Ready for lift-off

To view the digital version of this report, please <a href="http://edition.pagesuite-professional.co.uk/Launch.aspx?EID=5ba65744-0322-4018-a8b4-abb4b31b204c" onclick="window.open(this.href);return false;" onkeypress="window.open(this.href);return false;">click here</a>.To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.comForging a new identityThe stature of covered bonds as a funding tool continues to grow by leaps and bounds. Developments that will see senior debt become bail-inable by 2018 are adding to their allure; as is their legal robustness and unassailable place in the capital structure in the event of issuer insolvency. In short, covered bonds have offered a funding lifeline, certainly to non-peripheral banks whose access to capital has been ravaged by the effects of the eurozone sovereign debt crisis.As well as being a beacon in the turbulent eurozone market environment, covered bonds have continued their drive to globalisation – exemplified by the coverage in this Special Report – with Australia and New Zealand coming on stream, and Belgium about to pass its covered bond law. The US remains the major elusive jurisdiction; the upcoming presidential elections in November 2012 will see the covered bond bill run out of time in the current administration as more pressing items gain precedence, but its supporters continue to lobby hard.On the currency front, crisis-driven sovereign and bank volatility may have reduced the overall proportion of covered bonds sold in euros, but issuers have found a willing reception in the US dollar market, while for domestic issuers, Australian dollars and sterling have proved reliable sources at a good price. In the UK, covered bonds in floating-rate format have been a good market in 2012.For sure, covered bonds have not been able to insulate peripheral eurozone issuers from distress, and peripherals continue to be shut out of the market. The ECB’s second covered bond purchase programme has had limited impact in this regard and the programme, which is running below target, is widely seen as much less effective this time around. What is as yet unclear, though, is if or how the Spanish bank bailout unveiled at the summit of EU leaders, held at the end of June, will offer Spanish banks renewed access to private capital and on what terms.Beyond the peripherals, there have been issues to deal with but none are seen as deal breakers. The 3CIF issue caused a hiatus in issuance of covered bonds out of France, far and away the most active jurisdiction in the public market into the first quarter. But while 3CIF caused a degree of confusion at the time, market professionals do not expect it to derail issuance into the medium term.In Canada, in its quest to deflate a housing bubble, the government passed new legislation in May to stop Canadian banks using CMH-guaranteed mortgages in their cover pools. This, and minimum overcollateralisation levels, will increase the cost of funding through covered bonds, but any wider effects have yet to be seen.In the German Pfandbriefe market, the incidence of negative yields at the short end of the government curve in the second quarter helped to stir a major resurgence of German issuers in the public benchmark market. Germans had been notable for their absence early in the year, preferring to tap the active private placement market.In essence, Pfandbriefe private placements offer issuers much better execution. Most had avoided paying up to issue benchmarks. But faced with irresistible underlying yields, the likes of Berlin Hypo, Munich Hypo, HSH, LBBW, Deutsche Bank and others stormed into the public market and were able to lock in funding at such tight levels that the overall consensus was that those levels were absurd. But even though they were optically tight, they still offered a decent pick-up to Bunds. And to a predominantly German investor base, this was deemed to be a

To view the digital version of this report, please click here.Issuance of covered bonds from the eurozone is in decline. This year issuance from the eurozone is expected to hit a paltry €120bn according to figures from Barclays. Compare that with 2010, which saw a hefty €253.2bn gross issuance. What happened?Tim Skeet, managing director in debt capital markets EMEA at RBS, elegantly pointed out that Europe has become a four-tiered market depending on strength of investor appetite, funding need and cost of market access for covered bond issuers. “Those who can, those who could, those who would and those who can’t.”German and Scandinavian financial institutions fall into the first category; British and French into the second; Italian banks perhaps into the third; and Portuguese and Spanish banks into the final grouping.The great divideThere is a stark gap between borrowing costs for German Pfandbriefe and the rest of Europe. In early June, Muenchener Hypothekenbank sold a €1bn 10-year 1.75% covered bond at mid-swaps plus 10bp or 63.4bp over Bunds. Compare that with Norwegian financial services group DNB Boligkreditt (like all Scandinavian issuers, given the dearth of German paper, the darling of covered bond investors) which in mid-June sold a €1.5bn seven-year covered bond at mid-swaps plus 40bp. And then look at Paris-based Caisse de Refinancement de l’Habitat which managed to sell a €750m tap of its 3.6% March 2024 covered bond at mid-swaps plus 103bp.Europe has become a four-tiered market depending on strength of investor appetite, funding need and cost of market access for covered bond issuers. “Those who can, those who could, those who would and those who can’t”At first sight the difficulty in European covered bond issuance looks like a straightforward hangover from the eurozone crisis. Although the country has also been distracted by elections, certainly that is why there has been little seen out of France so far this year. The only French deal since April was a SFr200m (US$205m) six-year from Credit Agricole in