Cédulas plot through the sovereign crisis

An escalation of the sovereign bond crisis, leading to European Central Bank buying of Spanish government bonds, has spooked covered bond investors. Added to that, bank restructuring and the associated demise of the multi-issuer cédulas structure, alongside a shrinking pool of eligible collateral, suggests that the cédulas market’s heyday might be over — though it is probably not out.

As matters stood at the end of 2010 few bankers could have predicted the scope of Spanish cédulas funding seen in the first half of this year when both the national champions and many tier two borrowers successfully accessed the market.

According to Dealogic, cédulas issuance as a proportion of total European covered bond issuance has steadily risen over the past three years from a low of 9% in the first half of 2009 to 11% in the same period a year later and then to 13% in the first half of this year.

But whether this improving issuance trend indicates a return to the heady days of 2006, when Spanish supply accounted for nearly one third of all covered bonds in Europe, seems doubtful at this juncture.

Defunct multi issuer format

For a start, the multi-issuer format is now defunct. In this structure the savings banks, or cajas, pledge smaller sized covered bonds backed by mortgage loans to a special purpose vehicle which then issues a jumbo cédulas. The problem is that these jumbo deals can only be as strong as the weakest constituent caja. And, since many cajas over-extended credit during the property boom years, their ratings have fallen.

The multi-issuance structure got its most damning indictment earlier this year when Standard & Poor’s downgraded 53 tranches with an original value of €117bn. Some deals were downgraded by as much as nine notches from AAA to BBB-, though most were downgraded a severe four to six notches, from AAA to the single-A area.

The rating agency cited several factors, but the main one was that the credit rating of underlying borrowers that had participated in the deals had been downgraded. Added to that, the concentration risk, or exposure to single borrowing entities, had increased. This is because of the consolidation of the caja sector has seen the number of lenders shrink from 53 lenders down to 26 as of September. Finally, the agency tweaked its correlation, stress and default assumptions to reflect its updated view that the Spanish banking sector will take longer to recover than it initially thought.

Though the severity of some downgrades caught some market participants by surprise, the fact that spreads were already trading around mid-swaps plus 380bp area suggests a significant degree of the bad news had already been discounted in the price.

But AyT is still the largest in Europe

"The response from the secondary markets was rather subdued," said LBBW covered bond research analyst Alexandra Hauser back in July. She noted a 10bp spread widening in the iBoxx euro covered bond pooled cédulas sub-index in the two days that followed the announcement.

The largest arranger of these types of structure is Ahorro Corporacion Financiera which issued under the AyT label. As of July this year AyT had €42bn of cédulas outstanding which, according to Bernd Volk at Deutsche Bank covered bond research, makes it is the second largest European issuer.

It, along with all other multi-cédulas special purpose vehicles such as Fondo de Titulización de Activos, (TdA) and Intermoney Master cédulas Fondo de Titulizacion de Activos (Intermoney), have issued a collective €131bn of outstanding bonds representing 36% of the Spanish cédulas market, according to Volk.

The S&P move had been presaged by Fitch which had downgraded 50 multi-issuer cédulas deals largely from AAA to the AA area. In order to keep the top rating, over-collateralisation would need to have risen beyond a level that many weaker borrowers could have complied with. This is exacerbated by the fact that virtually all banks are not lending on the scale they had been four years ago.

Issuers near minimum 25% OC threshold

According Moody’s second quarter 2011 EMEA covered bond monitoring overview, which was published in October, several major issuing banks are close to the 25% minimum overcollateralization level defined by the cédulas law.

As of June 2011 Moody’s stated that the overcollateralization level of Caixabank’s programme was just 27.8%. It has the lowest level of overcollateralization of an programme according to the agency, though there are several other programmes which are also getting very close to the 25% limit. These are Unicaja’s which stood at 36.9%; Banco Pastor’s which stood at 32.4%, Banco Popular’s which stood at 31.2%, Banco Santander’s which stood at 35.02% and Banesto’s which stood at 35%.

Admittedly there are others that have plenty of capacity – though these are generally the smaller lenders. For example, Bankia’s OC stood at 654%, Banco Caixa Geral’s OC stood at 375.3% and CAI’s stood at 203.2%.

According to the UBS European Credit Tracker published in early March 2011, many Spanish banks that had been heavily reliant on covered bond financing for some time "have little issuance capacity remaining". UBS illustrated the point by drawing an analogy between La Caixa and its top five peers.

The researchers said the lender had capacity to issue a further €22bn, which equated to 60% of its outstanding issuance and implied it needed to keep OC at a minimum of 170%. If this level of OC were to be applied to all five peers, UBS said their issuance capacity would range from 45% of outstanding issuance to as little as 10% of outstanding issuance.

