Pfandbriefe/Covered Bonds 2005 - New markets, new borrowers
The covered bond family continues to expand, with new jurisdictions and borrowers coming on stream. William Thornhill outlines the major developments in the recently established, already established and yet to be approved jurisdictions.
The Italian senate in early May approved an amendment to the law 130 that should allows private sector Italian banks to issue covered bonds. The law is expected to go to the lower house on May 9 and should be approved as, being under Fiducia decree, parliamentary debate is not required.
The present law 130 provides the basis to issue ABS structures, but with the amendment, borrowers will be allowed to provide guarantees. Sources familiar with the process say borrowers will be able to issue under the true sale initiative to a special purpose vehicle (SPV). Once the SPV buys the cover pool, it holds this in its balance sheet and makes it available as a back-up to the guarantee.
Investors are expected to have a preferential claim on the asset pool of the bankruptcy-remote SPV. Since the law would be specific to covered bonds it should fall into the UCITS 22.4 definition, and pending approval from Italy's regulator, the Bank of Italy, a 10% risk-weighting should theoretically be achievable. Secondary legislation is likely to prove technically the most complicated, and could take up to four months to complete. Italy will want to make sure that its framework is on a par with the most up-to-date jurisdictions.
In addition to the legal and rating challenges, issuers will need some time to develop a structure that can be applied universally to all private sector Italian banks – band that can be applied to both mortgage and public sector backed debt. This will undoubtedly be shaped with a view to achieving Triple A marks, and in this way, agencies are likely to be involved as part of an ongoing consultative process.
The optimistic view is that work could be completed by the latter part of the fourth quarter, but in reality spring 2006 seems more likely. Intesa, Capitalia, IMI, Banca MPS and Unicredito are all likely to be interested in issuing covered bonds.
Paulo Ferreira, head of funding at Banco Espirito Santo (BES), explained that the primary covered bond law was almost ready last year, but with the change of government, matters were put on hold.
After Portugal's prime minister left to run the EU commission, the Ministry of Finance's priorities changed. "Our understanding is that covered bond legislation is not a top priority of a new government, so the best we can expect is for something to emerge late this year or early next," said Ferreira.
Other than BES, any or all of Caixa Geral de Depositos, Banco Portugues de Investimento, Millenium Bcp Investimento, Banco Totta and Banco Monte Pio could potentially issue.
The Portuguese covered bond law – or Obrigacoes Hipotecarias –was first enacted in 1990 and revised five years later, though so far falls short of what is required. The updated law, when it eventually transpires, is expected to give issuers the option to choose one of three types of structure.
The first will be along the lines of the Spanish cedulas market and will be on-balance sheet. The second will follow the French model and will be off-balance sheet. The third option will be structured, utilising an SPV as in the UK model. "The three options are designed to give maximum choice to enable borrowers to adapt to changes in the market," said IXIS CIB's Alessandro Bergamo-Andreis.
Sofia Magalhaes, assistant to the minister of finance and public administration in Portugal, believes the final legislative form would have all the essential ingredients of a covered bond such as preferential bondholder claims, segregation of assets, asset eligibility tests and asset liability management tests, amongst other factors. At present the national regulator, the Bank of Portugal, applies a 20% risk-weighting to covered bonds.
Australia in UK’s footsteps
Australian banks are following developments in the UK and are keen to emulate the HBOS structure. However, their regulatory authority, the Australian Prudential Regulation Authority (APRA), is concerned about the subordination of depositors.
According to the Policy Research and Statistics Division at APRA, Australia operates in unique circumstances as it has "an explicit depositor preference regime but no deposit insurance arrangements." Because of this, "a weakening in the protection afforded to depositors must outweigh any incremental benefits to issuers."
It goes on to say that it "cannot undermine the will of Parliament on depositor protection. Hence, we could not agree to any watering down of depositor preference on a selective basis."
Despite this, optimists point to the fact that the Australian government is reviewing the merits of introducing a limited explicit guarantee into parts of the Australian financial system. If this review were to lead to changes in Australia's depositor preference regime, APRA, in its own words, "would be willing to revisit its approach to covered bonds."
