"This is a product that has been traditionally placed among retail investors in Spain, but it is a new product for the institutional investor market," says Pedro Urresti, JP Morgan's capital markets director for Spain and Portugal. "The reason this product hasn't been launched until now is that cédulas hipotecarias have to be denominated in domestic currency. "In the past, the Spanish peseta market was very narrow, and the institutional investor base was relatively small, so there was not much demand. Now, with the euro, the domestic currency for bond issuance, Spain can tap the entire euro market. Every financial institution in Spain holding a mortgage portfolio is going to consider this product."
Carlos López Jall, debt capital markets director at Salomon Smith Barney, says there was a major change in Spanish legislation at the beginning of this year regarding tax treatment for institutional investors. "Bonds listed domestically no longer attract a 25 per cent withholding tax for domestic institutional investors," he says. "To some extent this was done to protect the domestic market and encourage companies to issue domestically. As a result, there has been a big increase in issurance in the senior debt market by big corporates such as Endesa and Telefónica, which are issuing domestic bonds in euros."
The inaugural transaction of this new Pfandbrief-type mortgage-backed asset was launched earlier this year by Argentaria, Spain's third-biggest bank until its recent merger with Banco Bilbao Vizcaya (The Banker, 10/99, page 38). There was a second wave in the autumn when Argentaria came back with a second issue. This was swiftly followed by Banco Bilbao Vizcaya (BBV), Spain's second largest bank, and savings bank Caja Madrid, both of which also tapped the market with quite sizeable transactions.
The market has taken the view that while some elements of the pricing in the recent issues off the mark in a very volatile environment, the situation has now settled down to a level where customers are taking an interest in this instrument, which has sold quite well because of the yield pick-ups. Argentaria's first issue was a e1.5bn ($1.5bn) five-year transaction at 8 basis points over the German jumbo Pfandbrief. BBV and Caja Madrid launched e1bn 10-year transactions at 6bp to 8bp over Pfandbrief.
However, Argentaria's inaugural transaction got the new market off to a sticky start. The problem was that the issue failed to replicate the Pfandbrief when the bank marketed it to its clients. A Madrid-based banker says: "It had only Goldman Sachs as lead manager instead of the usual four or five banks, and it had no market-making commitment, so there was no guaranteed liquidity. It didn't help Argentaria's efforts to continue issuing and gave a bad name to the Jumbo CH concept."
Bankers say the pricing was also off, because the deal came in at about Euribor +5bp for an AA1-rated 10-year issue. As this was the first issue, there was no reference for the market, so it was perceived to be extremely tight and seemed far too aggressive for an inaugural deal. BBV's issue was lead managed by Deutsche Bank, Dresdner Bank, ABN Amro, France's CDC and BBV's investment banking arm itself, with each underwriting 20% of the issue.
"This enabled us to give the issue a pan-European flavour and our roadshow hit Frankfurt, Holland and France," says Juan Urquiola, BBV's capital funding manager at BBV. "We wanted names in the syndicate that were well acquainted with the Pfandbriefe market, and this also guaranteed the issue a high level of liquidity."
Caja Madrid's issue had a broad European spectrum of lead managers, which included Société Générale, Hypobank, DG Bank and Commerzbank. BBV's Mr Urquiola adds: "We felt it would be useful to reactivate this market and give it more depth. In the past it was directed at the retail investor, volumes were low, maturities were short and there was a lack of liquidity. The CH market took off on the back of the Pfandbriefe mortgage issuance that has been gathering momentum in Europe. The advent of the euro allows us to attract foreign investors to the Spanish market, giving more depth to the CH. Our bond was rated triple-AAA, and this allows us to issue in large volumes while the investor can diversify his risks."
The second wave of CH transactions has been much more successful as the product has been well publicised in the market. There is also a good follow-up in terms of market-making activities from the banks involved in selling these securities.
Mr Urresti says: "After this inaugural effort by major Spanish banks, we believe this market will grow in size along the lines of the product launched in the French and Luxembourg markets. I think most financial institutions with a mortgage portfolio in Spain will consider cédulas hipotecarias as an alternative source of funding. It is going to be a very successful product. After all, how many double- and triple-A-rated liquid bonds can you find paying a spread of about 40bp over the benchmark?"
The Jumbo CH is likely to attract the interest of most Spanish financial institutions holding a mortgage portfolio. Until the early 1990s, Spanish banks were not big players in the mortgage market, as the mortgage portfolio was not considered a strategic product until after 1993. The Jumbo CH has become a tool that allows the bank to cover this new business segment, and it is a new source of financing for the savings banks that represent about half of the Spanish financial system.
The main consideration for the banks is the degree of saving they can obtain compared with senior unsecured borrowing. The CH market is small now that bankers are confident of its ability for significant growth, as it represents a cheaper source of financing for the issuing banks. "Argentaria's first issue is trading at around 7bp to 8bp over Euribor," says Vince Staniforth, associate director of interest rates at Warburg Dillon Read. "If they were to do senior unsubordinated debt financing, they might get somewhere in the 20bp range. The attraction for the investor is the yield pick-up. You've got a similar structure to the Pfandbrief and, as long as you appreciate that it is not identical to a Jumbo and you treat it as a slightly weaker credit, you have got a 5bp-to-10bp pick-up in a liquid instrument."
