Spanish banks prepare for covered bond change
* Asset encumbrance and bail-in prompt covered bond rethink
* Cover pool restrictions on the cards
By Aimee Donnellan
LONDON, Sept 27 (IFR) - Spanish banks are considering issuing covered bond securities with restricted cover pools - rather than their entire balance sheet - as they seek to reduce asset encumbrance and enable an easier application of bail-in legislation by the Bank of Spain.
Although the Bank of Spain has no powers to change legislation, it is carrying out preliminary conversations with lenders, to sound them out on issuance patterns and to find out if they would look at other structures too, according to a financial sector source.
"The Bank of Spain is probably contemplating a register of covered bond assets which would mean that bondholders no longer have a claim to the entire balance sheet," said Richard Kemmish, head of covered bond origination at Credit Suisse.
"It would mean that investors have less collateral cushioning them from default but will create greater clarity about the assets that they have a claim on and will bring Spain in line with other European covered bond models."
According to market sources, a Spanish issuer is already in discussions with investors to see if there is appetite for these new style instruments.
But the reception is likely to be lukewarm at best.
At the moment, the country's covered bonds - Cedulas Hipotecarias and Cedulas Territoriales - offer investors unparalleled protection.
The instruments benefit from a legal minimum over-collateralisation (OC) requirement of 25% and 43%, respectively, which is the highest of all covered bond jurisdictions in Europe.
However, Spain is the only country where banks can use their entire balance sheet for this overcollateralisation.
These features have created an unwelcome headache for the Spanish regulator, which is looking for the easiest and fastest possible method of applying bail-in legislation should a Spanish bank run into difficulty.
However, soaring OC levels and claims to entire bank balance sheets have reassured investors that their holdings are safe in even the most dire market situations, allowing national champions and second tier issuers to fund in the public market.
So it is understandable that analysts view any change to Spain's covered bond laws with fear and suspicion.
"We would view it as highly problematic if any covered bond legislation was changed leading to a weakening of investor protection, in particular if such changes were be applied retro-actively," said Jan King, a covered bond analyst at RBS.
Bernd Volk, head of covered bond research agrees, but believes that the Bank of Spain is merely trying to limit excessive levels of OC.
"They're right to change the law or at least think about it," he said.
There are instruments known as Bonos Hipotecarios that are similar to covered bonds issued in other countries and backed by specific cover pools, but Spanish banks have been reluctant to use them, and they have not really taken off.
RUNNING OUT OF MORTGAGES
However, some bankers say the regulator is likely to be unsuccessful in its mission, adding that talks are in very early stages.
"Our understanding is that nothing has been agreed and according to all of them, there are no concrete plans to change the current legislation at this stage," said King.
Others, however, argue that something needs to be done about the collateral situation in Spain and that new instruments that use fewer mortgages could ease funding pressures on banks, which have relied on covered bonds and are running out of assets to pledge to the ECB for cheap funding.
According to Fitch report published in June, on a weighted average basis - based on a sample of 135 covered bond issuers (101 banking groups) worldwide - Spanish, Swedish, German and Portuguese banks are at the top of the sample, with asset encumbrance from cover pools ranging from 28% to 12% at end-2012.
In Spain, overall encumbrance increases slightly despite the substantial transfer of real estate loans of rescued banks to the bad bank SAREB, reflecting both a preference for covered bonds over securitisation for contingency liquidity purposes as well as deleveraging.
The Bank of Spain declined to comment. (Reporting by Aimee Donnellan; additional reporting by Sarah White; Editing by Helene Durand and Julian Baker)
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