Sweden, the next century
The introduction of new covered bond legislation in July last year will allow borrowers to issue covered bonds as opposed to mortgage backed bonds which did not give a preferential claim to investors.
Talking about its history, S&P's Per Tornqvist explained that "Sweden has had a mortgage bond market for a good 100 years. The last specific law (Kreditaktiebolagslagen) was taken away when Sweden joined the EU in 1994, At that point, lobbying for a German-style bond legislation had already started, and in 2004 this effort was crowned with the introduction of the Lag om Säkerställda obligationer."
DrKW Research believes the older outstanding mortgage backed bonds (worth about €70bn) could well be converted to the new structure, "to avoid placing existing bond creditors at a structural disadvantage." Under the old law, investors tended to be largely domestic but DrKW Research says that under the updated version, international investors are taking an increasing share.
However, according to S&P's Per Tornqvist, "Sweden has not yet converted existing debt to the new legislation." He went on to point out that "under the present system there is no specific link between a bond and the underlying asset. This changes at conversion as bonds and cover assets are registered in a special ledger. He went on to suggest that borrowers could either convert everything to the new legislation or split the assets in a fair manner to make sure existing bond holders are not put at a disadvantage.
In light of the fact that there is little funding advantage to issuing in euros, Swedish borrowers do not appear to be in any hurry to bring a large euro benchmark, and accordingly, Sweden is not likely to boost the market significantly over the near term. Nevertheless, SBAB and Stadhypotek are could prove to be among the first-wavers while Handelsbanken, Nordea Hypotek and SEB might come to the table if the arbitrage funding advantage improves.
With reference to the rating of Swedish covered bond, Moody's' Juan Pablo Soriano said, "Our view is likely to be released during the course of the year after publication of our final revised methodology. This will likely be timed together with our analysis of the first rating of a Swedish Covered Bond."
While Moody's may take a few more weeks to publish its analysis Soriano nevertheless conceded that "the key aspects of a covered bond legislation are in place in Sweden – this is the ring-fencing of assets primarily for the benefit of investors. On this basis we don't see any obstacle to Aaa issuance being possible, though this will take further consideration."
Norway could debut in October
Since Norway's deposit base is relatively small compared to lending, the covered bond funding tool offers Norwegian borrowers a distinct advantage. "There is therefore good reason to suggest Norway takes off a bit faster than others," believes S&P's Per Tornqvist.
DNB-Nor is expected to bring the first covered bond benchmark, possibly around October this year pending legal clarification. The law was passed in 2002 but supplementary legislation was drawn up in 2003. However, according to DNB-Nor's head of funding, Helg Stray, some legal anomaly surfaced regarding the mortgage market in general and this is unlikely to be resolved until early June. Nevertheless, everything is in place regarding covered bond legislation specifically.
Apart from DNB Nor, which aims to issue a benchmark of €1bn to €1.5bn once or perhaps twice a year, Terra Bolig creditt and Sparebank-1 Gruppen are also expected to issue Norwegian covered bonds, though possibly in smaller size.
From a ratings perspective, S&P's Per Tornqvist says they are particularly looking at the ability of issuers to maintain timely payments in the event of bankruptcy. More specifically, this centres on the ability of the liquidator to create liquidity in the event of insolvency. Ideally this would allow the liquidator or receiver in bankruptcy to use the assets backing maturing debt to issue new financing.
With regard to maturity mismatches, the law allows for the use of derivatives on the proviso that the derivative provider is of sufficient quality and as long as the derivative survives bankruptcy. "We do not foresee a problem on this specific issue with regard to applying a de-linked approach," said Tornqvist.
Finland, small but annual?
After Aktia Hypo brought the inaugural Finnish deal last year, Sampo is next in line and is expected with its inaugural €1bn five-year this autumn via DrKW. The borrower is likely to return annually in a slightly smaller size annually thereafter (refer to the Borrower Profiles section for more).
