Designer: Sheldon Pink Printing Wyndeham Grange Ltd Advertising Sales Subscriber Services Editorial The Covered Bond Report is a Newtype Media publication 38a Bramshill Gardens London, UK NW5 1JH +44 20 7263 2732 March 2011 To the lifeboats! Can covered bonds offer safety after bail-in panic? Australia A whole new ball game Sterling UK gains home advantage US legislation The FDIC rears its head The Covered Bond Report
  6. 6. 4 The Covered Bond Report March 2011 MONITOR: LEGISLATION & REGULATION The introduction into the House of Rep- resentatives of a new bill on 8 March put covered bonds firmly on the agenda in the US, as supporters and critics posi- tioned themselves for what looks set to be a tough fight to get legislation final- ised this year. Republican Congressman Scott Garrett, who has led the US covered bond push, made the opening gambit, introducing the latest iteration of proposed legislation to the House Financial Services Subcommittee on capital markets, insurance and Government Sponsored Enterprises. The bill is co-spon- sored by Democrat Carolyn Maloney. Supporters of legislation have hoped that the passage of the Dodd-Frank Act last summer would help clear the way for due consideration to be given to a covered bond bill, with Washington’s focus on GSE reform helping put it on the agenda. However, at a hearing on 11 March of the subcommittee, which Garrett chairs, it quickly became clear that the United States Covered Bond Act of 2011 (HR 940) could become bogged down in the objections of the Federal Deposit Insur- ance Corporation, which have stifled previous efforts to stimulate a US market. “We support the covered bond mar- ket,” FDIC chairman Sheila Bair had said only a week earlier, before adding a caveat that was expanded upon in the regulator’s submission to the subcom- mittee hearing: “I think it is important to get it right and we don’t want the FDIC as the implied government guarantor of covered bonds.” In its subsequent submission, the FDIC said that any legislation “must preserve the flexibility that current law provides to the FDIC in resolving failed banks” and that “any legislation that fails to preserve these important receivership authorities would make the FDIC the de facto guarantor of covered bonds and the de facto insurer of covered bonds investors”. Witnesses testifying at the hearing, aware that the issue of whether tax- payer support would be necessary for a market to develop, were quick to rebut such claims. “HR940 does not provide an explicit federal guarantee of covered bonds is- sued under the provisions of this bill,” said Bert Ely, a financial institutions and monetary policy consultant. “Fur- ther, no provision in HR 940 even sug- gests an implicit federal guarantee of covered bonds.” And Tim Skeet, board member of the International Capital Market Association, said that – contrary to claims made by fel- low witness Stephen Andrews, president and CEO of the Bank of Alameda, a com- munity bank European covered bonds did WASHINGTON FDIC unmoved by new US covered bond push “We don’t want the FDIC as the implied government guarantor” US Bank Covered Bond Capacity 3Q10 2009 2008 2007 2006 2005 Aggregate FDIC Insured Depository Institution Liabilities 11,859 11,642 12,550 11,687 10,614 9,761 Capactiy for Covered Bonds Outstanding (4% of Total Liabilities) 474 466 502 467 425 390 Fannie Mae and Freddie Mac MBS Outstanding 4,390 4,761 4,411 4,119 3,454 3,169 Covered Bond Capacity % GSE MBS Outstanding (%) 11 10 11 11 12 12 Fannie Mae and Freddie Mac Mortgage Purchases 643 1,159 915 1,110 867 906 Source: FDIC, Fannie Mae and Freddie Mac public filings, Fitch Ratings. Legislation & Regulation
  7. 7. Covered bonds? 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 Europe Figures as of 17 March 2011
  8. 8. 6 The Covered Bond Report March 2011 not require government support. “There are no implicit guarantees,” he said. “What there is – and we mustn’t confuse the two things – there’s explicit legislation, and there is good supervision provided by arms of the state. But that is not the same as any form of guarantees – nor do the investors factor that in.” The FDIC also claimed that legislation is unnecessary to stimulate a market, say- ing that the Best Practices and a Policy Statement on covered bonds it released in 2008 were sufficient, and pointing to issuance before this from Washington Mutual and Bank of America. But Ralph Daloisio, chair of the American Securitization Forum board of directors, contradicted this. “Without the right kind of legislation, there will be no US covered bond mar- ket,” he said. “It should be clear by now that a US covered bond market can only be seeded by a specific enabling act of legislation, which has, at its cornerstone, a dedicated legal framework for the treat- ment of covered bonds in the event the issuer becomes insolvent.” FHLBanks enter the debate Democrat Senator Charles Schumer gave the covered bond cause a fillip days later, when he said on 15 March during a Sen- ate Banking Committee hearing on hous- ing finance that he is considering intro- ducing a covered bond bill in the Senate. Schumer, who co-sponsored with Re- publican Senator Bob Corker covered bond legislation introduced into the Sen- ate in May 2010 – raised the prospect of introducing legislation when questioning Geithner – and Shaun Donovan, secre- tary of the US Department of Housing & Urban Development – in a hearing fol- lowing up on the Obama administration’s “Reforming America’s Housing Market” report to Congress. “Covered bonds work in Europe, haven’t caught on in the US because we don’t have a statutory framework that provides certainty regarding their treat- ment in the event of insolvency,” said Schumer. “There has been a bill intro- duced just recently in the House that I’m considering introducing in the Senate, by Representatives Garrett and Maloney on covered bonds.” The senator noted that Geithner had indicated a willingness to work with Congress on exploring a legislative framework for covered bonds, and asked him what he thought of the proposed bill and the FDIC’s concerns. “Yes, we would support a legislation that would help create better conditions for a covered bond market,” said the Treas- ury Secretary. “It’s important to recognise that we do have a covered bond market in the US today in the form of the Federal Home Loan Banks financing structure. It’s essentially the functional equivalent. “The questions you raise about the FDIC are very legitimate concerns – we have to work through those. Again, for this to work, you’d be putting the taxpay- er in some sense behind private inves- tors and that has its own consequences. But that’s something that we can work through and I think it can play a better role, a greater role in our system.” Geithner’s reference to the Federal Home Loan Banks system recognised criticisms made by Bank of Alameda’s Andrews and the FDIC in their com- ments to the House subcommittee hear- ing, with the FHLBanks said to be siding with the regulator and community banks to fight the introduction of legislation. Moody’s said in a report that the avail- ability of covered bonds as an alternate funding tool could reduce “the overall footprint and profitability” of FHLBanks. In a report quoted by Representative Maloney in the hearing, Fitch noted that a 4% limit on covered bond issuance rel- ative to total assets could limit issuance volumes. See Legal Brief on pages 46-51 for an explo- ration of the proposed bill and its criticisms. “We don’t have a statutory framework that provides certainty” PROGRESS? 2008: Rocket scientist Neel Kashkari (left), formerly of spacecraft manufac- turer TRW, leads covered bond push. (His time at TRW took in work on the successor to the Hubble Space Telescope.) 2011: Senator Chuck Schumer (right): “That’s why I want to get involved: it’s not rocket science. I can probably deal with it…” (Although he is campaigning for a retired shuttle to go to the Intrepid Museum in New York.) MONITOR: LEGISLATION & REGULATION
  9. 9. March 2011 The Covered Bond Report 7 The Reserve Bank of New Zealand has set a limit on the amount of assets allowed to be encumbered by covered bond issu- ance at 10%, with a review of the limit to be held within two years. The New Zealand central bank con- firmed its position in March, when com- menting on feedback to a consultation it had launched in January, where the plan for such a cap had been set out. “An initial limit of 10% will allow banks to develop covered bond pro- grammes, whilst providing a conserva- tive ceiling on issuance in the short term,” said RBNZ deputy governor Grant Spencer. Unlike limits set by several other reg- ulators, which base their limit on issu- ance relative to total assets or liabilities, New Zealand references the amount of assets encumbered for the benefit of cov- ered bondholders. Regulators have typically set limits on covered bond issuance because it subor- dinates the claims on a bank’s assets of senior unsecured bondholders and, most importantly, depositors. However, as overcollateralisation levels change over time, the amount of assets encumbered in favour of covered bondholders will change even if the amount of issuance remains consistent. The RBNZ said in March that there was broad agreement among respond- ents to its approach, at least for the short term, and rebuffed alternatives. “The Reserve Bank does not consider that a limit based on the face value of the bond would be appropriate as it does not address the primary prudential con- cern arising from the issuance of covered bonds, namely the encumbrance of as- sets,” it said. “The Reserve Bank recog- nises that this approach places the onus on institutions to set issuance levels that include sufficient headroom to reflect the level of risk of downgrade that is inherent in their operations. “As a result, stronger institutions may feel more comfortable issuing a higher volume of covered bonds. The Reserve Bank considers that this outcome is more appropriate than weaker institutions en- cumbering a higher proportion of assets to support the same level of issuance as more robust entities.” The central bank said that the review would consider the level of the constraint as well as “the merits of adopting a more case-by case, or sliding scale, approach to reflect the specific characteristics of the institution”. Issuance on hold Bank of New Zealand opened the New Zealand covered bond market in June 2010, shortly after the Reserve Bank had released its first guidance to recognise covered bonds. BNZ sold a a NZ$425m two tranche domestic issue, and followed this up with a Eu1bn seven year deal in November. “This inaugural euro covered bond is- sue is a very cost effective form of term funding for BNZ,” said Tim Main, BNZ treasurer. “It also increases the bank’s ac- cess to a significantly broader range of global investors.” Westpac NZ had hoped to issue its first covered bond in euros in February, a five year deal, but put plans on hold after the Christchurch earthquake and amid deteriorating market conditions. Barclays Capital, BNP Paribas, UBS and Westpac had the mandate for the subsidi- ary of Australia’s Westpac. In December a new company, ANZNB Covered Bond Trust Ltd, was established, suggesting that ANZ National Bank will be entering the market, while ASB Bank, a subsidiary of Commonwealth Bank of Australia, has indicated an interest in is- suing covered bonds. MONITOR: LEGISLATION & REGULATION NEW ZEALAND RBNZ targets encumbrance STOP PRESS UK budget promises pro-investor covered bond review The UK government announced plans for a review of the UK covered bond regime as part of its budget on 23 March. “The Government and the Financial Services Authority (FSA) will shortly publish a review of the UK’s regulatory framework for covered bonds,” said HM Treasury. “The review will consult on measures to enhance the attractiveness of UK covered bonds to investors, making it easier for banks and building societies to raise fund- ing in order to lend to households and businesses.” See for updates. “It is important to get standardisation of reporting formats” page 24