early July.The French covered bond market has certainly been both thin and twitchy this year thanks to the Centrale du Credit Immobilier de France (3CIF) affair, which at the time of writing remains up in the air. In the middle of May Moody’s downgraded 3CIF from C/A3 to E/Caa1 and muttered darkly about the possible need for nationalisation. Some of its bonds, covered and senior, were suspended, but not before widening dramatically. CIF Euromortgage’s 3.25% February 2016s, for example, jumped 65bp on the bid before the suspension.Even more than other issuers, French ones are known for their price sensitivity. “As soon as spreads look more attractive they are likely to come to the market. French issuers are very focused on how much they need to pay,” said Torsten Elling, co-head of rates syndicate at Barclays. Until then – like many of Europe’s banks – they will continue to take advantage of the European Central Bank’s €1trn cheap three-year funds that the ECB injected into the market.Spanish painWhile it might be easy to explain away what investors have seen in the French market as characteristic of the eurozone problems, the issue is more complicated than that. A look at the Spanish market shows that Spanish banks have traditionally been heavy covered bond issuers.There are €418bn of Cedulas outstanding, almost half of them redeeming in the next three years. There is little chance of them coming to market at least in the short term. Aside from the broader issue of deteriorating bank credit, deposit flight and an arthritic private placement market, even if Spain were able to sell covered bonds, it would be like putting a sticking plaster on a bullet wound.But as Ralf Grossmann, head of covered bonds at Societe Generale, pointed out that explanation is not quite so simple. “Even if Spanish banks could issue covered bonds, the volume that they could sell would not replace the Cedulas that are redeeming. There would

To view the digital version of this report, please click here.Since the end of May a string of German issuers has come to the market with Pfandbriefe that have flown off the shelves and priced tighter and tighter. The pinnacle – so far – was reached with Landesbank Baden-Wuerttemberg’s 1.375% €500m five-year which went at 7bp over mid-swaps, the tightest print of the year. Since then it has tightened even more in the secondary market by 3bp–4bp. No wonder then that bankers have called the current pricing levels insane.With no let-up in the eurozone crisis, Spanish 10-year debt hitting 7% in mid-June and Italian three-year bonds up to 5.3%, German debt, especially Pfandbriefe have become the ultimate in safe haven trades. The pricing on German covered bonds might be offering small yield, but at least it is still there.“You have to see the pricing of German Pfandbriefe in the context of the Bund issuance. They are still offering a pick-up over Bunds,” said Armin Peter, head of covered bonds at UBS in London. It is worth remembering that two-year Schatz yields at the end of May hit zero while 10-year Bunds have been below 1.5%.Massive order booksNo surprise then that order books have been massive. Bookbuilds are fast and books that are double the final print are commonplace. Sven Schukat, head of treasury, at the Berlin-Hannoversche Hypothekenbank, reopened the Pfandbrief market on May 23.“We started to bookbuild on Monday [May 21] afternoon. We had €1.2bn orders in an hour and a half. Within 45 minutes on Tuesday [May 22] we had reached €2.2bn orders and closed the book,” he said. The €1bn five-year issue priced at mid-swaps plus 9bp and has since tightened in secondary. “This is our one and only offering in 2012. Investors knew that if they wanted to buy BHH debt then this was their only opportunity,” said Bodo Winkler, head of investor relations at BHH.Rarity value and high demand is what is allowing such tight prints. Every deal seen recently has priced at the tight end of guidance. Indeed many of the deals could have printed even more tightly than their final level.Rafael Scholz, head of treasury for Muenchener Hypothekenbank, is of the opinion that his €1bn 10-year which guided at 10bp–12bp over and went out at 10bp over mid-swaps, could have priced at 9bp over. But as Torsten Elling, co-head of rates syndicate at Barclays in London, pointed out, although German issuers could push for tighter pricing, they don’t. “German issuers don’t want a 100% German book,” he says.Changing the mixBut tight pricing means that the traditional mix of investors has changed. “Banks and asset managers are currently driving public Pfandbrief issuance,” said Ralf Grossmann, head of covered bonds at Societe Generale. Given the lack of yield, this is perhaps not surprising. For Deutsche Hypothekenbank’s €500m five-year, banks and asset managers took 49% and 37% respectively, while insurance companies took 1%.It was a similar story for HSH Nordbank’s €500m four-year. Banks took 46%, fund managers 27% while insurance companies and pension funds only took 2%. Deutsche Hypothekenbank priced at mid-swaps plus 9bp and HSH Nordbank priced at mid-swaps plus 18bp with coupons of 1.25% and 1.125% respectively.In an ideal world, insurance companies want a yield of 3%–4%, though even they are having to lower the bar. Aarreal Bank’s €500m 1.375% five-year which sold at a comparatively generous mid-swaps plus 20bp saw a 16% take-up from insurance companies.Nonetheless, the flurry of Pfandbrief issuance since late May cannot hide the fact of how little supply there has been this year. There has been only €5bn issuance so far, according to Barclays. On the back of €38bn of redemptions, total supply out of Germany is expected to reach only €28bn. And it is unlikely to change going forward.The lack of supply has been down to the winding down of public sector Pfandbrief issuance. And even though there is a comparative boom in the German housing market, residential

