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Monday, 23 October 2017

Pfandbriefe/Covered Bonds 2007: Best of both worlds

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The announcement that HSBC intended to use a single mortgage portfolio for the issuance of either covered bonds or RMBS was real evidence of a convergence many had thought had been happening for some time. But while the structure offers diverse funding opportunities, these are not the paramount concern to such a well-funded bank, as Philip Wright reports.

While the convergence of the covered bond and RMBS worlds had been a topic of market conversations for some time, it was not until the latter part of 2006 that any substance was added to the conjecture.

Although often – wrongly – described as a hybrid programme, HSBC’s move allows it to use a single mortgage portfolio against which to issue covered bonds and RMBS. The resultant flexibility has certainly provided food for thought for a number of others involved in the market, most of whom have been complimentary, even to the point of envy.

“If we were starting from scratch, this would be the way to go. It makes more sense, especially in a Basel II environment, and is more efficient and flexible, as HSBC is able to issue either asset class off the one collateral pool,” said one rival banker at the time the announcement.

“The principal advantage of having a single mortgage pool is the flexibility it gives you. You can adjust the balance between covered bonds and RMBS as your funding and capital needs change,” said Neil Sankoff, director of covered bond and RMBS issuance at HSBC.

By taking assets off balance sheet, the RMBS side of the equation currently offers capital relief, but in a Basel II environment this will no longer be a key driver, given the lower requirement for on-balance sheet assets. The pendulum therefore swings in favour of covered bonds.

“Any way of funding mortgages on balance sheet – from a capital requirement perspective – is more favourable than it used to be, and covered bonds are one means of funding loans or assets while still on the balance sheet,” said S&P credit analyst Andy South.

When details of the programme were released at the beginning of October 2006, some suggested that investors might associate its apparent complexity with additional risk, and demand a premium. This view was roundly discredited just a month later, however, when the inaugural €1.5bn five-year covered bond attracted €5.3bn of demand at a reoffer spread of mid-swaps less 1bp, making it the first jumbo UK covered bond to price through mid-swaps.

In spite of the discussions surrounding the structure, HSBC’s covered bonds are standard UK covered bonds and the RMBS will also be in customary format. In fact, the RMBS programme has not yet been launched. What has been set up is the LLP that holds the single mortgage pool. As and when RMBS are issued, that will be via a separate SPV that will acquire the right to receive cash flows from the mortgage pool to service the debt, and this only to the extent of the excess capacity existing in that pool.

According to HSBC’s Sankoff, covered bonds are easier to execute due to their simpler structure, and currently more attractive to the bank. Having an RMBS programme gives HSBC the capability of tapping both markets simultaneously, thereby increasing its funding capacity at any given time. The exercise was not born of any immediate necessity, however, as HSBC’s large retail deposit base means it is not as reliant on the wholesale funding markets as some of its peers. So RMBS are just: “one of a number of available funding and capital management tools”, said Sankoff.

Given the lack of any urgent need for the funds, securitisation of any description constitutes a short-term cost as far as HSBC is concerned, although the technology is now sufficiently familiar and user-friendly for that cost not to be as onerous and therefore preclusive as it once was.

“It is now a mature technology, and the set-up costs have come down quite a bit. On a cost/benefit assessment it makes a lot more sense for us now,” added Sankoff.

The reality remains, however, that even if covered bonds constitute a cheaper source of term funding, if the bank does not need the liquidity, it will not issue.

So in spite of HSBC’s natural requirement for US dollars, it is unlikely that it will jump on the current bandwagon and take covered bonds to the US investor base. The additional disclosures required to venture down the 144a route are onerous – documentation is often some 200 pages longer than for a Reg S transaction. So unless the exercise is going to be a sizeable one – and as Sankoff said, HSBC’s requirements are limited – it is not an efficient process.

More likely is a trip to the more easily accessible Swiss arena, where the bank’s high profile among investors makes for cheap funding costs, and the relatively small sizes on offer are no deterrent, as they mirror HSBC’s modest needs. One thing is for certain: the bank has plenty of options at its disposal as and when it needs them.

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