  10. 10. 8 The Covered Bond Report March 2011 Market MONITOR: MARKET Geopolitical events totally unexpected at the turn of the year became the key driv- ers of market sentiment as the first quar- ter of 2011 drew to a close. When Fitch surveyed investors in December about the biggest challenges ahead for the covered bond market, rev- olutions in the Middle East and natural disasters in Japan were so impossible to forecast that such events barely regis- tered on investors’ radars, save possibly as part of a 4% “other” vote. Another potential challenge not cap- tured by Fitch’s detailed answers was sup- ply, as one head of covered bond origina- tion commented on The Covered Bond Report’s website. But in the first week of the year alone issuers piled into the mar- ket with 15 new benchmarks (of Eu500m or more), taking the week’s issuance to a record of more than Eu18bn. This resulted in a rather predictable turn of events, as Commerzbank analysts noted after the record week. “The market soon began showing some first signs of fatigue,” they said. “The spread targets became increasingly defensive, most new papers are now trad- ing above their issuance levels, the books have recently tended to fill up at a more sluggish pace, and the first postpone- ments of projects have taken place. “In view of these contradictory sig- nals, it is not easy to assess the funda- mental strength of the market.” It proved more resilient than could have been expected, with more than Eu43bn of benchmarks being priced by the end of January and over Eu24bn in February. Around Eu13bn during a slow- er first half of March took issuance from 1 January to 18 March above Eu80bn. Regulatory developments helped maintain the market’s momentum. While the inclusion of covered bonds in liquid- ity buffers envisaged under Basel III were a theme going into the year, a European Commission paper proposing that senior unsecured creditors be “bailed-in” when banks are bailed out catalysed fears of this outcome, leading to a flight of some issuers and investors into the secured as- set class. In the second week of March only one new benchmark was launched, a Eu1bn three and a half year Pfandbrief for Berlin-Hannoversche Hypothekenbank, with markets volatile in the wake of the earthquake, tsunami and nuclear fears in Japan and awaiting impending United Nations-sanctioned action against the Gaddafi regime in Libya. This overshadowed improved senti- ment towards southern European debt in the government markets that might oth- erwise have opened the door to further supply from the region. Spanish covered bonds had rallied since mid-January and, alongside Italian covered bonds, de- linked themselves from Portugal. An EU summit beginning the day of the Japanese natural disasters had even raised hopes that the euro-zone’s leaders might finally be ready to take decisive ac- tion to stem the region’s debt crisis. As The Covered Bond Report was being printed, the outcome of a follow-up meeting on 24-25 March was being awaited. EUROS A first quarter of shock and awe 0 50 100 150 200 250 300 350 04/01/201018/01/201001/02/201015/02/201001/03/201015/03/201029/03/201012/04/201026/04/201010/05/201024/05/201007/06/201021/06/201005/07/201019/07/201002/08/201016/08/201030/08/201013/09/201027/09/201011/10/201025/10/201008/11/201022/11/201006/12/201020/12/201003/01/201117/01/201131/01/201114/02/201128/02/201114/03/2011 Basispoints Date iBoxx spreads against asset swaps Canada France Germany Other Spain UK
  11. 11. March 2011 The Covered Bond Report 9 MONITOR: MARKET FRANCE CFF flies European flag Compagnie de Financement Foncier launched the only dollar benchmark for a European issuer in the year to mid-March, with a $1.5bn three year deal that took its dollar benchmark issuance to $6.3bn (Eu4.56bn) since the beginning of 2010. “Last year we issued $4.8bn in dollar benchmarks and with this transaction we now represent 20% of the existing covered bonds outstanding in the US, so we are definitely one of the key players on this market,” said Paul Dudouit, head of medium and long term funding at CFF. “We are now marketing to tier two accounts and we see more and more interest from these, which is very important in terms of diversification, not hav- ing only the big players in- volved.” However, as The Cov- ered Bond Report was go- ing to press, several issuers, mainly Nordic, were said to be preparing to access the US investor base. DOLLARS US goes loonie for Canadians Marfin Popular Bank is preparing to launch a debut covered bond off a Eu2bn programme, which would be the first public issue from Cyprus after the country’s framework was finalised in December. The Marfin group has previously issued Greek law covered bonds backed by residential mortgages through Greek subsidi- ary, Marfin Egnatia Bank. “We have experience utilising the Greek assets using the Greek law and it’s a very good opportunity for us now to use the Cypriot law,” Dimitrios Spathakis, Marfin Egnatia bank deputy head of wholesale funding, told The Covered Bond Report. “Our view is that the law is very strong and it will facilitate us in going to the market”, he added. “There is a more positive outlook towards Cypriot as compared with Greek banks.” The bank plans to have two separate programmes, one com- prising Cypriot assets and the other mainly Greek assets. It plans to enter the market with residential mortgages and grad- ually move to commercial assets and eventually to a shipping portfolio, which Spathakis acknowledges is “the most challeng- ing one of all”. The Central Bank of Cyprus, the Ministry of Finance and the Association for Cyprus Banks and all its members worked together on the project. “Now the legal and regulatory framework is in place, it is up to each individual bank to go ahead with its issuing,” said Christina Antoniou Pierides, senior officer at the Association of Cyprus Banks. Moody’s has estimated the potential of the Cypriot covered bond market as Eu4bn. Marfin Popular was downgraded from Baa2 to Baa3, on negative outlook, by the rating agency at the beginning of March. Its Greek covered bond programme is rated A3, on review for downgrade. National Bank of Canada sold its first covered bond in January and Caisse Cen- trale Desjardins was roadshowing a new programme for US investors in March, as Canadian banks picked up where they left the US dollar market last year. Dollar issuance, at just four bench- marks totalling $6bn to mid-March, was subdued compared with last year’s surge, especially when compared with the record volumes witnessed in the euro market, but Canadian issuers sold three- quarters of the new dollar supply. National Bank of Canada’s $1bn three year 144A issue was sold in late January after Bank of Montreal had returned for $1.5bn and Canadian Imperial Bank of Commerce had returned for $2bn. “People just love Canadian risk,” said a banker on Bank of Montreal’s deal, “and all the US investors are happy to add more.” NBC’s US$5bn (Eu3.75bn/C$4.94bn) global covered bond programme are backed by a Canada Mortgage & Hous- ing Corp (CMHC) insured pool of resi- dential mortgages, like all of its peers’ bar Royal Bank of Canada. Caisse Centrale Desjardins, part of Quebec’s Desjardins Group of credit unions, was marketing its new pro- gramme, also backed by a CMHC pool, in March with Royal Bank of Scotland. The Desjardins Group forms Canada’s largest credit union and would be the first such institution to enter the cov- ered bond mark from Canada. Paul Dudouit, CFF National Bank of Canada CYPRUS Marfin carries Cypriot hopes “No evidence to suggest that a legally stipulated publication obligation necessarily leads to a better result” page 19
