Cassa Depositi e Prestiti (CDP) is expected to launch its inaugural Italian covered bonds deal early next year, but it's unlikely to provide a satisfactory blueprint for Italian issuers who, for sometime, have been looking to edge into the European covered bonds arena.
"Although CDP is issuing a covered bond, it falls under an entirely different subject because CDP is a state-owned entity," explained Fabrizio Dotti, Financial Markets Lawyer at Simmons & Simmons. "It's regulated under a different set of laws that allow them to set up, something different."
CDP is an Italian financial institution 70% owned by the Italian Ministry of Economy and Finance. CDP said it intended to launch its 20 billion ($26.6 billion) program with a 2 billion issue that's been assigned a triple-A rating by Standard & Poor's. Little has been divulged about exactly how CDP intends to structure its transaction.
Some industry sources are speculating that, because the bank is state owned, it's likely that whatever structuring techniques are applied will then be brought forth to legislators, who will then bend the existing legal framework to accommodate this new deal. According to Fitch Ratings, CDP has been part of the state administration until the end of 2003 when it was privatized under Article 5 of Law Decree 269/2003, which also poses as the legal foundation for its covered bonds deal.
Under Article 5, CDP can segregate part of its assets (patrimonio separato) for the benefit of specified secured creditors by submitting a corporate resolution. The patrimonio separato can then not be amended unless the changes comply with the provisions of previous corporate resolutions and the Intercreditor Agreement continues to be effective after CDP's bankruptcy.
The bonds will be backed by segregated assets, and unlike other European covered bonds, the rights of the bondholders are exclusively referred to the segregated assets. In case of insolvency under the covered bonds, bondholders will have no claim against CDP. The portfolio backing the covered bonds issuance will consist of loans repayable or guaranteed by Italian regions, provinces or local authorities.
Potential issuers outside the public sector, however, might find regulators less cooperative on the matter. "At the moment, there is no specific law allowing other financial institutions to issue covered bonds," said Simmons & Simmons' Dotti. "Presently, banks are not particularly popular and the creation of legislation that is seen to allow banks some exemption to clawback laws might not be at the top of the legislators agenda."
The Italian RMBS market has already experienced a slowdown that could be linked to the expected opening of a covered bonds alternative. Researchers at Commerzbank said in its latest issue of its Covered Bonds Navigator that total RMBS issuance from Italy for 2003 and year-to-date 2004 was recorded at 9 billion and 6.7 billion, respectively. In the past, market sources have estimated a 200 billion potential in Italian covered bonds products.
A bill to introduce a specific covered bonds law was proposed two years ago, but it is more likely that financial institutions could find a safer harbor and a quicker solution under an amended Italian securitization law that would allow guarantees to be issued by the SPV set up to ring-fence the selected mortgage assets. "The Italian financial players are more likely to look at the securitization law and see what changes can be made to allow for these types of deals," said Dotti. "It ultimately seems to be the better solution because market participants are familiar with the securitization law."
One structure Italian institutions have considered is to sell the mortgage assets through an Irish entity. Because the assets are located in Italy, to a certain extent the Italian law would still affect the entity and thus create a legal difficulty with the use of the Irish law, added Dotti. However, people are still speaking of this possibility and evaluating what changes would need to be made to the current securitization framework to support such an option.
While securitization has allowed financial institutions to free up capital, it remains both a lengthy and expensive financing tool that would be well complimented by the more straightforward covered bond structure. "So far, Italian issuers have only gone down the true sale securitization route achieving some regulatory capital relief and risk transfer alongside funding," said researchers. "Under Basel II and International Financial Reporting Standards, it will be less favorable to use RMBS; therefore a shift in issuance towards covered bonds can be expected."
At the moment, however, the Italian Parliament may have its hands tied with more important issues, added Dotti, referring to the bill that proposes the establishment of a single financial regulator that would oversee all aspects of the Italian financial markets.
Further developments to U.K. law
The U.K. has quickly established itself as a covered bond hotbed, despite any specific legislation on covered bonds (see ASR 7/5/04), but a hesitant FSA has shadowed the development of the market with threats to impose limits on the use of structured covered bonds in an attempt to protect unsecured depositors in the event of a windup.
The FSA issued a private letter to the Council of Mortgage Lenders and the British Bankers Association stating that it had been "content for current issuers to issue bonds equating around 4% of total assets," according to reports. This would put many current issuers close to limits but analysts at the Royal Bank of Scotland reported that even with this soft ceiling imposed, as much as GBP92 billion ($177 billion) could still be expected via structured covered bonds.
The largest lenders - HBOs, Abbey National, Nationwide Building Society, Lloyds TSB and Barclays plc - with an combined market share estimated at 60% and totaling GBP775 billion residential mortgage loans outstanding at the end of 2003 - would not be able to fulfill all of the potential under the proposed limitations. "Based on our work on Basel II and the European Capital Directive, we assessed that regulators would have the final say over capital determination for member banks," reported RBS analysts. The proposed limitation should therefore be approached as something more malleable that will be assessed on a case-by-case analysis.
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