news blog from Michael

Banks adapt covereds in search for cheap funding

Covered bonds have become the go-to funding tool for banks as investors increasingly favour secured issuance over all else, and the pricing differential between senior and covered remains elevated.However, limits on the type of collateral that can be used under current covered bond legislation mean that banks are now seeking to make use of other assets sitting on their balance sheets.The new style covered bonds would offer many of the sought after characteristics of the traditional product, but would differ most significantly in their use of a wider range of assets beyond mortgage and public sector collateral.”These bonds will provide dual recourse to the issuer, collateralisation by a dynamic cover pool and allow issuers to sell fixed rate covered bonds with bullet maturities which is quite unusual in the RMBS market,” said Boudewijn Dierick, covered bond structurer at BNP Paribas.According to a recent S&P report summarising the discussions at a True Sale International conference in September, structured covered issuance would allow funding for assets that are not eligible for German legislation-enabled bonds, such as loans to small- and mid-sized enterprises, trade or leasing receivables, and consumer loans.S&P added that despite issuers looking for news ways of structuring secured funding: “traditional German covered bond issuers are likely to continue to distinguish their product from newer developments.”Bankers say that German issuers with significant price differentiation between their senior and covered debt are likely to benefit most from any new structures. The current range of between 150bp and 200bp makes it almost impossible for certain banks to sell unsecured paper.Deutsche Pfandbriefbank is already looking at the possibility of using structured covered bonds for 2012. “High over-collateralisation requirements highlight the need for alternative approaches, for example using non-encumbered assets and analysing the possibility of structured covered bonds,” the issuer said in an investor presentation published at the beginning of September.HOW MUCH?Covered bankers say it is still too early to tell where exactly a structured bond would price, although they estimate a level somewhere between an issuer’s regular covered bonds and its senior unsecured paper.”Anything you can fund in-between covered bonds and senior will be beneficial to banks in the current market,” said Ralf Grossmann, head of covered bond origination at Societe Generale.”The wholesale funding market is in bad shape but covered bonds are standing out as the funding instrument of choice. At the moment funding costs are increasing so any penny you can save will go a long way in reducing your overall funding costs.”Andrew Porter, global head of covered bonds at HSBC, thinks pricing will depend on the type of assets used, how much over-collateralisation is provided, and whether or not the issue is triple A rated.”If the issuer is using well-regarded assets, offering 30% OC, and a high rating then it will be more likely to price closer to covered bond levels as opposed to where senior unsecured paper is trading,” he said.TARGETING INVESTORSFor now, the challenge for issuers is to find an investor base for the new instrument, given that a certain breed of covered bond buyer would be unlikely to buy a watered down version of a product that they already view as safe.”These new structures would fall outside of the covered bond label and that is quite deliberate,” said Mauricio Noe, head of covered bond origination at Deutsche Bank.”Covered bond investors are not so rigid that they won’t consider a new structure that has the bank’s guarantee. There is definitely a market for these kinds of structures, but they will have to add a premium over special law covered bonds.”Banks for now are hoping that a portion of traditional covered bond buyers, investors that previously bought senior unsecured debt, and RMBS investors will be the likely owners of the new bonds.”Issuers are motivated to use this kind of structure where either they have spare capacity to encumber more assets or they can re-direct assets which would otherwise have been used for ECB repo funding,” said Porter.Noe agreed: “It makes sense to mobilise assets to lower the cost of funding for banks such as the Germans whose covereds trade so much tighter than senior, but for the French where there is less of a difference they may be better off to wait for more certainty on the bail-in discussions.”