  12. 12. 10 The Covered Bond Report March 2011 MONITOR: MARKET Denmark’s mortgage banks achieved bet- ter than expected yields in auctions in the first two weeks of March, despite com- ments from European Central Bank presi- dent Jean-Claude Trichet having initially threatened to push rates higher. The auctions faced high volatility be- cause of comments from Trichet suggest- ing a possible move to tighter monetary policy at the start of the month and the Japanese natural disasters. “The outright yield level increased just at the start of the auction and then we have seen this risk aversion scenario after the events of Japan,” said an analyst at Danske Bank. “It pushed down the outright yield levels at the end of the auctions.” Nykredit Realkredit was the most ac- tive, selling Dkr80bn in local currency and Eu1.6bn in euros over an 11 day period. “The positive thing was that over the 11 days of the auction the average yield tightened 10bp to swap and that’s defi- nitely more than usual,” said Nykredit first vice president Lars Mossing Madsen. “Another thing of interest was that we saw the bid-to-cover being much higher than normal during the auction.” The average bid-to-cover was 4 times, compared with 2.6 in December and 3.4 in October. Realkredit Danmark, a subsidiary of Danske Bank, had planned to issue Dkr26.6bn and Eu408m; it came close to those targets with Dkr26.4bn and Eu410m. The bank edged up to a bid-to- cover of 3.2 this month, compared with a rate of 2 in December. The Danske analyst said spreads gener- ally tightened at the auction, in euros and Danish kroner. “At the beginning of the auction they were priced around 40bp-45bp to Eonia, the one years, and they ended up being priced around 37bp,” he said. Nordea Kredit had anticipated a spread of 57bp over Eonia, according to Jacob Skinhøj, chief analyst at Nordea Kredit, but was “very happy” with spread tighten- ing during the auctions. The bank issued Eu115m and Dkr8.205bn over two days, with an aver- age bid-to-cover of 3 or 4, roughly on par with previous auctions. “I think in a world such as that we have today, with the uncertainty about Japan, investors go for safe havens and these cov- ered bonds are a safe haven and will re- main a safe haven in a situation like this,” said Skinhøj. INDEX CSI: Europe A new Covered Bond Market Sentiment index (CSI) unveiled by Crédit Agricole in February aims to provide market participants with a quantitative tool to measure confidence across the asset class. It measures investor and issuer confidence in funding conditions and investment conditions, respectively, resulting in a score on a scale from 0 to 10, with 0 being the worst and 10 the best. Like Germany’s established Ifo Business Climate Index, the CSI includes current situation and expectation components. “The ultimate goal is to get this established among issuers and investors and get as much feedback so I can actually break it down country by county,” says Crédit Agricole senior covered bond analyst Florian Eichert. “Then the main use would be for the issuer community, for example, to say: ‘OK, it doesn’t make a lot of sense to go marketing in this region.’” More than 106 investors and 19 issuers from a variety of countries participated in the January survey, released in February, which arrived at an opening level of 5.2. The latest month’s scored edged up to 5.5, but had fewer respondents, with 86 investors and 28 issuers. Investors and issuers received CSI surveys in the last week of each month and results were produced at the beginning of the following month. Eichert expects the av- erage number of participants to stabilise within the next couple months and attributes the drop in responses to European holidays in some countries when it was conducted. “I’m surely hoping to get that number up,” he says. “One hundred and six was quite nice, but I’d certainly like to get that number even higher. Eichert said his survey was greeted with an enthusiastic response, with many investors and issuers showing interest. “This is kind of what I’ve been doing all along – just trying to talk to issuers and in- vestors and trying to relay the information back and forth,” said Eichert. “I’ve just never done it in as systematic a way as the index before.” AUCTIONS Crises lower Danish yields F1 SDO DKK 3/3 4/3 7/3 8/3 9/3 11/3 14/3 15/3 16/3 17/3 2,30 2,20 2,10 2,00 1,90 1,80 DAILY YIELD (GREY) AND CUMULATIVE AVERAGE YIELD (BLUE) OVER NYKREDIT AUCTIONS
  13. 13. March 2011 The Covered Bond Report 11 GERMANY New analyst pairing for DZ DZ Bank is hiring Joerg Homey from Moody’s as part of a new pairing for its covered bond research, after Sebastian Sachs left the bank to head up research at Berenberg Bank. Homey was a vice president and senior analyst at Moody’s. He is set to join DZ in April to work alongside Michael Spies, who joined DZ in November and has been working as a covered bond analyst since January. Sachs, who worked at DZ from Feb- ruary 2006, left for Berenberg Bank in early March, where he will be establish- ing credit and rates research. Berenberg Bank, which claims to be Germany’s oldest private bank, is headquartered in Hamburg, but Sachs will be based in the bank’s Düsseldorf office when he joins in April. André Hovora, who previously worked alongside Sachs as a covered bond analyst, recently moved to work in the bank’s credit department. MONITOR: PEOPLE & INSTITUTIONS Scott Stengel has joined King & Spald- ing as a partner from Orrick, Herrington & Sutcliffe, while a former colleague, Howard Goldwasser, also recently moved to a new firm. Stengel is a member of the steer- ing committee of the US Covered Bond Council, which operates under the aus- pices of the Securities Industry & Fi- nancial Markets Association (Sifma). He testified in the House Financial Services Subcommittee hearing on the US Cov- ered Bond Act of 2011 on 11 March. “This was a compelling opportunity to join a first class global law firm, where I can draw on an extraordinarily deep bench of capital markets and regulatory lawyers to grow the covered bond and the general banking practices,” Stengel told The Covered Bond Report. “King & Spalding is widely recog- nized as a global leader in both finance and real estate, and our expertise there will be critical to clients as we move for- ward on covered bonds as well as GSE reform in the US.” Stengel worked at Orrick from 1997 until February. Goldwasser, who worked with Sten- gel for many years at Orrick before join- ing Allen & Overy in 2006, joined K&L Gates last month. He arrived at K&L Gates from Curtis, Mallet-Prevost, Colt & Mosle, which he had joined after leav- ing A&O in September 2009. “To me, one of the big draws at K&L Gates is that the firm has one of the mar- ket-leading housing finance practices in the US and can offer a level of expertise in that space that will position us well when the covered bond market starts up in the US,” said Goldwasser. “And it also has a very international footprint.” Goldwasser has been a member of the US Covered Bond Council and the American Securitization Forum’s covered bond sub-forum. At A&O, he worked on the first US covered bond programmes and some of the early Ca- nadian programmes. HIRES Syndicate moves Lorenz Altenburg returned to covered bond syndicate in late February, joining Nomura from Crédit Agricole. Altenburg worked in covered bond syndication for Société Générale in Paris until late 2009, before moving to sover- eign, supranational and agency trading. He left SG to join Crédit Agricole in Lon- don in a similar role in December. Meanwhile, Martin Rohland will be joining Barclays Capital’s syndi- cate desk in April. He will be joining from Landesbank Baden-Württemberg, where he was a director on the bank’s fixed income syndicate. LEGAL Orrick alumni on the move Scott Stengel: Capitol witness Sebastian Sachs: head for Berenberg “This was a compelling opportunity to join a first class global law firm” People & Institutions
  14. 14. 12 The Covered Bond Report March 2011 MONITOR: PEOPLE & INSTITUTIONS/RATINGS SPAIN Multi-cédulas withstand cut Fitch cut 51 classes of multi-cédulas issues on 10 March, driven by collateralisa- tion rates, but the impact of the news on the asset class was muted, even along- side a downgrade of the Kingdom of Spain from Aa1 to Aa2 on the same day by Moody’s. “As far as I can see, things are holding up in the secondary market and they haven’t really been hit too hard,” said one syndicate official. “A couple of basis points widening here and there, but nothing tragic.” An analyst added: “Spreads will be more driven by headlines on savings banks and details of mergers and not by ratings – at least not as long as they are in double-A territory.” Fitch cut 50 classes from AAAsf to AAsf and one from AAAsf to AA+sf, with the downgrades relating to 46 transactions. The actions concluded a review of the sector by Fitch. “CR (collateralisation rate) is the major driver of the downgrades,” said the rat- ing agency. “The agency’s MICH (multi-issuer cédulas hipotecarias) rating meth- odology is based on the ‘first dollar loss principle’ implying that if the weakest link in the CDO failed in a particular stress scenario, regardless of its participation in the overall transaction it would imply a default of the transaction as a whole under such rating stress. MICH transactions have traditionally comprised CH issued by multiple Spanish financial entities. “Fitch’s CR analysis includes updated cover pool market value risk assump- tions. Market value risk stems from the assumption that in the event of a CH default, the insolvency administrator may be forced to sell cover pool assets at a distressed price in order to meet payments on CHs. This is addressed by applying a refinancing spread that accounts for the cost of funding of a potential buyer plus a profit margin. Fitch has updated the components of the liquidity risk market value discount considering current market conditions and future expectations.” Tim Skeet is understood to be joining Royal Bank of Scotland, where he will work in debt capital markets. Skeet left Bank of America Merrill Lynch, where he was head of covered bond origination, in October after four years at the US bank. He has recently been work- ing as a consultant for Amias Berman. Skeet is a board member of the Inter- national Capital Market Association. He testified on behalf of the association at a House Financial Services Subcommittee hearing into US covered bond legislation in March. Prior to joining BAML he worked at ABN Amro before its European invest- ment banking operations were acquired by RBS. NETHERLANDS ABN builds with Hessels ABN Amro has hired Joop Hessels from ING as it builds out in debt capital markets. Hessels joined as a director in ABN Amro’s FIG origination team in March. Previously he worked at ING as a vice president in DCM origination, where he was responsible for coverage of Dutch and Nordic financial institutions. At ABN Amro, Hessels reports to Maurizio Atzori, head of debt capital markets origination. ANALYST CreditSuissegetsWinkler Credit Suisse is understood to have hired Sabine Winkler as a covered bond analyst. Winkler resigned from Bank of America Merrill Lynch in March. She joined Merrill Lynch in March 2007. Beforehand she worked as a cov- ered bond analyst at ABN Amro. Bank of America Merrill Lynch is un- derstood to be seeking a replacement for Winkler. UK Skeet on way to RBS Don’t forget to visit our website at Tim Skeet
  15. 15. The Covered Bond Report Did you know that The Covered Bond Report has its own database of benchmarks? Did you know that we link directly from bond data to relevant coverage? Did you know that we include price guidance, book sizes and distribution statistics? Did you know that you can run league tables by country and currency? To register for trial access to The Covered Bond Report, visit or contact Neil Day, Managing Editor, at And don’t forget: if you are an investor in covered bonds you can qualify for free access to the website. The Covered Bond Report is not only a magazine, but also a website providing news, analysis and data on the market.