To view the digital version of this report, please click here.With the runaway successes of the covered bond structure in Australia since November – US$11.2bn issuance year to date according to figures from UBS – little surprise then that the rest of Asia is looking to follow suit. But investors who had hoped for a wave of Asian issuance have been disappointed.The natural place to start is South Korea. “Korea is the reference point for covered bonds in Asia. Everyone else is thinking about it, but they are all watching Korea,” said Kyson Ho, head of structured finance for Asia-Pacific at HSBC.Three covered bond issues from the country have hit the market to date. Kookmin Bank, Korea’s largest bank by both asset value and market capitalisation, was not just the first Korean, but the first Asian bank to test the covered bond structure in Asia with an innovative deal in May 2009 via Citigroup and HSBC. The US$1bn five-year sale won plaudits for having opened the market, but criticism for containing some credit card receivables. Nonetheless it paved the way.It was followed by a US$500m 5.5-year issue from government-related financial institution Korea Housing Finance Corp (KHFC) in July 2010. More recently in July last year, KHFC came to the markets again and sold a US$500m Reg S/144a/3c7 covered bond deal via BNP Paribas, Nomura and Standard Chartered. Rated A3 by Moody’s, the 5.5 year paper priced at 218bp over US Treasuries and was the lowest dollar 144a coupon a Korea borrower achieved last year.But the hoped-for wave of issuance has not emerged since then.“Korea is the reference point for covered bonds in Asia. Everyone else is thinking about it, but they are all watching Korea”There are several reasons why this has not happened. Even though South Korean covered bond guidelines have been praised by the ratings agencies noting they provide a roadmap for potential issuers and an incentive for continuous issuance in the asset class, they are just that – guidelines. “They are yardsticks, but you still have to go to the regulator,” said Jerome Cheng, a vice-president and senior credit officer at Moody’s.At the end of June, the Korean regulator finally formed a task force to legislate the Korean Covered Bond Act and there are hopes that there will be a covered bond-specific law before the end of the year. Above all, Korea wants to maintain stability of its currency and avoid any currency spikes. That is why every cross-border deal requires sign-off from the regulator. “It is not a lack of demand for covered bonds. Korea simply does not want a bottleneck of redemptions in one year,” said Thanh Hung Thai, head of structured credit syndicate at Standard Chartered Bank in Hong Kong.Investor credibilityAside from currency concerns, niggling detailed issues also remain to be addressed before a meaningful market can emerge. Depositor protection issues have to be clarified, as do issues on the structure of the cover pool. The Kookmin deal in 2009 had a tranche of credit card receivables, so it could therefore be structured using a bankruptcy-remote vehicle. This was useful for the issuer, but not for investors wary of anything that smells however faintly of asset-backed securities. Issues need to remain on balance sheet if they want the same investor credibility as Pfandbriefe.On top of that, moves by Korea’s Financial Services Commission requiring a minimum proportion of fixed-rate loans in any loan cover pool have slowed down potential issuance. The FSC wants to force households to hedge exposure to variable interest rates. The problem is that only around 5% of Korean residential loans have fixed rate at the moment – a long way off the 30% the FSC expects by 2016.If this turns into a definite requirement for cover pool, it will take banks another couple of years to originate the loans required to back new issuance. This, like many other issues, remains unclear. Korea not the only playerBut if, by virtue of being the only issuer to date,

To view the digital version of this report, please click here.It is now easy to forget that until October last year, Australia did not have a covered bond market. Progress had been hampered for years by regulatory concerns, the main one being the impact it would have on the existing senior unsecured market: any claims made on banks by investors in the senior unsecured market are subordinated to covered bond claims in the event of a default.The Australian Prudential Regulatory Authority also worried about the impact on depositors, with any depositor guarantee scheme sitting awkwardly alongside a thriving covered bond market. Eventually, however, the need for a covered bond market became irresistible. “APRA had to move because Australian banks had a limited choice when it comes to assets that count as liquid assets under Basel III,” said Mauricio Noe, head of senior and covered bonds, EMEA at Deutsche Bank. “The Australian government doesn’t issue because they run a surplus, so they needed to give the banks something to invest in.” The regulator’s concerns about structural subordination are valid, said Derry Hubbard, head of covered bond origination at BNP Paribas, though ultimately they were neatly resolved in much the same way some other jurisdictions have tackled the issue, via an issuance cap, which for Australia stands at 8% of issuance. Suncorp joins the partySo far issuance has been dominated by the so-called “big four” Australian banks, though more recently Suncorp, in the second tier of antipodean lenders, has also joined in the party. In the Australian covered bond market’s short life, there have been obstacles, including a few significant disappointments that threatened to undermine the appeal of this emerging asset class. The euro crisis has proved a difficult backdrop against which to launch successful deals, especially given the inherently European nature of the covered bond sector. “The Australian government doesn’t issue because they run a surplus, so they needed to give the banks something