Covered bond debate: What’s next in a developing market?
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Covered bond debate: What’s next in a developing market?

Despite its size and maturity, the covered bond market is fast changing. New countries, new asset classes and new issuers vie for investors. But does the conflict between regulators’ desire for quality and consistency clash with investors’ needs for yield and diversification?

Poll participants

HH, Fitch In February this year, the UK’s Financial Services Authority announced that it was working on a framework to allow UK banks investing in covered bonds meeting the Ucits directive to benefit from preferential regulatory capital treatment. Is this a significant development?

LH, vdp Yes it is, because it makes the product much more attractive to UK issuers and they are potentially very large users of this kind of instrument; it also reduces the risk weighting of covered bonds from other countries.

JO, Euromoney But do you think that English covered bonds, without primary legislation, will be naturally inferior to covered bonds issued through a specific legal framework?

LH, vdp It’s the market that decides. But I am in favour of specific legal frameworks because they give investors an unambiguous and transparent product.

LD, ECB I totally agree with Louis. A legal framework gives additional security to investors.

CV, Commerzbank The UK system is clumsier, because you have to analyse every issue in nitty-gritty detail. The more issuers that come in, the more difficult that gets.

JO, Euromoney I gather that after the February announcement residential mortgage-backed securities (RMBS) tightened and that now there is an expectation that some investors will treat asset-backed securities and covered bonds as equals and hold them in the same portfolios.

PT, SBAB I wasn’t expecting this convergence between RMBS and covered bonds to occur for a few years yet but I’ve always thought that they would eventually. There isn’t much difference between them apart from the legislation, and investors clearly don’t put a huge value either on having legislation or a huge cost on the analysis burden that various structures around Europe bring with them. The FSA announcement is perhaps the ultimate sign of convergence and this trend will continue.

JO, Euromoney That’s from the investor perspective. But do/will issuers regard the two products as one?

CV, Commerzbank When I was still in the structured finance team, we agreed with the covered bond guys that these products are complementary not competitive, because there are different reasons for issuing a covered bond and a securitization. You need both instruments for the best funding mix.

PT, SBAB Yes. At SBAB in the past we securitized for two main reasons – funding diversification and capital relief. Capital relief might not still apply after the introduction of Basle II, and reduces many issuers’ incentive to continue securitizing. But the funding diversification aspect continues to apply.

LH, vdp I agree with Claudia and Per it still makes a big difference whether the issuer securitizes or whether he uses the covered bond model. As for the tools to manage your risk in the cover pools, sometimes they are the same tools that you use in the structured finance world. No matter where these risk management tools come from, if they are good , why not use them. In so far I don’t see any difference between a covered bond and a structured covered bond, because all of the traditional covered bond issuers actively manage their pools and they use structured finance tools, because they all have to cope with the same kind of risk.

New markets

HH, Fitch Aside from the UK, there have been developments in a number of markets. Portugal’s legislation has just been passed, and they are looking at either having issues directly from the issuer’s balance sheet, or creating specialized subsidiaries with bank status. Luxembourg and Denmark are thinking about opening up the possibility for non-specialized institutions to issue covered bonds. What are your views on the best way forward?

LH, vdp For a country starting out in the covered bond market it might be easier to have a specialist, because it’s easier to segregate the covered assets from the rest of the bank. We know in Germany how difficult it is to have cover pools within the issuer, and if that’s not a specialized bank it makes it even more difficult. You have to think very carefully about how to segregate these cover assets in case of issuer insolvency. It’s also easier for an investor to understand if the issuer is a specialized institution.

PT, SBAB I think issuers with previous experience at securitization might find it easier to segregate the assets within the financial institution. Others without that experience should go the specialist-bank route. We have chosen to set up a dedicated subsidiary, even though we have previous experience. One reason is that this lets us clearly communicate one credit as being the covered bond credit and the other as being the unsecured credit. Another reason is to resolve swap problems and manage the interest-rate risk between the parent and the subsidiary. There are other benefits, and if you look around Sweden you will notice that all the potential covered bond issuers are already subsidiaries within banks, so they will become sort of specialist banks in themselves.

LI, Sampo The Finnish experience is very similar. It doesn’t involve any more work to have a specialist bank, except that you have to apply for the license. But the disadvantage is that there’s no recourse to parent company assets, but in our case that doesn’t really have any effect on the success of the bond.

