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catalystresearch.ca-cib.comCrédit Agricole Corporate and Investment Bank is authorised by the Autorité de Contrôle Prudentiel (ACP) and supervised by the ACP and the Autoritédes Marchés Financiers (AMF) in France and subject to limited regulation by the Financial Services Authority. Details about the extent of our regulation by the Financial Services Authority are available from us on request.
Covered Bonds November Update“Stuck in a moment you can’t get out of”…?
U2, 2001
November 2011
Florian Eichert, CFASenior Covered Bond Analyst+(44) 20 7214 6402 [email protected]
12 December 2011
Quick recap of the year so far in EUR…
SECTION 1
“All That You Can't Leave Behind”, U2, 2000
3
12 December 2011
Quick recap of the year so far – nothing for weak nerves…
4
12 December 2011
Benchmark covered bond issues by country (USD bn)
Source all charts: Bloomberg, Crédit Agricole CIB
USD 2011 benchmark covered bond issuance by country (%)
4
6
18
1 1
29 28
0
5
10
15
20
25
30
35
2005 2006 2007 2008 2009 2010 2011CA EN FR GE IR SW Oth. NO
CA, 53%
EN, 4%
FR, 11%
GE, 2%
NO, 15%
SW, 11%SZ, 4%
4
12 December 2011
EUR Benchmark covered bond issues by country (EUR bn)
Source all charts: Bloomberg, Crédit Agricole CIB
EUR 2011 benchmark covered bond issuance by country (%)
Quick recap of 2011 – EUR benchmark primary market…
05
101520253035404550
1/1
0
2/10
3/10
4/1
0
5/1
0
6/1
0
7/10
8/10
9/1
0
10
/10
11/
10
12/
10
1/11
2/1
1
3/1
1
4/1
1
5/1
1
6/11
7/1
1
8/1
1
9/1
1
10/
11
11/1
1
020406080100120140160180200
FR GE NordicSP Other Total (RHS)
DE1%
EN10%
FR27%
NE6%
NO5%
SP11%
SW6%
SZ2%
Oth.9%
IT8%
GE15%
5
12 December 2011
9095
100105110115120125130135
8/1/
201
1
8/1
5/2
011
8/29
/20
11
9/1
2/2
011
9/2
6/20
11
10
/10/
2011
iBoxx € UK Covered 3-5
ABBEY 3 5/8 09/08/16
RBS 2 1/2 09/07/14
BACR 2 1
/8 0
9/08
/14
NWIDE 3 1/8 10/13/16
5
12 December 2011
New issue premia of 10-15bp…August saw EUR16.3bn in new EUR benchmark issuance with another EUR5.4bn following in September and EUR10.2bn in October.
However, issuers had to pay up to access the primary market.
As opposed to the new issues tightening in, the secondaries initially widened out as a result. In recent days, this has changed a little with CRH 2023s tightening in by around 10bp since launch for example.
There will be windows in the weeks to come – but only at a price…
There will be issuance windows in the weeks to come before year end especially with the ECB’s CBPP 2.0 up and running.
However, we do not see the typical crisis pattern of frantic issuance as long as the window is there, which is followed by a pronounced shut down of the primary market being replaced by orderly issuance sometime soon.
This will keep new issue premia at elevated levels for the time being.
ASW spread 3-5Y covered bonds (bp) and timing of selected new issuance
Source: iBoxx, Bloomberg, Crédit Agricole CIB
Source: Bloomberg, Crédit Agricole CIB
New EUR benchmark covered bond issuance since August by country (EURbn)
Quick recap of 2011 – EUR primary market – effects on sec ondaries…
40
60
80
100
120
140
160
8/1
/201
1
8/1
5/2
011
8/2
9/2
011
9/12
/201
1
9/2
6/20
11
10/
10/
201
1
iBoxx € France Covered Legal 3-5
BPCECB 3 3/4 09/13/21
ACACB 2 7/8 09/09/16
CRH 3.6 09/13/21
CRH 4.3 02/24/23
7.48.6
2.01.0
1.83.0
1.5 2.3
5.3
0
1
2
3
4
5
6
7
8
9
DE EN FR GE IT NE NO PO SP SW SZ Oth.
All EUR benchmarks
6
12 December 2011
6
12 December 2011
Average senior – covered spread (bp)
Performance bank shares from the Euro Stoxx 50 (%)
Sources all charts: iBoxx, Bloomberg,Crédit Agricole CIB
Some stabilisation at least for a while…August and September certainly fall into the doom and gloom category…
Attention remained on the periphery but also turned to French covered bonds.
Driven mainly by DexiaMA, iBoxx France Covered Legal Index widened by 63bp since the beginning of August.
On the other hand, Dutch, German and Nordic covered bonds have fared best widening “only” by 10 to 15 bp.
