In association with NORDIC FIs & COVERED INSIDE: 2 Sør Boligkreditt covered payment delay has ‘no credit impact’ 3 Brave new world? Market reacts to final CBPP3 details 6 Nordic euro FI spread data Thursday, 9 October 2014 Covered win swap concessions, but law changes for OC seen ESMA released final draft RTS on central clearing requirements for OTC derivatives on Wednesday of last week (1 October) that featured several concessions to the covered bond industry, but the regulator did not make all the requested changes and related changes to Norwegian and Swedish laws are now in store. The European Securities & Markets Authority (ESMA) released proposals in July whereby derivatives related to covered bonds that met certain conditions would be exempt from central clearing obligations under the European Market Infrastructure Regulation (EMIR). During a consultation on proposed Regulatory Technical Standards (RTS) that ran until mid-August, the European Covered Bond Council and others argued that covered bond-related derivatives should be fully exempt from such obligations, with no qualifying criteria being necessary, given that they cannot be cleared by central counterparties, and they also raised issues with several of the conditions that ESMA had put forward as criteria for exemption. In conjunction with releasing the final draft RTS, ESMA summarised comments it received during the consultation and gave its feedback as to why it did or did not make changes in response. However, it does not appear to have done so in relation to an ECBC argument for an unconditional exemption for covered bonds. “It’s very strange that they didn’t say anything about the market’s view,” said a covered bond banker. ESMA nevertheless noted that market participants had welcomed its recognition of the “specific nature” of covered bond derivatives. “Getting an exemption for covered bond specific derivatives from central clearing requirements is an important and positive decision for the covered bond market,” said Florian Eichert, (continued on page 5) Issue 99 Moody’s highlights lower fire-sale risk from SCBC soft bullet Moody’s noted that the soft bullet mechanism used by SCBC for the first time on a Eu1bn covered bond launched on Tuesday of last week (30 September) reduces fire-sale risk associated with covered bonds in the event of default, which is the major driver of cover pool losses. The Swedish Covered Bond Corporation (SCBC) deal is understood to be the first time a soft bullet has been used by a Swedish issuer, although the structure is widely used in many other jurisdictions, with Moody’s noting that it is an accepted market norm in neighbouring Norway, for example. In SCBC’s case, the soft bullet structure implies an automatic extension of the bond’s maturity date by a maximum 12 months if the bonds are not repaid in full on the initial maturity date, according to Moody’s. “We expect that the soft bullet bonds will — while the issuer is not insolvent — be repaid by the issuer at the initial maturity date,” the rating agency said. “However, in periods of severe stress the maturity extension helps to reduce firesale risk as it allows additional time to (continued on page 2) Latest Nordic FI benchmarks Senior unsecured (z spreads mid) JYBC POHBK MINGNO 3mE+50 1.125% 1.500% 06/17 06/19 05/19 30bp 31bp 39bp Covered bonds (asw spreads mid) DANBNK DNBNO SBAB 0.375% 0.375% 0.625% 08/19 10/19 10/21 -3bp -6bp -2bp Source: CACIB trading 8/10/14 Page 1 Thursday, 9 October 2014 Issue 99 Moody’s notes Swede’s soft bullet move towards Norwegian norm (continued from page 1) raise alternative financing or to liquidate the cover pool assets in a more orderly manner, thereby avoiding a high discount. “This gives the issuer additional flexibility also in a pre-insolvency situation. Firesale risk exists when cash collected from the cover pool assets is insufficient to make timely payments on the covered bonds after the issuer has become insolvent.” Moody’s said that fire-sale risk is the major driver of cover pool losses in most covered bonds, including SCBC’s. For SCBC’s programme, the Maximum Mismatch — which is the rating agency’s measure of the portion of the cover pool subject to fire-sale risk — is 64%, compared with a European average of around 43% and around 60% for Swedish programmes. Moody’ said that