to invest in” In October, when the big four banks started launching their transactions, the US dollar market seemed the way to go: “The euro market was experiencing acute volatility at the time relating to the sovereign debt crisis, while dollar pricing looked favourable,” said Sean Henderson, head of DCM at HSBC in Australia.The logic seemed sound enough at the time but in retrospect it was the wrong call. “The US investor base isn’t as broad or deep as Europe in the product and so the deals were not without their challenges in execution,” said Henderson. “Some read too much into the outcome of those trades,” he said. The banks are sophisticated enough to know one or two tougher trades do not undermine the relevance of the product, and subsequent issuance has demonstrated this point, he added. Given the fact that it is a young market, it remains to be seen whether the regulator and the public will reach the same conclusion.Antipodean appealAlthough the quality of the issuer and the cover pool of a specific transaction are important factors in determining the outcome of a covered bond transaction, the principal consideration is the perception of the country from which the issuance is made, said Heiko Langer, head of covered bond research at BNP Paribas.And Australia looks pretty appealing from an economic perspective right now, especially from the vantage point of an overwhelmingly European investor base. There is a strong link between a covered bond and a sovereign bond from the same country, and in the absence of Australian sovereign paper, covered bonds have become a good way of taking on Australian sovereign risk for international investors.Yet the Australian covered bond market is driven principally by domestic investors. Australian banks have issued around A$30bn, with about 40% of this denominated in Australian dollars. Those that assumed the Australian covered bond market would be dominated by offshore accounts have be

To view the digital version of this report, please click here.Some £6.6bn of sterling-denominated covered bonds were issued last year, representing 25% of the total (with the majority of issuance still in euros) according to Barclays. The positive trend continued this year and year to date supply stands at £5.25bn, representing 14% of sales. That compares with 3% in 2010.In seeking to explain the surge in sterling covered bond issuance analysts cite some circumstances that have helped the market slip the reins that held it back after HBOS sold the first UK covered bond in 2003.“It’s both push and pull,” said Frank Will, head of covered bonds at RBS. ”On the issuer side the euro has been impacted by the eurozone sovereign crisis, and the cost of swapping back into sterling has increased substantially. At the same time the UK investor base has expanded, with covered bonds offering a yield pick-up to the rates space and regulators seeming to favour the asset class.”UK sterling covered bonds offer a relatively high spread pick-up against Gilts with comparable maturities. In other covered bond jurisdictions the average spread over the sovereign is around 100bp, whereas sterling bonds pay 180bp–260bp over Gilts currently, according to Barclays.In all but two UK programmes, covered bond collateral consists of highly homogeneous UK residential mortgages and small amounts of cash. The loan-to-value limit varies across programmes, but issuers can fund only up to 75% loan to value while levels of overcollateralisation on a nominal basis run from 140% (Abbey) to 187% (Barclays).Key playersConcern over the fate of the euro, meanwhile, has seen issuance in that currency drop and euros accounted for 79% of securities sold this year (to May), according to Barclays, compared with 88% at the end of 2010.The key players in the sterling space are Abbey National Treasury Services, which accounted for 35% of issuance last year and Lloyds TSB, which had a market share of 35%.This year RBS and Barclays have been conspicuous players, issuing £1bn each in January.An additional boost has been that issuers have gone out of their way to make sure that recent deals have met investor needs, both in terms of format and maturity.The Barclays and RBS transactions were longer-dated, with pay-offs scheduled for 2022 and 2024 respectively. These are exceptionally long durations for the covered bond market, but not so much for the sterling space where 45% of the deals last year had an initial term to maturity of more than 10 years, and the remaining 55% of supply had a term to maturity of seven to 10 years. “Sterling deals have come at much longer maturities than their Continental European counterparts, and that’s because issuers are aiming them at insurance companies and pension funds looking to match longer-term liabilities,” said Jussi Harju, a strategist at Barclays. “For these investors it is a matter of getting a spread pick-up against Gilts and more favourable regulatory treatment compared with RMBS or senior unsecured debt.”Attractive alternativeAnother interesting recent development from an issuance perspective has been the emergence of publicly placed floating rate sterling-denominated covered bonds. Some £4.1bn of publicly placed floating rate covered bonds were issued by UK banks and building societies between January and March this year, according to Barclays, priced to offer an attractive alternative to senior RMBS notes sponsored by the same institutions.Santander UK in January issued sterling-denominated senior RMBS notes from its Holmes master trust that paid a coupon of 175bp and 185bp over three-month Libor with weighted average lives of 2.8 and 4.9 years.In the beginning of February, Abbey issued a three-year floating rate sterling-denominated covered bond with a coupon of 160bp over three-month Libor.“We invest in both RMBS and covered bonds, so it is not a matter of either or in that respect, but covered bonds can offer a good alternative to