Since the ECB announcement to set up a second covered bond purchase programme, things had stabilised somewhat only to start spiralling down in the past few days though.
Quick recap of 2011 – EUR secondary market…
10Y bond yields selected government bonds (%)Asset swap spread change on selected covered bond sectors since beginning of August
020406080
100120140
10/1
1/2
010
11/1
1/2
010
12/1
1/2
01
0
1/1
1/20
11
2/11
/20
11
3/1
1/2
011
4/11
/20
11
5/1
1/2
011
6/1
1/20
11
7/1
1/2
011
8/1
1/2
011
9/1
1/2
011
10/1
1/2
011
11/1
1/20
11
Total average France Italy Spain
12345678
7/1
1
7/1
1
8/1
1
8/11
8/1
1
8/1
1
8/1
1
9/1
1
9/11
9/1
1
9/1
1
10/1
1
10/1
1
10/1
1
10/1
1
11/1
1
11/1
1
GER FR IT SP
1963 45
15 16 15 12
-33
119154
5622 38 29
-100-50
050
100150200
AS
FR
- le
gal
FR
- s
truc
.
GE
R -
M NE
GE
R -
PS
Nor
dic IR IT PT
SP
- P
ool
ed
SP
- S
ing
le
UK
US
-11%
-11%
1%
-22%
-4%
10%
-13
%
-28%
-30%
-41% -3
2%
-57
%
-27%
-35
%
-47%
-55%-80%
-60%
-40%
-20%
0%
20%
SANTAN BNP DB SOCGEN BBVASM ISPIM UCGIM ACAFPsince 08/31/11 Since 07/01/11
12 December 2011
Covered bonds vs. govies –hijacking pole position…?
SECTION 2
“Stay (Faraway, So Close!)”, U2, 1993
8
12 December 2011
Covered bonds vs. govies – hijacking pole position…?
9
12 December 2011
9
12 December 2011
Sources: Bloomberg, Crédit Agricole CIB
ASW spreads sovereign vs. covered bonds and difference in bp
Covered bonds tighter than govies…?In the course of the sovereign crisis, in some countries covered bonds have become tighter than govies.
There have been actual flows behind this.Italian accounts were buying OBGs at more than 200bp through BTPs as one example.We have yet to see an issuer actually price a new issue at these kind of levels though.
Rationale for proponents of this is that a covered bond from such a country would survive the sovereign default and that even if not, potential losses on the cover pool would be below a haircut on the sovereign.
However, in a systemic banking sector crisis, rating agencies tend to increase D-Factors towards 100% or TPIs to very improbable (happened in Portugal for example).
A sovereign haircut of this magnitude or even mark to market losses beforehand would put domestic banks in serious danger.In addition to this, Moody’s assumed pool losses of the National Bank of Greece cover pool for example are at around the same level (52%) as the discussed Greece haircut of 50%.
Covered bonds vs. govies – hijacking pole position…?
0
100
200
300
400
500
600
2/1
1
2/1
1
3/1
1
3/1
1
4/1
1
4/1
1
5/11
5/1
1
6/11
6/1
1
7/11
7/1
1
7/1
1
8/1
1
8/1
1
9/1
1
9/1
1
10/1
1
10/1
1
11/1
1
-200
-150
-100
-50
0
50
100
Difference BTP 2016 OBG 2016
0
200
400
600
800
1000
1200
2/11
2/1
1
3/1
1
3/1
1
4/1
1
4/1
1
5/1
1
5/11
6/11
6/1
1
7/1
1
7/1
1
7/1
1
8/1
1
8/1
1
9/1
1
9/1
1
10/1
1
10/1
1
11/1
1
-350-300-250-200-150-100-50050100150200
Difference PT Govie 2016 PT Covered Bonds 2016
10
12 December 2011
10
12 December 2011
Source: Bloomberg, Crédit Agricole CIB
What’s our take on it…For the time being, we don’t see any issuer being able to price a covered bond inside their sovereign.
There will be ongoing selective interest by some investors for covered bonds at these levels though.
It will be mainly domestic interest in our view by investors that already have a high exposure to that sovereign and want to diversify away while staying within the country.There are also distressed debt buyers that are interested in expected pool losses vs. cash price. As a result, this game only kicks in at very distressed price levels (i.e. Portugal).
Covered-sovereign bond spreads become more and more negative especially at low cash prices
The prevailing opinion in the market will in our view remain that govies are the floor for covered bonds for now.
We don’t see international flow investors adding exposure to a country that is in distress no matter what the asset class. The decision process often stops at the country line already.
And if the opinion about a sovereign is positive, investors might as well profit by buying the higher yielding government bond that at the same time will always be more liquid.
