At a standstill
The Spanish covered bond market, once one of the most vibrant in Europe, is closed for the season, thanks to the Spanish sovereign rating downgrades and concerns over the strength of Spanish savings banks. When it reopens, the market may look quite different. Denise Bedell reports.
The Spanish covered bonds market, Cedulas, has been booming over the past year. This year, however, may see a sea-change as the effect of a sovereign downgrade, deleveraging financial markets and restructuring savings banks take effect.
According to research by Moody’s Investors Service, Spanish Cedulas accounted for 17% of the European market at year end 2009. At that time Spain was the second-largest European covered bond market by volume, after Germany, it found. And in the first few months of 2010, Spain had a record €14bn of new issuance by the end of April – ahead of the German market, which saw only €12bn.
Most market pundits expected this encouraging start to set the tone as 2010 progressed, though there was some volatility even early in the year. Volumes died off as issuers and investors waited to see what Spain would do. After some positive news in March, the market re-opened with a bang: Santander launched a €1bn, 7-year single Cedulas on March 18, coming in at 75 bp over comparables. This was followed by over €7bn of issuance in the last two weeks in March, and further issuance in April.
Jorge Alegre, managing associate at Linklaters, divided recent transactions into two waves, the first in October and November of 2009, and the second launching and closing in spring 2010. Market participants expected a third wave going into the summer, but events conspired to prevent it materialising.
But when turmoil flared again in late April, with S&P downgrading Spain’s long-term rating to AA from AA+, the Cedulas market closed its doors for the season. Spreads widened on sovereign debt, which ultimately stopped all issuance. Fitch’s Spanish sovereign debt downgrade on May 28 – to AA+ from AAA – was another nail in the coffin.
“The Spanish sovereign downgrade killed the market,” said Ramon Ruiz de la Torre, counsel at Linklaters in Spain. “It is the underlying credit to which these banks issues are linked. It meant that yields to be paid by banks went significantly up and investor appetite goes down because of the increased concern over risk.”
Although the largest Spanish banks generally have greater access to other sources of liquidity and are in relatively good shape financially, this is a big hit to the Spanish savings banks, known as Cajas. They rely on multi-cedulas issuance – where a number of banks pool collateral for a covered bond transaction – for much of their funding.
Multi-cedulas are particularly important for small and medium Spanish financial institutions, said Juan Pablo Soriano, managing director of covered bonds at Moody’s Investors Service, because traditionally it means cheap and long term funding. “Around 30% of total funding by Cajas with a rating lower than A3 is obtained through multi-cedulas,” he said.
The closing down of the Cedulas market has accelerated the pace of Cajas restructuring and consolidation that picked up speed when Spain’s Central Bank intervened to aid savings bank Cajasur in May.The Cajasur intervention will have significant repercussions in the Spanish market, according to Soriano. “It implies that many international counterparties will be less willing to provide funding to Spanish financial institutions, the Spanish banks are going to pay a premium on the interbank market. So going forward, and for weaker financial institutions, the only source of funding will be the ECB funding and their deposit base,” he said.
Others insist the Spanish banking system is relatively robust. It is governed by rules for provisioning against bad loans that require Cajas to set aside 400% more provisions than required. The Financial Stability Report from the Bank of Spain, published in March, outlined a pretty robust picture in terms of Spanish bank funding needs. Spanish banks have already issued around €4.5bn in senior debt in 2010, it said. More that 60% of medium- and long-term Spanish debt will not mature until 2014.
Ralf Grossman, head of covered bond origination at SG, believes the closing of the Cedulas market will prove a short-term phenomenon. He predicted a market recovery once it returns, probably led by BBVA and Santander – though at much wider spreads than seen earlier this year.
“The banking system – apart from the savings banks – is not in bad shape,” Grossman said. “Clearly earlier in the year there was an appetite. In addition, we already saw good take up from the domestic market, Spanish investors were investing in the product, which was encouraging to see and helped the market to restabilise–before the sovereign problems kicked in. But with the widening of spreads on the sovereign side there was a crowding out effect on Cedulas.”
The biggest concerns as far as covered bonds go are sovereign stabilisation and longer-term economic factors coming out of sovereign actions. As the Spanish administration tightens its belt, this can spill over into negative market sentiment, resulting in reduced spending by both consumer and corporate Spain. This could lead to increase in non-performing loans if unemployment spikes, which will mean more difficulties for Spanish banks.