UBS said that "for many Spanish banks, the picture is a challenging one". At that time UBS said it was a seller of Santander, BBVA, Popular and Sabadell.

But according to Moody’s, BBVA and Sabadell’s OC stood at 52% and 50.3% respectively, suggesting they still both have some headroom to supply the market.

Collateral constraints are generally more conspicuous for the smaller savings banks, such as Caja Avila, Caja Segovia and Unicaja, whose cédulas programmes are close to the minimum 125% OC level that is stipulated by the cédulas law.

BBVA leads H2/2011 redemption calendar

But many of these smaller names do not have redemptions that need to be refinanced in the next six months. In contrast the national champions and a few others face total redemptions of €7bn through to the end of this year.

According to Dealogic, Santander issued a €2.5bn five year deal in 2006 that matured in September, BBVA issued two five year bonds in 2006 that mature in October and November. La Caixa, Bankia, BBK and Bankinter have also issued smaller deals that are due to mature over the remainder of this year.

Deleveraging reduces funding needs

But, whether all these deals need to be fully refinanced is doubtful given that all banks have been deleveraging by running down their loan books. Santander, for example, is thought to have reduced its loan-to-deposit ratio in its domestic operations by one third in the past three years.

It’s probably fair to assume other lenders will have deleveraged by a similar, or perhaps even greater degree.

Banco Popular Español has also been deleveraging. Its director of capital markets, Santiago Armada, says the Spanish banking system as a whole has reduced reliance on ECB funding by 60% in the last 12 months "as banks deleverage and reduced their loan portfolios".

"We would have anticipated fewer cédulas transactions in the second half of the year because many issuers are restructuring and current financing costs are too high, but sovereign volatility during the summer will make it even lower," says Armada.

Banco Popular Español has been growing deposits while at the same time keeping its lending book stable. As a consequence the commercial gap, which is the difference between borrowing and lending, has reduced by €3bn in the 12 months to date.

The bank’s has long term maturities of €3.2bn this year that are already funded. It has raised €1.5bn in covered bonds, €0.5bn in senior unsecured and it has reduced the commercial gap by €1.5bn since January. However, Armada says the bank could do with being pre-funded next year, so if the opportunity arises, "we could go for one more benchmark cédulas".

Kutxa prefunded to mid 2012

Kutxa Bank has also deleveraged. "We are actually decreasing the loan book because on the one hand we are required to set more capital aside, but it’s also very difficult to give out loans above 80% loan to value," says Sabin Izagire, head of funding at Kutxa. Izagire says the deleveraging has also occurred because local SMEs are decreasing their borrowing.

While acknowledging that the market is closed for most Spanish issuers, Kutxa is one of the few Spanish banks that is in the enviable position of being pre-funded.

"We’re very comfortable with our funding" says Izagire, who points out that the bank is pre-funded through to the first half 2012.

However, the bank’s future funding needs will also have to include its prospective merger partners.

The three-way merger, with Kutxa BBK and Kutxa Vita, will take the total amount of assets on balance sheet up from €20bn to around €75bn. If the integration plans go through, Kuxta may be in a position to return to the capital markets in the first half of 2012.

Like many Spanish cédulas issuers the borrower had been dependent on multi-issuer cédulas format for its funding, but in October 2010 it decided to go it alone with its debut covered bond. The transaction was successful and was followed by another in March this year.

"We knew the markets were difficult, but we saw a window in late March," says Izagire. Fortunately the borrower had recently been visiting investors and it managed to open and close books just before the resignation of the Portuguese finance minister. "We’ve been very successful and between these two issues raised €1.3bn in four year paper," Izagire adds.

Investors may have been attracted to the deals by the fact that in the local Basque region house prices have fallen by just 10%, which is about half the national average. Prices have held up better partly because unemployment, at about 10%, is also about half the national average.

Added to that, there are €8.6bn of assets backing its deals and this gives a very high over-collateralisation of 277%, affording Kutxa’s cédulas a comfortable triple-A rating with S&P.

Easing of sovereign bond volatility needed

Reyes Bover, head of financial institutions, debt and capital markets, at BBVA, believes that the re-opening of the European primary covered bond market, together with an easing of sovereign bond market volatility "will provide a good indication for a re-opening of the primary cédulas market".

But in the case of saving banks, progress on the consolidation and capitalisation of the caja sector "will be key to determining their access," she says.

Bover points out that investor perception of the Spanish covered bond market could potentially be bolstered by the fact that core capital requirements for Spanish banks, which are set by the Bank of Spain, are much higher than Basel III requirements. Moreover, the government is committed to fiscal rectitude and labour market reform which should put it in good stead.