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Derivatives

Cajamar shows why a new rating approach is needed

The restructured Spanish bank Cajamar, which has grown its capital base and cleaned up its balance sheet, had its recently issued covered bond downgraded to junk this year by Moody’s. The rating action, which could potentially affect many other issuers, did not take into account the bond’s safety both from a regulatory and structural point of view and, writes Bill Thornhill, was out of sync with the other agencies.

In May this year the newly formed Spanish bank Cajamar made its debut in the capital markets, issuing what turned out to be a well received €500m three year Cédulas. 

However, the deal’s success was not always assured. The bank’s treasury team had its work cut out on the roadshow, not least because the issuer was, in effect, only seven months old, having been created out of the merger of Cajamar and Ruralcaja in November 2012. 

While the new group name is Cajas Rurales Unidas it continues to operate under the name of Cajamar on the high street and in the bond markets. 

The treasury team also had to explain what had happened to its balance sheet and capital ratios in recent months — in January 2013, Cajamar’s core tier one capital ratio stood at just over 9%, which was down from 13.42% six months earlier. 

The sharp fall was the result of the bank’s decision to write off bad loans and reclassify others as non-performing. “After the merger our capital ratios were down to accomplish the obligatory provisions established by the Spanish royal decrees,” says Miguel Angel Gadea, Cajamar’s head of funding.  

Things had improved somewhat by the roadshow and by the end of the first half of 2013 the issuer’s core tier one capital ratio had bounced back to 10.53%, mostly as a result of the bank’s co-operative base of partners stepping up and increasing their share of capital. 

The roadshow was also used to update investors on how the bank had become less dependent on wholesale funding, having managed to increase its deposit base last year by as much as €5bn to a total of €25bn.

And the issuer also made a special effort to tell investors about its cover pool, stressing in particular the high level of protection that this offered relative to other Cédulas programmes. According to Fitch, as of December 2012 the over-collateralization (OC) ratio of its mortgage pool stood at 208% based on the eligible and ineligible mortgage pool which investors can claim on. Based on the eligible mortgage pool, OC stood at 86% which was still more than double the 37% average for the Cédulas sector as a whole. 

Moreover, the underlying loans had an original weighted average loan to value ratio of just 59%. And, with a weighted average seasoning of nearly five years, investors had a good history of the creditworthiness of the underlying mortgage borrowers.

Moody’s makes its mark

Unfortunately Moody’s thought otherwise. The rating agency ignored these obvious strengths and on July 10 downgraded Cajamar’s bonds to junk, forcing investors to dump their holdings. Moody’s does not even publicly rate the bank at the issuer level and only rates its Cédulas which were moved from Baa2 to Ba2. 

The rating action was barely justified with the agency stating in a short note that, because the timely payment indicator was Improbable, it constrained the maximum achievable covered bond rating to Ba2. 

As a consequence of this action a good proportion of the 115 investors that bought the deal at launch breached their investment guidelines and became forced sellers. Ten weeks after the rating move, the bond’s spread had widened from its 290bp over mid-swaps launch level to above 400bp. 

In contrast Fitch still rates the borrower’s Cédulas at BBB and DBRS rates them at BBB (high). “We think that investors take DBRS’ rating as another opinion that reinforces the Fitch rating and confirms that Moody’s methodology should be updated,” says Gadea. 

Gadea is frustrated that Moody’s approach fails to take into account the fact that covered bonds are explicitly excluded from bank resolution regulatory proposals. He is also exasperated by the fact that the programme’s high level of OC was not taken into account by Moody’s. 

“Covered bonds are the most secure assets in the market but their rating is linked to the senior unsecured rating. We haven’t even got a senior unsecured rating with Moody’s even though they keep rating our covered bonds.” 

The harsh action shows just how vulnerable small European banks are to Moody’s rating approach, which would see one third of all the covered bond programmes it rates being downgraded if the issuer were to be downgraded.  

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