To view the digital version of this report, please click here.French banks have been going through a funding roller-coaster ride in 2012 as volatile sovereign markets have dragged covered bond spreads to historic wides only to tighten again as the ECB arrived with unlimited cash to ease the pressure on European financial institutions. For the second half of 2012, syndicate officials say the country’s banks are in a comfortable position of almost being fully funded and covered bond spreads are likely to remain stable for the foreseeable future.Derry Hubbard, head of FIG syndicate at BNP Paribas said: “Issuance levels will remain low for the second half of 2012 compared with the first half of 2012 and last year. This is not necessarily spread driven but it’s more to do with French banks being well funded. If you look at what has happened to the 10-year we sold earlier this year, it priced at 85bp, widened to 90bp and is now at 83bp.”Laurence Ribot, head of covered bond syndicate at Natixis shared this view: “French banks have less of a need for funding. This is partly to do with deleveraging and partly to do with the fact that they are getting fewer requests for mortgages.”As a sign of this containment, Caisse de Refinancement de l’Habitat (CRH) sold the first covered bonds since the news of 3CIF broke and bankers believe the tap format and the opportunistic strategy is what will be expected from France’s banks for the second half of 2012.Strong startAt the beginning of the year, pragmatic French borrowers decided to take advantage of a relatively liquid market to price six 10-year deals raising €9bn in the process, almost a third of the total covered bond tally at the beginning of the year.“Issuance levels will remain low for the second half of 2012 compared with the first half of 2012 and last year. This is not necessarily spread driven but it’s more to do with French banks being well funded”The wounds of 2011’s disastrous market encouraged banks to continue funding throughout the first quarter and into the second quarter where a total of about €21bn of covered bonds were predominantly through long-dated deals.It’s easy to see why French banks went to the long end. With unlimited three-year funding available through twin ECB funding vehicles, the 10-year part of the curve proved to be a hit with French and German insurance companies seeking the magic 4% coupon, which all six deals provided. But the market impact of this flood of issuance was severe, with each new deal coming wider than the previous one.“Imagine the investors that bought CRH at 160bp and now for CoFF to come 30bp wide of that,” said a syndicate official at a French bank in January. “There is of course a credit differential between all of the French names and €1bn of funding is €1bn the issuer didn’t have before, but I am nervous about the execution of these deals.”All of the nervousness proved to be unnecessary as in February spreads unexpectedly tightened encouraging the likes of Credit Agricole to take advantage of cash-rich investors. But it was BNP Paribas that waited until March to squeeze every last basis point out of the market and priced the tightest long-dated French bond of the year.BNP Paribas Home Loan SFH sold a 10-year deal that came almost 100bp inside its peers, vindicating the bank’s decision to wait for the market to improve before launching a deal.According to Valerie Brunerie, head of funding and securitisation at BNP Paribas, the issuer held off from accessing the market in order to benefit from the full effects of the LTRO that she predicted would take some time to drive spreads tighter.At the time of writing, the 10-year offering is 7bp tighter in the secondary market, and bankers are hoping that a period of prolonged stability will give market access to those who need it.Small stainHowever, there is a small stain on the French market that might prevent participants from selling bonds in the second half of the year.The unresolved situatio

To view the digital version of this report, please click here.With investors searching for sanctuary from the ravages of a turbulent global economy, few markets offer better shelter than covered bonds.For those looking for an extra layer of protection, Nordic issuers offer the ultimate kite mark: “In this highly cautious market, many investors seek covered bonds issued by strong banks from countries with healthy balance sheets,” said Ted Lord, head of European covered bonds at Barclays. “In addition to covered bonds issued by Australian and German banks, many investors favour Nordic covered bonds.”While confidence in the Nordic region has been somewhat undermined by the sovereign debt crisis, the impact has been mild compared with the rest of Europe. Nordic countries look healthy from a macroeconomic perspective: Norway runs a current account surplus, while Sweden breaks even. Bank ratings are under some pressure, but less so than in other countries. Nordic issuers have relatively low exposure to the euro crisis and problematic, Southern European sovereign bonds, compared with some of their continental peers.Back on trackEven financial pariah Iceland can hold its head high in the covered bond space. The Icelandic financial crisis of 2008 enhanced the covered bond brand.“In 2008 in Iceland, there was a total meltdown of the country’s financial system leading to the full-scale nationalisation of Iceland’s banks,” said Lord. “Outside Iceland, more than 500,000 retail depositors in Icelandic banks found their accounts frozen, which led to diplomatic disputes. Repayments on Icelandic bank debt were stopped – except on the outstanding covered bond issues of Glitnir and Kaupthing. Investors in these issues got their money back in full, on time, and with interest.” “Iceland has a strong covered bond legislation. Given the developments elsewhere in the eurozone, some investors are showing interest in Icelandic covered bond issuance in the major currencies”Now the asset class is one of the few bright spots in the troubled country. Arion Banki, the new financial institution which was established from the old Kaupthing, successfully placed ultra long-dated Icelandic covered bonds, with 30 years duration, to pension funds in the local market.