A high number of newcomers are currently making their covered bond debuts in rapid succession. From the U.K., Yorkshire BS and HSBC are readying the launch of their respective debut U.K. covered bonds programs. From Sweden, Swedish Nordea Hypotek and SCBC are also prepping parallel issues. But market analysts say that the covered bond issuance deluge should not pressure performance because demand for this paper remains sufficiently high, especially since it offers name diversification.
"Last year's example of Sampo and ABN Amro successfully launching their inaugural deals within the same week indicates that a cluster of newcomers does not necessarily burden performance," said Ted Packmohr, a research analyst at Dresdner Kleinwort Wasserstein. "Nevertheless, it has clearly become a buyers' market, and too ambitious a pricing target - even if only slightly so - can materially undermine a new issue's success. The upcoming newcomers should therefore adhere to the typical new entrant premium requested by investors."
Packmohr attributes the bundling of an unusually large number of issues to the expansion of the European mortgage market, issuers increasingly recognizing the covered bonds market as a funding tool and growing investor demand. According to a report published by Dresdner, records are coming thick and fast in terms of monthly new lending in the U.K. In August, (gross) lending totaled GBP32.7 billion ($61.7 billion), approximately 21% up on the year, beating the previous high reached last June.
There is no end in sight to this trend, Packmohr said. Dresdner equity analysts forecast total gross lending to amount to GBP315 billion this year, which will place volume ahead of last years' levels. "While the growth rate of the mortgage stock is likely to decrease over the coming years, the positive trend should remain intact," Packmohr said. "This supports banks' growth targets, but at the same time, also raises the need for more flexible funding structures. Against this background, covered bonds should naturally remain valuable funding instruments for U.K. banks. The fact that, with Yorkshire BS and HSBC, two new entrants have announced inaugural deals therefore comes as no great surprise."
Yorkshire BS is the fourth largest building society in the U.K. Its covered bond program size amounts to 7.5 billion ($9.4 billion). The structure used by Yorkshire BS is in line with the one other U.K. covered bond issuers already established. To prepare for the introduction of an E.U. compliant supervisory regime for covered bonds in the U.K., the program's documentation contains conversion language. This should ensure that the bonds can benefit from any advantageous regulatory framework when enacted.
The collateral will mainly comprise of U.K. prime residential mortgages. Yorkshire benefits from strong asset quality, which is reflected by the fact that the minimum over-collateralization required from Yorkshire BS for their covered bonds is lower than the level required from all other U.K. issuers, Dresdner analysts said. The maximum indexed LTV accounted for within the cover pool will be 75%, with a lower threshold for loans in arrears.
HSBC's inaugural deal planned for early November includes the addition of MBS as covered bond assets. "The structure is very similar to other U.K. programs and deliberately so," said Dominic Swan, a managing director at HSBC. When the program is finalized, the bank will transfer 15 billion of U.K. mortgages into an off balance sheet limited liability partnership. The LLP guarantees bonds issued directly by HSBC Bank plc, turning them into covered bonds. From a structural perspective, Swan said, the structure would employ a hard bullet maturity and not an extendable maturity that is similar to the HBOS program.
As for the MBS assets held in the LLP pool, these could be used to secure the covered bonds issue and separately support a distinct RMBS program, Swan explained. "We've entered the covered bonds market later than other people because at HSBC, we have more diverse senior unsecured funding," said Swan. He added, "But it is nice to have the option and going forward, in five to 10 years, covered bonds will be an important bank financing tool."
Dresdner's Packmohr said despite HSBC's presence as a much larger and better-rated company, he does not expect the two debut U.K. issues to significantly cannibalize each other in the market. In the U.S., Packmohr said, it is widely expected that other banks will follow the Washington Mutual precursor set earlier this year with its debut covered bond deal (ASR, 9/11/06). Most countries in Europe having already established covered bond legislation or which are in the final stages of establishing such legislation, so there is very little room left for expansion, Packmohr said. For instance, Italy has passed legislation and has now moved into the regulatory phase, which is currently under discussion. In Portugal, the secondary legislation was recently published, and Packmohr said an issue is expected to come to market by year-end.
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