JO, Euromoney There’s a possibility that Washington Mutual will issue the first ever US covered bond. But will covered bonds ever become truly popular with US issuers and investors?

LA, SGCIB There are others looking too, but the development of this market will depend on the Federal Reserve and the Securities and Exchange Commission (SEC). Australia is similar and there the APRA [the Australian Prudential Regulation Authority] looked at the idea and said no. As for investor interest, that will be a function of the development of a domestic market. Once investors become familiar with a domestic product then they look at other covered bond products. In that sense the US situation is comparable with, for example, Italy. Italy has a very large investor base that could be a powerful force in covered bonds but they don’t have their own domestic market and so are not very active investors yet. Obviously US investors also prefer dollar products and that is an issue. There’s also the point that in the US individual depositors are insured up to $100,000 by the Federal Deposit Insurance Corporation, so subordinating depositors is not the issue that it is in Australia, for example. The US could avoid some of the problems that other countries have faced.

LH, vdp The German Pfandbrief issuers have been trying to tap the US capital markets for some time. Interest from US investors hasn’t been as strong as we had hoped, because covered bonds are not familiar to US investors. So if a US domestic market developed, then there is a good chance that the US investor base would open up to Pfandbriefe and other covered bonds, which would be very good news. However, we hope that if they do create a domestic market they do it properly.

JO, Euromoney Properly?

LH, vdp I hope they keep to a high-quality product, mostly in the AAA range. They have become interested in covered bonds because of the UK and Dutch experiences, where you see that structured finance techniques and covered bond techniques have converged. The covered bond only makes sense if you use it as a high-quality product, and I hope they’ll contact the European Covered Bond Council (ECBC) to exchange views. We would be prepared to give an opinion on what they are doing. But so far we have not been contacted.

JO, Euromoney Tell us a bit about why Sweden joined this market. There was talk of a covered bond law back in 2001. What precipitated the current activity?

PT, SBAB It’s taken a long time for Sweden to introduce covered bonds. Initial discussions took place in the early 1990s and then it was put on hold a couple of times until around 2002, ahead of the euro referendum, when Sweden initially was expected to vote ‘yes’. That turned out to be a ‘no’ but the Swedish legislator decided to push ahead anyway. We will have very good use of that legislation, even though the assets will be mainly in Swedish crowns. Sweden also wanted to be on a level playing field with other European issuers, so the legislator has watched developments in Europe closely, when introducing the new covered bond legislative framework, the primary purpose of course being to gain best access to the cheapest funding.

Emerging markets

JO, Euromoney Intermediaries are also excited about Turkey, I believe.

HH, Fitch You don’t feel it sitting here in London but when you’re there it’s as though everyone thinks they will be issuing tomorrow. What is interesting about Turkey and also other countries like Ukraine is that they’re starting from the opposite position to the banks from the developed markets. Covered bonds are more associated with countries with developed mortgage markets as a way of refinancing mortgage lending. In these new markets, there are tiny or non-existent mortgage markets and covered bonds are being developed to encourage growth in the mortgage markets.

LH, vdp I think this is a problem. It’s not enough just to establish a covered bond law. You need a mature mortgage market and safe collateral, and the bank needs the ability to foreclose on the loan. All these procedures have to be in place, and if they’re not, the covered bond doesn’t really help you. And that’s where I have my doubts. I don’t know how safe and well regulated the Turkish mortgage market is, or how mortgage financing is done there. The other question will be whether or not the banks have lots of deposits. Poland has a terrific covered bond law – very safe, very modern – but the banks don’t use it because they have access to many deposits and it’s much easier for them to fund their loans through those.

JO, Euromoney And that comes back to the earlier point about wanting to keep covered bonds high-quality. Would you view the creation of lower-rated covered bonds favourably? After all, investors right now want yield and they want diversification.

LH, vdp It is the responsibility of issuers to try to keep the quality high, because if something happens to one, all of them suffer. For example, there is a huge investor group in Asia who, in the event of a problem, will decide that covered bonds are not for them any more. The issuers who put a lot of effort, money and work into keeping the quality shouldn’t allow any free riders.