“Iceland has a strong covered bond legislation,” said Lord. “Given the developments elsewhere in the eurozone, some investors are showing interest in Icelandic covered bond issuance in the major currencies.”Crucially, the Nordics experienced their own financial crisis in the 1990s from which they have learnt lessons other countries are only just learning. Nordic issuers are cautious and conservative, having been small players in the structured finance markets and having lent more moderately to home buyers. There are considerable differences between the Nordics: Sweden and Norway both maintain their own currency, while Finland, a euro area country, has no real alternative to euro issuance. Yet they are at least united by the perception of them as conservative, safe markets. German enthusiasmGerman investors have always been the key to the success or failure of covered bond deals. Germans are big believers in Pfandbriefe and the broader covered bond markets, and perhaps the biggest factor determining the success of the Nordic markets is the enthusiasm of German investors. “The German Pfandbrief market is shrinking due to some German banks reducing their balance sheets in preparation for Basel III. New Pfandbrief regulations, such as keeping repayment amounts in cash or near cash for six months before payment, have also had an effect on limiting issuance of jumbo public Pfandbriefe,” said Lord.This has forced German investors to look abroad for investment opportunities. Taking a top down view of the markets, the best substitute for Pfandbriefe, many have concluded, is the Nordic markets, which are the most comparable covered bond markets available from a sovereign credit risk perspective, said Monika Rast

To view the digital version of this report, please click here.Now more than halfway through the 12 months it set aside for the programme, the ECB has only spent a third of its €40bn kitty and there appears little it can do to claw open Spain and other markets locked shut by the crisis.ECB analysis shows that in contrast to the first programme, which slashed covered bond yields before a single euro was even spent, the launch of the second one had little immediate impact.In fact, swap spreads continued to climb well into its second month and only reversed once the first of the ECB’s twin LTROs was unleashed at the end of December.Apart from the headline figure – the first covered bond programme was worth €60bn – differences between the two programmes are mainly cosmetic.As in 2009–10, the current programme buys in both primary and secondary markets with the aim of easing general funding conditions and improving market liquidity.The maturity of bonds eligible for purchase has been pushed up to 10.5 years from about seven years and minimum issuance volume has been cut to €300m from €500m.When it started the new purchases in November it wanted to spend more of its money in the primary market than the first time around when almost three-quarters of its purchases were in the primary market.Experts suspect it was to try and help banks with less than guaranteed market access get bonds away. Correct tacticsBut its plans have been scuppered by the intensification of the crisis. The split between primary and secondary market purchases currently stands at 65%/35% in favour of the secondary market, having been 56% in the primary market in February when markets were still basking in the afterglow of the LTROs.With little fundamental difference between the two programmes, many blame the impotence of the current one on a mix of the paralysing power of the debt crisis and a belief that the ECB simply did not get its tactics right.“Sometimes the solutions fit the problem and sometimes they don’t,” said one senior covered bond analyst at a large European bank.“Back in 2009 we were in a banking crisis and the spreads between the resident sovereigns and the covered bonds were tremendously wide. When the second programme started it was no longer a banking crisis; it was a sovereign crisis so it was a totally different situation.”“Many covered bonds were already trading almost flat to the sovereign so what can you expect a purchase programme in this situation to do. The answer is nothing, there is zero impact,” he added.Analysis shows that there was only a drop in spreads once the ECB buried banks neck deep in ultra-cheap LTRO cash.Side effectsThe side effect of the monster injections, however, has been a major reduction of new covered bonds issuance in many major markets. There is little sense for a bank in Spain to pay 5% or 10% to issue a covered bond when it can just knock on the ECB’s door and get 1% money no questions asked.In fact, there has only been about €45bn worth of eurozone covered bonds issued so far in 2012, nowhere near where it was this time a year ago.Analysts also added that issuance from outside the eurozone could even top that from inside the bloc this year, something which would be unprecedented.Benjamin Sahel, head of the ECB’s market operations analysis department said that it was not really a problem that the LTROs appear to be cannibalising the covered bond market because overall banks are benefiting from both.Cavalry and the Big BerthaWhile banks may have used the LTROs to get their one to three-year funding, CBPP2, as it is known, helps out if they are looking for anything longer.“The cavalry and the Big Bertha are complementary,” Sahel said at an IFR conference in Frankfurt in May. No prizes for guessing which one was the LTRO.ECB experts do admit, however, that CBPP2 does not have the power to reopen markets that have been slammed shut by the problems of their sovereigns. Risk aversion to troubled parts of the eurozone

