How rating agencies see it
ISSUERS THAT OPT for a structured covered bond in a jurisdiction where covered bond legislation exists are always going to ruffle feathers. This year alone banks in both Germany and France – the bedrocks of the covered bond market – have decided to spurn the traditional legislated option and issue deals outside the specific law. Landesbank Berlin in Germany and BNP Paribas have both established structured covered bond programmes in countries with legislation and in the latter case Crédit Mutuel quickly followed suit. These issuers have attracted some pretty pointed criticism from market purists. Traditional players have been at pains to point out publicly the perceived shortcomings of structured covered bonds and insist that this new section of a very old market is inferior to the established product. "Investors are not fully aware of the risks associated with structured covered bonds," claims one industry veteran. "There is not total transparency."
The point of contention seems to be that for structured covered bonds there is no specific legislation stating that the cover pools are bankruptcy-remote if there is an insolvency. No surprise there – that is the nature of the beast. But critics question the extent to which investors are aware of the risks that this entails and the potential that the failure of a structured covered bond might have to taint the image of the covered bond market as a whole. Attention seems to be focused more on the French and US structures than the UK and Dutch deals – jurisdictions with plans to issue covered bond legislation.
France has a long-established obligations foncières (OF) covered bond framework and most banks refinance their mortgage lending via a form of promissory note known as the CRH (caisse de refinancement de l’habitat). BNP Paribas has so far issued €7 billion of bonds out of its €25 billion covered bond programme, a structure that was subsequently adopted by CM-CIC. It is an open secret that several other French institutions are looking at the product – the most likely candidates being Crédit Agricole and Société Générale. The inaugural BNP Paribas deal was a five-year issue, and the most recent €2 billion deal in March carried a three-year maturity via ABN Amro, BNP Paribas and Commerzbank.
BNP Paribas’ reasons for issuing outside the OF framework were pretty clear-cut. First, issuing under OF law requires the establishment of a société de crédit foncier (SCF) vehicle and the transfer of the assets off the balance sheet – all of which is expensive. By issuing the bonds under contract rather than OF law, the loans can remain on balance sheet and security is granted over them under the EU collateral directive. The structure entails the establishment of a special purpose vehicle but the loans are not transferred to it unless there is a default.
"In France, issuers are creating structured covered bond programmes as they have specific needs that cannot be met by the existing covered bond legislation," says Jason Wolf, director, FIG, at ABN Amro, which co-underwrote the BNP Paribas deal. This basically boils down to the types of assets permitted. The assets backing the BNP Paribas programme are not mortgages but guaranteed home loans. Known as "la caution", this product is unique to France, but has grown to account for most French lending for house purchases (such loans are 20% risk-weighted rather than 100%). The loans backing the BNP Paribas structure are guaranteed by Crédit Logement, a leading player in the sector (other French banks, such as those in the Caisses d’Epargne system, have their own guarantor – SACCEF). Guaranteed home loans have been securitized before – the first time in a 2004 deal arranged by SG CIB. But this is the first time they have been used to back a covered bond.
Under OF legislation there is a cap of 20% on inclusion of guaranteed home loans in cover pools. Although this is to rise to 35%, these loans now account for more than 60% of the French home loan market. BNP Paribas was therefore looking for a way to monetize these assets in the covered bond market. Under the structured covered bond, the entire cover pool can be loans issued under la caution and no transfer of assets to a SCF was required either – a win-win situation as far as the bank was concerned. "Using an SCF structure would have entailed moving the assets, which the bank wanted to avoid in order to limit operational cumbersomeness," explains Gregory Benteux, senior associate at French law firm Gide, which advised on the deal. It is this avoidance of mandatory transfer (and thus of the establishment of an SCF vehicle) that has attracted the attention of critics of the programme. They suggest that the bankruptcy-remoteness of the SPV in this case (BNP Paribas Covered Bond) is not robust. "The question is: what happens if BNP Paribas fails?" asks one covered bond expert. "It is not clear that the SPV will be bankruptcy-remote under law. It will not be if it is seen to be a fictitious company or that there is commingling of assets." He asserts that as the SPV in the company has no employees it could be seen as fictitious. "It will be up to the various French courts."
Not surprisingly, BNP Paribas and its legal adviser, Gide, vigorously rebut any suggestion that any uncertainty surrounds the structure. "We obviously have a watertight legal opinion on the transaction and this legal opinion covers bankruptcy remoteness together with other structural features," says Derry Hubbard, head of covered bond marketing and execution at BNP Paribas. "The bonds are issued by a regulated institution that is capitalized."
Benteux at Gide says: "The bankruptcy remoteness of this structure has been recognised by the rating agencies, in accordance with their usual bankruptcy-remoteness criteria, and by investors." Benteux emphasizes the point that the application of the EU Collateral Directive in France makes the legal regime of pledge of collateral used for this covered bond structure particularly strong (the collateral directive relates to financial collateral arrangements and secures any financial obligations between banks). "Where one bank is granting security to another bank, the enforcement of collateralized assets (and their transfer to the creditor) does not require any formality in order to be effective and is not affected by any of the relevant provisions of the French Commercial Code on insolvency and other related proceedings," explains Benteux.
