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Overview

Spurred by the marked recovery in primary covered bond market activity in mid-2009, Spanish benchmark supply doubled to €17.3bn in 2009, from €8.8bn in 2008. Part of this development was due to the fact that as several smaller savings banks (cajas de ahorro) could access the market at relatively lower funding levels, they opted for an independent issuance of plain vanilla covered bonds instead of participating in pooled issues as before. In 2010, year-to-date issuance stood at €12bn at the time of writing. As a result of the recovery – which, however, has come to an abrupt halt of late because of spill-over effects arising from a pronounced volatility phase of government bonds’ swap spreads – the Spanish benchmark covered bond marked could defend its position as the world’s largest covered bond market in terms of volume. At the time of writing, the aggregate amount outstanding of mortgage and public sector backed Spanish benchmark covered bonds amounted to €263.5bn from 151 deals by 22 different issuers (Figure 214). In mid-May 2009, the market volume still stood at €251bn from 139 benchmark deals. The overall amount outstanding of the historically dominant jumbo Pfandbrief market, in comparison, further declined and stood at €215.6bn from 146 deals at the time of writing, down from €247bn from 159 issues in mid-May 2009.

Despite doubling from 2008 when issuance, overshadowed by the global financial crisis, had plummeted to €8.8bn and thus its lowest levels since 2001, the recovery to an issuance of €17.3bn in 2009 is still markedly lower than the average annual volumes in between 2003 and 2007, which oscillated between €32bn and €65bn. In 2010, we estimate issuance to increase to €25bn versus redemption payments of €23bn at the same time. In light of the high correlation between Spanish government and covered bonds and the recent weeks’ rollercoaster ride with regards to swap spread development, however, we expect issuance to remain subdued in the remainder of 2010. Overall, new issuance was strongly geared towards mortgage-backed covered bonds, which dominated 2009 supply. Following the sharp increase in debt issuance on behalf of Spanish Autonomous Communities, which, for some investors, provided a well suited alternative, it was not until March 2010 that the issuance of public sector backed covered-bond was revived.

Leef H Dierks +49 (0) 69 7161 1781 [email protected]

Figure 214: Outstanding Spanish covered bonds

a) Outstanding Spanish covered bonds b) Issuers’ market share, as at June 2010

0 100 200 300

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 0.0 0.5 1.0 1.5 2.0

Jumbo Covered Bonds outstanding (€ bn) (LS) Average size (€ bn) (RS) SANTAN 11% CAJAMM 9% BANEST 6% BANSAB 3% IMCEDI 5% POPSM 4% BBVASM 15% AYTCED 18% CAIXAB 11% Others 10% CEDTDA 8%

Overall, neither the pick-up in issuance nor the steadily increasing redemption payments have had a material impact on the market shares of Spanish covered bond issuers. As in the years before, the five largest players accounted for a combined 64% of the outstanding volume. Multi-Cédulas issuer AYTCED, Europe’s third-largest issuer with €48.2bn of covered bonds outstanding at the time of writing, accounted for 18% of all volume outstanding, up from 17% in mid-May 2009, followed by BBVASM (15%, up from 14% in mid-May 2009), CAIXAB 11% (down from 12% in mid-May 2009), CAJAMM (unchanged at 9%), and SANTAN (11%, up from 10% in mid-May 2009) (Figure 214). In other words, the (opportunistic) covered bond issuance on behalf of several smaller savings banks that joined the market in 2009, among them BILBIZ, UNICAJ and CAZAR, has so far failed to leave its mark on the market which, as before, remains dominated by the five major players previously outlined.