LD, ECB And there are other structures for issuers that want to repackage lower-quality assets. But covered bonds, where you have stable and secure assets as collateral, seem not to be the right refinancing tool for that.

HH, Fitch I think out of the eastern European countries or emerging market countries you would be constrained, for instance due to the lack of liquidity of the mortgage market, although covered bonds ratings may breach the sovereign ceiling.

LD, ECB Yes, already in the cover pools you have some assets from eastern European countries, public assets or even mortgages, but in any case they should be of good quality. However, initially we were talking about low-rated or non-performing assets, and that’s not the purpose of a covered bond.

HH, Fitch Apart from the issuer’s rating, I don’t think there’s a natural floor on a covered bond rating.

PT, SBAB It has more to do with the minimum requirements of the legislation and the standard in the underlying mortgage market. The unsecured rating of the issuing entity is obviously relevant when the raters set the ultimate AAA or BBB on the covered bond rating. But the covered bond has the support of legislation. It’s a high credit quality investment tool with a high rating. But, the term “covered bond” is not synonymous with jumbo issuance and liquidity. There are other ways of issuing covered bonds. We have a system with very good liquidity. It’s a €80 billion market that used to be the third largest in Europe until Spain started issuing a couple of years ago. Due to a unique feature of the Swedish legislation, the existing outstandings have to be converted into covered bonds to preserve the depth and liquidity in the marketplace. Issuance can be done in very small amounts in the same series, so it’s a different kind of liquidity with a very committed market-maker group to support that liquidity.

LA, SGCIB Investors today are looking for diversification. I think the Nordic issuers in the market and entering the market are lucky because they don’t have to go through what the French, the Spanish, even the UK issuers did. Today they can come in at levels that are on a par with prime covered bond issuers. They don’t have to prove themselves by issuing three, five, 10 basis points cheap to a regular Pfandbrief issuer, and I think obviously Sampo proved that last year. And again it’s a bullish market, so it works.

Chinese covered bonds?

JO, Euromoney When will our first Chinese covered bond come out?

LH, vdp Well, we’re working on it. We have been to China three times with the Pfandbrief conference but in spite of an auditorium of 150 people, we all know that the investor base in China is very limited. Still, why not? China is developing very rapidly.

LA, SGCIB And what about Japan? Japan is a big, strong country, with a large mortgage market. The Japanese banks have been having problems, so they might want to turn to a Japanese Pfandbrief. And one can probably trust Mr Suzuki to make it a point of honour to pay back his mortgage, no matter how far under he is. So it’s a very safe investment. I think Japan before China.

CV, Commerzbank Yes, I think so too. Some German mortgage banks are looking at China. But I was wondering about the legal problems because it’s still a communist country. Is it safe to refinance and mortgage in China given the communist system with property? Japan is definitely a better prospect. And you can’t use Chinese property as collateral for the Pfandbrief.

LH, vdp It is true that mortgage assets in China are not eligible. But it still makes sense to do business. We are talking about big commercial property transactions and not about small size housing finance here. So I think lenders have found solutions for these transactions. Lots of the deals are done with the big international property investors, so besides the property you still have the borrower that has to pay back the loan. And it’s certainly a fascinating market. We are talking to China Development Bank, which is publicly owned. They are very interested in implementing an organized housing market and a housing finance market, and they want to know what they need to do as a prerequisite for having property as collateral, which then could be used for either issuing mortgage-backed securities or covered bonds.

JO, Euromoney Are you ready for the covered bond to move away from the aegis of the likes of the ECBC?

CV, Commerzbank From an analyst’s perspective, I hope that the ECBC manages to keep a tight grip on it to make sure that the high quality standards are maintained.

LH, vdp The scope of the ECBC is not limited to Europe. We see ourselves as promoting covered bonds internationally. The ECBC has proven to be a great success, because of the commitment of its members. I am very confident that if we become even more international, other federations might want to get involved.

Pool innovations

JO, Euromoney In the late 1990s Luxembourg became fashionable as German issuers moved offshore to do more exciting things with their cover pools. This is happening again, isn’t it?