  16. 16. 14 The Covered Bond Report March 2011 A request for comment from Standard & Poor’s is being awaited after the rat- ing agency in January made a last minute decision in the face of criticism to delay the application of new counterparty risk criteria to covered bonds. Until then the proposed changes had, not for the first time in S&P’s experi- ence, cast a shadow over the rating out- look for the asset class, with those fall- ing foul of the new criteria due to have been placed on CreditWatch negative the following week. “Had the initial criteria been applied to the covered bond market,” says an analyst, “we could have seen a sizeable chunk of the market being downgraded. Even covered bonds by well rated issuers would not have escaped unscathed.” Market participants had been critical of the application of the criteria to cov- ered bonds alongside structured finance transactions, but were not wholly unsym- pathetic to S&P’s covered bond team. “It seems S&P has a lot of discussions internally,” said one analyst, “covered bonds versus structured finance.” When Fitch released new covered bond counterparty criteria in mid-March mar- ket participants contrasted the actions of the two rating agencies. The introduction of Fitch’s criteria followed an exposure draft released in October 2010 and a cov- ered bond banker who had met with Fitch ahead of its final criteria, and also with S&P regarding their counterparty criteria, said that he felt Fitch had handled the changes to their criteria more carefully. “Fitch said that there would be some changes given the feedback that had been made,” he said. “They were more taking on board the feedback in terms of what we wanted to change, making some im- provements, and they seemed quite open to the ideas we presented to them. “We also got the feeling that the whole approach was more thought-through and convincing than S&P, where the changes seem to have been driven by people not close to covered bonds.” Fitch described in its release changes it had made to its proposals in light of in- dustry feedback. “Market participants generally ex- pressed their support for a separate cov- ered bond-specific counterparty criteria report that takes into account the dual- recourse and dynamic nature of covered bond programmes,” it said. “Having reviewed the feedback, the agency has made various changes and clarifications to the final counterparty criteria com- pared to the exposure draft.” When S&P in January announced that it was delaying its implementation to covered bonds of counterparty criteria for structured finance transactions, and would be reviewing the relevant criteria, it said that the new review would take into account “the dual recourse nature of covered bonds” as well as “the multiple number of counterparties that may pro- vide support to the covered bonds”. A market participant said that he ex- pected revised proposals from S&P to emerge by next month. The impact of Fitch’s counterparty criteria changes is also expected to be smaller than was feared from S&P’s. “The agency expects that application of the criteria to existing rated covered bond programmes will have an immedi- ate effect on a limited number of covered bond ratings,” it said. “Most programmes, particularly those with internal counter- parties, will only be affected if the issuer’s rating deteriorates by several notches. This is based on the expectation that is- suers, notably of programmes with ex- tended maturity for principal payments, will be able and willing to improve the liquidity protection against potential missed interest payments shortly after an issuer or account bank default.” The rating agency said that a potential mitigant issuers may choose to increase is overcollateralisation. “If this risk remained insufficiently mitigated, according to the new criteria, the affected programmes’ ratings would be tied more closely to the applicable Is- suer Default Rating (IDR) through a largely increased Discontinuity Factor (D-Factor),” added Fitch. “This may auto- matically result in downgrading covered bonds’ ratings from their current level.” MONITOR: RATINGS CRITERIA Fitch counterparties on after S&P delay “The whole approach was more thought-through and convincing” Ratings S&P loomed large
  17. 17. March 2011 The Covered Bond Report 15 DOWNGRADE Portuguese on watch MONITOR: RATINGS Investors are more willing than previously to consider buying non-triple-A covered bonds, according to a survey released by Fitch last month, which also highlighted a surprising flexibility among the buy-side towards innovative structures. Some 88% of investors surveyed by the rating agency in December said that they were prepared to examine non-tri- ple-A covered bonds, with 14.6% view- ing a triple-A rating as irrelevant, while 73.2% found it important but were open to non-triple-A issues. Hélène Heberlein, managing director, covered bonds, at Fitch told The Covered Bond Report she was surprised to find that “some investors are disregarding the covered bond rating and looking at the bank rating first”. However, a triple-A rating was still viewed as “very important” by 84.2% of respondents. The idea of pass-through covered bonds was also gaining acceptance, the survey found. The majority of respond- ents (52.5%) said they would consider purchasing either partial or full pass- through covered bonds. Only 38.8% re- fused to even consider non-bullet pay- back structures. Head of covered bond strategy at Deut- sche Bank, Bernd Volk, was surprised by the willingness of investors to accept pass- through covered bonds when “all existing pass-through covered bonds are on balance sheets of central banks for repo reasons”. “A pass-through structure would re- duce overcollateralisation requirements,” he said, “and hence allow higher covered bond issuance, i.e. the need for expensive unsecured funding would be reduced.” Heberlein cautioned that the diversity of investors polled must be taken into consideration when noting this result. “If you had conducted this survey primarily among insurance companies and pension funds, they would probably have said they only want hard bullets,” she said. The survey found that 43% of inves- tors were uncomfortable with the inclu- sion of residential mortgage backed as- sets in cover pools, while the remainder either viewed it as acceptable (19%), rea- sonable as long as they were compensat- ed with higher spreads (20%), or stated no opinion (18%). Eighty-two investors, all but one based in Europe, participated in Fitch’s survey. The majority of respondents, 58%, had less than Eu5bn of covered bonds under management, while 34% had between Eu5bn and Eu50bn, and the remaining 8% upwards of Eu50bn. FITCH No triple-A? No problem “A pass-through structure would reduce overcollateralisation requirements” The fate of Portuguese covered bonds has been under scrutiny after Moody’s on 15 March cut the sovereign from A1 to A3, putting ratings pressure on the country’s banks. Moody’s warned in December that if the senior unsecured long term ratings of Caixa Geral de Depósitos or Banco Espiríto Santo were downgraded by more than one notch then the mortgage covered bonds of each bank would be downgraded by one notch. However, the knock-on effects of the sovereign action on covered bond rat- ings could be limited, suggests Frank Will, head of covered bond and fre- quent borrower strategy at RBS. “We expect that the Aa2 covered bond rating of BES will be confirmed as we expect only a one notch issuer downgrade (unless the standalone rat- ing of BES is downgraded as well). “With regard to mortgage cov- ered bonds issued by Caixa Geral de Depósitos,” he added, “we expect a one notch downgrade of the Aa1 cov- ered bond rating as we view a two notch issuer downgrade as likely (unless the standalone rating of CGD is downgrad- ed by a few notches as well).” Fitch had the previous week affirmed the triple-A rating of Caixa Geral de Depósitos’ mortgage covered bonds (obrigacoes hipotecarias) and removed them from Rating Watch negative.