Spread drivers between covered bonds and sovereign bonds
5055
6065707580
859095
2/1
1
2/1
1
3/11
3/1
1
4/1
1
4/1
1
5/1
1
5/1
1
6/1
1
6/1
1
7/11
7/11
7/1
1
8/1
1
8/1
1
9/1
1
9/1
1
10
/11
10/1
1
11/1
1
-350-300-250-200-150-100-50050100150200
ASW spread difference covered-govie (RHS)Price PT govie 2016Price PT covered 2016
In our view, there could be pressure on regulators to scrap some of the privileges of sovereign debt at some point though.
This could change the picture a bit but this is more of a long term issue.
Source: Crédit Agricole CIB
Drivers Which product does it favourCollateralisation CoveredRating CoveredLiquidity GovieRisk weight (banks) GovieECB haircuts (banks) GovieCapital charge (insurance companies under Solvency II)
Govie
Timeliness DependsAssumed losses Depends
Covered bonds vs. govies – hijacking pole position…?
12 December 2011
ECB buyback programme –how was it last time, what can we expect this time…
SECTION 3
“Rattle and Hum”, U2, 1988
12
12 December 2011
ECB CBPP 2.0 – back to work…
13
12 December 2011
4.8
15
11.29.9
6.6
3.21.9 1.6 1.5 1.4 1 0.9 1
0
2
4
6
8
10
12
14
16
EC
B
GE
R FR IT ES
NL
BE
GR AS
PT FI
IR
Oth
er
0%
100%
200%
300%
400%
500%
600%
Share central bank of the EUR60bn
Share vs. available eligible domestic covered bonds as of June 2009 (RHS)
13
12 December 2011
Overview ECB CBPP 1.0
Source: ECB, Crédit Agricole CIB
Allocation of the EUR60bn and size of that allocation relative to the outstanding volume of domestic covered bonds at the time
Quick review of CBPP 1.0…The Eurosystem’s first purchase programme in 2009-10 comprised a total of EUR60bn, which was evenly spent over 12 months.
The ECB reserved EUR4.8bn for itself and the remaining amount was then split up and allocated to the national central banks based on their ECB capital share.
The information that was provided to the market was fairly scarce, with only the daily purchase amount and the split between primary and secondary market purchases revealed. Based on anecdotal evidence there are a few trends that can be highlighted though:
Central banks exhibited a fairly strong domestic bias for their own products when spending their allocation from the purchase programme.
Initially, purchases were focused on low-beta sectors at the time, such as Germany and France, and on the better names.Bonds were bought along the curve between 3Y and 10Y, but the biggest part was apparently in the 3-5Y segment.
ECB CBPP 2.0 – back to work…
CBPP 1.0 DetailsTotal size EUR60bnTotal number of purchased bonds 422Primary market purchases 27% / EUR16.2bnSecondary market purchases 73% / EUR43.8bnMaturities 3-10 years, with strong focus on
maturities up to 7 yearsDuration 4.12 (as of June 2010)Minimum rating At least one AA rating and no
rating below BBB-Minimum size EUR500mn but in any case not
less than EUR100mn
Holding period ECB intends to hold bonds until maturity
14
12 December 2011
14
12 December 2011
Asset swap spread 3-5 covered bonds per country (bp)
Source: iBoxx, Crédit Agricole CIB
Covered bond spread vs local sovereign bonds per country (bp)
ECB CBPP 2.0 – back to work…
Why things are a little different this time…Last time around:
We were facing a banking crisis in which covered bonds from all sectors (even Pfandbriefe) were in a very distressed spread environment.In addition to this, sovereign markets were still in much better shape than is the case today.By choosing to kick-start bank funding through the covered bond market, central banks were actually tackling the relevant sector and were quite successful at that.
This time around:The banking crisis has evolved into a sovereign crisis, which has again put severe stress on to the banking sector. The actual cause of the current problem is mainly the sovereign and not the banking sector.In addition to that, Pfandbriefe, as an example, are at very tight spread levels already, so how much more room for tightening is there in the end? As a result it will be much harder this time around to be successful with any potential covered bond purchase programme.
The success in our view should be more measured in terms of new issue volumes in coming weeks than significant spread tightening.
98 112
114
86
140
50
136
121
117 16
9
20 9
4
48 1
38
303
-81
116
-37
3
-3
138
-600
-400
-200
0
200
400
Au
stri
a
Fin
lan
d
Fra
nce
Ge
rma
ny
Irel
and
Ita
ly
Ne
ther
land
s
Por
tug
al
Sp
ain
Spa
in M
ulti
08/05/2009 11/11/201111
3
121
76
37
8
92
152
150
109 16
3 231
66
119
36
450
335
58
894
44
307
131
0
200
400
600
800
1000
AT
FR
GE IR IT NL
PO
SC
A
SP
UK
08/05/09 10/11/11
15
12 December 2011
15
12 December 2011
Source: Eurosystem, Crédit Agricole CIB
ECB CBPP 2.0 – announcement 3 rd November…
What they announced on November 3rd…To make a long story short, there was not much to get overly excited about.