fire-sale risk is currently “significant” as the weighted average life of SCBC’s cover pool assets is 22.8 years, compared with 2.8 years for the covered bonds. Moody’s said that as the Eu1bn issue accounts for just 6.2% of SCBC’s outstanding covered bonds it will affect the rating agency’s assessment of fire-sale risk “only marginally”. “If SCBC were to issue only soft bullets in future, the share of hard bul- let covered bonds would decrease over time,” it added. “However, a significant risk of a fire sale remains in structures in which not all series are soft bullet.” The rating agency said it reflects reduced fire-sale risk for those issuers that issue only soft bullets in two steps of its methodology: through its expected loss analysis, requiring lower OC consistent with the lower current Aaa rating; and a possibly higher Timely Payment Indicator (TPI), reflecting a higher probability of timely payments in the event an issuer is unable to make payments on the covered bonds. n Nordic FIs & Covered Bonds Produced by NewType Media, publisher of The Covered Bond Report Neil Day Managing Editor [email protected] +44 20 7428 9575 Susanna Rust Deputy Editor [email protected] +44 20 7267 5354 news.coveredbondreport.com Page 2 In association with Vincent Hoarau Head of FIG Syndicate [email protected] +44 20 7214 6162 Julian Burkhard Global Head of Capital Solutions, Head of FI DCM Nordics & UK [email protected] +44 20 7214 5472 Florian Eichert Senior Covered Bond Analyst [email protected] +44 20 7214 6402 Sør Boligkreditt covered payment delay has ‘no credit impact’ A brief payment delay on a covered bond from Norway’s Sør Boligkreditt that matured last month and which was due to an operational error has no credit impact and is extremely unlikely to happen again, according to Moody’s, which rates the issuer’s covered bonds Aaa. The Sør Boligkreditt issue was due on 26 September but because of a “technical error in the payment process”, in Moody’s words, whereby custodian DNB Bank had failed to update the maturity date when it was amended in September 2011, the payment was not made. The payment was then made on 29 September — one working day later, noted Moody’s — with investors receiving three days’ additional interest. “The cash to repay the bond was available in the issuer’s account, and the bank immediately ordered the bond’s repayment once the error was acknowledged,” said the rating agency. “The issuer confirmed the maturity dates of the outstanding covered bonds were correctly set in the payment chain so that the error will not happen again in the future,” it added. Moody’s noted that such an operational error does not trigger a default of the covered bond under the contractual agreement. “Moody’s definition of default is intended to capture events whereby issuers fail to meet their debt-service obligations as outlined in original credit agreements and indentures, and which subject those creditors to economic loss,” it said. “According to the contractual documentation of the programme, upon failure of the issuer to fulfil its payment obligation, the maturity is automatically extended by one year. As a consequence of this feature of the programme — Norwegian standard — there has been no default of the covered bonds. “In addition, because the cash was already available in the issuer’s account, the bond trustee did not need to call the liquidity facility granted by Sparebanken Sør (A2/P-1), the sponsor bank to the issuer (Sør Boligkreditt).” n Issue 99 Thursday, 9 October 2014 A brave new world Market reacts to final CBPP3 details Having announced the third covered bond purchase programme (CBPP3) at its last press conference, at the beginning of September, the European Central Bank last Thursday (2 October) followed up with the technical details of CBPP3 — which didn’t disappoint our expectations as the eligibility criteria are very wide. General modalities: size and duration CBPP3 will differ from CBPP1 and CBPP2 in a number of respects. l First of all, CBPP3 and the ABS programmes will not have a concrete size limit. To us, this is only natural as the required volume of asset purchases will depend directly on the volume of TLTRO take-up. l Secondly, while the previous two covered bond programmes were both structured as 12 month programmes, CBPP3 will last for at least two