CV, Commerzbank Yes. The innovation at that time was that the whole OECD was cover-pool eligible. Now the Luxembourg regime is being used by mortgage banks to pool covered bonds off, which they then issue as another covered bond. But I ask myself if that is really the idea behind a covered bond. Shouldn’t it just be a product that is backed by primary assets? We have also seen the Landesbanks moving towards Luxembourg and including assets in the cover pool that are no longer eligible in Germany. What’s your view on that from a rating agency’s perspective?

HH, Fitch As long as this is legally eligible, for which we rely on the statement of the bank authorities and of the lawyers of course, then we can rate almost anything. So it doesn’t matter if you have Pfandbriefe as part of the cover pool backing the issuance of lettres de gage, or if you have other assets that would not eligible in a different country. We would rely on the asset quality. If you had covered bonds as a cover asset, you would look at the rating of those covered bonds and you would take a formal view on how risky the cover pool will be, just as for any other static credit analysis.

CV, Commerzbank But going back to Luxembourg, with the wide range of products included, when it comes to the insolvency of one of those original issuers, do you think there could possibly be a delay with regard to payment to covered bonds investors?

HH, Fitch Just as with other types of assets, it could take time to sort out which payments are owed to whom.

CV, Commerzbank So no longer than for a covered bond that is backed by primary assets?

HH, Fitch Let’s differentiate between a default of the covered bonds issuer and default on the cover assets. In the event of an issuer defaulting, payments on the covered bonds may be delayed due to defaults among the cover assets. The length of recovery time we factor in for defaulted assets in the cover pool depends on the type of assets, with public sector assets taking the longest. In the unlikely case of a public authority or government defaulting, the time we factor in for recovering the defaulted amounts is between five and 10 years for some countries. But in the event of an issuer defaulting, payments on the covered bonds may also be delayed due to the lack of liquidity in the cover assets, even if they are performing. This is our concern in Spain, for instance, where the mortgage cover pools do not include highly liquid debt instruments. However, should a Spanish bank default and the cover pool be liquidated, which we assume could take two to three years, recoveries on its cédulas would so far most likely be 100%, due to the high over-collateralization.

JO, Euromoney Can I just go back to the question of what other assets could be made eligible for pool inclusions and the pros and cons there?

LH, vdp Are we limited to mortgage loans, public sector loans and probably ship loans? That’s a good question. I still believe that the Pfandbrief was invented for a purpose. The government wanted the banks to provide cheap loans so that borrowers could afford a house or so that Germany could be reconstructed after the war, or because they wanted low funding for municipalities or other government entities. So the question really is, what now is the specific purpose governments might have to introduce a law that allows banks to make use of other assets to get lower funding costs?

LI, Sampo If you used the UK structure to have some other collateral, what would we call that kind of a bond then? It’s a covered bond to all intents and purposes.

LH, vdp Well, the CRD [Capital Requirements Directive] makes a point there by saying: “You will only get the low risk weighting if the assets used are mortgages, public sector assets or ship loans.” But of course that’s not a definition. I think that in theory you could take any kind of asset and although you wouldn’t benefit from the lower risk weighting, you could still use the term “covered bonds”. The members of the ECBC as drivers of the market will have to decide whether they want to limit covered bonds to funding only the mentioned assets. I am very sure that they will be very cautious not to damage the image of covered bonds in which they have a tremendous interest.

HH, Fitch On the Fitch web site there is a dedicated covered bond web page where you see all our 38 issuers, and the rating of each issuing institution. Then you’ve got three columns. You’ve got the mortgage covered bonds, public sector covered bonds and then a third column called “other covered bonds” for cases that can’t be allocated to mortgages or to public sector. And currently we have two entries in that column. They have a different mixed pool of assets and it shows that there is more advantage in hunting in packs, so if you belong to a larger group then it makes more sense. If you can convince 10 or 20 of your competitors to do the same, then it becomes a new category.

LA, SGCIB Yes, housing and public finance is generally seen as a longer-term loan, whereas credit cards will be three-month revolving, and auto loans will be two years, three years maximum. Your funding advantage for doing an auto covered loan or a credit card covered loan is going to be much less. So there might be natural barriers.

HH, Fitch But there are short-term bonds backed by mortgage assets. In Ireland they’re called mortgage-backed promissory notes.

Bonds on tap

JO, Euromoney There has been a fair amount of debate about the merits of tap issues. It seems to work well in Sweden but there are complaints elsewhere. What are your views?

