Reuters: Bankruptcy News: Trust fades in last bastion of bank funding

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Trust fades in last bastion of bank funding Jul 27th 2012, 13:28 Fri Jul 27, 2012 9:28am EDT * Covered bond haven losing lustre * Anxious investors getting pickier * Clarity needed to end bail-in worries By Aimee Donnellan LONDON, July 27 (IFR) - European investors are questioning the perceived safety of covered bonds amid bail-in discussions and sovereign volatility that are eroding the core fundamentals of the product. Since the crisis kicked off in 2009, covered bonds have achieved a kind of gold standard in the bank funding world. Triple A ratings, dual recourse and lashings of voluntary overcollateralisation gave investors comfort in buying debt from even the most troubled jurisdictions. But in the past few months that unconditional faith has been shaken. Jittery investors are now being even more selective in their investment decisions, avoiding peripheral Europe altogether, and even in some of Europe's core countries, the covered bond label is no longer holding sway. "We are getting back to the days where investors will increasingly only buy a covered bond from an institution where they are comfortable buying its senior debt," said Julia Hoggett, managing director, head of covered bond and FIG Flow Financing EMEA at Bank of America Merrill Lynch. Highlighting this shift in investor sentiment, of the 19 benchmark deals that have been sold in the euro market since the beginning of May, 18 originated from Nordic or German issuers. From peripheral Europe, there hasn't been a single Italian covered bond sold in 2012 and Spanish banks have been locked out of the market since April due to prohibitive funding costs. Marc Stacey, portfolio manager at Bluebay explained that there are many unknowns that are causing anxiety amongst investors. "Investment grade credit investors are more concerned about the probability of default and not the loss given default," "Covered bonds as an asset class have never experienced a default or wind-up scenario before so it's very hard to anticipate how a bank's insolvency proceedings would unfold and this creates a degree of uncertainty amongst potential investors," he said. The possibility of bail-in applying to voluntary overcollateral under the draft regarding the EU Resolution Regime raises questions of how banks' assets will be divvied up in the event of a default. Under the terms of the draft, covered bonds either have a full exemption or are treated as a normal secured liability with bail-in only possible if the market value of assets does not cover the secured liabilities. The latter could pose a problem if a bank fails to match assets with liabilities. According to Bernd Volk at Deutsche Bank, that is where the bail-in will become crucial. "Unfortunately, the draft is silent in this respect," he says. "In our view, eligible covered bonds will be fully exempt from bail-in. However, there is a risk that the respective national legislation transferring the EU directive into national law will not fully exempt eligible covered bonds from bail-in measures," Volk added. The general regulatory stance of Germany, France, Denmark and Sweden indicates that they are likely to make covered bonds exempt from bail-in measures. Moody's believes that in jurisdictions with long-established covered bond markets, it is unlikely that regulators would not take advantage of the option to safeguard the product. While Germany has a long-established framework, this is not the case for countries such as the UK and Italy, for example, where covered bonds are a 21st century product. Some bankers believe that newer jurisdictions might not be as quick to safeguard the product. The UK is one such jurisdiction where the regulator, the FSA, has failed to make any comment on the specifics of how covered bonds will be protected. And according to Volk, "Spain might be willing to exempt eligible covered bond but might have to recognise it doesn't have the financial strength to do so." In the past year, the majority of Spanish banks have become reliant on covered bonds as their only source of public funding, as the eurozone sovereign crisis has effectively shut all but the best out of the senior market. SOVEREIGN TRUMPS COVERED Although the prospect of bail-in is a concern, the majority of European investors are being driven by the ongoing sovereign volatility, and bankers say investors are having trouble focusing on anything other than restoring stability in Europe at the sovereign level. "I don't expect regulators to do anything, anytime soon," said Verbeek. "With all of the different issues they are firefighting on a sovereign level I'd say this is pretty far down the list of their priorities." However, the sovereign issues are having a noticeable impact in dividing the market into the haves and the have-nots and preventing banks in certain jurisdictions from accessing the public market. "The divides are becoming more palpable. The bail-in proposals, whilst not at the front of peoples' minds given the scale of the other concerns, focuses investors on fundamental strengths and therefore is likely to reinforce this divide," said BAML's Hoggett. Bankers say that in order for covered bonds to regain some of the support they have lost, specific statements need to be made by regulators about what will and won't be bailed in so that investors know where they stand. "The elevated status of covered bonds is still there. We're not at the stage where certain countries cannot issue in the public market at all and I think we need to get to a stage where investors are able to differentiate between the troubled banks and those that are located in a troubled jurisdiction," said Verbeek. (Reporting by Aimee Donnellan; Editing by Julian Baker) Link this Share this Digg this Email Reprints

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