EUROWEEK: Tell me about the pass-through
structure.
Vincent Hoarau, CA-CIB: In a pass-through, after an issuer event of default and after the maturity date of the relevant bond, or breach of amortisation test, incoming cashflows will be passed to covered bond creditors. The covered bond company of a pass-through structure will attempt to sell the mortgage pool but only if the bonds can be redeemed at par. This differs markedly from a soft-bullet structure where the pool has to be sold within the extension period, even if this results in a loss on the bonds. On the downside, investors of a pass-through structure could face a longer extension period compared to a soft bullet, but on the upside there is a greater probability they will be redeemed in full.
EUROWEEK: NIBC could be about to market a pass-through structure that will be a lot more stable from a rating perspective and could offer hope to weaker banks in the periphery, but at the end of the day it’s still the same mortgages and issuing entity. Do you think investors could be tempted?
Goldfischer, CA-CIB: Issuers will argue the structure is better protected against rating migration but investors will be worried about extension risk. So the real question will be to see if issuers and investors can meet in the middle in terms of pricing. CRD IV compliance will be the game-changer. If the structure complies then, from a capital point of view, it becomes a lot more attractive in an environment where we have people looking for yield.
Juhasz, World Bank: Pass-through structures will presumably be more immune from rating volatility, which is definitely good, but again I see this structure as a hybrid animal between ABS and covered bonds. We would definitely take a look, but there has to be a decent spread to compensate for the additional risk. The analytical framework will be different and that means the pricing should be different too.
Cortazar, BBVA AM: In the event a pass-through structure was presented to us, we would certainly look at it and try to assess where the right spread should be for this novel risk.
Burmeister, DeAWM: The pass-through helps issuers to reduce OC while at least keeping their ratings or possibly getting better ratings, so there’s some kind of rating arbitrage. It seems incongruous that the bond gets a better rating but may take years to fully repay. So therefore the pass-through structure is not something that I would welcome as I wouldn’t feel comfortable with the idea that I might not get my money until the debtors pay.
Hoarau, CA-CIB: Yet, I’m convinced that investors will accept pass-through covered bonds as long as issuers have the right marketing and pricing approach. Education will be key in the selling process. The pass-through offers two major advantages: limited risk of a disadvantageous fire sale of assets, in the event of the issuing bank’s insolvency and de-linkage from the bank rating. With more and more bonds on the cusp of junk, investors are getting increasingly rating sensitive, which makes this a key element.
Prokes, BlackRock: As an issuer you may start to question whether to do an RMBS instead of a pass-through covered bond. The issuer should do an RMBS and not try to sell the covered bond more expensively to investors that will probably be forced to sell it if the pass-through mechanism is triggered. If I can price it, I can buy it, but I disagree with the notion that you should be happy as a covered bond investor simply because they have a better rating.
Lavastre, CDC: As a covered bond and ABS portfolio manager, I can consider pass-through covered bonds backed by prime residential mortgage loans. We will not be surprised to see new pass-through covered bonds in the near future. But we must keep in mind that pricing of these new covered bond structures, while potentially attractive for weaker names, must be reflected in the spread paid to the investor.
Hoarau, CA-CIB: I’m convinced that with some education, experience and a bit of spread premium investors will be won over. When Crédit Agricole helped to sell the Commerzbank SME covered bond, the pass-through element was not an obstacle.
When soft-bullet structures were introduced years ago many investors were reluctant to buy them, but today it’s barely taken into account in the investment decision process.
Prokes, BlackRock: I will need to be paid for the fact that I’m to take on the liability management risk of the issuer. Frankly it doesn’t give me any more peace at night that something is rated triple-A just because it’s now a pass-through, when before it was rated only double-A minus. I hold the same collateral and I hold the same issuer credit risk so what’s the benefit?
Hoarau, CA-CIB: In the end, the credit profile of the bank sponsor, the quality of the underlying assets, and the legal framework are going to be the decisive factors — not the structure of the maturity. NIBC’s structured conditional pass-through programme will very likely be the first to test the water later this year.
Prokes, BlackRock: I’m not opposing the idea. Having the right investor base for this type of product can be very beneficial. I quite like the idea that I can do more work on monitoring my cashflow and I’m not stuck in a bullet bond. But I’m also going to be demanding more spread for buying this compared to a hard or soft bullet bond from the same issuer.
Denger, MEAG: I never say ‘never’, but honestly I guess it is more a pure rating benefit for issuers rather than something covered bond investors really need. I guess soft bullets have been more or less accepted and given some rating relief.
Prokes, BlackRock: Pass-through is not a bad idea but it is being brought into the covered bond market for rating reasons. I don’t have a problem with a covered bond that morphs into pass-through on an issuer’s default, I just have to be paid for it. My concern is that it takes away some of the regulatory support, because it is almost impossible to call an event of default as the structure ensures there is virtually no asset-liability mismatch.
A good 80%-90% of traditional covered bond investors cannot hold RMBS. So they will have to sell the bonds in the event of an issuer’s default, which means potentially greater mark-to-market price pressure for these structures under stressed market conditions, so where is the benefit?