Following the ECB’s May 2009 announcement that it would acquire €60bn of “€- denominated covered bonds issued in the euro area” in the period between July 2009 and June 2010, swap spreads of covered bonds started markedly tightening. Owing to their relatively high sensitivity, Spanish covered bonds were among the papers that strongly benefitted from this development. By early October 2009, the iBoxx Euro Spain Covered Index had fallen to 90bp, from 200bp in early May 2009, and thus stood at the same levels as in September 2008. Given mounting concerns regarding the fiscal position of some Mediterranean rim sovereigns, however, by November 2009 the situation started to change again. Following the sharp and abrupt widening of Spanish government bonds swap- spreads in Q1 10, the swap spreads of respective covered bonds came under renewed pressure and sharply widened (Figure 215). In particular, longer-dated Spanish covered bonds were affected and traded at their historically widest levels (mid-swaps plus 225bp) in the days before the EU announced its €750bn rescue package.

Taking into consideration the marked swap-spread contraction of bonds issued by Mediterranean rim sovereigns in the aftermath of the EU’s announcement (Figure 216), swap spreads of Spanish covered bonds are likely to recover in the short term but, in our view, are unlikely to return to “pre-crisis” levels for the foreseeable future, particularly as the situation in the Spanish housing market so far has shown little signs of a broad-based recovery. In addition, the economic situation in Spain with an unemployment rate of 20%,

Swap spreads: Back to where we stood a year ago

Figure 215: Swap spread development on the Spanish covered bond markeT

a) Swap spread development b) iBoxx Euro Spain Covered

0 50 100 150 200 250

May-04 May-05 May-06 May-07 May-08 May-09 May-10 iBoxx Euro Spain Covered (Swap spread in bp)

50 100 150 200 250

Oct-08 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10

Spain Covered 1 to 3 years 3 to 5 years

5 to 7 years 7 to 10 years >10 years

Source: Barclays Capital

High correlation with spread development of sovereign debt

the steady increase in non-performing loans (NPLs), and the impact of the government’s recently announced austerity measures, as well as the consolidation of the country’s savings banks sector are adding to investors’ perception of a phase of elevated uncertainty. In light of the developments portrayed above, the once relative homogeneity of the Spanish covered bond market has dissipated. Whereas the swap-spread difference between plain vanilla and pooled covered bonds amounted to little more than 20bp in early 2008, it has since increased and amounted to 70bp at the time of writing. Pooled covered bonds, ie, the so-called Multi-Cédulas, have been particularly sensitive to the recent market distortions; a development which, in our view, is due to the fact that as many as 26 different savings banks can participate in selected Multi-Cédulas issues. These often are smaller-sized entities with a strong regional focus. Also, these lenders, among them many we expect to be affected by the consolidation process, often are geared towards (residential) mortgage lending and on several occasions feature sizeable exposures towards property developers. As of late, this strategic alignment has been reflected in steadily rising ratios of NPLs. Thus, irrespective of Multi-Cédulas per se being less exposed to potential risks regarding the geographical concentration of the collateral pool (as a result of the diversification across different non-benchmark covered bond issuers) and the additional protection provided by a liquidity facility, which helps bridge any possible delays in payments related to an issuer event of default, investors have remained distant.

Plain vanilla covered bonds issued by larger commercial banks trade at markedly tighter levels (130bp) than those of savings banks (165bp), for example. What is more, plain vanilla covered bonds from larger savings banks, with established (liquid) benchmark curves have on average, over the past few years, traded at significantly tighter levels than covered bonds issued by smaller savings banks which previously limited themselves to an issuance within the scope of pooled covered bonds. Also, the swap-spread difference between Spanish government debt and plain vanilla single-name covered bonds issued by major commercial banks has markedly contracted. On several occasions over the past year, investors could switch out of covered bonds and into sovereign debt with literally no give-up (Figure 217).

Figure 216: Correlation between Spanish sovereign debt and covered bonds

a) Swap spread development b) Correlation analysis, May 2008-May 2010

-50 0 50 100 150 200 250

May-08 Nov-08 May-09 Nov-09 May-10 iBoxx Euro Spain Covered iBoxx Euro Spain

y = 71.085Ln(x) - 302.31 R2 = 0.6321 -50 0 50 100 150 200 50 100 150 200 250

Covered bond swap spreads (bp)

B o n o s sw a p sp re a d s (b p )

Source: Barclays Capital (Note: light blue mark = 14 May 2010)