Back on its feet
Like all mortgage-related asset classes, Spanish covered bonds – in particular the cedulas hipotecarias – have endured a difficult first half of this year, but investor interest in recent deals suggests the market may be regaining some ground, despite steep premiums for issuers. Yet experts warn it will be some time before it regains its former luster. Savita Iyer reports.
According to Juan Pablo Soriano, managing director at Moody’s Investors Service in Madrid, 2008 issuance volumes of cedulas will decrease by about 30%. In addition to the general malaise that dogs mortgage assets globally, the Spanish banking system has had to contend with a more pronounced weakening of the real estate market than initially anticipated, he explained.
The real estate boom of the past years, driven by a high demand for residential property against the background of a vibrant economy, had fueled the boom in the cedulas market on both the investor and issuer side. Now things have slowed down significantly. In addition to dealing with a challenging funding market, Spanish banks are faced with highly indebted domestic households, threatening a rapid increase of problem loans that will quickly feed into the cedulas market.
The ratio of non-performing loans on Spanish bank balance sheets has risen significantly, agreed Florian Hillenbrand, vice president of covered bonds at Unicredit in Munich. Further loan losses on mortgages would in turn negatively impact the Cedulas market and exacerbate an already dicey situation, particularly if there is a crisis in the Spanish construction sector which would result in massive unemployment. Looking ahead, some of the smaller, weaker issuers could find themselves faced with the choice of going under or merging with a stronger entity.
“It’s always easy to talk about the bad aspects, so it’s important to take a look at the mitigating factors,” said Hillenbrand. The greatest of these is the strength of Spanish banks. Banco Santander Central Hispano, the second largest issuer of Cedulas with €26bn outstanding, has seen spreads on its issues widening by 30 bps to 35 bps, he said. “If this had happened anywhere else, you’d have seen the bank go belly-up, but not in Spain.”
Spanish banks have been business-savvy enough to develop strong and diversified balance sheets, able to offset the potential downturn of a mortgage loan crisis. “They do not have a great deal of subprime exposure, and they are probably the most highly efficient and profitable banks on the planet, with 10 years of solid performance behind them,” Hillenbrand said.
Spanish banks enjoy recurring and stable earning streams and boast very strong efficiency indicators. Despite having the highest branch coverage per capita in Western Europe, they show sizeable capital gains and significant counter cyclical provisions to absorb potential impairment losses, added Soriano.
Currently, the volume of subprime mortgages granted by Spanish institutions is close to 30% of overall loan volume, said Sergio Nasarre-Aznar, associate professor of civil law at Spain’s University Rovira I Virgili. The volume of credits in arrears is only slightly above 1.2% – far below both the 15% registered during Spain’s last real estate crisis in the early 1990s and the 5% current figure for the US market.
However, the bigger challenge for the covered bond market in Spain is the regulatory and legal framework in which it operates. While Spanish authorities have made changes to bring the legislation governing Cedulas and other covered bonds more in line with Eurozone requirements (even as recently as this month, there have been some changes to the law), there needs to be further reform of mortgage securities to give them more transparency, strength and an optimal situation in an insolvency crisis.
“The security of Spanish cedulas is really unknown and dark, while their behaviour in case of insolvency is far from being optimal in relation to other legislations – like the German one,” Nasarre-Aznar said.
In the Spanish legal framework, the creditor privilege of Cedulas holders extends to the entire mortgage lending portfolio, meaning there is a huge over collateralisation, while the banks’ depositors enjoy less protection in case of bankruptcy. The recent legal changes enacted in Spain, which go towards easing the withholding tax on Cedulas, could help the Cedulas market recover a bit, but is unlikely to facilitate a return to the kind of volumes seen in the past three or four years, due to the slow down in the mortgage market.
Spreads on Spanish Cedulas are currently between 50 bps and 120 bps wider than those on German Pfandbriefe, highlighting investors’ preference for transparency and regulation. Unless legal reform is undertaken in a serious manner, Nasarre-Aznar said, Spanish Cedulas will remain more expensive and less attractive than other European covered bonds.