Using the German pfandbriefe market as an analogy, analysts are predicting that the takeoff of the new Irish covered bond market will have minimal effect on the level of RMBS securitizations from that country, mainly because of the different nature of asset eligibility requirements in the Irish laws.
"If you look at Germany there is a healthy pfandbriefe market but there is also a healthy RMBS market," explains one market analyst. "What you see in the securitization market are mortgages above 60% loan-to-value, because up to 60% they are eligible for the pfandbriefe but above that they are more suitable for securitizations. There is no reason why this would not happen in the Irish market."
But such mathematics is precisely what might keep lenders from participating in the covered bond markets. The Irish draft legislation permits the allowance of LTVs in mortgage portfolios up to 75%, but such considerations are only a fraction of the dilemmas that mortgage lenders must contemplate before participating.
"There are two motivations behind the creation of this market," said one market analyst. "One is to create a level playing field for local banks and it's also an effort to arbitrage the German pfandbriefe legislation because there is more flexibility and it will be effectively a usable market for any continental European bank."
According to the Irish legislation, the location of the mortgage credit assets, public credit assets and substitution assets that make up the cover pools is limited to the Republic or Ireland, Switzerland and other G7 countries not in the European Economic Association (EEA), which includes the U.S., Japan, Canada, U.K., France, Germany and Italy. There is no concentration limit for EEA assets and there is a 15% cap for the assets from Switzerland or G7 countries not in the EEA. Additionally, the inclusion of commercial mortgages is limited to 10% of the pool.
The consensus is that the Irish covered bond market's creation was primarily driven by public sector interest. The first issuer is expected to be DePfa, who has been in Ireland since 1993 doing public sector business. With EURO40 billion of assets that will be eligible for an asset covered pool, bank officials say that all they are waiting for at the moment is for all regulations of the new Irish legislation to be passed by the Irish central bank, at which point the bank will establish a new designated credit institution to issue the public sector covered bonds.
"Everybody knew that the first issue that was going to come out of Ireland was going to be a public sector issue," said one market source. "It's not so much they rushed it but they were definitely the drivers for getting this legislation up and running. Some of the finer points that potential RMBS issuers would have liked to see included has been postponed to a certain extent."
One of those points is the possibility of including RMBS as part of the pool, which is currently not permitted under the asset eligibility guidelines. However, a provision in the Irish legislation practically leaves the door open for new suggestion that simply require an express order of approval.
Still, one of the more pressing issues now is perhaps the size of the Irish mortgage lenders. The European covered bond market has traditionally been driven by jumbo issuance and it's not clear whether Irish local lenders will have enough assets to participate. "My understanding is that at the moment the Irish banks are too small," said one analyst. "In the future I imagine it will be a useful tool but they are certainly not going to do anything this year." In terms of expectations going forward, sources estimate that at least 20% of total issuance will be backed by mortgages.
Mortgage lenders might consider banding together to amass the liquidity required. Some market sources suggest they take an approach similar to the Spanish cedulas cajas transactions, where typically 15 to 20 banks partcipate in the cover, which makes it more eligible for obtaining a higher rating. But Irish banks are generally bigger than the average Spanish lender participation in a cedulas transaction, said one analyst, adding that there are also fewer of these banks, which would take away from the diversity appeal of the Spanish cedulas.
"For the mortgage sector it will eventually be regarded as another source of funding," said a spokesman with the Irish Banker's Federation in Dublin. "They can continue doing SPVs and RMBS but with this market available they will have to do a cost analysis to determine which is better. And for some banks it may become a source of funding issue."