The document did not give details on the country allocation of the EUR40bn, but it hinted at a similar approach to last time.
However, the real important aspect is not the allocation but thespending criteria, ie, not who will be allocated how much but will there be internal rules as to what has to be bought with the allocation.
Characteristics of CBPP 1.0 vs CBPP 2.0CBPP 1.0 CBPP 2.0
Total size EUR60bn EUR40bnAllocation ECB retained
EUR4.8bn, the rest was distributed based on ECB capital share
"Across the Eurozone"
Geographical scope
Eurozone Eurozone
Currency EUR EURMaturities 3-10 years, with strong
focus on maturities up to 7 years
Up to 10.5 years residual maturity
Minimum rating At least one AA rating and no rating below BBB-
BBB-
Minimum volume (EURmn)
As a rule 500, in any case not below 100
300
The eligibility criteria for the CBPP 2.0 are wider than for the CBPP 1.0.
Both the minimum rating as well as the minimum volume is lower at BBB- and EUR300m, while the maximum maturity is slightly longer at 10.5 years.This hints at a more pragmatic approach and is especially positive for second and third tier issuers.
The release has not changed our main opinion about the CBPP 2.0.
We are still cautiously optimistic.
We still expect a bigger focus towards the more distressed sectors. And we still expect a higher primary market share.
12 December 2011
Regulatory issues – Basle III and Solvency II…
SECTION 4
“Hold Me, Thrill Me, Kiss Me, Kill Me”, U2, 1995
17
12 December 2011
Regulatory issues – Basle III/CRD IV + Solvency II…
18
12 December 2011
2011 2012 2013 2014 2015 2016 2017 2018 2019Presentation of a defailed framework for SIFIS by end-year
-June: implementation of the 9% CT1 ratio under the EBA criteria
-July to december : strenghtening of the shadow banking's regulation
-Observation period begins for the net stable funding ratio
-Start of the observation period for the LCR
-EBA finalises "liquid asset" definition
-Publication of the definition of the Leverage ratio's criteria
-Gradual implementation of new capital levels
Beginning of deduc-tions from CET1
-implementation of the liquidity coverage ratio
-Disclosure of banks' leverage ratio
- Implementation of IFRS9 to replace IAS39
-begining of the implementation of the SIFI capital surcharge
-mid-2016: begining of the review period for the leverage ratio
-Fully implementation of the Leverage ratio
-end of the observation period for the net stable funding ratio and introduction of minimum standards
-Fully implementation of the SIFI capital surcharge
-Fully implementation of Basel III
Highlights and timelineWith Basel III/CRD IV and Solvency II there are currently two major regulatory reforms in the works that affect covered bonds.
Banking regulation is affecting the biggest investor base in the covered bond universe.
Main theme is positive here even though a lot of uncertainty remains.
Insurance sector regulation is affecting the biggest investor base at the long end of the curve and the biggest takers of private placements.
Main theme is neutral to slightly negative.
Source: EU Commission, Crédit Agricole CIB
Regulatory issues – Basle III/CRD IV + Solvency II…
Time line banking regulation
Source: Bloomberg, IFR, the cover, coveredbondreport, Crédit Agricole CIB
Investor participation EUR benchmark covered bonds
30%
42%
11% 12
%
4%
1%
0%5%
10%15%20%25%30%35%40%45%50%
AssetManagers
Banks CentralBanks
InsuranceCompanies
Other PensionFunds
2007 2008 2009 2010 2011
19
12 December 2011
CRD IV proposal published on July 20thNew regulation on liquidity will introduce two ratios – the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR).
Liquidity coverage ratio – what is considered a “liquid asset”?The definition of liquid assets is broadened somewhat and made more flexible. The criteria are supposed to move away from strict asset type and rating criteria towards actual liquidity levels of different sectors.Also, particular business models in some countries could be taken into account where liquidity and leverage rules would lead to unintended consequences for the real economy.
The decision is now with the European Banking Authority (EBA) who has two years to come up with a proposal.EBA will look at things like market depth, bid-ask spreads, maximum price decline, turnover of bonds, etc.Big question is at what level will the criteria be applied, overall covered bond market, countries, issuers, ISINs…?
The way to risk weight covered bonds in the standardised approach will change
Relevant will be the covered bond rating and not the sovereign (option 1) or issuer rating (option 2).The approach in the IRB approaches will not change however.
Credit step covered bond rating
AAA to AA-
A+ to A-
BBB+ to BBB-
BBB+ to BB-
BB+ to B-
≤ CCC+
Covered bond risk weight
10% 20% 20% 50% 50% 100%
Covered bonds risk weights (standardised approach)
Source: EU Commission, Crédit Agricole CIB
Regulatory issues – Basle III/CRD IV…
Source: Bloomberg, Crédit Agricole CIB
Average bid-ask spreads 3-5y jumbo covered bonds
10.5
9.1
9.1
6.7
50.4
15.