years. Where will the ECB buy? What about retained bonds and issue share limits? The ECB will purchase bonds in the primary as well as secondary market. Different than during CBPP1 and CBPP2, the central bank will, however, also be able to buy retained bonds directly from issuers. Ulrich Bindseil, director general, market operations at the ECB, did mention the other day that the ECB would prefer to co-invest and buy new issues in the market, but at least the programme offers the option to go straight to the source should issuance not be as frequent as the ECB would like it to be. Bindseil also mentioned that the ECB wants to maintain a functioning covered bond market. In that context one would probably have to mention the issue share limit of 70% for covered bonds, other than from Greece and Cyprus (30% in these two cases). In other words, the ECB will not be able to hold more than 70% of any given ISIN. We are not sure if one can call a market with a free float of potentially 30% functioning, especially if much of that “free float” will sit with other buy-and-hold investors. But, for whatever it is worth, it is of course hard to argue against the fact that 30% free float is better than no free float at all. We are still not sure how buying retained bonds works with the overall balance-sheet growth target. Banks that sell their retained deals to the ECB can save the haircut, which can be anywhere between 14% and 25% depending on the rating. Based on the roughly Eu230bn in retained covered bonds from Ireland, Italy, Portugal and Spain, this adds maybe around Eu25bn in extra liquidity (70% of the Eu33bn estimated haircut) and thus balance sheet growth to the ECB. However, if there are external investors buying 30% of the deals, the balance sheet of the ECB would actually shrink by close to Eu70bn. During the two previous programmes the criteria talked about UCITS-compliance. Compared with UCITS, CRR limits the eligible collateral to mortgages, Details of CBPP3 vs CBPP1 and CBPP2 (differences highlighted) CBPP 1 CBPP 2 CBPP 3 Start date 7/10/2009 11/14/2011 2nd half October End date 6/30/2010 10/31/2012 Duration 12M 12M At least 24M Total size EUR60bn EUR40bn No target size Remaining balance EUR31.9bn EUR13.5bn Where will they buy? Primary, secondary Primary, secondary Primary, secondary + retained Allocation ECB retained EUR4.8bn, the rest was distributed based on ECB capital share "Across the Eurozone" "Carried out progressively by the ECB and the Eurosystem NCBs" Location of issuer scope Eurozone Eurozone Eurozone Currency EUR EUR EUR Collateral Private and public entities Private and public entities Private and public entities Maturities 3-10 years, with strong focus on maturities up to 7 years Up to 10.5 years residual maturity no limit Minimum rating At least one AA rating and no rating below BBB- BBB- (best rating counts) BBB- (best rating counts) Minimum volume (EURmn) As a rule 500, in any case not below 100 300 no min volume ECB can buy up to X% of each deal No explicit limit (based on observations as much as 20%) No explicit limit (based on observations as much as 20%) 70% per ISIN (30% for Greek and Cypriot covered bonds) Regulatory min. requirement UCITS or equivalent safeguard (similar to own use covered bond rules) UCITS or equivalent safeguard (similar to own use covered bond rules) CRR Source: ECB, Crédit Agricole CIB Page 3 Thursday, 9 October 2014 Issue 99 covered bonds have come in more than 30bp — looking at the ECB’s statements above and the potential duration of the programme, we could very well not be at the end of this, though. Looking at new issue spread levels, one thing has become clear. Eurozone covered bonds have profited most from CBPP3 as they will be the direct target of CBPP3. Non-Eurozone covered bonds have been dragged along with them, but have lagged. While French covered bonds, for example, still traded at wider levels than strong Nordic covered bonds, this has now reversed. DNB from Norway issued its latest five year deal at mid-swaps minus 3bp while CFF and Commerzbank priced theirs at minus 5bp. Retained covered bonds by country, plus haircut banks could save by selling to the ECB (EURbn) 140 124 120 100 70 80 60 40 11 20 0 24 10 2 Ireland 4 Italy Portugal 18 Spain Retained covered bonds Haircut estimate (14% for A- to AAA FRN, 25% for BBB+ to BBB- FRN) Source: Bloomberg, iBoxx, Moody’s, AIAF, www.coveredbondlabel.com, Crédit Agricole CIB as we can see (even Eu50m Pfandbriefe are repo-eligible, after all). l There is no maturity limit. The ECB will thus participate in whatever eligible issuance comes to market. If there are only five year deals, they will buy five years; if there are 15 year deals, they will buy 15 years. l Minimum rating will have to be BBB- (best rating). l Euro-denominated covered bonds issued by financial institutions located in the Eurozone l The collateral can be public and private sector-backed. public sector assets and ship mortgages. While the own-use covered bond rules allow for equivalent legal safeguards to be sufficient as well, the CBPP3 purchase programme eligibility criteria don’t include this option. At the moment there is nothing outstanding in these sectors, so it’s not a big deal. The only non-CRR-compliant covered bonds that could have hoped to benefit from a UCITS wording are NordLB’s aircraft Pfandbriefe and Lettres de Gages from Luxembourg. Looking to the future, however, the ECB seems to be pushing the responsibility for these alternative collateral asset classes clearly over to the ABS programme. CBPP3 will concentrate on only the most traditional covered bond categories. As long as we stay in these categories, we shouldn’t run into too much trouble overall with the programme: How has the market reacted to CBPP3? Secondary markets: Since the initial CBPP3 announcement, spreads — especially in the periphery — have tightened quite considerably. Five year Portuguese l There is no minimum size as far Spread change since CBPP3 announcement five year average covered bond spreads per country Average distribution of EUR benchmarks before and after the CBPP3 announcement, by investor type 100 0.5 80 0.4 60 0.3 40 0.2 20 0.1 0 -20 -4 -6 -3 -4 -40 -60 0 -14 -29 -43 AU FR 03/09/2014 DE SE Current IE IT PT -35 ES Change (bp) Source: Bloomberg, Crédit Agricole CIB Page 4 Primary market and investor distributions: One of the fears associated with CBPP3 has been that the ECB could be crowding out investors and reducing the diversity we have managed to get in the past few years. For the time being, we cannot say that these fears have proven to be true. Following the CBPP3 announcement, issuance has picked up and book volumes have been very healthy. Also, the average number of investors per book has been stable around 100 since the announcement. There has, however, been a shift in the investor distribution of deals since the CBPP3 announcement. The shares of asset managers and insurance companies have dropped by 2% and 3%, respectively, while central banks and official institutions have nearly doubled in weight (up from 11% to 19%). -0.1 8% -2% -2% Asset Managers Banks 2014 prior CBPP3 -3% CB / OI Insurance 2014 post CBPP3 -1% Other Change Source: Bloomberg, The Cover, The CBR, IFR, Crédit Agricole CIB Issue 99 Bottom line The ECB announcement last Thursday was in line with expectations — as was the market reaction. The ECB came out with a very broad programme without size limits or a concrete deadline and the market went tighter. Looking at the market after the September announcement and the latest details, in core covered bond markets we have reached levels where longer term market funding can certainly compete with TLTRO money on cost grounds. For stronger peripheral issuers we are fast getting there, but for many weaker names Thursday, 9 October 2014 TLTRO money is still the better option. But since the ECB is targeting spread compression and also wants to enable second tier banks to access the market successfully, we believe that we are not at the end of the compression in covered bond markets yet. It will continue at the higher spread end of the market. The tight range across sectors and issuers we have already reached at the short end and when looking at the strongest names in each country will continue to extend out along the curve and increasingly also encompass the weaker issuers in the coming weeks. At some point when everything is trading in a fairly narrow range we will have reached a new equilibrium where investors grudgingly accept the low spreads and don’t dare go against the ECB. Looking at the planned duration of CBPP3, this state of mind will also be with us for the