PT, SBAB Obviously it’s difficult for Sweden to export its system elsewhere in Europe but it’s an interesting concept and it’s worth looking into as an alternative way of making a market.

LD, ECB We already have tap issues in our markets but investors don’t like it if it disturbs their performance in the secondary market. There are some issuers that are famous for an opportunistic tapping policy. If you have a really tight issue because it is very well placed, then a tap is opportune, but to do it constantly damages the performance in the secondary market.

PT, SBAB The tap issuance I’m referring to in the Swedish market today doesn’t affect the market and doesn’t squeeze the loans either, because one of the foundations the market-maker system is relying on is that in today’s unsecured world we as issuers are providing repo facilities to market-makers, should the need be there. Obviously we cannot provide unlimited repos when we have made the transformation to covered bonds, because each issuance of bonds would have to be covered by corresponding assets, and there’s a finite amount of assets, but we will still provide repo facilities to market-makers in order for them to be able to preserve the liquidity in the market, not to squeeze the bonds.

LD, ECB From an investor’s point of view I don’t mind. I can sell my bond if it tightens a lot, so I will be happy, but if a tap issue comes out and it widens by a couple of basis points, then I lose out. It’s a problem caused by the market-making system, not by the investor side.

PT, SBAB Exactly. We look at it as providing a service to the market-makers in order for them to provide liquidity.

LA, SGCIB There are two sides to this. I’m very close to our market-makers, and there’s been so much frustration in 2005 with tax squeezes and the Landesbank Pfandbriefe and so on. I can appreciate Lars’s point of view because he benefits from squeezes. But 2005 was a year where we saw a lack of liquidity in many issues and that was quite frustrating. The market-makers make this market breathe on a daily basis, so you must appreciate that their job is quite tough if they find themselves with a bond that can’t be tapped. If market-makers decide to stop quoting a bond, investors will find themselves long an illiquid bond that they can only sell at a discount. In this case, they may well appreciate a tap.

LD, ECB Some issuers are opportunistic and I don’t like it if they use market levels to their advantage. They issue €750 million or €1 billion in the primary market, wait until it tightens and then all of a sudden issue another €500 million. If you are not prepared or not quick enough, then that bond will underperform and that’s not fair to the investors.

PT, SBAB When we launch a new bond or a new series of bonds, we try to make the bond reach about Skr3 billion or Skr4 billion within the first few days, in order for it to obtain benchmark status. Then we make that particular maturity available to our borrowers, and as they choose those maturities and we get in assets based on those maturities, we issue on tap. We can pick up the phone and issue Skr100 million, or even less, each day to a price that we are fairly confident is achievable. It’s very easy to increase the size of that series subsequently as the years go by. So at the beginning it might have been Skr3 billion but over a year or two it might grow to Skr10 billion, but it’s still the same series of bonds. It’s a different kind of tap issuance mechanism from what you see in euroland.

LD, ECB So you outsource your asset liability management to the market-makers. As you get in your assets, you just tap your bonds.

PT, SBAB We are extremely matched. I think we are more matched today than the legislation prescribes.

HH, Fitch And do you buy back bonds by the same token?

PT, SBAB Yes, and ahead of maturing bonds we start reducing the size of the bonds so that we reduce the refinancing risk at the point of time when they mature.

HH, Fitch But what about country diversification? When will we see the first covered bond out of Sweden?

PT, SBAB We have three main mortgage bond issuers who have obtained their covered bond license. We are one of them, Nordea is another, and Stadshypotek is the other one. And all three of us have stated Q2 this year as the first covered bond issuance time, and then we will see when and who during Q2 will be first. I don’t know.

Public sector/Italy new market

JO, Euromoney What about public sector covered bonds? Will this market fade away in Germany because of changes to the Landesbank system?

LH, vdp Everybody expects this market to get smaller because loans to public banks without state guarantee are not eligible any more and about 30% of all the public Pfandbrief cover assets are loans to public banks. However, German Pfandbrief issuers now engage much more in the international public sector loan business. So I still expect the public sector covered bond to remain a big market in Germany.

HH, Fitch What about mixed cover pools, which are possible in certain countries, such as France and Sweden? We often hear from investors, ‘We only want to invest in mortgage assets or only in public sector assets’, rather than being exposed to a mix of them.