5
7.3
98.5
29.7
4.9
2.3
1.9
1.3
74.1
4.8
1.6
76.5
7.2
020406080
100120
Aus
tria
Fin
land
Fran
ce
Ger
man
y
Irel
and
Ital
y
Net
her
land
s
Por
tuga
l
Spa
in
Covered Sovereign
0
10
20
30
40
50
Oct
-08
Dec
-08
Feb
-09
Apr
-09
Jun
-09
Aug
-09
Oct
-09
De
c-09
Feb
-10
Ap
r-10
Jun-
10
Aug
-10
Oct
-10
Dec
-10
Feb
-11
Apr
-11
Jun
-11
Aug
-11
Oct
-11
France Germany Italy Spain UK
Source: Bloomberg, Crédit Agricole CIB
Average bid-ask spreads 3-5y bonds (bp)
20
12 December 2011
Solvency IIThe process for Solvency II is much further advanced than is Basle III.
QIS 5 was done in 2010.The last final touches will be done in 2011.The framework will come into force from 2013 onwards.
Capital charges for insurance companies are determined by a number of risk modules.These include risk modules on interest rate risk, spread risk and concentration risk.Covered bonds are treated separately in the spread risk and concentration risk module.
Covered bonds benefit from a preferential treatment vs. senior unsecured bonds but are at a huge disadvantage compared to government bonds.
Compared to senior unsecured bonds, covered bonds benefit from a lower spread risk factor and a higher limit on the concentration risk.Compared to government bonds, who receive a 0% spread risk factor down to a rating of AA- (e.g. Portuguese government debt is considered to be spread risk free…), covered bonds are at a huge disadvantage.– A differentiation by country is not foreseen in the rules, ratings are taken as the sole differentiating factor.
Very importantly, registered and bearer bonds are treated the same regarding the capital charges.Insurance companies are heavily geared towards registered bonds which they don’t have to mark to market but can use the acquisition price for accounting purposes.– Solvency II however does not want to take into account accounting rules but develop its own set of standards.
Regulatory issues – Solvency II…
21
12 December 2011
Required spread pickup depends on a number of factors and varies from insu-rance company to insurance company…
Covered bond’s duration.The longer this is, the higher the capital charge, the higher the required spread.
Covered bond’s rating. Only if the rating is AAA, do covered bonds get the beneficial treatment.Already a AA+ rating means almost double the capital charge.
Expected investment horizon. The longer the position is held, the lower the average capital charge, the lower the additional spread requirement.
Internal cost of capital of the insurance company. The higher this is, the more pick-up is needed from the investment to cover the capital cost of the investment.
Spread risk factors by bond type and rating per 1Y duration
Source: CEIOPS, Crédit Agricole CIB
Regulatory issues – Solvency II…
Type of bond Rating Spread risk factorAAA 0.9%AA 1.1%A 1.4%
BBB 2.5%BB 4.5%
B or lower 7.5%Unrated 3.0%
Covered Bonds AAA 0.6%AAA 0.0%AA 0.0%A 1.1%
BBB 1.4%BB 2.5%
B or lower 4.5%Unrated 3.0%
Governments, central banks, multilateral development banks, international organisations
Corporate bonds, sub + hybrid debt, ABS, CDO
22
12 December 2011
Effects of Basle III / CRD IV and Solvency…Basle III / CRD IV: The effects of are generally positive for covered bonds, however a lot of uncertainty remains…
There is no scope for further national discretion, all it takes is EU Council and Parliament approval.
The aim to avoid unintended adverse consequences gives some scope for interpretation though.There will be no clarity regarding covered bond’s treatment for liquidity regulation purposed for the next two years as the EBA now has the task to come up with an adequate definition of what is considered liquid and what is not.
Regulatory issues – effects…
Solvency II: The effects are neutral to slightly negative for covered bonds…The interest rate risk component will keep insurance companies invested at the long end.Insurance companies will however take care of minimising that gap through capital efficient investments such as sovereign bonds or through the use of derivatives.Covered bonds could very well go slightly shorter as well, especially if not rated AAA.Investments will have to earn the additional capital cost that result from Solvency II � steeper spread curves.Solvency II will create a rating trigger between AAA and AA+.
Combined effects on issuersThe Basel III / CRD IV rules aim to stabilise and term out the funding of banks.At the same time, Solvency II will reduce the demand or at least increase spreads on longer dated issuance.Issuers will find it harder to issue long dated registered covered bonds as they are treated the same way as bearer bonds from a capital charge perspective.Combined, both reforms are clearly favouring one bank business model over the other– Universal banks with solid deposit bases are favoured, wholesale funded specialised banks are put at a disadvantageThe big challenge and main differentiating factor going forward is going to be access to senior funding.
