The ECB announced last week that it was intending to buy eurozone covered bonds as of June in its version of quantitative easing. However, it appears one ECB-bank member may already have beaten them to it – at least in terms of playing the covered bond market.
Barclays Capital on Wednesday morning cites Spain’s Expansion newspaper on a report that Banco de España has already been delving into the covered bond market with money from gold-sale proceeds . The Barcap report states BdE has even confirmed the story, explaining it as a reduction in gold reserves in favour of acquiring ‘other assets’, among them covered bonds.
As Barcap go on:
Purchases, however, have been done over the course of “various months” already. Obviously, these purchases are NOT within the scope of the measures the ECB announced last Thursday (€60bn purchase programme of covered bonds) but instead are to be regarded as a separate activity on behalf of Banco de España. However, it highlights the overall support for the covered bond product by the Eurosystem. We note that the latest available data, as reported to the IMF for March, show that Spanish gold holdings at end-March were 9.054mn oz, unchanged since end-July 2007. That said, it should also be noted that Spain slashed its gold holdings during 2005-2008: from 16.826mn oz at end-2004 to 9.054mn in July 2007.Spain’s covered bond market, of course, was for the longest time among the hottest in Europe. According to the latest data from the European Covered Bond Council, the total outstanding covered bond market in Spain was worth some €283bn in 2007, the bulk of which were collateralised by jumbo loans. To compare, in 2003 the market was worth some €62bn.
In 2007 (now seen as one of the worst vintages for leveraged securities; see chart below from Barclays Capital as example), Spanish and French banks were amongst the largest issuers of covered bonds, with issuance of €57bn and €61bn respectively according to the ECBC.
And as the ECBC reports in one of its latest industry reviews:
Up to October 2008, some issuers largely refrained from tapping the primary market; in particular, UK and US issuers issued no covered bonds, while issuance by Spanish issuers was reduced in relative terms in the first ten months of 2008 (see Chart 9). However, the relatively large number of new entrants in the covered bond market suggests that the concern has been largely limited to certain traditional issuers.
Chart 9 referred to by ECBC (click to enlarge)
In the last year, however, problems clearly began to emerge in Spain, especially for one of the country’s most prolific issuers — Santander. As early as last May, Bloomberg was reporting the following regarding Santander’s broader mortgage-backed Hipotecario issues:
Spanish mortgage defaults are triggering losses for holders of AAA rated bonds sold by Banco Santander SA, the country’s largest lender.
Investors in the highest grade portions of 2.8 billion euros ($4.33 billion) of bonds issued by Santander last year will have to wait about 8 years for the debt to mature, rather than little over a year when the notes were issued, Santander said in a report to investors this month. The maturity was extended because of rules designed to protect the holders against default. Spanish mortgage arrears are at the highest in at least six years after the biggest monthly jump in the jobless rate since the 1993 recession to 9.6 percent.
Fast forward to 2009 and downgrades for the mortgage-backed bond issues persist. In April, S&P downgraded junior portions of three transactions sold by Banco Santander SA as ninety-day arrears on loans packaged in one of the notes, Santander Hipotecario 4, climbed four-fold in the last quarter to 10.3 per cent.
This is important because interest payments on the junior notes stop when 18-month arrears surpass 7.7 per cent, according to a Jan. 15 Santander report.
Meanwhile, Fitch put both Santander’s Hipotecario 3 and 4 issues on a rating watch negative. As Fitch explained:
The RWN reflects the continued deterioration in both transactions due to the pools’ weaker collateral composition as well as the deteriorating Spanish housing market and macro-economic conditions.
And if all that wasn’t enough, S&P reported on April 6th that Caja Madrid had become the first Spanish bank to stop interest payments to mortgage-backed bond investors — a very bad indicator for all investors in Spanish mortgage-backed securities. As Bloomberg reports S&P estimates more than half of the transactions it rates include interest-deferral triggers, acting as safeguards to protect the most senior notes.
As if by magic, come May the negative news was indeed in overdrive. Note the following overview from Barclays weekly report:
Moody’s has downgraded the Class C and D from IM Pastor 3 and Classes B, C and D from IM Pastor 4 as well as the Class A1 and A2 notes from BBVA RMBS 3. These were due to a worse-than-expected performance of the collateral and also the new Moody’s rating methodology for rating Spanish RMBS. For the same reasons, Moody’s has also downgraded the Class A1 notes from Bancaja 11 from Aaa to Aa1. Bancaja 11 also breached a trigger such that the Class A notes switch from sequential to pro rata – this before the Class A1 notes have fully paid down, though with a pool factor of 0.0764, it is likely to be repaid soon.
