Covered bonds have been a crucial funding source for Spanish banks in recent years. But following a surge in supply in late 2007, the cupboard of Spanish cédulas has been bare. Oversupply has often been the products problem, but Spain had made big efforts to moderate this and with updates to the domestic covered bond framework Spanish issuers were on track to improve their profile. In difficult market conditions, will this be enough to bring issuers back to market?
The surge in cédulas supply to some 30% of outstanding jumbo covered bond issuance at the end of 2007 has not come without a price. But if the spreads demanded for cédulas hipotecarias in recent years looked punitive, the treatment of cédulas hipotecarias issuers in 2008 has been even harsher.
At the time of going to press, no Spanish benchmark covered bond had hit the market for more than four months. The last such transaction was the Eu1.05bn two year IM Cédulas issue in mid-November.
Since then a new issue for AyT Cédulas Cajas was discussed in November, BankInter came very close to launching its debut cédulas in January, and other Spanish issuers have been seeking opportunities behind the scenes. But to no avail.
And with capital markets set to remain difficult for the foreseeable future, observers have begun slashing their forecasts of Spanish benchmark supply in 2008. Analysts at Barclays Capital, for example, cut their forecast for Spain from Eu35bn to Eu10bn at the end of February, alongside a cut in UK supply expectations from Eu15bn to Eu7bn.Cédulas have been among the worst victims of the "hot potato" trade among market-makers (see market-making section in the Overview chapter for further details), which have pushed already wide spread levels wider still, scaring off investors. This has been particularly true of long dated Spanish paper, where the offloading of small tickets has resulted in spreads quickly ballooning.
Spanish covered bonds were also for the most part caught on the wrong side of the 20bp dividing line recommended by the European Covered Bond Councils eight-to-eight committee in January, a move that was condemned by some cédulas issuers."It is a way of going back to the core/non-core type of approach," Alejandro Sánchez-Pedreño, managing director, capital markets, at Ahorro Corporación Financiera, which runs the AyT Cédulas Cajas programme, told The Cover. "Why 20bp and not 30bp? Or 10bp? It is basically saying that market-making is not working."
Spanish issues have also suffered disproportionately because of their weighting towards the long end of the curve, where spreads are naturally wider.
The fate of cédulas is all the more painful for Spanish issuers given the efforts they had been making to improve their profile in the covered bond market. Issuance ahead of the crisis was less crowded than in previous years, supply levels had been moderating, and spreads in the first half of 2007 had been grinding in to record tights.
Furthermore, the Spanish covered bond framework was being updated. It passed the Spanish parliament in November and the final touches were being put to secondary legislation as this special report was going to press.
Soledad Nuñez, director general of treasury and financial policy for the Kingdom of Spain, says that the changes to the framework should benefit both sides of the market. "What we wanted to do was to give more flexibility to the issuers... in order that they are able to compete on good terms with the rest of the European issuers," she says, "and to enhance the protection of the investor."
Cajas multi-cédulas hit hard
The pain has been felt most strongly by those savings banks raising funding through the pooled issuance of the AyT Cédulas Cajas, Cédulas TDA, IM Cédulas and, most recently, Pitch programmes. The spread difference between credits such as AyT Cédulas Cajas and individual banks like Banco Bilbao Vizcaya Argentaria has been as much as 25bp at times.
This is partly because these are among the largest issuers, but also because of concerns about the way in which the savings banks might be hit by the slowdown in Spain that everyone is expecting and some believe could be serious, even if most early indicators suggest it will be a soft landing.
Jose de Pablo López, head of capital markets division at Caixa Galicia, says that fears about the Spanish savings banks position are unfounded.
"Our sector is very well placed with regard to its liquidity position," he says. "The Bank of Spain and the European Central Bank have said that our liquidity positions are good enough."
Some analysts and parts of the press have repeatedly said that Spanish banks have become overly-reliant on the European Central Banks liquidity facilities, and that they are therefore in a vulnerable position.
Gorka Barrondo Agudín, chief financial officer, investment bank division, at Caja Castilla La Mancha, says that such talk is untrue.
"We are using the amount that corresponds to the size of the Spanish financial system within the euro-system."This is a proportion of around 10%, although it had been around 4%-5% before the crisis. However, Caixa Galicias de Pablo López points out that according to the Bank of Spain much of the extra borrowing is not from Spanish banks per se, but the Spanish arms of foreign banks that have Spanish banking licences.
The higher number of around 10% in November and December might have also been the result of extra borrowing from the Spanish savings banks, but only as a safeguard.