medium term. Welcome to a brave new world. Florian Eichert Senior Covered Bond Analyst Stephan Dorner Covered Bond Analyst Crédit Agricole CIB Norwegian OC move underway, Swedish probable (continued from page 1) senior covered bond analyst at Crédit Agricole CIB. “Centrally cleared swaps automatically accelerate once the counterparty defaults but for covered bond derivatives to be an effective protection for investors they have to be able to survive the default. “And since there is no way yet for clearing houses to distinguish between ordinary and covered bond related derivatives, it was vital to get an exemption.” Luca Bertalot, secretary general of the EMF-ECBC, described ESMA’s final position as a “success story” for the industry’s lobbying. ESMA amended the wording of some of the six criteria in response to technical issues raised by the industry that would have unnecessarily caused problems for issuers in certain jurisdictions. For example, in its first condition it changed a reference to “default” of a covered bond issuer to “resolution or insolvency”, and added “or recorded” to a condition that derivatives be “registered” in a cover pool. A condition relating to derivative counterparties being pari passu with covered bond was also relaxed. But changes proposed by the ECBC to two other conditions were not made. ESMA clarified that a reference to a requirement for a “legal” collateralisation level of at least 102% refers to a regulatory minimum and cannot be contractually-based, and hence changed the requirement to being “regulatory”. Jurisdictions that are faced with addressing the final OC requirement include Norway and Sweden. Torkil Wiberg, analyst, banking and capital markets, at Finance Norway, said that a proposal has already been put forward by the Norwegian government whereby the Ministry of Finance will have the authority to set a quantitative OC level. This is part of a new act on financial institutions that is expected to be dealt with in the Norwegian parliament (pictured) this autumn, he said. “OC-limits, if not necessarily regulatory, are now increasingly being incorporated into other central parts of EU regulation, such as the LCR,” said Wiberg. “It was also highlighted by the EBA, in its report, as a possible area for harmonisation. “Of course one can argue over the specificities in the ESMA criteria,” he added, “but overall the exemption is positive.” Jonny Sylvén, senior advisor at the Association of Swedish Covered Bond Issuers (ASCB), said that Swedish legislation will probably have to be changed. “The Swedish issuers do not have any problems with that kind of OC requirement today,” he said. “There are discussions of other requirements in some other new regulatory changes, such as LCR, large exposures and the harmonisation project, and we have asked authorities to coordinate this.” According to another Swedish market participant, the possibility of the ESMA requirement being met through changes to regulations set by the Swedish FSA (Finansinspektionen) has been explored, but issuers’ preferred and expected route is an amendment to Swedish covered bond legislation. He said that this should be achievable within the necessary timeframe, with the bigger Swedish issuers expected to have to comply with the RTS in the next nine to 10 months. Crédit Agricole CIB’s Eichert noted how OC is becoming an issue across regulatory initiatives. “ESMA rules will require covered bonds to have a minimum legal OC of 2%,” he said. “While minimum OC is becoming a topic in a number of regulatory documents, the actual levels as well as the nature of it differs across regulatory dossiers. Basel large exposure limits talk about voluntary OC, the draft LCR act doesn’t specify the 2% and 7% levels for 1B and 2A levels further, and EBA is aiming for unspecified legal minimum levels. “The diversity across regulatory documents is clearly not ideal for countries aiming to change their legal frameworks. Regulators are pushing for transparency and harmonisation — it would be good they did the same.” The ECBC had also argued that covered bonds should only have to be UCITS and not CRR-compliant, but ESMA did not change its position, preferring the tighter criteria. “For derivatives to be outside the scope of central clearing they have to be CRR-compliant,” said Eichert. “This rules out