  18. 18. 16 The Covered Bond Report March 2011 BUY-SIDE: ICMA’S CBIC Transparency Investors have been asked many times by issuers, in different contexts, what their information needs are. So far there has been no unified answer to this question, but following the growth of the covered bond market there has been an increased fragmentation in the type of information provided by issuers. The CBIC has set up a transparency working group that has tried to indentify the key information that investors in cov- ered bonds need in order to make a fully informed investment decision as to covered bond issues, including their respective cov- er pools and the issuer itself. It is expected that the information required would be available on a regular basis (for example, a half yearly update) to meet investors’ trans- parency and information needs. The CBIC believes it is of vital impor- tance to improve transparency in order to increase the investor base. The objec- tive is to make it possible for investors and analysts to compare and form an independent qualified assessment of all covered bond programmes. The internationalisation of formerly domestic covered bond markets began 10 years ago and many European countries introduced new covered bond legislation or updated existing rules to be a part of this development, and to also respond to the considerable growth of mortgage lending activities in the European Union. Each different country’s covered bond laws regulate what assets are eligible to back covered bonds, minimum quality requirements for assets, and how inves- tors will be protected if the issuing bank The International Capital Mar- ket Association is one of the few trade associations with a European focus having both buy-side and sell-side representation. One of the Association’s industry groupings, created nearly two years ago — the Covered Bond Investor Council (CBIC) — serves to consider issues related to the evolution of the prod- uct in Europe and the type of infor- mation available to investors. The Council is an investor driv- en organisation, independent of issuers and the sell-side. It aims to promote the quality of the cov- ered bond product and represent the interests of European covered bond investors. The CBIC promotes greater harmonisation in the mar- ket, the transparency and simplicity of the product, and the quality of the underlying assets. Nathalie Aubry-Stacey, direc- tor of regulatory policy and market practice at ICMA and secretary of the CBIC, sets out the Council’s agenda. The voice for investors “It is of vital importance to improve transparency in order to increase the investor base”
  19. 19. March 2011 The Covered Bond Report 17 BUY-SIDE: ICMA’S CBIC goes bankrupt. The legislation therefore stipulates how the collateral framework must operate. It is also clear that the quality of the information available to investors re- mains uneven. Key information such as loan to value (LTV) and non-perform- ing loans (NPLs), for instance, need to be fully explained when presented to in- vestors, allowing them to assess how the calculations are being made. The CBIC is also addressing the issue of creating a level-playing field in terms of access to this information, looking at a common platform that would provide information to investors. Simplicity and quality Following governmental discussions re- garding the inclusion of loans to small and medium sized enterprises (SMEs) in covered bonds’ cover pools, the CBIC discussed the definition of a covered bond and what should be included in the cover pool. The CBIC promotes the view that cov- ered bond pools should be “clean” and should consist only of specific types of loan. The CBIC believes that SME loans do not belong in the covered bond cover pools. High quality cover pools of cov- ered bonds should only include tangible assets with a long historical track record and/or public loans. This is considered one of the essen- tial cornerstones for the future develop- ment of a sound European covered bond market. Covered bonds are best used for strong prime mortgages and some pub- lic loans. Likewise, it is important for the CBIC that covered bonds are not confused with ABS. The two asset classes attract different types of investors and by lowering the qual- ity of the cover pool and therefore blurring the distinction between the two asset class- es there is a risk that banks’ accessibility to term funding may be weakened. The CBIC will be interacting with the relevant policy- makers on this specific issue. There is another question raised by the directive amending capital require- ments for trading books and for re-secu- ritisations and the supervisory review of remuneration policies (CRD III) propos- al, as to whether ABS should be allowed in covered bonds’ cover pools at all. The proposal highlights that the exception made for the use of intra-group ABS in the cover pool could end up being per- manent as from 2013. The CBIC will also be considering this issue. The European covered bond market as a financing tool for mortgages has survived the crisis without massive pub- lic intervention and the CBIC believes that only a continued focus on uphold- ing quality will safeguard the market against any future crisis. Any dilution of the quality of the product or confusion with other fixed income products should be avoided. Engage The CBIC has been recognised by regula- tors as the voice for investors. However, the CBIC would like to take the Council further in actively engag- ing investors with an interest in covered bonds in its work, and be more active in the regulatory space. This market will continue to develop and it is essential that investors, as a group, participate in discussion on the future development of this market which is so essential for mortgage and public fi- nancing in Europe. “The CBIC would like to take the Council further in actively engaging investors” CBIC chairman Claus Tofte Nielsen (second from left) engages with (left to right) Michel Stubbe, head of monetary operations analysis division at the ECB, Deutsche Bank head of covered bond strategy Bernd Volk, HSBC global head of covered bonds Andrew Porter, and Santander’s Antonio Torío, European Covered Bond Council chairman.
  20. 20. The Covered Bond Report The Covered Bond Report is not only a magazine, but also a website providing news, analysis and data on the market. Are you a covered bond investor? Then you could be receiving free daily news bulletins from The Covered Bond Report and access to its coverage of the market as well as its proprietary database of new issues and cover pool data links. If you would like to gain complementary access to The Covered Bond Report’s website and to receive free copies of The Covered Bond Report’s magazine, contact Neil Day, Managing Editor, at or visit to register*. *Investors directly linked to covered bond issuers may not qualify for this offer.
  21. 21.  W hen Fitch recently pub- lished its covered bond investor survey, it was hardly surprising to find that “underlying collateral per- formance” was ranked second among the key covered bond spread drivers for 2011 – beaten only by “sovereign risk”. The surprising fact was that “indi- vidual issuer quality” was completely missing. However, since mortgage books usu- ally constitute a considerable share of the issuers’ balance sheets, it is quite reasonable to assume a high correlation between issuer credit quality and cover pool performance. Another aspect also weighs heavily on the importance of “underlying col- lateral performance”: numerous classi- cal ABS/MBS investors have in recent months – albeit involuntarily – shifted away from their original investment home base and explored the covered bond universe. Traditionally, invest- ing in ABS/MBS has meant keeping a close eye on the cashflow situation of the ABS/MBS collateral. The outcome of these cashflow models formed the basis of conclusions on the future valuation of the various tranches of a specific trans- action. But cashflow reporting for ABS/MBS is way beyond what is currently deemed state-of-the-art in cover pool disclosure practice among covered bond issuers; and given the rather complex situation of covered bonds as quasi-master-trust structures, it is unlikely to become stand- ard practice on a broad basis anytime soon. Here we provide an overview of what constitutes state-of-the-art in various countries with regards to homogeneity and detailed- ness of reporting. We discuss the deficits, and provide an overview of the range of opportunities given the lack of loan-by- loan data, and how these deficits can be overcome by way of secondary sources. Pfandbrief first For quite some time, the only covered bond law setting explicit standards for disclosure of cover pool metrics was the Pfandbrief Act. The relatively young Greek covered bond law, too, regulates certain disclosure to the investing pub- lic. Legislation in some other countries, such as Spain, tackles disclosure in a dif- ferent context: not vis-à-vis investors but regulators, a topic that we do not address in this context. In fact, after the introduc- tion of §28 Pfandbrief Act, the cover pool disclosure of German issuers was setting standards. However, it was, admittedly, in 2005 that the transparency regulations be- came legally binding in a format com- ANALYSE THIS: COVER POOL DISCLOSURE Living with the data deficits Is legal or voluntary disclosure yielding the most useful information? Florian Hillenbrand, senior covered bond analyst at UniCredit, weighs the results and recommends how investors cope with a lack of transparency. March 2011 The Covered Bond Report 19