To view the digital version of this report, please click here.Spanish banks are facing an uncertain future in the covered bond market. Grappling with a capital shortfall anywhere from €62bn to €100bn, the country’s banks are now shut out of the covered bond market, their only source of public funding, for the foreseeable future.In spite of the pledging of eurozone bailout funds to address their capital shortfalls, Spanish banks are facing an uncertain future in the covered bond market – their only source of public funding in the recent past.In June, Moody’s issued a stern warning to the market that the increase of Cedulas issuance accompanied by a drastic decline in mortgage lending would affect overcollateralisation levels, which would have a negative effect on existing covered bondholders.“This issuance surge diminishes the overcollateralisation enjoyed by covered bondholders, a credit negative. The decline in Spanish mortgage lending will further reduce the overcollateralisation,” the ratings agency said.Moody’s estimates that during the next 18 months there will be an average 30% decline in overcollateralisation.Barclays also took a view that dwindling collateral levels spell bad news for a country that is desperately trying to repair its banking system that was overly exposed to the now crippled real estate sector.Analysts at the UK-headquartered bank noted that the issuance reduces overcollateralisation to the legal minimum of 25% and increases asset encumbrance. “All this is bad news for existing Cedulas holders,” they said.The fact that Spanish banks’ mortgage lending business has declined means there are fewer mortgages to replenish cover pools to protect bondholders in the event of a bank insolvency.Spanish banks were largely trading through government bonds, which Barclays’ analysts said reflected the resilience of the investor base. However, they expect this to change.“High spread volatility in Spanish government bond markets, combined with negative rating actions on the sovereign, the senior rating of Spanish banks and, more recently, covered bonds, have started to affect Spanish covered bonds,” Barclays said.Hope fadesEarly in the first quarter, market participants were hopeful that a high stockpile of LTRO cash, the introduction of bank reforms in Spain and a tightening of spreads would continue to allow the country’s banks to access the covered bond market.For a time they were correct. Spain’s banks sold €7bn worth of covered bonds to both domestic and international investors during two months of relatively energetic issuing activity.Santander was the first to take advantage of this growing demand – it broke the seal on the peripheral bond market and sold the first Spanish transaction in more than eight months in February. It priced a €2bn three-year issue at mid-swaps plus 210bp via Barclays, Citigroup, Natixis and Santander.Banco Popular, Bankia and Sabadell followed suit and highlighted just how supportive the country’s domestic investor base is. Analysts were convinced that despite ongoing uncertainty in Spain domestic investors would support their financial sector.“Despite a noticeable drop in the current assessment score, Italian and Spanish investors still have the biggest confidence in their domestic markets,” said Florian Eichert, head of covered bond research at Credit Agricole CIB in April as the market door slammed closed.Using four covered bond deals that priced earlier this year as a sample, international investors accounted for an average of 60% of the distribution, down 13% from the total received from the borrowers in the past 18 months. In the case of BBVA’s senior unsecured bond, the international take-up was significantly larger, with more than 72% sold to non-Iberian investors.However, this confidence and initial optimism from domestic investors around Spain’s ability to lead its banks out of financial ruin faded fast as those who steered clear of the country’s bank credit as they believed

To view the digital version of this report, please click here.Canadians have accounted for 52% of all US dollar covered bond issuance since 2010, providing the market a solid foundation at a time when the US has failed to give its own banks the right to access the cost-effective market.Of the roughly US$26bn raised in the first half of this year, about US$11bn came from Canadians. Top banks from the eurozone issued over US$6bn, with Barclays returning for the first time in a few years; Australians more than US$3bn, with a debut from National Australia Bank and the remaining amount from UBS and Credit Suisse. That compared with US$18bn in the first half of 2011, and US$39bn for the entire year.Yet now even the Canadian foundation for the fledgling US market could be crumbling.Canadian banks are precluded from issuing any Yankee covereds until their own country’s legislation for the structure is enacted, a process which could take months.“The timing of  US dollar covered bond supply during the second half of 2012 is uncertain – New Canadian supply may be delayed [conceivably for six months or more] while legislation is implemented and the CMHC, as administrator of the new legislative framework, sets up its registration and oversight processes,” said Riz Sheikh, head of Americas covered bond structuring at Barclays in New York.Lobbyists in the US have also once again failed to get the politically unsexy subject of covered bonds on this year’s legislative agenda for congress.As for the Australians, they are likely to return to the US market, but for how much and how often is unknown. Westpac, for instance, chose the euro market instead in July to issue a seven-year covered, a tenor it probably could not access at the same competitive pricing in the US.Worst of all, there’s a possibility Canadians won’t bother accessing the US covered market at all once their new legislation is enacted.The new law prohibits Canadian banks from using mortgages insured by the government’s Fannie Mae, called the CMHC, one of the principle reasons why Canadian banks have to date been able to price at half the spread of its closest comparables. (See “Shifting the goalposts”.) Without that pricing advantage, some bankers are wondering whether they will bother to go through the process of setting up a US programme and tying up collateral for just a few extra basis points of savings versus senior unsecured issuance in the US.