U.K. regulatory body Financial Services Authorities said last week in a letter to the British Banker's Association that it will make decisions on covered bond issuance on a case-by-case basis and reiterated that the limit for banks will be roughly 20% of all assets. Regulators will also leave the risk weightings for these instruments at 20%.

The FSA said it realized that the refinancing advantages and greater liquidity that covered bonds offer exceeds the risk of individual depositors suffering losses. The FSA's previous position on covered bonds was contained in a letter to the British Bankers' Association last August, in which it warned that heavy covered bond issuance could lead to more strict capital requirements placed on banks by the FSA. In the letter, the FSA suggested that even 4% of a bank's total assets sold as covered bonds might be excessive. But a number of the U.K. banks, actively issuing these instruments - Abbey National, Bradford & Bingley, HBOS and Northern Rock all have programs - have long since passed the 4% threshold.

"The FSA said that many in the market had wrongly interpreted the previously mentioned number of 4% of total assets as a hard limit," said Dresdner Kleinwort Wasserstein analysts. "In fact, it was a threshold, above which the FSA views a U.K. issuer's covered bond issuance to be material enough to warrant entering into a dialogue with the bank or demanding additional information on its future issuance policy."

Most banks' individual capital requirements would probably need to be increased once the 20% mark is breached, the FSA reported in its update. Consequently, U.K. covered bond issuers should be assigned individual issuance limits between 4% and 20%, explained analysts.

The latest development should have a neutral impact on British covered bonds but indicates that the market will not dry up, added Commerzbank analysts. However, analysts at DrKW are a bit more optimistic and said that the FSA's clarified stance on the use of covered bonds should allow both established issuers and future newcomers to plan ahead with more certainty, which should have a positive effect on the development of the market. "With this year's primary-issuance volume approaching 5 billion (excluding HBOS social housing bonds), the U.K. segment has lagged behind expectations," said DrKW analysts. "Given that uncertainty has now been eliminated, issuance activity could, however, pick up."

(c) 2005 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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