* Investors balk at dilution of covered bond product
* Spanish and Italian politicians seeks SME funding solution
* Bankers hope for ECB endorsement of hybrid product
By Aimee Donnellan
LONDON, March 14 (IFR) - Spanish and Italian plans to revive SME lending by introducing a new type of covered bond are unlikely to take off, as investors fear a loosening of the product’s strict standards could expose them to greater risk.
In recent months, the two peripheral countries have drafted proposals that would allow lenders to use a wider range of assets including corporate and SME loans to back the new covered issues, as well as reduce the level of overcollateralisation (OC) in a bid to reduce asset encumbrance.
Covered bonds played a crucial role in the financial crisis, helping banks obtain wholesale funding when the senior unsecured sector was shut off for the majority of borrowers due to prohibitive funding costs.
However, unlike traditional covered bonds, which are built on strong legal frameworks and follow rigorous collateral rules, the new instruments would have much looser criteria, leaving investors in a more uncertain position if a lender was to hit trouble.
“The new asset class has not been regulated as an extension of the traditional covered bond frameworks, which support Cédulas and Obbligazioni Bancarie Garantite (OBG), but as a separated, less-regulated, dual-recourse instrument with no ex-ante defined monitoring/surveillance requirements,” BBVA analysts wrote in a note this week.
They added that the new Italian collateralised bonds, despite including preferential treatment of the cover pool and asset segregation, would likely be categorised as non-UCITS and non-CRD eligible.
“This raises questions about the degree of systemic support,” they wrote. They added that in Spain, the new hybrid instruments would not legally be a cédula nor be backed by the mortgage market law.
Bankers and investors alike question whether anyone will be willing to buy these instruments given the greater risks attached to them.
“There are considerations for banks to issue bonds backed by assets with higher than 80% loan to value, which could be a hard sell,” said Christoph Anhamm, head of covered bond origination at RBS.
“Investors would need to have a lot of expertise in the mortgage market and economies of these countries which only a few of them will have.”
Hans-Georg Otten, responsible for managing the liquidity reserve portfolio at Commerzbank, said investors like him prefer traditional secured instruments because they are more transparent and offer liquidity even in the more difficult market situations.
“I don’t think we’ll see a lot of demand for hybrid covered bonds compared to the traditional covered bond market,” he said.
A failure of the initiatives to take off would be a blow to the peripheral countries, which are desperately searching for an attractive means of funding small and medium-sized companies to promote growth in their economies.
In Spain, the new bonds that could emerge from a change to the securitisation law will feature a pass-through structure similar to NIBC’s EUR500m five-year deal that priced last year, but banks will also be looking at Commerzbank’s SME-backed issue.
“Spain would like its banks to try the Commerzbank SME-backed instrument and it’s quite possible that the ECB would accept these bonds because the ECB is aiming to foster an improved funding situation for medium and small companies within the eurozone,” said Anhamm.
“It would help Spain and Italy a lot if the ECB made a clear statement about the eligibility of SME covered bonds so that the market felt there was a great level of support.”
But once again, some investors say this is not something they want to see more of.
“We won’t look at pass-through structures and I think most investors faced with a pass through feature and a traditional covered bond both having the same rating they will pick the latter,” says Otten.
“I’d expect hybrid covered bonds and pass through deals like the NIBC one to remain niche samples in a traditional market.”
Analysts at BBVA said the difficulties in defining the eligibility criteria for SME loans and the more complex monitoring process risked jeopardising the traditional covered bond investor base.
This has left “collateralised/structured covered bonds as a less regulated asset class with only the basic features of covered bonds,” they said. (Reporting by Aimee Donnellan; Editing by Helene Durand, Julian Baker)