PT, SBAB Yes, the law is indifferent to mortgage pools or public pools. We will have a mix in the Swedish pools – mortgages and public assets in the sense of loans to either municipalities or states, or mortgages guaranteed by states or municipalities. And we view that as a strength. They complement each other and it’s a true representation of what exists in the Swedish mortgage market.

JO, Euromoney What about CDP in Italy? The first issue was hammered by the press, but they’ve had better luck since then.

CV, Commerzbank Well I think the CDP was a rather clever decision, given that rating agencies are looking rather critically at Italy. I think they’ve opened up quite a good refinancing tool in case something happens to Italy.

HH, Fitch Currently, Italy is one step further ahead than Portugal in that the intermediary draft legislation is already in discussion. Banks in that country are discussing the content of this secondary legislation.

CV, Commerzbank The Italian supervisory authority might have the same concerns as the FSA about covered bond issuance to 4% of total assets.

LA, SGCIB I think the 4% figure has gone up. I’ve heard 20% talked about, like in the UK, which should allow for healthy issuance. As far as I know the issuers are keen to do it. UniCredit, of course, is HVB Group now, so obviously they have that Pfandbrief experience to transfer to Italy.

HH, Fitch I’m often being asked whether AAA-rated mortgage-backed covered bonds will price better than the Italian government?

LA, SGCIB Pricing will be done versus other covered bonds as opposed to BTPs, as is the case for CDP. They will be priced against their peers in Europe, and therefore if you look at BTP spreads, especially in the longer end of the curve, where the BTP asset-swap spreads are wider than most covered bonds, any Italian covered bond could well be richer than BTPs. At the shorter end of the curve, BTPs tend to be richer than covered bonds and therefore two-year to five-year Italian covered bonds would price cheaper than BTPs.

CV, Commerzbank Have the Italians sorted out how they would set up the SPV? Because it was not quite clear whether they would set up one SPV which would service a cover pool with the assets put in on a revolving basis, or whether they would set up one SPV per issue, which would then be very much like a securitization. Nobody answered that question, and the only thing I’ve heard lately is that they might have one SPV serving as a programme and then use it more as a cover pool. But there’s no real indication whether they would go down one specific route or whether they want to keep flexibility within all the Italian issues. That would make comparability within the country really difficult.

CV, Commerzbank Another question is how the Italians tackle the issue of long recovery periods if it comes to insolvency. To my knowledge, it might take up to eight years.

Threats to the market

JO, Euromoney Pfandbriefe arguably survived their biggest test in the AHBR incident last year. Louis, could you take us briefly through that?

LH, vdp Well it started after AHBR issued ad hoc information that they could not exclude the possibility that they would have to be wound up. This was after its mother company, BHW, was sold to Postbank: the result was a liquidity problem, so BaFin , the German regulator, had to react. It’s BaFin’s task to prevent any bank’s insolvency. This was reinforced because AHBR is a big Pfandbrief issuer and BaFin did not want the Pfandbrief market to be damaged. A group of German banks provided liquidity to AHBR. It was also in the interest of the banks to step in because AHBR is a private bank and so belongs to the private banks’ deposit guarantee scheme. If there had been any accident, this guarantee scheme would have had to pay the depositors. Since this deposit guarantee scheme belongs to the private banks, they were asked, as the stakeholders, to resolve the problem. The next stage in the rescue plan was to try to sell AHBR, which they finally succeeded in doing (to Lone Star). In the course of this development, market-making for AHBR Jumbo Pfandbriefe was suspended although prices were quoted to investors. This caused discussions on the liquidity of jumbo Pfandbriefe.

CV, Commerzbank One very positive thing about this crisis has been that the German mortgage banks went through a new paragraph in the legislation – paragraph 28 – where you have transparency through mortgage banks publishing the composition of their cover pools on their web sites on a quarterly basis. So now you can track the development of the cover pool regularly. I like this very much. You get more of a feeling for where the business is going and what they do, if you compare that with the balance sheet.

PT, SBAB Given our experience with securitization, we set up a dedicated web site to show investors the pool contents and the performance over the years. We intend to be very transparent with our covered bonds too. Hopefully, if issuers become more transparent, that will also make it easier for investors to differentiate between different AAA covered bonds.

