Pfandbriefe/Covered Bonds 2005 - Mutual respect
The UK's fourth largest mortgage lender and seventh largest retail bank, Nationwide, is poised to join the UK covered bond market this year with a €14bn issuance programme arranged by Barclays Capital and Deutsche Bank. With some of the cleanest mortgage collateral in any market, Nationwide should be a shoe-in to the ranks of the benchmark issuers, as Joti Mangat reports.
High street competition notwithstanding, Nationwide is the world's largest mutual society, and as such – by law – must fund at least 50% of its assets with its retail deposits. In fact, Nationwide exceeds that limit, with retail deposits accounting for almost 70% of its asset base. The borrower looks to the wholesale markets to fund the balance via two MTN programmes (US dollar and euro-denominated) and other short-term money market instruments.
Mark Hedges, head of structured finance at Nationwide, explained how covered bonds fit into its funding strategy: "Whilst we expect to continue issuing off both our US and Euro MTN programmes, our covered bond programme will enable us to diversify our distribution, extend our maturity profile and bring larger, more liquid issues."
Although its EMTN shelves have enabled Nationwide to target both public and private demand for its name, it has found its maturity curve restricted to issuance around the three, five and seven-year points. Covered bonds offer a mechanism for extending its presence beyond this point.
"Covered bonds will enable Nationwide to extend its maturity profile into the 10 and 15-year points of the curve," Hedges said.
Because of a priority to adapt its IT systems to meet mortgage regulations, Nationwide's covered bond systems development had been confined to the back seat. Furthermore, the fact that Nationwide had never developed the infrastructure required to issue a true-sale residential mortgage securitisation meant that it faced significant start-up investment.
With the implementation of mortgage market regulation in the UK in November 2004, Nationwide has focused its IT efforts on covered bond systems exclusively, the completion of which is imminent.
Once the programme is signed, however, Nationwide expects, to get into the market at the first opportunity in the last quarter. "Our debut covered bond issue is likely to be a benchmark euro [probably €1bn] five-year issue, as there is a much bigger market for euro paper – and part of our motivation with covered bonds is to achieve the widest and deepest distribution possible," Hedges said. Launch could be in November 2005.
Despite Nationwide's intent to extend its curve beyond the seven-year point, it will be responsive to investor appetite first and foremost, according to Hedges. Drawing on valuable lessons learnt in the reverse inquiry-driven EMTN market, the borrower is keen to ensure that investors get a product they actually want. In its ambition to become a programmatic, regular covered bond issuer, Hedges said that Nationwide planned to issue annually €2bn–€2.5bn from two benchmark sized transactions.
The cover pool and structure have not been finalised but the collateral would be broadly representative of its global mortgage book. Nationwide estimates the LTV of its total book at 36%. Mortgage arrears (three months or more) reduced by 6.6% from £7.6m at 4 April 2004 to £7.1m at 4 October 2004. The percentage of mortgage cases three months or more in arrears at October 4 2004 was 0.29% (at April 4 2004 this figure was 0.35%).
The borrower's mutual status places certain constraints on how the programme can be structured. Under the conventional Plc issuer structure – as adopted by HBOS and Northern Rock – legal title over the assets passes to the LLP upon perfection of assignment. Applied to a mutual society, members would in effect no longer be members.
The programme arrangers are thus working on a structure which gives investors the same security over assets as the Plc model, without the negative implications of perfection for its membership.
"We expect to achieve a structure which achieves an equitable assignment of assets, giving investors much the same security as the Plc structure. The Nationwide structure will be just as strong as any Plc vehicle," said Arjan Verbeek of Barclays Capital's covered bond structuring team.
In view of its mutual status and subsequent funding base, recent comments from the FSA regarding issuance ceilings for the UK covered bond market have limited application to Nationwide. "The FSA's 4% ceiling should not be seen as a hard and fast rule. Rather, this is a trigger for further detailed discussion with the regulator who will consider each case on an individual basis," said Hedges. "I don't foresee that this initial ceiling will limit our programme."