Salomon's Mr López Jall agrees that the CHs are an attractive funding instrument for the banks. He says: "The CH offers an issuer a considerable savings on the cost of funding. For example, Argentaria's first bond was launched at about Euribor +5bp, while a 10-year senior bond with a double-A rating could be paying at least 35bp to 40bp over Euribor."
Mr López Jall says that from an investor's viewpoint, the attraction of the CH is the spread. "The CHs offer a spread of 5bp to 10bp above the Pfandbrief yield," he says. "The premium you pay is in the rating of the bonds. The Pfandbriefe are all triple-A-rated, while only some of the CHs enjoy this rating. Argentaria's bonds were rated AA1, while those issued by BBV and Caja Madrid were assigned triple-A ratings, two notches above senior rating, based on the bonds' collateralisation. For investors, the differentiation is in terms of the market-making commitment of the underwriters, and the liquidity."
There are several distinctions between the German Pfandbriefe and Spanish CH jumbos, although in essence they similar. One difference is that in a Pfandbrief there is a segregation of the portfolio backing up the bonds, while in the case of the CH there is none, so it is a fully on-balance sheet transaction. Only retail and savings banks with a mortgage portfolio can issue CHs, to the extent that these are bonds that have to be backed up by a portfolio that needs to be of an extremely high quality.
CHs are securities collateralised by mortgages and issued by banks domiciled in Spain. They are only backed by mortgages, not public lending such as Offentliche Pfandbrief, making them more like Hipotheken Pfandbrief. Unlike Germany or France, where the issuer has to be a special mortgage bank, in Spain they can be issued by general commercial banks and this, market participants say, has a slight weighting on their rating.
"The main difference is that CHs do not enjoy the first claim of assets on the underlying mortgages," says Warburg's Mr Staniforth. "Spanish banks have the ability to issue bonos hipotecarios and participaciones hipotecarias, which are debts that are senior to CHs. The CHs' collateral isn't stored in a separately segregated asset pool. They are obligations that give the holder a claim on the entire bank's mortgage assets, rather than specific assets, and that asset pool can be diluted. There is an inherent degree of over-collateralisation because the issuing bank cannot issue CHs with a value higher than 90 per cent of eligible mortgage loans."
The loan-to-value of qualifying mortgages can only be 70 per cent of the value of the commercial property and 80 per cent of the residential property. So 90 per cent of the eligible mortgage assets can be re-financed leading to 11 per cent over collateralisation. The loan-to-value ratio is used by banks in mortgage origination, since they do not fund for the entire value of the property being bought. There is an appraisal of the property and the loan is only worth that percentage that is funded by the bank. Collateral on CHs is governed by the Bank of Spain, unlike in Germany or France. In the event of bankruptcy, the parent bank has to be wound up for the CH holders to get their money because the assets are part of the bank's general assets.
In German and French mortgage banks it is assumed that the asset pool is sufficient to cover the continuing payments and debenture maturity of the bonds. Under Spanish legislation, in the event of liquidation holders of CHs have first claim on the bank's entire mortgage portfolio. There is some concern over the vagaries of Spanish legislation covering the CH market.
"It is difficult to get a legal definition of a new credit, which is what the CH is," says a bond trader. "The legislation covering the CH market could do with some clarification and tightening up of some of the collateral aspects of the issues in order to boost investor confidence."
In the German and French systems the segregated assets because they are matched maturities are sufficient to pay the coupons on the outstanding maturity of the bonds plus the final principal. So, in theory, what should happen in the event of default of a Pfandbrief is that the issuing bank gets wound up and the secured bonds continue to have a timely payment coupon and a final payment of the principal, leaving the final winding up of the mortgage bank until the redemption of the longest dated Jumbo.
"The fact that the assets are not segregated is a weak point from a legislative point of view, but a strong point is that the bonds are backed by the bank's entire asset pool," says BBV's Mr Urquiola. "Generally speaking, European investors are not that well informed on Spanish legislation."
Spanish issuers have only recently cottoned on to the success of the Jumbo Pfandbriefe market, as traditionally this has been a domestic Spanish market geared to the retail investor. They have now seen the pan-European appeal of Jumbos and have decided to try to issue something similar, which is how this year's four issues came about. Warburg's Mr Staniforth believes the smaller Spanish banks might possibly enter the CH ma
rket with one or two issues. "There is a question of whether their names are well known enough and whether they could find enough takers for the distribution of their paper," he says. "The profile of smaller Spanish banks is not that well known in the international capital markets. Once people get comfortable with the issuers, the CH market is likely to spread. This will help to raise the banks' international profile as issuers."
There is little doubt, however, that the leading banks are determined to make full use of this new market to bring down their funding costs. "We are waiting to see how the market looks in the early part of next year,with a view to possibly issuing again in the first quarter," says BBV's Mr Urquiola. Salomon's Mr López Jall is confident the banks are looking at further issuance next year to take advantage of their large mortgage portfolios.
"Caja Madrid has a big programme in the works," he says. "If the market allows, they could raise up to e5bn next year in CHs. Some of the smaller banks are looking at the CH market and these are mainly the savings banks. La Caixa is also considering the CH as an alternative source of funding, and it could come to the market by the end of the year."