  22. 22. 20 The Covered Bond Report March 2011 ANALYSE THIS: COVER POOL DISCLOSURE parable to today and at that time other markets (except for Germany, France and Spain) were still in a ramp-up phase: the UK and Ireland were emerging, Austria and Luxembourg were absolute niche markets, while Nordic issuers as well as Portuguese and Italian banks were still a long way from issuing. Since the introduction of the disclo- sure policy for Pfandbrief issuers in 2005, German practice has barely changed or improved. In April 2006 the Associa- tion of German Pfandbrief Banks (vdp) started an initiative to further develop practical issues, such as timeliness of publication, positioning on the issuers’ webpages, and increasing homogeneity of publication. Nevertheless, improve- ments in the form and function of the disclosures did not materialize until 2010. Most issuers currently present their historical as well as current cover pool metrics in harmonized Excel and PDF format. Furthermore, the vdp provided an internet platform where investors can easily access cover pool metrics. Strong pressure from outside the Pfandbrief market certainly accelerated the process of improving quality of disclosure. In the meantime, Pfandbrief disclo- sure is quite streamlined and the degree of detail is also quite solid. According to the Pfandbrief Act, a Pfandbrief bank shall publish on a quarterly basis the total volume of mortgage Pfandbriefe, public Pfandbriefe, ship Pfandbriefe and aircraft Pfandbriefe outstanding, as well as the corresponding cover pools in the amount of the nominal value, the net present value and the risk-adjusted net present value. In addition, issuers have to pub- lish the maturity structure of each type of Pfandbrief outstanding, as well as the fixed interest periods of the correspond- ing cover pools in pre-specified bands. Furthermore, information has to be pro- vided regarding the share of derivatives in the pool and the amounts held in the form of further or substitute collateral. Mortgage Pfandbrief issuers have to provide the distribution with the amounts assigned as cover in their nomi- nal values according to their amount in specified tranches, as well as according to the states in which the real estate collat- eral is located, and according to the pur- pose of financed properties. In-arrears figures and foreclosures, etc, must also be supplied. Issuers of public Pfandbriefe have to provide information regarding the individual states in which the bor- rowers and, in the case of a full guaran- tee, the guaranteeing bodies are based. UK raises the stakes Although the degree of detail is quite solid – as previously mentioned – there is still room for improvement. We have already mentioned the pressure on Ger- man issuers from abroad. UK covered bond issuers were the driving force with regards to cover pool disclosure, fol- lowed by US, Canadian and French issu- ers of non-obligations foncières. Without any legally binding disclosure obligation, each group of issuers managed to establish an outstandingly homogene- ous, highly detailed reporting format. Next to the conviction that in the long term openness pays off in terms of inves- tors’ trust, the high quality of the reporting was facilitated by two technical factors. Firstly, the vast majority of issuers in the aforementioned countries are experi- enced ABS/MBS issuers and are therefore usually eager to meet ABS/MBS report- ing standards. Secondly, all issuers in the respective countries or markets have recently set up covered bond IT systems and are therefore also technically capable of producing highly sophisticated data. Not only do we consider original LTV ratios as an example of sophisticated data, but also current ones and even in- dexed current LTV ratios. Also, the depth of information on the debtor provided by some issuers, such as debt-to-income ra- tios or employment status, is something that far exceeds what can be considered standard in Germany. The voluntary disclosure formats we see also show some higher standards with regards to frequency of publication. While quarterly publications can certainly a be deemed sufficient as long as the time lag is not too large, the majority of issuers out- side the German market are able and will- ing to stick to a monthly schedule. A wish list Overall, there is absolutely no evidence to suggest that a legally stipulated pub- lication obligation necessarily leads to a better result than a voluntary publica- tion. The question is rather: is there any more room for improvement and, if so, what is the direction of improvement? In order to point out fields of im- provement, one has to recognize the limitations of current disclosure formats. We identify two areas that have become increasingly important in recent years: the first is the assessment of liquidity is- sues; the second, the full comprehension of credit quality. With regards to liquidity issues, inves- tors and analysts are mostly dependent upon what is published by rating agencies, which is, however, also the result of agen- cy models rather than figures fed into own analytical models. This is one of the fields in which traditional ABS/MBS investors request more information. What would be needed in order to assess liquidity risk would indeed be classical cashflow report- ing – at least providing cash inflows and cash outflows per period. However, this is quite demanding with regards to cover pool IT. And, since in an ABS/MBS con- text we have already seen reporting like this, we do not deem cashflow reporting as unrealistic going forward. “Discussing both fields of improvement has always been wishful thinking” Florian Hillenbrand
  23. 23. The second aspect – comprehension of cover pool credit quality – is likely to re- main a “problem” going forward. In order to assess credit quality, it is necessary to either obtain detailed loan-by-loan data (banking confidentiality might constitute an obstacle) or in depth information about cross-effects such as covariances of the distribution of all details provided in the cover pool reporting – in layman’s terms: providing information as to how certain combinations of characteristics material- ise. Analyses of the cover pools without the knowledge of covariances is nothing but rolling dice, i.e. are higher LTV ratios (bad) associated with higher (bad) or low- er (good) debt-to-income ratios? Since in- formation would be needed for each and every combination of characteristics, the complexity becomes ridiculous. Hence, in this context, going forward we will realis- tically have to rely on secondary sources, such as Moody’s collateral score. Coping strategies Discussing both fields of improvement has always been wishful thinking. The question is rather: what is the best ap- proach for assessing cover pool quality given current limitations? As previously indicated, we believe that, given current deficits, the most proper way to assess current cover pool quality is to use secondary sources. Moody’s collateral score appears to us to be the most comprehensible figure – however, Fitch and Standard & Poor’s provide similar information. But since we are talking about covered bond investments that are usually longer dated, quality is multidimensional: it can vary over time. Hence, cover pool dis- closure documents have to be checked in combination with each investor’s in- dividual view on the future development of the asset types in the pool. This is of paramount importance since cover pools usually reflect the average business the is- suer is underwriting; a negative view on a specific type of lending in the pool also has kickbacks to the issuer itself. This brings us to the last point: changes in the cover pool must always be assessed versus the overall business strategy. As an example, investors should be alerted if a typical owner-occupied residential mort- gage lender is adding significant amounts of buy-to-let loans to its cover pool without any proper explanation. In a nutshell, we be- lieve that the com- bination of an external quality meas- urement and an analysis of cover pools with respect to both market ex- pectation and busi- ness plan-matching is the optimal strat- egy given current con- straints. ANALYSE THIS: COVER POOL DISCLOSURE “So, tell me about your cover” March 2011 The Covered Bond Report 21
  24. 24. 22 The Covered Bond Report March 2011 STERLING MARKET: HOME ADVANTAGESTERLING MARKET: HOME ADVANTAGE Last November the first sizeable sterling UK covered bond in four years kicked off what market participants hope could become a stable source of funding. Can UK financial institutions get better results at home? By Hardeep Dhillon Sterling gives UK home advantage
  25. 25. March 2011 The Covered Bond Report 23 STERLING MARKET: HOME ADVANTAGE  £ 3bn of covered bonds have hit the sterling mar- ket this year in the wake of a £250m issue for Leeds Building Society in November, the first sterling covered bond benchmark in four years. The surge in supply – from Nationwide Building Society, Lloyds TSB and Abbey National Treasury Services – was long overdue in the eyes of many observers. Indeed the development of the sterling market contrasts with how the asset class has developed elsewhere. “Other jurisdictions targeted their domestic markets and then moved out after that,” says Sally Onions, partner in the covered bond and securitisation group at Allen & Overy. “It is a reverse situation in the UK, where issuers ac- cessed the euro market first and are now further accessing the sterling market.” The first sterling covered bond backed by UK assets was is- sued in December 2004, a £500m 20 year transaction off a Bank of Scotland £3bn Social Housing Covered Bond Programme. This was less than 18 months after a euro deal off the bank’s residential mortgage backed programme had opened the UK market, and was followed by a £500m five year transaction in February 2005 and a £500m 10 year in November 2006. However, the asset class failed to gain a strong foothold and become a liquid product in the UK. “We were really focussing on the best way to fund the un- derlying assets and not on development of the UK investor base for covered bonds per se,” says Robert Plehn, head of structured securitisation and covered bonds at Lloyds Banking Group. “Given UK investor familiarity with the underlying social hous- ing assets and the bank’s desire not to confuse European inves- tors with multiple covered bond programmes from the same issuer, it chose to focus on the UK investor base and only issue in sterling. “However, this clearly required a fair degree of education on the nature of the covered bond instrument. We were still at an early stage in the use of covered bonds by UK issuers and many still had not come to market with the traditional resi mortgage covered bond product that was being sold to European inves- tors. Our hopes of a development of a deeper and more liquid sterling investor base were, to a certain extent, curtailed by the credit crunch.” He cites other factors relating to the lack of the develop- ment of the UK investor base, including the fact that many UK investors were relatively full on UK bank risk and were not capable of providing for risk adjusted investments in terms of line allocations. In addition, investors were sanguine with bank risk and preferred to buy higher yielding bank capital instruments that provided a pick up to the very tightly priced covered bonds spreads. “Covered bonds were not a natural part of investors’ portfo- lios, which usually would have included equities and real estate in the risk bucket and Gilts and government securities in the non-risk bucket,” adds Tim Skeet, board member and adviser to Covered Bond Investor Council (CBIC) at the International Capital Market Association.
