Covered bond volumes could see an increase in jumbo Euro issuance this year as many European jurisdictions move into the final phases of implementing specific legislation for these instruments or improve existing laws.
The effort to push through the secondary phase of legislation in Italy is under way. Market participants were hopeful that this necessary second step to enact the law might be ready by the end of 2005, but additional debate appears certain (ASR, 5/30/05).
"Italy already has its legislation framework in place. It's now moved into the regulation phase," said Ted Packmohr at Dresdner Kleinwort Wasserstein.
Alberto Nobili at Standard & Poor's said in a report published at the start of this year that the new law should be ready for implementation by the first quarter of 2006.
A key issue that worries market participants is the proposed limitations that are being discussed.
Potential issuers are hoping regulators reconsider issuing limits. Packmohr said some Italian banks are considering this market for issuance later this year.
It's much like the scenario that played out under the regulatory stance the Financial Services Authority took at the launch of the U.K. covered bonds market in 2003.
In the U.K. there is no specific covered bonds legislation in place. However, the FSA regulates the use of structured covered bonds. In an attempt to protect unsecured depositors, the FSA initially proposed that institutions be limited to issuing a maximum of 4% of their total assets.
The FSA plans to issue its finalized guidance by the fourth quarter of this year.
The motivation for Italian regulators has been the same. The concern is that if banks issue a significant amount of their covered assets, their depositors would be left with weaker assets in the event of insolvency. Italian regulators may propose a 5% limit for issuance from retail banks. Banks that do not take deposits would have no limit imposed.
But if Italy is to take the FSA's lead, it will look to incorporate more flexibility into any proposed limit in the legislation.
The FSA in February said it was looking to propose new notification thresholds between 4% and 20% of total assets. These notification thresholds are viewed primarily as triggers for discussions between the FSA and the issuing firm.
"The FSA no longer has that low fixed limit. It's been forwarded up to 20%, and this clears the way and provides a more certain environment for issuers looking to get into this market," Packmohr said. "Smaller issuers can count on not hitting this new FSA threshold."
The FSA now proposes that the 4% trigger be viewed as a monitoring phase, but didn't foresee this initial trigger would activate a change to a firm's individual capital ratio.
"The proposal suggested the 4% notification level and effective 20% maximum of total assets for full capital relief for the issuer," said Chris Greener at the Royal Bank of Scotland. "Over 20%, the issuer would be penalized using Pillar 2 [regulatory review] capital requirements."
The FSA is looking to move its regulatory stance to be more in line with a European-wide directive that dealt with covered bonds.
The FSA will recognize preferential risk weightings for covered bonds issued by banks. These bonds are currently weighted at 20%, but would be eligible for a risk weighting of 10% under the EU capital directive.
Starting in January 2007, European banks holding bonds issued by HBOS, Northern Rock, Bradford & Bingley, Abbey and Nationwide should benefit from lower risk weightings, thus eliminating one of the main disadvantages U.K. covered bonds have faced.
"Should [the FSA] finalize the guidance, [under Basel II] standardized approach bank investors would get a 10% risk weight instead of 20% when buying highly rated qualifying issues," Greener said. "Currently, outstanding issues may not qualify depending on the final criteria. For bank investors taking the [Internal Ratings Based] approach, there would be little difference. Capital is dependant on internal ratings assigned and calculated from probability of default and loss-given default."
Claudia Vortmueller at Commerzbank said as soon as the FSA made its announcement, U.K. covered bonds tightened close to German Pfandbriefe levels.
But these more favorable conditions for covered bonds that are being proposed are not likely to significantly threaten U.K. RMBS issuance going forward. Vortmueller said the securitization market is seeing issuers move to selling mostly highly rated triple-A' tranches. She expects issuers will issue as much as they can via the structured covered bond market and use the rest as RMBS.
"They would be looking at mortgages that have below a 60% or 75% LTV. The rest would be put into an RMBS transaction," Vortmueller said.
Portugal moved into the second phase of implementing its new covered bonds legislation and awaits its secondary legislation where many details will be modified and incorporated into the final regulatory framework.
According to Packmohr, the volume of the Portuguese residential real estate market is around 70 billion ($83.3 billion). Italy's potential is more than 350 billion ($417 billion). Jumbo issuance is still anticipated by the Portuguese state-owned Caixa Geral de Depositos, which is expected to issue its covered bond issue soon after the law is finalized.
Packmohr added that the Nordic region was also increasing its covered bonds potential. Sweden is in the process of changing its law, which will open the way for larger-volume, euro-denominated issues. Norway is in the pipeline for a large euro-denominated issue and the market could see some further potential from Finland.
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