Portugal's covered bond market is always going to be one of Europe's smaller ones — but the country's issuers are determined that it should be seen as perfectly formed. Legislation took years to come to fruition, but since Caixa Geral de Depósitos began issuing in November, investors have been able to try out for themselves what the Portuguese say is a state-of-the-art framework.
When Caixa Geral de Depósitos priced the first Portuguese covered bond, or obrigações hipotecárias, in November last year, market participants congratulated it on achieving pricing well inside its neighbours in Spain.
Lead managers Barclays Capital, CaixaBI, Nomura and Société Générale built a book of Eu6bn with price guidance in the 5bp area over mid-swaps. That enabled CGD to price a Eu2bn 10 year benchmark at 4bp over — 4bp inside where observers said a new cédulas hipotecarias issue in that maturity would have been priced.
However, that was not quite good enough for Filomena Oliveira, head of capital markets at state-owned CGD in Lisbon. While pleased with the pricing, she would prefer it to have been closer to the mid-swaps flat level achievable by similar credits in more established markets.
"We had from the very beginning the clear view that our transaction should be priced inside Spanish cédulas," she says. "The main question was how close we should be from Pfandbriefe and obligations foncières.
"These are of course better known and come from countries with stronger macroeconomic fundamentals, nevertheless I had believed that we could do better than the final 4bp price. However, I understand that this is the premium that investors demand for new issuers, and I would expect that in future we will not have to pay so much."
Oliveira's confidence is based mainly on what she sees as the strengths of the Portuguese legal framework. "The most important thing is that everything is very transparent and clearly described in the legislation, so that when an investor reads it there is no room for doubt," she says. "The segregation process, overcollateralisation, valuation procedures, etc are all made very clear.
"We have to report a lot of information to the central bank on a monthly basis and have an independent cover pool monitor, so there is a lot of oversight of the cover and bonds." Oliveira's analysis of the strengths of the legislation is supported by many observers in the market. "The legislation is based on the German, Irish and Finnish models, and as details are regulated rather strictly, it can be regarded as one of the most stringent laws," said analysts at Dresdner Kleinwort at the time of the issue.
A crucial funding instrument
Oliveira expects CGD to launch at least one benchmark deal this year. "We have not yet a final figure for our funding needs for 2007 or what part will be funded through covered bonds," she says. "But covered bonds will play a crucial role in the funding strategy of Caixa and will very likely be the most important funding instrument used this year and in the future.
"The reason is that more than 50% of our assets are mortgages, so covered bonds are an ideal instrument."
Before launching its covered bond, 73% of CGD's funding came from deposits (80% of which were from individuals); 10% from its Euro medium term note programme, 7% from the interbank market, 5% from Euro commercial paper and US commercial paper, and 5% from elsewhere.
As well as a second jumbo, CGD plans to begin issuing covered bond private placements from the second quarter of this year. "But we are not considering such highly structured issues as we have done on an unsecured basis," Oliveira adds, "and the minimum size that we will accept for a covered bond private placement will be higher, Eu25m-Eu50m."
Just how much CGD raises through covered bonds this year depends partly on its asset growth. "This will be dependent on credit growth in Portugal, which is in turn very dependent on the economy," says Oliveira. "Although we have not yet had very strong signs of recovery, the economy is picking up and we are optimistic about the rest of the year."
The Portuguese mortgage market, in which CGD originates 30% of gross new loans, grew by an estimated 18% to an outstanding stock of Eu94bn last year. While this means that the country will remain, in size terms at least, in the second tier of covered bond markets, further jumbo issuers are expected to emerge.
Banco Espírito Santo is said to be preparing its first transaction, but the arrival of Banco Comercial Português and Banco BPI in the market has been delayed by their merger.
As well as obrigações hipotecárias backed by mortgages, the Portuguese legislation allows banks to issue covered bonds backed by loans to the public sector, obrigações sobre o sector público. This, too, could be of interest to CGD.
"After the successful inauguration of the mortgage covered bond market, we may consider issuing covered bonds backed by public credits," says Oliveira. "It is not in our immediate plans and would involve setting up a separate programme, but we do have a significant public sector credit portfolio and are analysing the possibility."