There are few other banks of a size large enough to warrant issuing covered bonds in this specific region. Nordea has pan-Nordic operations and thus might conceivably originate assets from Finland.
S&P's Per Tornqvist noted that as Finland is a small market with a relatively small funding need, it has one of the lowest leverage ratios due to its deposit base being relatively large.
"The systemic need to fund is relatively small. It is structurally smaller than Norway and Sweden so we would expect more from these latter two countries in the near-term."
Netherlands, structured covered bond
In the absence of legislation, an up-to-date structured covered bond from the Netherlands is expected from ABN AMRO, possibly this September. The new structure will be issued by a bankruptcy-remote limited liability partnership set up by ABN AMRO and is expected to be similar in design to HBOS.
"The structure is based on the standard set by HBOS, but is adjusted to accommodate the Dutch market and is further simplified to bring the programme more in line with covered bonds from other jurisdictions, which have a covered bond law. The LTV will be a little higher than HBOS but in line with the 80% maximum stipulated in the UCITS directive, and will probably be similar to the obligations foncieres sector," explained ABN AMRO's Marco Roddenhof.
"My hope is that we produce a programme that is appreciated by investors and that other Dutch houses can copy. This will help improve transparency on structures as well as improving liquidity," was the ABN line.
Speaking on the new addition, European Covered Bond Council chairman Louis Hagen said, "We welcome the Netherlands to the covered bond market. Following the UK model is a step in the right direction but hopefully not the last. The EU landscape will be nearly complete with the Dutch covered bond."
Act forces German changes
The introduction of the universal banking act (GPA) from July 2005, with its constituent loss of the specialist banking principle, means universal institutions such as Deutsche, DrKW and Commerzbank could become covered bond issuers.
Commerzbank is considered the most likely and has a mortgage portfolio of nearly €20bn, Deutsche Bank has a portfolio of over €30bn while DrKW has a portfolio of nearly €25bn. DrKW's potential could be larger given its owner, the Allianz-Group, also holds a significant chunk of mortgage assets.
Domestic funding specialists note that the significant credit curve flattening of the last two years has however reduced the incentive to issue. The cost saving from issuing a Triple A pfandbrief compared to an unsecured Single A borrowing is typically 10bp to 15bp compared to 50bp at the height of the German banking crisis two years ago and a historical average of about 25bp. In addition, funding needs have been curtailed by relatively anaemic loan growth.
Aside from these limiting factors, other preconditions include the cost of setting up risk management and IT systems along with a commitment to issue regularly. On the positive side, investor diversification offers a significant advantage.
In the event the credit curve steepens, the arbitrage funding advantage would probably improve especially for Single A rated names like DrKW and Commerzbank. Indeed, the advantage could prove more interesting after January 2007 when Basle 2 and CAD-3 take effect. Under certain conditions, investors will be able to risk-weight covered bonds as low as 3.5% – thereby increasing their relative attractiveness vis-à-vis government bonds.
Landesbank Baden-Wuerttemberg is preparing a format that would allow savings banks to refinance up to €40bn of mortgage portfolios in jumbo format. Other savings banks, such as those in the Cologne area are also pooling resources under their own steam.
UK, herd lines up
Both the Nationwide and Abbey National are widely expected to bring inaugural benchmark covered bonds this year (see Borrower Profiles for more). Other than them, several prime lenders with significant mortgage books are undoubtedly following developments. Standard Life, RBS, Barclays, HSBC and Lloyds have been mooted.
Of these, RBS is likely to prove a favourite and could come as early as this year with a deal structured along the lines of HBOS (as opposed to Northern Rock). Timing will pivot on its ability to put IT systems in place which bring all its mortgage origination brand names under one roof.
Barclays, with a relatively large corporate business in relation to its retail network, is also considered a fair possibility. HSBC, on the other hand, has a strong retail global network and the allure of covered bond funding is therefore not so compelling. Lloyds is Triple A with Moody's and rare so they are unlikely to issue.