Favorable regulatory treatment for the covered bond sector in Europe has spurred its growth. said panelists at the Global ABS 2011 conference held this week in Brussels.
This trend is demonstrated clearly by the numbers, while covered bonds have seen a sharp increase in volume, senior unsecured debt issuance has dipped significantly.
The same unfortunate story can be told of the European ABS/RMBS markets where regulations have prescribed higher capital treatment for these securities versus their cover counterparts.
Panelists discussed the reasons that might have caused this disparity. ABS/RMBS, according to the speakers, were given the “short end of the stick.”
David Kim, a director at Barclays Capital, said that structured finance has been cast in a negative light as the cause of the financial turmoil, which is ironic because the core ABS/RMBS performance has held up nicely during the crisis. It is only the “derivative types” of these products that have suffered, he said.
During the panel, a member of the audience pointed out that one of the problems is that even triple-A RMBS suffered during the crisis, and have not performed according to what the rating category represents. Additionally, and corollary to this, the audience member said that the covered bond market has a deeper investor base.
Another problem with securitized product, according to panelists, is that there have been no market-making agreements in the sector, which covered bonds have. Covered bonds are also homogenous and are simple or “plain vanilla”, which make them effective for market-making.
“There’s a utility to covered bonds, “ Kim said, noting that these are fixed-rate, bullet securities. Meanwhile, the more complex ABS/RMBS involve trading for credit.
Panelists also mentioned that covered bond players have been more organized and cohesive in terms of lobbying regulators for the benefit of the sector, while there has not been the same concerted effort on the ABS/RMBS front. It helps, panelists said, that organizations such as the European Covered Bond Council have promoted the sector.
Aside from these, four of the largest economies in the Eurosystem, Spain (the biggest issuer), France, Germany and Italy, are heavy users of covered bonds. Meanwhile, the biggest RMBS markets are the U.K. and the Netherlands; and the U.K. is not currently part of the Eurosystem.
Sharing the Same Pool
Another thing that’s getting bad press is the inclusion of RMBS in cover pools. Some of the speakers said that this would destroy the “vanilla appeal” of covered bonds.
“I struggle to see the advantage,” Leef Dierks, head of covered bond and SSA strategy at Morgan Stanley. “Why not just do it directly?”
An investor in the audience said that this would not work for her because the investment guidelines that she uses for each sector are different, and she will not be able to “put them in any of my portfolios and rewriting guidelines is not fun.”
Kim said that what people are failing to distinguish between self-originated RMBS and those that are not. He added that by including RMBS in cover pools, you’re actually adding to the security of the covered bonds not only because of the RMBS’ triple-A rating but also because of the credit enhancement and overcollateralization, which ihas been steadily increasing, in these securities.
Another advantage is these mortgages are repo-eligible and in distressed situations can be subjected to a workout.