Nearly there . . . finally

IFR Pfandbriefe Covered Bonds 2008
7 min read

Evolution has been painfully slow in the Italian covered bond market since the Bank of Italy gave the green light to secondary regulations issued by the Ministry of Economy in May 2007. Progress has finally been made however, with the inaugural issue off the new framework expected the coming weeks. Andrew Perrin reports.

The slow emergence of the Italian covered bonds industry can be at least partly explained by negative developments in the broader covered bond market, where spread volatility had hampered issuance volumes across most jurisdictions. Even so, arguably even more significant has been what one market professional described as the “sluggish response by Italian banks to get their act together”.

Yet after a number of false starts a handful of potential issuers seem finally almost ready to take the plunge. Intesa Sanpaolo was initially expected to be first out of the blocks through Banca IMI and HSBC. The issuer’s initial covered bonds will be collateralised using public-sector assets, although the bank also plans to structure a covered bond programme on residential mortgages this year.

Banca Popolare di Milano (BPM) has also revealed its intention of issuing in the asset class off its €5bn covered bond programme through UBS and HSBC, and is now tipped as favourite to be the first to surface, along with UBI Banca. Banca Carige, which has appointed Natixis and UBS to structure a €5bn covered bond programme secured by residential mortgages, expected to be finalised in September with a deal to follow thereafter. Other banks bandied around as potential candidates to issue covered bonds include UniCredit and Monte dei Paschi.

Along with Greece (see boxed item), Italy is one of the last remaining large Eurozone countries to establish a covered bond market, and, as such, its arrival in the covered bond world has been eagerly awaited. Covered bond participants hope that the introduction of a fully-fledged covered bond market in Italy will encourage greater participation from the Italian investor base into the covered bond product, whose interest in the asset class has already seen healthy increases in recent years.

One common topic of deliberation is where OBGs should price in relation to other already established European covered bond markets. The Italian framework was built to resemble the UK mechanism but was originally based on statutory law. To achieve this it devised a system where an operating entity assigns collateral to a special purpose company which, in turn, guarantees an issue of the operating entity.

However, Mauricio Noe, managing director and head of covered bonds at ABN/RBS, said “the quality of the law is no longer as relevant in determining value, as spreads seem to be driven by perception and less rational factors. Ireland is a good example of this despite very solid [covered bond] legislation, while Spanish Cedulas have also found the going tough this year as Spain’s cooling housing market has seen selective investors demand higher yields.” He identified Portuguese Obrigacoes Hipotecarias as probably the most useful covered bond pricing benchmark, but believes the Italian senior unsecured and RMBS markets are more relevant to assess relative value in the current environment.

Andrew Porter, head of covered bonds at HSBC, agreed. “Italian banks have held up well against their European peers, having escaped the worst of the fallout from the market turmoil as the Italian private sector is perceived as being less leveraged than many other jurisdictions,” he said.

Italian banks still trade wide at senior level versus many other European jurisdictions. Intesa Sanpaolo, rated Aa2/AA-/AA-, paid Euribor plus 85bp to secure funding in three-year fixed, and the issue had compressed to plus 61bp bid as of May 19 – about 15bp over comparable French paper from BNP Paribas and Credit Agricole. Intesa Sanpaolo compares more favourably with outstanding Spanish bank paper, where Santander’s 5.125% April 2011 (Aa1/AA) was around the swaps plus 65bp area, having priced the same week as Credit Agricole at plus 90bp.

Other covered bond issuers that have tapped three-year senior fixed include DnB Nor (Aa1/A+) that priced at swaps plus 80bp and was around the plus 60bp area on May 19, broadly in line with Intesa. Meanwhile, Triple A five-year Italian RMBS was trading in the Euribor plus 110bp area, albeit well off the 200bp mark at which it was trading a couple of months previously. This compares to benchmark Dutch five-year paper at around the plus 70bp area in five-years on May 19, Spain around the plus 190bp area and Portugal something close to 130-135bp.

Cassa Depositi e Prestiti (CDP) is the only Italian entity that has issued covered bonds in the past, benefiting from a special legal regulation allowing the institution to collateralise public sector assets. CDP has been issuing since March 2005 and has a fairly well stocked curve out to 2013. This has sparked questions whether CDP will adopt the new OBG framework for its covered bond issuance in the future.

“This law is designed for banks and, as we are not a bank, this would by an impossible scenario now,” said Andreana Esposito, head of debt capital markets at Cassa depositi e prestiti. “Moreover, we have other sources of funding available to us and currently have no plans to return to the covered bond market this year as conditions remain unfavourable. We would prefer to watch from the sidelines and see how the OBG market develops before making any decisions on our longer-term strategy.”

Florian Hillenbrand, vice president of covered bonds at UniCredit, said the CDEP curve, that trades broadly in line with French structured covered bonds, is a helpful guideline to gauge the spread for OBGs – in as much as a Mortgage backed OBG could potentially trade around 5bp-10bp wider, depending on the unsecured credit quality of the issuer.

“A sensible range for OBGs could be between the CDEP/French structured and Portuguese Obrigacoes Hipotecarias, possibly a bit tighter as Obrigacoes Hipotecarias has an unjustified widening bias due to the geographical proximity to Spain,” said Hillenbrand. “In the current environment a range between 25bp-35bp [over swaps] at the short end and 30bp-40bp for a five to seven-year issue look like a reasonable assumption.”

This has overshadowed an ongoing discussion regarding where new OBG paper will trade compared to Italian government bonds (BTPs). Covered bonds are expected to be awarded a Triple A rating from the three rating agencies, while the sovereign has a Aa2/A+/AA- rating. Some analysts have previously suggested OBGs could at some point trade flat or even through BTPs, notwithstanding the fact that no Italian international bond has ever done so up to now.

The fact that BTPs were yielding 27bp less than swaps in three years, 7bp less in five-years and 7bp more in 10-years on May 20 suggests this will not be an issue anyway, at least for the foreseeable future. The spread to BTPs has actually proved to be a taboo subject for some potential issuers; one origination official suggested up-front opinions on the subject could actually jeopardise a bank’s prospects of securing a mandate.