Michael Marray examines the Spanish covered bond market and reasons behind the recent boom in both issuance and investor appetite.
Spanish issuance of covered bonds (cedulas) grew rapidly to hit €32bn in 2004, making Spain the second biggest issuer, behind only Germany. Both forms – single name issuers, and groups of smaller banks combining to sell structured cedulas – are becoming increasingly popular with global investors. Such has been the growth in the market that, in January, the EuroMTS trading platform set up a dedicated Spanish trading platform for covered bonds. Covered bonds trading on the EuroCredit MTS platform need to be issued in amounts of more than €2bn, but the new dedicated platform will include smaller issues.
“The benchmark issues trade on EuroCredit MTS just as they did before, but now we also have the dedicated MTS Cedulas Market, where cedulas with an outstanding size of €1.5bn and above, and supported by a minimum of seven market makers, can be traded,” says Laurent Viteau, head of covered bonds at EuroMTS in London. “Some banks will only access one of the markets, while other banks will access both; but a bank with access to both will only use one single screen, and the same price they send will be simultaneously displayed on the two markets.”
Mr Viteau says that over the past 12 months there has been strong growth in trading volume in cedulas and that January was a record month with €3.08bn traded. “The new MTS Cedulas Market is adding to this growth by allowing us to list additional bonds, and also allowing additional domestic banks to access the market,” he says.
Liquidity is vital for covered bond investors, most of whom are traditional buyers of sovereign bonds. They are looking for a yield pickup over sovereigns and normally want fixed rate paper with bullet repayments. For these investors it is critical to be able to trade in and out of issues very quickly, with the tightest possible bid/ask spreads.
Domestic demand
The move into Spain by EuroMTS also illustrates the strong growth in the domestic investor base for cedulas, which used to be sold mainly abroad.
“When the covered bond market first started in 1999, the domestic investor base was very small, and perhaps only 5% of our primary market books were allocated to Spanish accounts, partly because they were unfamiliar with the covered bond product,” says Fernando Cuesta, head of funding at Caja Madrid. “But today 20%, and in some cases even 30%, of the primary market investors are coming from Spain, with pension funds, asset managers and banks all buying paper.”
Mr Cuesta says that it is helpful for any market to have a domestic investor base because it makes the secondary market more stable and less volatile. He adds that, while Caja Madrid itself does offerings sized at €2bn and above, the new MTS Cedulas Market in Spain will be helpful for those transactions with issuance volume below €2bn.
Caja Madrid has already done its first offering of cedulas for 2005, and the 20-year deal was a long maturity for the Spanish market. Demand during book building amounted to €6.3bn for the €2bn issue, which priced at mid-swaps plus 11bps. And another 20-year offering from La Caixa priced even tighter, at mid-swaps plus 10bps.
Smaller savings banks also have access to the market via structured cedulas. In this way, a number of institutions each structure cedulas with the same coupon and maturity and sell them to a special purpose vehicle (SPV), which then brings the deal to the market. Though pricing is the same as for single-name deals, the setting up of the SPV and structuring work adds a few basis points to issuers’ costs.
“Up to now, most structured Cedulas transactions have received credit support from a reserve fund, funded by a subordinated loan provided by the issuers,” says Jose de Leon, structured finance analyst at Moody’s Investors Service in Madrid.
“But we are now seeing deals with liquidity facilities that reduce the likelihood of interest payment shortfalls, and can either be provided by any party with a P1 rating [Prime 1, the top rating from Moody’s relating to short-term debt with a maturity of less than 13 months], which could be one of the issuers themselves or an external party,” Mr de Leon explains.
Moody’s rationale is that the high overcollateralisation in the Spanish market enables the use of liquidity lines as mechanisms to support Aaa ratings, rather than using line of credit or subordinated loans. However, a significant decrease in overcollateralisation figures or any substantial change in the issuer’s pool composition could impact negatively the ratings of the notes.
Nonetheless, liquidity facilities are less expensive for issuers than setting up a reserve fund, so more structured cedulas deals are expected to be done in this way. One such example was the IM Cedulas 4 offering, issued by 10 financial institutions in February.
