IMAGINE YOU ARE at a party where the music is discordant, the food and drink are running low and the host is growing weary of guests who are taking advantage of his hospitality. That was the covered bond market five years ago. Now the mood music has altered, food and drink are flowing and the host is welcoming a stream of newcomers.
Newcomers have given the sector an increasingly international flavour over the past few years. If expectations are met, this trend will continue and investors will this year play host to an impressive range of new covered bond issuers from various countries. For a variety of reasons, including new regulations and the need for funding diversification, there is every expectation that the biggest, most liquid and highest-rated European bond segment is about to get bigger.
“Non-German issuance is increasingly prominent,” says Richard Kemmish, covered bond product manager at Dresdner Kleinwort Wasserstein. He estimates that new issuance from new jurisdictions could hit as much as €17 billion. German jumbo Pfandbrief new issuance is already outweighed by supply from Spain. Of the €135 billion-worth of jumbo covered bond issuance in 2005, 42% came from Spain and 34% from Germany.
“In Spain there is a change in issuance patterns away from large fixed-rate jumbos,” Kemmish says. The shift is towards new issues that are smaller, sometimes driven by reverse enquiry, have floating-rate coupons, are registered rather than bearer bonds and are denominated in non-euro currencies. “It’s a sign of the growing maturity of the cédulas market,” Kemmish says.
The Spanish cédulas market’s size and vibrancy have ensured that covered bonds are no longer seen as a dull German backwater, and further dynamism has been provided by issuers from Ireland and the UK that are creating top-quality securities that now attempt to vie for supremacy with the Pfandbrief. Now there is a new hierarchy of covered bonds, with some newcomers rising above the Pfandbrief.
The Iberian peninsula will continue to be a source of new covered bond names. Inaugural Spanish names include Caixa Catalunya, Santander Consumer Finance, Bankinter and Bancaja. And in Portugal secondary covered bond legislation is in the final stages of preparation. Market participants are in little doubt that the first issues will be forthcoming this year – most likely in the third quarter. Portuguese banks have used securitization as a funding tool in the past but with Basle II on the way leading financial institutions are embracing covered bonds. Caixa Geral and then BCP are the leading candidates to issue in the near term. Annual supply is likely to total between €2 billion and €4 billion.
Progress following the passage of primary legislation is not always straightforward. Take Italy, where sparse primary legislation covering public sector loans, mortgages and asset-backed securitizations of public sector loans and mortgages was passed in May 2005. The detail on how a covered bond law would actually operate has yet to be worked out. “The jury is still out on Italy,” says one banker. No one is able yet to explain fully what the structure will look like – some liken it to a securitization, others suggest that it will take another form.
There is also concern that the Italian regulator is as uncertain about the nature of covered bonds as the UK’s Financial Services Authority once was. Early talk is of a limit on the amount that Italian banks will be allowed to issue as a proportion of their balance sheets, similar to the one imposed on UK banks until recently. Despite this, it seems unlikely that the Italians will be left out of the party in the longer term. All European banks will want access to covered bonds, should they want it.
Clamorous issuers
The clamour from UK issuers to have a level playing field vis-à-vis other EU counterparts on their bonds’ compliance with Ucits regulations has been deafening. Ucits eligibility means that covered bonds attract a 10% risk weighting as opposed to 20% as bank debt. Of course HBOS, Northern Rock, Abbey, Nationwide and Bradford & Bingley all went ahead and issued structured covered bonds without this regulatory cover. Now that the FSA has provided that cover, several new UK issuers are expected to set up covered bond programmes [see Why the sun hasn’t set on RMBS, this issue].
The number of countries that have followed the UK route has doubled now that Dutch bank ABN Amro has issued a structured covered bond. The Dutch bankers’ association (NVB) is lobbying hard for the Dutch authorities to follow the FSA and put covered bonds in a regulatory framework.
The Netherlands is one of the last countries in Europe without covered bond regulation, and the NVB argues that this deficiency puts its banks in an uncompetitive position. “The covered bond market is expanding fast, and we want our banks to be able to take full advantage of this business opportunity,” says Ellen van den Broek, adviser on securities affairs at the NVB. “The fact that we do not have regulation makes it more expensive for investors to buy our structured covered bonds, if they are even allowed to buy them at all, and inclines them to favour foreign covered bonds.”
Ironically, Dutch investors are actually among the largest buyers of covered bonds. Other Dutch issuers are also said to be looking at covered bonds as a funding tool. Fortis is considering using covered bonds this way; the bank has massive portfolios that it could use as collateral and a change in the Netherland’s regulatory regime is likely to encourage it to act. ING is another bank thought likely to look at entering this sector although the bank says it has no concrete plans to do so at the moment.