23
12 December 2011
23
12 December 2011
Distribution EUR benchmark CB by investor type
Source: Bloomberg, IFR, The Cover, Coveredbondreport.com, Crédit Agricole CIB
Distribution EUR benchmark CB by country (%)
Source: Bloomberg, IFR, The Cover, Coveredbondreport.com, Crédit Agricole CIB
Distribution EUR benchmark covered bonds by country and maturity bracket (%)
Source: Bloomberg, IFR, The Cover, Coveredbondreport.com, Crédit Agricole CIB
22
%
9%
18%
38%
36%
70%
0%
31%
14
% 19%
0%
31
%
22%
7%
0%
10%
20%
30%
40%
50%
60%
70%
80%
AS DE EN FI FR GE IR IT NE NO PO SP SW SZ2007 2008 2009 2010 2011
Source: Bloomberg, IFR, The Cover, Coveredbondreport.com, Crédit Agricole CIB
Domestic investors participation in EUR benchmark covered bond deals from the same country
Regulatory issues – investor distributions…
1%
6%
6%
15%
37%
6% 6% 7%
12%
7%
4% 5%
5%
15%
39%
3% 3%
11
%
8% 9%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
Asia Austria Benelux France Ger Iberia Italy Nordics Others UK
2007 2008 2009 2010 2011
30%
42%
11% 12
%
4%
1%
0%5%
10%15%20%25%30%35%40%45%50%
AssetManagers
Banks CentralBanks
InsuranceCompanies
Other PensionFunds
2007 2008 2009 2010 2011
0%
10%20%
30%40%
50%60%
70%
80%90%
100%
<3Y 2011 5Y 2011 7Y 2011 10Y 2011 10+Y 2011
Banks Asset Manager Central Banks Insurance Companies Others
12 December 2011
Rating agencies – keeping up the good work…
"Mysterious Ways", U2, 1991
SECTION 5
25
12 December 2011
Rating agencies – keeping up the good work…
26
12 December 2011
Where are we heading…?Average AAA vs. non AAA split in the iBoxx EUR Covered per agency is currently at around 4 to 1.
However some of remaining AAA ratings are on rating watch negative at the moment.
If all these watches are resolved, we would be moving towards an average 2 to 1 split.
Fitch is the most severe of the three agencies having barely more than 60% of its covered bond ratings at AAA stable.S&P currently has the highest AAA share. But the implementation of its new bank rating methodology combined with the number of still AAA rated programmes with no or little leeway will lead to a lower figure going forward.
In addition to this, there are around 20% of the programmes still rated Aaa / AAA by Moody’s and S&P that have only one notch leeway on the issuer rating before the Aaa / AAA come under pressure.
We are moving hard towards a 60% / 40% split in the iBoxx EUR Covered between AAA / non AAA rated jumbo covered bonds.
Jumbo covered bond ratings (iBoxx EUR Covered)
Sou
rce
all c
hart
s: B
loom
berg
, S&
P, M
oody
’s, C
rédi
t Agr
icol
e C
IB
Rating agencies – keeping up the good work…
Number of AAA rated jumbo covered bonds on watch negative per country and agency
77% 68% 63%
6% 15%14%
17% 17% 23%
0%
20%
40%
60%
80%
100%
S&P Moody's FitchAAA stable AAA but rating watch negative non-AAA
Leeway for issuer rating downgrades of AAA rated jumbo covered bond programmes
0%
10%
20%
30%
40%
50%
60%
0 1 2 >1Moody's S&P
0%
20%
40%
60%
80%
100%
AS CA FR GE IR IT NE NO NZ SZ DE LX FI PO SP SW EN USS&P Moody's Fitch
27
12 December 2011
Changes in D-Factor / TPIs…Issuer ratings are not the only thing driving down covered bond ratings.
Fitch D-Factors as well as Moody’s TPIs are anything but static.
Stress on either the sovereign side or a collateral market can have impacts beyond merely increasing OC requirements.
Severe sovereign stress in a specific country leads to sever funding stress on banks from that region.
Agencies therefore not only adjust funding margins in their cash flow models upwards but also reassess the overall timeliness of a transaction.In case of collateral problems, agencies anticipate less demand to either sell these assets outright or accept them as collateral for secured bilateral bridge funding.
In case of a systemic banking crisis, agencies tend to massively reduce the credit they give for the covered bond structure and assume a covered bond default to follow the issuer default (D-Factor of 100% for example).
The rating uplift over the issuer rating is in these cases mainly down to the collateralised nature of the bond and can reach up to 2 notches in the case of Fitch, up to 3 notches with Moody’s and S&P.