UCITS but not CRR-compliant programmes, such as NordLB’s aircraft Pfandbriefe. “However, with the exception of the LCR, regulators have in recent months started to tighten eligibility criteria for covered bonds to continue to benefit from preferential regulatory treatment.” Some Danish issuance is also not CRR-compliant, although a market participant said that ESMA’s move is not expected to be a significant problem for the Danes. n Page 5 Thursday, 9 October 2014 Issue 99 Euro Nordic covered bond & senior unsecured secondary spreads Nordic benchmarks: covered versus ASW, senior unsecured (shaded) versus Z spreads, 8/10/14. ISIN Coupon Maturity Mid Spd AKTIA (*AKTIA REMB) XS0640889803* 3.125 22/06/2016 -7 XS0946639381 1.125 25/06/2018 -5 XS1056447797 1.000 15/04/2019 -4 BRF XS0882166282 2.500 31/01/2018 61 DANBNK XS1113212721 0.375 26/08/2019 -3 XS0469000144 4.125 26/11/2019 -8 XS1071388117 1.250 11/06/2021 0 XS0519458755 3.750 23/06/2022 3 XS0802067636 2.500 09/07/2015 5 XS0627692204 3.875 18/05/2016 9 XS0751166835 3.875 28/02/2017 16 DNBNO XS0728790402 2.375 11/04/2017 -15 XS0877571884 1.00 22/01/2018 -9 XS0992304369 1.13 12/11/2018 -8 XS0794233865 1.88 18/06/2019 -6 XS1117515871 0.38 07/10/2019 -6 XS0637846725 3.875 16/06/2021 0 XS0759310930 2.75 21/03/2022 1 XS0856976682 1.88 21/11/2022 1 XS0522030310 3.875 29/06/2020 28 XS0595092098 4.375 24/02/2021 36 XS0732513972 4.25 18/01/2022 39 EIKBOL XS0736417642 2.250 25/01/2017 -7 XS0851683473 1.250 06/11/2017 -8 XS0794570944 2.000 19/06/2019 -1 XS1044766191 1.500 12/03/2021 2 JYBC XS0856532618 3mE+110bp 20/05/2015 12 XS1078186001 3mE+50bp 19/06/2017 30 LANSBK XS0926822189 1.125 07/05/2020 -2 MINGNO XS0893363258 2.125 21/02/2018 29 XS1069518451 1.500 20/05/2019 39 NDASS XS0478492415 3.500 18/01/2017 -16 XS0731649660 2.375 17/07/2017 -14 XS0965104978 1.375 20/08/2018 -12 XS1014673849 1.250 14/01/2019 -9 XS0778465228 2.250 03/05/2019 -8 XS0874351728 1.375 15/01/2020 -6 XS0591428445 4.000 10/02/2021 -3 XS0801636571 2.250 05/10/2017 15 XS0916242497 1.375 12/04/2018 12 XS0728763938 4.000 11/07/2019 20 XS0520755488 4.000 29/06/2020 30 XS1032997568 2.000 17/02/2021 40 XS0801636902 3.250 05/07/2022 32 NYKRE (*senior secured) LU0787776052* 3.250 01/06/2017 40 LU0921853205* 1.750 02/05/2018 40 LU0996352158* 1.750 28/01/2019 45 Source: Crédit Agricole CIB Trading, Bloomberg — See disclaimer on page 7 Page 6 ISIN POHBK XS0785351213 XS0646202407 XS1076088001 XS1045726699 XS0758309396 XS0540216669 XS0931144009 XS1077588017 XS1040272533 SAMBNK XS0693226978 XS0834714254 XS0640463062 SBAB XS1117542412 XS0968885623 SEB XS0548881555 XS0894500981 XS0988357090 XS0614401197 XS0628653007 XS0730498143 XS0592695000 XS0972089568 XS0854425625 XS1033940740 SHBASS XS0760243328 XS0906516256 XS1050552006 XS0490111563 XS0732016596 XS0794225176 XS0965050197 XS0693812355 XS0819759571 SPABOL XS0495145657 XS0820929437 XS0738895373 XS0995022661 XS0942804351 XS0587952085 XS0674396782 SPAROG XS0853250271 XS0965489239 XS0876758664 XS1055536251 SWEDA XS0496542787 XS0925525510 XS1069674825 XS0768453101 XS0740788699 XS1045283766 Coupon Maturity Mid Spd 1.625 3.500 0.750 1.500 2.625 3.000 1.250 1.125 2.000 23/05/2017 11/07/2018 11/06/2019 17/03/2021 20/03/2017 08/09/2017 14/05/2018 17/06/2019 03/03/2021 -15 -12 -6 -2 14 10 18 31 41 2.750 1.625 3.875 19/10/2016 27/09/2019 21/06/2021 -12 -6 3 0.625 2.375 07/10/2021 04/09/2020 -2 45 2.625 1.500 1.625 4.125 3.750 3.875 4.250 2.000 1.875 2.000 16/10/2017 25/02/2020 04/11/2020 07/04/2021 19/05/2016 12/04/2017 21/02/2018 18/03/2019 14/11/2019 19/02/2021 -13 -7 -5 -1 9 12 20 30 27 41 1.875 1.000 1.000 3.750 3.375 2.250 2.250 4.375 2.625 21/03/2017 19/06/2018 04/01/2019 24/02/2017 17/07/2017 14/06/2018 27/08/2020 20/10/2021 23/08/2022 -14 -10 -8 7 7 6 17 32 34 3.250 1.250 2.750 1.500 1.500 4.000 3.375 17/03/2017 28/02/2018 01/02/2019 20/01/2020 12/06/2020 03/02/2021 07/09/2021 -10 -10 -9 -3 -2 0 2 2.000 2.125 2.125 2.125 14/05/2018 27/02/2019 03/02/2020 14/04/2021 39 44 51 67 3.375 1.125 1.125 2.375 3.375 1.500 22/03/2017 07/05/2020 21/05/2021 04/04/2016 09/02/2017 18/03/2019 -17 -5 -4 6 17 29 Issue 99 Thursday, 9 October 2014 Disclaimer This material has been prepared by Crédit Agricole Corporate and Investment Bank or one of its affiliates (collectively “Crédit Agricole CIB”). 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