Moody’s has also downgraded classes A1 and A2 of the BBVA RMBS 3 transaction citing similar reasons. It expects the class A notes to switch to a pro-rata payment in the near future.
S&P has placed classes B, C and D on CreditWatch negative from Bancaja 12 – class A were already on CreditWatch Negative. This is due to S&P downgrading Bancaja on 23 September 2008. It is now currently unrated, and as the interest rate swap provider, this has repercussions for the transaction. S&P states in its press release that Bancaja is taking steps to replace itself as the counterparty though this has not occurred yet.
News like that, unsurprisingly, would be enough to freeze any market, so perhaps it’s not so much of a coincidence Spain’s central bank decided to step into the market over some ‘various’ months in the year. Covered bonds – cedulas – are an obvious way of for the Spanish central bank to segue into the mortgage-backed market because of their relative safety compared to regular RMBS issues.
It is also interesting to note the ECB’s decision on May 8th to delve into covered bond purchases specifically came straight on the back of the annual meeting of the European Mortgage Federation and European Covered Bond Council with the ECB on April 29th. The meeting, the ECBC, notes “has become an important channel for both the ECBC and the European Central Bank to be able to communicate on covered bond developments”.
But while the ECB covered bond announcement has helped see prices rally it has done little to spur liquidity. Instead of narrowing, bid/offer spreads have been widening. As Bloomberg reports on Wednesday (our emphasis):
May 13 (Bloomberg) — The European Central Bank’s plans to buy 60 billion euros ($80 billion) of covered bonds has failed to revitalize the market because traders are concerned they may be wrong-footed when details of the program are announced.
The difference between the price at which banks buy and sell the debt has increased since the ECB’s announcement last week, said Fritz Engelhard, an analyst at Barclays Capital in Frankfurt. The bid/offer spread, a measure of the cost of trading, for some five-year French covered bonds has widened to 30 basis points from 20, he said. The $2.8 trillion market for the notes backed by mortgages and public sector loans has been roiled by the credit crisis with just 50 billion euros of the debt issued this year, down from 102 billion in 2008, according to data compiled by Bloomberg.
The market is now in limbo until June 4 when the ECB said it will identify which securities it will buy.
This comes largely because of doubts still remaining in the market over whether critical jumbo covered bond issues will be included in the ECB’s programme. As Bloomberg reported on Monday, bid/offer spreads on outstanding Spanish cedulas issues – most of which are jumbos – actually widened to 50 basis points after the ECB announcement from 30 basis points.
But there are some indicators to suggest jumbo issues will be included, or at least that the market thinks they will. Santander on Monday became the first European lender post- ECB-announcement to issue a covered bond. The sale came in the shape of a €1.5bn cedula note and was the first mortgage-linked debt sold by a Spanish bank in almost a year. Having attracted more than €3.2bn of orders, the market took this as a positive. France’s Credit Foncier de France followed suit with the sale of a 12-year €1.25bn bond.
However, as ING reported in a note on the matter (via Reuters):
“Coincidence or not, just two working days after the ECB announced it would start buying covered bonds, Banco Santander takes the lead in opening up the primary market for one of the most plagued covered bond species — the Spanish Cedulas,”
The market reopening comes a few weeks after the point when the total of outstanding Spanish Cedulas exceeded the total German jumbo Pfandbriefe market, ING said. The Spanish lead in market size is likely to widen this year, not because of new issuance but because 64 billion euros of Pfandbriefe are due to mature versus only 10 billion euros in Cedulas, ING said.
Remember, of course, that Santander has not had to tap the market in government-guaranteed bonds as yet. What’s more, its latest successful cedula sale — conveniently for which there is now a major secondary market buyer in the shape of the ECB — probably means it won’t have to.
Related links:
At least you’re not Spanish – FT Alphaville
Unemployment, Spanish edition – FT Alphaville
Property pawn: the demise of Metrovacesa – FT Alphaville
Unconventional conventions at the ECB - FT Alphaville