Average Fitch D-Factors per country and changes per country (%)
Source: Moody’s, Crédit Agricole CIB
Rating agencies – keeping up the good work…
Moody’s TPIs - transition matrix
Source: Fitch, Crédit Agricole CIB
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
CA CH DE FR GE IE IT NE NO NZ PT SP UK US0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
04/02/2011 14/10/2011 change from 4/11 - 10/11
Ver
y hi
gh
Hig
h
Pro
babl
e-hi
gh
Pro
babl
e
Impr
obab
le
Ver
y im
prob
able n/
d
Very high 17.6% 41.2% 29.4%High 3.4% 89.7% 3.4% 0.0%Probable-High 65.0% 12.5% 2.5% 17.5%Probable 4.7% 81.3% 6.3% 1.6%Improbable 25.0% 50.0%Very Improbable 66.7% 33.3%n/d 2.1% 6.4% 10.6% 46.8% 8.5% 6.4% 19.1%
Sta
rt ra
ting
End TPI
12 December 2011
Covered bond issuance –how far can issuers go…?
SECTION 6
“Take Me to the Clouds Above”, U2, 2004
29
12 December 2011
Covered bond issuance – how far can issuers go…?
30
12 December 2011
30
12 December 2011
2010 outstanding covered bonds and share of covered bonds of overall mortgage markets in %
Source: ECBC, Crédit Agricole CIB
Covered bond issuance needed to bring the covered bond share of overall mortgage to 50%
Source: ECBC, Crédit Agricole CIB
Covered bond issuance – how far can issuers go…?
Covered bonds will be a main funding tool…It will be the long term funding tool of choice for mortgage as well as public sector collateral...
Countries that are still lagging behind will catch up.
Specialised lenders will maximise their covered bond funding with all consequences for senior investors...
In the past, even banks like Hypo Real Estate had a lot of assets on balance that were not cover pool eligible.Eurohypo for example has only ca. 40% covered bonds on their liability side.The maximum is mainly determined by the OC requirements by rating agencies.
In strong legal frameworks like Germany, issuer ratings can be significantly below the covered bonds.Structural subordination of seniors does not hurt the covered bonds for quite some time.
Covered bond laws put a limit on eligible assets...We don’t see massive changes to legal frameworks to widen the scope of eligible assets.
For big universal banks with corporate exposure etc. covered bonds will not reach 50%+ levels.
11%
100%
0%
14% 21%16%25%
18%
6% 7%14%
31%40%
15%
36%
0
100
200
300
400
AS
BE
DE FI
FR
GE
R
GR IR IT NL
PT
SP
SW UK
NO
0%10%20%30%40%50%60%70%80%90%100%
Outstanding mortgage covered bondsMortgage covered bonds in % of mortgage lending
2973
26
213
481
2153
204260
70
206
47
481
27
0
100
200
300
400
500
600
AS BE FI FR GER GR IR IT NL PT SP SW UK NO
Covered bond issuance needed to bring the covered bond shareof overall mortgage funding to 35%
31
12 December 2011
iBoxx EUR Covered index outstanding in EUR bn. by c ountry
Source: Crédit Agricole CIB Research, ECBC
Covered bonds oustanding by issuance type in EUR mn .
Stable long term funding
Structural subordination of senior debtors
Positive effect on the issuer rating
Negative effect on the issuer rating
Covered bond funding
Main points:The question is always, what weighs more
Positive effect of stable funding or negative effect of structural subordination of the senior investors
There are a number of legal issuance limits out thereMany of the newer countries have implemented limits.
Rating agencies put most of their focus on the stable funding argument
Fitch published a report in 2008 about the matter.Anything below 25% seems uncritical.Above that level, the agency would have a closer look at the quality of the unencumbered assets and the overall business case of the bank.
Much depends on the business model of the issuerSpecialised vs. universal bankMost universal banks are still in single digit territory
At the other extreme, many specialised covered bond issuers have very high share of their funding done via covered bonds.
However: Over collateralisation has to always be funded senior unsecured, so 100% covered bonds is not possible...
Covered bond issuance – how far can issuers go…?
Country Limit on covered bond issuanceAustralia 8% of total Australian assetsCanada 4% of total assetsGreece 20% of total unencumbered assetsItaly Issuance limited to a percentage of eligible cover assets.
