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Euro Covered Bonds Survive Crisis
Asset Securitization Report--SourceMedia (February 4, 2008)
As more banks realize the liquidity potential in European covered bonds, issuance volumes are expected to rise in 2008.
"We are expecting it to be a very significant year, not just for the U.K. and Europe but around the world," said Peter Voisey, partner at Clifford Chance and chairperson at Information Manage-ment Network's inaugural global covered bonds conference held in London last week.
However, the fact that 30 European countries are now actively developing covered bond legislation could potentially lead to a supply and demand imbalance. HSBC analysts said that a major theme for 2008 is the difference between potential supply and realistic demand. If realistic demand is lower than potential supply, the result could be lower issuance or higher accepted spreads. "Investor demand will determine final issuance, with banks looking for more secured funding and investors remaining cautious on all liquidity, duration and credit risk," HSBC said.
Helene Heberlain, head of covered bonds at Fitch Ratings, recalled that the last major crisis the market endured was the tech bubble bursting. "I was asked then how the market would be affected and the answer was none, I wish I could say the same about what's happening today."
Covered bond spreads have already started to widen and issuance in the sector declined during the turbulent months of 2007, with no issuance seen last December. The level of tiering has increased and panelists said that there is no guidance as to where these bonds should price.
There is also the potential for negative rating actions. Massimo Catizone, Moody's Investors Service senior analyst, said that if there are any, these will be less aggressive than what has been seen in RMBS. Investors can find comfort in the structure because once the rating falls below a certain threshold, issuers are required to take steps to protect the investor.
A good example of how the structure functions in a ratings event is the December short-term rating downgrade of Washington Mutual by Moody's and Fitch, which triggered a segregation downgrade in its structured covered bond that obliged the bank to create a separate account to guarantee payments to the SPV, HSBC analysts said. They said that similar steps can be expected from Northern Rock this year. "Covered bond downgrades are likely to be triggered by downgrades of senior unsecured ratings rather than deterioration in asset quality or declining over-collateralization," analysts said.
Although the end of 2007 saw an issuance slowdown in the sector, overall it still proved to be a fairly liquid product. "The rationale of investment hasn't changed," Mauricio Noe, managing director and head of covered bonds at ABN Amro said. "There is no real concern for credit quality, spreads are relatively stable. Liquidity has remained pretty strong. There is no reason why investors won't participate. Covered bond investors are still there and, if anything, we will see new pockets of investors."
Panelists predicted that 2008 will be a landmark year, with the U.S. investor base becoming more established, the market is becoming truly global. "It's anyone's guess what the number will be in 2008 but what's clear is that there is a huge backlog of issuers from 2007 waiting for the right window," Fitch's Heberlain said.
The good news is that the bid lists circulating that have exerted pressure on ABS hasn't happened in the covered bond market. But, at the moment, some investors have bigger problems. In particular, U.S. investors currently have a domestic focus and, as a result, there have not been many quotes going out for European products. "European RMBS and covered bonds should be a great product for U.S. investors because it offers some diversification," Robert Plehn, head of securitization and covered bonds at Bank of Scotland Treasury, said.
Some market participants are starting to worry that as more players come to the sector, the structure behind some deals would become less recognizable as covered bonds. An example was the inaugural Japanese Shinsei covered bond deal, which was set up as a one-off vehicle.
"This deal looks more like a securitization and less like a covered bond - is there a danger then that we risk diluting the security of what a covered bond is," posed Debashis Dey, a partner at Clifford Chance. Moody's analysts said that while it's true that the Japanese bond functions similarly to a securitization, from a purely credit standpoint, the deal is a covered bond. Moody's has defined a covered bond as a debt instrument that has both recourse to the issuing entity and the issuing group as well as a substituting pool of collateral. In terms of the Shinsei deal, some argued that it was also structured to appeal to a purely domestic investor base and therefore does not challenge international investor perception of the product.
Other jurisdictions that might consider launching covered bonds include Turkey, which panelists said has a fairly robust infrastructure that would support a covered bond market. Last summer, Greece implemented its new covered bond legislation and is expected to launch two new issues in 2008. Meanwhile, German legislation is being reviewed to include MBS but the country has moved away from that after the credit crisis erupted.
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