LI, Sampo What about cross-border responsibilities. If a German bank issues under Irish law and something goes wrong, whose responsibility is it? Is it the Irish? Is it the Germans? The collateral is in another country, and the German problems are then transported to Ireland.

LH, vdp It’s the primary task of the shareholder to resolve the problems. And then only if that doesn’t work should you ask others for help.

LI, Sampo But you raised the point of the political support for covered bonds and in such a situation it would be very difficult to say where political support should come from.

LH, vdp But nobody should count on this support from other issuers or from politicians. We have to make that clear. The issuer and its shareholders are responsible. But the AHBR crisis demonstrated why it’s important to have a legal framework and the commitment of the regulator. The legislator of the country needs to commit itself and say: “We are making this legislation, because we want this product to be safe” – then I think that everybody will try hard to prevent an accident.

JO, Euromoney Are we any closer to knowing what would happen to the asset class in a severe credit crisis?

HH, Fitch I’m confident with the asset, because of the embedded protection. The constraints are strong and valuation procedures in different countries for the mortgage part do provide some protection. So the most risk we see in all of the covered bonds we rate is more on the mismatch side.

JO, Euromoney So in a credit downturn you want to be holding covered bonds?

HH, Fitch The trouble is, you cannot differentiate. You buy covered bonds, so you buy into the credit risk of the cover assets, but at the same time you buy into interest rates and currency management in the issuing bank. It’s difficult to distinguish between all the risk elements, because they’re all in together.

CV, Commerzbank And shouldn’t it then boil down to the issuer itself? Some of them are safer than others. You know that some covered bonds tend to outperform when it comes to a crisis, because investors expect some issuers to be more prudent than others.

LD, ECB Yes, you have to look at the issuer’s business model and at how he originates the assets. Every bank has its own business model, and that’s why it goes beyond just saying it’s a covered bond. Maybe everything has an AAA rating, but the unsecured rating of the bank and the business model are different, and that’s why we do fundamental analysis.

LA, SGCIB What’s your view on the Spanish mortgage market? Ninety-eight percent of Spanish mortgages are variable-rate loans, so what happens if you get the perfect storm where the European Central Bank hikes rates to 10%, unemployment goes to 20%, and real estate halves in value?

HH, Fitch In addition, there is risk in the case of Spanish cédulas because you have variable-rate assets and fixed-rate cédulas, and there is no regulation on interest rate mismatches like there is in Germany. On the asset side, the situation in Spain is similar to the UK. The problem with analysing this kind of situation is that if you had a lot of borrowers defaulting there would be a feed-back effect. The more people default, the more house prices fall and loan-to-value ratios weaken.

CV, Commerzbank Home ownership levels in Spain are very high, they’re about 80%, which is totally different from Germany. And once people have bought, they do everything to try to keep their home. As for a Spanish property bubble, when one of our analysts rebased the prices across Europe, and compared Spain with other countries, it didn’t look overvalued. It’s more or less the same direction that other markets have taken, apart from Germany. So if prices decrease, it could be a soft landing. Nevertheless, I think the critical element is the variable rate and that’s the biggest problem.

LA, SGCIB I would argue that a slowdown in mortgage origination wouldn’t do Spain too much harm. This would reduce the issuance of Spanish cédulas and tighten their asset-swap spreads. We’ve had a slowdown in the UK mortgage market and spreads are actually tighter. This happened even before the FSA’s announcement and reflects not only the quality of UK covered bonds but also the moderate amount of issuance.

PT, SBAB Another important aspect in this disaster scenario is the country-specific robustness of the credit infrastructure. Sweden has abundant sources of credit information and a very transparent system in terms of the collateral available for property. The creditworthiness of each individual, for instance, is publicly available to almost everybody. There is also the cultural aspect of how disciplined in general people are in paying their mortgages. There are cultural differences. All those factors come into play when we have the ultimate crisis scenario.

LI, Sampo In Finland there was severe crisis 13 years ago. We had very high unemployment. Interest rates were sky high due to market conditions, and still we had very few defaults on our housing loans. That’s partly because it’s traditional to pay your loans, but I think even more important are the infrastructural things like unemployment compensation and the social security system.

JO, Euromoney Well, that’s where we have to leave it. Thank you all very much.

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