  26. 26. 24 The Covered Bond Report March 2011 STERLING MARKET: HOME ADVANTAGE Andrew Fraser, investment director for fixed income at Standard Life Investments (SLI), says that at the time of the Bank of Scotland transaction, banks still had access to relatively cheaper senior unsecured funding and the securitisation mar- kets seemed to be the banks’ choice of funding vehicle, rather than covered bonds. “Also the legislation was common law, not contractual, and this all meant that the market remained a niche pre-crisis,” he says. Only in March 2008 did the UK’s Regulated Covered Bond regime come into force. Moving goalposts The situation has since changed dramatically and there has been a shift in the attitude of portfolio managers and issuers towards covered bonds. “There is a strong premium under the Basel III guidelines for banks to get term funding and that has not been so easy to achieve over the past few years,” says Ted Lord, head of Eu- ropean covered bonds at Barclays Capital. “Some UK covered bond issuers are now more willing to pay much more along the lines of where the market is.” Cheaper costs relative to alternative funding sources and the size achievable in the market prompted Leeds Building Society to favour the sterling covered bond market, says Paul Riley, the building society’s group treasurer. He acknowledges that while funding costs have risen, launching a senior unse- cured transaction would have been uneconomical and at least 100bp wider than the covered bond issued at Gilts plus 175bp. “We took on that market leader role because it was the right trade for us,” he says. “Covered bonds have become vital to us and the backbone of our funding going forward.” Riley views the new market as being of strategic impor- tance to the UK mortgage lending sector in its ability to raise funding for advancing new mortgages, particularly if slightly tighter funding spreads are available. In addition, he believes that if lenders cannot fund at the right price in the euro market, the sterling market could offer cheaper funding, or vice versa. “Having that access to a number of markets provides an advantage to an is- suer and makes it clear to the investor community that the issuer has access to more than one mar- ket,” says Riley. This could provide a fillip to UK issuers, w h o have arguably not been given full credit for their strengths or the UK legislative framework by investors in euros. “UK investors are generally more prepared to give better credit to domestic issuers than the continental investors, par- ticularly in longer dated maturities, and that will help the over- all pricing dynamic for UK issuers,” says Skeet at ICMA. Regulatory drivers are meanwhile pushing covered bonds to play a more prominent part in a bank’s funding profile, according to SLI’s Fraser. The regulatory backdrop, in terms of bail-in and re- structuring regulations, could impose losses on senior unsecured creditors, and execution risk for bank unsecured bonds has risen. “Covered bonds seem to be exempt from any resolution re- gime so would not absorb losses at that part of the capital struc- ture,” says Fraser. “The absolute cost of issuing covered bonds relative to unsecured is obviously much lower as well for UK banks so it makes sense for them to issue in covered bond for- mat while that gap still exists.” With Basel III regulations requiring banks to term out their funding much more, using covered bonds as a financing vehicle 24 The Covered Bond Report March 2011 “It is important to get standardi- sation of reporting formats” Andrew Fraser, SLI “Covered bonds could become a cheap and permanent source of funding in the UK” Lucette Yvernault, Schroders
  27. 27. March 2011 The Covered Bond Report 25 STERLING MARKET: HOME ADVANTAGE allows them to more appropriately match their asset pool with their liabilities. “The sterling market will help banks maintain access to capital markets by providing another funding tool at lower cost, which is good for liquidity and general treasury operations,” adds Fraser. Mixed results Gauging pricing references in a nascent market with few com- parables has been fairly complex. “To get a rough idea of similar levels, some investors have looked at triple-A rated RMBS, some at corporate bonds, while others are attracted to the favourable spread over UK Gilts,” says Lord. The pricing rationale for Leeds Building Society was to come inside where its senior unsecured bonds and UK RMBS were trading, says Riley, but slightly above euro covered bonds to provide a new market premium. “The pricing references were well understood and it was more of a debate on the size of difference between the three instruments,” he says. Leeds priced its £250m 10 year deal at mid-swaps plus 175bp in November. Since then Nationwide Building Society’s £750m 15 year issue came at 150bp over mid-swaps in late January, Lloyds TSB’s £1.25bn 18 year at 175bp in early February, and Abbey’s £1bn 15 year at 158bp over in early March. For those UK issuers that have access to a range of funding options including securitisation, euros, or the senior unsecured markets, the sterling covered bond market may not be the most economical. “The cost differential for a bank like HSBC to issue an un- secured or a covered bond is not going to be that great, so they may prefer not to encumber assets on their balance sheet under covered bond legislation,” says Fraser. There is the potential for non-UK issuers, whether from Eu- rope or elsewhere, to tap the sterling covered bond market and target a new investor base. However, bankers say that this might not benefit European issuers that trade tightly in their own ju- risdictions if UK investors demand a higher premium for them to access the UK market. Plehn at Lloyds notes that the cross-currency swap favours European issuers in the shorter end and could offer them a pick- up to offset the higher margin potentially being demanded by UK investors. “However, demand is lacking at the short end and when you go out to 10-15 years, that swap benefit disappears,” he says. “That differential will start to come in, but it has to make sense for issuers economically. “It is an interesting diversification for non-UK issuers,” he adds, “and ultimately we expect that they will access this market.” Onions at Allen & Overy believes the sterling covered bond market will develop alongside the UK securitisation markets. “It does not seem as though one market is replacing another, as there is still a market for securitisation and it will be down to particular investor appetite which bonds they prefer,” she says. “Covered bonds offer recourse back to the issuer, which is dis- tinct from securitisation. “Meanwhile, continuing issuance of residential mortgage- backed securities under Master Trust and standalone programmes shows there is still strong demand for securitised paper.” Winning fans Interest in the sterling covered bond market is already appar- ent, as there is a ready base of investors attracted to highly rated long dated bonds in the UK. “Ratings arbitrage still exists for insurance companies and the issue of how much capital they must put aside when investing in the bond market,” Lucette Yvernault, fixed income fund manager at Schroders. “Senior unsecured bonds carry a lot of capital pen- alties for them, whereas covered bonds do not as much.” Under Solvency II insurers will have to hold less risk capital against a triple-A rated covered bond compared with a similarly or lesser-rated plain vanilla corporate bond or senior unsecured bond issued by a UK bank. “Solvency II will be a driver of demand for the UK covered bonds and the fact that many UK insurers have long term li- abilities means it makes sense to match them with these long dated assets,” says Fraser at SLI. Leeds Building Society’s Riley believes that in addition to Solvency II, the advent of a bail-in framework, which will not affect covered bonds, is another prominent factor driving inves- tor demand. “Those two factors have been a catalyst for the speed of cur- rent development in the market,” he says. “It does not seem as though one market is replacing another” Sally Onions, Allen & Overy
  28. 28. 26 The Covered Bond Report March 2011 STERLING MARKET: HOME ADVANTAGE Investors also point to the added security of the cover pool as a primary benefit of covered bonds. In the event of a bank encountering problems or even insolvency, investors have first claim on asset within the cover pool, in addition to a claim against the underlying issuing bank if these assets are insuffi- cient to cover losses. “The probability of default is probably much the same be- tween a covered bond and an unsecured investment in a bank,” says Fraser at LSI. “But your loss given default is going to be sub- stantially lower in a covered bond than unsecured bonds.” Investor confidence in government debt has waned, says Lord at Barclays Capital, and as spreads on covered bonds are now more attractive, the asset class is seeing greater interest from those seek- ing to invest in an ultra-safe long-term product. “Investors are considering it relatively safer to be in a cov- ered bond, an instrument that has never seen a payment prob- lem since they were created in 1769, than certain sovereign debt,” he adds. The new generation sterling covered bonds have also been finding favour with non-UK accounts, with 10% of the Leeds transaction, for example, distributed into Europe, while 20% of the Lloyds deal was non-UK, 15% going into continental Europe. Riley notes that more non-UK investors seem less wary of taking on UK housing exposure, particularly in seasoned cover pools, as the threat of a housing bubble in the UK has dissipated over the course of the last 12 months. “The housing market is subdued, but the UK has not expe- rienced significant price deterioration like we saw in Ireland,” he says. “Therefore non-UK investors are becoming more com- fortable with the cover pools, the product and the strong quality of the underlying assets.” Lord says that the share of overseas demand has the poten- tial to grow. “There are large non-UK funds with fairly reasonable ster- ling portfolios that are able to buy covered bonds but not tri- ple-A rated RMBS, and demand from central banks with large sterling reserves,” he says. As good as their last result The UK has already been recognised for having strong disclo- sure and transparency. Fraser at SLI notes that the UK is more advanced than some European countries in the reporting of collateral. While issuers report on a monthly or quarterly ba- sis in the UK, elsewhere can be published as little as on an annual basis. “It is important to get standardisation of reporting formats so that investors can continually monitor the cover pool,” says Fraser. Work by the Bank of England to increase the level of trans- parency and introduce a national template for UK covered bonds is a major step forward, says Nathalie Aubry-Stacey, di- rector of regulatory policy and market practice and secretary of the Covered Bond Investor Council at ICMA. “The UK is highly transparent and investors have access to a lot of information and data,” she says. “Having national tem- plates in all European jurisdictions will allow investors to com- pare issuance from different countries on a like-for-like basis.” Maintaining cover pool quality so it does not deteriorate over time is one major concern for investors. SLI’s Fraser, for example, stresses that although a cover pool could initially con- tain good quality residential mortgage assets, banks in the UK might have the option to replace these with other assets, such as commercial mortgages. “In that scenario, we would question the bank’s actions as the underlying commercial mortgage market has a different dynamic and the pool quality would decline,” says SLI’s Fraser. Yvernault at Schroders believes it is imperative to sub- stitute any non-performing or high loan-to value (LTV) loan with a more robust one. Substitution is superior to re- plenishment, as it does not allow the quality of the covered bond pool to be diluted over time. She adds that tightening certain regulations would make sterling covered bonds as competitive as those on the continent and also reassure for- eign investors when comparing continental products with the UK market. “Once the market fully develops, there is no reason why the sterling market should not trade on a more comparable level to the continental market,” says Yvernault. “The covered bond could become a cheap and permanent source of funding in the UK, as we have seen through the crisis with well-established covered bond programmes in Europe.” “Covered bonds have become vital to us” Paul Riley, Leeds Building Society
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  30. 30. 28 The Covered Bond Report March 2011 COUNTRY PROFILE: AUSTRALIA