"We did go and get Eu100m from the ECB," says Pay Päben, head of investor relations at Caja de Ahorros Municipal de Burgos, "but the only reason was that at that time the situation had started to get crazy. We had far more liquidity than was necessary, but we just wanted to be on the safe side.
"In the end, we on-leant the liquidity. We havent used the ECB facility since then and we hadnt used it before the crisis."
Spanish banks point out that while many of them have issued large amounts of residential mortgage backed securities and cédulas hipotecarias that are ECB eligible, these are in most cases being retained in case such liquidity is needed. The volume of such transactions cannot, they say, be equated, as some observers have done, to the volumes of funding they are receiving from the ECB.
Spanish ready for the challenge
Savings banks also argue that they are comfortable with being able to live in a world where funding costs are higher. One Spanish issuer says that Spanish banks have been able to adapt from environments where 11% interest rate levels enabled them to achieve 8% net interest margins to a world of low interest rates where net interest margins have stabilised at around 2%.
"We will adapt," he says, "but we will protect our 200bp of spread."
Spanish banks in general should benefit from the growth in deposits in Spain, which have been keeping pace with loan growth in many cases. La Caixa, for example, in February reported that retail deposits grew 15.4% in its last financial year, faster than mortgage lending (13.9%).
This is partly the result of money coming out of funds and being moved into deposits, and Spanish banks are innovating deposit products that also offer exposure to, for example, equities, in a bid to get more funding.
Päben at Caja de Ahorros Municipal de Burgos also says that the savings banks are shoring up their defences ahead of the expected slowdown in the Spanish economy. This ranges from measures as practical as using telephone hotlines rather than the post to get in touch with borrowers who are in arrears, to increasing provisions.
Average coverage ratios in Spain are 298%, according to Nuñez at the Spanish treasury.
"The Bank of Spain, which is the supervisor of the Spanish banking system, is very strict, and makes the banks make provisions not only on defaulted loans, but also on expected losses on future loans," she says. "Thats the reason why the coverage ratio is so, so high.
"As you can imagine, banks have always complained about this. Now they are happy about it, because that is a very good picture we can shout about it."
Nuñez says that it is also partly thanks to the Bank of Spain that Spanish banks have been able to steer well clear of any direct hits from the subprime crisis and show healthy results for 2007.
"The Bank of Spain told the banks: if you want to invest in special purpose vehicles and all this kind of thing, you have to make provisions against it," she says. "So they were not incentivised [to do so].
"Spanish banks have hardly invested in the structured products linked to subprime mortgages and they do not have off balance sheet arrangements to provide liquidity lines to entities holding related structured products."
The other reason why Spanish banks have avoided problems, says Nuñez, has been the state of the Spanish economy.
"Spanish banks were facing a 20% increase every year of demand for credit, and if you are facing that you are busy trying to fulfil that demand," she says, "and then you are not interested in investing in products from abroad, because what you have to do is to fund those loans, and that was what the Spanish banks were doing. It is because of that they have been issuing cédulas and doing securitisation."
And should all the aforementioned safeguards and strengths come undone, observers familiar with the Spanish financial system believe that there will be one final solution that will allow the savings banks to avoid bankruptcy."No caja has ever gone bust," says José Sarafana, head of covered bond strategy at Société Générale. "Every time there has been a problem, the caja concerned has simply merged with another caja."Moodys gives credit for this implicit mutual support when rating cajas."
Assuaging investor concerns
However, according to Sarafana, the multi-cédulas structure causes some problems that have nothing to do with credit quality even if they are to do with credit approval. "Several covered bond investors do not invest in multi-issuer cédulas, because their credit department asks for a credit line for each issuer and this is too much effort," he says.
The result of this has been an increase in the number of savings banks that have issued on a standalone basis. Since the autumn issuers such as Caja de Ahorros del Mediterraneo have launched private placements, often of cédulas territoriales rather than cédulas hipotecarias, to top up their funding."We have done five or six cédulas private placements for Spanish banks and, unlike all the securitisation deals that are being retained, these are all being sold," says Pablo Llado, managing director, capital markets, Spain and Portugal, at Calyon. "They are being issued on a reverse enquiry basis to international investors who know the market well, do not have mark to market problems, and can now buy cédulas at levels that in the past they could only dream of." (For more on Caja Madrids move into Germanys registered covered bond market, see the Investor bases chapter on pages 18-19).
Meanwhile, if Spanish issuers can realise their dream and persuade investors of the strengths of their product and the way in which supply can be controlled, and the wider markets can calm down, issuance may not plumb the depths that now look possible."Should the first Spanish and UK issues in 2008, for example, prove to be successful," said Barclays analysts when revising their forecasts, "we might see several issuers trying to benefit from the respective window of opportunity, launching their covered bonds in the same period."