“There is some uncertainty as to whether the Canadians will be as active in the US dollar covered bond market as they have been in the past,  because without the CMHC insured collateral, the cost savings of issuing covereds versus senior unsecured will not be as material,” said one senior syndicate manager at one of the biggest US banks.“It will clearly cost the Canadian banks more to issue covered bonds with uninsured collateral, than where their deals now trade, but how much more expensive they will be we’re not sure,” he added.Canadian five-year covereds with CMHC insured collateral trade around 50bp, versus around 105bp for the Australians, so an uninsured five-year covered would presumably price somewhere between the two.Scotiabank’s five-year covereds trade around 45bp over Treasuries, compared with NAB’s debut covered this year at 105bp. That would compare with five-year Canadian senior unsecured trading around 125bp for five years.“Yes there are savings implied in the issuance of covereds versus senior. It’s just a matter of whether those savings are considered enough by a Canadian issuer to justify the cost of setting up a covered programme and using up the collateral that goes into play,” said the syndicate manager.Royal Bank of Canada, which does not use insured collateral, has an outstanding US dollar covered that trades at about 10bp–15bp back of Canadian comparables backed by insured mortgages. Those RBC bonds, however, are very illiquid and the bank has not been back to the market in two years. The bank is breaking new g

To view the digital version of this report, please click here.Canada’s new law on covered bonds is included in the 400-page Budget Implementation Bill (Bill C-38) that is working its way through Canada’s parliament amid considerable controversy. Nevertheless, the covered bond legislation in the bill is expected to pass into law before the end of the third quarter, and its key provision will prevent issuers in future from including insured loans – whether the cover comes from the public Canada Mortgage and Housing Corporation or private insurers, such as Genworth MI Canada – in cover pools.Given that 85% of the C$63bn of outstanding Canadian covered bonds are backed by insured mortgages, this will clearly be a game changer for both issuers and investors. Government insurance currently covers 100% of CMHC-backed loans and 90% of those covered by private insurers and so minimises the credit risk that investors take on the bonds.Quasi-sovereign viewThis comprehensive insurance has led many investors to view Canadian covered bonds as quasi-sovereign risk (although most traders do not wholly go along with this analysis), which offers a premium of 50bp–60bp over sovereign debt of comparable maturity (generally three to five years).“In effect, you’ve had sovereign risk, as the collateral was insured by the Canadian state,” maintained Tim Skeet, managing director in the financial institutions group at Royal Bank of Scotland in London.While the removal of insured mortgages from covered bond collateral pools – along with increased regulatory oversight of the CMHC – is deliberate government policy to prevent an excess of cheap home loan funding from causing a bubble in the Canadian housing market, the move will force all the country’s banks apart from Royal Bank of Canada (which already issues bonds backed by uninsured mortgages under its global contractual framework) to make significant adjustments to their covered bond programmes. (See “Crumbling foundation”.)    “They will all become much more credit-driven products than a rates-driven product.” said Skeet. “The banks will still be able to issue, but what we don’t know is how the market will respond to this change in their underlying characteristics.”More protectionOne inevitable change if banks want to preserve the Triple A credit ratings that all Canadian covered bonds currently enjoy will be a significant increase in the overcollateralisation of cover pools. Although the new law does not specify minimum levels of overcollateralisation, the ratings agencies will certainly demand more protection on this score to compensate for the heightened credit risk.Most issuers will probably have to boost the overcollateralisation in their pools by 100% or more from the present average level of just over 5% – bearing in mind that the highly rated RBC currently has to maintain approximately 9% overcollateralisation in its cover pool to keep the top investment-grade rating for its programme.   Vanessa Purwin, senior analyst at Fitch Ratings in Toronto, confirmed that overcollateralisation levels necessary to support Triple A ratings on any registered covered bonds issued under the new legislation were likely to be comparable to that in the RBC pool.“To achieve Triple A ratings, overcollateralisation levels need to be consistent with loss expectations under a Triple A stress scenario,” she said. “Overcollateralisation levels will ultimately depend on the credit attributes of the cover pool and the stressed market value of the assets in a liquidation scenario – as well as the historical default and loss performance of the issuer’s uninsured mortgages.”Purwin added that she expected most issuers to maintain overcollateralisation levels that would support Triple A ratings on bonds that they issue under the new regime.Demand for premiumRegardless of the ratings, however, investors are sure to demand a premium for the increased credit risk of the new registered bonds – particularly as the instruments wil