Bankers push for Italian SME-backed covered bonds

Fri May 17, 2013 5:06am EDT

* SME-backed covered bonds would unlock lending

* Commerzbank deal seen as pricing template

* French proposals under way to develop market

By Aimee Donnellan

FRANKFURT, May 17 (IFR) - Italy needs to change its covered bond law so that the country's banks can provide cheaper funding to the small and medium-sized enterprises (SMEs) that are the backbone of the economy, bankers said.

Banks across Europe have been looking at SME-backed covered bonds since Commerzbank sold the first such offering in February - a EUR500m five-year at 47bp over mid-swaps.

"SME-backed covered bonds have already been successfully sold elsewhere, so there's no reason why we shouldn't see the same thing in Italy," Derry Hubbard, head of FIG syndicate at BNP Paribas, said at an industry conference in Frankfurt on Thursday.

"Why do we want to make the ECB the bad bank of Europe, when we have a private-sector solution to a funding problem through these instruments?"

The introduction of an SME-backed covered bond framework has the potential to transform SME lending across Italy, which bankers say is needed.

Much like in Germany, Italy's SME market forms an integral part of its economy in the eurozone. But companies in the country have been struggling to repay loans.

Data this week showed bad debts held by Italian banks rose to EUR131bn in March, while lenders further reduced loans to households and businesses. The Italian banking association ABI said bad loans grew by around EUR3.3bn from the end of February and by 21.7% year-on-year.

Intesa Sanpaolo and UniCredit, the country's two biggest banks, set aside a combined EUR14bn in 2012 to cover bad loans, while smaller lenders have increased provisions after the central bank audited around 20 institutions.

Banco Popolare, Italy's fourth biggest bank, issued a profit warning after the audit prompted EUR684m of loan loss provisions in the fourth quarter, more than the total it set aside in the first nine months of the year.

To deal with this issue, and allow borrowers to roll over funding, bankers say SME-backed covered bonds are the obvious answer.

"Italian banks need to be motivated to lend to SMEs by being able to access cheaper funding. SME-backed covered bonds are an ideal way of achieving this," said Richard Kemmish, head of covered bond origination at Credit Suisse.

NATURAL FIT?

Covered bonds have benefited from regulatory favour since the crisis, with the ECB allocating EUR100bn to buy covered bonds outright and setting haircut margins at favourable levels against comparably-rated securitisations.

For this reason, investors are reluctant to see the covered bond brand tainted in any way.

Although some investors are positive about the emergence of a new product, they still want to be compensated for their risk.

"The pricing is still an issue," said Jozef Prokes, a London-based fund manager at BlackRock.

"It can go into my ABS or credit portfolio, but I don't view it as a real covered bond. And I know that many other investors certainly have mandate restrictions that means they will be unable to buy these instruments."

The ECB itself has struggled to assess the instruments adequately. It initially wanted a haircut on the Commerzbank bond as though it were senior unsecured bank debt, but changed that in late March to give it full covered bond treatment.

With that now cleared up, BNPP 's Hubbard thinks that Commerzbank has provided a useful pricing template that could be applied to an Italian bank.

"In Italy you would need to look at where mortgage-backed covered bonds are trading, senior debt, and bring in BTPs to make sure investors feel like they are getting good value," he said.

FRENCH FUSION

SME fever is certainly taking hold elsewhere.

In France, the country's banks have already set about establishing a market. They are working on a proposal with the Banque de France to ease SME funding, using a structure similar to covered bonds.

Banks keep the SME assets on balance sheet, but use them as security for secured loans from a securitisation SPV, which funds these in turn through untranched bond issues.

If the bank defaults, the SPV will use the covered bond law to recover the assets from the bank balance sheet.

Overcollateralisation will come from haircutting loan values, using a longstanding model from the Banque de France.

The resulting securities should be repo-eligible at the central bank, and seen as secure assets in the private market.