SocGen: the future of covered bonds

Author: Gemma Varriale | Published: 10 Jun 2014
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Ralf Grossmann is head of covered bond origination at Societe Generale in Frankfurt. He also chairs the European Covered Bond Council’s [ECBC’s] technical issues working group, a body that describes itself as the think tank of the covered bond community. In this frank interview, Grossmann reflects on the Council’s progress as it approaches its two year anniversary, as well as the importance of maintaining high standards in the face of a rapid evolution of covered bond structures, and why rating agencies need to rethink their treatment of aircraft covered bonds.

How would you gauge the success of the ECBC’s Covered Bond Label initiative?

The ECBC launched the label almost two years ago and, in that time it has been acknowledged by regulators and the market as a key initiative for increased harmonisation and transparency across the market.

The label gives the market access to a web-based platform that aggregates a wide variety of data on covered bond issuers. Investors can view information on specific issuers by means of individual transparency profiles. These profiles are presented in the form of standardised national templates that facilitate easy comparisons.

The ECBC is focussing on the national transparency templates because cross-border comparison is much less meaningful. [This is] because different countries operate under different mortgage lending frameworks and borrower preferences with regards to mortgage products and tenors vary between countries.

Moreover, the ECBC label helps to identify and ring-fence classical covered bonds against new-style covered bonds. It says that only certain assets are eligible for inclusion in the cover pool and only covered bonds that comply with the Capital Requirements Directive IV [CRD IV] will qualify for the label.

What are your thoughts on the momentum towards financing non-mortgage assets with covered bond instruments?

Covered bonds do have an important role to play in financing non-mortgage assets. Europe has a lot of high credit quality lending, be that infrastructure or transport assets – even in the SME [small and medium size enterprise] space we can generate high quality portfolios. Those assets are a natural basis for funding via covered bonds.

Should these new structures be considered covered bonds? If not, how important is it that such new products remain distinct from each other?

The challenge is that the term 'covered bond’ is not registered or protected in any way, so any issuer can use it for their product. Therefore, issuers should comply with certain technical standards to make sure they design robust, safe products and get investors on board.

The idea is to bring covered bonds that use new assets in the cover pool as close as possible to the classical covered bond market in terms of security features. After that, it’s up to investors to decide whether they will invest or whether they would rather stick to the classic mortgage covered bonds.

In this respect, aircraft covered bonds are interesting. They do not benefit from privileged regulatory treatment, despite the fact that aircraft lending is a very safe business. Aircraft are high quality assets that have to be constantly updated with the latest technology. If an airline encounters financial difficulty, the leasing companies that typically own planes can just pass the asset on to somebody else.

"The ECBC label helps to identify and ring-fence classical covered bonds against new-style covered bonds"

Ultimately the credit performance of aircraft as an asset class is essentially linked to growth of the global economy - so long as airline traffic increases at a certain minimal level the asset class will perform. All this means that for the lender the risk is very low. Here, therefore, we have a good example of a high quality asset that could be used in the cover pool, but that isn’t very much in use yet.

One key problem is that European rating agencies haven’t yet developed models to properly evaluate the asset pools. As a result, covered bonds backed by airlines only get a small rating uplift over the senior unsecured rating of the issuer. If the product were evaluated properly, triple A ratings should be feasible.

What is your view of efforts to harmonise the covered bond product across Europe?

The European Banking Authority [EBA] is due to come up with a comparative overview on covered bonds which will outline the areas it believes are in need of harmonisation across Europe. My understanding is that supervision, transparency and post-insolvency administration are the main areas the EBA thinks need harmonising. The ECBC initiative has made great progress towards enhancing transparency in the industry, but the regulator will likely push for more.

On supervision, the EBA is likely to focus on cover pools. At the moment, the banking regulator conducts a highly technical analysis of the cover pool, but there are differences in how different countries address this topic. While some countries– such as the UK – are very advanced, others are just starting to build their technical expertise. I think European authorities will be looking to strengthen supervision and potentially introduce harmonised stress testing regimes.

More and more jurisdictions are enacting covered bond legislation. Where do you expect to be the most active jurisdictions for covered bond issuance in the coming years?

Europe, Canada, Australia and New Zealand have established covered bond frameworks and will continue to be the backbone of the market. When looking at newcomers, I see the most growth potential in Central and Eastern European countries, as well as Turkey. There is also good potential from the higher rated OECD [Organisation for Economic Cooperation and Development] countries, such as Korea and Singapore. Thirdly, I would say the Latin American market presents good opportunities. It is more heterogeneous as a region, but there are some highly rated countries.

Look out for IFLR’s Covered Bond Guide 2014, which will be published in the July/August issue of IFLR magazine

See also:

SME covered bonds’ dubious future

Momentum grows for EU covered bond regime

Commerzbank’s SME covered bond