  31. 31. March 2011 The Covered Bond Report 29 COUNTRY PROFILE: AUSTRALIA  T he Australian government’s decision in December to free Australian financial institutions from the shackles of the Australian Prudential Regulation Authority’s strict interpretation of section 13A of the Banking Act 1959 and allow ADIs to issue covered bonds represented a victory for the Australian banking industry after years of lobbying. However, its success was born out of circumstances quite different from those that prevailed when David Addis, then chair of the Australian Securitisation Forum’s prudential committee and head of structured product origination and sales at ANZ, and Brian Salter, then partner at Clayton Utz, in 2005 received the letter abridged above. “Securitisation was in its heyday back then, so you were getting very tight deals done,” says Addis, now managing di- rector at Cygnus Advisory. “But covered bonds were better in a number of ways. They tended to be bullet with a revolving structure, which regular securitisations here were not, and they also went for much tighter prices, and in much bigger volumes than the local RMBS deals. “And when you are talking billions of dollars and a few basis points, it’s actually worth quite a lot of money to everyone.” But Addis acknowledges that a new funding avenue was not essential in the same way that it had become as lobbying for covered bonds intensified post GFC – Global Financial Crisis, as it is commonly known in Australia. “It would have enabled the banks to open up a new fund- ing stream,” he says, “which would have been helpful, but there wasn’t a pressing need in the same way that obviously there has been since the securitisation market became so restricted.” With Australian mortgage lenders so reliant on the securiti- sation markets, the effects of the US sub-prime crisis changed the Australian financial landscape. “Most of the non-banks really struggled through the finan- cial crisis,” says Addis, “because a lot of them relied very heavily on securitisation and when they couldn’t, they just basically got Australia winds up for delivery 25 January 2005 Dear Messrs Addis and Salter, Covered bond holders would have first priority over assets of an ADI (authorised deposit-taking institu- tion), ahead of the ADI’s depositors. We cannot see how such arrangements can be consistent with the principle underpinning Australia’s depositor prefer- ence regime that depositors have the ability to claim on the assets of an ADI in Australia in preference to all other potential creditors… In summary, APRA believes that the issuance of cov- ered bonds would not be consistent with Australia’s depositor preference regime and it is not, as a mat- ter of principle, prepared to accept issuance of such bonds (or structures with equivalent effect) by ADIs in Australia. Yours sincerely, John F Laker 12 December 2010To secure the long-term safety and sustainability of our financial system, we will… allow all banks, credit unions and building societies to issue covered bonds to broaden access to cheaper, more stable and longer- term funding… The Hon Wayne Swan MP, deputy prime minister and treasurer After years of watching from the stands, Australia’s banks are taking a run up for issuance as early as the third quarter. The banking industry is therefore hard at work ensuring the right balance is struck between issuer and investor needs in impending legislation. But could RMBS and smaller banks be dismissed cheaply? By Neil Day
  32. 32. 30 The Covered Bond Report March 2011 COUNTRY PROFILE: AUSTRALIA slammed by their banks or their funders. One of them had a lot of short term extendible CP paper in the US market and it couldn’t roll it over. “Some, like Aussie Home Loans, which was one of the origi- nal securitisers, were partially bought out and supported by the banks, but a lot just stopped writing mortgages because they just couldn’t fund them. During the GFC the banks’ share of new mortgage origination went to well over 80%, and the 15%- 20% that they were not actually writing directly, they were ef- fectively funding through those non-bank originators whom they chose to support.” However, Australia’s major banks have also come under pressure. Although they remain highly, Moody’s, for example, in mid-February put the Aa1 ratings of the country’s big four – Australia & New Zealand Banking Corporation, Common- wealth Bank of Australia, National Australia Bank, and Westpac Banking Corporation – on review for downgrade. “The review will focus on the Australian banking system’s structural sensitivity to conditions in the wholesale funding mar- ket,” says Patrick Winsbury, a senior vice president at Moody’s. “The global financial crisis has underlined the speed with which shifts in investor confidence can impact bank funding, warrant- ing a review of the four major banks, for whom market funds comprise on average 43% of total liabilities.” Gail Kelly, Westpac chief executive officer, told a Senate in- quiry into the government’s banking reform package in January that covered bonds should help. “Covered bonds are valuable for us,” she said. “It’s not a pan- acea for us, but it’s an important next step to allow us to leverage our mortgages… that’s very helpful.” Meanwhile, Cameron Clyne, group CEO of National Aus- tralia Bank has welcomed the government’s move and said that covered bonds could help lower funding costs for the bank’s A$28bn of bonds it was expecting to sell this year. GFC swings the debate Speaking at a roundtable for the Deloitte Australian Mortgage Report 2011: Reforming the Agenda, Axel Boye-Moller, head of mortgages at Westpac, outlined the challenges facing the Aus- tralian mortgage industry. “What we have is a structural issue, with a limited depos- it pool unable to keep pace with growth,” says Boye-Moller. “There isn’t enough growth in deposits so we are all just fight- ing over share. Savings are not being channelled into the bank- ing system hence banks are reliant on wholesale funding, and offshore wholesale funding in particular. “Covered bonds could be part of a solution to this struc- tural issue and we would support that development. But we need to think more broadly and consider other measures to facilitate securitisation of mortgages, as well as increasing the deposit pool.” Graham Mott, financial services partner at Deloitte, says that covered bonds are a must in this context. “Given how significant their funding challenges on an annu- al basis are, covered bonds are key for our banks locally, partic- ularly the majors, to allow them to compete and raise funds on a global scale,” he says. “That’s got to be the underlying driver here, which is why the government has relented.” Addis agrees. “I expect that Treasury has been convinced that, with the securitisation market and other bond markets really being quite subdued, the performance of covered bonds was de- monstrably better than MBS or other funding through the GFC,” he says. Westpac highlighted this in its submission to a Senate in- quiry in December, ahead of the government’s announcement. “Covered bonds through the GFC provided a stable source of funding in other countries, retaining their broad investor ac- ceptance,” it said. “They have stood the test of time including a “It’s not a panacea for us, but it’s an important next step.” Gail Kelly
  33. 33. March 2011 The Covered Bond Report 31 COUNTRY PROFILE: AUSTRALIA significant number of economic cycles and financial crises, and as economic and financial infrastructure has evolved.” Indeed billions in government guaranteed bank issues ben- efiting from such support begin come up for redemption from next year and offering ADIs an alternative funding option that might appeal to a similar investor base has been cited as an- other reason for the government’s decision. And as if these factors were not enough, some observers ar- gue that the launch in June 2010 of the first covered bond in New Zealand, by National Australia Bank parent Bank of New Zealand, was the final straw. “That was a big help,” says one market participant. “It just made the Australian position even stranger. It wasn’t just Eu- rope having covered bonds, it wasn’t just the US and elsewhere, it was now New Zealand. “The four major banks in New Zealand are subsidiaries of the four major banks in Australia, so it made a mockery of the fact that these same groups were doing it in New Zealand and yet not at home.” Boundaries expanded While a change to the Banking Act will allow ADIs to add cov- ered bonds to their funding options, the government will not give Australian banks free rein to issue covered bonds. “The Treasury will also consult on the appropriate level of cap to be placed on covered bond issuance for individual insti- tutions, for example 5% of an issuer’s total Australian assets,” it said. “This will ensure a substantial buffer of assets to cover depositor claims, making it extremely unlikely that a levy under the Financial Claims Scheme would ever be needed.” As The Covered Bond Report was going to press, a draft law for Parliament to consider was imminent, but market partici- pants have expressed confidence that the paper will double the 5% limit to 10% , a level settled on by the Reserve Bank of New Zealand in March. “The 5% level was quite swiftly and successfully explained as totally inadequate,” says one, “and it looks like being 10%.” According to calculations by Deloitte’s Mott, were banks across the board to take full advantage of a 10% limit, issuance could reach around A$180bn, which is more than twice the out- standing volume of Australian RMBS. “Certainly that would be the sort of capacity that the balance sheets would support,” he says. While the number is impressive, questions remain. “Initially the government was thinking only a 5% issuance limit relative to assets, but it seems there is an acknowledgement that it needs to be higher in order to make individual issuance the broader market for Australian covered bonds a meaningful and worthwhile,” says Alex Sell chief operating officer of the Australian Securitisation Forum. “That should perhaps mean that the percentage goes higher but with a secondary limit re- garding liability mix whereby if you’re very highly dependent on retail deposits you will be able to issue less than if you are less exposed. We understand that APRA has been calling for something along those lines, and this resembles the FSA’s ap- proach in terms of looking at overall asset encumbrance relative to liability mix.” Meanwhile, Fergus Blackstock, head of Australian debt capi- tal markets at UBS, says that the 10% limit takes into considera- tions the requirements of a variety of players in the market. “It’s clearly within the comfort limits of the rating agencies and it would make it efficient for some of the smaller issuers who have got smaller balance sheets,” he says. Investors drive law change The minimum that the government needs to do to trigger cov- ered bond issuance is amend the relevant section of the Bank- ing Act, which reads: “If an ADI becomes unable to meet its obligations or suspends payment, the assets of the ADI in Aus- tralia are to be available to meet that ADI’s deposit liabilities in Australia in priority to all other liabilities of the ADI.” However, while this de minimus approach might have been sufficient in 2005, when markets were roaring and UK banks were prospering from a similar position to price covered bonds just a few basis points back from products based on prescriptive laws, such as Pfandbriefe, the banking industry is now expect- ing something more thorough. “The government has already committed itself to amending the Banking Act to permit covered bonds by removing the ab- solute depositor preference provision that has been there since 1959,” says Sell, “which you might think means that structured and legislative would then be possible. But the government has indicated that it doesn’t wish to see structured covered bonds coming about.” While this might previously have disappointed some banks, all are said to be moving towards a position where they con- sider a more comprehensive framework to carry benefits for the industry. “The push locally has been that we need a legislative frame- work rather simply progressing with a structured solution,” says Mott at Deloitte. “And mainly that’s to demonstrate to the global investor community that Australia has the rigour of a legislative framework to support its covered bonds. “The people that we are listening to the most, which is the right answer, is now the investor community in our positioning of covered bonds.” Louise McCoach, a partner at Clayton Utz, echoes this. “The current iteration of the policy certainly takes into account more of the buy- side perspective.” Louise McCoach