Tighter spreads
In addition to cutting their structuring costs, Spanish banks are benefiting from a steady tightening of spreads in the cedulas market – because of growing global demand for covered bond products from investors such as central banks – giving them access to a very cheap source of funding.
There are other reasons for narrower spreads that are specific to the Spanish market. Spanish cedulas formerly suffered a disadvantage in that non-EU buyers were subject to withholding tax. But the country’s regulators recently relaxed the rules for countries with which Spain has taxation treaties, thus specifically excluding tax havens. This has opened the way for direct marketing of cedulas to important markets such as countries in Asia.
Funding sources
Cedulas can be backed by either public sector loans (Cedulas Territoriales) or mortgages (Cedulas Hipotecarias), but given the boom in the Spanish property market, it is the latter that dominates in volume.
The main alternative source of funding for bank mortgage originators is residential mortgage-backed securities (RMBS). Issuers see the two as complementary, since buyers of cedulas are very different to the specialised asset-backed securities (ABS) investor base. And with the housing market growing so strongly in Spain, there is plenty of collateral available for heavy issuance in both Cedulas Hipotecarias and RMBS.
“Cedulas are a very old established product in the context of the Spanish legal framework, and the quality of the assets has been shown to be very good,” says Antonio Torio, vice-president in the financial management department at Grupo Santander in Madrid.
“A growing number of investors are now buying cedulas and there has been a significant tightening of spreads over the past few years. There has also been a significant tightening of spreads on RMBS – though cedulas are still tighter than RMBS. Santander uses both types of instruments as an attractive source of funding and has a well established presence in both markets, which have distinct investor bases,” he adds.
Growth in Europe
The European RMBS market has also been characterised by strong growth on the buy side over the past two years and such is the investor appetite that, here too, spreads have tightened remarkably. Floating rate Triple A Spanish RMBS that two years ago launched at Euribor plus 27bps are now coming to market at 11bps to 13bps, depending on the quality of the portfolio.
Already in 2005 Spanish issuers have been taking advantage of extremely strong appetite for European RMBS: in February, for example, there was a €1.035bn RMBS offering from Bankinter. The €656m Triple A tranche, with a weighted average life of 6.37 years priced at Euribor plus 11bps.
During 2004, issuance of the structured variety of cedulas rose 49% to €18bn, catching up with RMBS, where issuance rose by 12% to €19bn.
FTPYME issuance
The third major ABS asset class was small and medium-sized enterprise (SME) loans transactions, which come under the name FTPYME. Here total issuance rose by 50% to €9.4bn. All the FTPYME issuance was concentrated in the final quarter because of the guarantee allocation process, which did not get under way until April and dragged on into the summer.
Cedulas issuance volumes are expected to continue growing in 2005, though at a much slower pace than seen in 2004. Conversely, the volume of FTPYME issuance is widely expected to fall during 2005.
The Spanish government has helped develop this market by partially guaranteeing these deals, and the 2004 budget set aside €1.8bn-worth of guarantees. Because the government does not want to see big increases in the total guaranteed amount outstanding – currently €5bn – that figure will be reduced to €600m this year.
Deterrent for some
“A number of issuers who only do FTPYME offerings for the guarantee will be deterred from coming to the market in 2005,” says Santiago Ruiz Morales, head of securitisation at Calyon in Madrid. “The guaranteed portion has been considerably reduced from about 70%-80% at the beginning, down to 18%-19% in the 2004 deals because of massive demand and limited allocation.
“However, some issuers will take the view that they want to do an SME deal anyway, so they might as well use the guarantee, even it is only a very small allocation,” Mr Ruiz Morales adds. There are bound to be some deals, even if total volume is unlikely to reach 2004 levels.
Nonetheless, bankers expect the Spanish cedulas and ABS markets to keep growing in coming years, backed by a booming housing market, and potential growth in other securitisation asset classes such as commercial mortgage-backed securities, auto loans and consumer loans.