Limits are based on capitalisation of the institution though (no limit if tier 1 >11% + tier 2 > 7%)
Netherlands Ratio between covered bonds to total assets has to be "healthy", the concrete level is determined by the DNB on a case by case basis
New Zealand Plan to implement 10%. Might be adjusted upwards in the future
UK Initially 4%. This was increased to 20%. These days, issuers can go above this level but only with the consent of the FSA. Deciding factor for the FSA amongst others: capital
US According to the FDIC's Covered Bond Policy Statement and the US Treasury's Best Practice Guide, covered bonds cannot exceed 4% of total liabilities
32
12 December 2011
Issuer or issuer group Country Use of covered bond funding (%)
Issuer or issuer group Country Use of covered bond funding (%)
Deutsche Genossenschafts-Hypothekenbank Germany 50 - 70 Ipar Kutxa Spain 10 - 20Crédit Immobilier de France Développement (CIFD) France 50 - 70 Banco Base Spain 10 - 20COREALCREDIT Germany 30 - 50 Yorkshire Building Society UK 10 - 20Eurohypo Germany 30 - 50 La Caixa Spain 10 - 20Duesseldorfer Hypothekenbank Germany 30 - 50 Banco Espanol de Credito (Banesto) Spain 10 - 20KLP Banken AS Group Norway 30 - 50 Nordea Sweden 10 - 20Dexia Credit Local France 20 - 30 Banco Popular Espanol Spain 10 - 20Danske bank Denmark 20 - 30 Banco Financiero Spain 10 - 20Wuestenrot Bank AG Pfandbriefbank Germany 20 - 30 Caja de Ahorros de Vitoria y Alava (Caja Vital)Spain 10 - 20Deutsche Pfandbriefbank Germany 20 - 30 DZ Bank Germany 10 - 20Achmea Hypothekenbank Netherlands 20 - 30 Bayerische Landesbank Germany 10 - 20Aareal Bank Germany 20 - 30 Caja de Ahorros y Monte de Piedad de Zaragoza, Aragon y Rioja (Ibercaja)Spain 10 - 20Swedbank Sweden 20 - 30 Catalunya Caixa Spain 10 - 20Genossenschaftlicher FinanzVerbund Germany 20 - 30 Banco de Valencia Spain 10 - 20Unnim Spain 20 - 30 Landesbank Baden-Wuerttemberg Germany 10 - 20Unicaja Spain 20 - 30 Banca March Spain 10 - 20Norddeutsche Landesbank Germany 20 - 30 NovaCaixaGalicia Spain 10 - 20Banco Mare Nostrum Group Spain 20 - 30 Banco de Sabadell Spain 10 - 20Banco Gallego Spain 20 - 30 Caja Tres Group Spain 10 - 20Depfa Bank Ireland 20 - 30 Nationwide Building Society UK 10 - 20Caja Laboral Popular Spain 20 - 30 Cajamar Caja Rural, Sociedad Cooperativa de Credito (Cajamar)Spain 10 - 20Caja de Ahorros y Monte de Piedad de Ontinyent Spain 10 - 20 Landesbank Hessen-Thueringen GirozentraleGermany 10 - 20Svenska Handelsbanken Sweden 10 - 20 Groupe BPCE France 10 - 20Banco Civica Group Spain 10 - 20 Bankinter Spain 10 - 20BKK Group Spain 10 - 20 Bradford & Bingley UK 10 - 20Banco Pastor Spain 10 - 20 Skandinaviska Enskilda Banken Sweden 10 - 20SpareBanken Vest Norway 10 - 20 EBS Building Society Ireland 10 - 20DnB NOR Norway 10 - 20 Principality Building Society UK 10 - 20Landesbank Berlin Germany 10 - 20 Newcastle Building Society UK 10 - 20Caja Espana de Inversiones Spain 10 - 20
Source: Fitch, Crédit Agricole CIB Research
Ratio of outstanding covered bonds of total balance sheet share of funding (%)
Covered bond issuance – how far can issuers go…?
33
12 December 2011
33
12 December 2011
Covered bond issuance – how far can issuers go…?
There are some banks currently discussing structure d covered bonds…
These “structured covered bonds” would be outside a dedicated legal framework...One of the potential differences to legal based products would be a different set of cover assets.Some banks are merely thinking about making use of for example high LTVs or a different geographic focus……others are thinking about new asset classes all together (SME loans for example).
However, the starting point is always the same - difficult market conditions in the senior market...These structured covered bonds would be replacing a portion (or all…?) of the wholesale senior unsecured funding of these banks.
The effect would be a reduction of the remaining available assets for senior unsecured creditors...By trying to solve a hopefully temporary problem, banks are turning it into a permanent one – senior wholesale funding will be even harder to get if most of the balance sheet is encumbered in various cover pools.
The big question for banks going down that route is going to be how to fund OC going forward…Only short term ECB funding…? But then that needs collateral as well.Deposits…? But then how about wholesale funded banks – after all these are the ones with the biggest problems on the senior unsecured side and therefore likely candidates for structured covered bonds…
Always look at the senior funding franchise of issuers and not look at covered bonds in isolation!
34
12 December 2011
Disclaimer
CertificationThe views expressed in this report accurately reflect the personal views of the undersigned analyst(s). In addition, the undersigned analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in this report.Florian Eichert
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